6.) Insider Dealing

Question 1

Define insider dealing

Answer 1

The deliberate exploitation of info by dealing in securities or their derivatives, having obtained the info by virtue of some privileged ratio ship or position

Question 2

In terms of punishments, what’s the difference between the CJA and the FSMA

Answer 2

The CJA provides for CRIMINAL sanctions such as jail and/or fines, but with a proof beyond reasonable doubt standard

The FSMA provides for ADMINISTRATIVE sanctions, e.g. Fines with a civil burden of proof (I.e. On the balance of probabilities)

Note that section 118 of the FSMA sought to provide administrative sanctions and the wider scope to cover all forms of market abuse, such as market manipulation and distortion not covered by legislation previously

Question 3

Describe the case the Guinness share-trading fraud, or the Guinness affair

Answer 3

The Guinness share-trading fraud was a famous British scandal of the 1980s.

It involved an attempt to massively manipulate the stock market, in order to inflate the price of Guinness shares, thereby assisting a £2.7 billion takeover bid for the Scottish drinks company distillers, which a bigger Guinness share price would have made easier

The defendants were to buy shares in Guinness, and help other investors do the same

The defendants would guarantee (without limit) the price of the shares for investors, meaning that investors would be paid if the value of their Guinness shares dropped

This created an unfair advantage in what should have been a fair marketplace

The scandal was discovered after testimony as part of a plea bargain by the US stock trader Ivan Boesky

Ernest Saunders, Gerald Ronson, Jack Lyons and Anthony Parnes, the so-called Guinness four, were charged, paid heavy fines, and with the exception of Lyons, who was suffering from ill health, served prison sentences late reduced on appeal

Question 4

Describe the purpose of section 52 of the CJA (criminal justice act 1993), and how the act defines insider dealing

Answer 4

Section 52 of the CJA creates the offence of insider dealing, whereby an individual who has info is guilty of insider dealing if they deal in securities that are price affected securities in relation to the info.

The acquisition or disposal in question has to occur on a regulated market, or the person dealing relies on a professional intermediary or is acting as a professional intermediary themself

An individual who has info as an insider is also guilty of insider dealing if:

X They encourage another person to deal in securities that are (whether or not the other knows it) price affected securities in relation to the info, knowing or having reasonable cause to believe that the dealing would take place on a regulated market, or the person dealing relies on a professional intermediary or is themself acting as a redoes signal intermediary

OR

X They disclose the info, other than in the proper performance of his employment, office or profession, to another person

Note that in relation to the second bullet point above, no info actually has to pass, nor does the recipient need to know that the securities they’re being encouraged to buy are price-affected securities

Also note that for an offence to be committed, the securities/shares must be traded on a regulated market

Question 5

As set out in the criminal justice act 1993, what does inside information mean

Answer 5

Information which:

A) Relates to either particular:

X Securities

X Issuer of securities

X Issuers of securities

B) Is specific or precise

C) Has not been made public

D) If it were made public would likely have a significant effect on the price of the securities

Question 6

When is a person perceived to have information as an insider

Answer 6

A person has info as an insider if and only if:

A) It is, and they know that it is, inside information

B) They have it and know that they have it, from an inside source

Question 7

When is a person perceived to have information from an inside source

Answer 7

A) They have it through:

X Being a director, employee or shareholder of an issuer of securities

X Having access to the information by virtue of his employment, office or profession

B) The direct or indirect source of his info is such a person

Question 8

What is the scope of insider dealing

Answer 8

An individual must either

X Been within the UK at the time when they were alleged to have committed the act constituting or forming part of the insider dealing

X The dealing occurred in a UK regulated market,

X Dealing was through a professional intermediary who was within the UK

The same scope applies regarding their location where they disclosed the information and encouraged the dealing, or the recipient of the info was within the UK when they received the information or encouragement to deal

Question 9

In respect of the dealing and encouragement offences of insider dealing, how may a defence exist

