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Insider Trading Law and Practice: report on questions arising from an inquiry into trading in the shares of Fletcher Challenge Limited in May 1999 [2000] NZSecCom 10 (20 November 2000)

Last Updated: 5 November 2014

Insider Trading Law and Practice
20 November 2000
REPORT ON QUESTIONS ARISING FROM AN INQUIRY INTO TRADING IN THE SHARES OF FLETCHER CHALLENGE LIMITED IN MAY 1999

SECURITIES COMMISSION
WELLINGTON, NEW ZEALAND

TABLE OF CONTENTS

PART 1 - INTRODUCTION

- THE COMMISSION'S INQUIRY
- EVIDENCE

PART 2 - REVIEW OF EVENTS AND SHARE TRADING

- BACKGROUND
- FCL'S COMPUTER SYSTEM
- SEQUENCE OF EVENTS
- EFFECTS
- SHARE TRADING

PART 3 - APPLICATION OF THE LAW

- SECURITIES AMENDMENT ACT 1988
- INSIDE INFORMATION
- LIABILITY AS INSIDERS
- HYPOTHETICAL QUESTIONS
- INSIDER TRADING CONCLUSIONS

PART 4 - COMMENTS ON THE LAW

- LIABILITY FOR TIPPING
- SECONDARY INSIDERS - THE "LENGTH OF THE CHAIN"
- RECEIPT IN CONFIDENCE

PART 5 - MARKET MANIPULATION

PART 6 - OBSERVATIONS

Appendices

• Appendix A,
  Terms of Reference: Fletcher Challenge Limited
• Appendix B,
  "Fletcher Challenge Announces Major Strategic Initiatives"

REPORT ON QUESTIONS ARISING FROM AN INQUIRY INTO TRADING IN THE SHARES OF FLETCHER CHALLENGE LIMITED IN MAY 1999

SECURITIES COMMISSION
WELLINGTON, NEW ZEALAND

PART 1 - INTRODUCTION

1. The Securities Commission has a function under section 10(c) of the Securities Act 1978 to keep under review practices relating to securities, and to comment thereon to any appropriate body. The Commission is authorised by section 28A of the Securities Act 1978 to publish any report or comment made by it in the course of the exercise of its functions under section 10(c).
2. An important part of the Commission's work consists of conducting investigations and inquiries into specific instances of market practice. The Commission's inquiries may not lead to prosecution or other court action (in particular, the Securities Amendment Act 1988 does not give a prosecution role to the Commission), but do afford us the opportunity to evaluate and comment on market practice and, where appropriate, on the effectiveness of securities law in implementing New Zealand's securities regulatory policy.
3. In May 1999 the Commission learned that a confidential document had been leaked from Fletcher Challenge Limited ("FCL"). This document concerned the then planned merger of the Fletcher Challenge Paper Division ("FCL Paper") with Fletcher Challenge Canada. The Commission also received information to the effect that persons who had access to this leaked document may have traded in FCL shares before and after the release of the information to the market.
4. In June 1999 the Serious Fraud Office ("SFO") advised the Commission that it was conducting a criminal investigation into these events. The Commission decided to suspend its work at that time. In the event the SFO decided not to prosecute any person in relation to these events. The SFO referred the matter back to the Commission to enable it to complete its work. The SFO agreed to release certain information from its files in order to assist the Commission.

The Commission's Inquiry

5. After an initial review of available information the Commission decided to conduct an inquiry under section 10(c) of the Securities Act 1978. Terms of reference were settled on 28 January 2000. A copy of these terms of reference is attached as Appendix A.
6. The inquiry was conducted by a quorum of Members of the Commission comprising Mr Euan Abernethy (Chairman), Mr Falcon Clouston, Mr Ian Farrant and Mr Lloyd Kavanagh.
7. After the Commission had completed its inquiry it circulated relevant parts of a draft report to affected parties and invited comment. The Commission has carefully considered all comments and representations made to it.
8. The Commission considered whether certain people who had access to this non-public information about FCL may have bought or sold FCL shares or advised or encouraged any other person to do so, or passed on this information to any other person knowing or believing that person would act on it. The Commission also considered the potential liability of the persons involved under the Securities Amendment Act 1988 (the "Amendment Act").
9. The Commission's conclusions are that these questions of liability are not clear-cut. The events outlined in this report raise serious questions about the interpretation and application of our insider trading laws. They also give rise to questions of whether we need specific laws targeting market manipulation and other undesirable market practices.
10. The topic of insider trading is very much in the public mind at present. Insider trading and other manipulative behaviour damage confidence in our public securities markets. However, the boundaries of insider trading liability in New Zealand can be unclear. The Ministry of Economic Development has recently released a discussion document on insider trading law reform. That document sought comment on questions of detection of insider trading and enforcement of insider trading law. It also sought comment on other areas where there might be a need for reform of the law relating to insider trading. This present inquiry has therefore been very timely.
11. The Commission has decided to publish this report. We describe the events as we understand them. We raise a number of questions for public discussion on the questions raised by our inquiry. A consideration of these may assist the Ministry in its more general review.
12. After careful consideration the Commission has decided not to identify the parties who were the subject of its inquiry. Particular questions have been raised by this inquiry concerning the circumstances in which a person is, or should be, considered an "insider", and the circumstances in which an insider (or another person who trades on inside information) is, or should be, liable for others' losses. We acknowledge that there might be interest in the identities of the people involved, but we do not recommend action be taken against any person in respect of the particular events. On balance we consider there is a public interest in focussing on the law reform questions raised by this inquiry, and in discussing those questions.
13. The Commission has made privacy and confidentiality orders under section 19(5) of the Securities Act 1978 in respect of this inquiry.
14. As this matter has already been the subject of an investigation by the SFO this report does not comment on matters of criminal liability.

Evidence

15. We have received certain information from the SFO arising from that office's investigation.
16. Certain of the individuals referred to in this report were interviewed by SFO investigators in the course of its investigation. Each of these persons has given their consent to the Commission for their statements to the SFO to be used as evidence by the Commission for the purposes of its inquiry. As such the Commission has not heard sworn oral evidence from any of these people. The Commission received affidavits and submissions from several parties in response to a draft of this report.
17. FCL co-operated fully with the Commission in the course of its inquiry, and provided significant information about its procedures and responses, including information derived from its internal investigation into these events.
18. We are grateful to the SFO, FCL, and the other parties for their assistance and co-operation.

REPORT ON QUESTIONS ARISING FROM AN INQUIRY INTO TRADING IN THE SHARES OF FLETCHER CHALLENGE LIMITED IN MAY 1999

SECURITIES COMMISSION
WELLINGTON, NEW ZEALAND

PART 2 - REVIEW OF EVENTS AND SHARE TRADING

Background

19. In early 1999 FCL management were considering options for a possible merger of FCL Paper with Fletcher Challenge Canada. By late April 1999 these plans were well advanced but remained confidential. FCL senior staff began to work on a draft news release. We understand from FCL that a version of this draft news release was circulated to three employees for comment using FCL's internal computer network situated at its corporate office in Penrose. The draft news release was a ten page document.
20. Part of this draft news release comprises the information that is the subject of the Commission's inquiry.

FCL's computer system

21. FCL's corporate office runs a Microsoft Windows NT Local Area Network (the "Corporate LAN"). The email system comprises a Microsoft Exchange server and Microsoft Outlook clients. FCL had in place an email policy for users of the Corporate LAN.
22. The email programs used on the system provide a screen interface for users in the form of "folders". Among other folders, each user has an "Inbox" folder which displays messages received and a "Deleted Items" folder which holds messages that have been marked for deletion from the system.
23. FCL informs us that in late 1998, in response to an increasing use of email by its staff for non-work related communications, the company established a "Notice Board" to run in conjunction with the email system. FCL advises us that the purpose was to provide a facility for system users to communicate "non-work related messages and low priority work-related messages requiring distribution to all staff." The Notice Board was implemented by means of a "public folder" (meaning a folder available to all authenticated LAN users) within the Microsoft Exchange system with a shortcut icon to this folder being added to the shortcut menu bar of each user's Outlook program.
24. FCL advises us that the Notice Board was routinely used for:
    1. Non-work related messages for which staff wanted wide circulation (e.g., 'for sale' notices);
    2. Notification of upcoming IT training courses;
    100. Notification of Fitness Centre events; and
    4. Secondary means of some general communications to all staff.

This last category included staff announcements such as promotions.

25. There were no express restrictions on material to be posted to the Notice Board other than those set out in FCL's email policy. This policy stated that classified, confidential, and secret material should not be sent via email. FCL further informs us that the nature of information posted to the Notice Board was such that staff did not have to "clear" use of this information with management. Confidential information was not placed on this Notice Board.
26. In April 1999 the Notice Board was available on the computers of all Corporate LAN users. FCL advises that this was about 200 people. Most of these were FCL staff. The FCL Corporate LAN was also available to staff of a small number of non-FCL organisations providing contract services to FCL.

