Category: What is Insider Trading


The business of rooting out insider trading and market manipulation has gone high-tech.

Brokerage firms and stock exchanges all over the world have joined traditional market watchdogs like the Financial Industry Regulatory Authority and the Securities and Exchange Commission in using high-tech tools to quickly and efficiently quickly spot “too-good-to-be-true” trades by insiders and those who know them.

Nasdaq, Inc. NDAQ, -0.21%  , for example, uses state-of-the-art software acquired in 2010 from SMARTS Group, a leading provider of market surveillance solutions to exchanges, regulators and brokers. Nasdaq is using that acquisition to diversify its commercial technology business and provide the same tools it used in-house to 40 marketplaces, 11 regulators and 100 market participants across 65 markets globally.

A multi-faceted team of markets, legal, fraud and financial reporting compliance professionals, primarily based in Nasdaq’s “MarketWatch Center” in Rockville, Maryland tracks the activities of its listed companies and those who trade Nasdaq-listed shares in real-time around the clock. (Nasdaq’s MarketWatch has no affiliation with this publication, which shares its name.)

At the MarketWatch Center, Nasdaq watches the markets using software with a colorful graphical user interface that’s peppered with charts and graphs, helping them visualize trends and spot unusual activity as millions of trades flicker by each day.

Source: Nasdaq OMX

Graphic displaying buy vs sell interest, with buy interest as blue bars and sell interest as red bars.

Martina Rejsjö, the head of the group, relocated from Nasdaq’s Stockholm office two years ago. Her group reviewed 51,549 issuer disclosures in 2015, typically all the 8-K filings with the SEC but also the earnings press releases that go out four times a year.

Nasdaq OMX

Martina Rejsjö, Vice President of Nasdaq MarketWatch, watches issuers, participants and trading activity across asset classes and markets.

Companies must notify the exchanges about news of “a material event or a statement dealing with a rumor,” that will go out between 7 a.m. and 8 p.m. by “telephone” at least 10 minutes before the announcement is made. Nasdaq’s review of these disclosures for material market moving information resulted in 425 trading halts in 2015, down from 509 in 2014 even though the volume of disclosures reviewed was more last year.

The Nasdaq MarketWatch team sets up alerts to look for disclosure activity that could require a halt and trading activity that could signal manipulative trading or a technical problem that could also require a halt. Although her analysts consult closely all day with companies on everything, the exchange has the last word on halts, says Rejsjö. When reviewing company disclosures, they are looking for “material events” that can move the market.

• An auditor resignation or a first-time “going-concern”

• Senior executive or director changes of a material nature or a change in control

• An announcement of a reorganization or an acquisition, including mergers, tender offers, asset transactions

• A bankruptcy filing

• Deviation in actual results compared to previously issued guidance

• Previously undisclosed, surprise material news such as new products, Food and Drug Administration approvals or revised financial outlook

When looking at unusual trade activity, the analysts check for significant price movement combined with higher volumes, especially concentrated from one broker. They are also looking for larger than usual transactions and block trades. Sudden and rapid price increases or drops are seen clearly on their charts along with moves in the opposite direction of market indices such as the Nasdaq Composite or the Dow Jones Industrial Average. The team also tracks online sites for rumors, and reviews blog posts and Twitter feeds.

Source: Nasdaq OMX

MarketWatch at Nasdaq monitors velocity, based on total volume against the expected volume for a certain stock, and force – the buy:sell ratio which indicating whether there is more pressure on the buy or sell side.

The MarketWatch team reviewed 387,260 surveillance alerts in 2015, resulting in 689 referrals to Finra for further review and drill-down on the activity at the brokerage firm level. Finra has its own proprietary market surveillance software, called Sonar, that it uses to identify activity for review. That surveillance is supplemented by the referrals and tips from customers, the public or exchanges like Nasdaq.

Cameron Funkhouser, the executive vice president in Finra’s Office of Fraud Detection & Market Intelligence, said in an interview said that they receive “all kinds of market intelligence from many sources. Between the surveillance and the investigation,” said Funkhouser, “we are going broad and deep, looking at who traded and when, down to the customer level, and which accounts made money.”

