Insider Trading Regulations

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Just like everything, the trading world has a dark side too. There are illegal practices developed by traders to increase their profits, insider trading is one of them. Sensing this increase, SEBI has decided to tighten insider trading regulations.

Insider trading, as the name suggests means the purchase or sale of a company’s stock by an insider or a person closely associated with a particular company.

This means that Insider trading might be carried out by an insider of the company, or someone associated with the insider.

Insiders, usually stakeholders, individuals in key positions have access to key information such as an imminent takeover, merger, product launch, and other significant events that can have an impact on the company’s listed securities.

Now, having access to such critical information gives such traders an unfair advantage over the rest. Therefore, trading on the basis of such material information is deemed illegal.

To keep the malpractice in check, SEBI has developed certain insider trading regulations that traders need to abide by or else face severe consequences in the form of penalties.

Here in this article, we take a closer look at some of the regulations that have chalked down by the authorities to curb traders from adopting this dark regime.

Insider Trading Regulations SEBI

SEBI Insider Trading Regulations suggest a strict stance on the unjust act of Insider trading. The stock market regulator first rolled out the list of directions for insider trading in 1992 and has since been updating the regulations from time to time.

In its list of share market rules and regulations, SEBI defines an “Insider” as a connected person or individual in possession of some kind of Unpublished Price Sensitive Information (UPSI) that can have an impact on the company’s securities prices.

In larger terms, an “Insider” can be a person who is or was associated with a company or an individual who has or can have access to any UPSI through their connections.

Further, the term UPSI is defined as the kind of information relating to the investment securities of a company that is not made available to the public and which is likely to affect the prices of the company’s securities.

So, an individual who has access to such material information can use it for their own gains in more ways than we can think of. A sudden increase in the number of insider trading cases has been seen over the past couple of years.

Reports suggest that SEBI had to look into well over 70 cases of insider trading during the 2019 fiscal year. The numbers are alarming and SEBI taking notice of the fact has made amendments to the existing PIT Regulations.

These PIT Regulations are the guidelines that govern the sphere around insider trading. The regulations define the terms, precautions, penalties in regards to the execution of insider trading in the country.

Prohibition of Insider Trading Regulations

Prohibition of Insider Trading Regulations or simply PIT Regulations are the set of rules installed by SEBI to keep a check on Insider Trading.

The rules were established in 1992 with the motive of ensuring market integrity and fairness to all investors, traders.

The recent surge in insider trading cases has called for amendments in the norms, and SEBI has reiterated that companies, insiders, and other sources dealing with companies need to stay compliant with the laid out regulations.

Further, all the parties must ensure to abide by the codes of conduct and to stay clear from any ill conducts that can lead to a possible imbalance in carrying out trade activities on the stock market.

Under Prohibition of Insider Trading Regulations, a trader, an investor can be guilty of insider trading on the basis of two grounds. The two grounds are :

Insider Trading UPSI
Procuring and Transferring Insider information

Insider Trading UPSI

The rules laid out by SEBI deter an insider not to trade in a company’s securities on the basis of unpublished price sensitive information. This is in order to maintain fairness and equal opportunity for everyone on the stock market.

Let us understand this through the means of Insider Trading Example.

For Example – Rishabh is the CEO of an automobile company. The company is about to launch a new product in the form of an electric SUV.

After closely inspecting their competitors in the market, there is a feeling that the product will be a grand hit among customers.

In all fairness, this seems like the perfect opportunity to invest in their company’s shares as the product launch will lead to an increase in the company’s securities prices. However, the official word from the company is yet to reach the streets.

Thus, this is a material UPSI. Rishabh, who by virtue of his position with the company has access to the information can not trade in the company’s shares until the company makes an official statement in regards to their product launch.

However, if Rishabh does purchase the company’s shares, it would be deemed illegal insider trading activity. He could even be subject to a penalty if found guilty on account of breach of the PIT Regulations.