Sequence of events

30 April 1999 - document released to Notice Board

27. On the afternoon of 30 April 1999 an FCL employee who had been sent a copy of the draft press release on the internal email system for review accidentally deleted his copy from his Inbox folder. Items which are deleted when using Microsoft Outlook are not immediately lost, but are sent to the Deleted Items folder, and can be retrieved from there. One way to do this is to open the Deleted Items folder and "click and drag" the particular message back to the Inbox folder.
28. We understand that the employee attempted to recover the draft news release in this way. On his screen the Inbox folder icon was positioned next to the Notice Board folder icon. As he dragged the shadow icon of the message across the screen it appears that he inadvertently released the mouse button while the message icon was positioned over the Notice Board folder rather than the Inbox folder. This sent the message to the Notice Board. No warning was generated asking if he wanted to confirm the posting. As we understand it the employee was unaware that he had released the message to the Notice Board, as he did not immediately check to see that the message had been returned to his Inbox.
29. The draft news release was posted to the Notice Board at around 2.15 pm. Once there it was available for all users of the Corporate LAN to view.

FCL's response

30. We understand from FCL that the Company Secretary was advised by an IT Manager of the posting of the draft news release to the Notice Board at around 2.40 pm. He quickly contacted the system administrator and had the document removed, and followed this up at around 3.47 pm by sending a warning e-mail message to each individual who had access to the Notice Board. This message read as follows:

"It has come to my attention that a confidential file has today appeared on the Fletcher Challenge e-mail Noticeboard.

Persons having read this file must be aware that the information contained in it cannot, under any circumstances, be communicated to anyone (including a fellow employee), disclosed or reproduced for any purpose whatsoever, either within the Company or outside. If you have already copied this file, please destroy it immediately and be aware that having read it, you are deemed an "Insider" under the Securities Amendment Act."

31. FCL's IT staff were later able to establish that 7 people printed copies of the draft news release before it was removed from the Notice Board. Six of these people were FCL staff. The seventh, AB, was an independent contractor who worked for a company that provided support services to FCL.
32. This company's computers were connected to the FCL Corporate LAN. Staff and contractors of this company could access their own files and public files (including the Notice Board). These people did not have access through the system to confidential FCL information.
33. We note also at this point that the Commission was advised by FCL that these incidents prompted it to review its computer procedures, including the working and layout of the Notice Board on Corporate LAN computers. FCL advises that it has taken steps to ensure that documents can no longer be placed accidentally on the Notice Board in the manner described above.

30 April 1999 -transmission from FCL premises

34. AB told the SFO that she saw the first page of the draft news release when it appeared on the Notice Board, and that she believed it was a press release. She said that the announcement appeared to be "confirmation of a confidential thing that was told to me" some 6-8 weeks prior to 30 April.
35. AB printed the first page of the draft news release. She told FCL and SFO investigators she believed this to be the entire announcement. She did this at 2.23 pm.
36. AB states that after reading the header of the printed document and the first bullet point (which referred to the proposed sale of FCL Paper) she sent a copy of the document by facsimile to a relative, CD, at his home. AB states that CD has been a long-term shareholder of FCL. This facsimile was sent at 3.11 pm.
37. The Company Secretary's email warning was sent at 3.47 pm. AB says that when she noticed this message she rang CD, and told him to destroy the fax and ignore its contents. Phone records show a call being made to CD's home at 4.46 pm.
38. CD has acknowledged that he received a facsimile from AB on 30 April 1999. The content of this message was the first page of the draft news release accidentally placed on the FCL Notice Board (referred to from here on as the "leaked page"). A copy of the leaked page is attached to this report as Appendix B.
39. CD was already a holder of FCL Paper shares. An FCL investigator recorded that CD told him he had asked AB to be on the lookout for any announcements relating to FCL shares, but in an affidavit later given to the Commission CD denied that he had made such a request. AB also denied through her counsel that any such request was made to her.
40. CD also acknowledged receiving a telephone call from AB late in the afternoon of 30 April in the course of which AB told him that he should destroy the facsimile because it had been sent out in error by the Fletcher Challenge Group.
41. CD has told the Commission that he believed the information in the leaked page to be already "in the public domain" at the time that he received the facsimile. CD told us he had read an article published in the Dominion newspaper the week prior to receiving the facsimile from AB.
42. An article headed "Fletcher considers Paper Sale" was published in the New Zealand Herald on 30 April 1999. The same article was printed, with minor additions, in the Dominion on 1 May 1999 (the day after CD received the facsimile from AB), under the headline "Sale of Fletcher Paper Rumoured." Both articles stated in part:

"...It is understood that for the last nine months the company (FCL) has been working on a deal where Fletcher Paper's Canadian subsidiary does a reverse takeover of the local paper stock...Attempts to confirm this at Fletcher have been unsuccessful..."

43. As CD lives in Auckland it might be that he saw the Herald article, rather than the Dominion version, in which case he might have seen this before he received the leaked page.
44. When initially questioned by FCL investigators CD stated that upon receiving the telephone call from AB he tore the facsimile into pieces and disposed of these in his rubbish bin. He later told the SFO that he in fact left the facsimile lying on his desk, which was in an untidy state. CD denies passing on the leaked page to any person.
45. CD told the SFO that he learnt in August 1999 that a relative of his, EF, had come to his house in early May and, unknown to CD, took a copy of the facsimile from CD's desk. CD denies telling EF about the leaked page or any information contained in it, and denies giving the leaked page to EF. He asserts that EF took the copy of the facsimile without his knowledge.
46. EF told the SFO that early in the week following 30 April 1999 he visited CD's home. He said that he was alone in CD's office when he noticed the leaked page lying on the desk. EF stated that he read this and then made a copy of the leaked page using CD's fax machine. EF said he replaced the original and put the copy in his pocket. He said that he did not discuss this with CD, and that CD had not told him about the existence of the leaked page.
47. EF told the SFO that he did not tell CD he had taken a copy because he felt that he was not supposed to know about the document.
48. EF could not remember the exact date of these events but feels it was probably the Tuesday or Wednesday of the week following 30 April. These dates were 4 and 5 May 1999.

7 May 1999 - document delivered to news media

49. On the morning of 7 May 1999 EF contacted an Auckland journalist. EF met the journalist, and handed him a copy of the leaked page. He did not give his name. EF described his motive for doing this to the SFO in the following terms:

"In giving the document to the ...reporter, it was my intention that he would write a story about it, it would force Fletcher's hand into making that public announcement official. If I had bought some shares in the meantime, the shares would go up in value and I would sell them and make a profit. That was my intention".

7 May 1999 - document released to sharebrokers

50. Between 10 am and 12 midday on 7 May 1999 EF went to a business services bureau in Auckland. He handed over a copy of the leaked page along with a list of facsimile numbers. He asked for the leaked page to be faxed to each of the numbers on that list. He gave a specific instruction that the document should not be faxed until 2 pm that day. He gave a false name to the receptionist at the business services bureau.
51. Phone records show that the business services bureau began faxing the document to the numbers provided at 1.58 pm. It took approximately 20 minutes to complete this. The document was faxed to 13 sharebroking firms and to the news media.
52. At around 2.30 pm EF returned to the business services bureau. He ascertained that the faxes had been sent successfully.

REPORT ON QUESTIONS ARISING FROM AN INQUIRY INTO TRADING IN THE SHARES OF FLETCHER CHALLENGE LIMITED IN MAY 1999

SECURITIES COMMISSION
WELLINGTON, NEW ZEALAND

PART 2 - REVIEW OF EVENTS AND SHARE TRADING (Cont...)

Effects

53. The leaked page was faxed to the sharebroking firms between 2 pm and 2.20 pm on 7 May. Some firms, when the fax came to the attention of principals, informed the Exchange. The Exchange halted trading in FCL shares at around 3.07 pm.
54. At around 5.30 pm on 7 May FCL made the following announcement to the share market:

"A document purporting to represent initiatives by Fletcher Challenge Limited appeared in the market today.

In response, the Company confirmed that the Board of Directors of Fletcher Challenge Limited has authorised management to examine alternatives for the reorganisation of the Paper Division. This process has extended to discussions with the Board of Fletcher Challenge Canada Limited.

No decisions have been reached, and further announcements will be made when appropriate.

The Company said the other initiatives referred to in the document were speculative, and it declined to comment further."

55. Trading in FCL shares recommenced at start of trading on Monday 10 May.
56. It appears that the release of this information (both the leaked page and the forced announcement by FCL) materially affected the price of FCL Paper shares.
57. There had been heavy trading in FCL Paper shares throughout April 1999, accompanied by steady price rises. There appears to have been some speculation in the market, as can be seen from the news articles on 30 April and 1 May. The week of 26 to 30 April saw FCL Paper share prices rise on very heavy trading from around $1.43 at the start of the week to close the week on $1.67 (a rise of around 17% in 5 days). The following week the price rose to $1.75 before falling back to around $1.72 at 2 pm on Friday 7 May.
58. After the release of the leaked page to stockbrokers at 2 pm on the Friday the price of these shares began to rise further. The price peaked at $1.94 at around 10 am on Monday 10 May (a rise of about 13% in a little over 2 trading hours) before dropping to close at $1.82 (up 6% on the 2 pm price for 7 May). The price continued to drop sharply on 11 May, closing at $1.68.

