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Insider Trading. Discussion document [2000] NZAHGovDP 5 (1 September 2000)

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INSIDER TRADING

DISCUSSION DOCUMENT

SEPTEMBER 2000

DISCUSSION PAPER INSIDER TRADING LAW

CONTENTS

ISBN no. 0-478-24200-X

PROCESS

This discussion paper has been prepared by the Ministry of Economic Development following consultation with other government officials and agencies. Written submissions on the issues raised in this paper are invited from all interested parties. The closing date for submissions is Friday, 13 October 2000. After receipt of submissions they will be evaluated and further comments sought as required before the Ministry develops recommendations for the Government to consider.

Submissions should be sent to:

Insider Trading Review
Ministry of Economic Development P O Box 1473
Wellington
Attention: Lisa Barrett Tel: (04) 470 2319
Fax: (04) 471 2658
Email: lisa.barrett@med.govt.nz

OFFICIAL INFORMATION AND PRIVACY ACT REQUIREMENTS

Please note that the contents of submissions provided to the Ministry in response to this discussion paper will be subject to the Official Information Act 1982 and the Privacy Act 1993. If the Ministry receives a request for information contained in a submission, it would be required to consider release of the submission, in whole or in part, in terms of the criteria set out in these Acts.

In providing your submission, please advise if you have any objections to the release of any information contained in your submission, and, if you do object, the parts of your submission you would wish withheld, and the grounds for withholding.

DISCLAIMER

Please note that any statements made or views expressed in this discussion paper are those of the Ministry of Economic Development and do not reflect official government policy.

Readers are advised to seek specific advice from a qualified professional before undertaking any action in reliance on the contents of this discussion paper. While every effort has been taken to ensure that the information set out in this paper is accurate, the Crown does not accept any responsibility whether in contract, tort, equity or otherwise for any action taken, or reliance placed on, any part, or all, of the information in this paper or for any error in or omission from this paper.

DEFINITIONS USED IN THIS DISCUSSION PAPER

ASIC Australian Securities and Investment Commission ASX Australian Stock Exchange
Commission New Zealand Securities Commission

Issuer company or other entity that has issued securities NZSE New Zealand Stock Exchange
Public issuer issuer that is listed on a stock exchange

SA Act Part 1 of the Securities Amendment Act 1988 SEC USA Securities and Exchange Commission

1 INTRODUCTION

• 1.1 The Government has identified as one of its key objectives promoting confidence in the New Zealand sharemarket. This objective involves increasing the certainty for market participants in relation to the integrity of the market, and the mechanisms for implementing the law. A number of factors can influence the level of confidence both domestic and international investors have in the New Zealand market. Strengthening the insider trading regulatory regime in New Zealand is only one activity geared at achieving this aim.

• 1.2 Where insider trading activity is perceived to exist it can be detrimental to investor confidence in the market. Well enforced insider trading laws are important in promoting the market to small investors, and also in determining how overseas investors view the New Zealand market. If investors believe that insider trading exists, and goes unpunished, they may presume that securities are the domain of those with access to privileged information and that others will inevitably miss out as the gains go to insiders.

• 1.3 Most of New Zealand’s insider trading law is found in Part 1 of the Securities Amendment Act 1988. Despite this legislation having been in force for over 10 years, no person has yet been found liable for insider trading under the Act.

• 1.4 It has been suggested that difficulties in interpretation or application of the SA Act may have hampered the effectiveness of the Act in combating insider trading. These difficulties have been said to include matters such as the lack of clarity in the core definition of “insider” and the circumstances in which an insider is liable for trading, the limitation of the SA Act to information about “public issuers” and questions about the application of the Act to activities occurring outside New Zealand.

• 1.5 It has also been suggested that there may be gaps in both the detection of insider trading and the enforcement of the legislation. Insider trading is difficult to detect and our current monitoring system is relatively outdated compared to other jurisdictions. There are also clear inadequacies in the area of enforcement. There is no public enforcement body to undertake prosecutions for insider trading and the only recourse individuals have is through private legal action. The cost of taking an action, the difficulties for an individual in detecting the trading, the considerable amount of time necessary and obstacles in obtaining information from the “insider” all act as significant barriers for individuals in taking an action.

• 1.6 At this relatively early stage in the life of the legislation, and in view of the small number of judicial decisions interpreting it to date, the Government believes it is preferable to focus on making the regime more effective by concentrating on prevention of breach, detection, enforcement of the existing law, and the

possibility of introducing criminal penalties. Effectively dealing with the issues of prevention, detection and enforcement is a fundamental step to ensuring the efficacy of our insider trading regime and could pre-empt the need for any further change. Once there is effective detection and enforcement of our insider trading regime, cases have been brought and the legislation tested in Court, it is believed we will be in a better position to know if the provisions of the SA Act are appropriate and workable.

• 1.7 Having said this however, the Government is also keen to canvas views on potential problems with the SA Act in the area of the key definitions. Therefore, in addition to the key issues outlined above, the paper also invites comment on the core provisions of the Act, and proposes some potential technical changes so as to clarify the interpretation of the current provisions.

Insider Trading Definitions

• 1.8 Over recent years a number of aspects of the insider trading legislation have been identified as being capable of improvement. Some of these changes relate to the core provisions of the SA Act, while others are more in the nature of fine tuning. Part 3 sets out some of the more fundamental issues for comment, and suggests some potential technical changes which, if appropriate, could readily be included in any amending legislation.

Prevention of breach

• 1.9 Insider trading involves trading in securities with the benefit of information that is not publicly available. One means of reducing the likelihood of insider trading is to increase the obligations on issuers of securities to make price-sensitive information publicly available. Part 34 sets out some options for doing this.

Detection

• 1.10 Detecting insider trading is a problem that has been recognised by nearly every country that has insider trading legislation. Detection is typically very difficult, even with the assistance of the most sophisticated monitoring systems. Part 4 sets out some options for improving the detection of insider trading activity in New Zealand.

Enforcement

• 1.11 The only recourse under New Zealand’s insider trading legislation is through private legal action. While specific provision is made in the legislation for current and previous shareholders to undertake legal action on behalf of a public issuer, the costs associated with obtaining leave of the court to do so may act as a significant barrier in some cases. Further, individual shareholders often have insufficient personal incentive to spend the considerable amount of time necessary to mount an insider trading action. Part 6 sets out some options for improving the enforcement of the legislation.

Criminal offences

• 1.12 As mentioned above, the only recourse under the insider trading legislation is through private legal action. The introduction of criminal penalties may provide a further deterrent to insider trading activity. Part 7 sets out the issues to be considered in relation to criminalising insider trading.

Co-ordination with Australian law

• 1.13 In view of the obvious advantages of co-ordinating New Zealand and Australian law, the Ministry of Economic Development will give particular attention to the Australian law relating to the issues raised in this discussion paper, and will welcome submissions on the appropriateness of this Australian law being adopted in New Zealand.

2 DESCRIPTION OF NEW ZEALAND’S INSIDER TRADING LAW

• 2.1 New Zealand’s insider trading law is found in three sources, the most important of which is Part 1 of the Securities Amendment Act 1988.

• 2.2 At common law, in certain circumstances a shareholder can recover from a director of a company, where the director purchased shares from the shareholder while having material information not available to the shareholder. However, a fiduciary relationship or other special relationship between the parties is necessary and this is normally not the case in a market transaction. See Coleman v Myers [1976] NZHC 5; [1977] 2 NZLR 225.

• 2.3 The Companies Act 1993 contains provisions relevant to insider trading:

• ➢ section 145 restricts the use of company information by company directors;

• ➢ section 148 requires directors to disclose share dealings to the board and these disclosures must be entered in the company’s interests register and disclosed in the next annual report; and

• ➢ section 149 requires the sale and purchase of securities by a director who has material information in his or her capacity as a director or employee of the company to be at fair value determined on the basis of all information known to the director or publicly available. This section does not apply to a company to which Part 1 of the SA Act 1988 applies.

Part 1 of Securities Amendment Act 1988

• 2.4 Paragraphs 2.6 to 2.14 below provide a brief summary of this Part, which applies to the use of inside information relating to entities that are, or were, listed on a New Zealand stock exchange.

• 2.5 The key definitions are –

“Public issuer” means a company or other entity that is or was listed on a New Zealand stock exchange;

“Inside information” means information that is not publicly available but would be likely to affect materially the price of securities of a public issuer if it were publicly available;

“Insider” means, in relation to a public issuer, -

• ➢ the public issuer itself;
• ➢ a director or employee or substantial security holder of the public issuer who has inside information about the public issuer or another public issuer; or

• ➢ a person who receives in confidence inside information about the public issuer or another public issuer from any of the persons referred to above.

