The Hindu Business Line : Checking insider profits

SEBI’s draft proposal that seeks to compel corporate insiders to surrender any short-term profit they make on trading in their company’s shares may, no doubt, be radical but that is no reason to discredit it. SEBI clearly sees all buy-sell transactions of company insiders as driven by inside information. Consequently, it feels they should give up the gains to the company.

On the face of it, the suggestion may seem quite harsh as it sanctions expropriation of private wealth without any proof of guilt and without due compensation. But against must be set the fact that insider transactions needlessly raise in the minds of investors at large suspicions of trading based on privileged and private information. This has, therefore, adverse consequences for a company’s reputation and for the market that allows unbridled insider transactions. Precisely for this reason many companies, especially in the West, have internal regulations that require an employee to seek permission before transacting in the company’s stock, even if the investment is long-term. Moreover, employees can be motivated to promote the company’s cause through the device of stock options. So, the fetters on their freedom to engage in secondary market transactions are not harsh. While insider trading is harmful to the market, proving it under law is difficult. It is debatable whether a legal bar is a sufficient deterrent. Far better, therefore, to remove the financial incentive from such trading so that a measure of self-correction is automatically in place. In the event, SEBI’s proposal is necessary and is in accord with the principle that the right to property can never be absolute and must always be subordinated to a larger public purpose.

Who should be considered an insider? While directors and senior management staff of the company concerned ought to be covered, there may be some questions about including in the sanctions those in the middle management and shareholders with substantial stake. It is preferable to structure the ban only around employees and leave out shareholders with a substantial stake from its purview. To the extent such shareholders also hold senior management responsibilities they would anyway be subjected to the new restrictions on ‘short-term’ profits. On the other hand, the move might restrict institutional investors from holding a stake beyond the threshold 10 per cent suggested by SEBI. The public sector financial institutions have a lot of legacy investments that are above the limit suggested by SEBI. Their operations will be severely curbed if these profits are to be surrendered to the company. In any case, greater institutionalisation of corporate ownership is desirable in itself as small retail investors are better off routing their equity investments through mutual funds.

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‘Insiders’ have to surrender gains from short-term deals

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