Share trading

59. To some degree all three persons who played a role in these events also acquired FCL Paper shares during the period under review.

AB

60. AB's husband bought a relatively small number of FCL Paper shares on 3 May in the joint names of AB and himself. AB told SFO investigators that her husband had not seen the leaked page and did not know what was in the document. AB added that she was not aware that her husband intended to purchase FCL Paper shares until after he had done so. AB told the SFO that her husband purchased these shares after seeing the Herald article on 30 April. She said that the purchase was made with money originally put aside to subscribe for shares in the Contact Energy float, but that the ABs were put off this by reports that subscribers would not receive many shares.
61. AB informed the Commission that she was aware of the proposed sale of FCL Paper approximately 6 weeks prior to these events, having been told of the matter in confidence by a co-worker who had learnt of it in confidence from an FCL employee.

CD

62. CD also purchased shares in the week following receipt by him of the leaked page. CD purchased shares on 3 May at $1.65, and further shares on 7 May at $1.72. He continued to purchase following the release of the facsimile to brokers, taking more on 11 May at $1.75. His purchases on 3 and 7 May totalled around 150,000 shares. We were informed by CD that he held these shares until the sale of FCL Paper to Norske Skog early in 2000.
63. CD told SFO investigators that when he received the facsimile from AB this prompted him to ring his broker and purchase some FCL Paper shares. However in an affidavit later given to the Commission he stated:

"In deciding to purchase shares I disregarded the contents of the press release and relied only on my own background knowledge of Fletcher Paper, the Article in the Herald and the reported market sales on the Thursday and Friday."

64. CD informed us that he believed the information in the facsimile to be "in the public domain" because it seemed to contain information that had already appeared in the newspaper.
65. We note again here that CD has acknowledged to the Commission that he received the telephone call from AB and that she told him the release was a mistake and that he should destroy his copy of the facsimile. He received this call on 30 April, very shortly before he contacted his sharebroker. CD has stated to the Commission that Mrs AB did not tell him the information was confidential or that it was a draft.

EF

66. EF was already interested in FCL Paper shares. He purchased around 100,000 FCL Paper shares shortly before the leaked page was sent to CD.
67. EF bought and sold further FCL Paper shares on 6, 7, 10, and 11 May. EF's trades appear to revolve around the timing of the facsimile to brokers.
68. EF purchased almost 300,000 FCL Paper shares on 6 May and on the morning of 7 May. The order placed on the morning of 7 May was accompanied by an express instruction that the purchases were to be made before 2 pm on that day.
69. On the morning of 10 May EF again contacted brokers, this time to request that they sell almost all his FCL Paper shares. Around 350,000 were sold in a number of transactions on 10 May for between $1.82 and $1.85. EF informed the Commission through his counsel that he sold the remainder over the next 10 trading days.
70. We have noted that EF had purchased a number of FCL Paper shares on 30 April. He acquired these at $1.69. There is no evidence that he was in possession of confidential information at the time of this purchase.
71. EF advised the Commission through his counsel that his transactions during this period produced a gross profit of around $40,000 (around $30,000 after deduction of brokerage fees).

REPORT ON QUESTIONS ARISING FROM AN INQUIRY INTO TRADING IN THE SHARES OF FLETCHER CHALLENGE LIMITED IN MAY 1999

SECURITIES COMMISSION
WELLINGTON, NEW ZEALAND

PART 3 - APPLICATION OF THE LAW

Securities Amendment Act 1988

72. Part I of the Amendment Act contains statutory provisions relating to insider trading in the securities of public issuers (companies and others listed on the New Zealand Stock Exchange).
73. Generally, liability lies under this Act for the buying or selling of securities of public issuers by insiders with inside information, and for tipping on inside information by insiders.
74. "Inside Information" is defined in section 2 of the Amendment Act. In relation to a public issuer it means:

"...information which -

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

75. Section 3 (1) defines "Insider" to include:

"

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

100. A person who receives inside information in confidence from a person described in paragraph (a) or paragraph (b) of this subsection about the public issuer or another public issuer:...

5. A person who receives inside information in confidence from a person described in paragraph (c) or paragraph (d) of this subsection about the public issuer or another public issuer:..."

76. Section 7(1) sets out the principal liability for insider trading. It states that:

"an insider of a public issuer who has inside information about the public issuer and who -

5. Buys securities of the public issuer from any person; or
6. Sells securities of the public issuer to any person -
   is liable to the persons referred to in subsection (2)."
   77. Section 7(2) provides for liability to the counterparty of any trade for loss incurred by the counterparty, and to the public issuer itself for gains made or loss avoided by the insider in buying or selling the securities, and also to the public issuer for any amount that the Court considers to be an appropriate pecuniary penalty (which can be as much as the consideration paid for the securities, or three times the amount of the gain made or loss avoided by the insider, whichever is the greater).
   78. Section 9(1) of the Amendment Act provides for liability where an insider tips another to buy or sell securities. This provision states:

"An insider of a public issuer who has inside information about the public issuer and who-

. Advises or encourages any person to-

1. Buy or sell securities of the public issuer; or
2. Advise or encourage any other person to buy or sell securities of the public issuer; or

1. Communicates the information, or causes the information to be disclosed, to a person knowing or believing that person or another person will, or is likely to,-
   1. Buy or sell securities of the public issuer; or
   2. Advise or encourage another person to buy or sell securities of the public issuer- is liable to the persons referred to in subsection (2) of this section."

79. The insider tipper is liable: (a) to the counterparty of the tippee for losses incurred; and (b) to the public issuer for any benefit received by the insider, for any gains made or losses avoided by the tippee, and for pecuniary penalties where the Court considers this appropriate.
80. To find out whether there has been insider trading consideration must be given to whether information is inside information and whether any person who bought or sold securities or tipped another to buy or sell securities is an insider with inside information.

Inside information

81. Inside information must be information about the public issuer that is both non-public and that would, or would be likely to, materially affect the price of shares of the issuer if it was publicly available.

Did the leaked page contain information about the public issuer?

82. The leaked page described a proposed merger of FCL Paper with Fletcher Challenge Canada. This was clearly information about the public issuer, FCL.
83. We consider that the leaked page contained further information about the public issuer not available in the newspaper reports referred to above (paragraph 42), in that it provided authoritative confirmation of the events speculated on in those reports. While the leaked page was a draft document it appeared at least superficially to be an official news release. It attributed the information to the company, and included apparent confirmation of certain details by the board of directors. The leaked page was sourced from within the company. CD knew this. EF seems to have shared this view. He told SFO investigators "I believed I had the real McCoy".
84. The knowledge that FCL executives were preparing this draft would indicate that there was a degree of truth in the matters being discussed in the news media. This confirmation of the intentions of FCL was itself information about the public issuer.

When is information publicly available?

85. Two questions arise - whether the information became publicly available when posted to the FCL Notice Board, and whether the earlier news media reports had served to make the information publicly available.
86. Neither the New Zealand Courts nor the Commission have previously commented on the degree of disclosure that might be required for information to be considered "publicly available" for the purposes of insider trading law.
87. According to the Interpretation Act 1999 the meaning of an enactment must be ascertained from its text and in the light of its purpose.
88. Part II of the Securities Act 1978 regulates primary offers of securities "to the public". The statutory goal of this legislation has been described as "to facilitate the raising of capital by securing the timely disclosure of relevant information to prospective subscribers for securities. In that way the Act is aimed at the protection of investors".1 For this purpose the term "offer to the public" is given a wide construction. The Act provides that evidence of an offer made to one member of the public is prima facie evidence of an offer made to the public at large.
89. Part I of the Securities Amendment Act 1988, by contrast, is concerned with trading in the secondary securities market. It refers to information that is "not publicly available", but that "would, or would be likely to, affect materially the price of the securities of the public issuer if it was publicly available." It does not seem to us that the broad constructions of "offer to the public" are very helpful in the context of this legislation. We consider that the purpose of insider trading legislation requires that the term "publicly available" be construed in the context of the activity that is being regulated.
90. The Amendment Act envisages that the degree of disclosure required for the information to be "publicly available" is such that it will be likely to affect the price of securities of the public issuer if the information is of a price sensitive nature. In order for information to be given the opportunity to affect prices it seems sensible that the information must be disclosed to the market generally. This supports the view that the term "publicly available" should be interpreted as meaning available at least to participants in the market in which the securities are traded, and probably also to potential participants, those who might act on the information.
91. This is similar to the position in the United States. US courts have held that insider trading is prohibited where the information that is used to advantage is "non-public information". The US Court of Appeals for the 2nd Circuit found in SEC v Texas Gulf Sulphur Co. that "before insiders may act upon material information, such information must have been effectively disclosed in a manner sufficient to insure its availability to the investing public." 2

Notice Board release

92. We do not consider that the placing of the draft press release on the Notice Board made the information publicly available in terms of Part I of the Amendment Act.
93. The FCL computer system can be accessed by about 200 people, all of whom are employees of the company or associated service providers of the company. The information was available on the Notice Board for around 30 minutes. We do not consider that this is the degree of disclosure envisaged as publicly available for the purposes of this legislation.
94. The Commission has expressed the view that information is publicly available for the purpose of the Amendment Act where it is provided by a public issuer to market participants, institutional investors, or analysts, with the full intention and expectation that the recipient is free to publish it generally.3 That was not the case here, however. The information arrived on the Notice Board by accident. There was no intention on the part of the public issuer that the information could be published freely or given further to any member of the public on request. The information was quickly removed from the Notice Board.
95. We do not think the fact that the information was, briefly, available to the users of the FCL computer system is sufficient for the information to be considered publicly available in the context of the Amendment Act.