Insider dealing

• 2.6 Under section 7, an insider who has inside information about a public issuer and who buys or sells securities is liable to –

• ➢ the person who sold or bought the securities, for any loss incurred by that person; and

• ➢ the public issuer, for the amount of any gain made or loss avoided by the insider plus a pecuniary penalty (but the penalty is not to exceed the greater of the consideration for the securities, or three times the amount of the gain made or loss avoided by the insider).

• 2.7 There are the following exceptions from section 7 –

• ➢ if the securities are bought or sold in accordance with a procedure approved by the Commission;

• ➢ if the purchase of securities results from a takeover offer made under the Companies Amendment Act 1963 or the Takeovers Code; and

• ➢ if the sale or purchase of securities was made in accordance with appropriate “chinese wall” procedures.

• 2.8 Sections 11 and 13 provide for similar liability, and exceptions, in respect of dealings by an insider of a public issuer who has inside information about another public issuer.

Tipping

• 2.9 Under section 9, an insider who has inside information about a public issuer and who encourages another person to buy or sell securities, or provides information to a person believing that the tippee will buy or sell securities, is liable to –

• ➢ any person who sells or buys securities from the tippee, for the loss incurred by that person; and

• ➢ the public issuer, for any consideration received by the insider, any gains made or losses avoided by the tippees, and a pecuniary penalty (but the

penalty is not to exceed the greater of the consideration for the securities, or three times the amount of the gain made or loss avoided).

• 2.10 There is an exception to section 9 if the person acted in accordance with a “chinese wall” procedure.

• 2.11 Sections 13 and 14 contain similar provisions in relation to tipping about securities of another public issuer.

Lawyer’s opinion

• 2.12 Under section 17, a shareholder or former shareholder of a public issuer may, with the prior approval of the Commission, require the public issuer to obtain an opinion from a lawyer on whether or not the public issuer has a cause of action against an insider. The public issuer is required to supply all relevant information to the lawyer, and must pay the lawyer’s fees.

Proceedings by shareholders

• 2.13 Under section 18, a public issuer’s right of action against an insider may, with the leave of the High Court, be exercised by a shareholder or former shareholder of the public issuer. The public issuer must pay the costs of a person to whom leave is given.

Distribution of amount recovered by public issuer from insider

• 2.14 Under section 19, any money recovered by a public issuer from an insider must be held by the public issuer on trust for distribution in accordance with the directions of the High Court. The Court may order that the amount be distributed to shareholders or former shareholders, retained by the public issuer, or paid for charitable purposes.

3 INSIDER TRADING DEFINITIONS – SECURITIES AMENDMENT ACT 1988

Introduction

• 3.1 This Part raises for consideration some general questions in relation to the existing insider trading definitions contained in the SA Act as well as a number of miscellaneous matters which have been suggested as suitable technical amendments to the provisions of the Act.¹

General Issues

• 3.2 It has been suggested that difficulties in interpretation or application of the SA Act may have hampered the effectiveness of the Act in combating insider trading. These suggested difficulties have generally related to three specific areas which are:
  • a lack of clarity in the core definition of “insider” and the circumstances in which an insider is liable for trading;
  • the limitation of the SA Act to information about “public issuers”, being persons who are or have been parties to a listing agreement with the New Zealand stock exchange; and
    • questions about the application of the SA Act to activities involving entities listed outside New Zealand.

Definition of Insider

• 3.3 The definition of “insider” contained within the SA Act determines the fundamental philosophy of the legislation. At present, there are essentially three ways a person can be an insider within the current definition. First, where a person is or has a relationship with a public issuer (as a director, employee or substantial security holder), and possesses the inside information. Secondly, where a person receives the inside information in confidence, directly or indirectly, from an insider. Thirdly, a person can be an insider simply by being a director or employee of, or substantial security holder in, a person who has inside information.

• 3.4 It has been argued that the present definition of insider is too broad in some instances, and accordingly, may lead to outcomes that are not intended. For instance, at present the law applies to transactions between informed parties. In

¹ In addition to these suggested amendments, a number of other amendments of a relatively minor nature are already included in the Business Law Reform Bill which is currently before Select Committee.

an instance where both parties are informed and aware of the confidential information, there is arguably no detriment to either party.

• 3.5 It has also been argued that the present definition is too narrow in some instances. For example, the current definition applies to a person who has received inside information in confidence from an officer of the public issuer. However, it is unclear as to whether the SA Act applies in a situation where the person has obtained illegal access to the officer’s records.

• 3.6 The issue is also sometimes raised that the SA Act is impractical in its application to situations involving due diligence. For example, an institutional investor may gain inside information about a public issuer in the course of acting as an underwriter in the raising of new capital.

• 3.7 Liability for tipping in the SA Act raises a further potential issue. At present, the law applies to make an insider who is a tipper liable for the trading of a tippee. Questions have been raised about whether the tipper needs to be aware that the information is inside information, and, if not, whether liability is appropriate in those circumstances.

Limitation to “public issuers”

• 3.8 At present the law relates only to inside information about a listed issuer. It has been suggested that the law should be extended to apply to all issuers of securities to the public.

Application to entities listed outside New Zealand

• 3.9 Under the SA Act, a “public issuer” means a person who is party to a listing agreement with a stock exchange. “Stock exchange” in turn is defined as the “New Zealand Stock Exchange; and includes a stock exchange registered under the Sharebrokers Act 1908”. These definitions effectively limit the application of the SA Act to insider trading activity in New Zealand listed entities only. It has been suggested that “public issuer” should be extended to include entities listed on exchanges outside New Zealand, for example, the ASX.

Proposed Technical Amendments

Definition of Insider

• 3.10 The definition of “insider” could be extended to include company officers of related companies of a public issuer, with respect to information “about the public issuer or another public issuer” that is received by the company officers in the course of their employment. In this context, “related company” would have the same meaning as in section 2(3) of the Companies Act 1993.
• 3.11 This would have two main effects. Firstly, it would expose officers of related companies of public issuers to liability in respect of inside information about the public issuer. Secondly, it would provide a basis on which to extend the protections of the Insider Trading (Approved Procedure for Company Officers) Notice 1996 to company officers of related companies of public issuers. At present this notice may only be used by directors and employees of a company that is a party to a listing agreement.

• 3.12 Section 3(1) of the SA Act could be amended by inserting the words underlined below:

“For the purposes of Part I of this Act, “insider”, in relation to a public issuer, means –

1. the public issuer;
2. a person who, by reason of being a principal officer, or an employee, or a company secretary of, or substantial security holder in, the public issuer or a related company of the public issuer, has inside information about the public issuer or another public issuer;”

• 3.13 Section 3(2) of the SA Act could be similarly amended to provide that inside information possessed by a company officer of a related company is presumed to be held by that company officer by reason of that person being a company officer of the related company.

• 3.14 Section 8(1) of the SA Act could be amended to allow company officers of related companies of the public issuer to take advantage of the approved procedure for company officers, as follows:

“No action shall be brought under section 7 of this Act against a director, or company secretary, or employee of a public issuer or of a related company of a public issuer if ...”

• 3.15 The Commission would need to consequentially amend The Insider Trading (Approved Procedure for Company Officers) Notice 1996.

Clarify references to spouse or child of insider

• 3.16 Any Commission insider trading notice establishing an approved procedure under section 8(1) may apply in respect of securities sold or purchased in the insider’s “own name or in the name, or on behalf, of that person’s spouse or child” (section 8(1)(a)). There has been difficulty in interpreting these words. Presumably the section is intended to apply in respect of securities sold or purchased by the insider either in his/her own name or in the name of his/her spouse or child and either on his/her own behalf or on behalf of his/her spouse or child. If so, the section could say so more clearly, as follows:

The securities are sold or purchased in the name or on behalf of:

(i) that person; or

(ii) that person’s spouse or child; and ...

Extend exception from liability for takeover offers

• 3.17 Section 8(2) protects the bidding company in a takeover from liability under section 7. The section 10 exclusions from liability for tipping do not make provision for an exception from liability for tipping in a takeover situation.

• 3.18 It has been suggested that section 10 should include an exception for both the bidding and target companies and any insider of either of them which does an act to which section 9 applies if the purchase or sale results from a takeover offer under the Companies Amendment Act 1963 or any Takeovers Code in force.

• 3.19 This proposal could remove doubt about liability incurred by recommendations from either company. It is consistent with the policy already found in section 8(2), applying it further to section 9 liability. It may increase certainty for directors in takeover situations and address a noted difficulty with the law.

