Risks of Insider Trading
Insider trading involves trading in a public company’s stock or other securities by those in possession of unpublished price sensitive information about the company.
Unpublished Price Sensitive Information(UPSI) is any information that could substantially impact an investor’s decision to buy or sell a security, including influencing the price of the security, that has not been made available to the public. A stock market transaction qualifies as insider trading when one of the parties is in possession of UPSI. A party in possession of UPSI by virtue of their position in the company or their relationship with people occupying such positions in the company are treated as insiders.
Insider trading poses a grave threat to the interests of minority shareholders, public shareholders, traders in the share market, the company itself and the economy as a whole. Thus, it is the responsibility of companies, stock exchanges and authorities to check insider trading. Companies shall maintain a corporate governance structure that eliminates all potential risks of insider trading.
A corporate governance structure can check insider trading only if it is able to separate the management and shareholders, insiders and outsiders of the company and maintain a delicate balance between transparency and confidentiality of internal matters before the shareholders. This balance shall be maintained to ensure that all shareholders enjoy same level of transparency in the internal matters of the company. This promotes shareholder democracy and ensures that the interests of the minority and public shareholders are treated at par with the interests of promoters and majority shareholders. It also ensures that all players in the stock market are in possession of same level of information regarding internal matters of a company and thereby capable of making informed decisions regarding trading of securities.
Significance of SDD
An ideal corporate governance practice that checks insider trading risks shall facilitate a constant monitoring of both UPSI and insiders of the company. The first step towards that is to ensure that all listed companies have a code of conduct that identifies all UPSI and designated persons.
The second step is to monitor the movement of UPSI amongst insiders to identify every insider in possession of every UPSI at every point of time.
The third step is to preserve the data regarding movement of UPSI in a structured format. SEBI has mandated maintenance of a STRUCTURED DIGITAL DATABASE for the very purpose of tracking movement of UPSI between insiders.
Preventive and remedial role of SDD against insider trading
SDD facilitates prevention, investigation and punishment of insider trading. The law mandates not just maintenance of SDD, but also requires the audit Committee to review compliance with the provisions mandating SDD at least once in a financial year and Compliance officers of listed entities to certify compliance with maintenance of Structured Digital Database and submit the same to BSE and NSE. Thus, Maintenance of SDD facilitates the audit committee, compliance officer, Board of Directors, stock exchanges and SEBI to supervise transmission of UPSI.
Apart from supervision, maintaining SDD also aids in investigation of insider training. Insider trading, like any other offence, requires both a motive and means. SDD is used to preserve updated data about all personal, fiduciary and financial relationships of insiders. This helps in identifying any interest the insiders have in the stock market trades of company securities thereby allowing the internal and external investigating officers to ascertain motive for insider trading. It also helps in identifying every insider with possession of particular UPSI, thereby allowing investigating officers to detect every person with means for leaking insider information.
Further, maintaining SDD also helps in enforcement of compliance. It can be used to ensure the following:
- Every insider is informed about the confidential nature of information they receive
- Ensure that they sign confidentiality agreements.
Thus, the requirement to maintain SDD in itself mitigates the risks of insider trading and also aids in ensuring compliance with other requirements under the laws and code of conduct. The SDDs shall act as a game changer in prevention, investigation and punishment of insider trading.
Author: Adv Alby Stephan, Legal executive at Legality Simplified