Explore the nexus between corporate governance and insider trading in India, examining regulations, penalties, and the impact on market efficiency.
This article examines whether good corporate governance weakens opportunistic insider trading by corporate executives. Despite public and academic interest in the topic of insider trading, previous research on the impact of corporate governance on insider trading has been relatively limited. A major challenge in studying this relationship is the ability to identify the types of insider trading that can affect corporate governance. The problem is compounded by the lack of consensus in the literature on whether trading in nonpublic information is explicitly bad (Bainbridge, 2001; Haddock, 2002).
In this article, I define opportunistic insider trading as the trading of company stock by company insiders based on nonpublic information.
Such insider trading exposes companies and outside shareholders to potentially significant costs, including the risk of adverse selection and violations of securities laws, while allowing corporate executives to realize their informational advantages. Compared to other market players. Consistent with views reflected in US and international securities laws, I believe that information-based transactions cost outside shareholders more than they benefit them, and I characterize such transactions as opportunistic transactions.
Insider trading:
The buying and selling of company stock by a company insider is not illegal per se. The fact that insiders, including company directors, officers and employees, trade in their own company’s stock is a positive feature that encourages companies because it aligns the company’s interests with those of insiders. What is prohibited are insiders preventing others from buying or selling company stock based on nonpublic information. Insider trading, so defined, is one of the most violent crimes in the belief in fair trading in the marketplace.
If the capital market allows insider trading to go undetected, people with inside information will have a consistent advantage in trading using inside information, while people without inside information will always lose in the market.
This latter group, and certainly the vast majority of investors, will eventually realize the losing game they are playing and will therefore think that all trades are against them. Slowly, the typical investor will exit the market, leaving important functions of the stock market behind, such as funding.
According to the SEBI regulations on Prohibition of Insider Trading, 1992 “the regulations”:
“insider” means any person who, is or was connected with the company or is deemed to have been connected with the company, and who is reasonably expected to have access, connection, to unpublished price sensitive information in respect of securities of a company, or who has received or has had access to such unpublished price sensitive information;
Means of controlling insider trading:
One way to deal with insider trading is to adopt regulations prohibiting such transactions, making them punishable, and enforcing civil and criminal laws against violators. However, experience tells us that this approach brings only slight relief, even in countries with stricter regulations. For example, the SEC only initiated 47 insider trading cases in 2002.
Another way to approach the problem is to encourage companies to self-regulate and take precautionary measures. It is intrinsically linked to the field of corporate governance.
It is a way for companies to signal to the market that effective self-regulation is in place and that investors can safely invest in their securities. In addition to prohibiting wrongdoing (not necessarily prohibiting it), self-regulation is also seen as an effective way to create shareholder value. A company can still regulate its directors/officers in a manner prohibited by law and inform shareholders of the facts.
Sanctions:
S.15G of the SEBI Act specifies the penalty for insider trading: “shall be liable to a penalty not exceeding five lakh rupees”. Section 24 is an omnibus criminal provision relating to prosecution for violation of any part of the Act, or any rules and regulations under the Act.
Section 11 of the SEBI Act gives the Board broad discretion to take appropriate corrective action. Quoting “Under the provisions of this Act, the board of directors has a duty to protect the interests of investors in securities and to regulate the development of the securities market by such measures as it deems appropriate.” It also has the power to give Corporate “appropriate instructions in the interest of securities investors” to anyone connected with the securities market.
The 2002 amendments to the Rules contained many recommendations, as well as many provisions expressed in the language of corporate governance. Most good governance clauses are provided as mandatory clauses. Good corporate governance combined with the punitive provisions of the law create a stifling regulatory framework, such as the obligation for certain meetings to be recorded and to be held only in the presence of two company executives.
Condition of Insider laws in India:
Insider trading is rightly considered one of the most violent crimes against efficient and intact capital markets. This reduces investor confidence in the market and hinders capital flows. India’s insider trading laws are much better codified than those of many western countries, especially the US legislation which has been developed mainly by case law and is rather uncertain in several respects (partly due to the refusal of the US legislator to define insider trading). US case law, although extensive, relies on the general anti-fraud provisions of the Securities Exchange Act.
However, India omits a place to provide for the effective civil consequences of insider trading. Section 11 of the Insider Trading Regulations gives SEBI the power to void insider trading.
SEBI may reverse trades made by insiders. However, this revocation is more about returning stolen goods. No penalties imposed – no financial burden imposed on insiders. There is no regulatory signal to the market that insider trading is economically inefficient for insiders.
Suggestion:
To facilitate compliance with the new trade reporting, issuers must designate a single broker through which all transactions in the issuer’s shares must be made by insiders, or require insiders to use only brokers who accept the procedures prescribed by the company. Designated brokers can help ensure compliance with a firm’s screening procedures and reporting obligations by monitoring all transactions and reporting them to issuers in a timely manner. If it is not possible to appoint a single broker, the issuer should require the insider to obtain an attestation from its broker certifying that the broker:
- verifies with the issuer that each transaction entered on behalf of the insider is pre-approved; and
- Immediately report to the issuer the details of each insider trading in the securities of the issuer.
REFERENCE :
1. SEC Annual Report, 2001
2. Ackerman A, Maug E (2006). Insider trading legislation and acquisition announcements: Do laws matter? Working paper, University of Mannheim.
3. Corporate Governance, History and Evolution by Praveen B. Malla
4. SEBI Act No. 15 of 1992
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