Chinese Walls exception

• 3.20 The wording of paragraph (a) of each of sections 8(3), 10, 12(2), and 14 has caused difficulties for firms attempting to establish Chinese Wall procedures. The difficulty lies with the words “arrangements existed to ensure ...”. This wording has caused confusion, and it has been suggested that the word “ensure” by itself means that no standard short of absolute separation will suffice to meet the test in section 8(3).

• 3.21 This confusion could be avoided in each case by replacing the words “arrangements existed to ensure” with “arrangements existed that could reasonably be expected to ensure”. This amendment could reduce compliance costs by providing a certain and familiar test against which market participants could measure their procedures. The requirement in paragraph (b) of each provision to the effect that no inside information is held by the decision-maker should be sufficient to ensure that the exception applies only where the arrangements are reasonably effective.

Remove automatic prohibition on managing companies

• 3.22 Section 382(1)(c) of the Companies Act 1993 provides that where a judgment has been obtained against any person in an action under Part I of the SA Act that person shall not take part in the management of a company for five years without the leave of the Court.

• 3.23 This provision may be too inflexible, particularly in view of the decision of the Court of Appeal in Colonial Mutual Life Assurance Society Limited v Wilson

Neill Limited [1993] NZCA 288; [1994] 2 NZLR 152 that liability under Part 1 of the SA Act is strict and is not dependent on fault. Section 382(1)(c) could be revoked without affecting the Court’s discretion to disqualify any person against whom a judgment has been obtained under Part I from directing or managing a company. This is provided for in section 383 of the Companies Act.

Lawyers appointed under section 17

• 3.24 It has been suggested that section 17 should expressly allow the lawyer to receive information from the Commission and to consult with the Commission. This could be achieved by inserting the following subsection:

17(3A) The barrister or solicitor may –

(a) receive from the Commission the books or papers of any person which may be material to the preparation of the opinion,

(b) consult the Commission in the preparation of the opinion,

(c) provide such reports to the Commission as the barrister or solicitor thinks fit from time to time in the course of preparation of the opinion.

• 3.25 It has also been suggested that a public issuer should be required to give a copy of the lawyer’s opinion to any person against whom the public issuer may have a cause of action. This reflects the practice to date and both this practice and that above were remarked upon by the Court of Appeal in the Wilson Neill case as being “consistent with the Act and useful in complicated cases”.

Share buy-backs

• 3.26 When the SA Act was enacted there was no provision for share buy-backs. Without any exception in the statute it seems that a company may be liable as an insider, to itself and its shareholders, where it purchases shares pursuant to a buy-back. The statutory procedure in the Companies Act regulating buy-backs contains detailed restrictions on the extent to which the board can hold material price sensitive information that is not disclosed to shareholders when making a buy-back offer. In these circumstances it has been suggested that buy-backs

should be taken outside the ambit of the insider trading provisions of the SA Act.

Statutory exception for certain transactions

• 3.27 It has been suggested that the transactions identified and excepted from liability in Procedure II of the Insider Trading (Approved Procedure for Company Officers) Notice 1996 should be extended, by statute, to all types of insiders without the need for a specific procedure to be followed. In other words no

liability should lie under Part I of the SA Act in respect of the following transactions:

(a) The selling or buying of securities of a public issuer under –

• ➢ any compromise, arrangement or amalgamation effected in accordance with the Companies Act; or

• ➢ any reorganisation or reconstruction of a public issuer that involves all the securities of the same class.

(b) The selling of securities of a public issuer where –

• ➢ the proceeds are to be used solely to buy rights to subscribe for securities of the public issuer that are offered to all security holders of the same class by means of a current registered prospectus; and

• ➢ the sale occurs during the offer period stated in that registered prospectus.

(c) The selling of securities of a public issuer as the result of the acceptance of an offer to buy the securities made by means of an announcement through a stock exchange in any country on which the securities are listed, being an offer that –

• ➢ was made in accordance with the rules of the exchange; and

• ➢ remained open for acceptance for a period of not less than 20 trading days.

• 3.28 The rationale for identifying these transactions is either that, like buy-backs, there is a statutory procedure regulating the transactions, or that these are transactions in respect of which an insider would not stand to make any greater gain or loss than any other shareholder.

Empower court to direct any person to reimburse the costs of the public issuer in obtaining a legal opinion under section 17

• 3.29 The preparation of a section 17 opinion is at the public issuer’s (and therefore its shareholders’) expense. It may sometimes be appropriate for the public issuer to recover from another person (other than the person seeking the opinion) the costs of obtaining the opinion, particularly, but not necessarily, where the public issuer (or a shareholder acting on the public issuer’s behalf) has obtained a

judgment against an insider under the SA Act. This proposal would allow costs to fall on a culpable party (usually, the insider) at the discretion of the court.

• 3.30 Alternatively, the power of the court proposed in paragraph 3.29 could be limited to requiring a person who has been judged to have committed insider trading, rather than any person, to pay the cost of a section 17 opinion.

Questions for submissions

• 3.1 Are there any fundamental difficulties with the definition of “insider” within the SA Act? If so, what are they?
• 3.2 Should the SA Act be extended to include unlisted issuers of securities?
• 3.3 Should the SA Act be extended to issuers listed outside New Zealand?
• 3.4 Do you believe the suggested technical amendments to the definition of “insider” would add clarity to the provision?
• 3.5 In your view, do the references to spouse and child in section 8(1)(a) require clarification as suggested?
• 3.6 Should section 10 be amended to provide an exclusion from liability for tipping in a takeover situation?
• 3.7 In your view, should the wording of the chinese walls exception be amended as suggested in the discussion?
• 3.8 Do you believe the automatic prohibition on insider traders managing companies should be removed? What would be the implications of leaving this to the Court’s discretion?
• 3.8 In your view, is it appropriate for lawyers appointed under section 17 to be permitted to receive information from, and consult with, the Commission?
• 3.9 Do you believe a public issuer should be required to give a copy of a section 17 opinion to any person against whom the public issuer may have a cause of action?
• 3.10 Do you think that share buy-backs should be removed from the ambit of the insider trading provisions of the SA Act?
• 3.11 Should the insider trading provisions be amended to exclude any liability under those provisions in respect of the transactions referred to in paragraph 3.27?
• 3.12 Should the court be empowered to direct any person (or, alternatively, an insider trader) to reimburse the costs of a public issuer in relation to a section 17 legal opinion?

4 PREVENTION OF INSIDER TRADING BY INCREASED DISCLOSURE

Introduction

• 4.1 As noted in paragraph 1.6, insider trading involves trading in securities with the benefit of information that is not publicly available. One means of reducing the likelihood of such trading is to increase the obligations on issuers of securities and directors to make price-sensitive information publicly available. Disclosure of material information to the public is already the basis of much of New Zealand’s securities laws.

• 4.2 Increasing the information disclosure requirements will not, of course, be a complete answer, as there will always be circumstances where price-sensitive information is not disclosed either for lawful reasons or despite the law.

• 4.3 The following non-exclusive options have been identified for improving the disclosure of price-sensitive information by issuers of securities and directors:

Option 1: Statutory continuous disclosure;

Option 2: Reporting of securities purchases and sales by company officers.

Option 1: Statutory continuous disclosure

Introduction

• 4.4 New Zealand law does not presently require continuous disclosure of material information by issuers of securities and company officers, although there is a requirement to disclose all material information while a public issue of securities is open for subscription², and there is provision for a periodic disclosure regime to be implemented by regulations under the Securities Act 1978. The NZSE Listing Rules contain comprehensive requirements relating to the disclosure of price- sensitive information. Australia has a statutory continuous disclosure regime, and this may provide a possible model for adoption in New Zealand.

Present New Zealand requirements

• 4.5 New Zealand law, and the NZSE Listing Rules, already include a number of information disclosure requirements.

• 4.6 Under the Securities Act 1978 and the Securities Regulations 1983 –

² Section 37A(1)(b) Securities Act.

• ➢ companies and other issuers of new securities to the public are required to produce a prospectus³ (which must be registered with the Registrar of Companies) and an investment statement⁴ (which must be given to every investor). The prospectus and investment statement must contain detailed information prescribed in the Securities Regulations;

• ➢ issuers of securities to the public must provide specified documents and information to investors and prospective investors on request;

• ➢ a periodic disclosure regime is provided for in the Securities Act, but regulations implementing this regime have never been made.

• 4.7 Under Part II of the SA Act 1988, a person who holds 5% or more of the voting securities of a public issuer must give notice of his or her holding to the public issuer and the NZSE. The person must also notify changes in his or her holding of 1% or more. The public issuer must state the names of all such persons and their holdings in its annual report.

