Understanding Why Is Insider Trading Illegal In India: “Insider” refers to a term describing a director or senior officer of a publicly-traded company, and any person or entity, which beneficially owns over 10% of the company’s voting shares.

However, for purposes of insider trading, this definition has been expanded and it includes anyone who trades a company’s shares on the basis of material non-public knowledge.

Insiders are required to comply with strict disclosure requirements regarding selling or purchasing shares of their company. 

Insider – Definition

According to SEBI, an ‘insider’ is anyone who has access to price-related information about a particular company’s shares or securities.

Therefore, an insider includes anyone who has been associated with the company in some way during the 6 months preceding the insider trade. Sometimes such persons tend to use the information to their advantage as such information is not available to the public.

To prevent such acts and to promote fairness and equality in trading in the stock market for the interest of common investors, market regulator SEBI has framed several rules and regulations around insider trading. 

Insider trading has been categorized as one of the most serious malpractices which exist in today’s share market. Do you know what is insider trading? Why is insider trading illegal in India?

If not, this article will help to gain some knowledge about insider trading. Read on to find out!

Insider Trading – What Is It?

Before answering the question, why is insider trading illegal in India, let us first understand in detail what is insider trading. Insider trading means trading shares by an ‘insider’ on the basis of unpublished price-sensitive information (UPSI).

Insider trading consists of buying or selling shares of a listed company through the help of information that can significantly impact stock price and has not been yet made public. The critical words here include ‘insider’ and ‘UPSI’.

An insider can be a company director or employee or a close relative. Apart from these, insiders include a legal counsel or banker to the company or even a stock exchange official or trustees or employees of an AMC who continuously interact with the company. 

UPSI – Definition

Unpublished price-sensitive information includes (but is not restricted to) information that is associated with the company’s quarterly results, M&A deals, capacity expansion or shutdown plans, or any information which has not been disseminated to the general public.

Therefore, whenever insiders use UPSI to conduct trades, they can be questioned by the regulator. 

Example of Insider Trading

For example, a manager of a company tells his father about a positive announcement that is yet to be announced.

As a result, the latter passes this information to his friends who conduct trades to benefit from the initial price reaction whenever the news goes public. Then, the manager, his father, and his friends can be booked and questioned for violating insider trading norms.

Why Insider Trading Norms Are Required?

Insider trading tends to hurt the integrity of capital markets. In the share market, symmetric information levels the playing field. But, when someone engages in trading on UPSI, it gives insiders an unfair advantage over regular market investors.

Retail investors, who might have spent time and effort in selecting stocks for making investments, may end up losing the trade. If investors, both regular retail investors, and FIIs, suspect insider trading, they might lose faith in the country’s stock market.

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As a result, to strengthen retail participation in the share market and to make sure that confidence is maintained, insider trading should be dealt with firmly and in a strict manner.

Insider Trading – Why Is It Illegal In India?

In this topic, we will try to answer the basic question, “Why is insider trading illegal in India?” In most countries, illegal insider trading is banned and prohibited as they have made all such rules and practices criminalized.

Coming to the point, the main reasons behind considering insider trading illegal in India include unfairness for other investors, moral and ethically wrong, impacting the confidence of investors in the equity market, etc.  

  • Insider trading is regarded as significantly unfair to other investors in the share market because such investors do not have access to information about the company. Through insider trading, an investor might end up making more profits in comparison to the regular investor in the share market. 
  • Insider trading is a morally wrong practice and is considered an unethical way of trading in the stock market. Individuals believe that all investors are required to get equal opportunities to trade with the same piece of information which is available about the company. 
  • Insider trading in the stock market tends to impact people’s confidence in the trading/investing process. This is because if investors did not think that the market is fair, they might be less likely to enter the trading world and this might impact the market conditions. Trading in stocks by specific insiders to any company, such as employees, is commonly allowed as long as the trade does not rely on material information that is not available to the general public. Jurisdictions across the world think that such trading is reported and adequately monitored. 

To track the activity of insiders, regulators, such as SEBI, monitor and assess the trading activities in the market during critical events. Regulators make use of software scanners, artificial intelligence, and natural language processing tools to spot insider trading activities. 

Why Should Retail Investors Care?

If insiders exploit their knowledge and information to make profitable trades, then retail investors don’t stand a chance to make money in stock markets.

Therefore, all time and effort which are put into understanding and short-listing a company will be wasted. This is because insiders can come and participate in time to pocket all the gains as they have access to material information.

What are the consequences of insider trading in India? 

According to section 15G, If any individual is found guilty of insider trading, they will be liable to pay a penalty which will not be less than 10 Lakh rupees and can extend upto Rs. 25 crores or three times the amount of profits made through insider trading, whichever is higher.  

Also Read: Best Time To Buy Stocks During The Day – Intraday Trading!

Bottomline

The answer to the question, why is insider trading illegal in India, lies in the fact that regulators try to promote equal opportunities for trading.

Insider trading points to trading in a listed company with the help of a connected person. If the insider makes use of information that the general public is not aware of for his gain, it is illegal.

However, the presence of market watchdogs tends to help limit insider trading to a large extent as they keep an eye on such instances to take necessary actions. 

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