Wild, Wild East: Insider Trading Skyrockets in India, As Regulators Promise Monitoring Crackdown

In surpassing the growth of other emerging markets, India has also become a more risky place to do business. Regulators are urging firms to take their lead on new technologies that can curb the threats of insider trading, bribery, and corruption.

Intense growth has put India’s stock market on course to overtake both the UK and the Middle East within three years, and, in line with the volumes of money pouring in, financial crime has rocketed.

According to Goldman Sachs analysts, India’s market capitalization will top US$5 trillion and become the fifth largest in the world by 2024. However, fraud, insider trading, and market rigging scams are growing in both number and sophistication, experts have said.

The stratospheric growth outstrips surrounding jurisdictions but also presents familiar compliance headaches for firms looking to do business in India. There are sizable opportunities for growth, but the risks are high.

Observing and controlling the actions of people on the ground are often difficult for Western compliance teams, which is one of the main reasons why companies are wary of bribery and insider threats when doing business in emerging markets. As a result, investments in technology, particularly around voice platforms, are on the rise.

Insider Threats Rising In The East

The Securities and Exchange Board of India (SEBI) is so concerned with the amount of market abuse occurring it has built a new in-house monitoring system and is urging banks to implement voice monitoring technology as part of efforts to improve trader oversight. 

Previously, insider tipping methods were amateurish and easily uncovered, but now criminals have begun to use complex derivative strategies to game the market and stay out of the regulator’s crosshairs.

“You can directly ascertain the intent of purchase or sale by an insider or his proxies but with derivatives, it is really difficult to do the same,” said a senior regulatory official. “The new platform scans and analyzes such complex trading data and tallies them with various other information, including the IP address from which the trade was made.” 

SEBI’s system scans approximately 20 million derivative trades a day while generating alerts that are “significantly more sophisticated than the existing insider trading alerts,” said the regulator’s annual report for FY21.

The platform also creates an insider database of suspect transactions along with the traders involved. India’s white collar crime and data protection laws do not carry the same restrictions on creating watch lists that Western jurisdictions have. 

“This feature will help SEBI establish patterns,” said the official. “If some trader frequently indulges in such transactions, the system will capture those and alert us. We then dig out more details and see if the trader is connected to any of the insiders.”

The regulator said rogue traders often rely on unrelated proxies, which means it has to establish a connection between the two parties in order to prosecute. 

Historic Struggles

Historically, SEBI has found it almost impossible to make cases and prove wrongdoing. In the last financial year, the regulator received 210 reports of insider trading, up from 185 last year. By comparison, just 30 new cases were opened for investigation this year versus 49 last year. 

SEBI hopes its new technology, along with the added pressure it’s placing on banks to upgrade their own systems, will help reverse the negative trend.

“We can’t do it all alone though,” the official said. “Businesses themselves have to be more proactive, starting with their compliance departments. This isn’t Wall Street or London, but we will encourage investment in technology like AI and machine learning. We want to see attitudes towards things like voice recording or email monitoring improve. We’re talking to our counterparts in the UK and the US to learn what works for firms who are using these more advanced tools.”

Laws introduced in 2018 forced brokers to retain evidence of orders for any trade executed. Records must be either physical notes signed by the client, SMS, email logs, or phone recordings. The broker must tell the client and provide instructions when the call is recorded. 

Firms told SEBI that the demands were unreasonable, and in three years the compliance burden has negatively impacted more than 70% of the banking market, according to a report by LexisNexis. 

Earlier this year, SEBI merged a handful of trading rules into a single regulation to ease the compliance burden on organizations but said in return it wanted the firms it regulated to invest in better monitoring technology.

It has also asked banks to put in place a code of conduct and an institutional mechanism to prevent fraud or market abuse caused by them and their designated persons.

Under this directive, the managing director or chief executive officer of market infrastructure institutions will be obligated to introduce these policies, and the board of directors will be responsible for ensuring that they are implemented.

Regulatory Progression

In June 2021, SEBI fined a senior executive of Franklin Templeton and his spouse for acting on insider information regarding their personal investments. The case was a landmark for several reasons, highlighting the increasingly bold approach of the Indian regulator. It also promoted questions amongst the Indian financial services sector of what constitutes insider trading and material non-public information.

The executive knew that the six credit risk schemes, whose redemptions were restricted in April 2020, were likely to endure high outflows and were running out of options to meet them. The executive said he based his decision on macroeconomic conditions in March and pointed to redemption pressures elsewhere. 

Until recently, the traditional view of insider trading was limited to individual securities, and non-public information in context to the fund meant front-running large client orders or advanced knowledge of portfolio rebalancing events. 

“That an early redemption of a scheme, based on advanced knowledge of portfolio-level attributes, could be the basis of an insider-trading charge is certainly novel, if not nuanced,” said Sivananth Ramachandran, Director of Capital Markets Policy, India at the CFA Institute. 

While individuals have a responsibility for good behavior, firms have a greater influence on conduct, he said. The main challenge to ethical conduct is situational influences, in which ethical individuals can be influenced to act in an unethical manner, because of factors such as obedience to authority, conformity with others, or responsiveness to incentives, said Ramachandran.

“SEBI has raised the threshold of what it considers acceptable executive behavior,” Ramachandran said. “It is up to the rest of the industry to exceed these lofty standards.”

A culture of compliance is essential for achieving the kinds of profitability and performance that companies expected to gain when they made their decision to enter emerging markets, such as India in the first place, said Jana Abanas, principal in Deloitte’s risk team.

“Regardless of where your organization stands now, there are several leading practices that can help companies mitigate legal and regulatory risks, and increase the likelihood of improving the returns on emerging market operations,” said Abanas. “It’s important to retain focus on corruption and fraud in parallel with a wider compliance program, and leverage the right technology and tools.”