• 4.8 Under the Companies Act 1993 –

• ➢ companies are required to prepare, and send to shareholders, annual reports containing information specified in the Act;

• ➢ as noted in paragraph 2.3, directors of companies are required to disclose share dealings to the board, and these disclosures must be entered in the company’s interests register and disclosed in the next annual report.

• 4.9 Under section 10 of the NZSE Listing Rules –

• ➢ public issuers have comprehensive obligations to disclose price-sensitive information and other information to the NZSE, which in general will immediately release it to the public. In particular a public issuer must immediately disclose price-sensitive information to the NZSE for public release as soon as –
  • the value to the issuer in keeping the information confidential ceases to exceed the value to the issuer’s shareholders in having the information; or
  • the issuer is unable to keep the information confidential to itself;

³ Section 37 Securities Act.

⁴ Section 37A(1)(a) Securities Act.

• ➢ the shareholdings of directors and associated persons in a public issuer must be disclosed in the issuer’s annual report.

Australian law

• 4.10 The Australian Corporations law prohibits a listed company or other entity from intentionally, recklessly or negligently contravening the listing rules of its stock exchange by failing to notify the exchange of information that is not generally available and that a reasonable person would expect to have a material effect on the price of the shares or other securities. Any contravention that is intentional or reckless is an offence.

• 4.11 The ASX Listing Rules require a listed company or other entity to immediately tell the ASX once it becomes aware of any information concerning it that a reasonable person would expect to have a material effect on the price of its shares or other securities. However this rule does not apply if a reasonable person would not expect the information to be disclosed and the information is confidential

and –

• ➢ it would be a breach of the law to disclose the information; or

• ➢ the information concerns an incomplete proposal or negotiation; or

• ➢ the information comprises matters of supposition or is insufficiently definite to warrant disclosure; or

• ➢ the information is generated for the internal management purposes of the entity; or

• ➢ the information is a trade secret.

• 4.12 The Australian Corporations law creates a similar offence in respect of companies and other entities that are not listed on a stock exchange but that have issued securities of a certain kind.

Comment

• 4.13 Laws on insider trading are a means to the end of preventing insider trading from occurring. One way to reduce insider trading is for public issuers to publicly disclose all price-sensitive information in a timely manner, thereby reducing the opportunities for those “in the know” to obtain a benefit from the use of undisclosed information.

• 4.14 Continuous disclosure requirements can assist in achieving both market efficiency and market integrity objectives. The timely disclosure of material information could reduce search costs and assist investors to make informed investment decisions, and could also encourage investors to have confidence in the integrity

of the market by helping to counter insider trading, the creation of false markets, and the distortion of markets through rumours.

• 4.15 It is obviously not reasonable to require public issuers to publicly disclose all material information as soon as they obtain or become aware of it. There are many circumstances where it may be appropriate for a company to keep such information confidential, and this is the reason for the exceptions referred to in paragraph 4.11 from the Australian disclosure requirements. These exceptions may be appropriate for inclusion in any New Zealand law requiring continuous disclosure. The disclosure requirements in the NZSE Listing Rules, which are referred to in paragraph 3.9 should also be noted in this context.

• 4.16 If a continuous disclosure regime is to be introduced into New Zealand law, the question of remedies and penalties for failure to observe the law will need to be considered. In Australia, there are the following remedies and penalties:

• ➢ the ASIC can prohibit trading in the securities;

• ➢ the ASX or another person can seek a court order to compel the issuer to disclose the information;

• ➢ the ASIC or a person who has suffered loss as a result of the contravention can claim damages. The measure of damages is the amount necessary to place the applicant in the position that it would have been in had the contravention not occurred;

• ➢ the court can make orders setting aside transactions that occurred on market at a time when the price of the securities was distorted by the failure to disclose the information;

• ➢ a failure to disclose that is intentional or reckless is an offence punishable by a fine or (in the case of a individual) imprisonment.

• 4.17 The introduction of a statutory continuous disclosure regime in New Zealand may involve additional compliance costs for those issuers to whom the law applies. If the law applies only to listed issuers, then the increase in compliance costs is likely to be minimal as these issuers already have a continuous disclosure obligation under the NZSE Listing Rules. However, if the law is to apply to all issuers, there may be more significant costs for unlisted issuers who are not presently subject to any form of continuous disclosure regime (except while they have a public issue open for subscription – see above).

• 4.18 If a continuous disclosure regime of the kind included in the Australian Corporations law is to be introduced into New Zealand law, the method of introduction will need to be considered. The options will include -
  • ➢ adding such a regime to the SA Act. This would mean that the regime would, under the current provisions, apply only in respect of listed issuers, who are already familiar with the concept of continuous disclosure by virtue of the NZSE Listing Rules;

• ➢ adding such a regime to the Securities Act 1978. This Act applies to all issuers, including unlisted issuers. The concept of continuous disclosure is not as familiar to unlisted issuers as it is to listed issuers (although, as noted above, unlisted issuers have a form of continuous disclosure obligation while they have a public issue open for subscription).

Option 2: Reporting of securities purchases and sales by company officers

Introduction

• 4.19 New Zealand law already requires company directors to disclose share purchases and sales to the board of the company, which must enter the transactions in the company’s interests register and disclose these entries in the company’s annual report. Other countries, including Australia, require public disclosure of these transactions at the time they are made. The perceived benefit of this requirement is that immediate public disclosure is a deterrent to improper trading.

Present New Zealand requirements

• 4.20 Section 148 of the Companies Act 1993 requires a director of a company who acquires or disposes of a relevant interest in shares in the company to forthwith disclose to the board, among other things, the number of shares acquired or disposed of and the consideration paid, and ensure that the particulars disclosed are entered in the company’s interests register. Section 208 of the Companies Act requires every company to prepare an annual report and send a copy of the report to each shareholder (unless the shareholder elects not to receive one). An annual report must, among other things, state particulars of entries in the interests register made during the year to which the report relates.

• 4.21 As noted in paragraph 4.9, the NZSE Listing Rules provide that the shareholdings of directors and associated persons in a public issuer must be disclosed in the issuer’s annual report.

Australian law

• 4.22 The Australian Corporations law requires a director of a listed company to notify the company’s stock exchange of the shares or other securities of the company or a related body corporate that the director holds or has a relevant interest in. The director must notify the exchange within 14 days of any change in the director’s holdings.

USA law

• 4.23 In the USA, the Securities Exchange Act 1934 requires that, upon becoming an officer, director, or 10% equity shareholder of a listed issuer, an individual must file with the SEC and any relevant stock exchange, a report disclosing the number of shares beneficially owned. Thereafter, in any month where there is a change in beneficial ownership, a statement must be filed with the SEC and the stock exchange within 10 days of the end of the month. Small acquisitions not exceeding $10,000 in market value are not required to be disclosed in this manner, but must be disclosed on an annual basis.

Comment

• 4.24 The present New Zealand law requiring disclosure of share transactions applies only to company directors. While “director” has an expanded meaning in the Companies Act, it does not include executives and other employees of a company who do not “occupy the position of” or “exercise the powers of” directors. It could be impracticable to require all employees of a company to disclose share transactions, however, it may be that senior executives should be subject to the same kind of disclosure as directors. If this suggestion were to proceed, it would be necessary to define the class of senior executives to whom this requirement would apply.

• 4.25 Under present New Zealand law, directors’ share transactions are required to be notified to the board of the company “forthwith” but are not required to be notified to shareholders until the company’s annual report is distributed, which may be more than a year later. Further, the transactions may not be notified at all to persons who cease to be shareholders after the dates of the transactions but before the annual report is distributed. While the present disclosure requirements may inhibit improper share trading by directors, it is likely that an obligation to forthwith give public notification of such transactions could be a greater restraint on improper trading.

• 4.26 Any additional disclosure requirement involves some additional cost for those who have to make and receive the disclosure. The costs of the additional disclosure need to be balanced against the perceived advantages of requiring disclosure.

• 4.27 Under the Companies Act 1993, while a director has an obligation to ensure that the required information relating to his or her share transactions is entered in the company’s interests register, failure to comply with this obligation may result in a personal action by a shareholder against the director, but not in a prosecution for an offence. It is doubtful whether any shareholder would have sufficient personal incentive to bring a court action to require compliance with the SA Act except in exceptional circumstances. It has been suggested that failure to comply with this obligation should constitute an offence with a penalty within the range of

penalties set out in the Companies Act 1993. This range is a fine of $5,000, a fine of $10,000, a fine of $50,000 or two years’ imprisonment, and a fine of $200,000 or five years’ imprisonment. The current penalty for failing to disclose interested transactions between directors and the company under section 140 of the Companies Act is a fine of $10,000.

