Insider trading is a term that often pops up in the news, especially when scandals break out in the stock market. It involves buying or selling stocks based on non-public information. This can give unfair advantages to those with access to this information, leaving regular investors at a disadvantage. This blog will explain what insider trading is, recent changes in SEBI’s rules, examples from India, and why it’s illegal.
What is Insider Trading?
Insider trading happens when someone uses non-public information to buy or sell stocks in a company. This information can give the person an unfair advantage over regular investors.
For example, if a company’s employee knows about an upcoming merger and buys the company’s stock before the news goes public, that is insider trading. Since the employee has access to information that isn’t available to others, they can make profits or avoid losses unfairly.
SEBI’s Latest Change in Insider Trading Rules
Recently, SEBI introduced new updates to make insider trading rules stricter. These changes aim to increase transparency and make sure everyone follows fair practices in the stock market.
SEBI now defines insiders more clearly. This means that not only employees but also others connected to the company, like consultants or family members, can be considered insiders if they have access to secret information.
Another major change is that companies need to keep better records of all insiders and their trading activities. SEBI requires companies to monitor insiders closely and report any suspicious activities right away. This helps catch insider trading before it becomes a bigger issue.
In addition, SEBI has increased penalties for those found guilty of insider trading. The new rules also focus on closing loopholes, so no one can misuse the system or gain unfair advantages.
Examples of Insider Trading in India
1. A CFO’s Accountant Acts on Confidential Information
An accountant working closely with the CFO of a large tech company learns that the company’s quarterly earnings report will reveal massive losses due to a failed product launch.
Before the report is made public, the accountant sells 2,000 shares of the company, knowing the stock price will fall significantly once investors learn about the losses. This act is illegal insider trading because the accountant used confidential information to avoid a loss.
2. A Family Member Uses Insider Information to Profit
Imagine my cousin is working as a project manager for a pharmaceutical company. During a family gathering, she mentions that their company is about to get approval for a groundbreaking new drug. Knowing this information isn’t available to the public, I quickly buy 1,500 shares of the company at Rs 200 each.
A week later, the drug gets approved, and the stock price shoots up to Rs 300 per share. I sell my shares for Rs 4,50,000, earning a profit of Rs 1,50,000. While this sounds like smart investing, it’s actually illegal insider trading.
3. A Government Advisor Uses Policy Knowledge
An advisor working in a government ministry knows about a major infrastructure project that will benefit certain construction companies. Before the news goes public, the advisor buys shares of these companies, expecting their stock prices to rise once the project is announced.
This is insider trading because the advisor used non-public government information to make a profit from the stock market.
Consequences of Insider Trading
The consequences of insider trading can be severe for both individuals and companies, impacting their financial stability, reputation, and legal standing.
| Consequence | Impact on Individual | Impact on Company |
| Legal Penalties | Heavy fines and possible imprisonment | Fines and regulatory sanctions |
| Loss of Job | Termination from the current position | Loss of trust from stakeholders and investors |
| Damage to Reputation | Personal reputation was severely damaged | The company’s brand image and public trust affected |
| Ban from the Stock Market | Prohibition from trading in securities markets | Possible ban on future market activities |
Why Is Insider Trading Illegal?
Insider trading is illegal because it creates an unfair playing field in the stock market, damaging trust and harming regular investors. Here’s why it is prohibited:
1. Unfair Advantage
When insiders use confidential information to trade stocks, they gain an unfair advantage over regular investors. This harms people who don’t have access to this inside knowledge, making the market unbalanced and unjust.
2. Loss of Market Trust
The stock market relies on trust. If investors believe that insiders are taking advantage of secret information, they will lose confidence in the market. This distrust can lead to fewer people investing, which negatively impacts the economy.
3. Hurts Regular Investors
Insider trading harms small investors who are unaware of the company’s secret information. They may lose money because they cannot react in time to events that insiders already know about. This creates an unequal opportunity for success.
4. Legal and Economic Risks
When insider trading happens, it damages the reputation of companies and individuals involved. Legal actions, heavy fines, and prison time are some of the consequences. On a larger scale, it can also hurt the company’s value, causing financial instability for shareholders.
How to Prevent Insider Trading
Preventing insider trading is crucial for maintaining market integrity. Here are some ways to ensure it doesn’t happen:
1. Training: Employees and insiders should be trained on the dos and don’ts of stock trading. They should know what qualifies as insider information.
2. Monitoring: Companies need to monitor the trading activities of their employees, especially those in senior positions, to catch any suspicious behaviour early on.
3. Whistleblower Policies: Encouraging whistleblowers to come forward with information can help in identifying cases of insider trading before they escalate.
4. Strict Penalties: SEBI must continue enforcing strong penalties to deter individuals from engaging in insider trading.
Conclusion
Insider trading is a serious offence that affects the fairness of the stock market. SEBI’s rules and penalties are designed to protect investors and maintain market transparency. By understanding what insider trading is and how to prevent it, investors can avoid falling into illegal activities. It’s important for everyone, from company insiders to retail investors, to play their part in ensuring a fair trading environment. Stay informed, follow the rules, and always make your investments based on publicly available information.
FAQs
Ans: Regular trading is done with public information, while insider trading uses secret, non-public information.
Ans: Yes, insider trading can happen in private companies if employees use private information for personal gain.
Ans: Always base your trades on public information, and avoid using or acting on non-public data.
Ans: SEBI sets rules, monitors markets, and punishes those found guilty of insider trading.
Ans: Yes, insider trading is a criminal offence in India, with punishments including fines and imprisonment.
