Define how UK law has evolved to curb the practice of Insider Dealing.

Further reform came from within the European Community with the introduction of the EC Directive on Insider Dealing (IDD) (EEC/89/592). Before the adoption of the IDD, the approach taken by relevant Member States to prohibit the practice varied widely. The implementation of the Directive attempted to harmonize minimum standards for insider dealing laws throughout the Community. According to Ashe, “co-ordinated rules have the advantage of making it possible through co-operation to combat transfrontier insider dealing more effectively.”

Frustration at the inability of the criminal regime to achieve conviction resulted in the Government introducing a civil offence of market abuse.

According to Welch et al, “the Financial Services and Markets Act 2000 (FSMA) provided the opportunity, both to reform the regulatory structure with the transfer of enhanced regulatory powers to the Financial Services Authority (FSA) and also to overhaul the substantive law.” The FSA was provided with the power to take action for market misconduct under section 118 of FSMA. It was expected that a civil process with the accompanying lower burden of proof and the non requirement of a jury would result in more actions against insider dealing being successfully brought. Unfortunately, this does appear to be the case. According to Ringshaw, “since 2001, the FSA has successfully brought just eight cases of misuse of information.” This is almost embarrassing in comparison with its US counterpart regulator the Securities and Exchanges Commission’s success; in contrast it imposes millions of dollars in fines and initiates criminal proceedings against dozens of people every year.  In its defence the FSA is a relatively new kid on the block and lacks the ability to plea bargain and to enter into immunity agreements with witnesses in return for hard evidence, which the SEC has used to great effect.  According to Margaret Cole, FSA Director of Enforcement, these are areas which are under active consideration. 

Pursuing insider dealer cases is notoriously complex and challenging. There is rarely a smoking gun and dealings are multifaceted and not easily understood by juries made up of lay persons. A real risk is that what may be evident to the sophisticated observer will become lost or hidden to a less sophisticated panel of jurors in the course of a long trial dealing with technical and often monotonous detail.  Investigators face hurdles both in finding the beneficial owners behind overseas nominees and in identifying the links between people privy to information and the trading accomplices to whom they pass that information. The trading may have been conducted through a number of accounts and attempts made to conceal the distribution of proceeds. The investigation into such activities increasingly involves a number of foreign jurisdictions.  In the majority of cases, the prosecution will be unable to obtain direct evidence that a person possessed inside information and knew that it was information of that nature; proving that the information was in fact price sensitive will involve expert testimony evidence. Alcock comments, “Rogues know that unless they carelessly leave a trail of paper to follow it will virtually be impossible to prove beyond reasonable doubt that they have dealt on inside information.”

So why is there a need for regulation in this area? According to McVea,  

“Regulators claim that legislation is justified on the basis of a range of different arguments, the most consistently cited of which is that insider dealing jeopardises the development of fair and orderly markets and by doing so undermines investor confidence.” 

Other rationalizations include assertions that it is morally reprehensible and against good business ethics; it impairs the efficiency of the market and reduces market liquidity.  

If a securities market is to be efficient, it must be properly able to ensure that the price of securities correctly reflects their true value. It could be said that in order to do this the market must have the means of preventing individuals taking advantage of superior knowledge gained through their informed positions, thus maintaining a level playing field for all. According to McVea, the theory of market egalitarianism promotes the idea that, “all individuals in the market should be placed on an equal footing, insofar as that is possible.” The implication is that anyone acting on superior information that is not available to all traders at that time is technically ‘stealing’ from the other market members. McVea goes further to say that, “carried to its logical extreme [market egalitarianism] would eliminate the use of all ‘informational advantages’, and remove the incentive to produce valuable information.” In other words rather than have a positive affect on the efficiency of the securities market it could have the reverse. Brazier comments, “The idea that the market should operate on the basis of complete equality….is too idealistic to be workable in practice….a requirement as to the immediate disclosure of all information would be too all-embracing. The market would be swamped with trivial material.”  

