Insider Trading Meaning: What It Is And Why It Is Illegal

Curious about which trading style might help you avoid an offence? Well, here is your answer. Due to the inherent inequality, insider trading is now one of the most serious crimes in the stock market. 

Since only a chosen few can engage in trading using sensitive information not known to the general population, this creates an unequal playing field in the stock market.

For instance, let us consider an individual who works at a firm and happens to know confidential information about an impending merger of a firm with another entity. 

He uses the information before it is publicly known to invest in stocks, anticipating an increase in their value. After the news was publicly disclosed and there was a subsequent rise in stock prices, he made a profit at the expense of other people who did not have access to such information.

What Is Insider Trading

Insider trading means the purchase or sale of securities of a firm based on unpublished information. This can affect the value of the securities and is not accessible to everybody. Since such information is expected to have a direct effect on stock values once released to the public, its use in making trading decisions is considered unfair.

Insiders are individuals, including promoters, directors, officers, employees, auditors, and consultants, who know confidential matters. As per the guidelines laid down by the Securities and Exchange Board of India, even those people who obtain such information through insiders can also be regarded as insiders¹.

Who Qualifies As An Insider?

The term 'insider' generally involves promoters, directors, employees, auditors, consultants, and any other person connected with the business. These individuals are privy to confidential information. According to the regulations laid down by the Securities and Exchange Board of India, people who receive unpublished price-sensitive information, even indirectly, such as through personal contacts, can also be treated as insiders.

How Insider Trading Works

Insider trading generally begins with being privy to unpublished price-sensitive information (UPSI). This may consist of information that has the capacity to influence the stock value of a business when made public. UPSI includes quarterly earnings reports, mergers or acquisitions, new contracts or agreements, changes in management, or regulatory permissions. Trading based on such information gives an investor an undue advantage over others.

Use Of Unpublished Price-Sensitive Information (UPSI)

So, what does UPSI basically mean? UPSI is private information about the company that is not available to the general public. This information can affect the stock prices of that company. As per SEBI (Prohibition of Insider Trading) Regulations, 2015, any trading based on UPSI is seen as an offence, irrespective of whether the trade results in gain or loss².

Real-Life Scenarios

Here are some real-life scenarios that can be defined as insider trading offences:

• The senior-level employee acquires stocks before the announcement of outstanding quarterly performance.
• The consultant disposes of his stocks after receiving knowledge about an upcoming regulation.
• The stock is acquired by a relative of the board member before the announcement of a merger.

Legal vs Illegal Insider Trading

Insider trading does not necessarily mean it is illegal. The insiders of a company, whether an employee or a member of the board of directors, can engage in trading activities. This could involve stocks of their own companies, provided they adhere to the required standards of disclosure. They also should not base their transactions on undisclosed price-sensitive data.

What Is allowed

Insider trading under legal conditions involves cases where individuals trade on their knowledge, or based on appropriate disclosures. This should not include any disclosure of confidential information. Offence would be an employee purchasing stock during an open window period, according to the corporate policy.

What Crosses The Line

Insider trading becomes an offence where the person engages in trading while in possession of price-sensitive information that is not yet known to the public. According to the SEBI (Prohibition of Insider Trading) Regulations, 2015, providing such information, which is referred to as “tipping,” is an offence.

Read more about the Insider Trading Penalties

Why Insider Trading Is Harmful

The effect of insider trading on the market is that it is unfair to everyone because some people take advantage of confidential information available only to them. Using this information, they trade, while others trade without the same privilege. 

This demoralises small-scale investors who depend on public information to make their decisions. In cases where stock prices change due to confidential information, it distorts the market price determination process.

Regulations In India

Insider trading in India is governed by the SEBI under the SEBI (Prohibition of Insider Trading) Regulations 2015.³ This sets out definitions for insiders, prohibits trading when an insider possesses any unpublished price-sensitive information, makes provisions for disclosure of information, and mandates companies to have a trading window and code of conduct in place. SEBI also has the power to take action on suspicious transactions, levy fines, prohibit individuals from participating in the securities market, and even file civil lawsuits.

Investing With Confidence: Why Transparency Matters

Building confidence as an investor means investing in channels. This includes one that has been well-regulated and is open for inspection in terms of information availability. You can go for investments that have structured options,  which give room for more disclosure. What do we mean when we say gives more room? Well, it is associated with platforms that offer transparency so that you can make informed choices before investing.  You can try trusted platforms such as Grip Invest. It is a regulated platform that encourages disciplined investment through its oversight role by institutions such as SEBI.     

Conclusion

Insider trading highlights how access to unpublished information can distort fairness in financial markets. While not all insider trades are illegal, the misuse of confidential information creates an uneven playing field and undermines investor trust. Regulations such as the SEBI (Prohibition of Insider Trading) Regulations, 2015 aim to ensure transparency and accountability in the system.

For investors, understanding how insider trading works is important not just from a compliance perspective, but also to make informed and responsible investment decisions.

You can explore regulated and transparent investment opportunities through platforms like Grip Invest, which focus on structured products designed to offer clarity and accessibility to investors.

Author: Grip Invest Editorial Team The Grip Invest Editorial Team is a group of Chartered Accountants, MBA (Finance) graduates, and Qualified Research Analysts dedicated to helping you invest smarter. We dive deep into India's fixed income landscape to deliver content that is accurate, up-to-date, and easy to understand. Whether you're exploring bonds, fixed deposits, or other fixed income opportunities, our guides cut through the noise and give you the clarity to make better financial decisions.

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