Inside jobs go under searchlight

By BRIAN FALLOW

You can say one thing for New Zealand's insider trading laws - they don't overburden the court system.

Actions under the insider trading provisions of the Securities Amendment Act are extremely rare, yet a majority of the submitters to a Ministry of Economic Development discussion document on insider trading in late 2000 believe insider trading happens in New Zealand and can undermine confidence in the market.

Legislation reported back from the finance select committee last week will give the Securities Commission the right to take suspected insider traders to court. At present that right is limited to injured parties or the companies concerned.

And last month's Budget boosted the commission's funding by $1.3 million, plus an $844,000 litigation fund.

But the question of whether the insider trading laws themselves are adequate, and if not how they could be repaired, is still at the stage of a "first principles" review.

The ministry has just released a three-volume discussion paper on insider trading, market manipulation and the associated penalties regime. It is long on questions - submissions are invited on 124 of them - but short on answers.

To be an insider does someone have to have a personal connection with the company? Or should an insider be anyone who has price-sensitive information that is not generally available?

The present law is based on the former, breach of confidence approach.

One of its shortcomings was illustrated by the Hyslop affair three years ago. Paul Hyslop used information, a draft Fletcher Challenge press release surreptitiously obtained, to manipulate the market. He bought shares, leaked the draft to the media, and sold the shares for a $40,000 profit.

But he did not count as an insider because the law allows the chain to go only two removes from a principal officer, employee or substantial shareholder of the company. He was further down the chain.

Australia has adopted the alternative, "information connection" approach. It reflects the philosophy that insider trading is a wrong done to the market itself, harming its efficiency and fairness, and not just a breach of confidence or a fraud on the counterparties in trading transactions.

Consistency with the Australian approach is an important consideration, given the Government's stated intention of achieving harmonisation of the two countries' business laws.

Part of the definition of inside information is likely to be that it is not generally available. But that raises the issue of how to deal with research and analysis.

The Australian definition of generally available information includes deductions, conclusions and inferences from information that is readily observable.

But information an analyst gleans from discussions with company officers or unpublished company documents does not fall within the research and analysis exception and may constitute inside information if it is material and price sensitive.

By contrast, a United States court found that an analyst who privately questioned corporate employees about rumours of possible fraudulent activities in the company, and then discussed his findings with clients who subsequently sold their shares, did not breach US insider trading laws.

To prohibit such diligent research could inhibit analysts, whose role was necessary for a healthy market, the court found.

Another deficiency in the current law relates to tipping and was highlighted by Prime Minister Helen Clark's advice to Air New Zealand's Mum and Dad shareholders last September to "hang on to" their shares.

The act prohibits anyone with inside information about a listed company from advising or encouraging someone else to buy or sell its shares. It doesn't mention advising people to hold on to them.

The discussion document asks if liability should be imposed on an insider who discourages or stops others from dealing in the shares.

Another question is whether insiders need to know that the information they possess is inside information.

In New Zealand they do not, but in Australia it has to be shown that the insider knew, or ought reasonably to have known, the information was not generally available and was materially price sensitive.

The discussion document also considers whether there should be specific provisions on market manipulation, which might be defined as conduct likely to mislead or deceive market participants about the value or trading volume of a security.

In its report on the Hyslop case the commission wondered aloud whether New Zealand should adopt something like the Australian Corporations Law's general prohibition against misleading or deceptive conduct in dealing in securities.

Market manipulation on this side of the Tasman is addressed through an ad hoc collection of statute and common law including the Crimes Act, the Fair Trading Act and the tort of deceit.

Among the thornier questions that would arise if market manipulation were written into the securities law is whether to include market stabilisation after a float.

Market stabilisation is the common practice of underwriters or even the companies themselves trading in the period immediately after a new issue to avoid the failure of the offering.

Underwriters and sub-underwriters also raise a problem for insider trading law.

They generally require full disclosure of all material information before deciding to underwrite an issue.

The ministry says opponents of making an exception for underwriters argue that it would be an invitation to significant abuse as brokers had shown themselves to be prone to take advantage of inside information. But that had to be weighed against the crucial role of underwriters in capital raising.

* In tomorrow's Forum: Stephen Franks and Paul Swain on the need for reform.

Feature: Inside deals