Insider Trading: Laws, Implications, and Defences

Defining Insider Trading and Key Terms

Insider trading refers to trading a company's securities based on material, non-public
information. As defined in the New Oxford Companion to Law, it involves improper
disclosure or use of precise, non-public information to gain an advantage in financial
markets. This practice, whether conducted by individuals within or outside the company,
undermines market integrity. The Securities and Exchange Board of India (SEBI) Act, 1992,
while not directly defining insider trading, provides definitions for key term1s:
1. Insider: Any person who is a connected person or has access to unpublished price-
sensitive information (UPSI).
2. Connected Person: Individuals associated with a company in various capacities,
either temporarily or permanently, granting them access to UPSI.
3. Price-Sensitive Information: Non-public information likely to materially affect the
securities' price, such as financial results, mergers, or changes in capital structure.

Section 11(2)(e) of the Companies Act, 1956, prohibits insider trading to ensure market
integrity and maintain trust among investors. The law primarily aims to provide equal
opportunities to all market participants, thereby fostering a level playing field. It ensures
fairness and transparency in transactions, emphasizing the free flow of information and
eliminating information asymmetry. Insider trading disrupts these principles by granting an
unfair advantage to individuals possessing sensitive, non-public information, which can harm
the broader market and erode investor confidence.

Certain types of information are considered price-sensitive and can lead to insider trading
litigations if used improperly during transactions. These include plans for intended dividend
declarations, periodic financial reports, and decisions related to the buy-back or issuance of
securities. Furthermore, significant changes in company policies or operative plans are
deemed critical, as they directly influence investor decisions and the company’s market
value. Upcoming takeovers, mergers, or acquisitions are particularly sensitive, as they often
have a substantial impact on the market valuation of the company’s securities. By regulating
access to and use of such information, insider trading laws protect the fairness and

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KOTAK SECURITIES'S WHAT IS INSIDER TRADING, https://www.kotaksecurities.com/tradingaccount/what-is-
insider-trading/
transparency of financial markets, ensuring all participants operate under the same set of
rules.

Purpose and Objectives of Insider Trading Regulations

The regulations are designed to uphold critical market principles, including fairness and
transparency. By preventing insider trading, SEBI ensures that all market participants have
equal access to information, fostering a level playing field. Additionally, the regulations
address information asymmetry, ensuring the free flow of accurate and timely information
in the market. These objectives are essential for promoting trust among investors and
maintaining the credibility of India’s financial markets2.

Prohibited Offenses and Regulatory Stance

The insider trading regime creates two types of offences: One is a "trading" offence whereby
an insider would be liable for trading while in possession of UPSI. The other is a
"communication" offence whereby an insider would be liable for disclosing UPSI to another
pe son, except if required "in furtherance of legitimate purposes, performance of duties or
discharge of legal obligations".

The first offence merits some discussion. Through SEBI's regulations, India has adopted a
strict stance towards insider trading based on the "parity of information" approach. Under this
approach, what matters is that the person trading is in possession of inside information. It
does not matter how that person obtained the information, i.e. deliberately or by accident.
This is very different from the approach taken in the United States (US) where insider trading
becomes illegal only if it accompanied by the breach of a fiduciary duty owed to the
company, its shareholders or the source of the information3.

4. India's current policy regime is also sharply in contrast to what prevailed earlier. For
instance, although the 1992 regulations required that an insider ought to have traded "on the
basis of inside information" in order to be liable for a violation, the regulations were
subsequently amended to suggest that mere possession of inside information at the time of
2
https://www.thehindu.com/business/Economy/sebi-tightens-noose-on-insider-trading/article68702885.ece
3
Abhirami B & Arya Kuttan, Insider trading laws in india - Pertinence And Problems, 4 INTERNATIONAL
JOURNAL OF LEGAL DEVELOPMENTS AND ALLIED ISSUES 443, 461 (2018).
trading was sufficient for a violation4. The SAT interpreted the regulations such that a person
in possession of inside information is presumed to have traded "on the basis of", or to have
"used", the information. The insider then carries the burden to prove to the contrary. Such a
rigorous approach is tempered by the availability of various defences, which are discussed
below.

Given the strict nature of insider trading regulation in India, the regime sets forth certain
defences that enable parties to carry on genuine transactions without necessarily being treated
illegal under SEBI (Prohibition of Insider Trading Regulations, 2015, reg. 3(1)5. the regime
provides immunity if the trades are of the following types:

 Off-market inter se transfer between promoters who were in possession of the same
UPSI;
 In organisations, individuals who were in possession of UPSI were different from
those making trading decisions and where appropriate arrangements are in place to
prevent communication of UPSI to individuals making trading decisions (Chinese
walls);
 Trades that are pursuant to a trading plan.