Questions for submissions

4.1 Do you agree that the present requirements on issuers and company officers to disclose information should be strengthened? If so, why?
4.2. Should either or both of the options identified in this Part be adopted? If so, why? Can you identify any other option or options that may be effective in preventing insider trading by increasing disclosure?

• 4.3 If a statutory continuous disclosure regime is to be adopted, do you think it should be similar to the Australian regime?
• 4.4 In particular, should the exceptions from the disclosure requirements be the same as those in Australia (see paragraph 4.16)? What are the reasons for your view?
• 4.5 Should a statutory continuous disclosure regime apply only to listed issuers or should it apply to all issuers of securities to the public? What do you believe would be the practical effect of this kind of disclosure requirement on unlisted issuers?
• 4.6 If such a regime is to apply only to listed issuers, can you identify how it would provide significantly greater benefits than the existing disclosure requirements in the NZSE Listing Rules?
• 4.7 If a continuous disclosure regime is to be introduced into New Zealand law, should it be added to Part 1 of the SA Act 1988 or, alternatively, to the Securities Act 1978? What are the reasons for your view?
• 4.8 Should the share dealing disclosure requirements of section 148 of the Companies Act be extended to apply to company executives as well as to directors and, if so, how should “senior executive” be defined?
• 4.9 Do you believe directors’ share transactions should be required to be notified to the public as soon as they have taken place? What would be the practical effect of such a requirement?
• 4.10 In your view, what would be the implications of making a failure to comply with section 148 of the Companies Act 1993 an offence? If it were made an offence, what penalty should be imposed (see paragraph 4.26), and why?

5 DETECTION OF INSIDER TRADING

Introduction

• 5.1 As noted in paragraph 1.3, despite the SA Act having been in force for over 10 years, no person has yet been found liable by the courts for insider trading under the Act although several insider trading investigations have been initiated by the Commission and a number of reports published⁵. This may be because insider trading is not widespread in New Zealand, or insider trading is not easy to detect, or the law is difficult to enforce, or a combination of these. Whatever the reason, it may be helpful to review the present detection mechanisms for the purpose of ascertaining whether they can usefully be improved.

Present New Zealand practice

• 5.2 The NZSE presently monitors share market activity and advises the Commission if it appears that any insider trading activity may have occurred.

• 5.3 At present the Commission and the NZSE operate on an informal basis to share information about trading of securities quoted on the NZSE.

• 5.4 The Commission will generally investigate possible breaches of insider trading law either on referral from the NZSE or on receipt of a complaint from a member of the public. The process for detection and investigation of breaches is as follows:

(a) The NZSE’s market control staff monitor price movements and trading volumes. If unusual price movement or trading volume is detected the market control staff will usually seek the advice of a designated panel of brokers in relation to any unusual trading activity identified.

(b) After taking the advice of the broker panel the market control staff may refer the matter to the secretary of the Market Surveillance Panel, who can make a price inquiry of the public issuer concerned.

(c) If there has been significant trading prior to an announcement by a public issuer the Market Surveillance Panel will usually refer the matter to the Commission. The NZSE will not usually play a further role in the investigation.

5. In addition, the High Court has recently granted leave for several shareholders of Fletcher Challenge Ltd to take insider trading proceedings in the company’s name against a former chairman of directors of that company.

(d) The referral from the Panel to the Commission will describe the unusual trading or price movement and any relevant announcement, and will be accompanied by a printout of trades taken from the NZSE’s trading system.

(e) On receipt of this referral the Commission staff will examine the trades. Commission staff will seek details of trades from certain brokers. The initial responses from brokers are in the form of printouts from the brokers’ trading system. These will display trades completed, current names, price, and the date of each trade.

(f) After reviewing the initial responses the Commission may seek further details of certain individual clients or trades from brokers. The Commission may also require production of brokers’ trading records, including audio tapes of telephone calls.

(g) Where this review highlights the trading of particular persons the Commission may then require explanations from these persons of their trading. At this stage the Commission might formally institute an inquiry and may take evidence from persons involved in trading.

• 5.5 At present, matters are referred to the Commission on the basis of information on the NZSE’s trading system. The NZSE does not obtain trading records or client details from brokers.

Australian practice

• 5.6 Under the Australian Corporations Law the ASX has certain statutory duties to assist the ASIC and to refer possible breaches of the Corporations Law to the ASIC. The ASX must also respond to requests for information from the ASIC.

• 5.7 The ASIC and the ASX have agreed certain memoranda of understanding relating to markets, company affairs, and membership matters. The markets memorandum of understanding is relevant to insider trading.

• 5.8 The Australian Corporations Law contains prohibitions on several specific types of market manipulation in addition to insider trading. The same surveillance and referral process applies to each activity.

• 5.9 The ASX has a proprietary electronic surveillance system which can detect a number of different events in the market. This system has programmable parameters for price movement and volume of trading of ASX quoted securities. The system can detect unusual movements both across the market and by any one or more broking firms. In this way the system is able to pick up signs of possible market manipulation in addition to insider trading.
• 5.10 Where an alert is triggered within the electronic system this will be examined by an ASX analyst. The analyst is able to call up a history of recent trading in the relevant securities and to detect patterns of alerts. Analysts are also able to replay bidding and trading for the securities.

• 5.11 Where the analyst believes that further investigation is warranted the ASX can require brokers to provide details of their trades including client names and other personal information. The ASX has power to do this under its Business Rules. These rules are a matter of contract between the ASX and its brokers, and are backed by a statutory duty of compliance.

• 5.12 The ASX will make a formal referral to the ASIC where the ASX is satisfied that a serious market matter may have occurred. The question of what constitutes a “serious market matter” in relation to either insider trading or market manipulation is agreed formally between the ASX and the ASIC.

USA practice6

• 5.13 The SEC is the agency charged with principal responsibility for the enforcement and administration of the Federal securities laws. The SEC has supervisory authority over stock exchanges and other self-regulatory organisations. The SEC’s relations with the self-regulatory organisations is important in the enforcement procedure.

• 5.14 One of the largest divisions of the SEC is the Division of Enforcement which is responsible for investigating and bringing actions against securities firms, corporate officers and others who violate the Federal securities laws. The other major division is the Division of Corporation Finance which administers the SEC’s full disclosure system.

• 5.15 The SEC conducts an extensive investigatory and enforcement programme. The New York Stock Exchange has an automated transaction audit trail which monitors its own performance and that of other exchanges. It also has a stop watch system of surveillance of share prices for manipulation.

• 5.16 The SEC has a Market Oversight and Surveillance System which gives it fully automated surveillance and oversight capabilities.

• 5.17 The majority of enforcement cases come to the attention of the SEC through complaints by disgruntled investors and tip offs from professionals in the industry. Other cases are picked up by online computer systems, like “Market Watch”,

6. The following information largely comes from “The Enforcement Dilemma in Australian Securities Regulation” by Dr V.R. Goldwasser, Australian Business Law Review, Vol 27 Dec 1999.

operated by the National Association of Securities Dealers, that flag down a stock when trading exceeds certain parameters in the absence of material public information. The SEC’s own Securities Compliance Examiners conduct routine oversight examinations of all broker dealers. The SEC also conducts cause examinations, for example when a broker is sacked in order to determine the “cause” of the dismissal.

• 5.18 Where appropriate, the SEC will conduct a formal investigation by issuing subpoenas, compelling testimony or production of documents. Depending upon the outcome of the investigation, the SEC may apply to the appropriate court for a civil injunction, institute an administrative remedy of its own, or refer the matter to the Department of Justice for criminal prosecution.

Hong Kong practice7

• 5.19 In Hong Kong, both the Securities and Futures Commission (“SFC”) and the Stock Exchange of Hong Kong Ltd (“SEHK”) have full-time surveillance units to monitor trading activity. The functions of each unit are different –

• ➢ the SEHK surveillance unit monitors the market to detect price and trading volume movements for the purpose of keeping the market properly informed by ensuring proper corporate disclosure;

• ➢ the SFC’s surveillance unit monitors the market to detect infringements of the law and to ensure that the SEHK is fulfilling its surveillance responsibilities.

There is close liaison between the SFC and the SEHK on a daily basis.

• 5.20 The SFC uses a sophisticated automated surveillance programme, called Securities Markets Automated Research, Training and Surveillance (“SMARTS”) to assist its surveillance unit. SMARTS uses a real time connection to the SEHK’s trading system. Alerts as to unusual price or trading volume movements are provided to surveillance unit staff on the basis of certain pre-set price and volume parameters which SMARTS automatically monitor. SMARTS also provides surveillance unit staff with various analytical tools for the visual display of trading data over a chosen time period. In effect, SMARTS can reconstruct a market transaction by providing an exact mirror image of the state of the market at a specific time and date.

