AN ASSIGNMENT
ON
INSIDER TRADING
SUBMITTED
as
Partial fulfilment for the Internal Assessment of the DSE-2 Optional Paper
“Investment Management” of Part 2, B.Com.(H),
DEPARTMENT OF COMMERCE,
INDRAPRASTHA COLLEGE FOR WOMEN
UNIVERSITY OF DELHI
TO
MS. T. JEYA CHRISTY
On
(15/02/2025)
BY
NAME: ASHMITA KUSHWAH
COLL. ROLL NO.: 23/COM/025
EXAM. ROLL NO.: 23029504025
SEMESTER: IV
SECTION: A
Table of Contents
Introduction .................................................................................................................................................................................. 3
Definition ........................................................................................................................................................................................ 3
Insider ......................................................................................................................................................................................... 3
Unpublished Price-Sensitive Information (UPSI) .................................................................................................... 3
How Does Insider Trading Work?........................................................................................................................................ 3
Insider Trading and Ethics...................................................................................................................................................... 4
Arguments Against Insider Trading (Unethical Aspects) ....................................................................................... 4
Arguments in Favor of Insider Trading (Ethical Justifications) ......................................................................... 5
Insider Trading: ........................................................................................................................................................................... 5
When Is It Legal? ................................................................................................................................................................... 5
When Is It Illegal?.................................................................................................................................................................. 5
Impact on the Market: .............................................................................................................................................................. 6
Regulatory Framework and Key Provisions of SEBI (Prohibition of Insider Trading) Regulation 2015:
......................................................................................................................................................................................... 6
CASE STUDY - Hindustan Lever ltd v. SEBI ..................................................................................................... 7
Conclusion ..................................................................................................................................................................... 8
Bibliography ................................................................................................................................................................. 8
Introduction
Insider trading is a controversial practice that has long captivated investors, authorities, and the general
public. It includes purchasing or selling shares based on important secret information that gives some people
a disproportionate advantage in the world of finance. These people, often known as insiders, have special
access to information that could include impending corporate statements, financial outcomes, or significant
events that could significantly impact the price of a company's shares.
Insider trading is a significant ethical and legal concern in financial markets. It refers to the buying or selling
of a public company’s securities by individuals who have access to non-public, material information. This
practice has been widely debated in the financial world due to its impact on market fairness and investor
confidence.
Understanding insider trading requires analysing legal frameworks, ethical considerations, and financial
consequences. This assignment aims to explore these aspects in depth.
Definition
Insider trading is the buying or selling of a company's securities by individuals who possess material,
nonpublic information about that company.
“Insider”
"The definition of an “insider” is broader than just corporate executives or board members. It includes:
Insider means any person who is:
i. a connected person; or
ii. in possession of having access to unpublished price sensitive information.
Connected person
1. any person who is or has during six months prior to the concerned Act has been associated with a
company, directly or indirectly;
2. in any capacity including by reason of frequent communication with ots officers or by being in any
contractual, fiduciary or employment relation; or
3. is a director, officer or an employee of the company or holds any position including a professional or
business relationship between himself and the company, whether temporary or permanent; or
4. that allows such person, directly or indirectly, access to unpublishes price-sensitive information or
reasonably expected to allow such access.
Unpublished Price-Sensitive Information (UPSI) is :
• Non-public information that is inaccessible to the general populace, and
• Capable of materially influencing the market price of a company’s securities upon disclosure.
Price sensitive information includes:
1. Periodical financial results of the company;
2. Intention to declare dividend;
3. Issue or buy-back of securities;
4. Expansion plans, project managers, amalgamation, etc;
5. Significant changes in policies, plans of the company;
6. Changes in Key Managerial Person.
How Does Insider Trading Work?
Insider trading often entails actions that enable those with access to confidential information to profit from
it. An outline of the process of insider trading is provided below:
● Information Acquisition: Through their positions or connections, insiders, such as corporate executives
or employees, can access sensitive and essential information about a corporation. Information that could
substantially impact the company's stock price includes forthcoming mergers and acquisitions, financial
results, regulatory clearances, product developments, and other information.
● Decision Making: Insiders decide whether to buy or sell securities using non-public information as a
basis for their judgements.
