Other publications: Insider Trading Law and Practice

Insider Trading Law and Practice

REPORT ON QUESTIONS ARISING FROM AN INQUIRY INTO TRADING IN THE SHARES OF FLETCHER CHALLENGE LIMITED IN MAY 1999

SECURITIES COMMISSION
WELLINGTON, NEW ZEALAND

PART 3 - APPLICATION OF THE LAW

Securities Amendment Act 1988

Part I of the Amendment Act contains statutory provisions relating to insider trading in the securities of public issuers (companies and others listed on the New Zealand Stock Exchange).

Generally, liability lies under this Act for the buying or selling of securities of public issuers by insiders with inside information, and for tipping on inside information by insiders.

"Inside Information" is defined in section 2 of the Amendment Act. In relation to a public issuer it means:

"...information which -

Is not publicly available; and

Would, or would be likely to, affect materially the price of the securities of the public issuer if it was publicly available:"

Section 3 (1) defines "Insider" to include:

The public issuer:

A person who, by reason of being a principal officer, or an employee, or company secretary of, or a substantial security holder in, the public issuer, has inside information about the public issuer or another public issuer:

A person who receives inside information in confidence from a person described in paragraph (a) or paragraph (b) of this subsection about the public issuer or another public issuer:...

A person who receives inside information in confidence from a person described in paragraph (c) or paragraph (d) of this subsection about the public issuer or another public issuer:..."

Section 7(1) sets out the principal liability for insider trading. It states that:

"an insider of a public issuer who has inside information about the public issuer and who -

Buys securities of the public issuer from any person; or

Sells securities of the public issuer to any person -
is liable to the persons referred to in subsection (2)."

Section 7(2) provides for liability to the counterparty of any trade for loss incurred by the counterparty, and to the public issuer itself for gains made or loss avoided by the insider in buying or selling the securities, and also to the public issuer for any amount that the Court considers to be an appropriate pecuniary penalty (which can be as much as the consideration paid for the securities, or three times the amount of the gain made or loss avoided by the insider, whichever is the greater).

Section 9(1) of the Amendment Act provides for liability where an insider tips another to buy or sell securities. This provision states:

"An insider of a public issuer who has inside information about the public issuer and who-

Advises or encourages any person to-

Buy or sell securities of the public issuer; or

Advise or encourage any other person to buy or sell securities of the public issuer; or

Communicates the information, or causes the information to be disclosed, to a person knowing or believing that person or another person will, or is likely to,-

Buy or sell securities of the public issuer; or

Advise or encourage another person to buy or sell securities of the public issuer- is liable to the persons referred to in subsection (2) of this section."

The insider tipper is liable: (a) to the counterparty of the tippee for losses incurred; and (b) to the public issuer for any benefit received by the insider, for any gains made or losses avoided by the tippee, and for pecuniary penalties where the Court considers this appropriate.

To find out whether there has been insider trading consideration must be given to whether information is inside information and whether any person who bought or sold securities or tipped another to buy or sell securities is an insider with inside information.

Inside information

Inside information must be information about the public issuer that is both non-public and that would, or would be likely to, materially affect the price of shares of the issuer if it was publicly available.

Did the leaked page contain information about the public issuer?

The leaked page described a proposed merger of FCL Paper with Fletcher Challenge Canada. This was clearly information about the public issuer, FCL.

We consider that the leaked page contained further information about the public issuer not available in the newspaper reports referred to above (paragraph 42), in that it provided authoritative confirmation of the events speculated on in those reports. While the leaked page was a draft document it appeared at least superficially to be an official news release. It attributed the information to the company, and included apparent confirmation of certain details by the board of directors. The leaked page was sourced from within the company. CD knew this. EF seems to have shared this view. He told SFO investigators "I believed I had the real McCoy".

The knowledge that FCL executives were preparing this draft would indicate that there was a degree of truth in the matters being discussed in the news media. This confirmation of the intentions of FCL was itself information about the public issuer.

When is information publicly available?

Two questions arise - whether the information became publicly available when posted to the FCL Notice Board, and whether the earlier news media reports had served to make the information publicly available.

Neither the New Zealand Courts nor the Commission have previously commented on the degree of disclosure that might be required for information to be considered "publicly available" for the purposes of insider trading law.

According to the Interpretation Act 1999 the meaning of an enactment must be ascertained from its text and in the light of its purpose.

Part II of the Securities Act 1978 regulates primary offers of securities "to the public". The statutory goal of this legislation has been described as "to facilitate the raising of capital by securing the timely disclosure of relevant information to prospective subscribers for securities. In that way the Act is aimed at the protection of investors".¹ For this purpose the term "offer to the public" is given a wide construction. The Act provides that evidence of an offer made to one member of the public is prima facie evidence of an offer made to the public at large.

Part I of the Securities Amendment Act 1988, by contrast, is concerned with trading in the secondary securities market. It refers to information that is "not publicly available", but that "would, or would be likely to, affect materially the price of the securities of the public issuer if it was publicly available." It does not seem to us that the broad constructions of "offer to the public" are very helpful in the context of this legislation. We consider that the purpose of insider trading legislation requires that the term "publicly available" be construed in the context of the activity that is being regulated.

