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Insider Dealing Dissertation
Insider dealing is understood to be the act of dealing in unpublished price sensitive information and it is seen to go against the principle of equal access to information. There have been controversies regarding whether insider dealing should be prohibited, this dissertation aims to justify the need for its prohibition. It would examine the basis of such prohibition and the form in which the law should intervene. It would then examine the problem of the regulation of insider dealing in financial markets in three jurisdictions namely Nigeria, US and the UK. It analyses the shortcomings of this regulation and how it can be improved. The primary objective of the dissertation is to identify the shortcomings of its regulation in the above stated jurisdictions and to render reasonable recommendations for reform where necessary. This dissertation will attempt to provide its own approach to the problem of insider dealing. This approach forwards the proposition that allowing insider dealing on the basis of inside information is against the principle of equal access to information and it is detrimental to market transparency. Based on this proposition, the dissertation investigates the shortcomings of the current regulation of insider dealing in Nigeria. The study carried out will consist mostly of secondary sources gotten from Nigeria, UK and US. It will provide a clearer picture of the current regulation in the above listed countries. The study aims at measuring opinions and attitudes of legal professionals and investors towards the basis and effectiveness of the regulation of insider dealing in. This is followed by a legal comparative study between the regulations of insider dealing in the three jurisdictions. The comparison draws conclusions from comparing the broader systems of regulation in the three jurisdictions. It concentrates on a functional comparison between the specific rules related to insider dealing.
The main problem examined in this dissertation is the subject of insider dealing. Although there seems to be a broad agreement to the prohibition of insider dealing, the debate on insider dealing is not completely settled. Insider dealing is identified as an area that affects equal opportunities amongst various categories of people. A variety of discussions show eagerness to regulate it. However, it is still unsettled over how the law should intervene. Over the years, different methods have been employed in order to prevent this activity. Emphasis has been placed on different policies and forms of legal interference; for example; a criminal regime deterring the act of insider dealing, or an administrative regime empowering the regulator to face insider dealing and market abuse and enforce a disclosure system. Insider dealing has however, generated various legal solutions, but it appears that all forms of legal interference are needed in order to attain an efficient system of regulation. A critical analysis of each form of legal interference reveals its individual shortcomings, but it is hardly suggested that a certain form should be completely abandoned. The suggestion seems to be to keep all forms of legal interference and highlight areas of priority.
Different sanctions are being employed for insider dealing Although the initial results of adopting different sanctions for insider dealing are not encouraging, the argument remains that regulation can be applied in certain cases. The common argument is that the immorality and the harm the act causes to the general public is one of the main reasons for the use of criminal sanctions and it seems to be a popular method. Its popularity is based on achieving deterrence and just punishment. However, there are arguments against criminal sanctions and the main one is that deterrence and punishment cannot be met due to difficulties in actual enforcement. The present development is towards authorising the regulator to face market-place problems, a system which is proficient in deterring insider dealing. An efficient regulator with clear regulatory priorities helps maintain a transparent market. Civil or administrative penalties, recent codes of conduct or disclosure requirements are all methods that have been used in controlling insider dealing.
Criminal sanctions seem to be the last and most severe course of action. Studying insider dealing regulations critically focuses attention on both its shortcomings and advantages. This helps in the further understanding of regulation and practice. Analysing the details of the long experience of those countries that first identified and faced insider dealing will add to the arguments. There are necessary lessons to be learnt by developing countries e.g. (Nigeria) from the experience of developed countries. Understanding the problem of insider dealing and the policy of its regulation would be the first step in discussing the law of insider dealing.
PURPOSE OF THE RESEARCH
This dissertation will attempt to investigate the need to prohibit and regulate insider dealing. It will identify the problems associated with its regulation in Nigeria, the UK and the US. It will look at the shortcomings of this regulation and how it can be improved. Insider dealing has been an area of interest for researchers for many years. Examining this area through a dissertation, with the added dimension of Nigeria, will be a valuable input to the current debate. In its formation and plan, this dissertation will attempt to be insightful. Insider dealing is a problematic legal area and as a result has attracted the interest of jurists who have tried to recommend different solutions to its regulation. However, this has led to the conclusion that insider dealing stimulates different views. A social study and Legal comparative methodology in this subject will therefore provide a useful resource for the legal profession and in particular the legal profession in Nigeria. The aim of the dissertation is to develop a broad understanding of the regulation of insider dealing. It may be appropriate to state that the aim/objective of this dissertation can be achieved by the following subsidiary steps:
- Examining the nature of insider dealing in the Nigerian financial markets.
- Investigating what its effects on the financial markets are.
- Exploring the shortcomings of the current rules directed to regulating insider dealing.
- Examining ways in which the law and regulation can be improved to prohibit insider dealing.
- Comparing the experiences of developed countries (UK and the US).
- Determining how to empower the regulators to enforce the rules.
- Working out the appropriate punishment to deter insider dealing.
- Looking at how insider dealing can be reduced
In this dissertation, an essential element for attaining the planned objectives lies in the research methodology. The research methodology is based on secondary evidence of comparative law methods.
Since I would be studying different legal systems it would require me comparing the ways in which the different systems provide solutions to the legal problems. The comparative law method of the study will be split into two. Firstly, there would be a literature review which will be used as the main method of gathering information. This will be carried out by examining academic resources from the comparative jurisdictions, and using them in support of the arguments in the study. Secondly, because this area of law continues changing, there will be a need to examine current statutes, drafts etc.
The structure of the dissertation is reasonably intended to represent the problem, the methodology and the objective. The dissertation begins with a literature review which examines theories concerning the regulation of insider dealing: The arguments for and against regulation. This is important for introducing the basis of the study. The specificities of the problem and the law of insider dealing regulation in Nigeria will then be identified. The dissertation will also investigate a comparative regulation of insider dealing. The comparison is a device for providing solutions to the problems raised. The jurisdictions that will be compared are the US, the UK and the Nigerian financial market. The comparative study provides a detailed functional comparison of the rules directed at insider dealing in the three jurisdictions. The structure of the dissertation concludes by introducing my opinions and recommendations.
THE PROBLEM OF INSIDER DEALING AND ITS POLICY
The aim of this chapter is to provide a literature review. Its aim is to discuss extensively the theories concerning the problem of insider dealing and the Arguments in support and against its regulation.
It is certainly not universally agreed that insider dealing should be prohibited or that it is wrong. Even for countries such as Japan where insider dealing is being regulated, the people of the country still believe that there is no harm in making money by getting inside information of a corporation. However, Insider dealing is said to be the unacceptable face of capitalism. But some others do not see anything wrong with it and even think it should be encouraged although this latter view has been less heard of late. It is however a view which economists and lawyers have put forward ever since the publication in 1966 of Professor Manne's book, Insider Trading and the Stock Market. This book stresses that Insider dealing is, in the economic sense, positively beneficial and ought not to be prohibited. Since then the debate on regulation has raged between those who would support Professor Manne's position and consider the problem in terms of economic efficiency alone and those whose arguments for prohibition would be based on, market integrity, notions of fairness, and morality. This debate is worth considering for it is interesting and while it is obvious that various jurisdictions regulate against insider dealing, the lack of consensus in this regard is evident. It is to these arguments that I turn.
THE ARGUMENTS FOR AND AGAINST
FAIRNESS AND EQUALITY OF INFORMATION
It is understood that one of the reasons why the debate over whether insider dealing should be regulated came about due to the‘fairness' concept to justify regulation in the US by the Securities and Exchange Commission (SEC) and the courts. In re Cady Roberts & Co. the SEC based its decision to prohibit insider dealing on grounds of‘fairness' and it was the same outcome in SEC v. Texas Gulf Sulphur. The court's finding was:
“...to prevent inequitable and unfair practices and to insure fairness in securities transactions generally, whether conducted face-to-face, over the counter, or on exchanges ...the Rule [meaning Rule 10b-5] is based in policy on the justifiable expectation of the securities marketplace that all investors trading on impersonal exchanges have relatively equal access to material information”.