Procuring and Transferring Insider Information

In addition to the above, SEBI prohibits individuals from procuring and transferring insider information and terms it as illegal.

Originally when the regulations were introduced back in 1992, only “trading while in possession of material undisclosed information” was considered a ground for violation.

However, the regulations were amended and simply having access to or possessing insider information was enough to be tried for insider trading.

The insiders or connected person should under no circumstances communicate, or allow access to UPSI to anyone. The only exceptions can be when they are under a legal obligation to relay the information.

Further, no individual can procure undisclosed price sensitive information from the ones who have access to or possess any kind of material information.

The exceptions to the rule, here again being legitimate and legal obligations.

For Example – Harnav is acting as a Managing Director for a pharmaceutical company that is in the process of being acquired by a hugely acclaimed MNC.

The move in all likelihood will cause the company’s securities to become a hot commodity inviting traders and investors in huge amounts. Thus, the company’s share prices are sure to go upwards.

Harnav communicates the information to his close friend Saybi, who instantly purchased 3000 shares in the company before the information regarding the takeover is made public.

Thus, Saybi will be profiteering from procuring insider information from Harnav. This kind of trading activity is prohibited by SEBI.

Here, both the parties involved, that is the “insider” and the “connected person” will be guilty of prohibiting the insider trading regulations.

In addition to this, PIT Regulations also mentions some of the criteria under which insiders can be pardoned for violating the norms:

The transaction is an off-market inter-party transfer between the promoters who were in possession of the same UPSI where none of the parties communicated, provided, allowed access to, or procured the UPSI.
The individual who possesses the UPSI is different from the one who carried out trade transactions. Most importantly, the individual who carried out transactions was not in possession of such unpublished price sensitive information.
The onus lies with the companies to ensure appropriate measures are in place to prevent the communication between individuals who possess or have access to UPSI and individuals who are trusted with making trade-related decisions.
The trade transactions were in accordance with a pre-defined trading plan.

Insider Trading Regulation Amendment

Taking notice of the increased violations of the existing norms, SEBI has decided to further strengthen the laws around the act and made Insider Trading Regulation amendments recently.

The past July saw the market regulatory body amend key clauses in regards to ensuring communication of unpublished price sensitive information.

The newly amended rule states that the responsibility of maintaining a well organized digital database now lies with other parties such as Intermediaries or Fiduciaries who possess UPSI.

This means that intermediaries and fiduciaries will have to maintain a proper digital database to keep account of everyone the UPSI is being shared.

Further, the database will include the names of persons who have UPSI as well as the information on the nature of UPSI.

The move will help SEBI in identifying the person or persons who have communicated or leaked the insider information. The same regulation states that the database is to be maintained for a period of 8 years

In addition, SEBI has replaced an existing clause with a new one.

The new clause states that if a designated person is found guilty of violating the laws and a listed company collects money from the person, in that case, the company will have to remit the amount to Investor Education and Protection Fund (IEPF) set up by SEBI.
The circular states that companies should report such violations of the Code of Conduct to stock exchanges instead of SEBI as required earlier.

The circular also mentions a format for listed companies to report such violations.

Conclusion

Insider Trading is one of the dark routines for making a profit in the stock market. The number of traders and investors taking up the ill practice seems to be increasing with each passing day.

Having access to insider information such as an imminent takeover, merger, product launch, or other significant events lends insider traders an unfair advantage over traders.

This can be disheartening for anyone who trades on the basis of his understanding and analysis of the market conditions etc.

However, there are insider trading regulations developed by SEBI to keep such transactions in check and deter traders.

The insider trading regulations in India hold insiders guilty, firstly on Trading on the basis of UPSI and the second on procuring and transferring UPSI.

SEBI investigated around 70 cases of insider trading during the 2019 fiscal year, which is indicative of the fact that traders seem to be taking the regulations lightly.

Subsequently, the market regulator has taken notice of the fact and has made amendments to the existing PIT Regulations.

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