Insider Trading

 

                         Insider Trading

 

      On June 9, 2010, the Stock Market Regulator of India (Sebi) fined Mr. Manmohan Shetty, the promoter of Adlab Films Limited, Rs.1 crore for the offense of Insider Trading. On 23 April 2006, the meeting of the Board of Directors of the company was held. It was decided to demerger the FM Radio business of that company to a wholly owned subsidiary. As the promoters are sure that the market price of the company's shares will decrease as a result, Mr. Shetty sold one million shares of his company within 24 hours after the meeting of the board of directors. On 24/4/2006 at 10.11 am Rs. 402.6 per share and saved his huge losses. So the investors who bought these million shares due to lack of this information, had to bear the loss due to falling share prices. This incident once again brought the subject of Insider Trading into discussion.

Insider Trading - ref

 

       Trading in these terms means buying or selling of shares in the secondary stock market. And Insider means the insider of the company.Insider Trading means selling or buying more shares in the stock market by the insider of the company owned by himself or his relatives/friends. Some information, decisions or events of the company are such that it affects the business and profits of the company. Decisions/events/information that increase the company's business and profits increase the market demand for the company's shares and (according to the law of supply and demand) its market price goes up. Conversely, if the news/incident/decision will reduce the company's business and profits, the demand for the shares will decrease. Shareholders start selling shares, the supply of shares in the market increases and consequently.

   Market prices of shares fall. When this information or decision/event about the company is announced or published, it is available to all and the shareholders can take decision about their shares keeping in mind its effect. But before such information is released to everyone, some people in the company know a little in advance. They are called insiders of the company. If they get the information first, they take decisions to increase their profit or reduce their loss by buying/selling shares before other shareholders get the information. This is called insider trading. Insider trading is banned worldwide to protect the interests of ordinary investors. Insider trading has been stopped in India by passing (Prohibition of Insider Trading) Regulations, 1992 by SEBI.

Who is the insider?

   A person currently or formerly associated with a company who has access to sensitive, unpublished information affecting the market price of the company's shares is called an insider. This may include directors, officers, key employees or major shareholders of the company.

   

     Incumbents know something more about the company because of their position. People in the Research and Development (R&D) department come up with ideas for the company's future projects. Those who work to send the decisions of the board of directors to the media also get information in advance. Although the company's brokers, bankers, lawyers are not employees of the company, they also have access to some information before it becomes public. All these can be called Insiders.

 

What is sensitive information?

 

Sensitive information that changes the market price of a company's shares.

  E.g.  Company Quarterly/Half-Yearly/Annual Statements (Profit/Loss), Amount of Dividend, Issue of New Shares, Repurchase of Shares by the CompanyExpansion plans, merger of the company, sale of a division of the company, penal action against the company by the government level etc.

 

   Insider buying and selling of shares is completely legal. But an insider is bound by law when he buys and sells shares for his own benefit based on unpublished information. Insider is in a sense a trustee of the shareholders. He acts contrary to his role as a fiduciary of shareholders when he uses undisclosed information from his position for his own benefit. Such information can be used by themselves, relatives, friends and family to their advantage and to the detriment of ordinary investors, (who are not aware of it). Information asymmetry is the foundation of Insider Trading. Responsibilities:

   Insider trading is a very difficult thing to prove. Although restricted by law, those who have access to such information are ethically expected not to engage in insider trading. Moreover, such information should not be discussed (shared) with anyone until it is published. Sometimes information spreads through such discussions in the market.

 

    In India, SEBI has made a provision under Rule 13 (6) of the Prohibition of Insider Trading Regulations 1992 to provide certain information to SEBI. According to Rule 13 (4), directors and officers of companies have to inform SEBI about their shareholding.

   It mainly includes purchase/sale of shares, number of shares, date, share purchase and sale and shareholding ratio. By studying the information in such statement, SEBI can decide whether insider trading has taken place or not.

   In the year 2007, there was a merger of 90 large companies in the United States. Out of them, the shares of 37 companies were traded in an unusual amount for a few days before the merger decision was announced. This was the experience with the shares of companies such as Enron and World Com. In IndiaIn January 2007, IFCI's share price was Rs. It was 13.45. Due to various inside information it increased to Rs. Went from 70 to 74. Expectations of IFCI's strategy sale failed and prices fell sharply.

 

   In 1996 Hindustan Liver Ltd. This company Brook Bond Lipton et al. 8 lakh shares of the company were purchased. And just two weeks later, the two companies merged. Sebi investigated the transaction in 1997 and convicted the chairman, all executive directors and the company secretary of Hindustan Lever for insider trading. Criminal action has been initiated against 5 directors (Common Directors) who are also directors of both the companies. Hindustan Liver then appealed to the Appellate Authority and the appeal was decided in favor of Hindustan Liver.

 

  In short, those who get undisclosed information about the company because of their position or close relationship with the company, use it to buy and sell shares of the company for their own benefit, it is called insider trading. Such transaction changes the market price of the company's shares and if there is no undisclosed information, common investors suffer losses. Insider trading is prohibited to protect their interests. But the experience is that it is difficult to prove that Insider Trading has taken place. In many cases the actions taken by SEBI have been overturned in appeal. Just like protecting the interest of the investors with the help of the law, the way of awakening the sense of fiduciary role of the concerned people should also be followed. It may also create ethical dilemmas for other forms of insider trading.