Insider Trading

Insider trading means buying or selling securities while possessing unpublished price-sensitive information, commonly called UPSI. It can give certain people an unfair advantage over other investors.

• UPSI may include financial results, dividends, mergers, acquisitions, buybacks or changes in capital structure.
• Trading while possessing UPSI may violate the SEBI (Prohibition of Insider Trading) Regulations, 2015.
• Sharing UPSI with another person for trading purposes may also be prohibited.
• Insiders may trade legally when they do not possess UPSI and follow the required disclosure and compliance rules.

• Violations may lead to financial penalties, repayment of unlawful gains, market restrictions or imprisonment.

  
  
  

Insider trading refers to buying or selling a company’s securities while possessing material information that is not available to the public.
This unpublished information may affect the price of the securities when it becomes public. Using it for trading can give the person an unfair advantage over other investors.
Illegal insider trading is prohibited in India under the SEBI (Prohibition of Insider Trading) Regulations, 2015. These regulations aim to protect investors and maintain fairness in the securities market.
 

Insider trading may happen when someone uses confidential company information to make a trading decision. The process may involve the following steps:

• Accessing information: A director, employee, adviser or another connected person receives confidential information, such as financial results, a planned merger or a regulatory decision.
• Making a decision: The person decides whether to buy or sell securities based on how the information may affect their price.
• Executing the trade: The person trades directly or passes the information to another person who trades.

• Making a gain or avoiding a loss: When the information becomes public, the security price may change. The person may earn a profit or avoid a possible loss.

  
  

Using relatives, intermediaries or other accounts does not make such trading legal.

Insider trading can take different forms depending on how the information is received and used.

Legal insider trading

Legal insider trading happens when directors, employees or other company insiders trade without possessing UPSI and follow the applicable disclosure rules.

For example, an insider may trade during an allowed trading period after obtaining any required approval and making the necessary disclosures.

Illegal insider trading

Illegal insider trading happens when a person trades securities while possessing UPSI.

The person does not always need to be a director or employee. Anyone who receives UPSI and trades while possessing it may face regulatory action.

Tipper insider trading

Tipper insider trading occurs when a person shares UPSI with someone else who may use it for trading.

Sharing UPSI without a legitimate purpose, legal duty or authorised business reason may violate insider trading regulations.

Tippee insider trading

A tippee is a person who receives UPSI from an insider or another source and then trades using that information.

The tippee may face action when they knew, or should reasonably have known, that the information was confidential and price-sensitive.

Accidental insider trading

A person may trade without deliberately intending to misuse information but may still possess UPSI at the time of the trade.

Regulators examine the facts, available evidence and permitted defences. A lack of intention alone may not automatically make the trade lawful because SEBI regulations generally prohibit trading while possessing UPSI. 

Insider trading can negatively affect financial markets and investor confidence. Its effects may include:

• Giving certain people an unfair information advantage
• Reducing trust in the fairness and transparency of markets
• Affecting security prices before information becomes public
• Causing financial harm to investors who do not have the same information

• Weakening the fair flow of information in the market

  
  

When investors believe that markets favour people with private information, they may become less willing to participate.

SEBI regulates insider trading mainly through the SEBI (Prohibition of Insider Trading) Regulations, 2015.

The regulations apply to insiders, connected persons and people who possess or receive UPSI. A connected person may include someone who has a professional, employment, contractual or other relationship with a company and may reasonably have access to UPSI.

Depending on the circumstances, this may include:

• Directors and employees
• Immediate relatives of connected persons
• Holding, associate or subsidiary companies
• Intermediaries and their employees
• Stock exchange or clearing corporation officials
• Auditors, legal advisers and consultants
• Trustees and employees of mutual funds or asset management companies

• Bankers and other professional advisers

  
  

SEBI generally prohibits insiders from communicating, providing or allowing access to UPSI unless it is required for a legitimate purpose, performance of duties or discharge of legal obligations.

Insider trading in India is governed by the SEBI Act, 1992 and the SEBI (Prohibition of Insider Trading) Regulations, 2015. The earlier reference to Section 11(2)(e) of the Companies Act, 1956 is not the correct current legal basis for regulating insider trading.

