Insider Trading and Market Manipulation: Overview White Collar Crime and Serious Fraud Conference 2 nd July 2010 New Zealand Governance Centre 1
strong focus on information asymmetries and disclosure. Accurate disclosure has an important role to play in investment decisions, as well as a further role in the price setting process and in the prevention of market abuse. 2
Interference with the price setting process : damages investor confidence adversely affects investor confidence in the fairness, honesty and integrity of the market. This may distort the choices made by investors, scares investors away from the market and raises the cost of capital for issuers. 3
Market Abuse Insider dealing involves traders who know something other traders do not, and who take advantage of that information asymmetry. 4
Market Abuse Market manipulation traders manipulate the market by: - disseminating false or misleading information - engaging in trading activity that gives a false impression as to the demand for or liquidity of a particular security. 5
2. Prevalence of Market Abuse Some studies indicate that market abuse may be quite prevalent. Attracts a lot of media attention. The U.S. Securities and Exchange Commission (SEC) prosecutes over 50 cases each year. Many of the cases are settled out of court. The SEC and several stock exchanges actively monitor trading, looking for suspicious activity. In 2006, Britain’s Financial Services Authority estimated insider trading may have occurred in 29% of UK takeovers in the six years to 2004. 6
Concept of insider trading The basic principle behind the New Zealand’s original insider trading regime was that an insider who obtains price-sensitive information by virtue of his or her position as an insider should be prohibited from dealing in securities or tipping until the information is published or otherwise reflected in market prices. Under the regime introduced in 2006, a person no longer becomes an insider because of his or her position in or connection with the entity that the inside information pertains to. Rather, a person becomes an insider because of a connection with the inside information itself. While insider trading regulation is no longer based on the fiduciary principle, fiduciary obligations and obligations of confidence under the common law and the Companies Act 1993 remain in place. 7
Characteristics of new legislation A person who overhears inside information in passing, and then trades on that information may be just as liable to prosecution under the legislation as the company director who learns of inside information by virtue of their office. 8
Key features of insider trading provisions An insider is defined not by reference to a relationship with a public issuer, but by reference to a relationship with “inside information”. Broadens definition of persons to “outside insiders”. In previous provisions possession was the trigger and there was no requirement that the insider knew the information was inside information. The introduction of the mental state of a person as an element both narrows the class of potentially liable persons and adds an element that will be evidentially difficult to establish. 9
If complexity was the principal shortcoming of the pre-2006 regime, it seems highly improbable that the new provisions have cured that deficiency. The prohibited actions remain basically unchanged. An “information insider” must not trade, (SMA 2006, s 8C) disclose the information, (SMA 2006, s 8D) or advise or encourage others to trade. (SMA 2006, s 8E) 10
Market Abuse: Market Manipulation White Collar Crime and Serious Fraud 11
1. Introduction MED- “Market manipulation is a deliberate attempt to interfere with the free and fair operation of the market.” Market manipulation impedes securities markets from operating as independent pricing mechanisms and thus can be regarded as the enemy of market efficiency and investor confidence. 12
While insider trading involves taking advantage of information asymmetries, market manipulation involves providing misleading information to the market – creating information asymmetries. 13
Crimes Act 1961, s 240 "Every one is liable to imprisonment for a term not exceeding 5 years who conspires with any other person by deceit or falsehood or other fraudulent means to defraud the public, or any person ascertained or unascertained, or to affect the public market price of stocks, funds, shares, merchandise, or any thing else publicly sold, whether the deceit or falsehood or other fraudulent means would or would not amount to a false pretence as hereinbefore defined.“ A conspiracy is an agreement between two or more person. Offence is complete as soon as agreement is reached. 14
R v Adams Crown alleged that Mr Hawkins and Mr Darvell conspired by deceit, falsehood and other fraudulent means to affect the public market price of shares in Equiticorp Holdings Limited in that they agreed to dishonestly support the company's share price. Although the Crown was able to establish that both defendants had misled the press and the NZSX, the Crown failed to establish that this conduct resulted from any concerted action between the two accused that amounted to a conspiracy for the purposes of section 257. This section is targeted at preventing conspiracy, but does not cover fraudulent conduct carried out by an individual. 15
NZSX Code of Conduct Avoiding misleading or deceptive acts or representations Member Firms and their representatives shall refrain from any action which would hinder or disrupt the fair, efficient and orderly functioning of the market. Member Firms shall not communicate groundless or false information or rumours and may not undertake any activities, including advertising, which are misleading or deceptive or would mislead or deceive others about the true state of the market. Member Firms and their representatives shall not engage in any manipulative practices such as trades which involve no change in beneficial ownership, or which falsely indicate activity. The NZSE will not discourage new trading strategies provided they are not prohibited by law (such as insider trading) and they do not diminish the fairness, openness or efficiency of the market . 16
2. Overview of Market Manipulation Practices The practices which are generally considered to come within the ambit of market manipulation are of two main types: Disclosure based manipulation. This occurs where a person disseminates false or misleading information which has the effect of misleading other participants about the value or trading volume of a security. Trade based manipulation. This is the buying or selling of a security by a person which misleads or deceives other participants about the value or trading volume of that security. 17
2.1 Disclosure Based Market Manipulation Disclosure based market manipulation generally involves a person releasing information that misleads the market and in this way materially affects the price of shares. An example is where a person disseminates unrealistic, unsubstantiated or incorrect data, projections or evaluations. The information could also relate to more general political and economic affairs. The manipulator then uses the demand generated by the false information to sell their shares. This is sometimes known as “hype and dump” or “pump and dump” – because once the price has risen, the manipulators dump the securities. 18
Example A person, such as an investment advisor, purchasing a security before recommending it to others, with the intention of selling it at a profit after the recommendation has resulted in an increase in price. Conversely, “slur and slurp” involves the price of securities being talked down, allowing the manipulator to buy at a lower price. When this takes place over the Internet, it is called “cyber-smear”. 19
Early example In R v De Berenger (1814) 105 ER 536, not so “noble” members of the English aristocracy conspired with De Berenger. De Berenger was to appear in Dover as a French officer who would bring the (false) news of Napoleon’s death. Upon De Berenger’s disguised appearance as a French officer bringing the news, City stockbrokers and the public started buying government debt notes pushing their price appreciably higher, while the members of the syndicate offloaded their holdings, as originally planned, at considerable profit. The discovery of the scheme meant criminal conviction of its perpetrators, who were stripped of their titles and removed from public office. 20
Early example Nathan Rothschild, the banker, was known for maintaining a network of communications between Continental Europe and Great Britain thanks to a system of carrier pigeons. He allegedly deceived the City by spreading the rumour that Napoleon was winning the battle of Waterloo (18 June 1815), after which his agents openly sold government securities (called “consuls”). Simultaneously, he was covertly purchasing large quantities of the same securities, taking advantage of the depressed price caused by the false rumour. Wellington won the battle. 21
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