Professor Manne, one of the defendants of insider dealing, argued that insider dealing should not be regulated at all and he criticised the legal grounds for regulating insider dealing. He argues that there has been no careful analysis of the subject. He believes that in the absence of sufficient economic analysis, the attitude of the debate turns to moralistic and emotional issues instead of one of logic. Moore (1990) does not support the theory of fairness. She explains that one is not morally obligated to tell those whom we deal with everything that is in their interest to know. However, there is the idea that there should be absolute equality between market participants. What about the moral obligation to threat others as we would ourselves? Due to the observation that insider dealing is largely based on the idea that it is unfair, In order to maintain fair transactions, it would only be reasonable that investors in the market have equal access to information. Now, since insider dealing opposes equal access to information, it is considered to offend the notion of fairness.‘Fairness' as a concept has therefore been resorted to as a justification for regulating insider dealing. The legal philosophy of fairness considers it unfair when insiders have an advantage and a better bargaining position than outsiders. Based on this, probably the most practicable justification for the regulation of insider dealing is‘equality of information'. Information as to the basis of decisions made by investors should be equally available to all investors. Thus, all traders owe a duty to the market either to disclose or abstain from dealing based on non-public information. This approach is compatible with the need to make public as much information as possible so investors will be equally informed.
Equality of information (Market Egalitarianism) requires that all investors trading on impersonal exchanges should have relatively equal access to material information. However, regulating insider dealing has attracted its share of criticism. Professor Manne tried to argue against the ethics of insider dealing by stating that he thinks fairness as an argument for regulating insider dealing is a respected concept, but is difficult to determine. He thinks relying on fairness is vague and cannot be defined, let alone be used as an argument for regulation. However, those who argue fairness as a justification for regulation reject these contentions. Their belief is that Professor Manne ignores the fact that‘fairness' is the dominant premise underlying our understanding of the law. In challenging the ground of fairness, Manne depended on two grounds:
His first ground being that the inequality in bargaining positions between the parties in a share transaction or between investors in the market is an inevitable fact. He believes that no law or regulation can ensure equality of bargaining position and he also believes that there is always inequality in terms of information between the parties in share transactions. The stock market, according to him, is an information exchange. The second ground for criticism is that he believes that insider dealing is a victimless crime and indeed it is frequently asserted to be a victimless crime He believes that in anonymous market dealings, the insider deals with a person as a result of the random matching of orders and this person would have dealt anyway at the same market price at the same moment in time. So in his view, this goes to show that the other party to insider dealing is not misled or harmed by the insider and there is no unfairness to him. However, It should be noted that although it is not possible to show the casual link between the activities of the insider and the outsider's dealings which then incurs a loss, it may still be possible to regard the outsider as a victim because he is a victim of an informational advantage possessed by the other people in the market of which he is ignorant, and which he could not have obtained. Although it is accepted that it is not possible to put people on a completely equal footing, for there will always be transactional inequalities and informational advantages based on superior experience, foresight and diligence, It is argued that it should be possible to remove informational advantages achieved unfairly through access to information which cannot be obtained by others and which in all probability is being used by the insider in breach of some fiduciary or other duty
All things considered, Manne's hypotheses seem weak and simplistic. One significant response to Manne's arguments is that the‘fairness' principle should not be narrowly interpreted as equivalent to the protection of investors. It is maintained that‘fairness' as a principle is equivalent to a public policy. Meaning that the concept of fairness can be depended on even if the harm cannot be pin pointed to the particular investor. If it is expected that insider dealing will be harmful, not necessarily to a particular investor but rather to the market as a whole, for reasons of public policy, such acts should be regulated.
INSIDER DEALING AS A MEANS OF COMPENSATION
Manne maintains that his main argument is that allowing insider dealing is the only effective means of compensating entrepreneurs. He argued against the notion that insider dealing harms investors. He distinguished between corporate managers and entrepreneurs. He stated that Managers' do not include innovators. He believes that their work is a mere service which includes operating the firm normally and that such work is predictable therefore a salary can be sufficient compensation. On the other hand, He believes that entrepreneurs provide innovative contributions to the productivity of the firm. Manne argues that allowing insider dealing is the only appropriate means of compensating entrepreneurs so that they will be given an incentive to produce more information. He stated that a predetermined salary may not reflect the service provided by the entrepreneur, since it does not reflect the value of the innovation. He argues that only allowing entrepreneurs to buy securities prior to a public disclosure, and to sell them after the price rises following the disclosure, is the appropriate method to value his innovation.
Carlton and Fischel maintain this view. They argue that advanced salary agreements fail to compensate innovators. They believe that allowing insider dealing enables agents to receive their compensation. Insider dealing provides more accurate valuing of agents' innovations than a salary. It is therefore argued that more incentives should be given to agents in other that they produce information.
These proponents of insider dealing argue that by permitting insider dealing, the interests of the insider will be aligned into that of the company. They believe that at the end of the day, the shareholders benefit from the acts of the insiders and this is because the corporate insiders may find it beneficial to enhance corporate risk taking thereby, developing growth and opportunities that will increase the value of shares of the company to which the shareholders will benefit from. However, this idea has been criticised as being flawed because a person who benefits from trading on insider information is not necessarily the innovator. Insider dealing enables the insider profit whether their ideas fail or are successful in that they profit from both negative and positive information whereas the company may not. Say even if the negative or false information did not pose problems for the company, the argument for insider dealing as an incentive overlooks the difficulties posed by “free riders” _ those who do not actually contribute to the creation of the information, but who nevertheless are aware of it and can profit by trading on it. Unless those who do not contribute can be excluded from trading on it, there will be no incentive to produce the desired information. Besides to create added value to the company will entail a significant investment of time and energy on the part of the insider to generate new information in order to profit from inside dealing. It is often said that it would be equally profitable and much easier for the insider to start a rumour that the company is about to strike a deal or has acquired a new product rather than actually invent a new product.
It appears that in considering insider dealing as a compensation for innovation, Manne has failed to acknowledge the property right of the firm to such information. For If it is established that a company has a property right to the information produced inside the company, or if the case is that the insider is entrusted not to use such information, then obviously it is wrong to propose that the use of such information should be allowed as the most appropriate means of compensation.
Schotland, is of the idea that insider dealing is not necessarily a better compensation than a salary. He believes that a company is best placed to assess whether or not an employee is expected to provide innovative ideas. Rider and Ffrench state that Manne does not explain why insiders should be permitted to benefit from producing negative news. Because allowing insiders to deal on the basis of negative inside information allows them to evade losses whether the company succeeds or not and they are supposed to be acting in the best interest of the company. If a manager was behind a loss to the company, why should he be able to avoid a personal loss by allowing him to sell his own shares before the information is made public? In my opinion anything done on behalf of the company must be in the best interest of the company and insider dealing hurts the company (its reputation, its standing in the capital market) so it is not in the best interest of the company and should therefore be prohibited.
OPTIMAL OR TIMELY DISCLOSURE
Companies generate a lot of information as they carry on their business activities and that is why information plays a vital role in an economy. The extent to which information is made available on the market influences the degree of economic efficiency. Stephen Bainbridge believes that to have successful regulation of insider dealing requires rules relating to the timely disclosure of material information. He believes that if the aim is to put investors on an equal footing in regards to having access to inside information, the rules governing insider dealing are not the proper method to achieve it. And therefore disclosure requirements could be designed to keep to minimum non-public price sensitive information in a way that the opportunities for abusing such information would be reduced. His belief is that disclosure requirements are a better solution than regulating insider dealing in order to achieve in-formativeness in the market. This statement leads to questioning the competence of regulating insider dealing, and supports the case that the problem is better dealt with by continuous disclosure. His belief is that effective regulation of insider dealing requires rules relating to the timely disclosure of material information. In this regard, the equality of information theory has been criticised. It has been argued that prohibiting insider dealing on such a ground would not lead to an advanced disclosure system. This argument was established in the US, where the law had been reluctant to compel issuers to disclose material non-public information. It was therefore declared that, irrespective of permitting insider dealing or not, the investors will not have the same access to information as insiders unless there is a system of timely disclosure. However, the revelations from Enron to World Com have further exposed the inadequate material disclosure of information, not only in the United States, but also in Nigeria.
