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Insider Trading: A Comprehensive Overview of Laws, Regulations, and Practices - Prof. Jaco, Study notes of Business Taxation and Tax Management

A comprehensive overview of insider trading, exploring its definition, legal framework, and implications. It delves into the history of insider trading laws in the united states and india, highlighting key regulations and penalties. The document also examines methods for preventing insider trading, including disclosure requirements, chinese walls, and trading window facilities. It concludes by discussing the ethical and legal considerations surrounding insider trading, emphasizing the importance of fair and transparent market practices.

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2024/2025

Uploaded on 03/11/2025

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INSIDER TRADING
Insider trading refers to the practice of purchasing or selling a publicly
traded company’s securities while in possession of material information that is
not yet public information. Material information refers to any and all
information that may result in a substantial impact on the decision of an investor
regarding whether to buy or sell the security. By non-public information means
the information is not legally out in the public domain and that only a handful of
people directly related to the information possess. An example of an insider
may be a corporate executive or someone in government who has access to an
economic report before it is publicly released. Insider trading is defined as a
malpractice wherein trade of a company's securities is undertaken by people
who by virtue of their work have access to the otherwise non-public information
which can be crucial for making investment decisions.
When insiders, e.g. key employees or executives who have access to the
strategic information about the company, use the same for trading in the
company's stocks or securities, it is called insider trading and is highly
discouraged by the Securities and Exchange Board of India to promote fair
trading in the market for the benefit of the common investor. Insider trading is
an unfair practice, wherein the other stock holders are at a great disadvantage
due to lack of important insider non-public information. However, in certain
cases if the information has been made public, in a way that all concerned
investors have access to it, that will not be a case of illegal insider trading.
The Securities and Exchange Board of India (Prohibition of Insider
Trading) Regulations 1992, does not directly define the term Insider Trading.
But it defines the term "Insider", "Connected Person" and "Price Sensitive
Information". Insider Trading is the trading of securities of a company by an
Insider using company's non-public, price-sensitive information while causing
losses to the company or profit to oneself.
Eg: The CEO of a company divulges important information about the
acquisition of his company to a friend who owns a substantial shareholding in
the company. The friend acts upon the information and sells all his shares
before the information is made public.
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INSIDER TRADING

Insider trading refers to the practice of purchasing or selling a publicly traded company’s securities while in possession of material information that is not yet public information. Material information refers to any and all information that may result in a substantial impact on the decision of an investor regarding whether to buy or sell the security. By non-public information means the information is not legally out in the public domain and that only a handful of people directly related to the information possess. An example of an insider may be a corporate executive or someone in government who has access to an economic report before it is publicly released. Insider trading is defined as a malpractice wherein trade of a company's securities is undertaken by people who by virtue of their work have access to the otherwise non-public information which can be crucial for making investment decisions. When insiders, e.g. key employees or executives who have access to the strategic information about the company, use the same for trading in the company's stocks or securities, it is called insider trading and is highly discouraged by the Securities and Exchange Board of India to promote fair trading in the market for the benefit of the common investor. Insider trading is an unfair practice, wherein the other stock holders are at a great disadvantage due to lack of important insider non-public information. However, in certain cases if the information has been made public, in a way that all concerned investors have access to it, that will not be a case of illegal insider trading. The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations 1992, does not directly define the term Insider Trading. But it defines the term "Insider", "Connected Person" and "Price Sensitive Information". Insider Trading is the trading of securities of a company by an Insider using company's non-public, price-sensitive information while causing losses to the company or profit to oneself. Eg: The CEO of a company divulges important information about the acquisition of his company to a friend who owns a substantial shareholding in the company. The friend acts upon the information and sells all his shares before the information is made public.

