Insider Trading And Its Effect On Indian Financial Market

Abstract:-

“Insider Trading generally means trading in the shares of a company by the persons who are in the management of the company or are close to them on the basis of undisclosed price sensitive information regarding the working of the company, which they possess but which is not available to others.”

Insider trading refers to the practice of purchasing or selling a publicly-traded company’s securities while in possession of material information that is not yet public information. Material information refers to any and all information that may result in a substantial impact on the decision of an investor regarding whether to buy or sell the security. Insider Trading highly affects market volatility. As far as an emerging economy market is concerned where the market is still immature, prices take time to adjust to information flow, and factors like speculation and insider trading leads to high market volatility. Insider trading affects the integrity of the investors as well as of the market. Insider Trading benefits only a certain person and the market is adversely affected due to it. It leads to investor exploitation. Insider trading also affects companies related to it. It is very necessary to stop insider trading. In India, insider trading is regulated by the Securities Exchange Board of Indi (SEBI). SEBI had framed various rules and regulations to curb insider trading. The person involved in inside trading are imposed with heavy penalties and punishment framed by SEBI. The transaction under insider trading is considered as null and void. Various measures and strict provisions have also been implemented to reduce insider trading.

I. Introduction: –

The practice of Insider Trading came into existence ever since the concept of trading of securities of a company became prevalent among investors worldwide and has now become a formidable challenge for investors all over the world. Insider Trading means buying or selling or dealing in the securities of a listed company by a director, officer, employee, relative above person or any other person, having knowledge of unpublished price sensitive information. Such information, had it been published, would have materially affected the price and worth of the securities of that company. In many countries, there is a debate about the merits of insider trading centers around the economic efficiency and morality dimensions. As per Indian Law, Insider trading is considered morally wrong and is persecuted as legally forbidden, since the usage of privileged information to gain profits causes in the loss of investors’ confidence to markets and leads to the serious asymmetric information problem.

Hypothetical Examples of Insider Trading :

• The CEO of a company divulges important information about the acquisition of his company to a friend who owns a substantial shareholding in the company. The friend acts upon the information and sells all his shares before the information is made public.
• A government employee acts upon his knowledge about a new regulation to be passed which will benefit a sugar-exporting firm and buys its shares before the regulation becomes public knowledge.

II. Scope Of The Paper:-

This paper shall explain:

• Insider trading
• Its effects on the Indian financial market
• Current regulations in place by the regulatory authority, viz. Securities and Exchange Board of India (SEBI).
• Punishment and penalties
• Measures to stop Insider Trading; viz Chinese wall and Restricted / Grey List.

III. Research Methodology:-

Background:

Over the years, most of the jurisdictions around the world have recognized the requirement to restrict insider trading in one form or other and accordingly put in place legal restrictions to this effect. The United States of America was the first country to formally enact legislation to regulate insider trading.

India was also not late in recognizing the detrimental impact of insider trading. The first Governmental effort to regulate insider trading was the formation of the Thomas Committee in 1947, which gave its recommendation in 1948. Thereafter in India provisions relating to Insider Trading were incorporated in the Companies Act, 1956 under Section 307 and 308. Later on, the Sachar Committee in 1979, the Patel Committee in 1986 and the Abid Hussain Committee in 1989 proposed recommendations for a separate statue regulating Insider Trading. Securities and Exchange Board of India (Prohibition of Insider Trading) Regulation was introduced in the year 1992.

SEBI (Prohibition of Insider Trading) Regulation Act :

Due to Inadequate provisions and regulations and the rapidly advancing Indian securities market needed a more comprehensive legislation to regulate the practice of Insider Trading, thus resulting in the year SEBI (Prohibition of Insider Trading) Regulations, 1992. Later on, the Act went under a series of minor amendments in the years 2002, 2003, 2008, 2009 and 2011. Based on the recommendations of Sodhi Committee, SEBI (Prohibition of Insider Trading), 2015 came into effect.

The Act clearly prohibits insider trading of any sort. It clearly specifies that insiders shall not themselves trade nor on behalf of another person, based on unpublished price sensitive information, nor shall they communicate or counsel other parties about any unpublished price sensitive information. The Board also has the authority to appoint a qualified auditor in case it finds a company suspicious of insider trading to investigate into the books of the company.

Also, a compliance officer of senior level has to be appointed by every company, who reports to the Chief Executive Officer (CEO) of the company. The compliance officer is responsible for preserving the price sensitive information till it is made public, setting rules and procedures in line with SEBI regulations, and monitoring the same.

Insider :

“Insider” means any person who is or was –

• a connected person – director, employee or officer of the company whether temporary or permanent
• deemed to be connected person – related to connected person
• in possession of unpublished price sensitive information.