The information produced is a commodity and is only gathered when it is cost effective to do so. The idea is; the more information available, the greater the economic efficiency. Companies produce information to profit from it and it is argued that where insider dealing is permitted, insiders will be motivated to get more information in order to profit from. Proponents of insider dealing believe that when insiders trade in securities on the secondary market, they speed up the flow of information and feed their knowledge into prices, thereby making market more efficient. Therefore if insider trading is permitted and insiders with fore knowledge trade in the securities of their company, it will be a signal to outsiders observing the price movements to infer that the insiders are optimistic about the company's future prospects and may in turn buy shares which may cause the price move in a certain direction. However, it is asserted that even when insider trading is informative and could be a channel of communicating information; it would often be preferable if insider information were communicated directly to the public rather than through the stock market. This will be better than an unexplained rise in the price of the securities of the firm through the trading activities of insiders.
However, there is a challenging view that insiders withhold and manipulate information in order to cash in thereby distorting market efficiency. Indeed, insider trading might be expected to induce a variety of perverse behaviours by managers who would compete to acquire and hoard information within the firm.'
The notion that disclosure rules are the primary method of reaching market in-formativeness is reasonable but it should be understood that regulation of insider dealing has a preventive role. In circumstances where an unexpected event occurs, the issuer will need more time to clarify the situation otherwise, an immediate announcement might cause false or misleading disclosure. In certain situation, the issuer is exempted from making a timely disclosure, if it is thought that such disclosure would be detrimental to the legitimate interests of the issuer. In such situation the information should be kept confidential. It is these circumstances which are crucial for insider dealers, and therefore the regulation of insider dealing is essential to prevent misuse of information during this period. Thus, disclosure rules alone are not sufficient enough to achieve in-formativeness in the market and so regulation of insider dealing is essential.
One other argument Manne postulates is that insider dealing creates market efficiency. He argues that insider dealing acts as a replacement for the public disclosure of inside non-public information. He argues that when insiders deal on the basis of inside information they gradually bring the market price to a more realistic informed level. This is what Gilson and Kraakman call a‘derivatively informed trading mechanism'. The suggestion is that uninformed investors will be informed through‘market information', meaning, through volume, number and trend of trades. He argues that a gradual adjustment is better than violent price fluctuation. His belief is that insider dealing is an effective way to release information into the market.
Gilson and Kraakman however, point out that derivatively informed trading, function slowly and sporadically. So it is unlikely that allowing insider dealing will have much effect on market efficiency. However said, Insider dealing may be a factor for nudging prices in a particular direction as the up to date position of the company becomes known to the market but in many cases, the disclosure of that information would have occurred regardless of any related insider dealing.
The hypothesis of insider dealing influence on the market price is uncertain. There are circumstances; where insider dealing is influential e.g. the period prior to an announcement of a takeover offer. One of the most interesting facts to emerge from the Boesky investigation in the United States is the links which was exposed between insider dealing and take-over bids. It is however doubtful whether the influence by insider dealing is the usual trend or just an exception.
Assuming, for the sake of argument, that insider dealing moves prices in the right direction, in the long term it is expected that uninformed investors' inability to acquire information would be detrimental to the market. Those who argue in favour of de-regulation, base their argument on the idea that it is a form of disseminating information into the market. Nevertheless, it hasn't been proven that indirect disclosure of information into the market is more efficient than direct disclosure.
Insider dealing has an effect on the transaction costs market participants bear. The superior information insiders possess generates informational asymmetry on capital markets. Asymmetric information increases the cost of trading. Insider trading on non-public information might reduce market liquidity. Reduced market liquidity implies higher trading costs. In order to achieve maximum efficiency, the most prompt disclosure possible of material information is therefore necessary.'‘The more efficiently information about a security is reflected in price, the more efficient the market for that security is thought to be.' It is not clear the point to which information quickly becomes public with or without insider trading. However, what is clear is that market prices are more accurate once the information is released. Investors believe that they will earn fair returns on their investments so permitting insider dealing would create opportunities for exploitation of the market by insiders at the shareholders or investors expense. If investors believe that insider trading exists, they may reduce their investment in the securities of that company and this reduced investment will have unsettling effect on the overall liquidity of financial markets and the ability of companies to raise capital. Therefore, this will affect the allocation of resources and hence the attainment of market efficiency.
PROTECTION OF INVESTOR CONFIDENCE
Another ground for regulating insider dealing would be to maintain market confidence. This is vital for the efficiency of the market. If investors perceive that the market is unfairly favouring insiders, they will not direct their investment into the market. It is, therefore, imperative that‘investor confidence' be protected and that serves as a sufficient justification for regulating insider dealing. Rider and Ashe indicate that “... the main (if not only) convincing justification for controlling insider dealing is that it has a perceived, adverse impact on confidence”. For the financial markets to be effectively operated, confidence and integrity is essential. Investors will only invest into a market they believe to be reasonably managed and regulated. If the public perception of the capital market is negative, investors will direct liquidity to alternatives and companies will therefore lose customers. Capital markets play a major role in allocating resources and confidence in them can be fragile. So there is the need to maintain confidence and the integrity of capital markets. However, Investor confidence as a rationale was criticised as an emotional and sentimental force which is thought to be speculative. Therefore, justifications based on‘protecting investor confidence' are said to be unsophisticated, and the relationship between insider dealing prohibition and investor confidence is a‘myth'. Investors consider it their right to have‘equal access to information'. So their lack of confidence is only logical if insiders are allowed to be advantaged over other investors. Therefore, investor confidence is not necessarily an emotional force. It is rather based on the expectation of investors that the regulatory system should treat all investors equally in terms of access to information.
One other reason put forth for the regulation of insider dealing is the concept of fiduciary relationship which could be attached to the insider. It is clear that the directors of a company owe a fiduciary relationship to the company but it is not quite clear whether the director is in a similar relationship with shareholders individually. This is also the case at Common Law.
According to the notion of breach of fiduciary relationships, insider dealing regulation is derived from identifying that a precise legal relationship has been breached. The idea here is that corporate insiders owe a disclosure duty based on a pre-existing relationship with the company. Insider dealing here is justified on the basis that the insider is in a position of trust and so should be legally liable when breaching the trust for his personal gain. Thus the insider should be legally responsible to return any profit he has made due to the breach of trust. The idea here is understood to be in breaching the trust, rather than looking for any perceived harm to any other party. However, the problem with this line of reasoning is that it is only applicable to situations where there is a former fiduciary relationship between the source of information and the insider. So, the pre-existing relationship raises an obligation of trust and this justifies regulating insider dealing. A person can only be held liable, if he is a fiduciary but a considerable number of those likely to deal while in possession of inside information are not in a fiduciary relationship. So the obvious problem here is that a person can be an insider if he has access to the inside information or the information is passed to him from an inside source. Therefore, the question is can liability arise where those who misuse inside information are not fiduciaries? Although the fiduciary approach represents a logical ground for the liability of fiduciaries, it is limited as an approach for regulating other forms of insider dealing. In the US, Common Law development has been diverted to legislation. Regulating insider dealing in the US has been developed by the SEC and judicial precedents. The major problem has been in finding the ground for liability for those‘outside' the corporation who misuse inside information. Therefore, different legal theories have been used to determine the definition of insiders, and therefore to apply accepted legal norms.
