Insider trading is the buying or selling of a company's securities by persons who possess Unpublished Price Sensitive Information (UPSI) information that, if made public, would materially affect the security's price. It is prohibited because it gives insiders an UNFAIR advantage over ordinary investors who lack access to the same information, undermining market integrity and investor confidence.
Legal Framework
| Provision | Subject |
|---|---|
| S.195 Companies Act | Prohibition of insider trading (references SEBI Act) |
| S.12A SEBI Act | Prohibition of manipulative and deceptive devices including insider trading |
| S.15G SEBI Act | Penalty for insider trading (Rs.25 crore or 3× profit whichever higher) |
| SEBI (PIT) Regulations, 2015 | Comprehensive framework: definitions, prohibitions, disclosures, trading plans |
| Regulation 3 PIT | Prohibition on communication of UPSI |
| Regulation 4 PIT | Prohibition on trading when in possession of UPSI |
Key Definitions
| Term | Definition |
|---|---|
| Insider | Any person who possesses or has access to UPSI (Reg.2(1)(g)) |
| Connected person | Person associated with the company (director, officer, employee, professional adviser, relative) who has or is likely to have access to UPSI (Reg.2(1)(d)) |
| UPSI | Information relating to a company that is not generally available AND which upon becoming generally available would materially affect the price of securities (Reg.2(1)(n)) |
| Trading | Buying, selling, subscribing, or agreeing to buy/sell/subscribe securities includes off-market transactions |
| Generally available | Information accessible to the public on a non-discriminatory basis (published in media, BSE/NSE announcements, annual reports) |
What is UPSI?
| Category | Examples |
|---|---|
| Financial results | Quarterly/annual results before official announcement |
| Dividends | Proposed dividend before board declares |
| Capital restructuring | Mergers, acquisitions, demergers, buybacks before announcement |
| Changes in key personnel | MD resignation, new CEO appointment before announcement |
| Material contracts | Winning/losing a major contract before announcement |
| Litigation | Major lawsuit filed/decided before announcement |
| Change in auditors | Auditor resignation/qualification before announcement |
| Regulatory action | SEBI order, RBI restrictions before announcement |
Why: UPSI creates ASYMMETRY the insider knows something the market doesn't. If the insider trades on this knowledge, they profit at the expense of the public investor who sold/bought WITHOUT the same information. This is not "smart investing" it's exploitation of privileged access. Markets work ONLY when all participants have equal access to material information.
Prohibitions
| Prohibition | Regulation | Content |
|---|---|---|
| No trading while in possession of UPSI | Reg.4(1) | No insider shall trade when in possession of UPSI |
| No communication (tipping) | Reg.3(1) | No insider shall communicate UPSI to any person (except legitimate purpose) |
| No procuring | Reg.3(2) | No person shall procure UPSI from an insider |
| Presumption | Reg.4(2) | If insider trades during UPSI period, PRESUMED to have traded on basis of UPSI (reverse burden) |
Defences (Reg.4(3))
| Defence | Content |
|---|---|
| Trading plan | Trade was pursuant to a pre-approved trading plan (filed 6 months in advance) |
| Off-market inter se transfer | Between insiders who both possess the SAME UPSI |
| Contrary trade | Trade was AGAINST the UPSI (sold when UPSI was positive) lacks motive |
| ESOP exercise | Exercise of stock options at pre-determined price |
| Tender offer/Buyback | Participation in open offer/buyback available to all shareholders |
Compliance Framework
| Requirement | Who | Content |
|---|---|---|
| Code of Conduct | All listed companies | Must frame a code of conduct for insiders (Reg.9) |
| Trading window | Company | Closure of trading window around UPSI events (quarterly results, board meetings) |
| Disclosure | Insiders (promoters, directors, designated persons) | Disclose trades within 2 trading days if exceeds Rs.10 lakh (Reg.7) |