A primary target for surveillance at Finra is mergers-and-acquisition activity. “The starting point may be a referral from an exchange like Nasdaq or our own surveillance alerts. We look for unusual price or volume movement, married with the trading timeline and a network analysis of the relationships between those who made profitable trades.” Finra is also responsible for reviewing options activity. “The real leverage in insider trading,” says Funkhauser, “is in options.”

Last year Finra referred approximately 421 instances of potential insider trading to the SEC, which then assesses those cases for further investigation and possibly civil enforcement action. The SEC can also make a referral to the Department of Justice for a criminal case. A spokesman from the SEC declined comment on its cooperation with Finra and the exchanges on insider trading or market manipulation referrals.

Two recent SEC insider trading enforcement actions began with Nasdaq MarketWatch referrals to Finra, said a Nasdaq spokesman. On June 3 the SEC charged childhood friends with insider trading in pharmaceutical stocks. On May 31 the SEC charged an investment banker with passing inside information to his plumber in exchange for a new bathroom.

Nasdaq also disciplines its members on its own and in conjunction with FINRA. In April of this year, Deutsche Bank Securities was fined $3 million for failing to report and failing to correctly report options positions to the required Large Options Positions Report. Deutsche Bank Securities also failed to have an adequate system and procedures for supervision related to compliance with options reporting, according to a settlement whose findings Deutsche Bank did not agree with or deny.

In March FINRA and Nasdaq announced that they jointly censured and fined Wedbush Securities Inc. $675,000 for supervisory violations in connection with its handling of a client’s redemption activity and trading of leveraged exchange-traded funds. The firm’s failures led to chronic fails to deliver in several ETFs for more than two years. Wedbush did not admit or deny the findings.

Nasdaq also fined Great Point Capital $1.05 million in December for manipulating the price discovery process Nasdaq uses to cross buy and sell orders at a single price at the opening and closing of the session. Great Point did not admit or deny the findings.




Six months into the new regime, is still grappling with the strictures and stipulations. The biggest grey area has been the dos and don’ts on price-sensitive information.

The Securities and Exchange Board of India (Sebi) now expects companies to adopt a ‘need to know’ strategy while communicating on key business issues. “While drafting these regulations, we want companies to themselves determine what needs to be communicated and what shouldn’t be,” said a regulatory official.

However, the regulatory intent has not been able to put across the message. Some in corporate circles and the legal fraternity are touting some of the stipulations in the insider trading code as too restrictive, leading to a virtual freeze in communication.

  • 1992: drafted the (PIT) regulations
  • 2002: Regulations amended to ask companies to draft a model code of conduct
  • 2008: Regulations amended to widen the definition of an insider
  • 2012: Sebi forms committee headed by ex-judge N K Sodhi to re-look at the regulations
  • 2013: The report prescribes stricter norms
  • 2014: Sebi clears insider trading regulations
  • 2015: New regulations come into effect


The Sebi insider trading code of 2015 has deemed close relatives, members of the board of directors and people connected with a decision (that is price-sensitive) as ‘connected persons’. The regulations bar any form of communication of such information by these people.

The bar on communication by itself without any trading or wrong committed has been brought in the new regulations. This restriction could even be unconstitutional. If a husband shares some information with his wife, and she does nothing to misuse it, both would still fall afoul of the new rule. “If one were to analyse it from the perspective of criminal law jurisprudence, there is neither any intent nor any action to commit a wrong, yet an offense is caused,” said Sandeep Parekh, founder, Finsec Advisors.

Finding merit in the argument that the requirement is onerous, Arpinder Singh, partner at EY India, said actions of individuals would now come under greater scrutiny. The presumption of having utilised price-sensitive information to conduct trade would mean that actions of individuals would be open to greater scrutiny than before. The new regulations widen the definition of persons or individuals with access to unpublished price-sensitive information but legal experts feel legitimate communication should not be hampered. “An onerous requirement is now transferred to the individual who will have to establish that the price-sensitive information has not been misused,” said Singh.

Legal experts add that companies would need to maintain a record of information to refute any allegations of misuse of such information. “Organisations would now need to be far more diligent in identifying employees who might have access to unpublished and price-sensitive information, and ensure they do enough to sensitise these individuals on how to handle such information,” says Singh.

Another area of regulations that has been questioned is the due-diligence clause for deals that do not trigger an open offer of equity. The issue is that Sebi has outlined the treatment for deals that culminate but the regulator has been silent for deals that fail to happen.

