Insider trading increases as markets scale record highs. Is it all bad though?

Insider trading has picked up as stocks continue to scale new highs, according to a report. Insiders sold shares worth Rs 10,000 crore in July, and Rs 7,000 crore in June and May, according to a Business Standard report. Selling had slowed down in April when the market experienced correction due to the outbreak of the second wave of COVID-19 infections, the report mentioned.

Insider trading is an unfair and illegal practice in stock markets around the world. It involves using the pieces of information not available in the public domain to make trades in a company's stock.

When insiders, like key employees of the company who have access to its strategic plans, use it to carry out a trade is insider trading. It is highly discouraged by the markets regulator SEBI.

To be specific, information that is not available in the public domain and can have a substantial impact on an investor's decision to buy or sell a security. SEBI defines it as unpublished price sensitivity information or UPSI.

However, it is not always insiders who are guilty of insider trading. A connected person--anyone associated with the company in some way during the six months preceding the insider trade--is also guilty, as defined by SEBI. This could be close relatives of chief employees or bankers or legal counsel of the company.

While trading on UPSI is illegal, it is not completely bad. Many executives of a company, by the virtue of their position, will always possess UPSI and yet trade in the shares of the company.

They can do so by selling their holdings in employees' stock option programs (ESOPs) for personal or professional needs. In fact, several executives told Business Standard they "had to sell their holdings to generate cash to subscribe to shares in the fresh ESOP." Some others said they have been liquidating for some time to meet other requirements.

Which is not bad. If such trades are disclosed to the stock exchanges as per SEBI rules, they are not counted as illegal. Given that a proper intimation was sent to the regulator within a few days with trading details of the executive if securities worth Rs 10 lakh-plus were traded.

In accordance with the compliance requirements, companies must disclose the transactions carried out by key executives in the company. Business Standard analysed this data to arrive at monthly numbers.

It found that in recent months, several head honchos at various banks and financial institutions and promoters of various mid- and small-cap companies have shaved their holdings.

While this does not necessarily mean insider trading, the rising instances of selling while the market is hitting record highs makes one sceptical.

Information is an important currency in the capital markets, perhaps more than the official greenback. Trading using undisclosed information when it can have a substantial impact on the price hurts the integrity of the market.

Access to information at the right time levels the playing field for everyone, whereas access to UPSI gives insiders an unfair advantage. If insiders keep using the information to their advantage, retail traders cannot stand winning in such a market.

Moreover, if retail and foreign investors get wind of rampant insider trading in the market, they quickly lose their trust and look for other avenues of investment.