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Insider
- 1. INSIDER TRADING REGULATIONSIN U.S. AND A PROPOSAL FOR TURKEY
- 2. WHAT IS INSIDERTRADING ? 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
- 3. 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.
- 4. 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
- 5. INSIDER TRADING DEBATEOpposing 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
- 6. REASONS FOR REGULATINGINSIDER TRADING Unfair practice to public investors Prohibiting it promotes efficiency of markets Property of material information belongs to the corporation for business purposes.
- 7. US REGULATION OFINSIDER TRADING Section 16 of the 1934 Securities Exchange Act SEC Rule 10b-5 Classical Theory Misappropriation Theory SEC Rule 14e-3
- 8. Section 16 ofthe 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
- 9. Rule 10b-5 Promulgatedin 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
- 10. Rule 10b-5 Itshall 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.
- 11. Rule 10b-5 LegalTheories of Rule 10b-5 Traditional Theory Misappropriation Theory
- 12. Traditional Theory ofInsider 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
- 13. Traditional Theory ofInsider 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
- 14. Misappropriation Theory ofInsider 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
- 15. Misappropriation Theory ofInsider 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
- 16. Misappropriation Theory ofInsider 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.
- 17. Scope of Rule10b-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.
- 18. Rule 14e-3 Prohibitsinsider 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
- 19. SEC Enforcement ofthe 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
- 20. Private Enforcement ofthe 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.
- 21. FRONT RUNNING Abroker 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.
- 22. INVESTIGATION, REGULATION, ENFORCEMENTCOMPARED 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
- 23. INVESTIGATIONS COMPARED Thesame 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
- 24. REGULATION AND ENFORCEMENTIN 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.”
- 25. REGULATION AND ENFORCEMENTIN 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
- 26. REGULATION AND ENFORCEMENTCOMPARED 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.
- 27. REGULATION AND ENFORCEMENTCOMPARED 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
- 28. WHAT IF FAMOUSCASES HAPPENED IN TURKEY? ? √ ? 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. O'Hagan √ In Turkey this case would be interpreted as manipulation. A columnist of the Wall Street Journal traded the securities he wrote about and in turn gained a profit. Carpenter √ √ √ 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 Dirks ? √ ? 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. Chiarella √ √ √ 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. Texas Gulf Sulphur √ √ √ A registered broker-dealer directed his customers to liquidate their holdings in Curtis-Wright stock because he had advance knowledge of a dividend cut . Cady Roberts Co. Turkey? Gain/Loss Materiality Subject Case Conviction in Turkey
- 29. A PROPOSAL FORTURKEY 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
- 30. THANK YOU SENEM DEMIRKAN
Editor's Notes
- #4 We will see that insiders do not have from inside the firm. The term insider encompasses may people ranging from a psychiatrist or a financial printer. ( Psychiatrist case is United States v. Willis. )
- #5 The European Council adopted the Directive on insider dealing and market manipulation (market abuse) on 3rd December 2002. The Directive is due to be implemented by Member States of its publication in the EU’s Official Journal.
- #6 However none of these views make sense. First, as Prof. Loss and Seligman noted, wage market already compensates hard worker and those who do not contribute to the company may also benefit from insider trading. Scienter is required to prove insider trading and investigations are difficult. Most of the illegal activity remains undetected. Maybe for equities trading you can say that the transaction anyway would occur. However for options for example, these information have crucial importance. You can not ignore them. Professors Loss and Seligman found that insider trading does not have any significant effect on market price and does not make prices smoother It is very difficult and costly for companies to monitor and discipline insider trading.
- #9 The purpose of §16 has two aspects According to § 16(a) these insiders file an initial report showing their holdings of all the issuer’s equity securities and if changes occur in their holdings they file a report within the first ten days of that month with the SEC and with the exchanges on which the securities are listed. §16(b) whether P and S or S and P of the issuer’s equity securities. If the issuer does not do so within 60 days, any shareholder can bring a suit against the corporate insider on behalf of the issuer. Statute of limitations is two years after the profit is realized. However short-swing profits are recoverable regardless of whether the insider actually traded on the basis of confidential information or even was in possession of any such information . Nonetheless, this conduct covered by §16(b) is not deemed to be unlawfu l and cannot cause any criminal liability or injunction of SEC.