Sometimes on the basis of unfavourable findings in the due-diligence, intending acquirers do not proceed further with an acquisition. In this situation, the question arises as to what will happen to the “unpublished price-sensitive information” that has been shared with the potential acquirer in such an aborted transaction.

“There is a protection given to some deals (open-offer related). However, it does not mean conversely that if a deal is of a non-takeover type or if a takeover deal is not fructified, that the sharing of information would automatically be considered illegitimate,” said Parekh. Having said that, it is important to share information in a due-diligence process with care, so that there is no allegation of preferential treatment of information that has the possibility of getting misused, he adds.

An official with the market regulator adds that the regulations lay greater emphasis on companies adopting best practices. “The regulations cannot be wished away and corporates would need to work with these,” he said.

Some do agree with the market regulator’s view. “Businesses outside India have developed risk intelligence in their business conduct and adopted due-diligence practices to facilitate legitimate business practices within the regulatory purview,” said at Thomson Reuters India. These aspects of regulations are in line with global best practices and corporate India will have to learn to live with these, he felt.



Recently, some banks approached Sebi to exempt them from these insider trading regulations, said a person aware of the development. But, even as banks argued that they are required to extend debt finance as part of their normal business, the market regulator is unwilling to make any exception in case of debt deals and for banks.

“If information sought while doing due-diligence for investments in debt securities is used to trade in any other securities such as listed shares of the entity in that case it will come under insider trading,” a Sebi official told ET.

In case of equity financing or inorganic deals like M&As, investment banks, lawyers and persons associated with the negotiations and entering into non-disclosure agreement, are considered as ‘connected persons’ – which means that if there is any accusation that a person privy to the deal has used any confidential information to trade, then the person has to defend himself to prove his innocence. Moreover, such information has to be anyway made public a little before a deal is closed.

Even if banks and other institutional investors in a debt deal are tagged as ‘connected person’, corporates (receiving debt finance) are reluctant to put up the information (shared for obtaining finance) on their company websites or on that of stock exchanges where their stocks are listed. On one hand, companies feel these are privileged information that should be kept away from competitors and do not have to be communicated as part of the listing agreement; on the other hand, banks – involved a ..

The 2015 law as well as the Sodhi panel say that “no insider shall communicate, provide, or allow access to any unpublished price sensitive information, relating to a company or securities listed or proposed to be listed, to any person including other insiders except where such communication is in furtherance of legitimate purposes, performance of duties or discharge of legal obligations.”

The Sodhi panel, which had submitted its report in 2014, also observed that “this provision is intended to impose an obligation not to make selective disclosures of such information except within the framework for fair disclosure set out in these regulations.” While this observation is missing in the 2015 Sebi Regulations, the regulatory stance (as spelt out by the Sebi official to ET) and the “fair practice code” in the law underscore the importance and obligation to share UPSI by corporates ra ..

Companies till now have ignored this. But if Sebi maintains its stand, shareholders and stock market investors may soon have access to a mountain of information that companies now keep close to their chest.

Many large, highstreet banks and finance houses are nonchalantly flouting insider trading rules while cutting deals to fund corporates that are listed on stock exchanges.

Capital market regulatory norms require a company to share with the public all information that it discloses to lenders and financiers — just as numbers of financial performance and ratios are divulged in M&As or placement of stocks once a deal is struck.

But, neither corporates bother nor banks insist on ..


In August 2000, the Securities and Exchange Commission (SEC) adopted new rules regarding insider trading (made effective in October of the same year). Under Rule 10b5-1, the SEC defines insider trading as any securities transaction made when the person behind the trade is aware of nonpublic material information, and is hence violating his or her duty to maintain confidentiality of such knowledge. Information is defined as being material if its release could affect the company’s stock price.

The following are examples of material information:

  1. The announcement that the company will receive a tender offer.
  2. The declaration of a merger
  3. A positive earnings announcement.
  4. The release of the company’s discovery such as a new drug.
  5. An upcoming dividend announcement.
  6. An unreleased buy recommendation by an analyst.
  7. An imminent exclusive in a financial news column.

In a further effort to limit the possibility of insider trading, the SEC has also stated in Regulation Fair Disclosure (Reg FD), which was released at the same time as Rule10b5-1, that companies can no longer be selective as to how they release information. This means that analysts or institutional clients cannot be privy to information ahead of retail clients or the general public. Everyone who is not a part of the company is to receive information at the same time.

