INSIDER TRADING

What is Insider Trading?

Securities trading by insiders based on material non

public information in violation of a fiduciary or
similar duty of trust and confidence to the company
issuing the security, to the company’s shareholders or
to the source of information
 Benefits of Insider Trading to
Insiders
 Make Profits
- James O’Hagan made a profit of more than
$4.3 million

 Avoid Losses
- Martha Stewart avoided a loss of $45, 673
 Who are Insiders?
Types of Insiders

Primary Insiders Secondary Insiders

Classic Constructive Tipee Accidental

Corporate Insider Insider
Insider
 PRIMARY INSIDERS

Classic Corporate insiders

 Directors

 Officers

 Shareholders holding substantial no. of shares

(10%)
 PRIMARY INSIDERS…contd.

Constructive insiders
Persons who are not employed by the
corporation but receive confidential
information from a corporation while
providing services to the corporation.
e.g. professional advisers, lawyers, investment
bankers
 SECONDARY INSIDERS

Accidental Insiders
Not liable for insider trading unless their
behavior proves otherwise
 SECONDARY INSIDERS
Tippee
Tipper Tippee

material price sensitive information

 No direct fiduciary relationship to the company or its

shareholders
 Tippee assumes a fiduciary duty to the shareholders of a
corporation not to trade in securities if the tippee knows or
should have known that the tipper has breached a fiduciary
duty

Dirks v. SEC
 Who are Insiders?
SEBI Defn.
A person who is or was connected to a
company or deemed to have been connected
with the company, and is reasonably expected
to have access to unpublished price sensitive
information in respect of securities or who has
received or has had access to such unpublished
price sensitive information.
 Insider - SEBI Defn
Connected Person Deemed to be Connected Person
Director Companies under the same management

Officer Specified Intermediaries

Professional relationship with Director/employee of public financial

the company institution
Official/employee of an SRO

Relative of the above

Banker to the company

Relatives of connected persons

Entities where connected persons/deemed

to be connected persons have > 10%
interest
 Who are Insiders?

Should corporates be included as Insiders?

- Some jurisdictions cover only individuals

- Subjecting corporates to sanctions motivates

them to introduce higher standards
 Violation of fiduciary a duty

The corporate insider by accepting employment has

made a contract with the shareholders to put the
shareholders interest before their own in matters
related to the corporation.

A duty to disclose inside information does not arise

merely by possession of the information but by the
existence of a fiduciary duty
 What is material price sensitive
information?
SEBI Defn.
 Periodical financial results of a company

 Intended declaration of dividends (both interim and

final
 Issue of securities or buy back of securities

 Any major expansion plans or execution of new

projects
 Amalgamation, mergers or takeovers

 Disposal of whole or substantial part of the business

 Any significant change in the policies, plans or

operations of the Company
 What is material price sensitive
information?……….contd.
In the US
Information of such a nature that someone who has
inside knowledge of it could be expected to trade
successfully in the securities in question and make a
profit or avoid losses

Malaysia/Singapore
Information that a reasonable person would expect to
have a material effect on the price of securities
 Misappropriation Theory
Anyone who misappropriates (steals) information from their
employer and trades on that information in any stock (not just
their employers stock) is guilty of insider trading

Misappropriation theory is a part of US Law

Can also be found in Indian Law

(Code for Prevention of Insider Trading by specified
intermediaries)

US v. James O’Hagan
 Methods of prevention of Insider
Trading
 Disclosure of interest by corporate insiders

Listed companies
Persons holding more than 5% of the shares/voting rights
(if change exceeds 2% of total voting rights)
Directors and Officers

(if change exceeds Rs. 5 lakhs/25000 shares/1% of capital

Other entities

Initial statement of holding
 Periodic statement of holding
 Methods of prevention of Insider
Trading
 Disclosure of Price Sensitive Information

- Different jurisdictions – different methods

1. By transmission of the information to a

news agency

2. By dissemination of the information by

the stock exchange
 Methods of prevention of Insider
Trading……contd.
 Limited access to price sensitive information
“Need to know basis”

 Chinese Wall
 Separate inside areas from public areas
 Bringing over the wall
 Methods of prevention of Insider
Trading……contd.

 Trading window facility

 Decided by the company
 closed during the time price sensitive information is un

published
 Opened 24 hours after the information is made public

 Exercise of ESOPs allowed

 Methods of prevention of Insider
Trading……contd.
Minimum holding period
 Securities to be held for minimum period
of 30 days to be considered as investment
 Also applies to IPO allotment (30 days
from the date of allotment)
 Can be waived of only in the case of
personal emergency
 Issues in the case of derivatives
 Methods of prevention of Insider
Trading……contd
 Restricted listed
only applicable to specified intermediaries

 Pre-clearance of trades
All directors / officers / designated employees to pre
– clear their trades
Pre-clearance to be given by Compliance Officer
Valid for one week
 Methods of prevention of Insider
Trading……contd.

 Pre-clearance of trades/Restricted

Prevents Front Running

 Pre – clearance vis-a vis Research Ananlysts

 Legal v/s Illegal Insider Trading
 Legal Insider Trading
- Trading after due disclosures
- Trading by accidental insiders
- Trading by tippees without a fiduciary duty

 Insider Trading
- Trading in violation of the rules & regulations
- Trading by tippee knowing that the tipper is
violating a fiduciary duty
 Why forbid Insider Trading?
 A Company’s information is its own property-
others should not profit from it
 It disrupts market efficiency
 Unfair competition to speculators outside the
company
 It undermines investor confidence in the
fairness and integrity of the securities market
 Penalties
US

Civil Penalties
4. 3 times profit made/loss avoided
5. Controlling persons -3 times profit made/loss
avoided or $1 million (higher)
6. Injunctions

Administrative Penalties
 Cease and desist order
 Penalties
Criminal Penalties

 Natural persons - Fine upto $5 million and/or

20 yrs imprisonment
 Other entities – fine upto $25 million
 Penalties
In India – for violation of code of conduct
By the organisation
 Disciplinary action
 Wage freeze
 Suspension
 Monetary penalty
By SEBI
 Unlimited Powers – ANY action
THANK YOU