What Are The Steps To Avoid Insider Trading?

Insider trading, a longstanding practice, involves traders adjusting their buying and selling prices using non-public information to prevent daily losses in the stock market. Each country's securities board has established stringent laws to deter this unethical behaviour, considering it a criminal activity. This illicit practice allows a select group of traders and investors access to sensitive information capable of manipulating share prices, creating a perception of unfair advantage that deters ordinary individuals from participating in stock market activities due to fears of financial loss and exploitation by influential market players.

What constitutes insider trading?

Insider trading is an illicit practice carried out by employees or directors of a company, involving the provision of crucial information about their stocks to external parties. This information is shared with them before becoming public, providing an advantage to enhance profits or mitigate losses. Armed with advance knowledge of stock prices, individuals can take pre-emptive measures before the news becomes widely known. The unlawful information shared, termed material non-public information, may circulate within the company to guide employee actions but transforms into an insider tip if disclosed before an official announcement. The act of disseminating influential information affecting stock prices is a punishable offense under the law. Regardless of the source or communicator, all parties using, sharing, and benefiting from such information are accountable and subject to legal proceedings.

In a scenario where an employee overhears non-public news and communicates it to another employee, who exploits the information for stock transactions, both individuals can face prosecution under insider trading policies, as per legal regulations. 

Examples of material non-public information include prior knowledge of company acquisitions, mergers, new ventures, buy-backs of stocks, share splits, undisclosed or special dividends, and leakage of a company's financial statements or sensitive financial information.

What are the legal consequences of insider trading?

Engaging in insider trading is a punishable offense, applicable to both employees and company directors. Profits obtained from insider trading are deemed illegal revenue, leading to potential imprisonment, fines, or a combination of both for the guilty party. In India, violating insider trading policies can result in a prison term of up to 20 years and a fine of five million rupees. Conversely, as per the regulations set by the Securities Exchange Board of India (SEBI), the penalty for the offender can amount to 250 million rupees or three times the illicit profit gained through the unlawful tip.

How to prevent insider trading effectively?

Preventing insider trading is the responsibility of top-level management, necessitating stringent measures to ensure compliance. Here are ways companies can prevent insider trading:

1. Limit Information Sharing:

   - Exercise caution while sharing information with employees.

   - Certain matters sensitive to the company's position should be restricted to a select few to prevent accidental leaks and potential insider trading.

2. Educational Programs:

   - Educate employees about legal boundaries.

   - Inform them about non-public information and encourage reporting any solicitation for unlawful disclosure.

3. Blackout Periods and Trading Windows:

   - Implement blackout periods prohibiting buying and selling of company shares.

   - During earnings announcements, enforce trading windows to allow employees to buy shares within specified time frames.

4. Conduct Due Diligence:

   - Prioritize thorough background checks during the hiring process.

   - Immediate rejection of applicants with red flags related to corporate misconduct.

5. Review and Update Restricted Lists:

   - Regularly review and update insider information lists based on market trends.

   - Remove outdated information, such as mergers, after official announcements.

6. Review and Revise Insider Trading Policies:

   - Avoid stagnant management images by revising insider trading policies regularly.

   - Demonstrate commitment to preventing illegal activities through timely policy upgrades.

7. Monitor Trading Patterns:

   - Vigilantly monitor company share trading activities.

   - Investigate sudden fluctuations in sale-purchase activities without apparent external factors.

Frequently Asked Questions

How To Avoid Insider Trading?

You can collect much information, but you might sometimes end up being naively caught up in insider trading.

Some instructions that can assist you in preventing or staying away from such a situation are given below:

 1. Cross-Check Your Broker’s Stock Tips

 As an alternative to taking your broker’s trading tips as final, you need to do some research on your own to validate that your broker is leading you on the correct path.

Simple research can be done on the net to verify the information.

 2. Beware Of Questioning Potential Insiders

If you know someone working for the company you are planning to invest in, please use restraint while asking questions. Avoid circumstances in which they accidentally disclose confidential company information.

 3. Check With Proper Authorities

For online trading, to ensure that the stocks in your portfolio were not a result of insider trading, you can narrate it to related authorities like SEC.

This implies that you had no mean intent while trading for the shares concerned.

 4. Accept Auditing

Many people are petrified of being audited. Conversely, auditors are well-informed and qualified people to confirm the information and confirm that your portfolio is clear of any insider trading.

 5. Implement Insider Trading Policies

In-person, you might be clean. On the other hand, there is a likelihood that one of your team members is not.

It is always good to create policies concerning dealing with information.

Your accountability is to ensure that everyone occupied in your trading recognizes and sticks to them.

How To Mitigate Insider Trading Risk?

1. Implement strict internal controls and access restrictions.

2. Conduct regular training sessions on insider trading laws and ethics.

3. Monitor and audit trading activities to detect and deter potential misconduct.

How To Implement Insider Trading Solutions?

1. Establish robust internal policies and procedures to prevent and detect insider trading.

2. Conduct regular training programs to educate employees on legal and ethical implications.

3. Implement advanced monitoring systems to track unusual trading patterns and enforce strict consequences for violations.

How can employees stay compliant with insider trading regulations?

Employees should be aware of the company's trading policies, undergo regular training, and seek pre-approval for transactions during restricted periods.

What are the consequences of insider trading violations?

Consequences may include legal action, hefty fines, termination, and damage to one's professional reputation.