Closing the Door on the Inside Traders: An Appraisal of the Concept of Insider Trading in Various Jurisdictions on the Journey to Nigeria
A popular African saying goes thus, “the theft of the meat in by an outside rat didn’t go unaided by the inside rat”. This saying paints a picture of a problematic situation in the corporate world which has formed a concept for scholarly discussions that is the concept of insider trading. While other jurisdictions have embraced the challenges which abound in the fight to curb this problem, others lack this resolve, thus in existence is this plague eating deep into corporate practice. While the fastest fingers point to the bodies responsible for the administration in the corporate world, this writer will appraise this concept in a bid to set the records straight and indeed give backing to the argument that the current Nigerian law hasn’t closed the door on the inside traders, in essence trapping them in their corporate mishap. The possibility of arriving at such a conclusion will indeed be aided by a review of the concept of insider trading in terms of its definition and theories, a sojourn into the laws of the United Kingdom and the United states and a review of the Nigerian law and reported, but unprosecuted cases of insider trading.
The concept of insider trading entails the buying and selling of shares, stock or other securities based on special knowledge not available to others, such as information about new products not yet public. It is also profitable trading in securities that is done using access to privileged information.The concept deals with having unfair usage of information which may be material in encouraging a decision to buy, sell or retain shares in a particular company. Cases of insider trading includes; Corporate officers, directors and employees who traded the corporation’s securities after learning of significant and confidential corporate developments; friends, business associates, family members, and other “tippees” of a company’s officers, directors and employees, who traded the securities after receiving such information; employees of law, banking, brokerage and printing firms who were given such information to provide services to the corporation whose securities they traded; government employees who learnt of such information because of their employment by the government; and other persons who misappropriated and took advantage of confidential information from their employers.
The concept leaves scholars with their daggers drawn as to whether there should be a coexistence of a legal form of insider trading and its illegal form, however the rationale given by those on the latter side transcends the fact that inside traders are exploitative of the tool to manipulate the stock market and corporate affairs in general, to the argument that this practice has adverse effects on the confidence of an investor in the stock market. Thus, Felix Salmon, arguing for bans on insider trading, wrote, “If you want a nation of shareholders, you need to give individuals some faith that they won’t get picked off like so many fish at a poker table.”This writer agrees that this is a worthy justification for the criminalization of this act in spite of the argument by Dylan Mathews that while every system pursues this ban to create fairness, such a system must not neglect the fact that every investor should be aware of potential risk in losses and the illusionary existence of fairness.
The concept of insider trading became internationally recognized from the 17th century, and the public perception of insider trading remained that it was part of the ‘perks’ of being an executive to have an advantage over other investors through information obtained from either being an insider or from other insiders which may inevitably influence any financial decision made.As the public perception changed, several jurisdictions took legislative measures against this concept. United States (USA) is the first jurisdiction to commence the prohibition of insider trading, before other countries like United Kingdom, Japan and China followed suit.
While this may be viewed as a plague in the system, there exists several views that it should be legalized. Such views consider the economic benefits of enrichment, the idea that it doesn’t make anyone suffer an actual loss and whether a duty is even owed to one who suffers any form of loss.While these arguments are strong, the most preyed on, being that of a nonexistent duty, doesn’t stand as a defining factor to the legality of other wise of this act as there has been a shift from the classical theory which has this as a defining factor, to the misappropriation theory which holds outsiders with no such fiduciary duty culpable.
This Article proceeds as follows: Part II will explain the propositions of the existent theories of insider trading and their scope of liability. Part III embarks on a sojourn to other jurisdictions in search of an answer to Nigeria’s enforcement questions. Part IV examines the Nigerian law on insider trading in a bid to proffer solutions to issues which leaves the door open to inside traders to conduct such mishaps and Part V concludes with the hope that the prepositions be brought to practice.
II. THEORIES OF INSIDER TRADING
In defining the concept of insider trading, the proper exposure will be lacking if this writer doesn’t address the arguments on the illegality of the act and the evolution of these in relation to the scope of liability, an exposure properly dished out with the theories in existent, being the classical theory and the misappropriation/unified theory.