Another theory which could come as a ground for the regulation of insider dealing is the‘misappropriation theory' which is the current position in the US. The regulation of insider dealing here is justified on the basis that it regards information as property of the issuer of the securities. Any person's use of the information for his or another person's benefit would amount to contradicting the owner's interests. Therefore, insider dealing is a misappropriation of the inside information which is the property of its source. However, the inside information will only be considered in the US as a property when it is misappropriated in breach of a fiduciary relationship. Hence, the idea in this approach is that not only the misusing of information is a justification for liability; the information and the capacity in which it was used should also be determining factor. This indicates that in order to hold an individual liable for any misappropriation, there should be an obligation on the individual not to misuse the information. This obligation is normally founded on a fiduciary relationship, but the fiduciary relationship here is slightly different. The‘insider' need not owe the duty to the other party with whom he deals, nor has he to owe the duty to the issuer of the subjected securities. The duty is owed to the source of the information. There is a second explanation for such duty. Here the obligation is attached to anyone who possesses the information knowing that its transfer is in breach of a fiduciary obligation. Such a person will be under a fiduciary obligation not to misappropriate it. The‘misappropriation' theory brings into question the legal issue of considering information as property. However, recognizing information as property has been criticised on the grounds that it will allow a private monopoly of information which should also be available to the public. However, the principle that inside information has to be disclosed is not absolute.
There are situations in which the law allows non-disclosure e.g. if it is for the benefit of the issuer. It has been observed that the recognition of information as property is important to sustain the misappropriation theory. However, assuming that the issue of property right to information is solved, there still arises the problem of determining the issues of ownership and possession. Misappropriation theory is criticised because it assigns ownership of non public information to an employee or principal, and ignores the wider range of relationships. This suggests that the public shareholders may also have a right to such information.
The main problem of this theory is that it does not show the importance for the protection of the investors or the other party in the transaction in regards to dealing in a market. It also provides no answer regarding the importance of disclosing material non-public information to the other party in the transaction. It therefore, pays no attention to the real reason behind regulating insider dealing.
Arguments for the deregulation of insider dealing do not appear convincing enough. Accepting the idea that permitting insider dealing would serve as a great compensation for the agents and entrepreneur's innovation will lead to conflict of interest.
This chapter has dealt largely with questions of the justifications underlying the regulation of insider dealing. It discussed the relevant legal, ethical and economic theories. I believe that the chapter has identified Insider dealing to have negative effects on an informed market, on transparency and on confidence in the market; hence the conclusion reached is that the practice ought to be regulated. However, the question is what form should regulation take? This would be discussed in chapter 4.
REGULATING INSIDER DEALING IN NIGERIA
The Nigerian securities law prohibits false trading of securities and market rigging transactions. The information the ISA and SEC Rules and Regulations try to portray to investors in secondary securities transactions is to ensure fair and transparent dealings.
The Investments and Securities Act (ISA) and securities market rules, in trying to protect investors, use means suitable for equitable, transparent and orderly trade relations between market participants, including investors, in the securities that are publicly traded on the market.
What this chapter aims to do is to examine the history and background to the regulation of insider dealing in Nigeria. It would evaluate the regulatory system and its shortcomings
THE REGULATION OF FINANCIAL MARKETS IN NIGERIA: A BRIEF HISTORY
The laws on securities regulation in Nigeria derive principally from the Companies and Allied Matters Act (CAMA) and the Securities and Exchange Act (SEC) 1998. It was first known as the Companies and Allied Matters Decree No1 and it was promulgated on the 31st of December 1990. Here provisions were made for the first time for the regulation of insider dealing or trading as it is called in the Act. Part XVII of the CAMA however was flawed in so many ways. However, the Securities and Exchange Commission (SEC) is the apex regulatory body in the Nigerian capital market, and lays down the regulatory framework for the primary and secondary securities markets. It regulates via its SEC Regulatory Rules while its powers are conferred upon it under the Nigerian Investment and Securities Act 1999 (ISA). The CAMA, prescribes the prospectus requirements for a public issue and contains the regulatory framework for unit trusts and tender offers. The CAMA generally draws on the prospectus provisions of the British Companies Acts and a farrago of other sources, while the SEC Act draws on the US Securities Act 1933 and the Securities and Exchange Act 1934. A consequence of this is that there are unintended overlaps between both statutes. For instance, while the CAMA in section 650 defines‘securities' as including "shares, debentures, debenture stock, bonds, notes (other than promissory notes) and units under a unit trust scheme', a wider definition exists in section 29 of the SEC Act. That section replicates the definition of the term in US federal securities laws, and therefore uses the investment contract concept. Nothing explains this dual definition of‘security', other than the fact that the CAMA adopts a definition that draws on Professor Gower's in his Ghanaian Draft Companies Code, and the SEC Act adopts the definition in US federal securities laws. However, the sections under the CAMA governing insider dealing have now been repealed.
THE REGULATION OF INSIDER DEALING IN NIGERIA
As stated above, insider dealing is governed by the SEC Act and the ISA Act. The ISA envisages that SEC is the top regulatory body in the capital market. Where financial institutions are involved in securities market activities, the “Central Bank of Nigeria” is at the heart of prudential regulations. Other institutional infrastructures include the Nigerian Stock Exchange (NSE) accounting standards and self-regulatory organizations (SRO).
The Nigerian securities law prohibits false trading of securities and market rigging transactions. The information that the ISA and SEC Rules and Regulations make available to investors in secondary securities transactions is to ensure fair and transparent dealings.
However, the SEC is a statutory corporation, to be statutorily funded from the consolidated fund with the Minister able to issue it with directives and even suspend it. In Nigeria, the act of insider dealing is seen as a criminal act but notwithstanding; the ISA 1999 provides for civil liability e.g. the payment of compensation to persons suffering loss. The inappropriate/poor drafting of certain sections in the CAMA led to the removal of the sections from the legislature to the ISA. However in other to fully understand the new laws under the ISA, it is imperative that the old laws under the CAMA are viewed.
COMPANY AND ALLIED MATTERS ACT 1990
Sec 615 of the Act prohibits insiders from buying or selling or otherwise dealing in the securities of the company not offered to the public for sale or subscription. They are prohibited from dealing only in public companies. It appeared that insiders were only prohibited from dealing in the securities of public companies but other prohibited persons where prohibited from dealing in both private and public companies and this is irrespective of the fact that most companies in Nigeria are private companies. It was not clear why there was this dichotomy between the two classes. The fact that most companies in Nigeria are private companies ought to have warranted an extension of the provisions to cover private companies as well. The act of counselling or procuring another person to deal or communicating confidential information was restricted to dealing on a stock exchange So although the provisions applies to all prohibited persons, it lasts only as long as the deal is on a stock exchange. So this would mean that even though tipees could not deal in the securities of a private company, they were not prohibited from passing the information to a third party to act on. The fine for the act of insider dealing was considered meagre and would not have deterred anyone from committing the act of insider dealing. In order that a ground for insider dealing be established, the plaintiff must have concluded a transaction of sale or purchase. No liability would arise even if it was shown that revelation of the confidential information would have induced a reluctant outsider to conclude the transaction. Civil liability only subsists for two years from the date of the completion of the transaction that gave rise to the cause of action. A shrewd insider may be able to evade liability by shielding the transaction for the length of time. Corporate recovery is based on the breach of a fiduciary duty owed by the insider to the company. Where the insider has already compensated the other party for the direct loss suffered, the company can no longer sue him for the profits realized on the transaction for then it would no longer be part of the direct benefits or advantages realized from the transaction. However the biggest blunder in this part of the CAMA was in s 617(2)(a ) and (b ) of the CAMA. It was supposed to be the equivalent of s 3(2)(a ) and (b ) of the Company Securities (Insider dealing) Act (CSA) 1985 which relates to facilitating the completion or carrying-out of a transaction. However, because the draftsman failed to align properly the comparable sub-sections, the CAMA legislated against what the CSA exempted and exempted what the CSA prohibited. Most of the sections relating to insider dealing are still the same as seen in the ISA 1999 but a few amendments have been made and this will be discussed under the heading Investment and Securities Act 1999.
