Know the world of 'insider trading'

Insider trading scams have become common in India. Few days back markets regulator Stock Exchange Board of India (Sebi) barred Future Group CEO Kishore Biyani and his brother from accessing securities market for a period of 1 year in a case pertaining to alleged insider trading between March and April 2017. Besides, Kishore Biyani has also been barred from buying, selling or dealing in securities of Future Retail for 2 years. Future Corporate Resources and the two Biyani brothers will each need to pay a penalty of Rs.1 crore within 45 days, reads the Sebi order.

Just yesterday, billionaire stock market investor Rakesh Jhunjhunwala has filed a consent application with the Sebi to settle an alleged insider trading case in the shares of Education Company Aptech Ltd dating to 2016.Aptech is owned 49% by Jhunjhunwala and his family.

Notably consent applications are out-of-court settlements over securities law violations. They are negotiated between the regulator and the entities concerned, without admission of guilt and without denial of liabilities, and involve the payment of a fee. The consent mechanism is a discretionary exercise on the part of the regulator.

Insider trading is a big menace and is most difficult to prove. It’s driven by most influential people who use listed company’s sensitive information before it is made public to get in a better position to make bigger gains in trading securities and shares. This practice is a nuisance which jeopardizes the interests of active investors who regularly track company disclosures and accordingly make investment decisions. It’s through this unfair and illegal way of using unpublished price-sensitive information (UPSI) which shakes the trust and confidence of common investors in the market.

Unpredictable and ever changing nature of stock market is not a new thing. It’s the market which lives with a life of its own, reacts to situations and leaves investors either reaping profits or with nothing at all. Though there are certain economic and financial indicators like inflations, interest rate scenario etc. that contribute to the movement of stock prices, a lot remains hidden behind this price movement game.

A listed company’s corporate information is one of the most vital things for an investor. Stealing of this corporate information especially by those who are custodians of such information and passing it on illegally to the selected people is one of the oldest crimes in the world of investments.

There is a famous insider trading case of Enron, the energy company. The company collapsed in 2001. The insider trading fraud wiped out its employees’ retirement accounts in four years and stunned the investors. Media reports highlighted that the company’s former CEO Jeff Skilling made a killing with a $89 million profit allegedly from the sale of artificially inflated Enron stocks and options.

Precisely, this illegal act of accessing the most confidential corporate information has seen many corporate bigwigs behind bars. Who can forget a US District Court judge in Manhattan some years back sentencing the prominent Indian-American business leader Rajat Gupta to two years in prison and imposing a fine of $5 million on the charges of stealing corporate information and passing it on illegally to the selected people.

As some big names in the corporate world have surfaced (and continue to surface) for allegedly using ‘insider trading route’ to make hay at the cost of common investors’ plight, it makes a sense for general investors to know the operational modus operandi of the scam.

What is insider trading?

Insider trading is simply a white-collar crime. It ‘implies buying, selling and dealing in shares and securities of a listed company by insiders such as directors, designated officers of management team, employees of the company or any other connected persons such as auditors, consultants, lawyers, analysts who possess material inside information which is not available to general investors’.

This trading takes place when those privileged with confidential information about important events use the special advantage of that knowledge to reap profits or avoid losses illegally and unethically in the stock market, to the detriment of the source of the information and to the typical investors who buy or sell their stock without the advantage of inside information.

Is it legal in any form?

Insider trading is legal only up to the point when trading is done without taking advantage of the non-public information some high profile employees have access to. It will be considered illegal the moment trading is manipulated to make profits or avoid loss based on the non-public information and thus potentially harming the other investors.

Can an outsider using a piece of information in the market to reap benefits revealed to him/her by an insider of a company, be held responsible for insider trading?

Let me explain. Any management official or any employee having access to price-sensitive information of a company shares some kind of material information of the company with you which is yet to be made public and can have impact on the share price of the company. By virtue of this communication, you are now every bit as much an insider as he is, with respect to that information. Firstly, it is illegal on part of the company’s employees to share the company’s material information with you before it becomes public knowledge. Secondly, it is equally illegal for you to do so because you are now a “temporary insider”. This remains true regardless of how many times the information is passed. Legally, anyone who has material information is prohibited from trading, based on that knowledge, until the information is available to the general public.

Precisely, by virtue of Sebi rules, an insider can be a person who is in possession or has access to unpublished price sensitive information (UPSI); his or her immediate relatives will be presumed to be “connected persons”. So, even if an insider gives trading tips to an outsider to buy or sell stocks of the company and help them make profits or to avoid loss it is to be considered as illegal insider trading. And most importantly, the onus will be on accused (insider) to prove his or her innocence.

How does insider trading works?

It’s simple. An insider in a company first buys the stock, then shares price-sensitive information with a small group of people who buy the stocks and spread the word. This leads to a huge artificial demand for the particular stock which results in higher prices. At a certain point when the prices hit the ‘satisfactory’ level the insider exits along with his small group of people and make profits. Soon the stocks witness fall resulting in huge losses for the public investors.

What is its impact on the market?

Insider trading leaves negative impact for both the small investors and for the markets. Since there is no fair play involved in this kind of trading and no fair demand and supply of stocks, it is all detrimental to the functioning of a healthy stock market. This white collar crime weakens the faith of investors in the investing system and the menace could keep off people from investing. This could ultimately harm the economy as a whole.

What should be done to curb this menace?

Sebi regulations are in place to curb insider trading. However, it’s very important for all important functionaries of a company not to share material information with anyone who is not an insider. Simultaneously they have to make sure all insiders understand the responsibility this places on them. Make sure everyone in the company understands the circumstances under which they might become “temporary insiders’ and how they must treat that situation.

How a common investor can save himself from this menace?

An investor you should be cautious to avoid getting into the dilemma of insider trading scams. You should never invest in a company that you have never heard of even if you get an attractive tip-off about the company.