Newspaper reports, 30 April and 1 May

96. We have noted (paragraph 42) that stories in the news media on 30 April and 1 May speculated on a possible sale of FCL Paper. On this basis it might be argued that the information about the proposal contained in the leaked page was already publicly available information prior to 7 May. If the information was publicly available then it was not inside information.
97. The Herald and Dominion articles speculated on a sale of FCL Paper, but the information in the stories was not attributed to any person, and both articles expressly stated that attempts to confirm the story at FCL had been unsuccessful. We consider that the information about the company's intentions that could be inferred from the leaked page was not freely available from the company at this time, and was not otherwise publicly available.
98. The "inside" connection of the information about the company's intentions was stressed in the Company Secretary's email. This e-mail referred to the draft news release as "a confidential file." It stated that no person must communicate the contents of the file to anyone else, even within the company. It asked people to destroy copies, and claimed that any person who read the file would be deemed an "insider" for the purposes of the Securities Amendment Act.
99. CD stated that AB did not tell him the information was confidential when she rang him on the afternoon of 30 April, or that its possession would make him an insider. He agrees that she told him the release was a mistake and that he should destroy the facsimile. It appears to us that CD should reasonably have been alerted by this to the non-public nature of the information. For his part, it seems that EF had some idea of the status of the information he found on CD's desk. He told the SFO "I believed I had some information that, while it was in the market place, it was only partially in the market place, if you know what I mean. It had been released publicly, but only to a certain segment of the public".
100. We have noted that the confirmation of the company's intentions contained in the leaked page constituted further information that was not available in the media articles of 30 April and 1 May. This information about the company's intentions was not available beyond a brief accidental exposure to users of the Corporate LAN (and because of this to CD and EF). This disclosure is not in our view sufficient to constitute public availability for the purposes of the Amendment Act.
101. To the extent that the leaked page contained express or implied confirmation from the company of its intentions regarding matters speculated on in the news reports, we consider that the leaked page contained information about the company that was not publicly available.

Was the information likely to materially affect the share price?

102. The leaked page was set out as an undated press release, apparently announcing that FCL was seeking to merge FCL Paper with Fletcher Challenge Canada. It was headed "Fletcher Challenge Announces Major Strategic Initiatives". It said that the initiatives were designed to add significant value for FCL shareholders. It seems clear that an announcement that a company is considering a major restructuring of one of its divisions is likely to materially affect the price of the shares of that division. This is so whether the release is known to be a draft document or a final news release, and whether or not there has been speculation in the market on these matters. An authoritative statement from within FCL on the subject would be an important event.
103. We consider that the release of the leaked page to the market on 7 May did in fact materially affect the price of FCL Paper shares, to a much greater extent than did the news articles a week earlier speculating on the same subject (see paragraphs 57 and 58).
104. We are satisfied that the leaked page faxed to CD by AB and later taken from his desk by EF contained inside information about a public issuer, FCL. This information was inside information from 30 April until the afternoon of 7 May 1999. At that time the information became publicly available through its transmission to market participants.

Footnote(s):
1

Re AIC Merchant Finance Ltd [1989] NZCA 229; [1990] 2 NZLR 385, per Richardson J at 391
2

[1968] USCA2 483; 401 F.2d 833 (2d Cir. 1968)
3

Report of an Inquiry into Aspects of the Affairs of Regal Salmon Limited Including Trading in its Listed Securities, Securities Commission, 1994, pp 161 - 163

REPORT ON QUESTIONS ARISING FROM AN INQUIRY INTO TRADING IN THE SHARES OF FLETCHER CHALLENGE LIMITED IN MAY 1999

SECURITIES COMMISSION
WELLINGTON, NEW ZEALAND

PART 3 - APPLICATION OF THE LAW (Cont...)

Liability as insiders

105. The next step is to consider whether any person who bought or sold securities or tipped any other to do so while in possession of inside information was an insider in terms of Part I of the Amendment Act.
106. A person is an insider (under paragraph (b) of the definition) if that person is a principal officer or an employee of, or a substantial security holder in, a public issuer and that person has inside information by reason of their position.
107. None of the people referred to in this report were principal officers or employees of or substantial security holders in any public issuer at the time of these events.
108. Two further main groups of people are "insiders" in terms of the Amendment Act. Under paragraph (c) of section 3(1), a person who receives inside information in confidence from a person described in paragraph (b) of the definition (see above) is an insider. Under paragraph (e) any person who receives inside information in confidence from a person who received it in confidence from a person described in paragraph (b) is also an insider.
109. We need to consider whether any of AB, CD, or EF may have "received" inside information "in confidence" from an insider and if so, whether any of them traded or tipped while in possession of inside information.

AB

Was AB an insider?

110. The draft news release came to AB's attention when it was posted to the Notice Board of the FCL Corporate LAN. This Notice Board is open to all employees who have access to the system. The Notice Board was used for staff announcements and notices. Staff did not have to "clear" with any person the use of information found on the Notice Board. FCL has informed us that confidential information was never placed on the Notice Board.
111. Although an obligation of confidence can be inferred from the nature of an employment or contracting relationship, on the information available to us we doubt that an obligation of confidence would be inferred in relation to information posted to this Notice Board.
112. It is relevant here, however, that AB has informed us she was told of the proposed sale of FCL Paper "in confidence" about 6-8 weeks prior to the end of April 1999. AB's work did not involve her in the plans for the merger. AB informs us she was told of the proposed sale by a colleague who was not an employee of FCL. This colleague, we understand, received the information in confidence from an FCL employee who was involved in the merger plans, and who had this information by reason of his employment. The information given to AB at that time was, she acknowledges, given in confidence. It was inside information.
113. Based on this chain of events, it can be seen that the FCL employee was an insider of FCL under section 3(1)(b) of the Amendment Act. The colleague who received the information in confidence from the employee was probably an insider under section 3(1)(c). AB, at the time she received this information in confidence from her colleague, probably became an insider under section 3(1)(e). She would have remained an insider until knowledge of the FCL's intention to sell FCL Paper was no longer inside information.

Liability for tipping

114. AB has stated that when the document appeared on the FCL Notice Board she believed this to be a company announcement confirming the information she had been given in confidence. She then considered she was able to pass on the information to CD.
115. We have already stated our view that the information in the draft news release remained inside information until late on 7 May. In terms of the law we consider it was still inside information when AB passed it on to CD, regardless of her belief. Likewise at that moment AB was still an insider of the company by reason of the information she had received earlier.
116. AB has stated that she passed on the information to CD because he was a long term shareholder of FCL. She knew he had an interest in the shares of FCL, and told FCL investigators that CD had already asked her about the article in the Herald.
117. In terms of section 9 (1)(b) we think there would be grounds to conclude that AB was an insider of FCL (by reason of her earlier learning about the proposed sale) who had inside information about FCL on 30 April (in particular the leaked page) and who communicated the inside information to a person knowing or believing that person would, or would be likely to, buy or sell securities of the public issuer.
118. The Court of Appeal observed in Colonial Mutual Life Assurance Society Limited v Wilson Neill Limited 4 that sections 7 and 9 of the Amendment Act impose absolute liability. This means that while liability under section 9 does depend on the insider intending to advise on or encourage trading, it does not depend on the insider's knowledge or belief about the status of the inside information itself. An insider can be liable under section 9(1)(b) for communicating a piece of information even where the insider is unaware that it is inside information.
119. As such, AB might incur liability under section 9 to the persons from whom CD purchased securities for the difference between the consideration they received for the securities and the value the securities would have had if the information had been publicly available at the time of the transaction. She might also be liable to the public issuer for these losses, and at the discretion of the Court, for a pecuniary penalty to the maximum of three times the losses avoided or the total consideration for the securities, whichever is the greater. If a judgment were entered against her she would be disqualified from managing a company for a period of 5 years.
120. We consider this would be an unexpected outcome to those who drafted the Amendment Act. It seems to be an unfortunate one. AB appears to have believed in good faith, at the time, that the information she faxed to CD was publicly available. She did not gain from his trading.
121. An argument could be raised that AB should have checked the source of the document with somebody before faxing it, particularly as it appeared to confirm something that she knew to be a confidential matter. She told FCL investigators she regrets not doing so. She said that she did not read the document closely, and thought the first page was the whole document. She does not appear to have turned her mind to its contents to any great degree, but to have assumed, upon reading the headline and the first bullet point, that its appearance on the Notice Board was confirmation of a public announcement. Given the importance of the announcement the question arises whether AB might have been expected to make a more careful check of the document.
122. We note AB's stated (but apparently mistaken) belief that company announcements were routinely posted to the Notice Board. Given this belief and the fact that confidential communications were not posted to the Notice Board we do not think it would be reasonable to expect a person in her position to check whether a document was posted in error.

