Regulator gets tough on insider trader
The Insider Trading Act was promulgated in 1999. This law governs how directors (and ordinary citizens) should approach stock market transactions – their buy and sell decisions – when they possess ‘sensitive’ information about a listed company. People who contravene the Act could run foul of the Financial Services Board (FSB), which investigates ‘insider trading’ and similar allegations through its Directorate of Market Abuse department. The FSB states: “If a person becomes an insider, the Act prohibits him/her dealing in the securities that the inside information relates to, encouraging another to deal, and disclosing the inside information.”
Punishing insider traders
The Enforcement Committee of the Financial Services Board (Committee) is responsible for ruling on insider trading infringements. Last week they announced the finalisation of their case against Johan Pieterse, managing director of Scharrighuisen Drilling (Pty) Ltd, a subsidiary of JSE-listed Sentula Mining Limited. In 2008, Pieterse became aware of a large impairment in the assets of the subsidiary and used this ‘inside’ information to trade beneficially in the company’s shares. Pieterse admitted the allegations and tendered a penalty of R1m, which was duly imposed by the Committee. The case against Nicolaas van der Merwe (accused of similar transgressions) is ongoing.
Ordinary Sentula Limited shareholders found out about the impairment the hard way. And they could only watch as their investments plummeted when the information was made public. On Friday, 30 May 2008 shares in the general mining company closed at 1585c. By the time the dust had settled on Monday, 2 June 2008, its shares were worth a mere 1190c. Investors lost 385c/share (or 24.92%) of their investment in a matter of hours. The share selling frenzy was triggered by the contents of a trading update (the insider information) which was distributed via the JSE SENS system at 08:56 Monday, four minutes before the market opened. The update – to which certain Scharrighuisen directors were already privy – mentioned a disappointing outlook for earnings for the 2008 financial year and some accounting errors that would require restatement of its 2007 results. These accounting errors proved extremely serious! The massive single day price movement prompted the FSB insider trading investigating just mentioned.
Meanwhile in the United States
International insider trading rules vary from country to country. The United States, for example, distinguishes between legal and illegal insider trading. Illegal insider trading occurs when an individual completes a market transaction armed with privileged corporate information not yet in the public domain. The argument is that such a person has an unfair advantage over the rest of the market because of this knowledge, thus violating the essential transparency requirement of an efficient capital market.
US website investopedia.com continues: “Inside information is not only unfair but disruptive to a properly functioning market. If insider trading were allowed, investors would lose confidence in their disadvantaged position (in comparison to insiders) and would no longer invest.” There are dozens of activities a director or connected person might know about that qualify as inside information. These include: knowledge of an upcoming merger or acquisition, knowledge of an earnings announcement, knowledge of a new discovery or innovation, an unreleased recommendation from a share analyst and knowledge of an imminent exclusive in a financial news column.
Although tightly regulated, directors of companies can purchase and sell shares in their companies. We refer to this activity as director’s dealings, while the US classifies it as legal insider trading. They refer to legal insider trading as “the trading of a corporations stock or other securities by individuals with potential access to non-public information about the company.” American investors are so intent on benefiting from this form of ‘insider’ trading that they’ve created the Claymore Sabrient Insider Exchange Traded Fund (AMEX:NFO) that tracks an index of 100 US-listed shares selected (from around 6,000) largely on the strength of which companies show “a trend of insider buying.”
Fair trading
Insider trading situations occur on a daily basis. They are fairly difficult to identify, and even more difficult to successfully prosecute. The best way to mitigate insider trading risk is to ensure everyone receives important information at the same time, and to punish directors and connected persons who act on ‘inside’ information
Editor’s thoughts: There have been precious few successful prosecutions of insider trading and market manipulation transgressions in South Africa. Is the punishment meted out in today’s insider trading case sufficient to deter future contraventions of the Act? Add your comments below, or send them to [email protected]
