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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...)

Hypothetical questions

Notwithstanding that neither CD nor EF could be insiders under the Amendment Act, it is useful to consider the question as to whether either of them would have been an insider if he had been within the prescribed degree of remoteness. It is important to consider this hypothetical question in any consideration of potential law reform implications. The manner in which both CD and EF appear to have come to possess this information raises difficult questions about the application of the law.

The issue that arises in respect of both CD and EF is whether or not each of them "received" inside information "in confidence".

The initial facsimile from AB to CD consisted simply of the printed page of the draft news release. There was no accompanying note or message. There was nothing on the face of it to suggest that the information was being passed on in confidence. Nor it appears did either AB or CD consider the communication confidential at this time.

In discussing who might be an "insider" under insider trading law the Commission's recommendations to the Minister of Justice in 1987 referred to case law on the equitable action of breach of confidence. When this legislation was introduced in Parliament the Minister of Justice said that it "approaches insider trading as a matter of breach of confidence".⁵ The action of breach of confidence in New Zealand protects confidential information communicated to a person in circumstances importing an obligation of confidence.⁶ On the wording of sections 3(1)(c) and 3(1)(e) we think that this test is to be followed in determining a person's status under the Amendment Act in the individual circumstances of each case.

The draft news release originally went out on a general noticeboard in a manner that probably would not lead to a conclusion that the information was being imparted in confidence. However, it was quickly removed. Moreover 1� hours later the Company Secretary sent a message to all Corporate LAN users stating that the document which had appeared on the Notice Board was confidential, and must not be discussed with or provided to any person. We think that at equity those people who saw the draft release on the Notice Board might, from the time they received the Company Secretary's email, be seen as subject to an obligation of confidence.

Upon noticing the e-mail AB rang CD and told him to ignore and destroy the information, and that it had been released by mistake.

The test at common law for whether information is imparted in circumstances importing an obligation of confidence is an objective one. The test is whether a reasonable person would assume an obligation of confidence arose in the circumstances.⁷ An obligation of confidence can arise after the acquisition of confidential information, and can bind a third party who receives the information innocently once the third party is on notice that the information is confidential.⁸ The question is whether the circumstances of this communication from AB to CD were sufficient, lacking the express words, to import an obligation of confidence. On the statements of CD we consider that AB's actions in informing CD that the release was a mistake, and her direction to CD to destroy the facsimile should have made it clear to CD that he was not at liberty to use or to publish the information.

From the time CD was advised of the mistake we consider that an obligation of confidence applied to him also. CD received this call before he bought shares.

The question this raises is whether the statutory definition of "insider" in the Amendment Act captures the breadth of obligations that can arise in equity. It can be seen that an action for breach of confidence can lie where constructive knowledge of a confidence can be inferred from the circumstances, or where a person is notified of the obligation of confidence after receipt of the information (from the time of notification, and in respect of any use of the information). Can section 3 of the Amendment Act be read in the same way?

This provision has not been examined by the courts. We do not think its boundaries are clear. On one interpretation, put to the Commission by counsel for CD, emphasis must be placed on the plain use of the word "received" in the statute. On this analysis CD might not be liable as an insider because he was not informed of the confidence until after the information was passed to him, and so the information was not received in confidence.

A similar approach to this can be seen in respect of interpretation of the offence of receiving stolen goods. This offence is established under section 258 of the Crimes Act 1961, and applies where a person:

"receives anything stolen, or obtained by any other crime...knowing that thing to have been stolen or dishonestly obtained".

This provision has been interpreted by the courts as meaning that the receiver must know the goods are stolen at the time of receipt.⁹ Liability does not arise where this knowledge is acquired afterwards. We note that criminal legislation is interpreted strictly. Liability under Part I of the Amendment Act can have penal consequences, and it was submitted to the Commission that on this basis the legislation should be strictly interpreted.

On the other hand, the Court of Appeal has stated in the Wilson Neill case that it "is fully conscious of the beneficial public purposes, aimed at improving commercial morality, of the Securities Amendment Act 1988".¹⁰ A Court might consider the purpose of this legislation favours taking a broader approach to the definitions of "insider".

Sections 3(1)(c) and (e) seek to describe the situation where an obligation of confidence arises in connection with the transmission of information.

There are two elements to this. First, the information must be transmitted, and secondly, there must be, seen objectively, circumstances importing an obligation of confidence. The first element was completed by AB faxing the leaked page to CD. We think it could be argued that the second element was completed from the time CD received AB's phone call alerting him to the mistake. It might be argued that these elements can be made out by two closely linked events, rather than by the isolated event of receipt. If these two elements can be satisfied sequentially in this way, then it may be concluded that CD was in a position whereby he had received the inside information in confidence.

As with CD, it is useful for law reform purposes to consider the question as to whether EF would have been an insider if he had been within the prescribed degree of remoteness.

It appears that EF took a copy of the leaked page without CD's knowledge or consent. From the account given by EF to SFO officers it appears that EF misappropriated information that he knew to be confidential, in circumstances that would lead an observer to conclude EF was not entitled to use the information freely. We note in particular EF's comment that he did not tell CD he had taken the copy because he felt he was not supposed to know about the document (see paragraph 47). He also said "I believed I had the real McCoy."