Liability for trading

123. There is also the matter of AB's husband's purchase of FCL Paper shares on 3 May. AB insists that she did not tell her husband of the information in the leaked page, and was unaware of the transaction until after the event. We do not have any evidence to the contrary. Despite this, we note that the purchase made by AB's husband was in the joint names of himself and AB. Under section 7 liability arises where an insider with inside information about a public issuer buys securities of that public issuer. "Buy" includes "acquire." As AB's husband purchased the shares in his and his wife's joint names, it might be argued that AB bought these shares on 3 May, even if she did not know about the transaction until after the event. We doubt the Act should be read this way. It seems more in keeping with the purpose of the legislation that liability will arise under section 7 only where the insider undertakes some action to acquire or dispose of securities.

CD and EF

Was CD or EF an insider?

124. On the information available to the Commission, neither CD nor EF could incur liability as insiders under the Amendment Act. In order to be an insider under section 3(1)(e) of the Amendment Act, a person must have received inside information in confidence from a person who received inside information in confidence from a primary insider. This chain of liability stops at two removes from the public issuer, its employees, and officers. So, even if CD received the information in confidence from AB (and if AB was herself an insider) CD would not be an insider.
125. The same applies to EF. He obtained the leaked page from CD's office. Even if he obtained the information in confidence from CD, he would not be an insider by reason of this.

Footnote(s):
4

[1993] NZCA 288; [1994] 2 NZLR 152 (the Wilson Neill case)

REPORT ON QUESTIONS ARISING FROM AN INQUIRY INTO TRADING IN THE SHARES OF FLETCHER CHALLENGE LIMITED IN MAY 1999

SECURITIES COMMISSION
WELLINGTON, NEW ZEALAND

PART 3 - APPLICATION OF THE LAW (Cont...)

Hypothetical questions

126. Notwithstanding that neither CD nor EF could be insiders under the Amendment Act, it is useful to consider the question as to whether either of them would have been an insider if he had been within the prescribed degree of remoteness. It is important to consider this hypothetical question in any consideration of potential law reform implications. The manner in which both CD and EF appear to have come to possess this information raises difficult questions about the application of the law.
127. The issue that arises in respect of both CD and EF is whether or not each of them "received" inside information "in confidence".

CD

128. The initial facsimile from AB to CD consisted simply of the printed page of the draft news release. There was no accompanying note or message. There was nothing on the face of it to suggest that the information was being passed on in confidence. Nor it appears did either AB or CD consider the communication confidential at this time.
129. In discussing who might be an "insider" under insider trading law the Commission's recommendations to the Minister of Justice in 1987 referred to case law on the equitable action of breach of confidence. When this legislation was introduced in Parliament the Minister of Justice said that it "approaches insider trading as a matter of breach of confidence".5 The action of breach of confidence in New Zealand protects confidential information communicated to a person in circumstances importing an obligation of confidence.6 On the wording of sections 3(1)(c) and 3(1)(e) we think that this test is to be followed in determining a person's status under the Amendment Act in the individual circumstances of each case.
130. The draft news release originally went out on a general noticeboard in a manner that probably would not lead to a conclusion that the information was being imparted in confidence. However, it was quickly removed. Moreover 1½ hours later the Company Secretary sent a message to all Corporate LAN users stating that the document which had appeared on the Notice Board was confidential, and must not be discussed with or provided to any person. We think that at equity those people who saw the draft release on the Notice Board might, from the time they received the Company Secretary's email, be seen as subject to an obligation of confidence.
131. Upon noticing the e-mail AB rang CD and told him to ignore and destroy the information, and that it had been released by mistake.
132. The test at common law for whether information is imparted in circumstances importing an obligation of confidence is an objective one. The test is whether a reasonable person would assume an obligation of confidence arose in the circumstances.7 An obligation of confidence can arise after the acquisition of confidential information, and can bind a third party who receives the information innocently once the third party is on notice that the information is confidential.8 The question is whether the circumstances of this communication from AB to CD were sufficient, lacking the express words, to import an obligation of confidence. On the statements of CD we consider that AB's actions in informing CD that the release was a mistake, and her direction to CD to destroy the facsimile should have made it clear to CD that he was not at liberty to use or to publish the information.
133. From the time CD was advised of the mistake we consider that an obligation of confidence applied to him also. CD received this call before he bought shares.
134. The question this raises is whether the statutory definition of "insider" in the Amendment Act captures the breadth of obligations that can arise in equity. It can be seen that an action for breach of confidence can lie where constructive knowledge of a confidence can be inferred from the circumstances, or where a person is notified of the obligation of confidence after receipt of the information (from the time of notification, and in respect of any use of the information). Can section 3 of the Amendment Act be read in the same way?
135. This provision has not been examined by the courts. We do not think its boundaries are clear. On one interpretation, put to the Commission by counsel for CD, emphasis must be placed on the plain use of the word "received" in the statute. On this analysis CD might not be liable as an insider because he was not informed of the confidence until after the information was passed to him, and so the information was not received in confidence.
136. A similar approach to this can be seen in respect of interpretation of the offence of receiving stolen goods. This offence is established under section 258 of the Crimes Act 1961, and applies where a person:

"receives anything stolen, or obtained by any other crime...knowing that thing to have been stolen or dishonestly obtained".

137. This provision has been interpreted by the courts as meaning that the receiver must know the goods are stolen at the time of receipt.9 Liability does not arise where this knowledge is acquired afterwards. We note that criminal legislation is interpreted strictly. Liability under Part I of the Amendment Act can have penal consequences, and it was submitted to the Commission that on this basis the legislation should be strictly interpreted.
138. On the other hand, the Court of Appeal has stated in the Wilson Neill case that it "is fully conscious of the beneficial public purposes, aimed at improving commercial morality, of the Securities Amendment Act 1988".10 A Court might consider the purpose of this legislation favours taking a broader approach to the definitions of "insider".
139. Sections 3(1)(c) and (e) seek to describe the situation where an obligation of confidence arises in connection with the transmission of information.
140. There are two elements to this. First, the information must be transmitted, and secondly, there must be, seen objectively, circumstances importing an obligation of confidence. The first element was completed by AB faxing the leaked page to CD. We think it could be argued that the second element was completed from the time CD received AB's phone call alerting him to the mistake. It might be argued that these elements can be made out by two closely linked events, rather than by the isolated event of receipt. If these two elements can be satisfied sequentially in this way, then it may be concluded that CD was in a position whereby he had received the inside information in confidence.

EF

141. As with CD, it is useful for law reform purposes to consider the question as to whether EF would have been an insider if he had been within the prescribed degree of remoteness.
142. It appears that EF took a copy of the leaked page without CD's knowledge or consent. From the account given by EF to SFO officers it appears that EF misappropriated information that he knew to be confidential, in circumstances that would lead an observer to conclude EF was not entitled to use the information freely. We note in particular EF's comment that he did not tell CD he had taken the copy because he felt he was not supposed to know about the document (see paragraph 47). He also said "I believed I had the real McCoy."
143. The status of a person who surreptitiously obtains information has not been considered by New Zealand courts in the context of liability for insider trading. The question in EF's case will turn on whether a person who misappropriates information can be said to have "received in confidence" this information. We have expressed the view (see paragraph 135) that the boundaries of sections 3(1)(c) and 3(1)(e) are not clear. Again the question will be whether the Amendment Act captures the breadth of obligations that can be found at equity.
144. Early cases on breach of confidence indicate that this action might lie for surreptitiously obtained information. In the 1970's and 1980's, the test for establishing this cause of action shifted, to focus on information that is "imparted in circumstances importing an obligation of confidence." This test has been adopted in New Zealand.11
145. However, more recently courts overseas considering actions for breach of confidence have once again been willing to look beyond the strict requirement that the information be "received" and "imparted". In a case in the House of Lords in 1990 Lord Goff expressed the principles behind the action for breach of confidence to be founded on:

"a duty of confidence [which] arises when confidential information comes to the knowledge of a person in circumstances where he has notice, or is held to have agreed, that the information is confidential, with the effect that it would be just in all the circumstances that he should be precluded from disclosing the information to others."12