| Pre-clearance | Designated persons | Must get pre-clearance from compliance officer before trading |
| Reporting | Company | Report violations to SEBI + stock exchange |
Penalties
| Penalty | Provision | Amount |
|---|---|---|
| Monetary penalty (SEBI) | S.15G SEBI Act | Rs.25 crore OR 3× profit made whichever is HIGHER |
| Disgorgement | SEBI power | Order insider to disgorge (return) profit made from insider trade |
| Criminal prosecution | S.24 SEBI Act | Up to 10 years imprisonment + fine up to Rs.25 crore |
| Debarment | SEBI order | Bar from securities market for specified period |
| Company penalty | S.195 Companies Act | Fine on company for failure to prevent |
Illustrations
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Classic insider trading (the CEO who sells before bad news): ABC Ltd's CEO knows (from board meeting) that Q3 results show Rs.500 crore loss (UPSI not yet announced). Before announcement, CEO sells 10 lakh shares at Rs.200/share. After announcement: share price drops to Rs.120. CEO's gain: avoided Rs.80 × 10 lakh = Rs.8 crore loss. This is insider trading: (a) CEO is an insider (connected person), (b) possessed UPSI (Q3 loss), (c) traded while in possession. Penalty: Rs.25 crore or 3× profit (3 × Rs.8 Cr = Rs.24 Cr) whichever higher = Rs.25 crore + possible criminal prosecution.
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Tipping (communicating UPSI): Company Secretary tells her husband at dinner: "Tomorrow we're announcing a merger stock will jump 40%." Husband buys 50,000 shares overnight (pre-announcement). After announcement: price jumps 40%. Husband's profit: Rs.20/share × 50,000 = Rs.10 lakh. BOTH are guilty: Secretary violated Reg.3(1) (communicated UPSI); Husband violated Reg.4 (traded while possessing UPSI procured from insider). Husband is also guilty under Reg.3(2) (procuring UPSI). Both liable for penalty.
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Trading plan (the legitimate defence): Director D knows she'll be in possession of UPSI throughout the year (attends every board meeting). She wants to sell shares to fund her child's education. Solution: file a TRADING PLAN (Reg.5) with SEBI 6 months in advance: "I will sell 5,000 shares on 15 December." If the trade happens per pre-filed plan regardless of what UPSI D possesses on 15 December D is protected. The plan proves the trade was NOT motivated by UPSI (decided months before knowing the information). This is the escape route for permanent insiders who want to trade legitimately.
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When information becomes "generally available" (safe to trade): ABC Ltd announces Q3 results on BSE at 3:30 PM on Monday. At 3:25 PM: the information is still UPSI (not yet public). At 3:31 PM: it's on the BSE website, Bloomberg terminal, and news channels NOW it is "generally available." The director who sells shares at 3:35 PM (after announcement) is SAFE information is public. The director who sold at 3:25 PM (5 minutes before announcement) is GUILTY traded while information was still unpublished. The line between legal and illegal is the MOMENT of publication.
Recall Check
- What is UPSI and why is it central to insider trading law?
- What are the main prohibitions under SEBI PIT Regulations, 2015?
- What defences are available to an insider who trades while in possession of UPSI?
Key Cases
Hindustan Lever Ltd v. SEBI (1998) Hindustan-Lever-v-SEBI-1998 Issue: Whether a company (not just individuals) can be guilty of insider trading when it purchases shares of another company while possessing UPSI about an impending merger. Rule: A company can be an "insider" if its officers possess UPSI. The company's trade is attributed to those officers' knowledge. Held: HLL purchased shares of Brooke Bond while HLL's officers knew of the impending HLL-Brooke Bond merger (UPSI). SEBI held HLL guilty of insider trading. Landmark: established that COMPANIES (not just individuals) can violate insider trading laws, and that MERGER information is classic UPSI.