- #10 Once bunu soyle **** §17(a) of the Securities Act and §10(b) of the Exchange Act are the general anti-fraud provisions applicable to insider cases. Although both §17(a) and Rule 10b-5 prohibit the same type of conduct, Rule 10b-5 has a broader scope. Rule 10b-5 applies to both purchases and sales of securities, whereas §17(a) applies only to sales.
- #11 unusually short and broad. There is no statutory definition of insider trading. It simply prohibits any person from doing any fraud in connection with any securities trading . The conduct should touch purchases and sales, so any decision to retain stock, although based on inside information, may not be considered under the scope of this Rule. The fraudulent act type is not specified in the rule and this interpretation is left to courts intentionally to provide flexibility in the application.
- #12 These are , as we will see, are complementing each other.
- #13 This fiduciary duty derives from common law where a company shareholder is a beneficiary of the insider’s fiduciary obligation. Corporate insiders breach a fiduciary duty only for a personal or economic benefit. Burada bu caselerden bahsetmek lazim.
- #17 The duty may arise from a fiduciary relationship or from a relationship of trust or confidence. The traditional theory and the misappropriation theory are complementary. The traditional theory targets a corporate insider’s breach of duty to shareholders with whom the insider transacts; the misappropriation theory prohibits trading on the basis of nonpublic information by a corporate “outsider” in breach of a duty owed to the source of the information.
- #18 The rule applies regardless of whether the security is exempt from 1933 or 1934 Act or not and regardless of whether the company is publicly or closely held. Use of instrumentalities of interstate commerce, such as phones, facsimiles, or the mails must be proved. A link between the fraud and the purchase or sale Transaction causation: in a face-to-face transaction between seller and purchaser the plaintiff’s reliance can be presumed from the materiality of the omissions. ‘fraud on the market’ theory for proving reliance, simply stating that the reliance requirement in a securities fraud action can be satisfied by a showing that the market price was affected by the misstatement or omission and the plaintiff’s injury is due to a purchase or sale at the then fraudulently induced market price. “loss causation” which provides the necessary connection between the challenged conduct and the plaintiff’s pecuniary loss. A plaintiff is required to prove that a defendant’s misstatement or misconduct was at least a “substantial factor” in causing a loss. As part of the Private Securities Litigation Reform Act of 1995. §21D(b)(4) of the 1934 Act now provides that loss causation is an element of a private law suit for securities fraud.
- #19 During the 1960’s, there was a substantial increase in tender offer in U.S but there were no disclosure provisions applicable to tender offers. 1968, Congress adopted the Tender Offer and Takeover of the Williams Act amendments to the Exchange Act. §14-e is one of the Williams Act amendments and it includes general antifraud provision for all tender offers However it is also quite limited in scope, since (1) it does not apply until the offeror has taken substantial steps towards making the offer and (2) both prongs of the rule are limited to information relating to a tender offer.
- #20 The SEC does not have authority to prosecute criminal actions against inside traders but it is authorized to ask the Justice Department a willful violation of Rule 10b-5 or 14e-3 is a felony that can be punished by a $1 million fine ($2.5 in the case of corporations) and up to 10 years in jail. The Insider Trading Sanctions Act (ITSA) of 1984 amended the Exchange Act by adding §21A . Since the SEC thus may seek both disgorgement and treble damages (civil penalty), an inside trader faces potential civil liability of up to four times the profit gained. The §21A penalty may be imposed on both traders and tippers and is payable into the Treasury. §21A applies only to transactions effected on an exchange or through a broker-dealer.
- #21 At first, private enforcement has evolved solely from judicial implications, even though these rules do not explicitly permit any private lawsuits. . In 1988, Congress enacted the Insider Trading and Securities Fraud Enforcement Act (ITSFEA) which amended the Exchange Act by adding §20A. SEC to pay a bounty to informers of up to 10% of any penalty collected by the SEC.
- #22 Section 15(F) requires that every registered broker dealer “establish, maintain and enforce written policies and procedures reasonably designed …. to prevent” violations of the provisions of the Exchange Act which prohibit insider trading and tipping,
- #23 However, examples of long established capital markets show that development of capital markets is usually matched with new insider trading schemes and a need for better regulations against it. beginning in the early 1980s, transnational insider trading cases have become increasingly prominent. from both national and international aspects, it is necessary to establish very comprehensive rules against insider trading.
