Insider Trading: Concept and Implications in the Stock Market

The term “insider trading” comes instantly into our minds whenever we speak about the stock markets, ethics, or financial regulations. Insider firms play a critical role in how the stock markets function and influence the individual investor and the finance system. The article explains the concept of insider trading, insider trading meaning, insider trading definition, its different forms, impact, regulation in India, and much more. It also discusses how the stock exchanges- the NSE insider trading and BSE insider trading and how they try to prevent and punish insider trading.

What is Insider Trading?

Insider trading is buying or selling stocks or other securities grounded on confidential, not public, information. The insider trading definition is pretty simple; somebody has traded securities using information not accessible to the public and likely to affect the stock’s price significantly. This kind of secret information is termed unpublished price-sensitive information or UPSI. It provides an insider who has access to such data before its release to the public unfair advantage.

Insider Trading Meaning

The insider trading meaning can take on the following two forms:

1. Insider Trading Legal: It is a state where firm insiders like executives and directors or significant shareholders buy or sell in the firm’s stock but do so within the rules provided.

For example, in India, SEBI requires company insiders to report any of their trades within a stipulated period. Therefore, such trades are also considered legitimate if they are done lawfully and in the open and are part of the regular market activity.

2. Illegal Insider Trading: This is the unethical and illegal type of insider trading. It involves using non-public information to generate a profit or avoid losses by trading a company’s stock before that information is publicly disclosed.

For example, if one company employee is given information about a merger that will increase its value and purchases shares before the public is informed of the merger, then illegal insider trading exists. Such behaviour breaches trust and distorts the equity of stock markets.

Insider Trading Regulations

To cope with the stringent laws regarding insider trading, most countries have their set of regulations, such as India. According to the Securities and Exchange Board of India Act 1992, insider trading regulations in India fall under the SEBI (Prohibition of Insider Trading) Regulations of 2015. The aim is that every insider or an outside investor follows the same rules while trading securities. Some of the essential aspects of the this regulations are as follows:

• Ban on disclosure of UPSI: No one in possession of unpublished price-sensitive information can pass it to anyone else unless for a permissible purpose. It thereby ensures that no one gets unfair access to confidential information.
• Restrictions on trades upon access to UPSI: No insider can trade in the shares of a company while accessing UPSI. For instance, if a company is about to report high profits, one should not buy or sell stock based on that before making it public.
• Reporting of trades: The insiders should report their trades in the stock to the regulatory bodies within some time frame. This can keep an eye on the regulators concerning the misuse of confidential information by the insider.
• Penalty for violation: SEBI can impose an enormous fine. The range may range between ₹10 lakh to ₹25 crore or three times the profit garnered through wrongful trading, whichever is higher. Such individuals involved in illegal insider trading might even face up to 10 years’ imprisonment.

To summarise what is insider trading, insider trading definition involves the use of confidential company information to gain an unfair advantage in the stock market. While legal insider trading is permitted if disclosed appropriately, illegal insider trading undermines market integrity and is subject to severe penalties.

NSE Insider Trading and BSE Insider Trading

The National Stock Exchange and Bombay Stock Exchange in India significantly contribute to detecting and preventing insider trading.

The exchange has been supplemented with monitoring systems that can raise the alarm regarding unusual trading patterns that may denote trading based on non-public information.

For instance, if vast amounts of stocks issued by a company are bought or sold within days before the information is broadcasted on the stock exchange, the exchanges will not hesitate to investigate any NSE insider trading or BSE insider trading cases.

• NSE Insider Trading: The National Stock Exchange engages with SEBI for follow-up on suspicious activities, and if someone is found trading on UPSI, then that person is reported to SEBI, and proper action is taken. All the monitoring systems by the NSE are so advanced that they detect any red flags early.
• BSE Insider Trading: The Bombay Stock Exchange also has such arrangements. BSE collaborates with SEBI and gets involved in investigations so that no investor is at a disadvantage in this market.

Both the exchanges are proactive, yet time and again, instances have cropped up where individuals have tried to manipulate these very processes. SEBI has been active in many high-profile cases, though enforcement and conviction can sometimes be an issue.

Impact of Insider Trading

The impacts of insider trading are as wide-ranging as they affect the individual investor and the financial market in general. Some possible impacts include;

1. Unequal Market: When insiders are free to use inside information for their gains, it throws the playing field off balance. The people who rely on public information- the average investors- are disadvantaged in such a market situation, and the market is not equal.
2. Loss of Trust: If investors hear about illegal insider trading, they lose confidence in the fairness of the market. Eventually, this loss of trust can result in fewer people investing in the stock market, reducing market liquidity.
3. Market Volatility: Insider trading can create more market volatility. Such non-public information often leads to sudden price changes, which confuse ordinary investors.
4. Legal Sanctions: Convicted criminals take the law through to imposition. The law with fines and imprisonment sentences them. Moreover, their professional reputation is marred because they will probably never work in the same industry again.

Prevention of Insider Trading

One of the best ways to avoid this is through solid regulation and very sophisticated monitoring systems, as in the case of the NSE and BSE. SEBI also plays a significant role by imposing fines and holding inquiries in the case of such unfair business practices. The aim is always to make the stock market fair and open to all investors.

Conclusion

Insider trading is another serious issue that breaks the foundation of integrity in financial markets. While legal insider trading is allowed under specific regulations, illegal insider trading may incur severe legal and economic consequences. SEBI takes a stringent approach to enforcement of insider trading rules in India to ensure all investors have an equal playing field.

The average investor who wants to stay on par and wants to experience a hint of what is insider trading, insider trading meaning, NSE insider trading and BSE insider trading would require one of the most reliable financial advisors. SMC Global Securities, for instance, can be a source of full service that will help the investor understand the nitty-gritty and the complications within the stock markets while adhering strictly to the rules and regulations.

FAQs

1. What do legal and illegal insider trading differ?

Legal insider trading is when insiders buy or sell their company’s stock, strictly in line with the regulations, and disclose their trades. Illegal insider trading occurs when some person utilizes non-public information to further their trade of the other company’s shares by selling or buying them before such information becomes public.

2. How do NSE and BSE prevent insider trading?

NSE insider trading and BSE insider trading have monitoring systems that detect unusual trading patterns, such as purchasing or selling a large quantity of a company’s stock before a significant announcement. It cooperates with SEBI to identify such activity and serves as a blow to insider trading perpetrators.

3. What are the penalties of insider trading in India?

SEBI also has the power to sentence wrong-doers to grotesque fines in the range of ₹10 lakh to ₹25 crores or three times the profits gained from such illegal trade. In addition, the convicted parties could also face imprisonment for ten years on charges of trading unlawfully.

4. What is the responsibility of an individual investor to safeguard himself?

In this regard, individual investors can take self-defence by being informed and knowing the latest news and developments made in the companies they are investing in. They should always be cautious of sudden price movements or abnormal trading activities. Further, consulting a financial advisor will lead the investor to more excellent and well-known decision-making guidance.

5. How do the effects of insider trading impact the stock market?

There are several ways through which the stock market gets negatively affected by insider trading. These include:
Unfair market: The playing field is uneven and favours insiders at an unfair advantage.

• Loss of trust: Insider trading may eventually be the reason for the decline of investor confidence in the principle of fairness in the markets.
• Market volatility: Insider trading may lead to some instances of sharp price fluctuations and increased market volatility
• Legal implications: when such offenders are apprehended, they undergo severe legal repercussions.

Author: All Content is verified by SMC Global Securities.