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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 5 - MARKET MANIPULATION

The dividing line between information-based market manipulation and insider trading often depends on whether the information concerned is accurate or misleading and on the use to which the information is put. Insider trading involves a person trading on reliable confidential material information about an issuer, which, if publicly known, would properly affect the price of the relevant securities. Disclosure-based market manipulation generally involves a person releasing information that misleads the market and in this way materially affects the price of securities.

In this case the information put into the market by EF was true in its content. It revealed that FCL was developing plans to merge its Paper Division with Fletcher Challenge Canada. The information was presented in a manner that superficially at least resembled an official company announcement. In fact the information was in a draft document. FCL was not yet in a position to announce the merger plans. It might be argued that the information released, while true, was misleading in the form and timing of its release.

The evidence we have suggests that EF played an active role in these events. He misappropriated a page of a confidential document. He purchased a number of shares, then released the leaked page to the news media and sharebrokers, and then sold for a substantial profit on the next trading day. One of his stated intentions was to cause a movement in the price of FCL shares by which he could profit. These actions resemble a deliberate attempt to manipulate the price of FCL shares. If a person "tips" the news media, intending that information about a company be published, then any liability that person could incur under insider trading law for gains and losses flowing from the action would be minimal, because this liability is measured by comparison to the price at which a trade would have occurred had the information been publicly available. A key part of EF's apparent strategy was that the information would be publicly available (and the price would have risen in reaction to this) by the time he sold. The question arises whether actions of this sort are better recognised by the law as deliberate attempts to manipulate a market, with liability being assessed accordingly.

Many countries have specific laws aimed at preventing manipulation of securities markets. Market manipulation laws usually target behaviour that aims to alter the market price or trading volume of securities through misleading disclosures or trading practices. Such practices can be harmful to the confidence placed in a market by investors. Manipulative practices can impede the proper price discovery mechanisms of a market. By reducing investor certainty and confidence, market manipulation can retard the efficient operation of markets by creating additional transaction costs and raised risk premiums.

Laws prohibiting manipulative practices in securities markets can contribute to investor confidence in a market in a similar fashion to laws against insider trading, and can enhance the integrity and efficiency of those markets.

At present market manipulation is addressed in New Zealand through an ad hoc collection of statute and common law, including the Crimes Act, the Fair Trading Act, and common law actions such as the tort of deceit. There is no single provision specifically targeted at market manipulation.

By contrast section 995 of the Australian Corporations Law contains a general prohibition against misleading or deceptive conduct in relation to dealing in securities. This provision states that "a person shall not, in or in connection with any dealing in securities...engage in conduct that is misleading or deceptive or is likely to mislead or deceive". The definition of "deal" in this legislation is broad, and includes to acquire or dispose of securities and to induce or attempt to induce another person to enter into an agreement for acquiring or disposing of securities.

It is established under Australian law that a statement can be misleading or deceptive even if it is literally true. The emphasis is on the objective effect of disclosure.

New Zealand Courts have reached the same conclusion in relation to section 9 of the Fair Trading Act 1986.¹⁹ Section 9 contains a general prohibition against misleading conduct similar to that found in Australian trade practices legislation. This section states that:

"No person shall, in trade, engage in conduct that is misleading or deceptive or is likely to mislead or deceive."

For liability to be incurred under section 9 of the Fair trading Act the activity must be conducted "in trade." This provision has been applied to professional share trading. However, the present case would not be covered by this provision as none of the parties involved was generally in the business of buying and selling shares.

We think cases like this one raise a question of whether consideration should be given in New Zealand to a general law prohibiting misleading or deceptive conduct relating to any dealing in securities, and perhaps to more specific laws against various forms of market manipulation. The Australian model might be useful here also (see sections 997 - 1001 of the Corporations Law). We consider that in the context of any reform of the law relating to insider trading thought should be given to adding to our securities legislation a general provision in terms similar to that in section 995 of the Corporations Law, described above.

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