The Classical Theory: deals with where the corporate insider trades in his own corporation’s stock on the basis of material, non-public information belonging to his corporation. The gist of this as stated in SEC v. Obus is that under the classical theory of insider trading, a corporate insider is prohibited from trading shares of that corporation based on material non-public information in violation of the duty of trust and confidence insiders owe to shareholders. The birth of this principle is credited to the United States Supreme Court Justice Lewis Powell who gave this theory based on the common law principle that nondisclosure of information by one with a fiduciary duty is fraudulent. Such a person is prohibited from trading in the corporation’s stock unless he discloses material non-public information that might be in his possession.This illegality exists unless this is done. The argument that this theory indeed fails to fill the holes in the liability created by this practice is bought by this writer. A learned author posits that this theory fails to explain settled law and provide answers to unsettled law that are intuitively appealing.
This failure leaves gaps in the laws of Nations who tow the path of the classical theory. Such gaps include the fact that since insiders do not owe fiduciary duties to bondholders, the classical theory means that the insider trading ban does not apply to trading in the corporation’s debt securities. Also, since the corporate entity itself cannot be said to owe these types of duties to shareholders, under the classical theory, the insider trading ban would not extend to a corporation’s repurchases of its own stock. Although the SEC takes theposition that corporate repurchases are subject to insider trading liability, the doctrinal grounds for this position are “shaky”.
The Misappropriation Theory: provides that it is illegal to trade in securities while in possession of material non-public information acquired from a person or entity to whom the trader owes a duty of loyalty and confidentiality.The difference between this and the classical theory revolves around the beneficiary of the trader’s fiduciary, or fiduciary-like, relationship and the nature of that relationship. In United States v. O’Hagan, a lawyer acquired information from a client about a company that he has no relationship with and subsequently used the information to profit from trading in that company’s stock. While the lower Court had held that the lawyer was not liable for insider trading under the classical theory, it was held on appeal that the lawyer violated insider trading law under the misappropriation theory but not the classical theory since he has a duty to the source of the information (i.e., his client) but not the shareholders against whom he is trading in the market. The misappropriation theory has historically been applied only to cases of insider trading involving corporate outsiders, meaning non-employees of the corporation whose stock forms the basis of the trade, but it is argued that there’s no barrier to the application of this theory to classical cases of insider trading.
A problem with this theory is that it would allow the fiduciary to remove himself from the reach of federal insider trading law simply by providing the principal with prior notice of the trader’s intent to trade on the principal’s information.
III. A SOJOURN TO OTHER JURISDICTIONS
In a bid to carve out the most suitable model which the Nigerian law should follow in addressing the issues of insider trading, a look at the laws of the United States and the United Kingdom is quite instructive.
The United States: is a leading country in prohibiting insider trading made on the basis of material non-public information.The law evolved from Section 15 of the Securities Act of 1933 which contained prohibitions of fraud in the sale of securities to the Securities Exchange Act of 1934 which in Section 16(b) prohibits short-swing profits (from any purchases and sales within any six-month period) made by corporate directors, officers, or stockholders owning more than 10% of a firm’s shares and in Section 10(b) (which evolved into SEC Rule 10b-5) prohibits fraud related to securities trading. These laws were based on common law criminalization of fraud and to specifically address the menace, the parliament enacted the Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988 which both place penalties for illegal insider trading as high as three times the amount of profit gained or loss avoided from the illegal trading.
The United States law has evolved from the classical to the misappropriation theory and with the continuous evolution of the laws and empowerment of the administrative body, the US Security and Exchange Commission prosecutes over 50 cases each year, with many being settled administratively out of court. Effective monitoring of transactions and seclusion of suspicious transactions are methods deployed to curb this menace and achieve results.
The United Kingdom: has its laws putting more of a burden on investors, stating that if they receive market-moving non-public information they are not supposed to trade. A landmark development in the UK law is that while criminal insider dealing requires deliberate intent, the UK’s Financial Services Authority has brought several big civil market abuse cases involving “inadvertent” or “unintentional” violations and successfully defended them on appeal, an example of this being the Einhorn case, where Mr Einhorn refused to trade with inside information but unintentionally told the individual requesting for such information about a fundraiser and the UK’s Financial Services Authority tagged this as inside dealing. This regime is indeed broader.
These developments are seen under the Financial Services and Markets Act 2000(Now 2010 amended), an enactment to solve issues under the 1993 Criminal Justice Act which require the standard of proof in prosecuting insiders to be beyond reasonable doubt, a difficult task for the regulators to prove.
The broad nature of the law of the jurisdictions examined above and the scope of authority given to the administrative bodies leaves much to be desired in Nigeria.