The status of a person who surreptitiously obtains information has not been considered by New Zealand courts in the context of liability for insider trading. The question in EF's case will turn on whether a person who misappropriates information can be said to have "received in confidence" this information. We have expressed the view (see paragraph 135) that the boundaries of sections 3(1)(c) and 3(1)(e) are not clear. Again the question will be whether the Amendment Act captures the breadth of obligations that can be found at equity.

Early cases on breach of confidence indicate that this action might lie for surreptitiously obtained information. In the 1970's and 1980's, the test for establishing this cause of action shifted, to focus on information that is "imparted in circumstances importing an obligation of confidence." This test has been adopted in New Zealand.¹¹

However, more recently courts overseas considering actions for breach of confidence have once again been willing to look beyond the strict requirement that the information be "received" and "imparted". In a case in the House of Lords in 1990 Lord Goff expressed the principles behind the action for breach of confidence to be founded on:

"a duty of confidence [which] arises when confidential information comes to the knowledge of a person in circumstances where he has notice, or is held to have agreed, that the information is confidential, with the effect that it would be just in all the circumstances that he should be precluded from disclosing the information to others."¹²

While this view has not to date been adopted in New Zealand, we believe it is to be preferred.

The New Zealand High Court has been willing to restrain a person from using confidential information obtained without the knowledge of the owner where that information was found on computer disks accidentally sold at auction.¹³ It was not clear from the decision that relief in these circumstances lay in breach of confidence or whether it was based on concepts of ownership of information. However it may indicate a willingness on the part of New Zealand courts to adopt Lord Goff's approach described above.

We think it is likely that EF obtained the leaked page in such circumstances that it would be equitable to preclude him from using that information or passing it to others, believing as he did that the information was "the real McCoy" and believing that he was not supposed to know about the information.

Taking into account our earlier comments concerning the interpretation of sections 3(1)(c) and 3(1)(e) (see paragraphs 134-140) we consider the better view to be that there was an obligation of confidence from the circumstances in which EF came to have the inside information. We think it is arguable that, questions of remoteness aside, EF would have been found to have received inside information in confidence. In saying this we acknowledge that commentators have published opinions to the contrary.¹⁴ We recognise that the wording of sections 3(1)(c) and 3(1)(e) might be ambiguous on this point. However we are of the view that this conclusion is consistent with the purpose of the Amendment Act. We do not believe it would be consistent with the policy of the Act for a person who surreptitiously misappropriates inside information to be free to trade, while if he or she had been given the information, he or she would have been prohibited from trading. We address this point in Part 4 of this report.

We note EF admitted that one of his purposes in passing the leaked page to the news media was to raise the price of FCL Paper shares. It seems that he communicated the information to the broking firms for a similar purpose. Whatever the liability that might arise if an insider tips the news media, we consider the circumstances in which EF did this resemble a deliberate attempt to influence the market in these shares. We comment on this in Part 5 of this report as a separate matter.

Insider trading conclusions

Our assessment of questions of liability under Part I of the Amendment Act is as follows:

On the information available to us, AB appears to have become an insider when first told, in confidence, of the proposed sale of FCL Paper. She remained an insider when she sent the facsimile (which contained inside information) to CD, even though she thought the information was no longer confidential. She appears to have communicated the information knowing or believing that CD might buy FCL shares as a result.
If this is the case AB may have incurred liability under section 9(1)(b)(i) of the Amendment Act. She may be liable for losses incurred by the counterparties to CD's trading. If judgment were to be obtained against her she would automatically be prohibited from taking part in the management of any company for a period of 5 years without first obtaining the leave of the High Court. At the discretion of the Court she might be liable for pecuniary penalties.
Neither CD nor EF was an insider of FCL under Part I of the Amendment Act because each was too many steps removed from the source of the information to incur liability as an insider in terms of section 3.
We think CD was a tippee of AB. This raises liability questions for AB if she is an insider, not for CD.

Our assessment of the further questions as to whether CD and EF received inside information in confidence is as follows:

We think it could be argued that CD received this information in confidence in that he received inside information from an insider and in the circumstances held the information under an obligation of confidence. However, we acknowledge that this is not clear.
On the evidence it appears EF misappropriated the inside information from CD. We think the preferable view is that EF received the information in confidence from CD although again we acknowledge that the point is arguable.
Because CD does not appear to have willingly given the information to EF, no question of CD tipping EF arises.

Footnote(s):

NZPD v 490 July 21 - July 28 1988 p 5281

AB Consolidated Ltd v Europe Strength Food Co Pty Ltd [1978] 2 NZLR 515

Laws NZ, Intellectual Property: Confidential Information, para 96

Malone v Metropolitan Police Commissioner [1979] Ch 344, per Megarry VC at 361

R v Tennet [1939] 2 All ER 86, R v Crooks [1981] 2 NZLR 53 at 56, 59

Above no. 4 at 161

Above no. 6

Attorney-General v Guardian Newspapers (No 2) [1990] 1 AC 109 at 281

Citicorp New Zealand Limited & Anor v Blomkamp and Anor, unreported 4/9/92, Blanchard J, HC Auckland CP1017/92

see eg Insider Trading, Nominee Disclosure and Futures Dealing, A. Van Schie, Butterworths, 1994, at p 13

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