Why ban insider trading ?
Why treat trading based on unpublished price sensitive information (non-public information) differently?
Why not just permit non-public information to reflect in the traded price – would that not bring efficiency? Market efficiency is the name of the game for capital markets isn’t it?
Not quite.
Introduction
The world of capital markets, like all Financial Markets, is complex and intricate, with a variety of different factors that can influence the success or failure of investments. One such factor is insider trading, a practice that has been a point of controversy for many years. Insider trading refers to the illegal activity of buying or selling shares in a listed company based on non-public, price-sensitive information that can significantly affect the stock price.
Consider a scenario where you and your group of friends engage in a game of cards. The game is played ethically, with equal access to a single deck of cards, and the outcome solely dependent on the players’ level of expertise and luck.
However, imagine one of your friends has faintly marked the cards a certain way so that he recognizes which cards you hold just by looking at the back of the cards. By possessing knowledge of what cards are on the horizon, this individual can play tactically, providing an unfair advantage, and resulting in a victory every time. The game of rummy would be ruined for all involved.
A closer look at the terms “Insider” and “UPSI”
The regulations set by the Securities and Exchange Board of India (SEBI) outline the term ‘insider’ as an individual who holds the status of a connected person or holds access to unpublished price-sensitive information (UPSI).
This group involves various individuals, such as board members or personnel of the company, and their near kin. This may also include the company’s counsel or banking institutions, along with individuals who operate within the stock exchange system or even people who work for asset management firms who have interacted with the company.
The term UPSI encompasses a wide range of data that pertains to a company’s financial performance, strategic decisions, and significant developments that have not yet been made available to the general public. This information may include insights into a company’s quarterly results, upcoming merger and acquisition deals, major plant expansions or shutdown plans, or any other crucial activities that could impact the company’s value.
Insider trading – Impact
Beyond the legal consequences of for the individual, insider trading harms the market as a whole.
In fact, the significant legal consequences are driven by the overall detrimental effect on the market.
One of the primary reasons that regulators are so “dead set” against insider trading is that it undermines the integrity of the capital markets. In order for a market to function properly, investors must be able to trust that the prices of securities are based on publicly available information, and not on secret knowledge held by a select few.
When insider trading occurs, it creates an uneven playing field, where some investors are able to profit from information that is not available to others.
This creates a situation where the market becomes less efficient, as prices are no longer based on a fair assessment of the true value of a company. This can lead to a variety of negative outcomes, such as inflated stock prices, decreased investor confidence, and a reluctance to invest in the market in the first place.
Furthermore, insider trading can also harm the companies themselves. When insiders buy or sell their own company’s securities based on inside information, they may even effectively be betting against the company’s future prospects.
This can have all sorts of consequences, from damage to the company’s reputation to making make it harder for the company to raise capital in the future.
Conflict of Interest
Insider trading can also create conflicts of interest for company insiders, as they may be more focused on their own personal gain than on the well-being of the company.
Conclusion
Insider trading not only raises moral concerns, but also poses a significant threat to the confidence and stability of the markets.
When investors perceive the market as rigged and unfair, they lose trust and may withdraw their investments. This can lead to a cascading effect that can destabilize the entire economy.
In addition, insider trading undermines the very idea of a level playing field, where everyone has an equal opportunity to succeed based on their knowledge and skills.
The strength of the market is only as strong as the trust placed in it. This is why Insider Trading hurts. And when Capital Markets hurt, it hurts everyone, directly or indirectly, immediately or over time.
This is the reason why regulators have no choice but to keep increasing regulatory oversight and compliance requirements; because without such oversight, everyone loses.