THE SECURITIES AND EXCHANGE COMMISSION RULES AND REGULATION AND THE INVESTMENT AND SECURITIES ACT 2007
The current statutes in Nigeria that cover insider dealing are the Securities and Exchange Commission Rules and Regulation 2007(SEC RR) and the Investment and Securities Act 2007(ISA). The sections regarding insider dealing under the SEC RR and ISA, is a mix of the Company Securities (Insider dealing) Act 1985, the CJA Act 1993 and Rule 10 and 10b of the US Securities Act 1933 and the Securities Exchange Act 1934. The relevant section under the SEC RR does not concentrate on insider dealing as a whole but on fraudulent activities. It however explains that a person involved in securities trading shall not deal in the securities of a company to which he is an insider. The ISA just like the SEC RR concentrates on fraudulent activities but notwithstanding; it defines the act of insider dealing, the exemptions/defences and the penalties. It however, does not define an insider. I presume this is done because it is the ISA that empowers the SEC in regulating and maintaining a fair and orderly market so they are one and the same rules. However, I deduce that if that is the case, then there should just be one statute so there is no confusion in legislating. It is important that the relevant sections are examined. Because of word limitation, not every aspect of the relevant sections would be considered only the most important parts will be.
The ISA in Sec 111(1) states that:
“a person who is an insider of a company shall not buy or sell, or otherwise deal in the securities of the company which are offered to the public for sale if he has information which he knows is unpublished price sensitive information in relation to those securities”.
Now it appears that there is the need to prove mens rea for the fact that he must know that the information he holds is unpublished price sensitive information, appears to be subjective. The SEC RR in defining an insider, omitted that the insider “must know” that he is an insider. But if one fuses both acts, the idea would be that an insider is one who is connected to the company whether he knows that he is connected or not is not a problem but what is important is that he must know that the information he holds is unpublished price sensitive information and that is where the subjective test lies.
Rule 110 SEC RR explains thus:
“'Insider trading' occurs where a person or group of persons who are in possession of some confidential and price sensitive information not generally available to the public, utilises such information to buy or sell or otherwise deal in the securities of such company for the benefit of himself, itself or any person.”
From the definition above, the person trading does not have to be truly a corporate “insider”, but he must have a special relationship with the company founded on trust and confidence. Included in the categories of persons with such special relationships are “primary insiders” who are the directors and other officers as well as agents of the company. Others are “secondary insiders” or “tippees”, who are persons who, directly or indirectly, knowingly obtain unpublished price-sensitive information from persons who are connected with the company, knowing that the connected persons hold the information by virtue of their being so connected with the company, and it is reasonable to expect that they would not divulge the information except for the proper performance of their official duties
For the purpose of Sub rule 1(e) SEC RR, dealing by an insider applies to dealings at a recognised securities exchange and also to off market securities.
There is the notion that only individuals can be insiders. However in Nigeria, a company could be held liable for insider dealing because it is believed that a company acts through the actions of its human agents. So a transaction (insider dealing activity) carried out for the company could be charged to the company.
According to the SEC RR, there are three main types of insiders:
- Individuals connected to a company ( Primary Insiders)
- Individuals contemplating a take-over offer for a company.
- Tipees (Secondary insiders)
In regards to individuals contemplating making a take-over offer for a company, the ISA prohibits an individual who has contemplated making a take-over offer for a company in one capacity, to deal in the shares of that company in another capacity if he knows that the information relating to the fact that the offer is contemplated or is no longer contemplated is unpublished price sensitive information. However, the Act does not explain how the term contemplated is to be used.
In regards to the tipee, (Secondary Insiders), they are persons who knowingly obtain (directly or indirectly) information from the persons so connected to the company under the definition of an insider. Under the Act, the meaning of the word obtained is not explained. However in the UK, where a judge held that an individual could only commit an offence under the subsection if he had actively sought the information prohibited and that receipt of unsolicited information was not sufficient provoked a controversy. The House of Lords and the Court of appeal held that the word “Obtained” had to be given its broader meaning. I.e. that one could obtain not only as a result of purpose or effort but also through passive receipt or acceptance. The effect of the ruling was to make guilty a tipee who knowingly traded in shares on the basis of unpublished price sensitive information, regardless of how the information was obtained. In regards to a tipee knowing that or having reasonable cause to believe that the insider holds the inside information by virtue of being connected, it appears that the prosecution has the choice of proving that the tipee either knew or had reasonable cause to believe the stipulated circumstances. But this poses a problem because proof of knowledge here may be difficult to acquire. In the case where the tipee obtains information directly from a sub-tipee, it is virtually impossible to convict and it gets harder the further one moves away from the source.
It is interesting to note that the connected individual may once the set six months expire, deal in the relevant shares even though the information still retains its unpublished price sensitive feature, the tipee is prevented from dealing in those shares on the basis of the same information until the prohibited information has lost its unpublished price sensitive feature.
Even if the elements of an insider dealing offence are proven, some individuals can rely on its exemptions. The prohibition in Sec111 ISA 2007 are rendered ineffective where the defendant can show that notwithstanding that he fulfilled all the conditions of insider dealing, the dominant purpose of his trade was not with a view to making a profit or avoiding a loss for either himself or another person. Some commentators have expressed concern over the nature of this defence, fearing that, if it is construed broadly, it could endanger the whole efficacy of the Act. In regards to the third exemption, it is aimed at those who perform specialist jobs. e.g. Market makers. This exemption recognises they play an important role within the securities market and that to provide them with no immunity would render the market less liquid.
To succeed in criminal proceedings under s.111 of the ISA and r.110 of the SEC Rules and Regulations, the prosecution must, in addition to proving his actus reus, prove the defendant's mens rea.
The violation of s.111 of the ISA attracts both civil and criminal proceedings. Under the SEC Regulations, a 5 percent shareholder is presumed to be an insider if he fulfils all other criteria found in Rule 110 (2) & (3)
A natural person who violates it commits an offence and is liable on conviction to a fine of NGN 500,000 or an amount equivalent to double the amount of profit derived by him or loss averted by the use of the information or to imprisonment for at most seven years or to both the fine and imprisonment. An offending body corporate is liable on conviction to a fine of NGN 1 million.
In addition, once a plaintiff has proved his claim in a civil action under s.111 and the SEC Rules and Regulations, the ISA prescribes payment of compensation by the defendant at the order of the SEC or the Investment and Securities Tribunal, as may be appropriate, to the aggrieved person, who in a transaction for the purchase or sale of securities contracted with the liable person. The measure of compensation is the difference between the price at which the securities would have likely been dealt when the said transaction took place if the contravention had not occurred. However, the ISA preserves “any liability that a person may incur under any other law or enactment”. If “any other law” is construed to include the general law, a plaintiff should also be entitled to the remedies of rescission and “rescissionary damages”, that is, the defendant's profit from the transaction.
An aggrieved person is prevented from commencing an action for recovery of loss at the tribunal until at least 2 years after the date of the completion of the transaction in which the loss occurred.
The prohibition on insider trading applies to trading in the securities of any company listed on the Nigerian stock exchange however it is immaterial whether the transaction was conducted outside Nigeria or that the insider was outside Nigeria at the time he committed the act of insider dealing and I commend this part because it is a rather restrictive rule that one has to be within the jurisdiction in other to be liable for committing the act. In my opinion, If one committed the act in a company listed on the stock exchange of that jurisdiction, that should be sufficient enough to hold a person liable under the Act.
The Nigerian legal system has taken a huge step in regulating insider dealing since it amended the Investment and securities rules (ISA) in 2007. It is also commendable that the ISA has also made insider dealing a wrong from which criminal and civil liabilities flow. These steps pose some measure of deterrence to potential violations, and follow the practice in the United Kingdom and the United States. However, the fact that a lot of the words used in both Acts are not explained may pose some ambiguity. I presume that because regulating insider dealing in Nigeria is lax, attention has not being drawn to this shortcoming.
Initially the penalty for insider dealing under the 1999 act did not fit the crime because in comparison to the gain made, the penalty was a maximum fine of 500, 000 Naira which is 2000 Great Britain Pounds (GBP). In comparison that is indeed meagre but since they decided to follow the steps of the US to increase the sanctions on insider traders, they amended the fine to include “Or an amount equivalent to double the amount of profit derived by him or loss averted by the use of the information”.