Partners in Crime
In insider trading that occurs as a result of information leaking outside of company walls, there is what is known as the “tipper” and the “tippee”. The tipper is the person who has broken his or her fiduciary duty when he or she has consciously revealed inside information. The tippee is the person who knowingly uses such information to make a trade (in turn also breaking his or her confidentiality). Both parties typically do so for a mutual monetary benefit. A tipper could be the spouse of a CEO who goes ahead and tells his neighbor inside information. If the neighbor in turn knowingly uses this inside information in a securities transaction, he or she is guilty of insider trading. Even if the tippee does not use the information to trade, the tipper can still be liable for releasing it.

It may be difficult for the SEC to prove whether or not a person is a tippee. The route of insider information and its influence over people’s trading is not so easy to track. Take for example a person who initiates a trade because his or her broker advised him or her to buy/sell a share. If the broker broker based the advice on material non-public information, the person who made the trade may or may not have had awareness of the broker’s knowledge – evidence to prove what the person knew before the trade may be hard to uncover.

Excuses, Excuses
Oftentimes, people accused of the crime claim that they just overheard someone talking. Take for example a neighbor who overhears a conversation between a CEO and her husband regarding confidential corporate information. If the neighbor then goes ahead and makes a trade based on what was overheard, he or she would be violating the law even though the information was just “innocently” overheard: the neighbor becomes an insider with a fiduciary duty and obligation to confidentiality the moment he or she comes to possess the nonpublic material information. Since, however, the CEO and her husband did not try to profit from their insider knowledge, they are not necessarily liable of insider trading. In their carelessness, they may, however, be in breach of their confidentiality.

Since illegal insider trading takes advantage not of skill but chance, it threatens investor confidence in the capital market. It is important for you to understand what illegal insider trading is because it may affect you as an investor and the company in which you are investing.

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An “insider” is any person who possesses at least one of the following:

1) access to valuable non-public information about a corporation (this makes a company’s directors and high-level executives insiders)

2) ownership of stock that equals more than 10% of a firm’s equity

A common misconception is that all insider trading is illegal, but there are actually two methods by which insider trading can occur. One is legal, and the other is not.

An insider is legally permitted to buy and sell shares of the firm – and any subsidiaries – that employs him or her. However, these transactions must be properly registered with the Securities and Exchange Commission (SEC) and are done with advance filings. You can find details of this type of insider trading on the SEC’s EDGAR database.

American domestic guru and TV tycoon Martha Stewart went to jail for five months. When she was allowed out on probation, she wore an electronic ankle bracelet so that the police would know if she has stepped out of her house.

Her crime?:

She was told by her friend, Sam Waksal, that his company Imclone‘s cancer drug has been rejected by the food and drug administration. Before this information was made public, Stewart told her broker to sell her 4,000 shares in the company and escaped unhurt when the stock got hammered. The day after she sold the stock, it dropped 16 per cent to $46 and Stewart saved $45,673.

From the above example, it is evident that those trading on the basis of insider information have an opportunity to enter and exit at the correct time.

Finally, when the news goes public, the stock goes back to its realistic price level.

Result: an ordinary investor, with little information, is stuck with the stock at a price, which could be too high or too low, while those who have inside knowledge manage to make a packet and a safe exit.

  1. Corporate officers, directors, and employees who traded the corporation‘s securities after learning of significant, confidential corporate developments;
  2. Employees of law, banking, brokerage and printing firms who were given such information to provide services to the corporation whose securities they traded;
  3. Government employees who learned of such information because of their employment by the government; and
  4.  Other persons who misappropriated, and took advantage of, confidential information from their employers.
Definition: Illegal Insider Trading is the trading in a security (buying or selling a stock) based on material information that is not available to the general public.It is prohibited by the US Securities and Exchange Commission (SEC) because it is unfair and would destroy the securities markets by destroying investor confidence.

The CEO was convicted of insider trading because he told his daughter to sell her shares of his company’s stock the day before the public announcement of bad news that caused the stock price to fall sharply.

Insider trading is often equated with market manipulation, yet the two phenomena are completely different. Manipulation is intrinsically about making market prices move away from their fair values; manipulators reduce market efficiency. Insider trading brings prices closer to their fair values; insiders enhance market efficiency.

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