7. The following information largely comes from a speech given by a member of the Hong Kong Securities and Futures Commission in December 1999.

• 5.21 SMARTS is not a solution to the SFC’s surveillance needs on its own. It is primarily a tool for alerting surveillance unit staff to unusual price and trading volume movements and for analysing those movements. The surveillance unit also needs other sources of information.

• 5.22 The SFC has found that the keeping of a detailed intelligence database is essential. The SFC surveillance unit’s database consists of two sorts of intelligence. First, the database has intelligence on listed companies, including records of corporate announcements, the directors and (to the extent that it is available) employees of listed companies and press articles concerning listed companies. The database also contains market intelligence including a database of traders to assist in establishing possible connections with listed companies or between traders. Also surveillance staff keep regular contact with market participants, especially brokers, to obtain details of market rumours.

• 5.23 Once all the information is gathered, surveillance unit staff analyse the movements to identify both clear trading patterns and possible suspicious activities based on the identified traders. The matter must then be referred to the SFC investigations unit, at which time a decision must be made on whether the matter warrants investigation. The SFC may commence an investigation when it has “reason to believe” that certain grounds of investigation are established. This threshold is a low one and an investigation can be justified on unusual price or trading volume movements alone.

Options

• 5.24 The following non-exclusive options have been identified for improving the detection of insider trading in New Zealand:

Option 1: Introduce a sophisticated electronic detection system;

Option 2: Make the relationship between the NZSE and the Commission more formal.

Option 1: Introduce a sophisticated electronic detection system

Introduction

• 5.25 Monitoring of trading on the NZSE by means of a sophisticated electronic detection system could be achieved -

• ➢ by the NZSE or the Commission, or both acting together, acquiring and implementing such a system; or

• ➢ by the NZSE or the Commission, or both acting together, entering into an agreement with a third party to provide monitoring by means of such a system.

The feasibility and costs of each of these possibilities would need to be examined.

Comment

• 5.26 Improving the detection system for insider trading in New Zealand could reduce insider trading by deterring those who otherwise may be tempted to take the risk of being caught. Investment in this area would also have an important signalling effect to the public at large as well as investors. The perception of insider trading occurring at the expense of other investors could therefore be downsized. However, the costs of introducing and maintaining a sophisticated electronic system should be considered and balanced against the likely benefits.

• 5.27 In addition to determining whether the benefits of any new system outweigh its costs, an important consideration may be to determine who should pay the costs of introducing and maintaining the system. Those who may be liable to pay some or all of the costs include:

• ➢ the NZSE, from transaction fees paid by investors and its members ;

• ➢ public issuers, by means of an increase in listing fees payable to the NZSE or application of part of the filing fees payable to the Registrar of Companies on filing annual reports; or

• ➢ the Commission, out of money provided by the Government.

• 5.28 Contracting a third party (such as the ASX) which already has a sophisticated electronic detection system to provide such a system for New Zealand may be an alternative means of improving detection in New Zealand. However, the feasibility of implementing such an arrangement would need to be carefully considered.

Option 2: Make the relationship between the NZSE and the Commission more formal

Introduction

• 5.29 The relationship between the NZSE and the Commission as to insider trading could be made more formal, for example –

• ➢ by the two bodies entering into a memorandum of understanding covering what and when insider trading information should be supplied by the NZSE to the Commission; or

• ➢ imposing on NZSE a statutory obligation to report insider trading information to, and respond to requests from, the Commission.

Comment

• 5.30 There is currently good cooperation between the NZSE and the Commission in regard to the possible detection of insider trading under the procedures set out above.

• 5.31 However, the introduction of a more formal relationship between the NZSE and the Commission may improve and extend the existing detection systems and procedures and accordingly deter potential insider traders.

• 5.32 A memorandum of understanding could cover the following matters:

• ➢ the scope of the relative surveillance roles of the NZSE and the Commission;

• ➢ matters which must be referred by the NZSE to the Commission, including possible insider trading and market manipulation;

• ➢ the referral procedure, including the information to be provided, timetables for action of referrals, and procedures for ongoing co-operation following a referral; and

• ➢ confidentiality.

• 5.33 A memorandum of understanding would be a voluntary arrangement between the two bodies. There is the potential disadvantage that a memorandum of understanding might not be entered into because agreement could not be reached. On the other hand, an advantage of such an arrangement is that a memorandum of understanding can be amended from time to time as circumstances require, providing, of course, that both bodies agree.

• 5.34 A statutory obligation on the NZSE to report relevant information to, and to respond to requests from, the Commission could cover similar matters as are referred to above in regard to a memorandum of understanding. A statutory obligation would not require the agreement of either body, but may be inflexible in that changes required by changing circumstances would need to be enacted by Parliament (or, possibly, by order in council if the legislation so provided).

• 5.35 A further issue that needs to be considered is the nature of any remedies or penalties for breach of a memorandum of understanding or statutory obligation. As a memorandum of understanding is voluntary, it may be unlikely that either the NZSE or the Commission would agree to the memorandum of understanding providing for significant penalties being imposed upon them in the event of their breaching the memorandum. If a statutory obligation were to be adopted, Parliament could decide what remedies or penalties were appropriate. It is

possible that the statutory obligation could include provision for the NZSE to be fined for failure to comply with the obligation.

• 5.36 The costs of entering into and implementing a memorandum of understanding are not likely to be significant. The memorandum of understanding could specify how these costs were to be shared between the parties.

• 5.37 The costs of introducing and complying with a statutory obligation are also not likely to be significant. The costs of complying with a statutory obligation are borne normally by the persons on whom the obligation falls.

Questions for submissions

• 5.1 Do you believe there is a need to improve the systems for detection of insider trading in New Zealand? What is the basis for your view?
• 5.2 Should a sophisticated electronic detection system be acquired by the NZSE or the Commission, or both, or should either or both of those bodies enter into an agreement with a third party to provide monitoring by means of such a system? What would be the costs and benefits of either approach?
• 5.3 Who do you believe should pay the costs of introducing and maintaining any new detection system, and why?
• 5.4 Do you believe the relationship between the NZSE and the Commission in relation to insider trading should be made more formal?
• 5.5 If so, do you think this could be adequately achieved by the two bodies entering into a memorandum of understanding?
• 5.6 Alternatively, do you believe a statutory obligation imposed on the NZSE to report insider trading information to, and respond to requests from, the Commission would be more effective in improving detection of insider trading?
• 5.7 Can you identify any other means of improving the detection of insider trading activity in New Zealand and, if so, what are they?

6 ENFORCEMENT OF THE EXISTING LAW

Introduction

• 6.1 At present, the only recourse in New Zealand for insider trading is through private legal action. While specific provision is made under the SA Act for current and previous shareholders to undertake legal action on behalf of a public issuer, it is not always practicable for shareholders to do this.

• 6.2 Two potential options have been identified as ways of assisting with effective enforcement of insider trading in New Zealand. These options are:

Option 1: Improve the private enforcement regime provided for under the SA Act;

Option 2: Enable the Commission to undertake insider trading enforcement actions under the SA Act.

Option 1: Improve the private enforcement regime

Introduction

• 6.3 This option involves improving the existing private enforcement regime for insider trading. The following possible changes to the law are raised for consideration:

• ➢ class actions;

• ➢ court approved settlements; and

• ➢ applicant for leave under section 18 not to be liable for costs.

Class actions

• 6.4 Interest in USA style “class actions” commonly arises when an event occurs that disadvantages a large number of people, but only to the extent that does not warrant any individual person taking legal proceedings against the wrongdoer⁸. The principal concern is usually one of money – how to fund legal proceedings by people of limited means against, usually, big business, and how to protect those people from costs awards if they lose. Concerns about the rules as to maintenance and champerty are often also raised in this context.

8. A recent example was the recent Auckland power crisis which resulted in threats of legal actions against Mercury Energy.

• 6.5 In the USA, a class action is a procedure in which one or more persons sue in court as the representatives of a large class of people who have suffered the same harm – for example, electric power outages. The judgment obtained in the litigation binds everyone in the class. The procedure is commenced by a person asking the court to certify a class, which needs to be defined precisely. Once a class is certified, only the representative plaintiff appears in court. The members of the class do not generally participate in the litigation, but are bound by the final decision. Two other aspects of USA law are relevant in this context –

• ➢ the usual practice in the USA is for each party to bear its own costs – the losing party is not subjected to having to pay the successful party’s costs;

• ➢ contingency fees are permitted in the USA. These involve lawyers undertaking an action on the basis that they will be paid only if successful but, if they are successful, will be paid an amount that exceeds a normal time based fee. The ability to earn large contingency fees encourages lawyers to conduct legal proceedings on the basis that they take the financial risk.