146. While this view has not to date been adopted in New Zealand, we believe it is to be preferred.
147. The New Zealand High Court has been willing to restrain a person from using confidential information obtained without the knowledge of the owner where that information was found on computer disks accidentally sold at auction.13 It was not clear from the decision that relief in these circumstances lay in breach of confidence or whether it was based on concepts of ownership of information. However it may indicate a willingness on the part of New Zealand courts to adopt Lord Goff's approach described above.
148. We think it is likely that EF obtained the leaked page in such circumstances that it would be equitable to preclude him from using that information or passing it to others, believing as he did that the information was "the real McCoy" and believing that he was not supposed to know about the information.
149. Taking into account our earlier comments concerning the interpretation of sections 3(1)(c) and 3(1)(e) (see paragraphs 134-140) we consider the better view to be that there was an obligation of confidence from the circumstances in which EF came to have the inside information. We think it is arguable that, questions of remoteness aside, EF would have been found to have received inside information in confidence. In saying this we acknowledge that commentators have published opinions to the contrary.14 We recognise that the wording of sections 3(1)(c) and 3(1)(e) might be ambiguous on this point. However we are of the view that this conclusion is consistent with the purpose of the Amendment Act. We do not believe it would be consistent with the policy of the Act for a person who surreptitiously misappropriates inside information to be free to trade, while if he or she had been given the information, he or she would have been prohibited from trading. We address this point in Part 4 of this report.
150. We note EF admitted that one of his purposes in passing the leaked page to the news media was to raise the price of FCL Paper shares. It seems that he communicated the information to the broking firms for a similar purpose. Whatever the liability that might arise if an insider tips the news media, we consider the circumstances in which EF did this resemble a deliberate attempt to influence the market in these shares. We comment on this in Part 5 of this report as a separate matter.

Insider trading conclusions

151. Our assessment of questions of liability under Part I of the Amendment Act is as follows:
     1. On the information available to us, AB appears to have become an insider when first told, in confidence, of the proposed sale of FCL Paper. She remained an insider when she sent the facsimile (which contained inside information) to CD, even though she thought the information was no longer confidential. She appears to have communicated the information knowing or believing that CD might buy FCL shares as a result.
     2. If this is the case AB may have incurred liability under section 9(1)(b)(i) of the Amendment Act. She may be liable for losses incurred by the counterparties to CD's trading. If judgment were to be obtained against her she would automatically be prohibited from taking part in the management of any company for a period of 5 years without first obtaining the leave of the High Court. At the discretion of the Court she might be liable for pecuniary penalties.
     100. Neither CD nor EF was an insider of FCL under Part I of the Amendment Act because each was too many steps removed from the source of the information to incur liability as an insider in terms of section 3.
     4. We think CD was a tippee of AB. This raises liability questions for AB if she is an insider, not for CD.
152. Our assessment of the further questions as to whether CD and EF received inside information in confidence is as follows:
     1. We think it could be argued that CD received this information in confidence in that he received inside information from an insider and in the circumstances held the information under an obligation of confidence. However, we acknowledge that this is not clear.
     2. On the evidence it appears EF misappropriated the inside information from CD. We think the preferable view is that EF received the information in confidence from CD although again we acknowledge that the point is arguable.
     100. Because CD does not appear to have willingly given the information to EF, no question of CD tipping EF arises.

Footnote(s):
5

NZPD v 490 July 21 - July 28 1988 p 5281
6

AB Consolidated Ltd v Europe Strength Food Co Pty Ltd [1978] 2 NZLR 515
7

Laws NZ, Intellectual Property: Confidential Information, para 96
8

Malone v Metropolitan Police Commissioner [1979] Ch 344, per Megarry VC at 361
9

R v Tennet [1939] 2 All ER 86, R v Crooks [1981] 2 NZLR 53 at 56, 59
10

Above no. 4 at 161
11

Above no. 6
12

Attorney-General v Guardian Newspapers (No 2) [1990] 1 AC 109 at 281
13

Citicorp New Zealand Limited & Anor v Blomkamp and Anor, unreported 4/9/92, Blanchard J, HC Auckland CP1017/92
14

see eg Insider Trading, Nominee Disclosure and Futures Dealing, A. Van Schie, Butterworths, 1994, at p 13

REPORT ON QUESTIONS ARISING FROM AN INQUIRY INTO TRADING IN THE SHARES OF FLETCHER CHALLENGE LIMITED IN MAY 1999

SECURITIES COMMISSION
WELLINGTON, NEW ZEALAND

PART 4 - COMMENTS ON THE LAW

153. The primary purpose of the Commission's inquiry was to consider whether there was any insider trading by any person in terms of the Amendment Act. However the inquiry has raised questions about the policy of laws regulating behaviour of traders in quoted securities. The particular questions are:
     1. Whether liability under Part I should always be absolute with regard to the tipping provisions and whether liability should always fall on the insider tipper;
     2. Whether liability as a secondary insider should be extended beyond the people covered by sections 3(1)(c) and (e); and
     100. Whether a person who has received or obtained inside information from an insider should be free to trade on that information when it was not initially communicated in confidence or when it was taken without the knowledge of the source.
154. The question is also raised whether our laws should expressly prohibit any forms of manipulative conduct in respect of stock prices and stock markets. This is addressed in Part 5 of this report.

Liability for tipping

155. We have commented that on the facts available to us AB may be liable under section 9 of the Amendment Act because, while she was an insider, she communicated inside information to another person knowing or believing that that person might thereby be induced to buy securities.
156. We have queried such an outcome where a person in the position of AB appears to have believed that the information she passed on was not inside information and she did not gain by her actions.
157. While the nature of liability has not been fully examined in relation to sections 7 and 9 of the Amendment Act the Court of Appeal indicated in the Wilson Neill case that it sees liability as being absolute, with no room for a defence of absence of fault.
158. When the Court made this observation its judgment mentioned the statutory exceptions from liability available under section 7 and 9. It stated "In such a legislative scheme there is no room for the principle applied in Civil Aviation Department v MacKenzie, [1983] NZLR 78...[which concerns a 'no fault' defence for strict liability offences]".15 The Court referred to the "Chinese wall" exceptions available in sections 8 and 10, and the exception, available under section 8(1), for company officers who buy or sell securities in accordance with a procedure approved by the Securities Commission.
159. Applying absolute liability for insider trading has a pragmatic justification. The experience overseas has been that it can be very difficult to prove a person's motive when bringing an action for insider trading. Imposing absolute liability where a person has suffered a loss or been deprived of the opportunity to make a gain allows an action to be determined on the basis of more readily discoverable facts.
160. In addition however absolute liability can be justified as a matter of principle. While the insider trading action remains a civil matter the basic liability of a trader to make good the losses incurred by his or her counterparties may be viewed, quite apart from questions of moral opprobrium, as a matter of restitution for unjust enrichment. The insider who has benefited from the trade is required to forfeit the profits, irrespective of fault.
161. The public interest in securing judgment in appropriate cases might be seen to favour restitution where a person, viewed objectively, has acted with benefit although without fault.
162. On the events described in this report we doubt that the restitution approach works so well in relation to liability for tipping because the tipper (insider) may be liable to counterparties of the tippee for losses incurred where the tipper did not receive any gain. On the policy of this legislation we query whether an innocent tipper who receives no gain should be required to restore the losses suffered by any counterparty of the tippee.
163. Two options present themselves to remedy this. Taking the approach that the primary liability provisions of our law seek to restore losses suffered by counterparties, it may be that it is the person who trades to an advantage as a result of the tip who should be liable to his or her counterparty for the losses. Alternatively, liability on an insider to account for losses arising in a transaction to which the insider's tippee is a party might be confined to situations where the insider tipper cannot establish that he or she acted without knowledge of the nature of the information.

Liability on the tippee

164. The question of a remedy for the losses of a counterparty in cases of tipping will involve balancing a number of factors. These include the possible inequity of permitting the recovery of losses from a person who entered into a bargain in good faith, the desirability of allowing restitution for counterparties, and the desirability of achieving certainty in stock market transactions (where no insider is involved in the transaction).
165. The chain of tippees whose trading can incur liability for an insider tipper currently extends for two removes from the insider, both where the insider tips by passing on information and by giving advice or encouragement. The tippee may not know about the inside nature of the information at issue. If there were a cause of action against the tippee the counterparty would have a claim against the person who actually profited from the trade.
166. The Australian Corporations Law provides a civil remedy where an insider trades or procures another person to trade. This civil action allows the counterparty to this trade to recover losses from "the insider, the other person, or any other person involved in the contravention". It appears that this provides a right of action against a tippee for losses sustained as a result of action taken by an insider. Under this provision the insider must have acted with knowledge of the nature of the information, but there is no "no-fault" defence available for the tippee.
167. It might be argued in the New Zealand context that this would produce a harsh result for a tippee who enters into a transaction in good faith expecting to achieve a final settlement, at least where that person entered into the trade without knowledge that information on the basis of which the trade was undertaken was inside information. It may be appropriate to limit any claim against a tippee to those occasions on which the tippee knew or ought to have known that the transaction was tainted.

