What is insider trading and why is it illegal?

Investors often seek out opportunities to trade stocks before they become public knowledge. This practice is called “insider trading.” Is it legal or unethical? In this article takes a look at what is Insider trading and why it is illegal.

What is Insider Trading? Insider Trading meaning

Insider trading refers to the act of buying or selling securities before they go public. This type of information sharing is usually done to benefit from price movements prior to the disclosure of important financial data.

Illegal insider trading arises when a person uses material, nonpublic information to make trades in securities. 

The person commits securities fraud if he or she buys or sells the security while in possession of the material, nonpublic information, and if the person knew or should have known that the information was material and nonpublic.

Insiders benefit from such knowledge because they have access to private corporate information before it becomes public. They can then use this information to gain an advantage over other investors. 

Insider trading has long been at the center of controversy, and some argue that certain regulations should not apply to them.

Insiders have a wide range of potential benefits and risks associated with their activities. Some insiders engage in stock manipulation, others simply sell before the release of negative information. 

However, the main risk is associated with insider traders who commit fraud. These individuals profit from their inside knowledge by using it to manipulate the markets and profit from the resulting rise or fall.

Types of Insider Trading

There are two types of insider trading: legal and illegal.

Legal insider trading refers to trading by corporate insiders – such as directors, officers, and major shareholders – who have access to confidential information about the company. This information gives them an advantage over other investors who do not have access to such information.

Illegal insider trading refers to trading by individuals who do not have access to confidential information but who trade on the basis of such information. This type of insider trading is illegal because it violates the fiduciary duty that corporate insiders owe to their companies and shareholders. 

Examples of illegal insider trading include:

– Trading on the basis of material non-public information about a merger or acquisition

– Trading on the basis of material non-public information about a company’s financial results

– Trading on the basis of material non-public information about a change in a company’s products or services

Examples of Insider Trading in India

In India, there are various examples of insider trading. Some of the most notable cases are:

1. Ketan Parekh Case:

Ketan Parekh was a stockbroker who was involved in a major insider trading scandal in the early 2000s. He was accused of using inside information to manipulate the stock market and make illegal profits.

2. Jignesh Shah Case:

Jignesh Shah is the founder of the National Stock Exchange of India (NSE). He was arrested in 2015 in connection with an alleged fraud involving the exchange.

3. Rajat Gupta Case:

Rajat Gupta is a former Goldman Sachs executive. He was convicted of insider trading in 2012 and sentenced to two years in prison.

4. Radha S Timblo Case:

Radha S Timblo is a mining tycoon in India. She was arrested in 2015 in connection with an alleged money laundering scheme.

Why is Insider trading illegal?

Insider trading is illegal because it is a form of fraud. It occurs when a person with access to nonpublic information about a company uses that information to make trades that will result in a profit. 

This type of trading gives the person an unfair advantage over other investors who do not have access to the same information. 

Insider trading is illegal because it violates the trust that investors have in the markets. When people engage in insider trading, they are breaking the law and they can be subject to civil and criminal penalties. 

Sebi Insider Trading regulations

Sebi (Securities and Exchange Board of India) has put in place regulations to prevent insider trading. These regulations require companies to disclose material information that could impact the price of their stock, and they prohibit company insiders from trading on this information. 

Sebi has also set up a special investigative unit to look into cases of suspected insider trading. If insider trading is found to have occurred, the individuals involved can be subject to civil and criminal penalties. 

The Sebi insider trading regulations are designed to protect investors and ensure that markets are fair. These regulations help to level the playing field between insiders and ordinary investors, and they help to ensure that companies disclose material information in a timely manner. 

Why Indian laws on Insider trading is not effective?

There are several reasons why Indian laws on Insiders Trading are not much effective:  

1. Lack of awareness: Most people are not aware that insider trading is illegal. This is because insider trading is not well publicized and there is no specific law against it in India.

2. Lack of enforcement: Even if people are aware that insider trading is illegal, there is no effective enforcement of the law. This is because the Securities and Exchange Board of India (SEBI), the regulator responsible for enforcing insider trading laws, does not have sufficient powers to investigate and prosecute offenders.

3. Lack of punishment: Even if offenders are caught and prosecuted, the punishment is not severe enough to deter others from engaging in insider trading. The maximum punishment prescribed under the law is a fine of Rs 5 lakh (approximately US$ 7,500).

4. Lack of transparency: The process of insider trading is often hidden from the public. This is because most transactions are done through personal contacts and are not conducted through formal channels such as stock exchanges.

5. Complex laws: The laws governing insider trading are complex and difficult to understand. This makes it difficult for the regulator to effectively enforce the law.

6. Weak regulation: The regulation of insider trading in India is weak.   For example, SEBI does not have the power to investigate or prosecute offenders.

7. Lack of political will: There is a lack of political will to effectively tackle insider trading. This is because many politicians and government officials are involved in insider trading.

Bottom line

Insider trading is a serious problem in India. It is estimated that about Rs.600 crore (US$95 million) worth of shares is traded each day on the basis of insider information. 

This illegal activity undermines the fairness and efficiency of the markets and hurts the interests of small investors. 

The government has taken steps to crack down on insider trading, but more needs to be done to prevent this illegal activity.  

This is a big problem because it is difficult to track and prosecute the people involved in it. Sometimes the people who are caught are just small fry and the big fish are still out there, making a mockery of the system. 

There needs to be more awareness about insider trading and its consequences. There also needs to be stronger penalties for those caught doing it. Only then will the markets be truly fair and efficient.