The Amendment Act envisages that the degree of disclosure required for the information to be "publicly available" is such that it will be likely to affect the price of securities of the public issuer if the information is of a price sensitive nature. In order for information to be given the opportunity to affect prices it seems sensible that the information must be disclosed to the market generally. This supports the view that the term "publicly available" should be interpreted as meaning available at least to participants in the market in which the securities are traded, and probably also to potential participants, those who might act on the information.

This is similar to the position in the United States. US courts have held that insider trading is prohibited where the information that is used to advantage is "non-public information". The US Court of Appeals for the 2nd Circuit found in SEC v Texas Gulf Sulphur Co. that "before insiders may act upon material information, such information must have been effectively disclosed in a manner sufficient to insure its availability to the investing public." ²

Notice Board release

We do not consider that the placing of the draft press release on the Notice Board made the information publicly available in terms of Part I of the Amendment Act.

The FCL computer system can be accessed by about 200 people, all of whom are employees of the company or associated service providers of the company. The information was available on the Notice Board for around 30 minutes. We do not consider that this is the degree of disclosure envisaged as publicly available for the purposes of this legislation.

The Commission has expressed the view that information is publicly available for the purpose of the Amendment Act where it is provided by a public issuer to market participants, institutional investors, or analysts, with the full intention and expectation that the recipient is free to publish it generally.³ That was not the case here, however. The information arrived on the Notice Board by accident. There was no intention on the part of the public issuer that the information could be published freely or given further to any member of the public on request. The information was quickly removed from the Notice Board.

We do not think the fact that the information was, briefly, available to the users of the FCL computer system is sufficient for the information to be considered publicly available in the context of the Amendment Act.

Newspaper reports, 30 April and 1 May

We have noted (paragraph 42) that stories in the news media on 30 April and 1 May speculated on a possible sale of FCL Paper. On this basis it might be argued that the information about the proposal contained in the leaked page was already publicly available information prior to 7 May. If the information was publicly available then it was not inside information.

The Herald and Dominion articles speculated on a sale of FCL Paper, but the information in the stories was not attributed to any person, and both articles expressly stated that attempts to confirm the story at FCL had been unsuccessful. We consider that the information about the company's intentions that could be inferred from the leaked page was not freely available from the company at this time, and was not otherwise publicly available.

The "inside" connection of the information about the company's intentions was stressed in the Company Secretary's email. This e-mail referred to the draft news release as "a confidential file." It stated that no person must communicate the contents of the file to anyone else, even within the company. It asked people to destroy copies, and claimed that any person who read the file would be deemed an "insider" for the purposes of the Securities Amendment Act.

CD stated that AB did not tell him the information was confidential when she rang him on the afternoon of 30 April, or that its possession would make him an insider. He agrees that she told him the release was a mistake and that he should destroy the facsimile. It appears to us that CD should reasonably have been alerted by this to the non-public nature of the information. For his part, it seems that EF had some idea of the status of the information he found on CD's desk. He told the SFO "I believed I had some information that, while it was in the market place, it was only partially in the market place, if you know what I mean. It had been released publicly, but only to a certain segment of the public".

We have noted that the confirmation of the company's intentions contained in the leaked page constituted further information that was not available in the media articles of 30 April and 1 May. This information about the company's intentions was not available beyond a brief accidental exposure to users of the Corporate LAN (and because of this to CD and EF). This disclosure is not in our view sufficient to constitute public availability for the purposes of the Amendment Act.

To the extent that the leaked page contained express or implied confirmation from the company of its intentions regarding matters speculated on in the news reports, we consider that the leaked page contained information about the company that was not publicly available.

Was the information likely to materially affect the share price?

The leaked page was set out as an undated press release, apparently announcing that FCL was seeking to merge FCL Paper with Fletcher Challenge Canada. It was headed "Fletcher Challenge Announces Major Strategic Initiatives". It said that the initiatives were designed to add significant value for FCL shareholders. It seems clear that an announcement that a company is considering a major restructuring of one of its divisions is likely to materially affect the price of the shares of that division. This is so whether the release is known to be a draft document or a final news release, and whether or not there has been speculation in the market on these matters. An authoritative statement from within FCL on the subject would be an important event.

We consider that the release of the leaked page to the market on 7 May did in fact materially affect the price of FCL Paper shares, to a much greater extent than did the news articles a week earlier speculating on the same subject (see paragraphs 57 and 58).

We are satisfied that the leaked page faxed to CD by AB and later taken from his desk by EF contained inside information about a public issuer, FCL. This information was inside information from 30 April until the afternoon of 7 May 1999. At that time the information became publicly available through its transmission to market participants.

Footnote(s):

Re AIC Merchant Finance Ltd [1990] 2 NZLR 385, per Richardson J at 391

401 F.2d 833 (2d Cir. 1968)

Report of an Inquiry into Aspects of the Affairs of Regal Salmon Limited Including Trading in its Listed Securities, Securities Commission, 1994, pp 161 - 163

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