Answer 9

X The individual didn’t at the time expect the dealing to result in a profit or avoid a loss

X The accused shows that he would have acted in the same way, even if he hadn’t had the information, e.g. the individual was forced to sell through economic necessity

X A further defence exists where it can be shown on reasonable grounds that the individual believed that the info has been disclosed enough to ensure that none of those taking part in the dealing would be prejudiced by not having the information

NOTE that a conviction for insider dealing can only be obtained in the criminal courts if a case is proven ‘beyond all reasonable doubt’, a demanding test

Question 10

In respect of disclosure of inside information (in relation to insider dealing), how may a defence exist

Answer 10

X That they didn’t expect any person to deal because of the disclosure

X That although they expected dealing would occur they didn’t expect that the dealing would result in a profit attributable to the fact that the information was price sensitive

NOTE that a conviction for insider dealing can only be obtained in the criminal courts if a case is proven ‘beyond all reasonable doubt’, a demanding test

Question 11

What is the penalty for insider dealing (crown court and magistrates)

Answer 11

On summary conviction, I.e. in a magistrates court, the penalty for insider dealing is:

A fine not exceeding the statutory maximum of £5,000, or

X A maximum of six months in prison, or

X Both of the above

On conviction on indictment (crown court with a jury), the penalty is:

X An unlimited fine, or

X A maximum of 7 years in prison, or

X Both of the above

Question 12

Describe the law set up in Jersey to combat insider dealing

Answer 12

Company securities (insider dealing) (Jersey) 1988

Maximum penalties are:

7 years in prison

Unlimited fine

An amendment to the legislation prohibits statements obtained during an investigation being used in proceedings against a person

Question 13

What are the maximum penalties set out in the Company securities (insider dealing) (Jersey) 1988, the law set up in Jersey to combat insider dealing

Answer 13

Maximum penalties are:

7 years in prison

Unlimited fine

An amendment to the legislation prohibits statements obtained during an investigation being used in proceedings against a person

Question 14

Describe why Jersey needs to have the Company securities (insider dealing) (Jersey) 1988, the law set up in Jersey to combat insider dealing, despite it not having a financial market (stock market)

Answer 14

The main purpose of Jersey insider dealing and market manipulation legislation is to enable the JFSC to be able to respond to requests for assistance from other securities regulators that investigate these offences.

The JFSC must be able to respond to such requests in order to maintain international reputation and ensure that the business conducted in the island doesn’t facilitate the committing of these offences

Jersey is vulnerable to abuse by those committing these offences as offenders may try to hide behind corporate vehicles and trusts, or just bank the proceeds of crime in Jersey

Question 15

Insider dealing is a kind of market abuse - name 2 other kinds of market abuse

Answer 15

Making false or misleading statements

Behaving in a false or misleading manner

Question 16

How can a person be convicted of insider dealing, or any other kind of market abuse, by a court

Answer 16

A conviction can only be obtained in the criminal courts if a case is proven ‘beyond all reasonable doubt’, a demanding test

Question 17

Define the acronym MAD

Answer 17

Market abuse directive (part of the EU’s financial services action plan)

Question 18

Describe the changes to the market abuse regime introduced in the UK as a result of the EU’s market abuse directive (MAD)

Answer 18

Introduced in 2005

The MAD is part of the EU’s financial services action plan, which seeks to create a single European capital market.

The directive is intended to provide a common harmonised approach to fighting market abuse across the EU, particularly cross-border

Question 19

Define market abuse (as per the definition in FSMA 2000, s118)

Answer 19

REMEMBER THE DREDD MARKET ABUSE STORY

Behaviour, by one person alone or two or more jointly or in concert, which:

X Occurs in relation to qualifying investments traded in a prescribed market

And

X Falls into one or more of the seven types of behaviour set out below:

1) Insider dealing
2) Improper disclosure
3) Misuse of information
4) Manipulating transactions
5) Manipulating devices
6) Dissemination
7) Distortion and misleading behaviour