These two aspects of USA law significantly reduce the financial risks of claimants in legal proceedings.

• 6.6 While New Zealand does not have class actions as such, it does have a similar procedure known as a “representative” action. A person may issue representative proceedings if the person has the consent of all members of the class to be represented, or the court orders that the plaintiff may represent all those members. All members of the class must have the same interest in the subject matter of the proceedings.

• 6.7 As to the funding of proceedings, it is permissible under New Zealand law for persons having an interest in legal proceedings to contribute to the cost of those proceedings. This does not contravene the rules against maintenance and champerty⁹. There is nothing in New Zealand law to prevent shareholders of a company, each of whom has a claim against an alleged insider, from contributing to a “fighting fund” to fund proceedings taken by one or more of the shareholders against the alleged insider trader.

• 6.8 If a person who has taken a representative action loses the case, that person will be liable for any costs awarded against him or her by the court. The person has no

9. Maintenance occurs where a person, without lawful justification, assists a party to a civil action to bring or to defend the action, thereby causing damage to the other party. Champerty is that form of maintenance in which the person giving the assistance does so in consideration of his or her receiving a share of anything that may be gained as a result of the proceedings.

right to recover a share of the costs from other members of the class represented, unless those members have individually agreed to indemnify him or her.
Furthermore, contingency fees are prohibited in New Zealand (although this does not prevent lawyers agreeing to undertake a case for no fee or for a fee lower than normal). Accordingly, a person who takes a representative action in New Zealand is exposed to greater financial risk than someone taking a class action in the USA.

• 6.9 As noted in paragraph 2.6 et seq, under the SA Act an insider trader is liable both to a person who bought or sold the securities for any loss incurred by that person, and to the public issuer for the amount of any gain made or loss avoided by the insider plus a pecuniary penalty. As noted in paragraph 2.13, a public issuer’s right of action against an insider may, with the leave of the High Court, be exercised by a shareholder or former shareholder of the public issuer. The public issuer must pay the costs of a person to whom leave is given, including any costs that are awarded against that person. The fact that, if the leave of the High Court is obtained, a shareholder can take proceedings against an insider at the expense of the public issuer means that this option will usually be chosen. However, the other option of the shareholder, or a group of shareholders, taking proceedings against an alleged insider on their own account (rather than the public issuer’s) remains open.

Court approved settlements

• 6.10 It is often desirable that claims brought against an alleged insider can be settled by agreement between the parties, thus avoiding lengthy and expensive litigation. However, in the case of a public issuer’s rights against an alleged insider, the possibility has been raised that a settlement of those rights may occur without all shareholders’ interests being sufficiently taken into account or, in extreme cases, the settlement may be a sham.

• 6.11 The following special features of a public issuer’s rights against an alleged insider may distinguish settlements of insider trading proceedings from settlements of more usual proceedings:

• ➢ the public issuer may be controlled by the insider;

• ➢ the insider trading proceedings may arise irrespective of any conventional loss by the public issuer;

• ➢ the public issuer may be obliged to obtain legal advice on the initiative of a shareholder;

• ➢ the right of action of the public issuer may in certain circumstances be exercised by a shareholder;
• ➢ a pecuniary penalty may be imposed at the discretion of the court if the matter proceeds to trial;

• ➢ a shareholder may be entitled to share in the distribution of any amount recovered by the public issuer from an insider.

• 6.12 A doubt has also been raised as to whether section 19 of the SA Act applies to money recovered by a public issuer from an insider under a settlement. This section gives the court the power to direct how the money recovered is to be distributed or applied.

• 6.13 It would appear that the only avenue for a shareholder unhappy with a settlement by or on behalf of a public issuer would be to apply under section 18 to take up the public issuer’s cause of action. However it may be that where a settlement has occurred there is no cause of action to take up – there would likely be a plea of issue estoppel from the insider.

• 6.14 To overcome these uncertainties it has been suggested that the High Court could be given the power to approve a settlement of any claim by a public issuer against an insider. In addition, it could be made clear that the power of the court under section 19 to give directions as to the distribution or application of money recovered by a public issuer from an insider can apply to money recovered under a settlement, as well as money recovered under a judgment. These powers of the High Court could be exercisable on the application of either the public issuer or the insider. It is also suggested that, if the High Court has not given its approval to a settlement, shareholders could be given the right to bring proceedings for a review and determination on the merits of any settlement. A time period may need to be established within which such proceedings could be brought, as the settlement would in effect not be final and binding until either that period had expired or the Court had ruled on any proceedings brought by a shareholder.

Applicant for leave under section 18 not to be liable for court costs

• 6.15 An application under section 18 for leave to exercise a public issuer’s right of action against an alleged insider may be a prolonged and expensive matter. While applicants may be willing to meet their own costs of the application, they may be unwilling to subject themselves to the risk of having costs awarded against them if the application is not successful.

• 6.16 It has been suggested that section 18 be amended to exclude the power of the court to award costs against an applicant under the section where the applicant is seeking to advance a cause of action identified in an opinion obtained from a barrister or solicitor under section 17.
• 6.17 However, the ability of a court to award costs against an unsuccessful party to proceedings is a guard against vexatious or frivolous actions. In deciding whether to award costs, a court is likely to take into account whether an opinion has been obtained under section 17 and the contents of any such opinion.

Option 2: Enable the Commission to undertake civil enforcement actions

Introduction

• 6.18 At present, the Commission has no power to undertake any form of enforcement action against an alleged insider, other than the power to give its approval under section 17 to a person requiring a listed issuer to obtain an opinion from a barrister or solicitor approved by the Commission.

• 6.19 This option involves amending the SA Act to authorise the Commission, in its discretion, to undertake an action under the SA Act on behalf of a public issuer or other person who has a right of action under the Act.

Comment

• 6.20 Securities regulators in various overseas jurisdictions, for example the ASIC and the SEC, have power to bring proceedings against alleged insiders. However, in those jurisdictions the role of the regulator differs significantly from that of the Commission in that, unlike the Commission, the regulator is generally given wide enforcement powers in relation to securities matters and the resources to match.

• 6.21 At present, the Commission’s enforcement powers are limited to matters such as suspending and cancelling prospectuses, investment statements and advertisements under the Securities Act, and bringing proceedings under the substantial security holder requirements of Part II of the SA Act 1988 and other relatively minor matters. Enabling the Commission to undertake enforcement actions against alleged insider traders would be a significant expansion of the Commission’s role and, as a result, it may be necessary to increase the Commission’s resources accordingly.

• 6.22 An issue that requires consideration in the context of this option is whether the Commission should have the right to take an action on behalf of a public issuer or shareholder in its own discretion, or whether the Commission would first need to obtain the consent of that issuer or shareholder. In view of the large number of shareholders of every public issuer, it would seem that, if neither the public issuer nor any shareholder was willing to agree to the Commission taking legal action against an alleged insider trader, then such action should not be taken.

• 6.23 Advantages of providing the Commission with enforcement powers in respect of insider trading are likely to include -
  • ➢ the provision of a public enforcement agency for insider trading activity could act as a deterrent for potential insider traders;

• ➢ the provision of cost-effective enforcement of the SA Act, having regard to the significant savings that may accrue in using the existing Commission infrastructure;

• ➢ the effective use of existing Commission expertise developed through previous inquiries into insider trading activity.

• 6.24 A potential disadvantage of providing the Commission with additional enforcement powers in this area is that it may inhibit the use of procedures already currently available under the law.

• 6.25 If any such powers are to be given to the Commission, they will need to be accompanied by some mechanism, statutory or otherwise, to fund enforcement proceedings undertaken by the Commission. There are a number of possible options for this:

(a) At present where a public issuer’s right of action against an alleged insider is exercised by a shareholder, the public issuer must pay the costs of the action. This could be extended to actions brought by the Commission.

(b) The SA Act could provide for the Commission’s costs to be paid first from any compensation or penalties recovered. This would have the attraction that the insider would pay the costs. However it may also mean that there would be less money available for distribution among the public issuer and its shareholders (or to charities). The possibility of the Commission receiving a preferential reward for proceedings undertaken by it may also raise questions of there being an inappropriate incentive for the Commission to commence proceedings. This concern could be alleviated by making the consent of the person in whose name the proceedings are taken a pre- requisite, and by limiting the costs that could be recovered by the Commission to expenses incurred by it solely for the purposes of the proceedings.

