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INFORMATION CONTROL IN MARKET PARTICIPANT FIRMS

PART 4 - CONCLUSIONS

102.

The Commission has drawn the following conclusions from its inquiry.

103.

There was no instance of insider trading or tipping in terms of the Securities Markets Act 1988. Marathon's intention to accept the RPI offer was not information it held as an insider. Since Marathon could not be termed an insider under the Act, the other persons who received information about Marathon's intention also fall outside the definition of insider.

104.

The case raised issues relating to the control of information received by market participants in the course of corporate finance or investment banking activities. Potentially price sensitive information was disclosed by Craigs to select market participants in the course of the takeover offer, on the basis of the firm's corporate finance or investment banking mandate. However, this mandate in fact required Craigs to communicate information about the progress of the offer to market participants and the market generally, including by using its network of client advisers. The mandate did not require Craigs to disseminate information by selectively telling its client advisers ahead of notifying the market generally.

105.

Different firms handled the potentially price sensitive information in different ways. Craigs' decision to release the information to its client advisers and to select market participants was inappropriate and poor market conduct. The Commission is publishing this report to provide guidance for market participants reviewing or developing their systems or procedures relating to control of potentially price sensitive information.

106.

All entities that receive price sensitive information about listed issuers in the course of market activities should have effective Chinese wall procedures and should use them. Effective Chinese walls can ensure that price sensitive information remains properly secured and that this information is not improperly used to further the objectives of other segments of a business. If it is essential, as a part of the investment banking or corporate finance mandate, that this information is disclosed to persons other than those directly associated with the assignment, then that information should be disclosed through proper market mechanisms rather than by selective disclosure to a few market participants.

107.

Where specific and potentially price sensitive information becomes available it should be disclosed to the market as soon as possible, including, where applicable, by way of a substantial security holder notice. If an appropriate notice or announcement is not yet ready for release to the market as a whole (for instance, because the relevant notice is being prepared), then the information should not be selectively disclosed by any market participant. This is so whether the holder of the information is a broking firm, as in this case, or any other market participant.

108.

We acknowledge Craigs' submission that it does not appear to have broken any legal obligations regarding the disclosure of information. Craigs submitted that therefore the Commission should conclude only that this inquiry raises the issue of whether there is a need for market regulation to prevent the selective disclosure of material market information. However, we consider the importance of Chinese walls, for information control beyond management of conflicts of interest, is well established in New Zealand and overseas. It is recognised in Craigs' own compliance manual. Therefore, this report concerns an example of poor market practice. Whether this conduct illustrates any need for further guidance to be given to market participants is a matter we refer to NZX for consideration in light of this report.

109.

We do not see that this case raises immediate law reform questions. New Zealand's insider trading legislation has been under review in recent years. A Bill reforming this area of law is before Parliament. If that Bill is passed in its current form, insider trading liability may be incurred regardless of the source of the information. There will still be a defence to liability where a body corporate has Chinese wall arrangements and uses them. With any increased scope for liability it will be even more important for firms to understand the need to have effective information controls and to provide training and support sufficient to ensure that employees are aware of and adhere to information control procedures. Quite apart from this, the Commission is of the opinion that the market is best served when it is fully informed, and this is not achieved through selective disclosure of material information.

110.

The Commission refers this report to the NZX to consider whether it wishes to take any action, including whether to provide any guidance for market participants on information controls and issues of selective disclosure.

APPENDIX A - INSIDER TRADING - APPLICATION OF THE LAW

1.

The Commission has considered whether questions arise of insider trading or tipping in terms of Part I of the Securities Markets Act 1988. An outline of the relevant provisions of the law can be found in Appendix B of this report.

2.

Liability can be incurred under the law for insider trading or for tipping. Both require the involvement of an insider of a public issuer who has inside information about that or another public issuer.

3.

A number of elements need to be satisfied in order to establish a case of insider trading or tipping.

4.

This part of the report examines these elements of insider trading and tipping and their application to the events of 18 June 2004.

Inside Information

5.

The first question to examine is whether this case involves any inside information. "Inside information" in relation to a public issuer, defined under the Securities Markets Act, means information which:

1. is not publicly available; and
2. would, or would be likely to, affect materially the price of the securities of the public issuer if it was publicly available.

6.

The events that are the subject of this inquiry concern a discrete item of information, namely the knowledge that Marathon intended to accept RPI's takeover offer for Wrightson.

7.

It is also worth noting that the liability provisions for both trading and tipping impose liability on an insider who has inside information about the public issuer. These last words are important in this case and are considered below.

8.

The Commission received a submission from the legal representatives of Craigs arguing that the information received from Marathon was not inside information because:

1. the information was information in relation to Marathon's intention about whether Marathon would accept RPI's offer; it was not information about Wrightson Limited itself; and
2. in any event, the information was not price sensitive;
3. our client considers that the reason the trading volumes were higher on Friday than during the preceding week was because Friday was the last day on which any arbitrageur who wished to acquire shares and sell them into the RPI offer would acquire shares and become registered holders under the standard T+3 settlement period;
4. Marathon's intention to accept the offer had no effect on the share price; this is shown by the attached graph of share trading prices over the relevant period. This shows that the shares traded on Monday and Tuesday in the same price range as the shares traded on the previous Thursday.

The elements of inside information and insider trading are discussed below.

Was the information publicly available?

9.