● Execution of Trades: Insiders carry out their trades through brokerage accounts or other channels to
profit from the expected price movement brought on by the privileged information. To hide their connection,
they may purchase or sell the stocks directly or indirectly through relatives, friends, or offshore accounts.
● Gaining Profit: When relevant information is made public and affects the stock price, insiders can either
sell their holdings for a profit at a higher price or avoid losses before the stock price decreases.
Information Acquisition Decision Making
Gaining Profit Execution of Trades
Insider Trading and Ethics
Arguments Against Insider Trading (Unethical Aspects)
1. Unfair Advantage & Market Inequality
Insider trading creates an information asymmetry, where insiders (executives, managers) have access to non-
public information that gives them an unfair advantage over regular investors.
This violates the principle of a level playing field, making markets unfair.
2. Violation of Fiduciary Duty
Corporate insiders have an ethical and legal fiduciary duty to act in the best interests of shareholders.
Using privileged information for personal gain betrays this duty and harms shareholders who do not have the
same access.
3. Harm to Market Integrity & Trust
The perception that some traders have unfair advantages reduces investor confidence in the market.
If people believe markets are manipulated by insiders, they may withdraw from investing, reducing liquidity
and efficiency.
4. Contradiction to Free Market Principles
Free markets rely on equal access to information. Insider trading disrupts this principle by allowing select
individuals to profit at the expense of others.
The paper argues that markets should be based on publicly available information, ensuring fair competition.
5. Violation of Property Rights & Misappropriation of Information
Insider information is considered a company asset and not personal property. Using this information without
consent is misappropriation and therefore unethical.
Misusing private company data for personal benefit breaches both ethical and legal standards.
Arguments in Favor of Insider Trading (Ethical Justifications)
1) Enhances Market Efficiency
Some scholars argue that insider trading helps in the faster adjustment of stock prices to reflect their true
value. By incorporating private information into stock prices sooner, insider trading may reduce market
inefficiencies.
2) Encourages Managerial Effort & Incentives
Proponents claim that allowing insider trading provides an incentive for executives and managers to work
towards enhancing company performance, as they too can benefit from increased stock value.
3) A Natural Right in Capitalism
The paper mentions a libertarian perspective, which argues that individuals have the right to use their
knowledge to trade, just like any other form of skill or expertise.
Some scholars view insider trading as a legitimate economic activity rather than an ethical violation.
4) Not Always Harmful
The utilitarian perspective suggests that if insider trading results in a positive-sum game (more winners than
losers), it may not always be unethical.
Some argue that insider trading does not always harm other investors, especially when it does not involve
fraud or manipulation.
Final Ethical Assessment
The general consensus in modern finance and law is that insider trading is unethical due to its negative
impact on market fairness, investor trust, and corporate integrity.
Insider Trading:
When Is It Legal?
Pulling the above together, insiders can legally trade their company's stock under the following conditions:
1. When trading is based on public information: After a corporate announcement, insiders can trade
based on this now-public information.
2. Through pre-established trading plans: In 2000, the SEC introduced Rule 10b5-1, which allows
insiders to set up prearranged trading plans. These plans must be established when the insider
doesn't have material non-public information. The plan must either (1) expressly specify the
amount, price, and date of trades; (2) provide a written formula, algorithm, or computer program for
determining amounts, prices, and dates; or (3) give all discretion regarding the power to execute
securities transactions to an independent body or person.
3. When the "insider" has filed SEC Form 4: This must be provided to the SEC to report changes in
their ownership of the company's securities, Fagel said. This includes transactions such as
purchases, sales, or exercises of stock options. Under SEC regulations, insiders are defined as
officers, directors, or owners of more than 10% of a company's stock. They are required to file
Form 4 within two business days of relevant transactions.
When Is It Illegal?
Insider transactions are illegal when individuals with access to material, nonpublic information use that
privileged knowledge to trade securities. The elements of insider trading often include the following:
1. Trading by insiders: For example, if a CEO sells shares after learning of an impending financial
loss before that information is made public, this constitutes illegal insider trading.
2. "Tipping": This involves an insider sharing confidential information with another person (the
"tippee"), who then trades on that information. Both the tipper and the tippee are liable for insider
trading violations.
