Parliament must tidy up primitive law

STEPHEN FRANKS* has some ideas on how to upgrade our unwieldy insider trading law.

Our insider trading law is crude. It wrongly catches ethical behaviour, yet leaves loopholes for some disgraceful conduct.

But it is nonsense to claim that it is light-handed. It is just badly enforced, like much of our law. And Parliament is busy multiplying grievance remedies even as grave crimes go effectively unpunished.

For businesses there are often no practical remedies for breaches of basic obligations, such as paying debts when they fall due.

So the failure to stop insider trading may be just another symptom of a community that has lost its determination to enforce values.

But dithering and inaction in other areas does not mean we need to tolerate insider trading. Standards of honesty would be higher if we had fewer laws more ruthlessly enforced.

Instead, Government ministers, officials and regulators are drifting into copying the ineffective laws of other countries.

No amount of fancy new rules will compensate for a lack of will to uphold existing basic rules of honesty. Indeed, complex new law can get in the way of enforcing basic laws. New privacy and employment laws give excuses to authorities who don't want to apply old-fashioned disincentives such as shame and immediately sacking people who disgrace their organisations.

We could have a straightforward insider trading law. A company's information is valuable property. People who knowingly take the benefit of that company property without justification should have to cough up the gains. They are guilty of theft or conversion.

But this simple position has got all mixed up in our law. Our law worries about the effect of market information and whether it is public, instead of focusing on the duties of those who hold it.

It is like basing a law about car conversion on whether the car gave the driver a speed or status advantage they had not paid for, instead of looking at whether they had permission to use it from a person with authority to permit the use.

We have reached this confused position because of a misapplied theory that it is wrong for anyone in a market to trade with better information than someone else.

So the present definition of inside information does not require that the information come from inside sources at all. It is enough that it is non-public and price-sensitive.

The equally informed market is an impossibility. The fairly informed market is achievable. It would punish those who misappropriate non-public information, but not those who create it or find out legitimately.

So our insider trading law is primitive. Beneficial practices such as due diligence, underwriter scrutiny of a company's affairs, and even use by a listed investment company of its own non-public analysis or research, or its own intentions to take over a target, can be culpable.

Yet a company making a formal takeover bid on the basis of inside information flowing through a nominee director may escape scot-free.

While we are thinking of criminalisation, Australia is looking at introducing civil remedies.

Perhaps we should criminalise insider trading proceedings. But it would be laughable on our basis of the present definitions, as the Securities Commission report on the Fletcher Paper Hyslop share scandal makes plain.

The courts would make technical mincemeat of prosecutions.

So until we have fixed the definition we should use the triple damages platform we have. The obstacles to enforcement are not mysterious. Some of them have been raised by the commission as far back as 1992. They could be removed quickly.

They are:

Reduce the Securities Commission power to prevent the appointment of an independent investigating lawyer at the request of a shareholder.

Protect the investigators against defamation and other tactical threats.

Provide for penalties on the company and on third parties who withhold information from the investigator.

Ensure full compensation to any public-spirited shareholder or company who successfully brings proceedings. It should be enough to outweigh the risks that dissuade rational people from enforcing even if they can recover the actual costs of bringing the proceedings.

To ensure support the law must provide for a proper purpose defence, where the disclosure or use of the information was in the company's interests and the recipient did not abuse confidentiality.

Anyone who knew or ought to have known that the information they were using was stolen property should have insider's liability.

The present director's exemption procedure can be exploited by dishonest directors. I recommend an alternative. Insiders should tell the market of their trading intentions in advance so people can know they are dealing with an insider with superior information. This last recommendation would go further than the US requirement for immediately reporting insiders' trades.

I believe it would be a good substitute, perhaps optional, for the present cumbersome director's and officer's exemption procedure.

None of these steps is complex. We need not delay while the foundations are strengthened to enable criminalisation.

The real change will come when New Zealanders accept that they have to penalise the dishonest - socially, in employment, and in reputation - instead of excusing them and leaving it all to the authorities.

* Stephen Franks is an Act MP and a former member of the Securities Commission.