INSIDER TRADING
REGULATIONS IN U.S. AND
A PROPOSAL FOR TURKEY
1

WHAT IS INSIDER TRADING ?
 There is no statutory definition
 Encompasses both legal and illegal
activity
 Our discussion: illegal one
 When those with confidential information
use that special advantage to gain profit or
avoid losses on the stock market
 Damages the source of information and
other typical investors
2

WHO ARE INSIDERS?
 Not just corporate directors, officers or major
shareholders
 A broader range of individuals;
 A partner in a law firm representing the acquiring company in a
hostile takeover bid who traded in target company stock.
 A Wall Street Journal columnist who traded prior to publication of
his column in the stock of companies he wrote about.
 A psychiatrist who traded on the basis of information learned
from a patient.
 A financial printer who traded in the stock of companies about
which he was preparing disclosure documents.
3

WHY US REGULATIONS?
 Insider trading has started to cross
borders
 EC Directive provides that members may
enact laws more stringent than set out in
the Directive
 U.S. has the most comprehensive and
detailed regulations against insider trading
4

INSIDER TRADING DEBATE
 Opposing Views
 Form of compensation for employees
 No statutory definition, unfairly penalize
traders
 Enforcing insider trading not cost effective
 Smooth prices and more efficient market
 Companies may prohibit it in the contract
5

REASONS FOR REGULATING
INSIDER TRADING
 Unfair practice to public investors
 Prohibiting it promotes efficiency of
markets
 Property of material information belongs to
the corporation for business purposes.
6

US REGULATION OF INSIDER
TRADING
 Section 16 of the 1934 Securities
Exchange Act
 SEC Rule 10b-5
 Classical Theory
 Misappropriation Theory
 SEC Rule 14e-3
7

Section 16 of the 1934 Act
 Designed to watch more closely the trading of
corporate insiders on their corporation’s stock.
 Covers officer, directors, and 10% equity holders
 §16(a) -> Disclosure Provision ->Every corporate
insider should report holdings and transactions.
Facilitates §16(b)
 §16(b) -> Recovery of Short-swing Profits ->These
insiders must disgorge profits from selling stock held
less than six months
8

Rule 10b-5
 Promulgated in 1942 under §10(b) of the
Securities Exchange Act of 1934
 Covers
 material corporate misstatements or non
diclosures,
 insider trading, and
 corporate mismanagement cases
regarding transactions in shares or other
securities
 Today a major weapon to curb insider trading,
as a catch-all anti-fraud provision
9

Rule 10b-5
It shall be unlawful for any person, directly or indirectly, by the use
of any means or instrumentality of interstate commerce, or of
mails, or of any facility of any national securities exchange,
• to employ any device, scheme, or artifice to defraud,
• to make any untrue statement of a material fact or to omit
to state a material fact necessary in order to make the
statements made, in the light of the circumstances under
which they were made, not misleading, or
• to engage in any act, practice, or course of business which
operates or would operate as a fraud or deceit upon any
person,
in connection with the purchase or sale of any security.
10

Rule 10b-5
 Legal Theories of Rule 10b-5
 Traditional Theory
 Misappropriation Theory
11

Traditional Theory of Insider
Trading
 Also known as “disclose or abstain rule”
 Insiders, acting on behalf of their company or on their own
behalf, have a fiduciary duty to the company’s shareholders
either to
 disclose material, nonpublic information before trading or
 to abstain from trading.
 Developed through major cases of
 In re Cady, Roberts & Co (1961)
 SEC v. Texas Gulf Sulphur Co. (1968)
 Chiarella v. United States (1980) -> Rule 14e-3
 Dirks v. SEC (1984)-> Regulation FD
12

Traditional Theory of Insider
Trading
 A person violates Rule 10b-5 by buying or selling securities
on the basis of material nonpublic information if
 she owes a fiduciary or similar duty to the other party to
the transaction
 she is an insider of the corporation in whose shares she
trades, and thus owes a fiduciary duty to the corporation’s
shareholders
 she is a tippee who received her information from an
insider of the corporation and knows or should know, that
the insider breached a fiduciary duty in disclosing the
information to her
13