In 1988, the US enacted the Insider Trading Securities Fraud Enforcement Act (ITSFEA) which increased the penalties for wilful violations of securities statutes and regulations in that jurisdiction from $100,000 and five years' imprisonment to $1,000,000 and 10 years' imprisonment. The penalties for non-natural persons also increased from $100,000 to $2,500,000. It is also noteworthy that the Insider Trading Sanctions Act of 1984 (ITSA) imposes a civil penalty of up to three times the insider's gain for violating insider trading prohibitions.
However, there is inadequate sanctioning of insider trading in Nigeria. Apart from a few cases that have surfaced of recent, it can hardly be said that insider dealing occurs quite regularly in Nigeria but there is the presumption that it does. The criminal sanctioning of the act requires the discharge of burden of proof in order to get a conviction but this is difficult to establish and so leaves the prosecution with circumstantial evidence which cannot secure a conviction. One major obstacle with the ISA is that in regards to proving civil liability, one is to prove beyond reasonable doubt. It stipulates that an insider who contravenes the provision “is guilty of an offence and liable on conviction” This appears as though it is a criminal liability.
The SEC Rules and Regulations do not have stringent provisions on disclosures. Hence they need to be proactive in issues regarding timely disclosure.
A COMPARISON OF ITS REGULATION IN THE US, UK AND NIGERIA
The problem of insider dealing is universal but notwithstanding, the nature and degree of the problem varies from one market to another. It is understood that the function of the law is to provide a solution to the legal problem and this could be achieved in different legal systems by different means. On one basis, it can be argued that there are similarities between the principles underlying the regulation of insider dealing in different jurisdictions and this is because the problem of insider dealing is universal however, there are differences between various jurisdictions in regards to the laws adopted to regulate insider dealing. The shortcoming in regulating insider dealing in the financial markets in Nigeria was discussed in the previous chapter.
This chapter will look at the US, the UK and the Nigerian Financial Market. It would evaluate and criticise the comparative systems in these three jurisdictions. It would explain the nature of the systems of each jurisdiction. It will examine the main characteristics of their regulatory systems and the characteristics of the rules relating to insider dealing.
At the end of the chapter there will be a conclusion summarising the difficulties and shortcomings of their regulatory system.
COMPARING THE REGULATION OF INSIDER DEALING
There are two main forms of regulatory system. The first is‘self-regulation', which is a principle by which market players independently adopt rules to be followed, and monitor the compliance with such rules. The belief is that self-regulation is a better method of regulation than the government. Self-regulation is still the dominant system in the US but under thorough monitoring by the Sec. The UK discarded self-regulation a while ago because it underpinned their financial industry.
The second form of regulatory system is‘statutory regulation', in which a government directly engages in regulation by introducing binding laws and statutes for markets. A statutory regulating authority may be more independent and free of market competition. In this form, the government ensures compliance with the regulation by delegating the necessary powers to a governmental authority. Further details of the system, such as statutes, the formation of a competent authority and the delegation of powers to that authority, are to be tailored to the needs of the country.
In the UK, the FSA was established as a statutory regulatory body and extensive regulatory powers were transferred to it from SROs. Its current statutory authorities are the Criminal Justice Act (CJA) 1993 and the Financial Securities and Market Act 2000(FSMA). In Nigeria, the SEC is the apex regulatory body and as stated earlier it regulates via the Investment and Securities Act 2007. In the US, the main federal statutory framework was introduced following the financial crisis of 1929; it included the Securities Act 1933, the Securities Exchange Act 1934 and the establishment of the Securities and Exchange Commission (SEC).
There is the need for a clear definition of the term insider dealing in order to provide certainty in the rules regulating it. The most important elements are “insider” and “inside information” and it is safe to say that the definition of these two terms are the core point of the problem of studying the law of insider dealing. The term‘insider' does not seem complicated until one evaluates its statutory definition.
It can be said that, in general, the US, UK and Nigeria regulations all adopt a similar approach (person connection approach) in defining an insider. That is, insiders are determined by a connection of one kind or another to the source of information. However, the recent trend in the regulation of insider dealing has been one of widening the definition of insiders in order to avoid any ambiguity.
The second approach is the‘information connection' approach which considers any person who possesses inside information relating to the issuer as an insider, regardless of his/her relationship to the issuer. This definition appears broad and unfair because people who are ignorant to the status of the information may be subjected to the prohibition.
The concept of an‘Insider'
The term‘insider' usually indicated those who were‘inside' a corporation and so had access to‘inside information', e.g. directors, employees and major shareholders. However, this conventional notion, based on general legal provisions, was done away with a while ago. Other persons can be deemed insiders, since they have regular access to inside information. Hence there is the need for prohibition to cover these people. It is this point which presented the difficulty in the US, when Rule 10b-5 was broadly interpreted to prohibit‘corporate outsiders' from insider dealing. The response to this problem was to introduce into statutory definition two groups of insiders,‘primary' and‘secondary' insiders. It is important to evaluate to what degree comparative law succeeded in fulfilling the function of defining an insider under these two main categories.
The comparison will be between the following laws: the CJA 1993, UK, the FSMA 2000, UK, the Nigerian Investment and Securities Act 2007, The Securities and Exchange Commission Rules and Regulation 2007 and reference to the US case law.
“Primary insiders” can be divided into‘traditional insiders' and “access insiders”. “Traditional insiders” are those who, because of their status, are more likely to possess inside information. “Access insiders” are those who, because of their function, profession or activities, have a relationship with the issuer which makes them likely to have access to inside information. There is a dual definition of‘insider' and‘inside information' under the CJA 1993 and the FSMA 2000 and initially it can be said that the two definitions of‘insider' under both legislations are in most instances similar especially the definition of the‘primary insider'. The CJA 1993 states “director, employee or shareholder” as‘primary insiders' while the FSMA 2000 states that they are members of an administrative, management or supervisory body, or shareholders. It appears that the confusion is whether under the FSMA 2000 “members of an administrative, management or supervisory body” includes all the directors and employees.
Both the CJA 1993 and the FSMA 2000 confer automatic insider status on individuals who may have inside information by virtue of their status. So, under the primary insiders, there are those who have traditionally been considered as more likely to possess inside information because of their status or relationship to the issuer. But the CJA 1993 also confers the same automatic status on employees, irrespective of their position, since it is not a condition that they occupy a position which could reasonably be expected to gain them access to inside information.
The position of both acts is that automatic insider status is also conferred on the shareholders of the issuer's securities, irrespective of the percentage of their shareholding. However, in reality, the larger shareholder is more likely to have access to inside information, and to therefore be an insider.
In the US, it was not difficult to attach responsibility to‘traditional insiders' because it was based on fiduciary duties. The basis of responsibility was the relationship of directors, officers and controlling shareholders to the issuer. Here it was acknowledged that such individuals breach their fiduciary duties when dealing on the basis of inside information. Also, Section 16(b) of the Securities and Exchange Act 1934 is dedicated to the prohibition of unfair use of information by any director or officer, or by a shareholder with more than 10% of the shares. It is apparent that this section was based on the classic notion that considers‘insiders' as those who have a relationship to the issuer.
In Nigeria, the same is said for directors, officers and employees of the company as being insiders. Because Nigerian Laws governing insider dealing are an offshoot of both UK and US Laws, they tend to be similar, By the definition of an insider, under Rule 110(3) SEC RR, it is obvious that it distinguished between a primary and secondary insider. It however makes mention of the insider needing to have being in one of these capacities if he is at anytime within the preceding six months been knowingly connected with the company whose securities have been traded. However, unlike the UK where mention is just made to a shareholder of an issuer of securities being an insider without actually putting a percentage to his shares, The ISA leaned more towards the US laws here by stating that the shareholder must be one who owns 5 percent or more of any class of securities of the company.
Another important category of‘primary insider' is that of those who do not have a relationship with the issuer, but have a connection because of the services they provide. E.g. Lawyers, Accountants.
