Insider Trading in Nepal's Stock Market and Its Effect on Middle-Class Investors

As Nepal's stock market expands, a disturbing trend mars its growth: insider trading. The improper practice, whereby individuals holding inside information trade securities for their personal gain, has gained popularity, especially with low float stocks. Although the Nepal Stock Exchange (NEPSE) has seen unprecedented growth in recent years, especially since the COVID-19 pandemic, insider trading risks are eroding public confidence and disproportionately hurting middle-class investors who have swarmed into the market with dreams of financial success.

The Post-COVID Boom in Nepal's Stock Market

COVID-19 pandemic, though with initial fears, brought about an all-time high boom to Nepal's share market. As per market sources, when the government reopened the share market in May 2020, the NEPSE index was at just 1,200 points. In May 2021, it had hit an all-time high of 2,823, the highest ever-with transactions of over Rs 13 billion on a daily basis. This spectacular surge never let up, and the market was experiencing turnover sizes of over Rs 20 billion almost every other day during subsequent phases.

Not just in the index levels but even in mass participation, this boom occurred. According to the Ministry of Finance Economic Survey 2022/23, investor activity in Nepal's stock market rose to the rooftop, with 19.4 percent of the country's population as of mid-March 2023 getting involved in share dealings. During the first eight months alone of the 2022/23 fiscal year, demat accounts increased from 3.789 million to 5.654 million.

Former NEPSE CEO Chandra Singh Saud attributes this growth to two reasons: technological advancement and easy availability of loans. "We have always tried to make sure that we would like to change according to time. Because of the software (Trade Management System), more and more people have started investing in shares," Saud stated. "There are over 600,000 people who use the software. They can trade even from home."

Technology has made the stock market more accessible, bringing in hundreds of thousands of middle-class Nepalis looking to invest during a time when traditional channels of business were restricted by the pandemic.

The Dark Side: Insider Trading in Nepal

Despite this healthy growth, Nepal's stock market has been tainted by a number of high-profile cases of insider trading. Insider trading is when individuals with access to non-public, material company information trade on the basis of such information in an attempt to gain an unfair advantage over other traders.

According to the Securities Board Regulation, 2064, insider trading refers to where "any person trades in securities or causes any other person to trade in securities based on any insider information or notice which are unpublished or disseminates any notice or information within the reach of such a person while in the course of performance of his or her duty in a manner capable of affecting the price of securities".

Low float stocks-those with relatively small numbers of shares available for public trading-are particularly vulnerable to manipulation through insider trading. When there are not many shares to trade, even small trades have a large impact on prices, and therefore such stocks are an attractive target for those who have inside information.

Real Examples of Insider Trading in Nepal's Stock Market

Some high-profile cases of insider trading have occurred in Nepal in recent years:

The Ridi Power Company Case

In March 2023, the Nepal Securities Board (SEBON) brought a case against former Ridi Hydropower Company chairman Guru Prasad Neupane for insider trading. According to SEBON, Neupane had conducted insider trading as company chairman by buying and selling shares from March 2021 to July 2022. An investigation showed that Neupane had committed Rs 32.3 million worth of offenses.

The Money Laundering Investigation Department also lodged proceedings against Neupane and Executive Director Kuberamani Nepal under the Prevention of Money Laundering Act 064. According to the investigation conducted by the department, Nepal served as a facilitator in the suspected insider trading, helping in receiving, acquiring, and disposing of approximately 1.19 million rupees in connection with the illicit activities.

The Nepal Hydro Developer Limited Scandal

SEBON penalized Gyanendra Lal Pradhan, the previous executive chairman of Nepal Hydro Developer Limited, in April 2023 for insider trading. During the investigation, it was found that Pradhan traded company shares registered in the names of his family members on the secondary market, contravening Securities Act rules against company officials trading in their organization's securities while serving or within a year after retirement.

As a penalty for violating these provisions, SEBON fined Rs. 75,000 on Pradhan and barred him from serving as a director of a public company for ten years. Later on, in December 2023, Pradhan was arrested in connection with an old case involving 26 crores.

The Sarbottam Cement IPO Controversy

Worst of all was the revelation that those who were supposed to regulate the market had themselves been guilty of insider trading. An investigation by Himal Khabar found that NEPSE CEO Chandra Singh Saud and SEBON Chair Bhishma Raj Dhungana bought shares in Sarbottam Cement for relatives at prices well below market value on the eve of its Initial Public Offering (IPO).

The Sarbottam Cement board had collectively agreed to dispose of 6 million units valued at Rs 750 per unit to mobilize Rs 4.65 billion. But before the public issue, the majority of the units were disposed of at less than Rs 250 per unit, with immediate relatives of both the regulators and Global IME Capital, which was handling the IPO, being the recipients.

Share market analyst Rabindra Bhattarai described this as "a clear case of an attempt by insiders to unethically influence the market price of a company offering premium shares".

The Corporate Development Bank Case

One glaring example of insider trading effects is that of Corporate Development Bank (CORBL), whose share prices rose from Rs 210 to Rs 498-in excess of 130% growth over only two weeks. This record-breaking increase was due to non-public information of the company's plan to float a 1:1.5 rights issue.

