Insider Trading: SEBI Regulations & Penalties

In an attempt to tighten the grip on insider trading in India, SEBI, or the Securities & Exchange Board of India, has determined that it would broaden the definition of “connected persons” (insiders) who have easy access to company price-sensitive data and information. According to a recent decision, a “connected person” would also include anyone, be it a company or an employee, of which the “connected person” is a partner. Furthermore, any family member linked to a “connected person”, sharing a residence with them, would also be held accountable.  

Insider trading has been the bane of the stock market since its inception. When price-sensitive and confidential company information is used by certain company “insiders” to make profits, insider trading raises its ugly head. SEBI has revised its rules periodically in attempts to mitigate the ill effects of insider trading and make trading activity fair. In its amendment of the Prohibition of Insider Trading Regulations (PIT regulations), 2015, SEBI has broadened rules by replacing the words “immediate relative” with “relative” to make regulations more stringent and include any person linked to guilty parties. Insider trading is punishable, and as a trader and investor, you should know about SEBI regulations and penalties, should you come across this activity.  

What is insider trading? 

Insider trading is a global practice, but that does not make it right. To define it, insider trading is the activity of purchasing or selling company assets or securities, particularly trading of stock, by people who possess specific material and data, non-public information, regarding the company in question. These “insiders” may have unrestricted access to sensitive information, and they use it to make profits in securities markets, either for themselves or by transacting the information with interested third parties.  

In the financial markets of India, this practice has long since been a cause for contentious concern. While the term “insider trading” potentially evokes images of big corporate employees secretly making profits from knowledge within the company, the reality of the issue is more complex. Some kinds of insider-related transactions (insider buying stocks) may be legal in nature, while others may lead to high penalties and punishment. Basically, it is important to note that an “insider” is a person who is a part of any given company (at any level in the employment hierarchy) who is actively involved in trading the given company’s shares/securities, based on specific potentially beneficial information about the said company’s assets. It is important to note that they may or may not be in possession of the said company’s non-public information of some other nature.  

Furthermore, an insider trading stocks may be doing so legally or illegally, based on the time when the trading activity takes place, not to mention country-specific laws and regulations that govern trading practices.  

How does SEBI regulate insider trading? 

The Securities & Exchange Board of India (SEBI), the chief regulator of the Indian financial markets and related agencies, has put forth specific regulations and laws to safeguard trading activity by ensuring clarity about insider trading and its legality. Consequently, any individual falling within the following categories are required to avoid any form of trading in equities related to the firm or company in which they are employed and are classified as an “insider”:  

• Any employee of the concerned company 

• A connected person’s or insider’s immediate relatives 

• An associated firm or holding company that is directly connected to the company involved in insider trading 

• An executive employed with a holding company as mentioned above, or an executive belonging to a parent company 

• Any official employed by a clearing house or any stock exchange 

• Board members of an asset management company (AMC) or mutual fund house trustees 

• The chairman or a board member of a public financial entity  

Additionally, it is important to note that SEBI forbids the acquisition of Unpublished Price Sensitive Information (UPSI), unless the specific requirement is mandated by law or for the purpose of legal affairs. Furthermore, the prohibition of insider trading has been established according to Section 11 (2) of the Companies Act, 1956, and an insider trading penalty is levied for insider trading. The act further states that insider trading is to be prevented to offer equal opportunities to all participants in the financial markets, ensuring transparency and fairness in transactions, and allowing the seamless flow of authorised information. 

When is insider trading considered legal? 

Investors may find that insider trading is deemed legal in certain cases. Commonly, this takes place in companies whose employees are eligible owners of the said company’s stock. For instance, say, a senior executive of a particular company owns stocks of the company they are working for as the company offers the perk of stock options to employees. The concerned senior executive will retire soon, and can sell their stock. In case they, at a later period, come into contact with unpublished price sensitive information (UPSI), they have not engaged in any illegal activity. Consequently, this cannot be deemed a case of insider trading and is perfectly legal as the employee has not made the decision to sell their stock on the basis of the unpublished price sensitive information.  

According to recent amendments in SEBI regulations regarding insider trading, in case such instances take place in companies, the companies concerned must have secure plans to take action against lapses in internal company security and leakage of sensitive and confidential information.  

From the standpoint of SEBI’s rules and regulations, insider trading incurs hefty cash penalties to large sums of amounts, according to the specific activity. This potentially amounts to crores of rupees to certain percentages of the profits made via insider trading activity. SEBI continues to make amendments (most recently in 2024) to rules and regulations concerning insider trading as curbs are required for this rampant offence in most exchanges and financial markets.  

Conclusion 

You should note that all insider trading transactions may not be illegal but there is a very thin line between illegal and legal insider trading. The lines differentiating what can be done and what cannot be done are often blurred and this is why some people potentially attempt it. The safest way to trade is to avoid getting near any sensitive data or information when it comes to traded assets or securities, especially stocks. Furthermore, this should be practiced when price-sensitive material is potentially transmitted.  

As the Securities & Exchange Board of India constantly endeavours to refine its rules and regulations concerning this kind of trading, it may still take place at certain levels in corporations. On the positive and fair side, corporations, on their part, are required to stringently adhere to requirements of disclosure and the cautious planning of any trading activity, besides having a vigorous grasp of what comprises non-public and material information.