Information used in making investment decisions should be confidential. It is a criminal offence in most countries. Inside information: Management information about a company, which is known by the company’s directors and management. This information is not known to the members of the public. Trading based on such inside information is called insider trading.
Arguments for Laws & Regulation
Regulating the system by prohibiting insider dealing has created unfair consequences for a few (the people who know a stock is going to go down but can’t trade on this information because it’s not public), but in the end, far more people benefit from a system that requires fairness.
Insiders
Not just limited to corporate officials and major shareholders. Can include any individual who trades shares based on material non-public information.
Reasons for prohibiting Insider Trading
Fraud-on-the-market: Poses threats to the integrity and confidence of the capital markets and undermines public confidence
Equity: Unfair on investors who do not have access to the information.
Harm to the corporation itself.
Harm to individual investors
It may de-stabilize markets by encouraging rumours
Arguments for Insider Dealing
Good for The Market. If an insider is trading, it points the market in the true situation of the corporation.
If the insiders are buying the stock, they must know more about their company than everyone else, so it is a good idea to buy the stock.
Materiality
Information about a listed company is material information if a reasonable person would expect it to have a material effect on the share price of the company if it were generally known to the market.
E.g. -Dividend increase, decrease or omission, Gain or loss of a major customer, Changes in management, Major acquisitions
The source of the information also impacts its materiality. The more reliable the source, the more likely it is that the information is material.
For example, you overhear the CEO of a hotel company tell his assistant that he’s about to announce a drop in quarterly corporate earnings, and you immediately call your broker to sell your shares, then the information is material and non-public.
On the other hand, if you sell your shares based on a recommendation from your dentist, who happens to follow the hotel sector as a hobby and thinks this particular company is under strain, that source of information is unreliable and therefore not material.
SEC v. Texas Gulf Sulphur Co.
General rule of insider trading:
Disclose information or abstain from trading (buying or selling).
Insiders can trade if information is not material or if it is material but has been disclosed to the public.
Point out three elements; 1. Disclose information, 2. Material, 3. Not disclosed to public
Facts: TGS downplayed a mineral find through a press release. The company wanted to wait to release the information because it was not a “sure thing” and they wanted to purchase the land around it without that land’s price going up. If there was information of mineral, then the surrounding land’s price would increase.
It is Business Judgment whether or not to release information to the public if there are business reasons to keep it secret, but then the insiders with that information have to refrain from trading until it has been disclosed
Dirks v. SEC
If a party has a fiduciary duty (e.g., they are an employee of the company), he will be held liable under insider trading laws for “tipping.”
“tippee”, can be held liable too if you know or should have known that the insider was breaching his fiduciary duty by disclosing the information or would somehow benefit from disclosing it.
If the person giving the insider information does not have a fiduciary duty, then the tippee has no duty either, and no liability would be imposed
Ways of controlling Insider trading
1. – Common Law Control
2. – Statutory Control
Common law Control
The common law imposes no specific prohibition on the use of inside information in share dealing, unless some special relationship exists when there is a legal duty to disclose all relevant information.
If the person giving inside information does not have a fiduciary duty, no liability would be imposed.
Percival v. Wright – Director has fiduciary duty only to the company, not to the shareholders.
The common law position has been replaced by the statutory provisions in both SL & UK.
Statutory Control
The prohibition of Insider trading was 1st introduced in SL by 1982 Companies Act.
The Securities and Exchange Act No. 36 of 1987 (SEC Act) repealed the provisions on Insider trading embodied in 1982 Act.
Apart from these Companies Act No 07 of 2007 is also applicable with regard to Insider Dealing
S. 197 Companies Act 2007
A director of a company who has obtained information in his capacity as a director or employee is prohibited from disclosing, making use of or acting on the information except for the company’s purpose, when he is authorized to do so by the Board or the company or as required by law.
Section 197(3), provides that the Board may authorize the director to disclose, use or act on the information if it is not likely to prejudice to the company.
Part IV of SEC Act
Prohibits the use of price sensitive information by connected persons with a company or individuals who have obtained such information from connected persons with a company in making profit from dealing in securities if that information is not generally available to the public
Section 32 (1) – pre-conditions that must be satisfied to establish offence of insider dealing
An individual who is connected with a company shall not trade in listed securities of that company if he has information which,
(a) he holds by virtue of being connected with the company;
(b) it would be reasonable to expect a person so connected and in the position by virtue of which he is so connected, not to disclose except for the proper performance of the functions attaching to that position; and
(c) he can reasonably be expected to know is unpublished price sensitive information in relation to those securities.
Section 32 (2) – situation of two companies
An individual who is connected with a company shall not trade in listed securities of any other company if he has information which
(a) he holds by virtue of being connected with the first mentioned company;
(b) it would be reasonable to expect a person so connected and in the position by virtue of which he is so connected not to disclose except for the proper performance of the functions attaching to that position;
(c) he can reasonably be expected to know is unpublished price sensitive information in relation to those securities of that other company; and
(d) relates to any transaction whether actual or contemplated, involving both the first mentioned company and that other company or involving one of them and securities of the other or to the fact that any such transaction is no longer contemplated.
A is Director of Company ABC. ABC engage in transactions with XYZ. Because of the transaction A knows certain inside information about XYZ. A prohibited of using those information of XYZ if it is price sensitive, material, confidential and non-public.
Section 32(3) – 3rd person
a person who is in possession of price sensitive information, but is not connected with the company as such and is therefore not prohibited by the provisions of 32 (1) & (2) is however prohibited from dealing in those securities if he has received the information directly or indirectly from another person who is or at any time in the preceding 6 months has been connected with a company and is aware or ought reasonably to be aware of facts or circumstances by virtue of which that other person is himself precluded by 32 (1) & (2)
A has inside information of XYZ, but A is not connected to XYZ. A got information from B who is connected to XYZ (covers under S.32 (1)). A can make liable.