Misappropriation Theory of Insider
Trading
 First mentioned in Chiarella case
 In Carpenter v. United States (1986) case Supreme
Court split 4 to 4
 Clearly accepted by the Supreme Court in 1997,
United States v. O’Hagan case
14

Misappropriation Theory of Insider
Trading
 A person violates Rule 10b-5 if
 Misappropriates material nonpublic information
 by breaching a duty arising out of a relationship of
trust or confidence to the source of information
 and uses that information in a securities transaction
 regardless of whether he owed any duty to the
shareholders of the traded stock
15

Misappropriation Theory of Insider
Trading
 Misappropriating information is :
 obtaining by improper means or
 converting it to his/her own benefit even if properly
obtained
 According to Rule 10b5-2 a duty of trust or confidence exists
when:
 a person expressly agrees to maintain information in confidence;
 the facts and circumstances of the relationship as a whole show a
history, pattern or practice of mutual sharing of confidences; or
 a person receives information from a spouse, parent, child or sibling,
unless the person receiving the information can show that, under the
facts and circumstances of the family relationship, no reasonable
expectation of confidence existed.
16

Scope of Rule 10b-5
 Applies to any purchase or sale by any person of any security
 Fall within the jurisdictional reach
 “In connection with the purchase or sale of a security”
 To recover damages reliance (transaction causation) must be
established (not for SEC)
 The plaintiff must also be able to prove “loss causation”
 Rule 10b5-1 presumes that someone who trades while in
possession of material non public information has in fact used
the information in making the trade.
 Statute of limitations is one year after discovery and three
years after violation.
 Tipper &Tippee liability applies to both theories. Contact
between them should be established.
17

Rule 14e-3
 Prohibits insider trading during a tender offer and thus
supplements Rule 10b-5.
 Rule 14e-3(a) prohibits anyone, except the bidder, who
possesses material, nonpublic information of a tender offer,
from trading the target’s securities
 Rule 14e-3(d) is a preventive provision complementing Rule
14e-3(a). Prohibits anyone with any form or connection to a
tender offer from tipping material, nonpublic information.
 Is not premised on breach of a fiduciary duty
18

SEC Enforcement of the Rule
10b-5 and Rule 14e-3
 Permanent or a temporary injunction
 Disgorgement of profits (most commonly used)
 Correction of misleading statements
 Disclosure of material information
 Cease and desist orders
 Disciplinary sanctions and civil penalties for securities market
professionals
 Bounty provisions by the §20A of ITSFEA
 §21A -> civil monetary penalty of up to three times the profit
gained or loss avoided by a person who violates Rules 10b-5
and 14e-3
19

Private Enforcement of the Rule
10b-5 and Rule 14e-3
 Under §20A’s express remedy, contemporaneous traders are
permitted to sue for a disgorgement of the improper profits (or
loss avoided).
 SEC’s power increased with private actions.
 A plaintiff in a private damage action must have been
purchaser or seller of the security forming the basis of the
complaint and transaction causation usually presumed but loss
causation is required.
20

FRONT RUNNING
 A broker trades on a security while in possession of material
non-public information concerning the imminent block
transaction of one of his customers
 The SEC has suggested that the exchanges designate front-
running as a practice “inconsistent with just and equitable
principles of trade”
 SEC’s current regulation is through its oversight authority
over the self-regulatory organizations (SROs); NYSE, AMEX,
NASDAQ.
21

INVESTIGATION, REGULATION,
ENFORCEMENT COMPARED
 Comprise at least about 10% of the enforcement actions of
SEC.
 As of 24.02.2003 only 10 out 820 suits of Capital Markets
Board of Turkey were related to insider trading.
 Development of capital markets is usually matched with new
insider trading schemes
 Transnational insider trading cases
 United States has the most extensive insider trading
regulations
22

INVESTIGATIONS
COMPARED
 The same for both companies
 Sources of cases
 Informants
• Anonymous Calls
• Market professionals
• Disgruntled employees
• Competitors
 Market Surveillance
 Investigative Steps
 Analyze market trading records
 Obtain chronologies
 Conduct Interviews
 Analyze Monthly Account Statements
 Analyze Telephone Records
 Chart Out Connection b/w Insiders & Traders
 Take Testimony
 Follow the Money
 Create and Update “Names” and Phones” Databases
23

