Batch 2023-26

White Paper on Legal Business

Issues
Insider Trading Laws

Harshvardhan Parmar, Lakshya Agrawal, Tanshq Rathod

Business Law
Prof. Harish Bapat

Paper Due Date

Jan 15, 2025
 Insider Trading Laws

DEFINITION
Insider trading is the buying or selling of a company's securities by individuals who possess
material, nonpublic information about that company.

Insider trading—the practice of buying or selling a company's securities based on material,

nonpublic information—has long been a contentious issue in financial markets. While the term
often evokes images of corporate executives secretly profiting from inside knowledge, the
reality is more complex. Some forms of insider transactions are perfectly legal, while others
can result in severe criminal penalties.

"The securities laws use 'insider' in different ways," said Marc Fagel, a lecturer at Stanford
Law School and former U.S. Securities and Exchange Commission (SEC) regional director.
"There are statutory insiders (officers, directors, 10% shareholders) who have certain legal
duties, but 'insider' for insider trading purposes is much broader."

KEY TAKEAWAYS

 Insider trading involves buying or selling a publicly traded company's stock based on
nonpublic, material information about that company.
 Material, nonpublic information is any undisclosed information that could substantially
impact an investor's decision to buy or sell a security.
 Illegal insider trading carries severe penalties, including potential fines, prison time, and
other penalties.
 Insider transactions occur all the time and are legal when they conform to the rules set
forth by the U.S. Securities and Exchange Commission (SEC).
 The SEC requires insiders to file reports of their trades, which are publicly available.
This article explores what constitutes insider trading, when it crosses the line into illegal
territory, and how regulators detect and prevent improper insider trading activities. By
understanding the rules and regulations around insider trading, investors can better protect
themselves and ensure they are operating within the bounds of the law. But it's also important
to see why these rules are so crucial to the market in the first place.

"Public trust is essential to the fair and efficient operation of our markets. But when public
company insiders take advantage of their status for personal gain, the investing public loses
confidence that the markets work fairly and for them," said Gurbir S. Grewal, director of the
SEC's Division of Enforcement.

UNDERSTANDING INSIDER TRADING

The notion of insider trading hinges on who is considered an "insider" and what constitutes
"material, nonpublic information," Fagel said. "It can be anyone with a duty to the company—
a low-level employee who is not a statutory insider still has a duty not to trade stock on
nonpublic information; a temporary insider (like a company outside lawyers and accountants)
who receives nonpublic information has a duty not to trade."

The SEC defines an insider as "an officer, director, 10% stockholder and anyone who
possesses inside information because of his or her relationship with the Company or with an
officer, director or principal stockholder of the Company."1 Such trading is illegal,
the SEC notes, when it's "the buying or selling a security, in breach of a fiduciary duty or other
relationship of trust and confidence, based on material, nonpublic information about the
security."

Given the above, we can define critical terms within insider trading rules as follows:

"Insiders"

 Corporate insiders: Officers, directors, and employees of a company.

 Significant shareholders: Those who own more than 10% of a company's securities.2
 Temporary insiders: Individuals who receive material, nonpublic information under
a duty of trust and confidence, such as lawyers, accountants, consultants, or other
professionals working with the company.
 Those who receive such information from insiders: Those who receive material,
nonpublic information from an insider and are aware or should be aware that the
information is not to be used to trade for profit.

"Material"

Material information is anything that could substantially affect an investor's decision to buy or
sell a security. Examples of topics traded on that led to SEC enforcement actions include the
following:

 Upcoming mergers or acquisitions

  Significant changes in financial performance
 New product launches or regulatory approvals
 Major changes in senior management

"Nonpublic"

This information hasn't been disseminated to the general public and is not readily available
through ordinary research or analysis. It's confidential or restricted to a select group of
individuals within a company or those with a special relationship to the company.

The Securities Exchange Act of 1934 was the first legislation in the U.S. to ban insider trading
that seeks to exploit nonpublic, material information for profit.