(c) The Commission could simply rely on the discretion of the courts to award costs in appropriate cases, and seek extra funding from the Government to cover the likelihood that the Commission would not be able to recover all of its costs. In other words, the Government would need to provide the Commission with a “fighting fund”.

Questions for submissions

• 6.1 Do you believe that enforcement of the insider trading laws is currently too difficult? What is the basis for your view?
• 6.2 Do you think that USA style “class actions” would be effective in increasing the incentives for shareholders to take insider trading proceedings? If so, why? If not, why not?
• 6.3 Should the High Court be given the power to approve settlements of claims by public issuers against insiders on the basis that, if such approval has not been given to a settlement, any shareholder could bring proceedings for a review of the settlement by the court?
• 6.4 If court approval of settlements is introduced, what should be the period within which proceedings could be brought for a court review of a settlement? What are the reasons for your view?
• 6.5 Do you believe section 18 should be amended to exclude the power of the court to award costs against an applicant who is seeking to advance a cause of action identified in an opinion obtained from a lawyer under section 17?
• 6.6 Do you think that authorising the Commission to undertake an action against an alleged insider trader on behalf of a public issuer or other person who has a right of action would be an effective means of improving the level of insider trading enforcement? What are the reasons for your view?
• 6.7 If the Commission was given this function, do you believe the Commission should have to obtain the consent of the public issuer or other person before taking such proceedings?
• 6.8 How do you think the Commission’s costs of taking enforcement proceedings should be funded? What would be the effects of the various funding options proposed? (see paragraph 6.25)?
• 6.9 Can you identify any other ways in which enforcement of the insider trading laws can be made easier and, if so, what are they?

7 CRIMINAL OFFENCES

Introduction

• 7.1 At present New Zealand’s insider trading law is enforceable by civil action taken either by the public issuer or by a shareholder or previous shareholder who has been disadvantaged by the insider trading. The penalty for which an insider may be liable is an amount of money equal to the gain made or loss avoided by the insider and a pecuniary penalty of an amount determined by the court.

• 7.2 In addition to these civil remedies, the Commission has the power of investigation and public comment. The Commission has on many occasions published its views about unacceptable market behaviour, including in cases where allegations of insider trading have been made. As a result of its investigations, the Commission makes available to the wider public information on which insider trading claims can be pursued by individual shareholders. The Commission’s powers are wide enough to allow it to make public comment about market practices, including suggestions of insider trading, without having to necessarily decide that a particular practice is illegal, or gives rise to a civil claim. Damage to reputation as a result of public comment by the Commission can be a powerful incentive to good market behaviour.

• 7.3 It has been suggested that criminal offences should be introduced into insider trading law. The following issues are relevant to this suggestion:

• ➢ Should there be criminal penalties for insider trading?

• ➢ Should criminal penalties replace, or be added to, the existing civil remedies?

• ➢ Is knowledge by the insider a pre-requisite?

• ➢ Who would conduct prosecutions?

• ➢ What penalties should be imposed?

• ➢ Should a criminal offence be a summary or indictable one?

Should there be criminal penalties for insider trading?

• 7.4 Opponents to criminalising insider trading argue that making insider trading a criminal offence will necessarily impose a higher standard of proof which will make it more difficult to prove a breach. In criminal proceedings the standard of proof usually required to convict is “beyond reasonable doubt”. In civil cases a party succeeds on the “balance of probabilities”. Proving insider trading activity beyond a reasonable doubt could arguably be an insurmountable task in an area of the law where the conduct in question is necessarily secret and detection is

difficult. However, this objection does not apply if civil remedies are retained in addition to criminal penalties.

• 7.5 There is also the potential difficulty that adding criminal offences to the SA Act could impede both the ability of a public issuer or other person to take civil proceedings and the ability of the Commission to investigate and make public comment. This is because of the rule against self incrimination – “where the plaintiff’s case rests wholly on the proof of matters that might be the subject of criminal proceedings, discovery cannot be compelled in any form”. When insider trading was made a criminal offence in England, the self regulatory disciplinary procedures of the stock exchange were brought to a standstill in insider trading cases on account of the rules against self incrimination.

• 7.6 Another matter that may weigh against adding criminal penalties to the SA Act is that it is possible that the Act would need significant amendment. This is because the SA Act is presently structured to create civil remedies and it may need restructuring and, possibly, tightening to make it satisfactory for criminal prosecutions.

• 7.7 Criminal convictions are, however, generally regarded as resulting in more “stigma” than an adverse judgment in civil proceedings. The fact a prosecution is brought may even, in itself have significant reputational effects. The consequences of a conviction may be quite broad-ranging, for instance, criminal convictions can result in an inability to obtain a visa to enter a foreign country, be considered for some kinds of employment or positions, or take part in the management of a company.

• 7.8 The deterrent effect of criminal liability is therefore likely to be more significant than the possibility of a civil action. While an insider may be prepared to risk the consequences of civil liability, they may be less prepared to risk the reputation and other broad-ranging effects of a criminal prosecution or conviction.

Should criminal penalties replace, or be added to, the existing civil remedies?

• 7.9 In a number of jurisdictions, for example Australia and USA, insider trading is subject to both criminal penalties and civil remedies. There is accordingly precedent for adding criminal penalties to the existing New Zealand regime. Further, it may seem inappropriate to replace civil remedies by criminal penalties and thus deny individual shareholders the opportunity to recover from an insider a gain made by the insider through the use of inside information.

Is knowledge by the insider a pre-requisite?

• 7.10 Offences can be divided into three different classes relating to the state of knowledge required –

• ➢ the first class is those in which mens rea (knowledge by the accused) is an ingredient of the offence and the prosecution is required to prove it;

• ➢ the second class is those that do not require the prosecution to prove mens rea. However it is a defence for the accused to prove total absence of fault on the balance of probabilities (these are called strict liability offences);

• ➢ the third class is offences of absolute liability, where it is not necessary for the prosecution to prove mens rea and total absence of fault is not a defence.

• 7.11 There is a presumption that, unless there is a good reason to the contrary, the prosecution should have the onus of proving mens rea. However, a strict liability offence may be created if the offence involves a protection of the public from those undertaking risk-creating activities, the threat of criminal liability supplies the motive for persons in those activities to adopt precautions in order to ensure that mishaps and errors are eliminated, and the accused is best placed to establish absence of fault because of matters primarily within the accused’s knowledge. Absolute liability offences have been the subject of critical comment on the basis that it is completely inappropriate to subject citizens to the criminal process in any circumstances if they can demonstrate absence of fault.

Who would conduct prosecutions?

• 7.12 Prosecutions for criminal offences are usually undertaken by the Police. However, the Registrar of Companies also conducts prosecutions for offences under companies and securities legislation. Using the Registrar of Companies to prosecute insider trading breaches could be a potential option.

• 7.13 A further possibility is to empower the Commission to take prosecutions for insider trading offences. However, this could involve a significant departure from the present role of the Commission and the Commission would require additional resources to perform it.

What penalties should be imposed?

• 7.14 The usual penalties for criminal offences are imprisonment and fines. However, imprisonment is not regarded as an appropriate penalty for a strict liability or absolute liability offence.
• 7.15 If a fine is to be imposed, the usual practice is to set a maximum fine and leave it to the court to determine the actual fine within this limit. A maximum fine should be set at a realistic level in relation to the gravity of the conduct which it is intended to punish. In the case of insider trading, the fact of a criminal conviction and possible liability under a civil action may be a more important deterrent than the amount of the fine. Nevertheless the maximum fine should be set at a sufficiently high level to deter potential insider traders.

Should a criminal offence be a summary or indictable one?

• 7.16 If an offence is proceeded with on indictment, the defendant cannot elect to have the offence tried summarily (in other words, the offence will almost always be tried by a jury rather than a judge alone). On the other hand, if the offence is a summary offence, it will be tried in the District Court, unless it is punishable by more than three months imprisonment and the accused elects jury trial.

• 7.17 On this basis, the questions for consideration in the case of an insider trading offence are whether such an offence should be tried by a judge alone or a jury, and whether it should be tried in the High Court or a District Court.

Questions for submissions

• 7.1 Do you think criminal penalties should be introduced for insider trading? What specific advantages and disadvantages do you envisage?
• 7.2 If criminal penalties are introduced, do you think they should replace, or be added to, the existing civil remedies? What are the reasons for your view?
• 7.3 In your opinion, should knowledge by the insider be a pre- requisite for a criminal offence of insider trading?
• 7.4 Which body do you believe would be best placed to conduct any insider trading prosecutions? What are the reasons for your view?
• 7.5 What do you believe would be appropriate penalties for criminal insider trading actions?
• 7.6 In your view, should a criminal offence be a summary or indictable one, and why?
• 7.6