Knowledge of the insider

168. Similarly it might be appropriate to consider whether to limit recovery against the insider tipper for losses caused by tipping to those situations where the insider acted with knowledge that the information in question was inside information, or alternatively where the insider is unable to establish that he or she acted without knowledge. Knowledge that the information is inside information is a requirement in all the overseas jurisdictions that we have observed, and has been raised in the discussion paper on insider trading published by the Ministry of Economic Development in September.
169. As is the case at present, the option of holding the tipper liable for losses of the tippee's counterparty involves compensation or damages for losses suffered (to a third party) rather than restitution for money paid. The argument in favour of a knowledge requirement for this is that an award of damages (rather than restitution for money paid) against a person who has not transacted should usually be made only where a wrong can be established.
170. Conversely, a knowledge requirement could make it more difficult for counterparties to recover their losses. For this reason we raise for discussion whether placing the onus on an insider to show lack of knowledge would lessen this burden.

Penal provisions

171. Whether or not any recovery of losses can be obtained from a tipper or a tippee, any further penalty should be considered in the light of the ethical nature of the insider's actions (including disqualification from management of a company under the Companies Act - the Commission has previously recommended to the Government that the law be amended so that disqualification is at the discretion of the Court). This was signalled by the Court of Appeal in the Wilson Neill case, where it commented that "absence of moral fault would clearly be important on any question of penalty and also on an application for relief from disqualification [from managing a company]...".16 This discretion on the part of the Court provides a valuable safeguard, and would perhaps be important on the facts of the present matter.
172. We consider that the insider tipper should remain liable for pecuniary penalties and disqualification from management of a company, as these can be identified as remedies going to the nature of the insider's actions. It will be a matter for the courts to determine the circumstances in which these further penalties should be imposed. Under either option discussed in paragraphs 164 to 170, the tipper can be liable for these penalties whether or not any gain is made, but conversely the innocent tipper who makes no gain should incur no liability.
173. Against this background it is clear that disqualification from management of a company as a result of liability for insider trading should be at the discretion of the Court. This is a penalty relevant to the ethical nature of the insider's actions. It does not fit well with the restitutory nature of the primary non-discretionary remedies.

Secondary insiders - the "length of the chain"

174. This section refers to people who are insiders by reason of the receipt of inside information rather than by reason of a pre-existing relationship with the public issuer. In the context of this report, we have commented that we do not consider that either CD or EF was an insider of FCL. It appears that EF took advantage of information that was inside information. It is not clear from CD's statements whether or not he could be said to have taken advantage of the information (see paragraph 63). This information, we consider, should reasonably have been known by both of them to be inside information at the relevant times. EF and CD both gained from trading on this information.
175. Liability arising from the receipt of inside information does not extend further than two removes from the primary source, nor was it intended to.
176. The proposals for the Amendment Act stopped the chain of insiders at two removes from the public issuer because the intention was to prevent insider trading near the source of the information. However, the recommendations also acknowledged "logic suggests that a sequence of confidences could reach to infinity, and that all in a sequence, however extended, should be regarded as insiders" 17.
177. The question arises whether the chain of insiders under section 3(1)(e) should extend more than two removes from the primary source of the information.
178. One way to achieve this would be to define an insider by reference to the receipt in confidence of inside information from any insider (including another person who is an insider under section 3(1)(c)). Sections 3(1)(e) and (f) would become redundant.
179. Adoption of this proposal would mean that the concept of insider could be extended, consistent with the concept of breach of confidence, as far as the string of confidences might go (so long as the information is still not publicly available, because it would then not be inside information).
180. A similar approach is found in the Ontario Securities Act, which provides for liability where a person in a "special relationship" with a reporting issuer trades in securities of that issuer "with knowledge of a material fact or material change with respect to the reporting issuer that has not been generally disclosed." The categories of people deemed to be in a "special relationship" with a reporting issuer include:
     1. A director, senior officer, affiliate, or associate of:
        1. the reporting issuer or a subsidiary; or
        2. a person or company (listed or unlisted) that is proposing to make a take-over bid for the reporting issuer or proposing to become a party to a merger or other reorganisation with the reporting issuer; or
     2. A substantial shareholder in the issuer; or
     100. A person that is engaging or proposes to engage in any business or professional activity with or on behalf of the reporting issuer or with any person described in paragraph (a)(ii) above; or...
     4. A person who "...learns of a material fact or material change with respect to the issuer from any other person or company [in a special relationship with the issuer], including a person or company described in this clause, and knows or ought reasonably to have known that the other person or company is a person or company in such a relationship".
181. This legislation maintains the concept of "special relationship" for disclosure to any degree from the primary insiders (up until the point that the information must be regarded as generally disclosed).
182. The Ontario law adds a requirement that the person receiving the information knows of the nature of the information and its source. We consider the requirement under our law that the insider is a person under an obligation of confidence adequately addresses this point.

Receipt in confidence

183. We have discussed above (paragraphs 129ff) that our insider trading laws are based on theories of breach of confidence. If this basic notion is to be preserved then there must be an obligation of confidence arising from the receipt or possession of information. Further, unlike liability arising at equity for breach of confidence, the source of an insider's information is vital under our insider trading law at present. People can be liable as insiders only if they receive the inside information from a "primary" insider (one who is an insider under sections 3(1)(a) or (b)) or from a person who is an insider under section 3(1)(c) or if they are themselves "primary" insiders.
184. The Commission's 1987 recommendations to the Government that led to the enactment of the Amendment Act stated:

"Our principal advice is that statutory causes of action should be established to enable companies and persons who deal with insiders to obtain, by means of civil proceedings, redress for the mis-use of information that is held in confidence" 18.

185. We think this statement sums up the policy intent of this legislation. It is common sense to infer an obligation of confidence in respect of CD's possession of the inside information following his receipt of the phone call from AB and in respect of EF's taking of the information that he believed he should not have. We think that such an obligation would be inferred in equity.
186. We do not consider it is consistent with this policy that a person is spared from liability who misappropriates inside information knowing it to be confidential, while the person who receives in confidence the same information voluntarily given attracts liability as an insider. We do not believe such a distinction is warranted or desirable.
187. We consider that if the legislation is unclear on this point it should be amended. One way to achieve a satisfactory outcome on this and the point discussed above might be to amend section 3(1)(c) to include as an insider under that provision any person who obtains or receives inside information from an insider (including a person who is an insider by reason of section 3(1)(c)) and who holds that information in circumstances importing an obligation of confidence in respect of the information.
188. Amending the law in this way would introduce the broader concept of "obligation of confidence" and leave the precise details of this to be decided by the courts. If a similar approach were taken to that used in equitable actions to restrain mis-use of information and to prevent breach of confidence then we are confident that such an obligation will be found to arise in appropriate circumstances even where the information concerned was taken without the knowledge of the person from whom it was obtained, or when an obligation of confidence, objectively assessed, arises in respect of the information after receipt of the information.

Footnote(s):
15

Above no. 4 at 162
16

Above no. 4 at 162
17

Insider Trading - Report to the Minister of Justice by the Securities Commission, Securities Commission, 1987, Volume 1 p 49
18

