me start with a fundamental question. What is insider trading? The
commonly accepted definition is "trading on price-sensitive
information obtained from insiders before it becomes public".
There are many kinds of insider trading but I have tried to classify
them into three broad categories. Each type evolves as times change.
Type 1. People closely connected with the management
get some price-sensitive information before it is made pubic and
they use the information to make a profit. At the most one would
term this as unfair trade practice, but in keeping with the average
human nature. The early stages of the stockmarkets saw such malpractices.
Type 2. This involves an operator-management
nexus. The evolution and growth of stockmarkets brought about the
entry of mutual funds. The markets grew and thus the opportunities
to manipulate increased. Insider trading took a new turn. The operator
could be a fund manager or have one as an associate. The fund manager
provides the resources and the management provides the inside information.
They trade on the insider information on their personal accounts
and use the fund for aggressive buying or selling to facilitate
perpendicular rise or fall. This helps them to square up their positions
at huge profits in a very short time. Risk is eliminated and quick
profits realised, thanks to other people's money. The fund acts
as a buffer should anything go wrong. This is a blatant abuse of
position leading to profits at the expense of others and a threat
to the system. It is easy to know about such manipulations, but
difficult to pin responsibility.
Type 3. Manufacturing so-called price-sensitive
information and making it public. A policy decision can wreak havoc
on the stock prices. For example, whether a public sector enterprise
will be disinvested or not, whether banks will be allowed to give
back government equity at par or a premium, or whether the State
Bank of India will be allowed to increase its foreign institutional
investor stake are all questions that weigh heavily on stock prices.
Those having access to such information on policy decisions are
in an enviable position to trade on insider information.
Or sometimes manipulators plant manufactured
price-sensitive information in the press. Irresponsible media persons
often end up helping such practices. The concerned people take positions
in the market on their own account and then make the information
public. More than individuals, it is the system that is to blame
The rules of the game of insider trading have
also changed with the advent of globalisation and market capitalism.
In the current scenario, insider information does not pertain to
particular companies but goes across sectors of the economy. Sensitive
information regarding certain policy decisions has wide ranging
ramifications on entire sectors and industries. The game has become
bigger, the players more powerful and sophisticated and the stakes,
higher. Thus, the job of the regulator has become very difficult.
The world over, conscious effort is being made
to curb this menace. But I doubt if it can be totally eradicated.
Where there is money there will be greed. What is more likely to
help in curbing such malpractices is the emergence of a sense of
morality among the various players in the market and a growing awareness
among the public of these pitfalls.
Parag Parekh is Chairman of Parag
Parekh Financial Advisory Services.