It is crucial to note that under statutory definition, which widens the scope of insiders,‘access insiders' need not have a connection or a relationship with the issuer when they have access to inside information relating to the issuer. The US experience reveals how difficult it is to hold “access insiders” liable in the absence of a statute clearly defining them as insiders. It was a victory for the‘misappropriation theory' in defining Rule 10b-5 when the Supreme Court considered O'Hagan as an insider in the case of United States v. O'Hagan.The court adopted misappropriation theory to attach responsibility to a corporate “outsider” who violates Section 10(b) and Rule 10b-5.
The CJA 1993 and the ISA 2007 requires that ‘access insiders' have inside information “by virtue” of their employment, office or profession while the FSMA 2000 requires that‘access insiders' have inside information “through the exercise” of their employment, profession or duties. The term‘by virtue' indicates that there should be a‘functional link' to the issuer. If there was no requirement for any‘functional link' the street cleaner and the director of the issuer would be on the same level of responsibility. This is seen as an unfair result.
The main difference between the CJA 1993 and the FSMA 2000 in regards to‘primary insiders' is the addition of a new means of access to inside information, which is‘by virtue of criminal activities' It is believed that the addition is directed to preventing the involvement of organised crime and terrorist groups in financial markets, in order to conceal their illegal activities and direct the profits to these activities. It is however possible that this addition intends to cover instances of theft of information or any other criminal activities aimed at gaining access to inside information. It seems unrealistic that this sub-section will fulfil its functions of confronting terrorist activities. Furthermore, the addition of this sub-section could also be criticized if the aim was to confront theft of information, since in relation to the latter it should be confronted by criminal law policy. To be concise, there appears to be confusion in the aims of the regulation of insider dealing when‘as a result of his criminal activities' was added as a means of access to inside information. It is also incongruous that catching‘criminal insiders' is attempted by the FSMA 2000, rather than by the criminal provisions under the CJA 1993.
The second type of insiders is the secondary insiders who are those persons who have received or obtained information directly or indirectly from a person who is an insider. In the US, the function of‘secondary insiders' used to be fulfilled by the‘disclose or abstain rule' This was so in the case of In re Cady Roberts & Co. However, the current position in the US is that‘secondary insiders' are held liable because their dealing while in possession of material non-public information is “misappropriation”, as was the case in United States v. O'Hagan. Under the CJA 1993 and the ISA 2007 a secondary insider is someone who has inside information directly or indirectly from a primary insider and no requirement of a relationship between the tippee and the inside source is needed. However, provided that there is no requirement of a relationship between the tippee and the inside source; there must be a requirement of knowledge of the source of information. This requirement by both Acts is thought to be almost impossible to prove because by requiring the secondary insider to know that he has the information from an inside source restricts the scope of insiders. This problem was faced under the Companies Securities (Insider Dealing) Act 1985, where Lord Lowery interpreted the word‘knowingly' in Section 1(3)(a) and 2(1)(b) as meaning that in order to hold a tippee liable he must know the identity of his informant. However, this comment has been criticized as over-restrictive because it would be difficult to require that sub-tippees know the identity of the inside source. Nevertheless, requiring the knowledge of the specific quality of inside information may also be interpreted as a restrictive reading of the provision. It seems, therefore, that the best solution would be to introduce an objective criterion; Maybe to suggest that the tipee know or ought to have known the position of the inside source. An advantage of this will be fewer impediments to proving the secondary insider's knowledge and this is what sec 118B (e) of the FSMA 2000 proposes. This actually rids off the problems of proving that he has the information from an inside source because here it would appear that in interpreting this sections, what would be expected based on legal criterion in determining‘knowledge' is that of‘a normal or reasonable person.
UNDERSTANDING INSIDE INFORMATION
The availability of information to investors is very important in order to maintain an informed and efficient market. Using inside information is the main reason for regulating insider dealing. Therefore, a clear definition of inside information is vital. The US approach in regulating insider dealing is one of the Sec's and courts' expansive definitions of Rule 10b (5). In the UK, there are two definitions of inside information under Section 56 of the CJA 1993 and Section 118(C) of the FSMA 2000.In Nigeria, for the purposes of explanation these requirements can be divided into two main elements of inside information:‘unpublished' and‘price sensitive'.
In understanding the definition of insider dealing in the above jurisdictions, scrutiny ought to be given to these particular set of words; specific and precise or precise unpublished/non-public and price sensitive.
Specific or precise information
The CJA 1993 uses the two terms specific and precise. It is understood that the term‘specific' was introduced because the UK government was aware that the use of the term‘precise' alone would be interpreted as only‘narrow, exact and definitive'. It is important to note that the two terms were not meant to be identical. Section 118C (5) of the FSMA 2000 replaced the term‘specific or precise', used in the CJA 1993, with the term‘precise'. If the term‘precise' is considered to have a narrower scope than‘specific', does omitting‘or specific' narrow the definition employed in the CJA 1993? Arguably, information under the FSMA 2000 must be both‘precise' and‘specific'. However, Section 118C (5) of the FSMA 2000 defines‘precise information' as that which: indicates circumstances that exist or may reasonably be expected to come into existence or an event that has occurred or may reasonably be expected to occur; and secondly, is specific enough to enable a conclusion to be drawn as to the possible effect of those circumstances or that event on the price of qualifying investments or related investments. It is unlikely that the term‘precise' has a narrow interpretation. The FSA gave its opinion in clarifying the meaning of‘precise information'. The FSA thinks that there may be information which is not‘wholly specific or precise', but is still‘relevant'. In the case of Arif Mohammed v. FSA, the Financial Services and Markets Tribunal held that a piece of information is‘precise' even if there is no certainty but only a serious possibility that the event referred to will occur. Requiring the specific or precise nature of information is aimed at excluding rumours and untargeted information from the purposes of the Act. Thus, rumour or speculative gossip should not be regarded as inside information. While this appears to be a matter of logic, a more problematic issue concerns inferences and conclusions which could be drawn from knowledge of inside information.
Under both the US and Nigerian laws there is no particular requirement that the information should be specific or precise. The only requirement in Nigeria is the information is unpublished price sensitive. In the US, it appears that the specificity of information is part of the general requirement for information to be‘material'. The source of this requirement in the US is case law. TSC Industries Inc. v Northway Inc. In this case, the US Supreme Court decided that the determination of materiality requires delicate assessments of the inferences a reasonable investor (in the facts of the case a reasonable‘shareholder') would draw from a given set of facts and the significance of those inferences to him. This means that inside information includes those inferences which a reasonable investor would reach from facts in his possession. The issue of materiality, according to this judgment, is a question of fact and it is judged by an objective criterion which is a reasonable investor. Thus, in SEC v. Texas Gulf Sulphur the US Second Circuit Court of Appeal decided that this approach does not prohibit an insider from trading on the basis of the conclusions he has reached with the benefit of greater powers of analysis or a superior experience of financial issues.
In the UK, both the CJA 1993 and the FSMA 2000 require information to be related to particular securities or to a particular issuer of securities. It is stated that the CJA 1993 attempted to cover in the definition, information which relates to a particular sector. That is to say, information is still inside if it relates to a particular sector‘issuers of securities', even if it does not relate to a specific issuer or security. However, this appears rather ambitious. Suffice it to say that it is not achievable to regulate dealing on the basis of information relating to a whole sector.
Information which relates to an issuer includes that which arises from inside the issuer, such as information about financial changes in the profits of a company. However, there are circumstances in which information may arise from outside the issuer, but which still relates to it. The classic example of this is a takeover bid where the information of tender offers arises from outside the issuer, but still relates to it. Under the CJA 1993, it is not important whether the information is from an inside source of the issuer of securities as long as it relates to it.
In the US, the problem of the source of information arose when there was adoption of misappropriation theory as a ground for liability. The emergence of misappropriation theory required a reconsideration of the meaning of‘inside information'. The initial assumption was that the original‘source' of the information must also be the issuer of the securities. Due to the Supreme Court's rejection of the conviction in Chiarella v. United States, the SEC introduced Rule 14e-3 under Section 14(e). This rule prohibits dealing on the basis of information regarding tender offers, and this relates to the issuer even if it is not the source of the information. Based on this, the rule appears to be introducing a ground for regarding information which arose outside the issuer, but is related to it, as practicable to be inside information.
