In your dealings with the stock world, you will often come across the term “insider trading.” In simple words, the meaning of insider trading is ‘the trading of shares based on knowledge not available to the rest of the world.

The first country to tackle insider trading effectively, however, was the United States. In the USA, the Securities and Exchange Commission is empowered under the Insider Trading Sanctions Act, 1984 to impose civil penalties in addition to criminal proceedings. Most countries have in place proper legislation to kerb the menace of insider trading.

The Securities scam of 1992 brought to light the great prevalence of insider trading on Dalal Street.  SEBI was established in 1992 and was given the power, with the prior approval of the Central Government. To bring about regulations to prevent insider trading and thus framed the SEBI ([Prohibition on] Insider Trading) Regulations 1992, framed under Section 11 of the SEBI Act, 1992, are intended to prevent and curb the menace of insider trading in Securities. Now SEBI has with effect from 20th February 2002 amended these Regulations and rechristened them as SEBI 9 Prohibition of Insider Trading Regulation, 1992. This Regulation was further amended in November 2002.

History & Development Of Insider Trading Laws In USA:

Insider trading has been a part of the U.S. market since William Duer used his post as assistant secretary of the Treasury to guide his bond purchases in the late 1700s.

The prevention of insider trading is widely treated as an important function of securities regulation. In the United States, which has the most–studied financial markets of the world, regulators appear to devote significant resources to combat insider trading. This has led many observers in India to mechanically accept the notion that the prohibition of insider trading is an important function of SEBI. In most countries other than the US, government actions against insider trading are much more limited. Many countries pay lip service to the idea that insider trading must be prevented while doing little by way of enforcement.

Insider trading appears unfair, especially to speculators outside a company who face steep competition in the form of inside traders. Individual speculators and fund managers alike face inferior returns when markets are more efficient owing to the actions of inside traders. This does not, in itself, imply that insider trading is harmful.

Insider trading apparently hurts individual and institutional speculators, but the interests of the economy and the interests of these professional traders are not congruent. Indeed, inside traders competing with professional traders is not unlike foreign goods competing on the domestic market — the economy at large benefits even though one class of economic agents suffers.

The prevention of insider trading is widely treated as an important function of securities regulation.

“Insider trading” is a term that is usually associated with illegal conduct. But the term actually includes both legal and unlawful conduct.

The Legal version is when corporate insiders—officers, directors, and employees—buy and sell stock in their own companies. When corporate insiders trade in their own businesses securities, they must report their trades to the. Unites States – Securities and Exchange Commission (SEC). This type of insider trading and the reports corporate insiders must file,: in  “Forms 3, 4, 5” online using EDGAR:

The Illegal Version refers generally to buying or selling a security, in breach of a legal duty or other relationship of trust and confidence, while in possession of material, non-public information about the security.

Insider trading violations may also include “tipping” such information, securities trading by the person “tipped,” and securities trading by those who misappropriate such information.

Tipper – is the insider who passed on the information to an outsider

 Tipee – is the person who receives the tip from and insider.

History & Development Of Insider Trading Laws In India:

The history of Insider Trading in India relates back to the 1940’s with the formulation of government committees such as the Thomas Committee of 1948, which evaluated among other things, the regulations in the US on short swing profits under Section 16 of the Securities Exchange Act, 1934. After that, provisions relating to Insider Trading were incorporated in the Companies Act, 1956 under Sections 307 and 308, which required shareholding disclosures by the directors and managers of a company.

Due to inadequate provisions of enforcement in the companies Act, 1956, the Sachar Committee in 1979, the Patel Committee in 1986 and the Abid Hussain Committee in 1989 proposed recommendations for a separate statute regulating Insider Trading.

The Patel committee in 1986 in India defined Insider Trading as,

“ Insider trading generally means trading in the shares of a company by the persons who are in the management of the business or are close to them by undisclosed price sensitive information regarding the working of the company, which they possess but which is not available to others.”7

The concept of Insider Trading in India started fermenting in the 80’s and 90’s and came to be known and observed extensively in the Indian Securities market. The rapidly advancing Indian Securities market needed a more comprehensive legislation to regulate the practice of Insider Trading. Thus resulting in the formulation of the SEBI (Insider Trading) Regulations in the year 1992, which were amended in the year 2002 after the discrepancies observed in the 1992 regulations in the cases like Hindustan Levers Ltd. vs. SEBI8, Rakesh Agarwal vs. SEBI9, etc. to remove the lacunae existing in the Regulations of 1992. The amendment in 2002 came to be known as the SEBI ([Prohibition of] Insider Trading) Regulations, 1992.

The laws of 1992 seemed to be more punitive in nature. The 2002 amendment rules, on the other hand, are preventive in nature. The amendment requires all the listed companies, market intermediaries, and advisors to follow the new regulations and also take steps in advance to prevent the practice of insider trading.

The new rules include mandatory disclosures by the Directors and other officers of listed companies and also by the persons holding more than 5% of the company’s shares10. Insider trading practice is also required to be curbed during important announcements of the company. These preventive measures ensure the reduction of the cases involving the practice of Insider Trading and also informing the persons who indulge in such practices, of the laws relating to Insider Trading.

Comparison of Indian and USA System of Insider Trading:

NASDAQ (National Association of Securities Dealers Automated Quotation System) alone has 180 fraud detecting officers along with 12 persons especially tracking insider trading activities, and they are supplemented by 350 persons of the SEC. The SEC has support staff including lawyers and auditors amounting to 940, while SEBI employs a small 356 individuals in toto. The US stock exchanges have advanced surveillance systems like Edgar (electronic data gathering) and SWAT (stock watch automatic tracking), unlike India.

In the US, the SEC has federal jurisdiction to monitor malpractices. The stock exchanges have SROs who conduct active market surveillance with the help of sophisticated computer systems which control the volume and price movements of stocks. If there are changes more than the predetermined parameters alert is generated, and the SROs carry out the preliminary investigation. If there is substantial evidence of insider trading, it is referred to the SEC which carries out further investigation and has the power to initiate criminal prosecution.

In India, the companies have to formulate a code of conduct and have to appoint a compliance officer to check insider trading within the enterprise, but there is no mechanism to control major players like brokers and promoters. The SEBI is not equipped with such technology which can monitor large-scale insider trading.

In the United States, any person who gives information to the SEC (Securities and Exchange Commission) about any insider trading activity gets a part of the profit made during such malpractice. This kind of reward for information is not yet incorporated in the Indian legal system.

Although the Indian Regulation is very much similar to the US laws on insider trading yet the implementation of the law suffers. By the Amendment of 2002, the penalty was increased to 25 crores or three times of profit made during the trading.

In the US, the sentence for insider trading is three times of the profit achieved during the trading. They also provide for imprisonment of ten years. The Indian legislation also needs a clause for punishment for offenders.

Eugene Soltes is a professor at Harvard Business School as well as the author of “Why They Do It”, which focuses on white-collar crime. He spent seven years speaking with some of the biggest white-collar criminals in history. Here he discusses a specific type of “inside trading” that is completely legal in America.

Explore my blog for:

  • Insider trading examples real life
  • Insider trading cases in India
  • Example of favoritism
  • What exactly is insider trading?
  • Types of insider trading
  • Insider trading case study
  • Insider trading famous cases
  • Rajat Gupta insider trading case
  • Penalties for insider trading in India
  • Insider trading cases 2016