2. 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
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.
3
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
4
5. 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
6. 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
7. 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
8. 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
9. 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
10. 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
12. 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
12
Dirks v. SEC (1984)-> Regulation FD
13. 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
14. 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
15. 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
16. 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
17. 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
17
between them should be established.
18. 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
19. 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
20. 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
21. 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
22. 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
23. 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
23
Create and Update “Names” and Phones” Databases
24. 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
25. 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
26. 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
27. 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
28. WHAT IF FAMOUS CASES
HAPPENED IN TURKEY?
Conviction
Turkey in
Case Subject Materiality Gain/Loss Turkey?
A registered broker-dealer directed his customers to
Cady Roberts Co. liquidate their holdings in Curtis-Wright stock because he √ √ √
had advance knowledge of a dividend cut.
Insiders of a mine company purchased company stock on
Texas Gulf Sulphur
the open market with knowledge of a valuable mineral find
√ √ √
that had not been publicly announced and made a
considerable profit after the announcement.
A financial printer deduced the names of the target
companies in takeover bids from the documents he printed.
Chiarella He purchased the target company’s securities before the ? √ ?
announcement of bids and sold them after the bids, thus
making a profit.
A company’s former official’s selective disclosure of
Dirks
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.
The attorney, after having learned of the law firm’s client’s
O'Hagan planned tender offer, purchased call options in the target ? √ ?
company prior to the announcement of the tender offer. 28
29. 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