Section 32 (4) – situation regarding a takeover offer
An individual who is making takeover offer for a company in a particular capacity, that same individual shall not trade in listed securities of that company in another capacity.
A is director of ‘Gannan Company”. A makes a take-over offer to company ‘Kelawuna’ as the director of ‘Gannan’. As a result of offer A allowed to certain inside information of the ‘Kelawuna’.
Section 32 (5)
If an individual has obtained information from an individual who is making a takeover offer in a particular capacity, such individual shall not trade in listed securities…..
If B gets inside information of Kelawuna by A, B is prohibited with using such.
Section 32 (6)
Who is for the time being prohibited by any provision of this section from trading in listed securities shall not counsel or procure any other person to deal in those securities, knowing or having reasonable cause to believe that person would trade in such listed securities.
Section 32 (7)
an individual who is for the time being prohibited as aforesaid from trading in listed securities by reason of his having any information, shall not communicate that information to any other person if he knows or has reasonable cause to believe that or some other person will make use of the information for the purpose of counseling or procuring any other person to trade in such listed securities.
Section 34
An individual is connected with a company if, he is a director of that company or a related company; or occupies a position as an officer or employee of that company or a related company; or a position involving a professional or business relationship between himself (or his employer or a company of which he is a director) and the first company or (‘professional or business relationship’ covers auditors, banks, insurance and likewise.)
Defenses for Insider dealing
Where the acts is done not with a view to make a profit or avoid a loss – S.32(8)(a) SEC Act 1987.
Where the transaction is entered into in good faith by a liquidator, receiver or trustee in a bankruptcy – S.32(8)(b) SECA 1987.
Where the information is obtained in the ordinary cause of business and the act is done in good faith – S.32(8)(c) SECA 1987.
Where the act is done in order to facilitate the completion of carrying out of a transaction such as a takeover offer – S.32(9) SECA 1987
Punishment
Section 33 (A) – Any person who contravenes any provision of this Part of this Act shall be guilty of an offence and shall on conviction after summary trial by a Magistrate be liable to a fine not less than one million rupees or to imprisonment of either description for a term not less than two years and not exceeding five years or to both such fine and imprisonment.
Issues
Non listed companies not covered under the act. Only the listed companies.
Only provision applicable to non listed companies are Companies Act. But that only impose liability to the directors.
According to the definition of insider in SEC Act shareholder can be hardly regarded as an insider.
This is disadvantageous, in Sri Lanka majority shareholder regimes exists. There is a high possibility of insider information being abuse by the majority shareholders for their benefit.
SEC Act use the term individual. Therefore, it does not cover artificial persons i.e. companies. People can use company as a shareholder to protect themselves from liability under insider trading.
Securities Exchange Bill – 2017 November
Section 135 (1) A person is an “insider”, whether such person is connected to the respective company or not…………
Section 135 (4) – shall be liable on conviction to a fine of not less than ten million rupees or to imprisonment of either description for a term not exceeding ten years or to both
UK
Financial Services and Markets Act 2000(FSMA) and the Criminal Justice Act 1993(CJA) covers the offence insider dealing.
Criminal Justice Act 1993
Section 52 – Criminal Law
(1)An individual who has information as an insider is guilty of insider dealing if, in the circumstances mentioned in subsection (3), he deals in securities that are price-affected securities in relation to the information.
(2)An individual who has information as an insider is also guilty of insider dealing if—
(a)he encourages another person to deal in securities that are (whether or not that other knows it) price-affected securities in relation to the information, knowing or having reasonable cause to believe that the dealing would take place in the circumstances mentioned in subsection (3); or
(b) he discloses the information, otherwise than in the proper performance of the functions of his employment, office or profession, to another person.
(3)The circumstances referred to above are that the acquisition or disposal in question occurs on a regulated market, or that the person dealing relies on a professional intermediary or is himself acting as a professional intermediary.
(4)This section has effect subject to section 53
Financial Services and Markets Act (FSMA)
Non- Criminal offence
Section 118 – which introduced the first State-focused non-criminal liability for insider dealing
This as amended in 2005 to implement the Market Abuse Directive 2003; Section 118A-C
Section 118B
Insider is any person who has inside information
(a) as a result of his membership of an administrative, management or supervisory body of an issuer of qualifying investments,
(b) as a result of his holding in the capital of an issuer of qualifying investments,
(c) as a result of having access to the information through the exercise of his employment, profession or duties,
(d) as a result of his criminal activities, or
(e) which he has obtained by other means and which he knows, or could reasonably be expected to know, is inside information.
Market Abuse Regulation
Article 8(1): ‘insider Dealing arises where a person possesses inside information and uses that information by acquiring or disposing of, for its own account or for the account of a third party, directly or indirectly, financial instruments to which that information relates’
Inside Information under Article 7(1): is of precise nature and has not been made public ‘relating Directly or indirectly to one or more issuers or to one or more financial instruments, and which, if it were made public, would be likely to have a significant effect on the prices of those financial instruments or on the price of related derivative financial instruments
Article 14) ‘a person shall not engage in insider dealing’, with no mental element, and instead a (rebuttable) presumption that a person who possesses inside information is presumed to use it (per Spector Photogroup NV v CBFA [2010] 2 BCLC 200
New Features through implementing MAR-
Prohibitions of attempts (Article 14)
Catches some decisions not to trade or to trade differently – upon Receiving inside information (Article 8).
Section 57 of CJA and Section 118(B) of FSMA are recognized shareholders as insiders.
Section 118(B) of FSMA use the term ‘any person’ – covers both artificial persons and natural persons.
Therefore, unlike in Sri Lanka, UK definition of insider is comprehensive.
