Insider Dealing and Market Abuse
The main principle of the stock market is that all the players should be in equal positions. This is the essence of the competition and the violation of this principle undermines the trust of investor as well as the market itself.
Insider dealing is illegal use or disclosure of the insider information of the company which may bring additional benefits. The insider dealing may be defined as “a criminal offense involving the purchase or sale of shares by someone who possesses inside information about a company’s performance and prospects which is not yet available to the market as a whole, and which, if available, might affect the share price.”1
The insider dealing is considered to be serious criminal offense and there are numerous examples of the cases of insider dealing or insider trading when such actions caused complicated negative consequences for the market and for the national economies of some countries. One of the cases which shocked the stock market was the collapse of Enron, USA. Alongside with the false finance statements the insider trading was among other reasons of the collapse of the transnational corporation which possessed 25% share of the world oil market. The management of the company encouraged employees to participate in the stock exchange operations presenting it as an innovative approach in HR policy. The result of that “innovative approach” was that the employees were hunting corporate information and got involved into insider trading. In case with Enron the insider dealing was some kind of a part of corporate culture of the company, because the entire corporation including top management got involved into securities trading, or it is better to say, corporate information trading.
The case of Marta Stewart and ImClone could also be considered as an example though the case of Stewart is a little bit controversial one. She was advised to participate in the operations with ImClone shares by her broker. Finally she was not charged with insider trading, but during the investigation she gave the false statements and was prosecuted for the false statement, i.e. lie to court.
The European Integration process requires joint efforts targeted to overcome the phenomena which could undermine the principles of the common market of the EU, namely market abuse and insider dealing. “In December 2002, the European Union adopted what may be the most far reaching attempt to curb trading abuses in member states. The Market Abuse Directive (MAD), which came into force at the close of 2003, and adopted by member states in 2004, has been plagued with challenges from the outset”.2
Market abuse relates to unauthorized disclosure of the information or misinformation aimed to gain additional benefits. Market abuse according to the Market Abuse Directive (MAD) “consists of insider dealing and market manipulation”3
Article 1 of the MAD defines the insider information as “information of a precise nature which has not been made public, relating, directly or indirectly, to one or more issuers of financial instruments or to one or more financial instruments and which, if it were made public, would be likely to have a significant effect on the prices of those financial instruments or on the price of related derivative financial instruments.”4
In case of Martha Stewart and Imclone she used the information obtained from her broker to gain some benefits. Stewart was accused in selling the shares after receiving insider information from Bacanovic, who at that time worked as a Merrill Lynch broker for both Stewart and ImClone founder Samuel Waksal. According to the criminal indictment, Bacanovic told Stewart on the eve of the FDA announcement that Waksal was selling his shares, prompting Stewart to do likewise. The stock fell sharply on the market following public disclosure of the FDA decision. Had Stewart sold her shares one day later than she did, she would have lost some $40,000. That was a typical example of insider trading operation.
The Criminal Justice Act 1993 gives following definition of insider dealing offence: “An individual who has information as an insider is also guilty of insider dealing if— (a) he encourages another person to deal in securities that are (whether or not that other knows it) price-affected securities in relation to the information, knowing or having reasonable cause to believe that the dealing would take place in the circumstances mentioned in subsection (3); or (b) he discloses the information, otherwise than in the proper performance of the functions of his employment, office or profession, to another person.”5
The actions of Martha Stewart did not fall under defences provided by the mentioned above Act. She believed that the information would bring her certain profit, she was aware that the information had been closed for public and she would never have done what she did if he had not acquired the information from her broker, i.e. the information unavailable for other market operators was the factor which encouraged her to fulfill the transaction. That information was her advantage over other stock market players.
Thus the basic condition for the offence should be of two elements. The offence is considered if (1) there is a person possessing the closed information (insider) and (2) a person possessing the closed information is dealing with the company securities.
The provisions of Criminal Justice Act 1993 regarding insider dealing correspond to those of Financial Services and Markets Act 2000 (FSMA). PART VIII describes behavior and conditions of market abuse.
According to Financial Services and Markets Act 2000 the conditions of market abuse are that “(a) the behaviour is based on information which is not generally available to those using the market but which, if available to a regular user of the market, would or would be likely to be regarded by him as relevant when deciding the terms on which transactions in investments of the kind in question should be effected; (b) the behaviour is likely to give a regular user of the market a false or misleading impression as to the supply of, or demand for, or as to the price or value of, investments of the kind in question; (c) a regular user of the market would, or would be likely to, regard the behaviour as behaviour which would, or would be likely to, distort the market in investments of the kind in question.”6
The Authority is granted a right to impose a penalty on a person “if the Authority is satisfied that a person (“A”)- (a) is or has engaged in market abuse, or (b) by taking or refraining from taking any action has required or encouraged another person or persons to engage in behaviour which, if engaged in by A, would amount to market abuse, it may impose on him a penalty of such amount as it considers appropriate”7
The Market Abuse Directive (2003/6/EC) is of great significance for all EU member states and for UK in particular. First of all the cross border character of transactions taken place in Europe requires new unified codes for business. The main aim of the Directive is to accord the business rules all over Europe.
At the same time the Directive gives the tools for the national legislation to counter such phenomena as market abuse and insider dealing. The Financial Services Authority (FSA) got the mechanism of prosecuting for insider dealing and civil penalties for the market abuse. At the same time there are certain controversies in definitions of the main provisions. Thus the definition of abuse is wide enough to be applied to both company and individual, either professional or not.
The key question of the MAD is that of territoriality. Both the member state in which the abuse takes place and the state in which the relevant instrument is admitted to trading have power to take action under MAD. “The UK favoured this approach as it wished to maintain the current scope of the UK market abuse regime. However, the effectiveness of this dual territoriality will depend in large part on effective practical cooperation between competent authorities in different member states. The key issue will be whether different member states take similar approaches to particular market practices in the context of cross-border deals.”8
The most important is that MAD creates the legal basis for making the European business unified by the common legislation though it will most likely create problems of correlating national legislations with the European one.
1. Glossary of Financial Terms
2. Mantas, Inc.
3. Official Journal of the European Union
5. Criminal Justice Act 1993 (c. 36)
6. Financial Services and Markets Act 2000, Part VIII
7. Ibid, Art. 123
8. Jonathan Herbst
· Glossary of Financial Terms, available at http://www.eagletraders.com/index.htm, retrieved 3.05.2006
· Mantas Inc., The EU Market Abuse Directive: Understanding the Implications of the EU Market Abuse Directive, available at http://www.mantas.com/Resources/asset_upload_file263_2105.pdf, retrieved 3.05.2006
· DIRECTIVE 2003/6/EC OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL, Official Journal of the European Union, available at http://europa.eu.int/eur-lex/pri/el/oj/dat/2003/l_096/l_09620030412el00160025.pdf, retrieved 3.05.2006
· Criminal Justice Act 1993 (c. 36), available at http://www.opsi.gov.uk/acts/acts1993/Ukpga_19930036_en_5.htm#end, retrieved 3.05.2006
· Financial Services and Markets Act 2000, available at http://www.opsi.gov.uk/acts/acts2000/00008–h.htm#end, retrieved 3.05.2006
· Jonathan Herbst , One law to rule them all, available at http://www.thelawyer.com/cgi-bin/item.cgi?id=108098;d=11;h=24;f=46, retrieved 3.05.2006