REGULATION AND
ENFORCEMENT IN TURKEY
 Only specific regulation against insider trading is Article
47/A-1 of CML:
“To benefit to his/her self-owned property or to eliminate a loss so as to
damage equal opportunity among the participants in capital markets with
the aim of gaining benefit for himself/herself or for third parties by making
use of non-public information which will be able to affect the values of
capital market instruments in insider trading. The chairman and members
of the Board of Directors, directors, internal auditors and other staff of the
issuers within the scope of Article 11, capital market institutions or of the
subsidiary or dominant establishment, and apart from these the persons
who are in a position to be have information while carrying out their
professions or duties, and the persons who are in a position to have
information because of their direct and indirect relations with these.”
24

REGULATION AND
ENFORCEMENT IN TURKEY
 In summary according to the CML;
 Scienter is required,
 The scope of possible defendants is very broad,
 A gain of profit or avoidance of loss is required,
 Materiality depends on the ability of the non-public information to affect the
value of the capital market instruments,
 CMB may request a legal prosecution and/or may prohibit the violators
temporarily or permanently from transactions on exchanges and other
organized markets (According to Article 46/i of the CML).
 The criminal penalty for the violation of this Article is a prison sentence from
two to five years and a heavy pecuniary fine from 10 billion TL up to 25
billion; If 2 or more cases are combined then min 3 max 6 years of prison.
 No upper limit for pecuniary punishment, but not less than threefold of the
benefits
25

REGULATION AND
ENFORCEMENT COMPARED
 Differences
 Philosophy different; in U.S. definition deduced from court
interpretations; an emphasis on breach of fiduciary duty
 Bounty system
 In U.S. insider trading seen as a private fraud <-> In Turkey public
fraud harming markets; no civil actions only criminal
 Subpoena Power
 In Turkey; no regulations like 14e-3, Regulation FD and no specific
front-running rules.
26

REGULATION AND
ENFORCEMENT COMPARED
 Similarities
 In Turkey; there is a public disclosure requirement similar to §16(a)
 Securities do not have to be traded or listed on an exchange in order to
attach a liability to an insider trader, in contrast to the case in many
European countries
 CMB’s power to temporarily (for 2 years) or permanently prohibit the
violator from transacting on exchanges and other organized markets
27

WHAT IF FAMOUS CASES
HAPPENED IN TURKEY?
Turkey Conviction in
Case Subject Materiality Gain/Loss Turkey?
Cady Roberts Co. A registered broker-dealer directed his customers to
liquidate their holdings in Curtis-Wright stock because he
√ √ √
had advance knowledge of a dividend cut.
Texas Gulf Sulphur Insiders of a mine company purchased company stock on the √
open market with knowledge of a valuable mineral find that
√ √
had not been publicly announced and made a considerable
profit after the announcement.
Chiarella A financial printer deduced the names of the target
companies in takeover bids from the documents he printed. ? √ ?
He purchased the target company’s securities before the
announcement of bids and sold them after the bids, thus
making a profit.
Dirks A company’s former official’s selective disclosure of insider
information to an analyst giving an unfair advantage to the
√ √ √
analyst and the analyst’s clients over the public generally
Carpenter A columnist of the Wall Street Journal traded the securities In Turkey this case would be
he wrote about and in turn gained a profit. interpreted as manipulation. √
O'Hagan The attorney, after having learned of the law firm’s client’s
planned tender offer, purchased call options in the target ? √ ?
company prior to the announcement of the tender offer. 28

A PROPOSAL FOR TURKEY
 The word “value” in Article 47/A-1 can be changed as “value
and/or price”
 The requirement for a profit gain or avoidance of a loss can be
eliminated
 An addition may be made to Article 47/A of the CML, in order
to provide CMB with pecuniary punishments for violations of
insider trading
 Adding bounty provisions
 Under CMB’s oversight, Association of the Capital Market
Intermediary Institutions of Turkey may prohibit front-running
by enacting a uniform rule to be applied in all exchanges and
organized markets.
 CMB may promulgate a regulation similar to Regulation FD
29

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