The Australian Security and Investment Commission (ASIC) has taken a more active and public stance recently in investigating and bringing civil and criminal proceedings against individuals and corporations in relation to insider trading.
The insider trading provisions are contained in Part 7.10 Division 3 of the Corporations Act 2001a(Cth) (Corporations Act) and affect both individuals and bodies corporate. As "insiders" are more likely to be directors and officers of bodies corporate, it is important for those holding such positions to understand the insider trading prohibitions to avoid breaching the provisions.
This article looks at the types of conduct by Part 7.10 Division 3 of the Corporations Act, the exceptions, defences and relief from breaching the provisions for insider trading, and the penalties for breaching the insider trading provisions.
Purpose of the Provisions
The main purpose of the insider trading prohibitions in the Corporations Act is to:
- give all market participants equal access to information
- underpin the fiduciary duty of company officers to the company and shareholders
- prevent damage to market integrity
- promote economic efficiency, and
- prevent damage to a company which issues securities, its shareholders and investors.
What is Prohibited
Under s1043 of the Corporations Act, the insider possessing the inside information cannot acquire or dispose of Division 3 financial products, either directly or indirectly, using inside information.
Insider trading occurs when an insider is in possession of inside information about a company that is not generally available and uses the information to acquire or dispose of, either directly or indirectly, Division 3 financial products.
Key Terms Defined
The insider trading provisions of the Corporations Act specifically define the key terms in relation to the prohibitions on insider trading.
Only financial products which are within the scope of s1042A of the Corporations Act are regulated by the insider trading provisions. They are known as Division 3 financial products and include:
- securities including shares (which is defined in s761A of the Corporations Act)
- derivatives (as defined in s 761D of the Corporations Act)
- interests in a managed investment scheme (as described in s764A(1)(b) of the Corporations Act)
- debentures, stocks or bonds issued or proposed to be issued by a government
- superannuation products (as described in s 764A(1)(g)), other than those Superannuation products provided by a superannuation entity that is not a public offer entity, or
- any other financial products that are able to be traded on a financial market.
Although most of the recent high profile cases including:
- Rene Rivkin, in a criminal prosecution
- Steve Vizard, under the civil penalty provision for insider trading
- the current civil proceeding by ASIC against Citigroup, under the civil penalty provision for insider trading;
involve trading in shares of listed companies. The provisions also have a wider application to financial products including securities (i.e. shares), therefore affect all corporations (i.e. body corporate) whether listed or unlisted.
This exposes all corporations, their directors and officers to the criminal, civil penalty provisions and compensation for damages by a person applying for, acquiring, disposing of or issuing Division 3 Financial products when there is a breach of the prohibitions.
An insider can be either a natural person or a corporation. The insider can be anyone and they do not have to be directly related to the company. Practically, officers and directors are more likely to be in possession of inside information.
Inside information, under s1042A of the Corporations Act, is information that is not generally available and if the information was generally available, a reasonable person would expect it to have a material effect on the price or value of the particular Division 3 financial product.
A reasonable person would expect that the information would have a material effect, under s1042D of the Corporations Act, if that information would, or would be likely to, influence a person who commonly acquires Division 3 Financial Products in deciding whether or not to buy or sell financial products.
Information that is generally available consists of readily observable matter or has been made known in a way likely to bring it to the attention of those who commonly invest and a reasonable period for dissemination has elapsed. Alternatively, it can be deducted, concluded or inferred from the readily observable matter or has been brought to the attention of a person who commonly invests.
Also Prohibited
Also under s1043 of the Corporations Act, an insider possessing the inside information cannot:
- incite, induce or encourage another person to acquire or dispose of Division 3 financial products using inside information, or
- communicate inside information to a person, either directly or indirectly, for the purpose of the other person acquiring or disposing of financial products.
Exceptions
The Corporations Act in s1043B to 1043K sets out a number of specifically drafted exceptions from the insider trading prohibition including:
- a member withdrawing from a registered scheme, where the responsible entity of a registered scheme complies with its obligations prescribed under Pt 5C.6 of the Corporations Act
- allowing underwriters to subscribe for and sell securities, and communicate certain information relating to securities, in accordance with the terms of an underwriting agreement
- the acquisition of financial products pursuant to a legal requirement imposed by the Corporations Act such as the requirement of a corporation to purchase shares from dissenting shareholders, where those share-holders so request
- the communication of information, pursuant to a legal requirement, imposed by the government or regulatory agency such as ASIC requiring the person to communicate information
- a corporation or partnership (chinese wall arrangement) entering a transaction or agreement for Division 3 Financial Products, where the decision was not made by a person with inside information and it could be reasonably expected that inside information was not communicated to the people making the decision
- where a natural person or body corporate does not commit an offence merely because they are aware that they purpose to enter into or has entered into a proposed transaction (i.e. takeover) in relation to a Division 3 financial product
- officers and agents acting on behalf of corporations or natural person that are granted the above exception, agents acting on behalf of the corporation or natural persons who are granted the above exception, and
- a financial services licensee, or a representative of a financial services licensee, when acting as an agent in a transaction concerning tradable financial products is, under certain circumstances.
Defences
Where a proceeding is instituted for insider trading, either under the criminal or civil provisions of the Corporations Act, the insider primarily has three potential categories of defences or relief for breaches under the Corporations Act, namely:
- establishing the application one or more of the exceptions to the insider trading prohibitions set out in s1043B to1043K of the Corporations Act
- demonstrating the information came into a person’s hands in a manner that would be likely to bring it to the attention of the persons who commonly invest, and
- the person proves that the other party to the transaction or communication knew or ought to reasonably to have known of the information (only for criminal proceedings).
Penalties
Failure to comply with the Corporations Act may result in criminal prosecution under s1311(1) of the Corporations Act. The maximum penalty for a person is fine of $220,000 and/or five years in prison.
There is also the imposition of a civil penalty under s1317E for breaches of the prohibitions. Companies can be fined $1 million and individuals may be fined up to $200,000.
Under s1043L, persons affected may also sue for compensation for damages suffered. ASIC can also institute an action on behalf of the issuer of the financial product.
Under s1317H of the Corporations Act allows any person who suffered loss to seek compensation for damages where they can show that there has been a breach of the insider trading prohibitions.
Prevention
Corporations and there directors and officers ought seriously consider implement and review the following areas to minimise the opportunity for and risk of insider trading:
- creating and managing a disclosure policy for information material to the company that complies with the Corporations Act and ASIC guideline principals
- having a policy for the management of conflict of interest issues that arise in relation to Division 3 Financial Products, and
- seeking independent legal advice in relation to acquiring or selling Division 3 Financial Products which may breach the prohibitions on insider trading.
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