- #24 The only difference is that CMB can only request telephone records through prosecutors and this procedure makes investigations longer.
- #26 In the case of the repetition of the acts subject to the penalties determined in this Article, the penalties given shall be increased them by one half. In order to raise the penalties, execution of the previous penalty is not a condition. ”
- #27 In US : civil proceedings of SEC, criminal proceedings of DJ and private actions. Why civil enforcement : extreme difficulty to prove insider trading. What is in the mind of the trader Direct evidence of insider trading is rare. Evidence is almost entirely circumstantial. You have to examine events like – meetings in restaurants, telephone calls, relationships between people, trading patterns This is why providing civil, as well as criminal, liability is vital to the insider trading program of SEC. Proving a purely circumstantial case is easier in the civil context, Where burden of proof shifts to defendant Subpoena -> to compel witnesses to testify or to produce books, records, and other evidence.
- #28 On the other hand, a provision similar to the §16(a)’s public disclosure requirement exists in the Serial :VIII, No:20 “Communique on Principles Regarding Public Disclosure of Material Events” Article 3/H-a which states that: “ major shareholders, chairman, members of BOD, general directors, assistant general directors should publicly disclose when they own more than 1% of the corp. Capital. They have to send it in writing in detail to the Board and the Exchange, every month once this amount is reached. §16 does not make short-swing transactions unlawful Current public disclosure regulations of CMB are as effective as §16 even though they don’t require recovery of such profits, since the main aim of these regulations should be to deter insider trading. As opposed to SEC’s injunction, cease-or-desist, disgorgement, civil penalty powers, the only penalty available to CMB other than criminal ones is prohibition of trading Similar to SEC, CMB also is authorized by law to request the correction of misleading statements and disclosure of material information.
- #29 1) Are the non-public information mentioned in these cases able to affect the Value of the security? 2) Have the defendants gained a profit or avoided a loss from this insider trading? Insider trading most often occurs when the inside information involves unexpected events crucial to assessing a company’s value. . Information about tender offers unrelated to business developments ; rather, it is market information about the amount that some third party was willing to pay in the market for the issuer’s stock. Although Turkey’s insider trading implications have not evolved yet to include third party insider trading and the judicial implications of such cases have not been established, due to the provision of “with the aim of gaining benefit for himself/herself or for third parties ” the convictions would also include tippers who have not traded but acted with the aim of gaining benefit for third parties who gained profit or avoided loss as a result of insider trading conduct. Manipulation under Article/A-3 where people giving and disseminating misleading, false, deceiving information and news, make comments or do not disclose information that must be disclosed, will be punished like insider trading.
- #30 Turkey’s regulatory system is much different than U.S. and providing CMB with civil action rights or more powerful subpoena power would not result as efficient as U.S. So I proposed more article based changes. This change will allow us to grasp all insider trading cases where the information would be considered important by a reasonable shareholder It will also be able to cover insider trading relate to tender offers. According to Article 47/A of CML,CMB can impose a pecuniary punishment of between 2 billion TL and 10 billion TL on real persons and legal entities if they act in violation of the regulations, standards and forms or general and special decisions made by the Board these fees are paid to the Investors’ Protection Fund. The amount of the fine may be stated as of up to three times profit gained or loss avoided against persons who violated Article 47/A-1 by trading in a security while in possession of material nonpublic information. Bounty : bounties to informants of up to 10% of the civil penalties recovered.
- #31 Turkey’s regulatory system is much different than U.S. and providing CMB with civil action rights or more powerful subpoena power would not result as efficient as U.S. So I proposed more article based changes. This change will allow us to grasp all insider trading cases where the information would be considered important by a reasonable shareholder It will also be able to cover insider trading relate to tender offers. According to Article 47/A of CML,CMB can impose a pecuniary punishment of between 2 billion TL and 10 billion TL on real persons and legal entities if they act in violation of the regulations, standards and forms or general and special decisions made by the Board these fees are paid to the Investors’ Protection Fund. The amount of the fine may be stated as of up to three times profit gained or loss avoided against persons who violated Article 47/A-1 by trading in a security while in possession of material nonpublic information. Bounty : bounties to informants of up to 10% of the civil penalties recovered.