What is Insider trading?
Insider trading refers to buying or selling securities by individuals with access to non-public information about a company. In most cases, this non-public information is obtained by people who work for the company or have close connections to it, such as board members or significant shareholders. Insider trading is illegal in many countries, including the United States, because it is considered a form of securities fraud.
Merits of Insider Trading
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Efficient Markets
One argument favoring insider trading is that it can make markets more efficient by incorporating information that is not yet public. When insiders buy or sell securities based on their knowledge of the company, they signal to the market about the company’s prospects. This information is then reflected in the price of the securities, which can help other investors make informed decisions.
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Incentivizes Investment
Another argument favoring insider trading is that it incentivizes investment in companies. If insiders can profit from their knowledge of the company, they are more likely to invest in it and work to improve its performance. This can lead to greater innovation and growth in the company, which can benefit all investors.
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Reduces Information Asymmetry
Insider trading can also help to lessen market informational asymmetries. When one side of a trade has more data than the other, this is referred to as information asymmetry. The market becomes more open by enabling insiders to trade on their expertise, and all traders have the same information.
Demerits of Insider Trading
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Unfair Advantage
One of the main arguments against insider trading is that it gives insiders an unfair advantage over other investors. Insiders have access to non-public information that can give them an edge in the market. This can lead to a situation where insiders can profit at the expense of other investors.
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Violates Fiduciary Duty
Insiders have a fiduciary duty to act in the company’s and its shareholders’ best interests. By trading on non-public information, insiders may be violating this duty. This can lead to legal and ethical issues for the insider and the company.
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Undermines Confidence in the Market
Insider trading can also undermine confidence in the market. If investors believe that the market is rigged in favor of insiders, they may be less likely to invest in the market or trust the information that is being provided by companies.
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Insider Trading in India
Insider trading in India is prohibited under the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015. These regulations aim to prevent insider trading in a company’s securities based on unpublished price-sensitive information (UPSI). The regulations require companies to establish an insider trading policy that lays down procedures to prevent insider trading and to ensure compliance with the rules. The policy should also define who constitutes an insider, the need for pre-clearance of trades by insiders, and the requirement to disclose trades made by insiders.
The regulations also mandate the establishment of an internal committee by companies to monitor compliance with insider trading regulations. This committee is responsible for investigating suspected insider trading cases and recommending penalties to the company’s board of directors.