Above no. 17 at p 73

REPORT ON QUESTIONS ARISING FROM AN INQUIRY INTO TRADING IN THE SHARES OF FLETCHER CHALLENGE LIMITED IN MAY 1999

SECURITIES COMMISSION
WELLINGTON, NEW ZEALAND

PART 5 - MARKET MANIPULATION

189. The dividing line between information-based market manipulation and insider trading often depends on whether the information concerned is accurate or misleading and on the use to which the information is put. Insider trading involves a person trading on reliable confidential material information about an issuer, which, if publicly known, would properly affect the price of the relevant securities. Disclosure-based market manipulation generally involves a person releasing information that misleads the market and in this way materially affects the price of securities.
190. In this case the information put into the market by EF was true in its content. It revealed that FCL was developing plans to merge its Paper Division with Fletcher Challenge Canada. The information was presented in a manner that superficially at least resembled an official company announcement. In fact the information was in a draft document. FCL was not yet in a position to announce the merger plans. It might be argued that the information released, while true, was misleading in the form and timing of its release.
191. The evidence we have suggests that EF played an active role in these events. He misappropriated a page of a confidential document. He purchased a number of shares, then released the leaked page to the news media and sharebrokers, and then sold for a substantial profit on the next trading day. One of his stated intentions was to cause a movement in the price of FCL shares by which he could profit. These actions resemble a deliberate attempt to manipulate the price of FCL shares. If a person "tips" the news media, intending that information about a company be published, then any liability that person could incur under insider trading law for gains and losses flowing from the action would be minimal, because this liability is measured by comparison to the price at which a trade would have occurred had the information been publicly available. A key part of EF's apparent strategy was that the information would be publicly available (and the price would have risen in reaction to this) by the time he sold. The question arises whether actions of this sort are better recognised by the law as deliberate attempts to manipulate a market, with liability being assessed accordingly.
192. Many countries have specific laws aimed at preventing manipulation of securities markets. Market manipulation laws usually target behaviour that aims to alter the market price or trading volume of securities through misleading disclosures or trading practices. Such practices can be harmful to the confidence placed in a market by investors. Manipulative practices can impede the proper price discovery mechanisms of a market. By reducing investor certainty and confidence, market manipulation can retard the efficient operation of markets by creating additional transaction costs and raised risk premiums.
193. Laws prohibiting manipulative practices in securities markets can contribute to investor confidence in a market in a similar fashion to laws against insider trading, and can enhance the integrity and efficiency of those markets.
194. At present market manipulation is addressed in New Zealand through an ad hoc collection of statute and common law, including the Crimes Act, the Fair Trading Act, and common law actions such as the tort of deceit. There is no single provision specifically targeted at market manipulation.
195. By contrast section 995 of the Australian Corporations Law contains a general prohibition against misleading or deceptive conduct in relation to dealing in securities. This provision states that "a person shall not, in or in connection with any dealing in securities...engage in conduct that is misleading or deceptive or is likely to mislead or deceive". The definition of "deal" in this legislation is broad, and includes to acquire or dispose of securities and to induce or attempt to induce another person to enter into an agreement for acquiring or disposing of securities.
196. It is established under Australian law that a statement can be misleading or deceptive even if it is literally true. The emphasis is on the objective effect of disclosure.
197. New Zealand Courts have reached the same conclusion in relation to section 9 of the Fair Trading Act 1986.19 Section 9 contains a general prohibition against misleading conduct similar to that found in Australian trade practices legislation. This section states that:

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

198. For liability to be incurred under section 9 of the Fair trading Act the activity must be conducted "in trade." This provision has been applied to professional share trading. However, the present case would not be covered by this provision as none of the parties involved was generally in the business of buying and selling shares.
199. We think cases like this one raise a question of whether consideration should be given in New Zealand to a general law prohibiting misleading or deceptive conduct relating to any dealing in securities, and perhaps to more specific laws against various forms of market manipulation. The Australian model might be useful here also (see sections 997 - 1001 of the Corporations Law). We consider that in the context of any reform of the law relating to insider trading thought should be given to adding to our securities legislation a general provision in terms similar to that in section 995 of the Corporations Law, described above.

Footnote(s):
19

Hieber v Barfoot and Thompson Ltd [1996] NZHC 1373; (1996) 7 TCLR 301

REPORT ON QUESTIONS ARISING FROM AN INQUIRY INTO TRADING IN THE SHARES OF FLETCHER CHALLENGE LIMITED IN MAY 1999

SECURITIES COMMISSION
WELLINGTON, NEW ZEALAND

PART 6 - OBSERVATIONS

200. The Commission does not consider that action should be taken against any person under the Amendment Act in respect of the events described in this report.
201. This case highlights the need for stringent security in electronic communications regarding sensitive company information. It also highlights the need for all companies to have in place procedures for prompt action in the event of any breach of electronic security. In the Commission's opinion FCL acted responsibly in attempting to minimise the effects of the accidental placement of this information on the Notice Board and in promptly reviewing its procedures after the event with a view to preventing similar occurrences in future.
202. In the Commission's opinion the events described in this report provide examples where the current liability provisions might operate inappropriately against those who have made no gain, and where, on the policy of the law, the current legislation might be too narrowly stated to catch all whose actions should be penalised under insider trading laws. We raise the following questions:
     1. Should liability to restore losses incurred by parties who trade with persons who have been tipped by an insider fall on the insider in every case as at present, or should it be extended to the tippee who has gained from the trade? If so, should it extend to the tippee only where that person traded with knowledge that the tip came from an inside source or was based on inside information?
     2. Should the insider tipper's liability for loss sustained by a counterparty of a tippee be subject to a defence where the tipper establishes that he or she acted without knowledge that the information concerned was inside information?
     100. Should the definition of insider under section 3(1)(c) be extended to include as an insider a person who obtains or receives inside information from any insider, including a person who is an insider under section 3(1)(c), and who holds that information in circumstances importing an obligation of confidence in respect of the information?
     4. Should section 3(1)(c) of the Amendment Act be clarified to state clearly that a person is an insider who obtains or receives inside information from another insider and who holds the information in circumstances importing an obligation of confidence in respect of that information?
203. The Commission considers that the events described also raise a serious question of whether New Zealand law should provide express sanctions against various forms of misleading, deceptive, or manipulative conduct relating to dealing in securities.
204. The Commission has not at this time reached conclusions on these questions. We would welcome public comment.
205. Lastly, the Commission restates its opinion that disqualification from management of a company should be a discretionary restraint able to be imposed under the Amendment Act rather than an automatic result of any judgment against a person under Part I of the Amendment Act.
206. The Ministry of Economic Development is currently considering questions of insider trading law reform. The Government has announced that the first priorities for insider trading law reform will be to address questions of prevention of breach, detection, and enforcement of insider trading law, and the possibility of introducing criminal penalties. These are important questions. The Commission also considers it is important to re-examine certain questions about liability and the concept of "insider" under the Amendment Act. The questions raised in this report seek to refine these parameters of liability without disturbing the core policy of our insider trading legislation.
207. We are referring this report to the Ministry of Economic Development for consideration in the context of the Government's more general review of insider trading law.

Euan H Abernethy
Chairman of the Securities Commission

20 November 2000
Securities Commission
WELLINGTON

REPORT ON QUESTIONS ARISING FROM AN INQUIRY INTO TRADING IN THE SHARES OF FLETCHER CHALLENGE LIMITED IN MAY 1999

SECURITIES COMMISSION
WELLINGTON, NEW ZEALAND

Appendix A

Terms of Reference: Fletcher Challenge Limited

Pursuant to sections 10 and 18 of the Securities Act 1978, the Securities Commission has decided to undertake an inquiry into the release, in April and May 1999, of confidential information concerning Fletcher Challenge Limited, in particular in a draft press release concerning the planned merger of the Fletcher Paper division with Fletcher Challenge Canada (the "confidential information"), and into share trading by persons who may have received or otherwise obtained access to that information before it was released publicly. For this purpose the Commission wishes to receive evidence as to:

1. The facts and circumstances of the release of the confidential information from Fletcher Challenge Limited and the subsequent provision of this information to sharebrokers and the news media;
2. The persons who may have received or otherwise obtained access to the confidential information, the use which they made of that information, and the details of any trading in the shares of Fletcher Challenge Limited;

100. Any other matters material to the inquiry;

And to consider:

4. Whether any person who had access to the confidential information:
   1. traded in the shares of Fletcher Challenge Limited; or
   2. advised or encouraged any person to trade in the shares of Fletcher Challenge Limited; or
   3. communicated the information to any person knowing or believing that person or another was likely to trade in the shares of Fletcher Challenge Limited; and
5. Whether the Commission should comment on any of the above matters or take any other action;

subject to the Commission's discretion to amend these Terms of Reference as it may consider fit.

28 January 2000

FLETCHER CHALLENGE ANNOUNCES MAJOR STRATEGIC INITIATIVES

Auckland, May x, 1999

Fletcher Challenge Limited announced today a series of initiatives, designed to create significant value for all its shareholders. These initiatives include:

• A merger of Fletcher Challenge Paper and Fletcher Challenge Canada Limited, to form NEWCO, an internationally competitive global pulp and paper company, headquartered in Toronto, Canada. The merger will end Fletcher Challenge's involvement in the paper industry.
• A significant strengthening of the Fletcher Challenge group balance sheet, following the NEWCO merger. Pro-forma December 1998 balance sheet numbers (refer Appendix 2) show that the Fletcher Challenge Group net interest bearing debt falls from $4.5 billion to $1.7 billion, and the debt to total capitalisation ratio improves from x% to y%. These improvements provide a strong financial platform for growth in the Building, Energy and Forestry Divisions.

The decision that the strategic direction of Fletcher Challenge Energy will be on focused upstream oil and gas exploration and production. As the replacement and growth of the current proven reserve base is a priority, the Division is targeting a $250-$300 million acquisition of a strategic set of producing properties with exploration upside.

• The announcement of the Directors' intention to undertake a buy-back, of up to 10% of the Fletcher Challenge Energy shares outstanding, unless the current share price discount to produce-out-value (POV) is closed.
• Confirmation that Fletcher Challenge Building and Fletcher Challenge group and its three Divisions, beginning in September this year with the announcement of the first quarter's results for fiscal 2000.
• The appointments of x and y to the Fletcher Challenge Limited Board.

In announcing these initiatives today, the Board of Directors confirms that Fletcher Challenge will remain as one company, with three operating Divisions - each represented by its own class of listed targeted shares.

REPORT ON QUESTIONS ARISING FROM AN INQUIRY INTO TRADING IN THE SHARES OF FLETCHER CHALLENGE LIMITED IN MAY 1999

SECURITIES COMMISSION
WELLINGTON, NEW ZEALAND