Lesson 18 / 07
The announcement on
Friday by BHP-Billiton, the world’s biggest mining company, that it
had made an offer for its rival Rio Tinto, the worlds fourth biggest
miner, made news around the globe.
If successful it would create the world’s fourth biggest
company, behind PetroChina, ExxonMobil, and General Electric.
Rio's shares in
Australia rose 15% on the day. More
interesting to some however was the news that its price had begun to
rise steeply on international stock markets, several hours before the
official public announcement in London, suggesting strongly that the
news had been leaked and that there had been significant insider
trading. The Australian
Stock Exchange was reported as looking into this aspect, as a matter of
is Insider Trading?
Insider trading is
a concept which is easy to describe and define generally but which can
be difficult to do specifically or precisely. Although a large number of
countries, probably the majority, have laws against insider trading, a
significant number do not. Amongst
those who do, the definition of what is insider trading varies, as does
the seriousness with which it is viewed, and the effort put into such
law’s enforcement. Thus,
for example, in the UK, negative insider trading, ie where a person
acquires information that would be considered insider information, but
which information such person then uses not to make a trade which he or
she otherwise would have done, is not considered illegal. This is presumably because of the added difficulty of proving
a negative. Other countries
make no such distinction.
The USA and the
Anglo-Saxon countries generally, including Australia, are amongst the
leaders in opposition to insider trading.
In Australia, the provisions relating to it are found in the
Corporations Act, which devotes a considerable number of pages to it and
provides a definition of sorts. Many
institutions and major companies have their own formal Insider Trading
Policy. The Monash
University Insider Trading Policy, for example, summarises the
definition of insider trading as follows;
“ Insider trading
is improper trading in securities on the basis of price sensitive
information that is not generally available to others.”
It goes on to note that “It includes procuring or inducing
another person to buy or sell securities about which insider information
One does not have
to be a lawyer to see the potential judicial problems inherent in such
definition. What is, for
example, “improper trading”?
Or “price sensitive information” or “ insider
the potential penalties are fines up to $200,000 and five years
imprisonment these are serious questions.
It follows that
insider trading as such is concerned with trading in or of a
corporation’s stock or other securities. The ASX maintains a special unit to monitor the market.
If unusual activities occur it will conduct an inquiry and can
refer the matter to the Australian Securities & Investment
Commission, which has broad powers of investigation. It is suggested that the ASX will conduct a routine
investigation if there is a one-day price movement in a security of 10%
If a person is
charged with an offence of insider trading, the problem widens from one
of definition to include questions of proof.
It is said that insider trading is easy to detect but difficult
to prove. Between 1985 and
2005, 32 persons were charged with insider trading but only 9 were
convicted. Earlier this
year ASIC unsuccessfully brought a major charge in the Federal Court
against Citibank, the world’s second biggest bank.
cases of Not
of the inherent difficulties in conducting a prosecution for insider
trading, two of the more recent notable cases, often thought, by the
public, to be insider trading cases, were in the event, not insider
trading cases at all; these were the Steve Vizard case in Australia and
the Martha Stewart case in the USA.
Steve Vizard was a
successful TV entertainer and businessman.
It was alleged that in 2000 as a director of Telstra he had
misused information he had acquired from his position as such to deal in
shares in 3 public companies thereby making a relatively small profit.
However, to much criticism, the Commonwealth Director of Public
Prosecutions declined to prosecute him criminally for insider trading.
He was subsequently tried in 2005, in a civil proceeding, for
breach of his duties as a company director, and was fined $390,000 and
disqualified from directing a company for 10 years.
In the Martha
Stewart case in the USA, Stewart also, like Vizard, a successful TV
personality and entrepreneur sold some shares she owned shortly before
the company announced some devastating news which caused a steep drop in
its share price. Since
Stewart was friendly with the president of the company it was assumed he
had leaked the news to her beforehand.
was sued for insider trading in a civil proceeding by the Securities
& Exchange Commission, the American equivalent of ASIC, but this was
dismissed. However in the
course of the proceedings Stewart made statements and did things for
which she was subsequently charged with making false statements and
obstructing the course of justice.
At the trial, the
judge dismissed the principal charge; namely that she had publicly
declared her innocence and hence had committed fraud.
However the jury convicted her of the other charges and she was
sentenced to gaol.
Reasons why it should be Illegal
Insiders in a company have
been implicitly entrusted by the company with access to information to
be used by them for the benefit of the company and not for the benefit
of the insider. There
exists an implicit duty not to breach such trust.
Any benefit derived by the insider trader belongs to the company,
which has been fraudulently deprived of it by the insider.
It is dishonest and
morally wrong, and hence a fraud, to engage in a trade when you are
possessed of inside information, which you are aware, the other party
does not possess. Whilst
asymmetric knowledge trading will always occur, the law should do what
it can to prevent it.
Anti insider trading laws
encourage investment in the market since it reassures investors and
gives them confidence that the law will protect them from the
Reasons why it should not be Illegal
facilitates the market process since it enables and encourages speedy
dissemination of information. It
gives those most likely to have information, namely insiders, an
opportunity to use and benefit therefrom.
The likelihood of major corporate disasters, such as HIH is much
reduced since insiders will want to use the information of its likely
occurrence, sooner rather than later, and hence will expose such
potential major disasters before they occur.
Insider trading is a
victimless act. There is no
way the law can preclude trading between parties with asymmetric
knowledge and to purport to do so merely inhibits the working of the
market to the ultimate detriment of all.
To make laws to prevent
people from using the information they possess, in the absence of a
readily discernible victim, is contrary to human nature and will merely
bring the law into disrepute.
Similar activities such as
insider trading in real estate or commodities are not burdened with such
12 November 2007