Unpublished Price Sensitive Information :

“Unpublished Price sensitive Information” means any information which directly or indirectly relates to the company and is not published by the company and which if published is likely to materially affect the price of securities of company.

The following shall be deemed to be price sensitive information –

• periodical financial results of the company
• dividend
• issue of securities or buy-back of securities
• any major expansion plans or execution of new projects
• amalgamation, merger or takeovers
• any significant changes in policies, plans or operations of the company.

Punishment and penalties:

If someone is caught in the act of insider trading, he can either be sent to prison or charged with fine, or both. According to the SEBI, an insider trading conviction can result with imprisonment for a term which may extend to five years or with a penalty which shall not be less than five lakh rupees but which may extend to twenty-five crore rupees or three times the profit made out of the deal, whichever is higher.

Effects of Insider Trading :

• Integrity of the market will be damaged.
• Will benefit only specific persons.
• High Market Volatility.
• Investors would be robbed or exploited.
• Weakens the faith of investors
• Investors will be discouraged from trading
• Reduces the size of the market.
• The companies become inefficient and in the long run, their economic performance becomes very poor.

Measures to Stop Insider Trading :

1. Chinese Wall :

To prevent the misuse of confidential information, the organization/ firm shall adopt a “Chinese wall” Policy that separates those areas of organisation/ firm which routinely have access to confidential information from those areas which deal with sale/ marketing/ investment advice or other departments providing support services. The employees in the respective areas shall not communicate any price sensitive information to other areas.

2. Restricted/ Grey List :

In order to monitor Chinese wall procedure and trading in client securities based on price-sensitive information, the organization/ firm shall restrict trading in certain securities and designate such list a restricted/ grey list.

Insider Trading cases :

The above chart explains the number of insider trading cases per year from 1996 to 2015. In the above chart X axis indicates Year from 1996 to 2015 and Y indicates Number of cases on the range of 5 from 5 to 30. Blue color shows a number of investigations taken up by SEBI and Red shows number of investigations solved.

The number of cases increased from the year 1996 to 2001. In the year 1996 and 1997, there were no cases solved. SEBI started completing its investigation taken up from the year 1997. Cases started to fall from 2002 till 2007. A number of investigation taken up by SEBI again started to increase from 2008 till 2011. Cases started to fall from the year 2011. In the year 2008, 2009 and 2013 SEBI solved all the investigations taken up.

Samir Arora Case:

The case of Samir Arora v. SEBI was an important case in the evolution of insider trading laws in India. The case relates back to 2003 wherein Samir C. Arora, the fund manager of Alliance Capital Mutual Fund was alleged to be involved in Insider Trading transactions when he disposed off the entire scrip of Digital Global Soft (DGL) held by him on the basis of the alleged unpublished price sensitive information of the merger ratio of DGL with HPI (Hewlett Packard) . It was alleged that based on inside information, Samir Arora had first moved up the price of the scrip from Rs. 537.55 on 2nd May, 2003 to Rs. 597.25 on May 7, 2003 with certain statements made by him to the Business Standard on April 30, 2003 which was published on May 5, 2003 and then sold all the holdings of the funds managed by him over the next four trading days thereby averting a loss of about Rs. 23 crore to the Funds managed by him. The SEBI found that he was prima facie guilt of the offence of insider trading. SEBI passed orders debarring him from accessing the securities market for a period of five years. On an appeal to the SAT, after carefully analysing the contentions of both parties concluded that the price-sensitive information which Samir Arora was alleged to have accessed was not correct information because the merger was not in fact announced on May 12, 2003. It held that information that finally turns out to be false or at least uncertain cannot be labelled as information. Thus, it was concluded by the SAT that the sale of securities prior to the board meeting could only be considered to be based on Samir Arora’s analysis and assessment of the information available in the public domain.

IV. Conclusion:-

In short, insider trading is when one person acts on information that has not been released to the general public, giving a huge advantage against others in the market. Insider trading is one of the activities that cause a lot of problems to the securities market. Many other problems that are caused by insider trading include high rates of inflation, losing of investor confidence, and wrong prices for the stock market among other problems, companies that are affected by insider trading become inefficient. The transactions under insider trading are considered as null and void and strict penalties and punishment are levied upon such person. To ensure the stability and efficiency of the security markets and to stop insider trading, strict laws need to be implemented and followed. It is also important to curb insider trading otherwise it will not show the correct and fair prices of shares of each company.

V. Reference:-

Books

1. Fraud, manipulation and Insider Trading in the Indian Securities Market by Sandeep Parekh
2. Insider Trading by Armaan Patkar
3. Securities Law and Capital Market by ICSI

Websites :

1. www.wikipedia.org
2. www.india.com
3. www.google.com
4. www.sebi.gov.in
5. www.nseindia.com