Non-public / unpublished information
One of the main characteristics of inside information is that it has not been made public. Disseminating non-public information into the public domain is the function of the disclosure system. Thus, it can be said that disclosure is what distinguishes between non-public and public information. If the information was disclosed according to the marketplace regulation, it should be acknowledged by the same regulation that the disclosed information is public and not relevant for the purposes of insider dealing regulation. There appears to be a difference between the information being available to the public and being available to market participants and investors. Hence, it is more realistic to disclose the information on the screen of the stock exchange in other that investors get the information. This practical need is recognised in developed jurisdictions, which are moving towards requiring issuers to follow a special process for the disclosure of information. However, there are still jurisdictions which require only the disclosure of inside information, without requiring the disclosure to the stock exchange. In such jurisdictions it would be difficult to determine if the disclosure made the information available for all the investors, and consequently to consider the information public. This is so because the disclosure of information to an agency not specialized in financial markets may not be effective in covering all the investors. Insiders may deal on the basis of disclosed information before the market absorbs it, thereby making a profit or avoiding a loss. There is the need for the language of the legislation to be clear and certain in order to avoid any ambiguity. In the absence of certainty in the legal language, there have been attempts to interpret the terms‘not public' and‘not generally available'. The interpretation of such terms may provide contradictory conclusions, which again lead to uncertainty. For example, the term‘not public' was said to be different from‘not generally available'. In the US, information should be non-public for the purposes of the regulation of insider dealing.
In the UK there are two definitions of inside information, under the CJA 1993 and the
FSMA 2000. The CJA 1993 uses the term‘has not been made public', which i under has the same meaning as unpublished as seen in sec 111 of the ISA. The FSMA 2000 on the other hand, uses the term‘not generally available'. However, comparing both definitions, it appears that the two terms refer to the same thing. Where information is published according to the requirements of a regulated market and to inform investors and their advisors, the information is regarded as‘made public' or‘generally available'. The problem which arises here is when, should information be regarded as made public? Such a problem is due to the fact that the market needs time to absorb the information, which means that insiders could take advantage of previous knowledge and deal immediately after disclosure. According to the wording of the CJA 1993 and the FSMA 2000, information enters the public domain at the time of disclosure; but there is no specific requirement that the information should be absorbed by investors, or should be reflected in the market price of securities. This is seen as a loophole which unfairly allows insiders escape liability. However, a more rational view is that not requiring the absorption of the information by the market has the advantage of clarity. It would be difficult to decide when the market absorbs the news to allow insiders to deal.
The scope of financial instruments covered by the regulation of insider dealing
In the US, for the purposes of the regulation of insider dealing, it is not required that the securities be traded or listed on an exchange. In other words, an insider could be held liable even if he dealt in the shares of a public company which was not traded or listed on an exchange. In Nigeria, the prohibition of insider dealing applies to trading in the securities of any company listed on the Nigerian Stock exchange. However, it is immaterial whether the transaction was conducted outside Nigeria or that the insider is resident outside Nigeria. In the UK, the securities must have been listed on the UK stock exchange and the most intriguing or rather difficult thing about proving insider dealing in the UK is that the act must have been carried out while the culprit was in the UK. If the culprit was not in the UK at the time the transaction was done, he will not be seen to have committed the act. This i find rather preposterous because we live in a modern world where things could easily be done so say if MR A called his stock broker in India from Africa and was told that he needed to sell his shares in company B in order that he avoids a loss. Wouldn't that be insider dealing? if Mr A did sell his shares based on the information he received from his stock broker. What this would mean, is that because Mr A was not in the UK at the time he was given the inside information and neither was his broker, none of them have committed the act of insider dealing even though they acted on inside information. In regards to this, i believe Nigeria is in a much better position to catch the insider dealers.
Also in the US in regards to types of securities, the judicial precedents indicate that the regulation of insider dealing covers equity securities of all types. However, in regards to debt securities and options the position of the law is less clear. The duty that is owed by the insiders to bondholders is a contractual duty and not a fiduciary one. Therefore, it cannot be said that an insider is under a duty not to disclose information to the bondholder when he deals with him. This shows the narrow scope of the regulation because it relies on fiduciary duties. By applying the “misappropriation theory”, means that insiders will also be prohibited from dealing in debt securities. Such an argument is based on the idea that misappropriation is a breach of duty to the source of information, rather than to the bondholder. However, it seems that this is another regulatory shortcoming resulting from unclear statutory regulation. In the UK, the scope of financial instruments is different under the CJA 1993 from that under the FSMA 2000. Under the CJA 1993, Section 45 Schedule 2 determined securities to which insider dealing provisions apply as the following: shares, debt securities, warrants, depository receipts, options, futures and contracts for differences. It is obvious that the CJA 1993 regulation of insider dealing covers shares and debt securities. The act therefore avoided a loophole which may exist in the US regulation by permitting an insider to deal in options rather than shares hence escaping liability. Thus, an insider who possesses inside information deals in the bonds of the related issuer rather than in its shares. The CJA 1993 also extended the scope of the regulation to cover other derivatives on securities such as options, futures, contracts and rights. In Nigeria, the CAMA in section 650 defines‘securities' as including "shares, debentures, debenture stock, bonds, notes (other than promissory notes) and units under a unit trust scheme', a wider definition exists in section 29 of the SEC Act. That section replicates the definition of the term in US federal securities laws, and therefore uses the investment contract concept. Nothing in the Acts explain this dual definition of‘security.'
It remains true that jurisdictions introduce different defences in which an act would not be prohibited in spite of its being within its theoretical definition. In the US, there is no clear determination of the exemptions but in the UK, under sec 53 CJA 1993, there are several exemptions and all of them appear to create a leeway for insiders to avoid liability. Because it shows that the prosecution would definitely face a difficult task at proving the intention of the culprit. For if the culprit is to state that by disclosing the information, he did not expect the individual to deal, how would the prosecution prove otherwise? or what of the exemption that the insider would have done what he did even if he did not have the information. With exemptions like this, it is no wonder that the numbers of insider dealing convictions are minimal compared to the US. In regards to the exemptions in Nigeria, see Chapter 3.
This chapter indicated those certain central issues and terminologies that need to be clarified in order that efficient regulation of insider dealing is carried out. These terminologies include but are not limited to insider, inside information, the scope of financial instruments covered by the regulation of insider dealing and the exemptions. The glaring problem with the US insider dealing regulatory system is the issue of leaving the interpretation of the regulation to the judiciary. The judicial and administrative precedents generate controversial interpretations of the antifraud provisions. Also the “misappropriation theory” appears to be extraneous in regards to the reading of the provisions. It is not surprising that the US approach has not been embraced by other jurisdictions because of its unclear interpretation of the anti-fraud provisions. However, The US has done quite well in regards to curbing insider dealing. It may be due to the use of administrative penalties and civil liability rather than criminal which has aided them in prosecuting more insiders than other jurisdictions.
In regards to the UK, the major problem used to be the fact that sanction was by criminal liability which obviously is difficult to establish however with the introduction of the FSMA 2000, civil liability emerged in the UK and this is commendable. The act of insider dealing in the UK is clearly defined and so poses no problem however, the territorial scope creates avenues to avoid liability and most of the exemptions seem unrealistic. Having the provisions related to insider dealing scattered between the CJA 1993 and FSMA 2000 appears confusing obviously because of the use of different words in defining the same thing and the fact that one statute may just be enough if drafted with the right wordings.
Nigeria apparently has the same issue with having two different statutes regarding insider dealing. Obviously one defines an insider while the other explains the prohibited activities. This seems disjointed. The issue of Nigeria trying to get the best of both worlds by imbibing the provisions of the CJA and the US anti-fraud provisions into its statute may seem efficient but is in fact rather ambiguous. Clarity of financial regulation should not be compromised.
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