Active investors regularly track company disclosures and adjust their portfolios depending on the nature and substance of announcements. As disclosures are often price sensitive, insiders are always in a better position to make bigger trading gains. But since this will be unfair to other investors, and in order to maintain trust and confidence in the market, trading on the basis of unpublished price-sensitive information is illegal.
However, insider trading is said to be fairly prevalent in the Indian stock market. A recent investigative report by Reuters lends credence to such claims (goo.gl/cjquLr). It recorded at least 12 cases of prescient messages regarding listed companies on WhatsApp groups. These messages were about quarterly results and the information was related to revenues, profits and margins. It also had information on revenue guidance and bonus issues. Interestingly, the information was not about penny stocks, but some of the most widely owned and tracked companies.
Nothing has been proved as of now and, as Reuters noted, it is possible that the information involved lucky guesses or good forecasts. All numbers did not match with official results. However, it has raised doubts in the minds of investors and the securities market regulator—Securities and Exchange Board of India (Sebi)—has rightly decided to probe the matter.
If some market participants make profits on the basis of insider information, it will put others in an unfavourable position and can affect investor confidence. At the macro level, lack of trust in the market can impede mobilization of capital, which can affect investment and economic growth in the long run. Therefore, it is important that investors don’t lose faith in the market.
Regulations in the context of insider trading are fairly robust in India and the definition of an insider is also quite broad. The Prohibition of Insider Trading Regulations, 2015, says: “…anyone in possession of or having access to unpublished price-sensitive information should be considered an ‘insider’ regardless of how one came in possession of or had access to such information.” According to the rules, communicating “any unpublished price-sensitive information to any person, with or without his request for such information except as required in the ordinary course of business or under any law” is punishable. For the record, the number of insider trading investigations taken up by the market regulator in 2016-17 went up to 34 compared with 12 cases in the previous year.
To be sure, it will not be easy for the regulator to eliminate the menace of insider trading. One of the problems is that Sebi is not adequately staffed. As the Kotak committee report on corporate governance highlighted, Sebi has just one employee for six listed companies, while the US securities market regulator, Securities and Exchange Commission, has about one employee for every listed company. In the division that looks after the quality of financial reporting, compared with Sebi, the US regulator has about 15 times more employees.
It is important that the market regulator is adequately staffed to be able to enforce regulations effectively. The other problem is that evolving technology and modern means of communication are difficult to track. This only raises the level of complexity for the regulator in tracking insider trading cases. Therefore, the regulator needs to work on increasing its capacity as well as capabilities. Adequate manpower with required skills and better use of technology will help improve implementation of regulations.
Effective implementation of regulations will not only help in penalising the guilty, but will also work as a deterrent. It is often argued that an offence like insider trading happens because of lack of fear. So it is important for the regulator not to allow such a situation to persist where people get away with breaking the rules of the game. It may not be exactly comparable in the present context, but by securing conviction in the famous Rajat Gupta insider trading case in 2012, the US regulator managed to set an example. The present messaging case could be an opportunity for Sebi to do the same. However, it is also incumbent on companies to protect price-sensitive information and make sure that it is released as per the law.
India has done well in the protecting minority investors indicator of the World Bank’s doing business rankings and was at the fourth position this year. Therefore, it is important that issues which can affect investor confidence are urgently addressed. In order to boost confidence, it will be critical that the difference between rules on paper and reality on the ground is minimised.