Dredd had received a report from FSMA 2000 on reports of INSIDER DEALING at a residence. Upon arrival, a naked man answered the door, who Dredd arrested for IMPROPER DISCLOSURE. The perp knew Dredd was coming, due to MISUSE OF INFORMATION, but that didn’t stop Dredd arresting him for both MANIPULATING TRANSACTIONS and MANIPULATING DEVICES. When he was about to leave, the nude man muttered “what about the pictures of me!?”, for which Dredd then charged him for DISSEMINATION, then once more, upon finding out he didn’t look good in the photos, for DISTORTION AND MISLEADING BEHAVIOUR

Question 20

Describe insider dealing, one of the seven types of behaviour that the FSMA 2000, s118, defines market abuse as

Answer 20

When an insider deals, or tries to deal, on the basis of inside info

Types of insider dealing include:

X Improper disclosure

X Misuse of info are kinds of insider dealing

Note that both of the above are also defined by FSMA 2000, s118, as types of behaviour that indicate market abuse

Question 21

Describe improper disclosure, one of the seven types of behaviour that the FSMA 2000, s118, defines market abuse as

Answer 21

Where an insider improperly discloses inside info to another person

For example:

An employee discovers his company is about to become the target of a takeover bid.

Before the info is made public, he buys shares in his company as he knows a takeover bid is imminent. He then discloses the info to a friend

This behaviour creates an unfair marketplace as the person who sold the shares to the employee may not have done so if he’d known of the potential takeover. The employee’s friend also has this info, and could unfairly profit from it

Question 22

Describe misuse of information, one of the seven types of behaviour that the FSMA 2000, s118, defines market abuse as

Answer 22

Behaviour based on info that’s not generally available, but that would affect an investor’s decision about the terms on which to deal

For example:

An employee learns that his company may lose a significant contract with its main customer.

The employee then sells his shares, based on his assessment that it’s reasonably certain the contract will be lost.

This behaviour creates an unfair marketplace as the person buying the shares from the employee may not have done so if they’d been aware of the info about the potential loss of the contract

Question 23

Describe manipulating transactions, one of the seven types of behaviour that the FSMA 2000, s118, defines market abuse as

Answer 23

Trading/placing orders to trade, that gives a false or misleading impression of the supply of, or demand for, one or more investments, raising the price of the investment to an abnormal or artificial level

For example:

A person buys a large number of a particular share near the end of the day, aiming to drive the stock price higher to improve the performance of their investment.

The market price is pushed to an artificial level, and investors get a false impression of the price of those share, and the value of any portfolio or fund that holds the stock.

This could lead to people making the wrong investment decisions

Question 24

Describe manipulating devices, one of the seven types of behaviour that the FSMA 2000, s118, defines market abuse as

Answer 24

Trading/placing orders to trade which employs fictitious devices or any order form of deception or contrivance

For example:

Buying shares and the spreading misleading info with a view to increasing the price

This could give investors a false impression of the price of a share, leading them to make the wrong investment decisions

Question 25

Describe dissemination, one of the seven types of behaviour that the FSMA 2000, s118, defines market abuse as

Answer 25

Giving out info that conveys a false or misleading impression about an investment, or the issuer of an investment, where the person doing this knows the info to be false or misleading

For example:

A person uses an Internet chat room to post info about the takeover of a company.

The person knows the info is false or misleading

This could artificially raise or reduce the price of a share, and lead to people making the wrong investment decisions

Question 26

Describe distortion and misleading behaviour, one of the seven types of behaviour that the FSMA 2000, s118, defines market abuse as

Answer 26

Behaviour that gives a false/misleading impression of either the supply of, or demand for, an investment, or behaviour that otherwise distorts the market in an investment

For example:

The movement of an empty cargo ship that’s used to transport a particular commodity.

