INSIDER TRADING - A VIEW FROM THE OUTSIDE

By Ruma Dubey

 “Buy ABC stock immediately, as much as you can afford as the company is going to announce a 1:1 bonus in a week’s time”

When your friend tells you this, will you ignore the ‘tip’ or go ahead and buy?  You may buy just 200 shares and feel like a King. But would your mind give a small nudge even once, telling you that you could be indulging in insider trading? No such nudge is likely to come as we do not consider this as insider trading at all! Yes, that is indeed the truth. The feeling is that being small traders, what insider trading could you possibly indulge in; isn’t insider trading done by the likes of Rajratnam and Goldman?  But if both acted on the same piece of news, though the quantity of the action might be different, how does it make him a criminal and you a smart trader?

Getting information before it becomes public is what you, me and all believe will help you make windfall gains. So when we make money by getting news of a company before it becomes public, does that tantamount to inside info? Or because we trade in small quantities, it is not really breaking the law?  Well, you can write ‘offence’ either in all caps or in italics or bold italics, but it still reads the same, ‘offence.

There is a very thin line which divides insider trading and trading on knowledge. You never know when this line is breached and you get on to the other side. But at the same time not every opportunistic behavior can be termed as insider trading. And as one can see, it is very difficult as such to discern what exactly can be called as insider trading, which is why the laws on insider trading also, world over are not as vigilant as they should be.  How does one know what info is passed on through the phone or when meeting over a cup of coffee? Investigations can happen only when it comes to light that insider trading has happened. If that itself does not get detected, how can one track this down?

Insider trading, despite all the prohibitions, is undetectable most of the times. Yet, new checks are put in place time and again, hoping to cover up the loophole. But every time a hole is covered, it opens up some more new holes in its wake. SEBI has indeed done its bit; it has put in place a set of Code of Conduct, to ensure that unsubstantiated news is not circulated to distort the prices. It restricted access to Internet forums, blogs, chat forums or e-mails by employees of broking houses and other intermediaries. Only recently it has been allowed to access phone records of investors which it is investigating but it not allowed to use wire taps, which is what help catch some of the biggest insider traders abroad.

The Securities and Exchange Board of India has been asking for more powers but has only recently been allowed to even look at phone records of the investors it is investigating. In July, the government started allowing SEBI to access the phone-company records of calls made. But SEBI is still not allowed to use wire taps which have been crucial to exposing insider trading in other countries. SEBI also has a software tools that would analyse discussions on social networking platforms such as Facebook and Twitter. Yet, very few ever get caught as these traders are two steps always ahead of SEBI. By the time SEBI starts unraveling the tangle and gets to the mailing addresses, it almost always reaches a dead end as they mostly come across fraudulent or dummy addresses. And if SEBI tries to use tracking data like PAN numbers, it is usually that of a distant relative or friend or even counterfeit PAN cards. And to a large extent, SEBI is like a toothless watch dog- it can bark but not bite. Thus when there is no fear of firstly ever being caught and secondly of no life-changing punishment, insider traders make hay, right under the nose of SEBI. So the point is - no one can really control insider trading, at least in India. To say that it does not exist simply because it is not detected is being naïve.

There is a growing community of thinkers world over, who propagate legalizing insider trading. The logic is that it should be left to the discretion of the company and market intermediaries to decide what info to give out and what not to. For eg: A big IT company taking over a smaller, listed IT company. It would not be in the interest of the big IT company to leak out this info as price of the small IT company would make valuations unattractive and the deal unremunerative. On the other hand, if a loss making company, indulging in window dressing, has some of its employees or market intermediaries giving out the real info, it would save not just gullible investors lured by fudged numbers but also banks who would have continued lending. When necessary info is blocked, it causes harm all around, giving unrealistic share valuations.

‘Insider trading’ has not been given a proper definition under law, it remains vague. Thus putting a blanket ban on something which is vaguely outlined makes no sense. Either the law should define what it means exactly by insider trading or leave it to the discretion of companies to decide what info to give and what not to. At least in fraud companies and mismanaged companies, such crucial info will reflect its true valuations and not what is perceived to be true.

Food for thought: Detecting insider trading is not about connecting the dots by going from one dot to the other but by starting at both dots and working towards the middle

For more information on Insider Trading, please refer to this wonderful report put forth by Nishith Desai at http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Insider_Trading_Regulations_-_A_Primer.pdf