Insider trading thus denotes use of price sensitive information by vested interests to make private gains or to avoid losses.
May 30, 2016 / 07:05 PM IST
Anil Lamba There are three ways of making money on the stock market. By investing with the help ofi. fundamental analysis;ii. technical analysis;iii. insider information. One of the fundamental assumptions of investment in stock markets is that all investors are in possession of, or have access to, the same information, qualitatively and quantitatively, and the profits made by some and losses by others should essentially be the result of differences in perception or interpretation of the information so received or which they could have received had they bothered to look for it. But when some persons are in possession of certain facts, by virtue of being at the helm of the company to which the information pertains, or happen to work in close proximity to the promoters, say in the capacity of employees or auditors or bankers, and such confidential, price-sensitive information is used by them to deal in the shares of the company thereby giving them an unfair advantage, to the detriment of innocent, not-so-informed investors, such trading is termed as ‘Insider Trading’. Insider trading thus denotes use of price sensitive information by vested interests to make private gains or to avoid losses. This malpractice is perhaps as old as the stock market itself and is a global phenomenon. Insider trading is harmful to the investing public in general, and is morally and ethically wrong, as a few persons make money, unfairly, at the cost of a larger number of innocent investors acting in good faith and constitutes an abuse for personal monetary gain of an office of trust and confidence reposed in the persons who are expected to be faithful to the company. Legislation: Global PerspectiveLegislation to curb this practice either does not exist, as was the case in India till 1992, and where it does, is fairly impotent, due to the difficulty in gathering evidence to prove that profits made are a result of insider information. Conscious efforts are being made by several countries to give more teeth to these laws. The Securities and Exchange Commission of the US was empowered to impose triple penalties under the provisions of the Insider Trading Sanctions Act 1984. Mr Ivan F Boesky, who made illicit profits to the tune of $ 203 million by insider trading was convicted and sentenced for three years imprisonment in addition to a fine of $ 100 million. In the US, the Companies Act, the Company Securities (Insider Dealing) Act, 1985, and the Financial Services Act, 1986, contain comprehensive provisions to prevent insider trading. A few years back a major toll of insider trading was the resignation of Mr Geoffrey Collier, securities chief of Morgan Grenfell Merchant Bank, UK. Mr Collier asked a stock broking firm to buy 50000 shares of an engineering company, which was being taken over by another company, utilizing the services of Morgan Grenfell as its corporate advisor. Mr Collier advising on the pricing and other details of take-over, possessed full knowledge of the proposed bid. The stock broking firm informed Morgan Grenfell of the share deal after the take-over bid was over. On inquiry, Mr Collier admitted breach of conduct on his part and submitted his resignation. Also some years ago, Mr R J Brealey was arrested on the charge of insider trading on the London Stock Exchange under the Financial Services Act. It was reported that Mr Brealey made a bid to acquire the controlling interest in shares of Titaghur Jute Factory (TJF) registered in Scotland, from Mr Mehta and Associates of Thomas Duff in Calcutta. In Japan three major insider trading scandals rocked its parliament and the business world. In Recruit Cosmos scandal, top politicians, civil servants and businessmen were involved. To buy favours from the government, 115000 unutilized shares in Recruits Cosmos, a subsidiary of Recruit, were offered under the table to politicians. They sold these in a month’s time when the issue was made in October 1986 and made profits of more than 250 million yen. The Meidenko affair involved insider trading in shares of Sankyo Seiki. Nippon Steel secured a stake in Sankyo Seiki Manufacturing for 53 billion yen. An investigation by the Tokyo Stock Exchange found evidence that 30 to 40 employees of the two companies bought shares in Sankyo Seiki in the weeks before the public announcement of the deal in July 1988 and made unfair gains. In the third case of Hanshin Sogo Bank, the lead bank to Tateho Chemical, sold its shares in Tateho, just a few hours before the company announced heavy losses. To prevent a recurrence of unregulated share trading, before an issue goes on sale to the public, the Japanese parliament has passed anti-insider trading law. The maximum penalty for the violation of the Law is $ 3700 or six months imprisonment. Anti Insider Trading Laws are also enacted by Switzerland, Netherlands, Hong Kong and the European Community. Switzerland has declared insider trading a criminal offence, while in Netherlands the law prohibits insider trading and prescribes a minimum penalty of two years imprisonment in addition to a fine. However Germany follows a Voluntary Code of Conduct to check the menace of insider trading, which is to be followed by companies, stock exchange dealers and bankers in order to prevent misuse of information by the concerned persons. Surprisingly there has been no major scandal of insider trading in West Germany despite its booming market. Legislation in IndiaIn India the Securities and Exchange Board of India (SEBI) brought out the SEBI (Insider Trading) Regulations, 1992 on 19th November 1992 which recognized Insider Trading an offence for the first time in India. As per Section 3 of these regulations it is an offence to deal in securities of a company on the basis of unpublished price sensitive information, communicating any price sensitive information or counseling another person to deal in securities on the basis of unpublished price sensitive information. The regulations also define who is an “insider”, “connected person”, “deemed to be connected person” and “unpublished price sensitive information”. Rothschild CaseInsider trading however is not a recent phenomenon. I do not know how far back can its roots be traced, but perhaps one of the earliest incidents took place in 1815, immediately after the battle of Waterloo. At the time Britain held sway over a large part of the world and British commercial interests were predominant. However if the battle were to be decided against Britain, it would have meant a serious change in the power balance and the consequent loss of British supremacy. Of course, what concerns us in the present context is the effect of a British defeat on the London Stock Exchange. Investors in London, therefore, were waiting with concern, news from Waterloo. From initial reports it appeared that French victory was imminent. A number of investors sold in the increasingly weakening market and buyers were almost non-existent. However there was one exception – Nathan Rothschild (baron of the Austrian Empire and head of Rothschild Banking House in London) who kept buying, so no matter how depressing the rumours. Communication, was back in 1815, was extremely slow. Whatever the outcome of the battle, the news would reach England only a couple of days or so later. It was well-known that Nathan Rothschild, because of having widespread business interests in various parts of the world, had developed a personal intelligence system and consequently came to know of important events before they were generally known. It was therefore assumed that Nathan would be among the first to learn of the outcome of the battle. Investors therefore felt that their best strategy would be to watch Nathan. If Nathan bought, everyone would buy. And if he sold, it would be indicative of a British defeat. Most investors therefore waited for Rothschild to act for an indication of the turn the battle had taken. If Rothschild purchased it would mean Britain had won and if he sold it would indicate French victory. Nathan Rothschild did learn about English victory before anybody else. He was also aware that the entire market would respond to his actions. Nathan Rothschild did not buy – he sold. As expected the investors went crazy and the London market crashed. It was only when the prices touched rock bottom levels did Rothschild begin buying. A little later the news of Wellington’s victory over Napoleon reached England, sending the prices soaring up again, earning Rothschild a whopping one million pound profit (in 1815) in the process.Author is a corporate trainer on finance management.
Tags: #Anil Lamba #insider trading #investing #regulatory framework #trading
first published: May 30, 2016 07:05 pm
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