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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 (Cont...)

Liability as insiders

The next step is to consider whether any person who bought or sold securities or tipped any other to do so while in possession of inside information was an insider in terms of Part I of the Amendment Act.

A person is an insider (under paragraph (b) of the definition) if that person is a principal officer or an employee of, or a substantial security holder in, a public issuer and that person has inside information by reason of their position.

None of the people referred to in this report were principal officers or employees of or substantial security holders in any public issuer at the time of these events.

Two further main groups of people are "insiders" in terms of the Amendment Act. Under paragraph (c) of section 3(1), a person who receives inside information in confidence from a person described in paragraph (b) of the definition (see above) is an insider. Under paragraph (e) any person who receives inside information in confidence from a person who received it in confidence from a person described in paragraph (b) is also an insider.

We need to consider whether any of AB, CD, or EF may have "received" inside information "in confidence" from an insider and if so, whether any of them traded or tipped while in possession of inside information.

Was AB an insider?

The draft news release came to AB's attention when it was posted to the Notice Board of the FCL Corporate LAN. This Notice Board is open to all employees who have access to the system. The Notice Board was used for staff announcements and notices. Staff did not have to "clear" with any person the use of information found on the Notice Board. FCL has informed us that confidential information was never placed on the Notice Board.

Although an obligation of confidence can be inferred from the nature of an employment or contracting relationship, on the information available to us we doubt that an obligation of confidence would be inferred in relation to information posted to this Notice Board.

It is relevant here, however, that AB has informed us she was told of the proposed sale of FCL Paper "in confidence" about 6-8 weeks prior to the end of April 1999. AB's work did not involve her in the plans for the merger. AB informs us she was told of the proposed sale by a colleague who was not an employee of FCL. This colleague, we understand, received the information in confidence from an FCL employee who was involved in the merger plans, and who had this information by reason of his employment. The information given to AB at that time was, she acknowledges, given in confidence. It was inside information.

Based on this chain of events, it can be seen that the FCL employee was an insider of FCL under section 3(1)(b) of the Amendment Act. The colleague who received the information in confidence from the employee was probably an insider under section 3(1)(c). AB, at the time she received this information in confidence from her colleague, probably became an insider under section 3(1)(e). She would have remained an insider until knowledge of the FCL's intention to sell FCL Paper was no longer inside information.

Liability for tipping

AB has stated that when the document appeared on the FCL Notice Board she believed this to be a company announcement confirming the information she had been given in confidence. She then considered she was able to pass on the information to CD.

We have already stated our view that the information in the draft news release remained inside information until late on 7 May. In terms of the law we consider it was still inside information when AB passed it on to CD, regardless of her belief. Likewise at that moment AB was still an insider of the company by reason of the information she had received earlier.

AB has stated that she passed on the information to CD because he was a long term shareholder of FCL. She knew he had an interest in the shares of FCL, and told FCL investigators that CD had already asked her about the article in the Herald.

In terms of section 9 (1)(b) we think there would be grounds to conclude that AB was an insider of FCL (by reason of her earlier learning about the proposed sale) who had inside information about FCL on 30 April (in particular the leaked page) and who communicated the inside information to a person knowing or believing that person would, or would be likely to, buy or sell securities of the public issuer.

The Court of Appeal observed in Colonial Mutual Life Assurance Society Limited v Wilson Neill Limited ⁴ that sections 7 and 9 of the Amendment Act impose absolute liability. This means that while liability under section 9 does depend on the insider intending to advise on or encourage trading, it does not depend on the insider's knowledge or belief about the status of the inside information itself. An insider can be liable under section 9(1)(b) for communicating a piece of information even where the insider is unaware that it is inside information.

As such, AB might incur liability under section 9 to the persons from whom CD purchased securities for the difference between the consideration they received for the securities and the value the securities would have had if the information had been publicly available at the time of the transaction. She might also be liable to the public issuer for these losses, and at the discretion of the Court, for a pecuniary penalty to the maximum of three times the losses avoided or the total consideration for the securities, whichever is the greater. If a judgment were entered against her she would be disqualified from managing a company for a period of 5 years.

We consider this would be an unexpected outcome to those who drafted the Amendment Act. It seems to be an unfortunate one. AB appears to have believed in good faith, at the time, that the information she faxed to CD was publicly available. She did not gain from his trading.

An argument could be raised that AB should have checked the source of the document with somebody before faxing it, particularly as it appeared to confirm something that she knew to be a confidential matter. She told FCL investigators she regrets not doing so. She said that she did not read the document closely, and thought the first page was the whole document. She does not appear to have turned her mind to its contents to any great degree, but to have assumed, upon reading the headline and the first bullet point, that its appearance on the Notice Board was confirmation of a public announcement. Given the importance of the announcement the question arises whether AB might have been expected to make a more careful check of the document.

We note AB's stated (but apparently mistaken) belief that company announcements were routinely posted to the Notice Board. Given this belief and the fact that confidential communications were not posted to the Notice Board we do not think it would be reasonable to expect a person in her position to check whether a document was posted in error.

Liability for trading

There is also the matter of AB's husband's purchase of FCL Paper shares on 3 May. AB insists that she did not tell her husband of the information in the leaked page, and was unaware of the transaction until after the event. We do not have any evidence to the contrary. Despite this, we note that the purchase made by AB's husband was in the joint names of himself and AB. Under section 7 liability arises where an insider with inside information about a public issuer buys securities of that public issuer. "Buy" includes "acquire." As AB's husband purchased the shares in his and his wife's joint names, it might be argued that AB bought these shares on 3 May, even if she did not know about the transaction until after the event. We doubt the Act should be read this way. It seems more in keeping with the purpose of the legislation that liability will arise under section 7 only where the insider undertakes some action to acquire or dispose of securities.

CD and EF

Was CD or EF an insider?

On the information available to the Commission, neither CD nor EF could incur liability as insiders under the Amendment Act. In order to be an insider under section 3(1)(e) of the Amendment Act, a person must have received inside information in confidence from a person who received inside information in confidence from a primary insider. This chain of liability stops at two removes from the public issuer, its employees, and officers. So, even if CD received the information in confidence from AB (and if AB was herself an insider) CD would not be an insider.

The same applies to EF. He obtained the leaked page from CD's office. Even if he obtained the information in confidence from CD, he would not be an insider by reason of this.

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