One issue that has exercised the minds of corporates and the regulators relates to whether a
due diligence exercised can be permitted when an acquirer takes up shares in a listed
company. During the due diligence process, the acquirer may come into possession of UPSI
that has been disclosed by the company. This creates some incongruence because while due
diligence is an essential process to enable acquisition transactions that may be beneficial to
shareholders, it results in a potential violation of the insider trading regime. Hence, in the
2015 regulations, SEBI has introduced specific safe harbour provisions that permit due
diligence under controlled circumstances. The regime is bifurcated into two parts, one where
the acquisition results in a takeover offer for the company, and the other where there is no
such offer.

In case of a takeover offer, the acquirer is entitled to have access to UPSI to carry out due
diligence. The justification for this exception is that the acquirer makes an offer to buy shares
4
Chandrakala v. Adjudicating Officer, Securities and Exchange Board of India, Securities Appellate Tribunal (31
Janu- ary 2012).

5
SEBI (Prohibition of Insider Trading) Regulations, 2015, reg. 3(1).
from all shareholders who are entitled to equal treatment in terms of price. Although there is
no specific requirement that UPSI needs to be made public before the acquirer acquires
shares in the offer, necessary information needs to be disclosed to the shareholders as part of
the offer in order to enable them to make a decision on whether they should divest or retain
their shareholdings.

In cases not involving a takeover offer, any UPSI disclosed by the company to an acquirer
must be made generally available at least two trading days prior to the proposed transaction.
In either case, the transaction must be subject to the fact that the acquirer shall keep the UPSI
in confidence and shall not trade in the securities of the company prior to the disclosure, and
also that the board of directors of the company ought to come to a conclusion that the
transaction is in the interests of the company. This structure set forth in the insider trading
regime reconciles the interests of acquirers (who may wish to conduct due diligence) with
those of other shareholders, as the acquirer must relinquish any informational advantage
(through a public disclosure) before it trades in the shares.

The evidentiary aspects of insider trading are crucial, as they can determine the effectiveness
of substantive regulation. Often, there is no direct evidence in insider trading cases, and
regulators are compelled to rely extensively on circumstantial evidence. This makes the task
of the regulators highly onerous. In India, given that insider trading is a serious offence, the
SAT has laid down a fairly significant burden on the regulator before an insider trading
charge can be sustained. Given this background, the explicit treatment by the 2015
regulations regarding the relative burdens of the regulators and the insider is welcome.

The regulations provide that the burden on the regulator is to show that a person is an insider
and that he or she was in possession of UPSI at the time of trading. The burden then shifts to
the person to show either that he or she is not an insider or that any of the defences is
available. However, the regulations have refrained from specifying greater details regarding
the evidentiary burden as that is left to the facts of each individual case. While this approach
is helpful, a lot would depend on the manner in which the proposed regulations are
implemented by SEBI and SAT. As SAT considers insider trading to be a serious charge in the
securities markets, the regulator's burden is quite heavy and similar to one that is involved in
a civil charge of fraud.
Global Evolution of Insider Trading Laws
Globally, insider trading laws have evolved significantly, driven by landmark legislation and
cases. The 1934 Securities Exchange Act in the U.S. established the SEC to oversee and
regulate securities markets. The 1942 Rule 10b-5 introduced a broad prohibition against
fraud and deceit in securities transactions. Landmark cases like SEC v. Texas Gulf Sulphur
Co. (1968) expanded insider trading liability to anyone possessing material non-public
information, while the 1984 Insider Trading Sanctions Act significantly increased penalties
for such offenses. Recent advancements, such as the 2022 amendments to Rule 10b5-1,
introduced stricter restrictions and enhanced disclosure requirements for insider trading plans,
reflecting the ongoing commitment to curbing insider trading6.

Conclusion
Insider trading laws, such as the SEBI (Prohibition of Insider Trading) Regulations, 2015,
reflect India’s commitment to safeguarding market integrity. By defining offenses, setting
defences, and introducing safe harbour provisions, these regulations balance market fairness
with practical needs like acquisitions and trading plans. Effective enforcement, coupled with
evolving global best practices, ensures continued investor confidence in financial markets.

6
https://www.sec.gov/Archives/edgar/data/1164964/000101968715004168/globalfuture_8k-ex9904.htm