LEGAL CONTEXT

Key Laws and Regulations Governing Insider Trading

India:

 SEBI (Prohibition of Insider Trading) Regulations, 2015

o Established by the Securities and Exchange Board of India (SEBI) to prevent
unfair trading practices.
o Defines insiders, unpublished price-sensitive information (UPSI), and penalties
for violations.
o Key Provisions:
 Companies must establish a "Code of Conduct" to regulate insider trading.
 Designated persons (e.g., employees, directors) must not trade in securities
when in possession of UPSI.
 Mandatory disclosures of trades by promoters and key employees.

 Penalties under SEBI:

o Monetary fines, imprisonment (up to 10 years), and bans from trading in
securities.

USA:

 Securities Exchange Act of 1934

o Introduced by the Securities and Exchange Commission (SEC) to regulate insider
trading.
o Prohibits insiders (employees, directors, consultants, etc.) from trading on non-
public, material information.
o Requires public disclosure of material information to ensure fairness.

 Insider Trading and Securities Fraud Enforcement Act (1988)

o Strengthened penalties for insider trading violations.
 o Allowed SEC to impose civil penalties on violators and firms failing to prevent
insider trading.

 Case Study: Martha Stewart’s Case (2004)

o Famous example where Martha Stewart was convicted for insider trading and
obstructing justice, which led to her imprisonment and financial penalties.

Global Perspective:

 European Union: Market Abuse Regulation (MAR)

o Covers insider trading, unlawful disclosure of information, and market
manipulation.
o Mandates strict disclosure requirements for sensitive information.

 UK: Criminal Justice Act, 1993

o Defines insider trading as a criminal offense punishable by fines or imprisonment.

HISTORICAL BACKGROUND OF INSIDER TRADING LAWS

USA:

 1929 Stock Market Crash:

o Insider trading was rampant during the early 20th century, contributing to the market crash.
o The crash highlighted the need for stricter financial regulations, leading to the Securities Exchange Act of
1934.

 Landmark Cases:
o SEC v. Texas Gulf Sulphur Co. (1969): One of the first major cases where insider trading was prosecuted.

India:

 Pre-1992 Era:
o Insider trading was not explicitly regulated, leading to market manipulation scandals like the Harshad
Mehta Scam.
o The scam exposed the absence of robust legal frameworks to prevent insider trading.

 Post-1992:
o Establishment of SEBI with the power to regulate and enforce insider trading laws.
o Introduction of SEBI Insider Trading Regulations, 1992, later revised in 2015.

WHY INSIDER TRADING LAWS ARE IMPORTANT

1. Protect Market Integrity:

o Prevents unfair advantages and ensures a level playing field for all investors.

2. Safeguard Investor Confidence:

 o Transparent markets attract more investors and foster trust in the financial system.

3. Encourage Ethical Business Practices:

o Holds individuals and companies accountable for their actions, deterring unethical behavior.

CHALLENGES BUSINESSES FACE DUE TO INSIDER TRADING

1. Legal Risks and Penalties

Businesses are held liable for insider trading by their employees or stakeholders. Regulatory bodies like SEBI
(India) or SEC (USA) impose strict penalties, including hefty fines, lawsuits, and bans.

 Example: In 2017, Infosys faced scrutiny when an insider was accused of trading shares based on
confidential information. While the company had a compliance framework, it suffered reputational risks
due to regulatory investigations.

2. Reputational Damage

Insider trading scandals erode trust among investors, customers, and stakeholders. A tarnished reputation can
result in:

 Lower investor confidence.

 Difficulty attracting capital or partnerships.
 Negative media coverage.

3. Ethical and Cultural Dilemmas

A company involved in insider trading cases may face internal ethical issues:

 Employees may lose trust in leadership.

 It creates a toxic work environment where unethical behavior is normalized.

Example: In 2001, Enron Corporation executives used insider information to sell off their shares before the
company's collapse. The scandal revealed deep-rooted unethical practices, damaging employee morale and
leading to widespread layoffs.

4. Compliance Costs

To avoid insider trading, businesses must implement strict compliance mechanisms:

 Monitoring employee access to sensitive information.

 Conducting regular audits.
 Installing technological surveillance systems.
Example: Financial institutions like HDFC Bank incur significant costs to comply with SEBI's insider trading
regulations, such as maintaining a "restricted trading window" for employees during sensitive financial events
(e.g., earnings announcements).

Thank You