Speeches: Regulating Insider Trading Effectively: Lessons From New Zealand

Regulating Insider Trading Effectively: Lessons From New Zealand

25th
Cambridge International Symposium on Economic Crime

Jesus College Cambridge

Speaking notes for
Jane Diplock AO
Chairman, New Zealand Securities Commission
Chairman of the Executive Committee of IOSCO

2nd - 9th September 2007

Capital markets are increasingly global. More businesses raise capital across national boundaries and investors place their money in other countries.

In this climate jurisdictions must develop legislative and regulatory mechanisms to help protect investors, and build confidence in their capital markets from both domestic and international perspectives. In other words, if countries want to operate in global capital markets, they need fair, efficient and transparent regulatory frameworks which are internationally acceptable.

New Zealand has been on a journey over the last two decades which has brought significant changes to its regulatory framework. It has moved from an extremely light-handed regime to one close to international best practice. New Zealand is a confident performer in global capital markets.

In capital market economies insider trading is a major risk to the transparent and fair operation of markets. All OECD countries now have laws providing criminal and/or civil sanctions against insider trading and New Zealand is no exception. Indeed, New Zealand has moved in recent years to strengthen its insider trading laws to enhance its ability to attract and retain both domestic and overseas investment.

Today I will outline the reforms of insider trading law, the thinking that has evolved and the changes made after the stock market crash in 1987 and up to today's global capital markets.

Although it is almost universally agreed that insider trading is unacceptable, varying approaches have been used to address it. I hope that insights from the New Zealand experience may be useful to other jurisdictions embarking on a similar journey.

The regulation of securities markets is of universal significance. The need to implement effective rules around the world led to the setting up of the International Organization of Securities Commission (IOSCO). Today IOSCO members include more than a hundred securities market regulators with jurisdiction over 90% of the world's securities markets, and many other affiliates. IOSCO is the international standards setter for securities regulation. It has a vision of markets operating across the world on coherent, sound principles and standards, and of regulators who effectively cooperate across borders and exchange information to enforce securities law.

One of IOSCO's three key objectives is that investors are protected from misleading, manipulative or fraudulent practices, including insider trading.¹ IOSCO members adopted a memorandum of understanding in 2002. (IOSCO MOU). Under this multilateral initiative securities regulators cooperate and share information. These information exchanges help detect cross border crime, including insider trading, and enforce securities law. Other IOSCO initiatives, such as its Regional Committees, provide opportunities to exchange information on agencies' individual experiences. These feed back into insider trading detection and prosecution.

As an IOSCO member New Zealand has applied the IOSCO Principles to its work on insider trading law reform and used the IOSCO MOU to assist in enforcement work.

New Zealand has reformed its insider trading laws to bring them more in line with those of other jurisdictions, particularly with its closest neighbour Australia. This fits well with the spirit of the Closer Economic Relations accord between our two countries. Incidentally, New Zealand and Australia have recently agreed to allow mutual recognition of securities offerings so that issuers can use the same offer document in each country.

The insider trading reforms have three key elements. First, the securities regulator, the Securities Commission, has been given enhanced powers to take enforcement action against insider trading. Second, the law has moved away from the notion that liability for insider trading is narrowly restricted to people with a fiduciary duty to, or connection with, a public issuer. The new rules focus instead on the public interest in the strengthening and maintaining market integrity and promoting investor confidence. And third, after nearly twenty years of a civil sanctions regime under which there were no judgments against anyone for insider trading, New Zealand's new law treats insider trading as a serious criminal offence.

2 SEQUENCING OF THE REFORMS

New Zealand's insider trading laws have been reformed in three waves.

The first reform began in 1988, after a Securities Commission report in the wake of the 1987 share market crash.² The report said that prohibitions on insider trading had been founded on a number of principles - from corporate injury and property rights, through moralist and fairness arguments, to market efficiency and international comity.

The Commission's recommendations were intended to incorporate the main concepts of insider trading regulation which applied at that time in the United States, Australia, Canada, and the United Kingdom. The resulting law thus based insider trading regulation on the principles of fiduciary duty. It defined an insider as "any person who by reason of their position as a director, officer, employee, or substantial shareholder of a company, had price sensitive information that was not publicly available". It extended this group to include those who might be under an obligation to the company having received such information in confidence from another insider.

The law prohibited insiders (with inside information) from trading and from tipping others to trade. The principal remedy was a form of civil penalty, with the right of action given to the public issuer whose information was used by the insider for his or her benefit. Rights of compensation were also available for shareholders.

The second reform, in 2002, left the core insider trading laws untouched, but increased their effectiveness significantly. They addressed the problem that the Securities Commission had no power to take court action in relation to allegations of insider trading. The Commission powers had been limited to reviewing and commenting on market practices relating to securities. The 2002 reform allows the Commission effectively to step into the shoes of the public issuer (which still has the primary right of action) and to pursue civil penalties against insiders. It can do this as of right if the public issuer concerned does not object, or with the leave of the court if the issuer does not agree that the Commission should pursue an action. In either case the Commission must be form the view that it is in the public interest for the Commission to take action.

The 2002 reforms also provided for the regulator's costs to be reimbursed from any money recovered from the public issuer (whether by litigation or settlement).

The Commission, given these powers in December 2002, wasted little time in exercising them. Proceedings were filed in October 2004 in an insider case against directors and a substantial shareholder of Tranz Rail, a company which had bought the previously state-owned railways. That case was finally settled in June this year with all six defendants for a total settlement of over $27.5 million. A second insider trading action was brought against Provenco Group and its directors in December 2004. This was settled in October 2005.

The 2002 reforms also introduced continuous disclosure of price-sensitive information by public issuers, and the disclosure of share dealings by directors and officers of listed companies. These are intended to reduce the likelihood of insider trading.

The third wave of reforms came in 2006 and is more fundamental. It creates significant changes in the tests for liability and the consequences for the insider trader. These reforms followed a thorough review of insider trading rules in New Zealand, Australia, the European Union, the United States and other jurisdictions, which had begun in 2002. The new law will come into effect later this year when regulations have been settled.

The framers of the new insider trading regime abandoned the fiduciary and misappropriation principles for liability and make a fresh start The new law is underpinned by the broad notion of market efficiency and fairness and sustaining investor confidence in the integrity of the market.

The reformed framework no longer identifies inside information as non-public price-sensitive information derived from within the company whose securities are being traded. It applies a much broader brush, treating inside information as any non-public price-sensitive information affecting particular securities that is not available to the market - irrespective of its source. The new provisions also do away with any attempt to regulate the extent of the fiduciary duty that a person who obtains inside information might owe to a company, and any recourse to misappropriation theory - the notion that the use of inside information obtained by a fiduciary by virtue of their position in a company is a breach of confidence.³

In a major policy shift, this new regime provides serious criminal sanctions for insider trading as well as liability for substantial civil penalties.

The much tougher approach shows that a sea change has occurred in the country's financial and political circles. The extent of this change was reflected in the media and parliamentary debates after the recent high profile settlement negotiated by the Securities Commission in the Tranz rail case. At over 27.5million dollars this is the largest securities market related settlement in New Zealand's history.

In summary - New Zealand has recently taken significant strides to strengthen its regulatory framework to meet the opportunities and challenges of today's global capital markets. I hope that an appreciation of our experience in building and implementing an efficient, sound and fair insider trading regime, a regime which adheres to international best practice, may be helpful to others.

Along the way we have drawn from the IOSCO Principles of securities regulation to develop sound law and we have gathered information from other regulators under the IOSCO MOU to help in insider trading prosecutions. This mirrors the global reach of capital markets.