IV. CONTEXTUALIZATION OF INSIDER TRADING IN NIGERIA
The concept of insider trading in Nigeria would have been viewed as an alien one as it didn’t gain a lot of attention until the crisis which rocked the Nigerian financial sector in 2007 and extended to 2008 of which the financial sector had to go through the process of mergers and acquisition mandated by the Central Bank of Nigeria as one of the corrective measures. This has spread to other sectors as the most evident is seen in the suspicious sale of shares of telecommunications giant, MTN, after they were slammed with a $5.2 billion fine by the Nigerian Communications Commission in 2015, a sell-off which happened before this information was made public. Unfortunately, the Nigerian Securities and Exchange Commission didn’t begin an investigation like their Johannesburg counterpart. Also in 2017, SEC suspended the shares of Oando PLC, an oil company, on the grounds of Insider trading for proper investigations.
Nigerian Law on Insider Trading: Tales of a Lip Locked Legal System
The Nigerian law isn’t silent on this concept, rather, the body movement tilts towards the stagnation of legal development as evident in various areas of the law. This reason accounts for the dearth of cases on this subject matter.
In following the trend set by the United States, Nigeria enacted the Investment and Securities Act 2007 to regulate insider trading. The presence of this law has neither deterred insiders nor curbed insider trading. However, this is now supplemented by SEC Rules and Regulations (SEC Rules) and the SEC Code of Corporate Governance for Public Companies 2011 (SEC Code of Corporate Governance).
Section 111 of the ISA precludes an insider of a company from buying or selling or otherwise dealing in the securities of the company which are offered to the public for sale or subscription if he has information which he knows is unpublished price sensitive information in relation to those securities. Rule 110(e) of the SEC Rules also contains a similar restriction. Worthy of note, is that Rule 17 of the SEC Code of Corporate Governance extends the restrictions to cover a director’s immediate family (spouse, son, daughter, mother or father).
Transactions made in violation of Section 111 of the ISA are voidable at the instance of SEC and could also give rise to criminal prosecution. A natural person is liable on conviction to a fine of NGN 500,000 or an amount equivalent to double the amount of profit derived by him or loss averted by the use of the information or to imprisonment for up to seven years. An offending body corporate is liable on conviction to a fine of NGN 1 million or an amount equivalent to twice the amount of profit derived by it or loss averted by the use of the information.
It has been suggested that one way of preventing insider trading is for regulators to enforce rules relating to the timely disclosure of material information. However, the mechanism by the SEC in the Exchange Listing Rule approved on 19th May 2014 is welcomed. The rule states that “No Director, person discharging managerial responsibility and Adviser of the Issuer and their connected persons shall deal in the securities of the Issuer when the trading window is closed. Any period during which trading is restricted shall be termed as a closed period.”
Closed periods are effective fifteen(15) days before the board sits to decide on the following matters or 24 hours after the circulation of the agenda papers for the following matter; a declaration of financial results, dividends, issue of securities, any major expansion plans or winning of bid or execution of new projects, amalgamation, mergers, takeovers and buy-back; disposal of the whole or a substantial part of the undertaking; any changes in policies, plans or operations of the company that is likely to materially affect the prices of the securities of the company; disruption of operations due to natural calamities; litigation/dispute with a material impact; or any information which, if disclosed, in the opinion of the person disclosing the same is likely to materially affect the prices of the securities of the Company.
Embracing the trends in other jurisdictions, the following solutions are proffered;
- A review of the existing laws regulating insider trading to include more stringent provisions especially sanctions imposed.
- The scope of the authority of regulatory agencies should be widened and the welfare/remuneration of their Staff reviewed.
- There is a need for regulators to forge closer relationship with other agencies (both local and international) fighting against financial crimes.
The concept of insider trading is one which leaves an argument as to whether it should be legalized or not. The views of this writer has tilted towards an affirmation of the recognition of this practice as illegal to ensure fairness and investor confidence in trading. While the misappropriation theory remains the best, being an all encompassing theory, Nigeria must continue to review its laws to meet emerging trends. The eyes of the regulatory bodies must be fixed on identifying and foiling suspicious trades which amount to insider trading. As a nation which seeks several investors to continue on the path of development, the doors must be closed on prospective and existent inside traders, so as not to let such information possessed be a tool which creates unfairness in the capital market.
Iheanacho Nelson is a 400 level student of of the Faculty of Law, University of Lagos. Born on 8th October, 1997. An indegene of Imo State, Nigeria. The author is a member of several organizations including the Lagos Model United Nations, the Mooting society University of Lagos, Gani Fawehinmi Student Chambers, Tax club, Oil and gas bar, Maritime forum and the ADR Society. The author’s area of interests includes human rights and commercial law topics.