The Commission has previously taken the view that a piece of information should be considered "publicly available" for the purposes of this law only once it is available to participants in the market in which the securities are traded, and probably also to potential participants, those who might act on the information. We have noted that the Securities Markets 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 the securities of the public issuer (if it is of a price sensitive nature). This effect can only be achieved once there is broad dissemination of the information. This view is consistent with the approach adopted by US courts in considering the phrase "non-public information". This led the Commission, in its November 2000 report on trading in the shares of Fletcher Challenge Limited, to the conclusion that:

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.

10.

Here, during the morning on 18 June, the information in question was known to Marathon, RPI, Craigs and a number of its employees, ABN AMRO NZ, managing principals of two other individual brokers, two clients of Craigs and one client of ASB, and to NZX.

11.

Given that the information was known only to the few parties mentioned above, we have no doubt that the information was not publicly available until, at the earliest, 11.16 a.m. when the first media announcement was made.

12.

The 11.16 a.m. news report stated:

A UK funds manager, which owns 12.2% on Wrightson Ltd (WRI.NZ), is to accept Rural Portfolio Investments Ltd's partial takeover offer for the New Zealand rural services and supplies company, a source familiar with the deal said on Friday....

This was the announcement made on the Dow Jones news service at 11.16 a.m.

13.

This media report was incorrect as to the extent of the holding of the UK fund manager, and did not name it. RPI told the Commission that the media drew their own conclusions about the name of the fund manager.

Was the information price sensitive?

14.

This is a matter to be determined by expert evidence. We observe there are preliminary indications that the information may have had some effect on price. It may be less clear that the effect should be considered to be material.

15.

Wrightson shares closed on Thursday 17 June at $1.52. By the time of the trading halt they were at $1.55. They closed at $1.57, having spent most of the afternoon at $1.57 and $1.58, and having briefly touched $1.59. This shows a movement from close to close of 5c, a rise of 3.2%, and a maximum movement through the day of 7c, a rise of 4.6%.

16.

It may be questionable, even before considering other causative factors, as to whether this price movement is material. In any event it would be necessary, independently of the actual price movement, to establish whether the Marathon information was information that would, or would be likely to, materially affect the price of Wrightson shares.

17.

The following events provide some indication of the materiality of this information:

Decision by NZX to halt trading in shares of Wrightson

Securities exchanges aim to provide an efficient market place for trading of securities. In the events under review, NZX decided to halt trading in shares of Wrightson with the following market announcement:

NZX advises that it has placed a trading halt on WRI securities on the basis that the market may not be equally informed in relation to the Takeover Offer for WRI.

This seems to indicate that NZX considered the information relating to Marathon's intention to accept the RPI offer to have certain pricing value which if known to all participants in the market would affect their decision to trade in the shares of Wrightson.

Price arbitrage opportunity becoming more certain

The RPI offer was priced at $1.65 while the shares closed on Thursday 17 June at $1.52. By the time of the trading halt, they were at $1.55. The price differential provided arbitrageurs an opportunity to buy shares in the market at a lower rate and then lodge these shares with RPI in the takeover offer. However, there was an element of uncertainty as to whether the conditional takeover offer would meet the target of 50% of the outstanding shares of the company. As of the end of 17 June 2004 RPI had lodged a substantial shareholder notice disclosing a holding of 27.555%. The additional information that a substantial shareholder intended to accept the offer made it more likely that RPI would be able to meet its target of 50%. This additional information may have had a pricing value associated with reducing the uncertainty about whether RPI would be able to make the 50% mark.

Was this information about a public issuer?

18.

This question relates to the definition of insider and to the operative words of the insider trading and tipping provisions of the law. These impose liability for trading or tipping by an insider who has inside information about a public issuer. Arguments have been raised before the Commission¹ that information regarding the intentions of a bidder in a takeover situation may not be information about the target company. The Securities Markets Act does not define the term "about the public issuer", nor has the phrase been the subject of judicial decision.

19.

The argument raised on behalf of Craigs is that the intention of a substantial security holder to accept a takeover offer is information about that person, not information about the public issuer for whom the offer is made.

20.

The Commission does not consider that the legislation requires such a narrow reading. When this legislation was introduced into Parliament the then Minister of Justice noted that it implemented the recommendations made by the Securities Commission in its 1987 report. That report sets out the Commission's reasoning for an insider trading law based on breach of confidence. The Commission's proposition for insider trading was that liability should be incurred where:

An insider in relation to a company...who buys or sells a security of the company while he has, by reason of his position as an insider in relation to the company, information that has not been published and that would be likely to affect the price of the securities if it was published, shall be liable...

21.

The legislation requires a link between a person and a public issuer in terms of how the information is acquired. It does not appear that there was any intention to impose any substantive requirement on the subject matter of inside information. Nor would such a requirement be consistent with the purpose of the legislation. The Act is concerned with the impact of the information, not with its subject matter. Whether or not information is inside information is to be determined by reference to the definition of that term in section 2 of the Act. This requires that the information be non-public and likely to affect the price of securities of a public issuer. It imposes no limits on the subject matter of the information. We are of the view that the phrase "about the public issuer" in sections 7 and 9 of the Act does nothing more than indicate that liability is imposed when a person who has inside information trades in or tips on the securities whose price is likely to be affected by the information.

22.

As such, the Commission is of the view that information about a decision or intention of a substantial security holder in the context of a takeover can be regarded as inside information about the public issuer that is the subject of the takeover offer, so long as the information is non-public and likely to affect materially the price of the securities.