The Karnali Development Bank Investigation

Recently, SEBON launched an investigation into alleged insider trading at Karnali Development Bank Limited (KDBL). At a Tuesday in late 2023, Nepal Rastra Bank declared KDBL troubled due to a lack of ability to comply with the norms of capital adequacy and took corrective measures. Despite this negative news, the share price of KDBL zoomed the following day by Rs 76.90 per unit to Rs 845.90. With 250,439 units being traded worth Rs 201.30 million, the timing suspicious and raised regulatory eyebrows.

SEBON official Niranjaya Ghimire said: "It is quite unusual that the share price of the organisation in crisis shot up at a bizarre rate just the very next day after it was announced to be problematic."

The Middle-Class Victims

Insider trading disproportionately damages Nepali middle-class investors who have increasingly relied on the stock market as an investment option. When insiders move prices on non-public information, ordinary investors are left to make uninformed decisions, frequently buying at artificially inflated prices or selling before they can reap meaningful profits.

The impact is worst on low float stocks, where manipulation of price is easier since liquidity is lower. Individual investors suffer huge paper losses when price bubbles created by insiders burst.

Also, the post-COVID boom in market turnover again puts more middle-class investors in the line of such risks. Economic Survey 2022/23 showed that market capitalization decreased by 25.5% between mid-March 2022 and mid-March 2023, from Rs 3.782 trillion to Rs 2.823 trillion. This destruction is likely to affect thousands of new investors who entered the market amidst its bull run.

The issue goes beyond loss of funds. Insider trading erodes trust in the market mechanism per se. When ordinary investors see high-profile cases of manipulation of the market-involving, exactly, those regulators tasked with maintaining market integrity-they lose confidence in the fairness of the system.

Regulatory Challenges and Recent Developments

Nepal's regime of insider fighting regulation has been lenient in the past. The 2063 Securities Act (2006) made provisions for rudimentary prohibitions, but the penalties were rather mild-imprisonment for up to one year and small fines.

Sensing these loopholes, the government has introduced significant amendments to strengthen insider fighting penalties. Finance Minister Bishnu Prasad Poudel recently tabled the Securities (First Amendment) Bill, 2024, in the House of Representatives, which has demanded much stricter penalties.

Under the new bill, those who engage in insider trading may be subjected to:

• Repayment of the amount
• Equivalent fines of up to Rs 30 million
• Imprisonment for three years
• Or a combination of these punishments

The bill also proposes removing chartered accountants and FNCCI members from SEBON's board of directors to avoid conflicts of interest. This comes after FNCCI Vice-president Chandra Prasad Dhakal quit as a SEBON board member in August 2021 following media reports on conflicts of interest-Dhakal was a chairman of various listed firms on NEPSE while working as a regulator.

Solutions to A More Transparent Market

To effectively combat insider trading in Nepal's stock market, especially in vulnerable low float shares, several measures have to be adopted:

Stronger Regulatory Powers

The Securities Board must have greater power to probe suspected insider dealing. This is catered to by the proposed amendment bill through allowing SEBON to investigate bank transactions, requisitioning relevant records from Nepal Rastra Bank for investigations related to securities. This harmonization of efforts among the regulatory agencies is necessary for meaningful enforcement.

Technological Solutions

Nepal has already made considerable progress with the adoption of the Trade Management System (TMS), which has improved transparency in trading. Further technological advancements could be:

• Sophisticated market surveillance systems to detect unusual patterns of trading
• Artificial intelligence software to detect potential insider trading activity
• Blockchain-based solutions to offer transparency in trading records

Market Structure Reforms

Particularly for low float stocks:

• Enforcing minimum free float requirements for listed companies
• Instituting circuit breakers for low liquidity stocks
• Creating special monitoring systems for thinly traded stocks

Education and Awareness

The majority of middle-class investors do not know the methods of insider trading. SEBON needs to conduct extensive education campaigns to inform investors:

• Recognize signs of suspected insider trading
• Learn about their investor rights
• Find out how to report suspected insider trading behavior

Whistleblower Protection

Having effective whistleblower protection measures may encourage employees and other people who possess information regarding insider trading to report it without fear of retaliation.

Confiscation of Illegal Gains

Beyond just fines and imprisonment, regulatory authorities should focus on confiscating profits made through insider trading, removing the financial incentive for such activities.

Conclusion

Even though Nepal's bourse is growing and attracting middle-class investors, fighting insider trading-most particularly low float stocks, which are sensitive to insider moves-is not merely a regulatory exercise but an economic and social necessity. The situations highlighted in this article indicate that insider trading is not theoretical in Nepal but an active and on-going menace to market integrity.

The legislative changes proposed to increase penalties and widen SEBON's powers of investigation are major steps in the right direction. But the trick will be good implementation. Insider trading has been considered a trivial offense in Nepal rather than the seriously inappropriate market manipulation it truly is for far too long.

Middle-class investors, who were, in many cases, introduced to the stock market during the pandemic as a vehicle to increase their savings, should be treated to a fair and transparent market. Without faith in market integrity, Nepal threatens to undermine the tremendous growth in market participation experienced in recent years.

The path forward requires regulators, market participants, and investors to commit. Through stricter supervision, implementing technology-driven solutions, and building transparency culture, Nepal can work towards having a stock market where achievements are measured in informed investment decisions and not in the ability to gain access to unpublished information on a selective basis.

Nepal's middle class-and its economic destiny-are waiting. The time has come to act forcefully against insider trading.

Article By: Sandip Poudel

Financial Researcher