Misusing price sensitive information of a listed corporate by its custodians is an act of robbery.
All of us know about the unpredictable and ever changing nature of stock market. It’s a market that lives with a life of its own, reacts to situations and leaves investors either reaping profits or with nothing at all. Though there are certain economic and financial indicators like inflation, interest rate scenarios etcetera that contribute to the movement of stock prices, a lot remains hidden behind this price movement game.
A listed company’s corporate information is one of the most vital elements for an investor. Stealing of this corporate information, especially by those who are the custodians of such information, and passing it on to other people is one of the oldest crimes in the world of investments.
This illegal act of accessing the most confidential corporate information has seen many corporate bigwigs behind the bars. Who can forget a U.S. District Court judge in Manhattan some years back sentencing the prominent Indian-American business leader Rajat Gupta to two years in prison and imposing a fine of $5 million on the charges of stealing corporate information and passing it on illegally to a select bunch of people!
Surfacing of irregularities at stock exchanges is nothing new. It’s only a matter of time when the scams are unearthed and culprits, especially the white collar criminals, spotted and booked. But not before the damage has been done extensively, more particularly to common, gullible investors who remain unaware of the tricks played by the influential market players, both inside and outside the system.
For instance, market players such as Harshad Mehta and Ketan Parekh are big names when it comes to the exploitation of the system from outside. Scams which demonstrate how the people inside the system have been playing fraud by misusing their authority to make profits for themselves have also been surfacing.
The latest scam in the series that surfaced at the country’s largest stock exchange, National Stock Exchange (NSE), in which its former MD and CEO, Chitra Ramkrishna, was arrested in connection with the co-location scam case. Chitra Ramkrishna was holding the position from April 2013 to December 2016. In the co-location facility offered by NSE, brokers could place their servers within the stock exchange premises giving them faster access to the markets.
Allegedly, select players obtained market price information ahead of the rest of the market, enabling them to front-run the rest of the market. The alleged connivance of insiders by rigging NSE’s algo-trading and use of co-location servers ensured substantial profits to a set of brokers.
Notably, algorithmic and high-frequency trading strategies give faster access to traders streaming real-time market data and enabling them to execute orders in milliseconds.
Algo-trading is an automated trading system that utilizes very advanced pre-programmed mathematical models for making transaction decisions in stocks, currencies or commodities. It involves two stages: identification of a buying or selling opportunity which entails what and when to buy or sell and how the trade will be executed.
High-frequency trading (HFT) employs superfast computers to track even the minutest price discrepancy in stocks, currencies and commodities and execute orders in a millionth part of a second in order to make profit by quickly buying and selling stocks at the slightest price differential. This means, while every HFT is algorithmic, every algorithmic trade is not necessarily high frequency.
Both automated trading systems face sharp criticism of common retail investors for breeding discrimination between rich brokers and common investors. The main argument has been that algorithmic trading has created inequality because small investors can’t afford such trading software. This has invited debate where tech-savvy stock traders call the inequality argument as frivolous.
Meanwhile, insider trading is viewed as a serious white-collar crime. It implies buying, selling and dealing in shares and securities of a listed company by insiders such as directors, designated officers of the management team, employees of the company or any other connected persons such as auditors, consultants, lawyers, analysts who possess material information which is not available to general investors.
This trading takes place when those privileged with confidential information about important events use the special advantage of that knowledge to reap profits or avoid losses illegally and unethically on the stock market, to the detriment of the source of the information and to the typical investors who buy or sell their stock without the advantage of inside information.
For example, if one of the top executives of a company shares with you some kind of material information of the company which is yet to be made public and can have impact on the share price of the company, you are now every bit as much an insider as he is, with respect to that information. Firstly, it is illegal on part of the management executive to share the company’s material information with you before it becomes public knowledge. Secondly, it is equally illegal for you to do so because you are now a temporary insider. This remains true regardless of how many times the information is passed. Legally, anyone who has material information is prohibited from trading, based on that knowledge, until the information is available to the general public.
By virtue of standing SEBI rules, the definition of an insider also includes persons connected on the basis of being in any contractual, fiduciary or employment relationship that allows such person access to unpublished price sensitive information (UPSI), employees. The masterstroke is that the onus lies on the accused (insider) to prove his or her innocence.
How does insider trading work? It’s simple. An insider in a company first buys the stock, then shares price-sensitive information with a small group of people who buy the stocks and spread the word. This leads to a huge artificial demand for the particular stock which results in higher prices. At a certain point, when the prices hit the ‘satisfactory’ level, the insider exits along with his small group of people and makes profits. Soon the stocks witness a fall resulting in huge losses for the public investors.
To be precise, insider trading harms small investors. Since there is no fair play involved in this kind of trading and no fair demand and supply of stocks, it is all detrimental to the functioning of a healthy stock market. This white collar crime weakens the faith of investors in the system and ultimately harms the economy as a whole.
Sajjad Bazaz heads Internal Communication Department of Jammu & Kashmir Bank Ltd. The views expressed are his own and not of the institution he works for.