The regulations are intended to:

• Prevent trading while possessing UPSI
• Restrict unauthorised sharing of UPSI
• Maintain fair access to important company information
• Require listed companies and intermediaries to establish codes of conduct

• Require applicable disclosures by promoters, directors and designated persons

  
  

Information that may be treated as UPSI includes:

• Financial results
• Dividends
• Changes in capital structure
• Mergers, demergers, acquisitions, delistings or business expansions
• Changes in key managerial personnel, other than those caused by normal retirement or completion of tenure
• Changes in ratings, excluding ESG ratings
• Fundraising proposals
• Agreements that may affect the management or control of a company

Whether information qualifies as UPSI depends on whether it is unpublished and likely to materially affect the price of the securities when made public.

India has seen several investigations and enforcement proceedings involving alleged insider trading. Some cases were settled without an admission or denial of the findings, while others were reviewed or overturned by courts.

Investigation involving a prominent investor

SEBI investigated transactions involving Rakesh Jhunjhunwala and other parties in the shares of Aptech Limited.

In July 2021, SEBI passed a settlement order involving Rakesh Jhunjhunwala and six other applicants. The matter was settled under SEBI’s settlement regulations without continuing the enforcement proceedings

Action involving jewellery firm leadership

SEBI initiated insider trading proceedings involving Balram Garg and other persons connected with PC Jeweller Limited.

However, in April 2022, the Supreme Court set aside the findings against the appellants after concluding that the evidence was insufficient to establish communication of UPSI and insider trading. The case therefore should not be presented as a final confirmed violation by Balram Garg.

Reliance Industries market manipulation case

SEBI took action against Reliance Industries Limited in relation to alleged manipulation involving Reliance Petroleum Limited derivatives.

This was a market manipulation matter rather than a confirmed insider trading case. Therefore, it should not be treated as a direct example of insider trading.

These cases show that insider trading investigations depend heavily on evidence connecting the person, the information and the trades.

The following fictional examples explain how insider trading may occur:

• A company director learns that the quarterly results will be significantly better than expected. The director buys shares before the results are announced and sells them after the share price rises.
• A researcher receives confidential information that a company’s drug trial has produced positive results. Before the results become public, the researcher purchases shares in the company.
• An employee learns that their company is about to be acquired. They share this information with a relative, who buys shares before the acquisition is announced.

In each example, a person uses or shares non-public, price-sensitive information for trading. Such conduct may violate insider trading laws.

Martha Stewart

Martha Stewart sold shares in ImClone Systems before the company announced negative regulatory news.

However, she was not convicted of insider trading or securities fraud. She was convicted of conspiracy, obstruction of justice and making false statements during the investigation. She received a prison sentence of five months, followed by home confinement.

Joseph Nacchio

Joseph Nacchio, the former chief executive officer of Qwest Communications, was convicted of insider trading.

He sold company shares while possessing non-public information about Qwest’s financial position. He was initially sentenced to six years in prison, with the sentence later adjusted.

Yoshiaki Murakami

Japanese investor Yoshiaki Murakami was prosecuted for trading shares after receiving undisclosed information about a planned tender offer involving Nippon Broadcasting System.

He was convicted under Japanese securities law and received a suspended prison sentence and financial penalties.

Raj Rajaratnam

Raj Rajaratnam, founder of the Galleon Group hedge fund, was convicted of conspiracy and securities fraud for trading using confidential information obtained from corporate insiders. He was sentenced to 11 years in prison.

Former Amazon employee

Former Amazon financial analyst Brett Kennedy was accused of giving confidential earnings information to a former college classmate in exchange for payment.

According to the U.S. Securities and Exchange Commission, the recipient traded before Amazon released its financial results and earned more than ₹1.11 crore ($116,000) in illegal profits.

The consequences of insider trading depend on the applicable law and the seriousness of the violation. They may include:

• Financial penalties: Regulators may impose monetary penalties based on the violation and the gains made or losses avoided.
• Disgorgement: A person may be ordered to return unlawful gains along with applicable interest.
• Market restrictions: SEBI may restrict a person from accessing or trading in the securities market.
• Civil action: Regulators may initiate proceedings for violating securities regulations.
• Criminal action: Serious violations may lead to prosecution and imprisonment where permitted by law.
• Professional consequences: Employees or directors may face suspension, dismissal or internal disciplinary action.

The exact penalty depends on the facts of the case and the relevant legal provisions.

Insider trading can harm the fairness and integrity of financial markets when people trade using unpublished price-sensitive information. It gives some participants an information advantage and may weaken investor confidence. SEBI regulates such activities through disclosure rules, trading restrictions and enforcement action. However, trades made by company insiders are not automatically illegal. They are permitted when the person does not possess UPSI and follows all applicable regulatory and company requirements.