Insider Trading has been around the United States from 1792. Hence, Laws against Insider Trading was formed strictly in the United States of America. The market crash in 1929 due to prolonged "lack of investor's confidence" in securities market followed by the Great Depression of US Economy, gave rise to the enactment of the Securities Act of 1933. The foundation of Insider Trading law was laid down by the Supreme Court of US in Strong vs Repide. Statutory Insider Trading Laws were first passed in the year 1933 and the Securities Exchange act in 1934. The second act created SEC (Securities Exchange Commission) to regulate the secondary trading of securities. These Acts were meant to create more transparency among the investors and placing due diligence on the preparers of the documents containing detailed information about the Security. In the United States vs Carpenter, 1986, the Supreme Court cited that the usage of Inside Information received by virtue of confidential relationship must not be used or disclosed and by doing so, the individual gets charged for Insider Trading. In 1997, O'Hagans Case, the court recognised that a company's information is it's property: " A Company's confidential information qualifies as property to which the company has a right of exclusive use. The undisclosed misappropriation of such information in violation of fiduciary duty constitutes fraud akin to embezzlement-the fraudulent appropriation to one's own use of money or goods entrusted to one's care by another." In 2007, representatives Brian Baird and Louise Slaughter introduced a bill "Stop Trading on Congressional Knowledge Act or STOCK Act". Insider Trading in India:

  1. In 1948, First concrete attempt to regulate Insider Trading was the constitution of Thomas Committee. It helped restricting Insider trading by Securities Exchange Act, 1934.
  2. In 1956, Sec 307 & 308 were introduced in the Companies Act, 1956. This change made it mandatory to have disclosures by directors and officers.
  3. 1979, the Sachar Committee recognized the need for amendment of the Companies Act, 1956 as employees having company's information can misuse them and manipulate stock prices.
  4. 1986, Patel committee recommended that the Securities contracts (Regulations) Act, 1956 be amended to make exchanges reduce Insider Trading.

Reasons for prohibiting insider trading

  1. Insider trading appears biased to investors as insiders have additional price sensitive information before them and can use it to make profits while the late reception of information makes investors suffer loss or not gain the deserved profits.
  2. If a market is integrated and free of illegal trading, it may lead to healthy growth of the market and such markets can inspire the confidence of the Investors.
  3. Insider trading leads to loss of confidence of Investors on the market which can lead to a halt in market dealings. Under SEBI Act, 1992- Penalty for insider trading- Sec.15G. If any insider who,— (i) either on his own behalf or on behalf of any other person, deals in securities of a body corporate listed on any stock exchange on the basis of any unpublished price-sensitive information; or (ii) communicates any unpublished price-sensitive information to any person, with or without his request for such information except as required in the ordinary course of business or under any law; or (iii) counsels, or procures for any other person to deal in any securities of any body corporate on the basis of unpublished price-sensitive information, shall be liable to a penalty which shall not be less than ten lakh rupees but which may extend to twenty-five crore rupees or three times the amount of profits made out of insider trading, whichever is higher. Significant Penalties:
  • SEBI may impose a penalty of not more than Rs. 25 Crores or three times the amount of profit made out of Insider Trading; whichever is higher.
  • SEBI may initiate criminal prosecution; or
  • SEBI may issue order declaring transactions in Securities based on unpublished price sensitive information; or
  • SEBI may issue orders prohibiting an insider or refraining an insider from dealing in the securities of the company.

Methods of Prevention of Insider Trading

  1. Disclosure of Interest by corporate insiders. a. Listed companies: -If change exceeds 2% of the total voting right of persons holding more than 5% of the shares/voting rights. -If change exceeds Rs.5,00,000/25000 shares/ 1% of capital by Directors and officers. b. Other entities: -Initial statement of holdings. -Periodic statement of holdings. This can show any suspicious time based and trading based activities by Insiders.
  2. Disclosure of Price Sensitive Information:  Limited access to price sensitive information, for ex.: Need to know basis.  Dissemination of information by the Stock Exchange.  Transmitting information to news agency.
  3. Chinese Wall: Separate inside area from public areas and bringing over the wall.
  4. Trading Window Facility:  Decided by the company.  Closed during the time price-sensitive information is not published.  Opened 24 hours after the information is made public.  Allowing the exercise of ESOP.
  5. Minimum holding period:  Securities to be held for minimum period of 30 days to be considered investment.  30 days holding from the date of IPO allotment.  Only personal emergency cases be excluded
  6. Pre-clearance of trades prevents Front Running.