Some critics claim that insider dealing actually benefits market efficiency. White argues that, “in the absence of immediate and complete disclosure…insider dealing can contribute to efficiency by causing the market price to move towards what the price securities would command if the inside information were publicly available.” Insider dealing moves the market in the right direction, reflecting the true value of a company at any given time. Brazier notes, “In essence, those economists are saying that a securities market with active insiders ensures accuracy in the pricing of the securities so traded.” Professor Manne purports insider dealing would avoid sudden and detrimental surges in market prices that are the result of knee jerk reactions to public announcements of price sensitive information. Steady adjustments in share prices are more desirable which could be achieved by gradual dissemination of information.  Similarly, if individuals close to a company were allowed to act on their privileged data, markets would react to their buying and selling thus creating a more natural ebb and flow of share prices. According to White the problem with this theory is that, “trading may take place in too small a quantity to affect the market price, and because insiders camouflage their activity, making observation difficult.”

Economists also put forward the argument that insider dealing is essentially a ‘victimless crime’. Acquisitions are usually made through an intermediary today so it is be difficult to make a direct connection between the individual benefiting from the information and the unsuspecting party who pays more or receives less. Alcock comments,      “the insiders gain is not really made at the expense of the party he trades with since this other party has already come on to the market as a willing buyer or seller at the prevailing market price. If he had not dealt with the insider it is likely he would have dealt with someone else on exactly the same terms.” As a financial crime, it may not attract the immediate moral outrage of a violent crime against a person but it is not possible to say that it is completely victimless. If investors form the opinion that they cannot trust the market and that people are habitually stealing a march on them, the health of the financial industry, of which we are all in one way or another dependent, will suffer. The theory is that insider dealing will alienate investors with harmful results for society as a whole. McVea comments, “…despite the fact that difficulties in harm are evident, it is not necessary to establish loss or injury to an individual or specified group; it is enough that harms (losses) are sustained which society thinks, in the absence of any compelling justification to do otherwise, ought to be prohibited.”

In conclusion, although there are arguments for allowing insider dealing, it is almost universally accepted that regulation is needed. The most important question to ask with regards the stock market is does it provide investors with an equal opportunity to use their skills, experience and judgment to share in potential rewards and to assess risks fairly? Insider dealing distorts the relationship between risk and reward. The insider dealer takes no risk - he places a one way bet. Prices should reflect supply and demand based on the best possible information being available to all. If some have more information than others do the use of skill and judgment will be overridden by those who are "cheating". Regulations allow for the provision of a level playing field meaning that some, not all, of the more obvious physical obstacles facing one side will also be faced by the other. McVea comments, “Share prices should reflect all available information and so provide reliable signals upon which investment decisions can be made.” Promotion of an efficient, orderly and fair market is essential to maintain investor confidence and according to Ashe, “for an effective market in securities every measure should be taken to ensure that the market runs smoothly and that to a large extent depends on investor confidence.” In other words investor confidence and market efficiency are inextricably linked; one does not exist without the other.

The question of the effectiveness of current regulation is put into doubt by recent examples of sharp rises in the share prices of Hanson plc and Reuters Group plc immediately before the announcement of takeover offers, indicating that leaks of inside information had probably occurred. There appears to be little fear among dealers intent on using inside information for their own benefit and their methods of implementation and obfuscation are becoming ever more resourceful. This can only compound the problems faced by the FSA in successfully bringing an action. It would appear that insider dealing will always occur in some shape or form and that it is almost impossible to eradicate it entirely.

Word Count 2,230

                                Bibliography

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Ashe, M 1992 The Directive on Insider Dealing Company Law 1992, 13(1)

Brazier, G 1996 Insider Dealing: Law and Regulation, London: Cavendish Publishing

Dignam A & Lowry J, 2006 Company Law (4th Ed) Oxford: Oxford University Press

Griffin, S., 2006 Company Law: Fundamental Principles (4th Ed), Harlow: Pearson Education Ltd

McVea, H What’s Wrong with Insider Dealing? 15 Legal Studies 390 (1995)

Manne, 1966 Insider Trading and the Stock Market, New York: Free Press

Ringshaw, G Hot on the trail of the insider dealers, May 13 2007 Times Online http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article1781456.ece

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White, M 1995 The Implications for Securities Regulation of New Insider Dealing Provisions in the Criminal Justice Act 1993 Company Lawyer 16(6), at 163 London: Sweet & Maxwell Ltd

Welch J., Pannier M., Barrachino E., Bernd J., Ledeboer P., 2005 Comparative Implementation of EU Directives (1)- Insider Abuse & Market Abuse, The British Institute of International and Comparative Law p 17 http://www.cityoflondon.gov.uk/NR/rdonlyres/3950D4A4-5792-412C-BA89-1B30827101C7/0/BC_RS_eudirectives_1205_FR.pdf

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