3. Misappropriation: This is the word used when individuals who are not traditional insiders, such as
lawyers or consultants, obtain confidential information through their work and use it for trading
purposes.
4. Front-running: This occurs when a broker or analyst uses advance knowledge of a pending order
to trade for their own account before filling client orders.
Impact on the Market:
1. Integrity of the financial markets - The practice of insider trading undermines the integrity of the
financial markets because it gives some market participants an unfair edge over other players. The
concepts of transparency, equal access to information, and fair competition are all undermined as a
result of this.
2. Confidence of the investors - Investors need to have faith that they are participating in markets
where information is given in a manner that is both fair and unbiased. The practice of insider trading
undermines the confidence of investors because it gives the impression that certain market
participants have an unfair advantage and that competition is not being conducted on an equal
playing field.
3. Efficiency - Both the efficiency and the liquidity of the market are susceptible to being distorted
when insider trading occurs. It is possible for the market to have mispricing of securities and
inefficient resource allocation if insiders frequently trade based on non-public information. This
situation can lead to insider trading.
4. Liquidity - The widespread belief that the markets are manipulated as a result of insider trading
tactics can discourage individual investors and other smaller market players from engaging in trading
activities. Because of this, the market's liquidity and diversity of players may suffer as a result.
5. Rise in regulation cost - Instances of insider trading provoke regulatory authorities to step up their
monitoring and enforcement activities, which leads to increased regulatory scrutiny. This may result
in greater expenses of compliance for businesses as well as a heightened emphasis on responsibility
and transparency.
Regulatory Framework of Insider Trading in India:
Regulatory Framework and Key Provisions of SEBI (Prohibition of Insider Trading) Regulation, 2015:
India's Securities and Exchange Board of India (SEBI) regulates insider trading and oversees the securities
market. SEBI's mandate includes developing and enforcing regulations to safeguard market integrity, protect
investor interests, and promote fair and transparent market activity. SEBI is responsible for preventing and
deterring insider trading by enforcing strict regulations. The SEBI (Prohibition of Insider Trading)
Regulation, 2015 is a key component of SEBI's regulatory framework, governing insider trading operations
in India. The legislation includes provisions to combat insider trading, promote transparency, and strengthen
market integrity.
Key provisions of the SEBI (Prohibition of Insider Trading) Regulation, 2015, include:
i. Definition of Insider Trading: The regulation prohibits insider trading and the sharing of unpublished
price-sensitive information by insiders.
ii. Prohibition on Insider Trading: The legislation prevents insiders from trading securities based on
unpublished price-sensitive knowledge, providing fairness for all market participants.
iii. Disclosure Requirements: Insiders must disclose their trading activities and shareholding positions to
approved authorities within prescribed periods for transparency and accountability.
iv. Trading Window and Blackout Periods: The regulation allows insiders to trade securities during
designated windows, with specified limits. Insiders are not allowed to trade outside of designated
trading windows to prevent illicit transactions based on confidential knowledge.
Securities Appellate Tribunal:
It is a statutory body established under the provisions of Section 15K of the SEBI (Securities and
Exchange Board of India Act), 1992 to hear and dispose of appeals against orders passed by the
Securities and Exchange Board of India, regarding imposition of penalties or by an adjudicating officer
under the Act and to exercise jurisdiction, powers and authority conferred on the Tribunal by or under
this Act or any other law for the time being in force
CASE STUDY - Hindustan Lever ltd v. SEBI
Facts
Both Hindustan Lever Limited (HLL) and Brooke Bond Lipton India Limited (BBLIL) were managed by
the same parent company, Unilever Inc. of the UK. On March 25, 1996, HLL paid UTI 8 lac shares of
BBLIL at a price of 350.35 rupees each. 25 days after the purchase transaction, a merger announcement was
made. HLL made a statement about the merger with BBLIL and informed the stock exchanges. Following
the merger, the share price of BBLIL increased by Rs. 50 per share.
The market and the media both alerted SEBI about the leak of merger-related information and insider
trading. Due to the investigations SEBI had conducted, it was discovered that HLL had violated the terms of
the Insider Trading Regulations and the SEBI Act by purchasing BBLIL securities from UTI as an insider on
the basis of unpublished price sensitive information (UPSI) regarding the pending merger. Consequently,
UTI suffered losses.
