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What Is Insider Trading? Is It Illegal?

Have you ever been in a game where you lost and later realised that the winner won by cheating? You end up feeling it’s unfair. Such instances also occur in the stock market, known as ‘Insider Trading’.

This article will guide you on insider trading, its types, why it is illegal and unethical, its penalties, and real-world examples of insider trading in India.

What Is Insider Trading?

Insider trading means trading by an insider of the company. As defined by the Securities Exchange Board of India, an “insider” means any person who is a connected person or in possession of having access to unpublished price-sensitive information.

In simple words, insider trading means trading in a public company’s stock, using confidential non-public information, and thus having an unfair advantage over other investors.

When Is A Trade By An Insider Not Considered Illegal?

You may often perceive insider trading as illegal. However, whether insider trading is legal or illegal depends on the information insiders use.

For instance, Kiyan, the CEO of XYZ Company, sold 5000 shares of XYZ on April 13, 2022, and sent the changes in promoter holdings to the SEBI by April 15, 2022. Even though he is an insider of the company and involved in trading, he was not penalised, and here is why.

When any company employee/manager/executive carries out the trading activity using information available to the public, that is considered legal insider trading. 

In legal insider trading, the transaction is reported to the regulator (for instance, SEBI for India)  and the company itself. As investors have access to such information, they are not at a disadvantage. Therefore, legal insider trading does not attract any penalties.

When Is A Trade By An Insider Considered Illegal?

For instance, Ziya, an employee of ABC company, sold 15000 shares of the company on May 4, 2022, as she was well aware that ABC would be losing the government contract in the next 15 days. She didn’t report the transaction. As soon as SEBI got to know this, she got penalised heavily. 

Here is why. Insider trading is illegal when a person associated with a company indulges in trading using confidential, non-public information, which can affect stock prices. The reason is an inside trader can benefit hugely. However, other investors are disadvantaged as they cannot access such information. For such instances, regulatory bodies can levy penalties on insiders.  

Why Is Insider Trading Illegal And Unethical?

Let’s understand why what Ziya did is not just unethical but also illegal.

  • Ziya knew that losing the government’s contract would negatively affect the revenue. Moreover, she didn’t report this transaction, making it illegal. 
  • Ziya took this step as she had the inside information about the company. Though, other investors of the company are still unaware of this fact. Therefore, it is unfair to them. Insider trading is ethical and legal when all the investors have access to the same piece of information.
  • The stock fell when investors and the public realised that the company had lost a government contract. Investors who bought ABC’s stock might not have done so if they knew the company would lose that government contract. 

Insider Trading Penalties In India

According to The Securities and Exchange Board of India Act, 1992 (Section 15G),

  • If any insider deals in securities of a public company based on any unpublished price-sensitive information, or,
  • They communicate any unpublished price-sensitive information with other people, except it is required in the ordinary course of business, or by the law, or
  • Counsel or procure any person to deal in securities of a public company based on any unpublished price-sensitive information,

They shall be liable to a penalty of twenty-five crore rupees or three times the amount of profits from insider trading, whichever is higher.

Insider Trading Examples

  1. India’s Big Bull, Rakesh Jhunjhunwala, was caught indulging in insider trading.

    In September 2016, the Share price of Aptech Limited touched the upper circuit of 10% because Mr Jhunjhunwala’s brother and sister bought 2.5 lakh and 5 lakh shares worth over ₹100 crores combined. 

    After a few days, the company entered a new preschool education segment. SEBI claimed that Rakesh Jhunjhunwala traded possessing non-public, price-sensitive information. Due to this, Rakesh Jhunjhunwala was required to pay ₹18.5 crore, including ₹6 crore as a disgorgement amount.
  2. Another instance of insider trading in India is related to an IT Giant, Infosys. Two employees, one from Infosys and one from Wipro, were indulging in insider trading in Infosys scrip. They earned ₹2.6 crores when Infosys announced a strategic partnership with Vanguard in July 2020. The stock price increased by 20% between July 10 – July 31 in 2020.

    Taking action against this instance, SEBI banned both employees from dealing in securities and took custody of ₹2.6 crores from their bank accounts.

Final Thoughts

Insider trading means trading in a listed company by a connected person. Insider trading is not always illegal. If the insider uses information, which the general public is unaware of for his gain, it is immoral and illegal. However, there are market watchdogs who keep an eye on such instances and take necessary actions.

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FAQs

Why is insider trading unethical?

Insider trading is unethical since an insider can take unfair advantage by having access to a piece of confidential, non-public information, which is against the interest of a large number of investors.

Who gets hurt by Insider trading?

Insider trading hurts the general public and the efficiency of the stock market. Moreover, the reputation of a company and the market overall get damaged by such instances.

How do Insider traders get caught?

To catch the inside traders, the regulators like SEBI keep their eye on the trading activities in the market, especially during critical events. They use software scanners, artificial intelligence, and natural language processing tools to identify insider trading activities.

Is insider trading legal?

Whether insider trading is legal or illegal depends on the information insiders use. If an insider uses confidential information, it is not just immoral but illegal. Using information inaccessible to the general public is against the interest of other investors and may lead to unfair gains.

What Is Insider Trading? Is It Illegal?

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What Is Insider Trading? Is It Illegal?

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