Distinctions
| Aspect | Insider Trading | Legitimate Trading |
|---|---|---|
| Information | Trades BASED ON non-public material information (UPSI) | Trades based on publicly available information + own analysis |
| Advantage | UNFAIR information not available to market | FAIR all investors had same access to public data |
| Legality | PROHIBITED (SEBI PIT Regulations) | PERMITTED (normal market activity) |
| Knowledge | Possesses UPSI at time of trade | No UPSI at time of trade (or trades per pre-approved plan) |
| Impact | Undermines market integrity; harms public investors | Enhances market efficiency (price discovery) |
| Aspect | Insider Trading (S.12A SEBI Act) | Fraud (S.447 Companies Act) |
|---|---|---|
| Subject | Trading securities using UPSI | Any act to deceive/gain undue advantage |
| Regulated by | SEBI | MCA/ROC/NCLT |
| Penalty | Rs.25 Cr or 3× profit + up to 10 years | 6 months to 10 years + fine up to 3× amount |
| Victim | Investing public / market integrity | Company / shareholders / creditors |
| Investigation | SEBI investigation | SFIO (Serious Fraud Investigation Office) |
Flashcards
Q: What is insider trading? A: Buying or selling securities while in possession of Unpublished Price Sensitive Information (UPSI) information that would materially affect price if made public. Prohibited under SEBI PIT Regulations.
Q: What is UPSI? A: Information relating to a company that is NOT generally available AND which would materially affect securities' price upon becoming public. Examples: financial results, merger plans, dividend decisions before announcement.
Q: Who is an "insider"? A: Any person who possesses or has access to UPSI includes connected persons (directors, officers, employees, advisers, relatives) and anyone else who possesses UPSI.
Q: What is the penalty for insider trading? A: Rs.25 crore OR 3× profit made whichever is HIGHER (S.15G SEBI Act). Criminal: up to 10 years + Rs.25 crore fine (S.24 SEBI Act).
Q: What is "tipping"? A: Communicating UPSI to another person (Reg.3(1)) the tipper violates by communicating; the tippee violates by trading on the UPSI.
Q: What is a Trading Plan? A: A pre-approved plan filed with SEBI 6 months in advance specifying trades to be executed on future dates. Provides a defence for permanent insiders who need to trade legitimately (Reg.5).
Exam Scenario
D, a director of Alpha Ltd, attends a board meeting on 15 March where the board approves a Rs.500 crore acquisition. The acquisition is to be announced on 1 April. On 20 March, D buys 1 lakh shares of Alpha at Rs.100/share. After announcement on 1 April, shares rise to Rs.150. D's brother-in-law B also buys 50,000 shares on 22 March (D told him about the acquisition over a family dinner on 20 March). Advise on liability.
D's liability: (1) D is a "connected person" (director) and an "insider" (possesses UPSI acquisition information not yet public). (2) D traded (bought 1 lakh shares on 20 March) while in possession of UPSI. (3) Under Reg.4(1): prohibited. Reg.4(2): PRESUMED to have traded on basis of UPSI. (4) D's profit: (Rs.150 - Rs.100) × 1,00,000 = Rs.50 lakhs. (5) Penalty: Rs.25 crore or 3 × Rs.50 lakhs (= Rs.1.5 crore) whichever is higher = Rs.25 crore (minimum penalty is Rs.25 crore under S.15G). (6) D is also liable for "tipping" under Reg.3(1) communicated UPSI to B at family dinner.
B's liability: (1) B received UPSI from D (procured under Reg.3(2)). (2) B traded while in possession of UPSI (bought 50,000 shares on 22 March). (3) B is an "insider" (Reg.2(1)(g): any person possessing UPSI need not be connected person). (4) B's profit: (Rs.150 - Rs.100) × 50,000 = Rs.25 lakhs. (5) Penalty: Rs.25 crore (minimum) or 3 × Rs.25 lakhs = Rs.75 lakhs whichever higher = Rs.25 crore.
Both D and B: Subject to disgorgement of profits + penalty + possible criminal prosecution (S.24: up to 10 years). SEBI can also debar both from securities market.
Lesson: Insider trading liability extends beyond corporate insiders ANY person possessing UPSI who trades is liable. "Tipping" (even at a casual family dinner) creates liability for BOTH tipper and tippee.