By using its authority granted by Section 11 B of the SEBI Act in conjunction with Regulation 11 of the
Insider Trading Regulations, SEBI ordered HLL to make up any losses that UTI had incurred. The losses
incurred by UTI were estimated by SEBI to be worth Rs. 3.04 crores. The difference between the market
price of the BBLIL shares at which UTI sold them to HLL before and after the merger announcement,
excluding premiums, served as the basis for this calculation. UTI and HLL appealed the SEBI's decision
separately to the appellate authority.
Issue
One of the main issues up for discussion before the appellate authority in this case was the definition of the
term "Insider" under Regulation 2(e) of the Insider Trading Regulations. In this regard, the appellate
authority noted that the term "insider" should include the following three components:
1. The person must be an individual or other legal entity.
2. The individual must be related to someone else or be assumed to be related.
3. The connection should be used to acquire UPSI.
4. The SEBI had also interpreted in its order the third requirement of acquisition of UPSI by the
Insider by virtue of the connection with the Company by envisaging two alternative
situations: Where the Insider is actually received or had access to such UPSI.
Judgement
The following reasons, however, led the Appellate Authority to overrule SEBI's decision: Since the market
was aware of and acknowledged the merger news, it was not a UPSI. The price at which the transaction was
completed could not be significantly impacted by information about a merger. SEBI's decision to
compensate UTI was procedurally flawed. SEBI's directive to HLL to make up for UTI shortfalls Because
the order failed to specify the justification for the prosecution, SEBI failed to specify the rationale for the
prosecution, and SEBI failed to use specific adjudication powers under Section 15 G of the SEBI Act,
SEBI's direction for prosecution under Section 24 of the SEBI Act was inappropriate. Therefore, the
Appellate Authority reversed SEBI's decision to charge HLL.
Some other prominent landmark cases -
Case 1: Harshad Mehta Scam
Harshad Mehta, often referred to as the “Big Bull” of Dalal Street, was involved in one of the most infamous
market manipulation and insider trading scandals in India.
Background
Harshad Mehta used his influence to manipulate stock prices by exploiting loopholes in the banking system.
He used money from banks to artificially inflate stock prices, benefiting from the subsequent rise in his
portfolio value.
Impact
His actions led to a massive stock market crash in 1992, resulting in losses amounting to thousands of
crores. The scandal not only affected individual investors but also shook India’s financial system.
Case 2: Ketan Parekh Scam
Ketan Parekh, a former stockbroker, was involved in a high-profile insider trading scandal in the early
2000s.
Background
Ketan Parekh manipulated stock prices through circular trading and secured funds from banks and financial
institutions to inflate stock prices of select companies.
Impact
The collapse of these manipulated stocks led to a market crash in 2001, causing substantial financial damage
to retail investors and financial institutions.
Case 3: NSEL Scam
The National Spot Exchange Limited (NSEL) scam involved several high-profile individuals in a case of
insider trading and financial irregularities.
Background
Key executives of NSEL were involved in fraudulent practices, including misrepresentation of trading
volumes and manipulation of stock prices.
Impact
The scam resulted in a massive financial collapse, affecting thousands of investors and leading to a
crackdown on regulatory loopholes.
Conclusion
Insider trading, with its intricate blend of legal, ethical, and financial dimensions, remains one of the most
challenging issues confronting modern financial markets. Its practice—wherein individuals leverage
confidential, non-public information for personal gain—not only disrupts the fairness of market operations
but also erodes investor trust. Despite the robust regulatory frameworks established by bodies like SEBI and
the SEC, the persistence of insider trading underscores the need for continuous vigilance and adaptive
enforcement mechanisms.
Bibliography
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Bhattacharya, U., & Daouk, H. (2002). The world price of insider trading. The journal of Finance, 57(1), 75-
108.
Scheppele, K. L. (1993). " It's Just Not Right": The Ethics of Insider Trading. Law and Contemporary
Problems, 56(3), 123-173.
Doffou, Ako. (2007). Insider Trading: A Review of Theory and Empirical Work.
Mohmmed, John & Shaik, John. (2023). Insider Trading and Its Implications for Corporate Governance and
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