This could create a false impression of changes in the supply of, or demand for, that commodity or the related futures contract. It could also artificially change the price of that commodity or the futures contract, and lead to people making the wrong investment decisions

It would be or be likely to be regarded by a regular user of the marketplace (I.e. A hypothetical, reasonable person who regularly deals in the marketplace) as behaviour that’s would distort or be likely to distort the market in the investment. A regular user of the market is also likely to view the behaviour as a failure to observe the proper standards of behaviour for the market in question

Question 27

Describe the penalties for market abuse

Answer 27

Maximum penalty = a fine and NO imprisonment

The maximum penalty the FSA has ever imposed against a individual for market abuse and breaching FSA principles is £750,000

Where the FSA is satisfied that a person is engaging or has engaged in market abuse, or by taking or refraining from taking any action that’s required/encouraged another to engage in behaviour which would amount to market abuse, then it may impose a penalty of such amount as it considers appropriate

The FSA may also publish a statement to the effect that a perish has engaged in market abuse, instead of imposing an penalty on them.

It’s a valid defence for a person to have believed on reasonable grounds that his behaviour wasn’t market abuse, or to have taken all reasonable precautions and exercised all due diligence to avoid behaving in a way that consistories market abuse

Question 28

Why was insider dealing legislation put into place/why is insider dealing wrong?

Answer 28

Insider dealing legislation was put into place on the assertion that abuse of confidential info is wrong, and that a market with deep inequalities of access to such info cannot command the confidence of investors

The objective of the legislation is to preserve and enhance confidence in the markets (see above). This is important because if investors feel that they’re taking greater risks because they don’t have access to confidential and privileged info they should, if they’re rational, demand greater rewards. This in turn would give rise to greater costs of capital with obvious consequences in terms of economic growth

This legislation seeks to deal with the misappropriation of shareholder info. Info about a company is the property of the shareholders of that company. If the directors or any other connected person abuse their fiduciary duties to shareholders, by using unpublished and privileged info to make dealing profits for their own account, they’re engaging in theft

Question 29

What case provides an example of market abuse and insider dealing

Answer 29

The Guinness affair, or the Guinness share-trading fraud

Question 30

What crimes does the case The Guinness affair, or the Guinness share-trading fraud, provide examples of

Answer 30

Insider dealing

Market abuse

Question 31

Describe the DREDD market abuse story, which gives the definition of market abuse, and the seven types of behaviour that FSMA 2000, s118, says it falls into

Answer 31

Remember the DREDD MARKET ABUSE story

Behaviour, by one person alone or two or more jointly or in concert, which:

X Occurs in relation to qualifying investments traded in a prescribed market

And

X Falls into one or more of the seven types of behaviour set out below:

Dredd had received a report from FSMA 2000 on reports of INSIDER DEALING at a residence. Upon arrival, a naked man answered the door, who Dredd arrested for IMPROPER DISCLOSURE. The perp knew Dredd was coming, due to MISUSE OF INFORMATION, but that didn’t stop Dredd arresting him for both MANIPULATING TRANSACTIONS and MANIPULATING DEVICES. When he was about to leave, the nude man muttered “what about the pictures of me!?”, for which Dredd then charged him for DISSEMINATION, then once more, upon finding out he didn’t look good in the photos, for DISTORTION AND MISLEADING BEHAVIOUR

Question 32

What is the penalty for insider dealing on summary conviction in a MAGISTRATES court

Answer 32

£5,000 fine

6 months in prison

Both of the above

NOTE that the MAGISTRATES handles LESSER crime, more serious crimes would go to the crown court for conviction

Question 33

What is the penalty for insider dealing on conviction in a CROWN court

Answer 33

Unlimited fine

7 years in prison

Both of the above

NOTE that the CROWN court handles more SERIOUS crime, lesser crimes would go to the magistrates court for summary conviction

Question 34

What two offences is market abuse made up of

Answer 34

Insider information

Market manipulation

Question 35

What are the penalties for market abuse

Answer 35

FCA may impose a penalty or publish a statement

Maximum penalty is a fine, but NO imprisonment