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Chapter 1 - Background

Published in:
Casino capitalism? Insider trading in Australia / R Tomasic
Canberra : Australian Institute of Criminology, 1991
ISBN 0 642 15877 0
(Australian studies in law, crime and justice series) ; pp 1-3


Insider trading is the public scar of the industry and is certainly a problem.
(ASX compliance official, March 1988)

Insider trading is no new phenomenon to Australia. The Rae Committee reported on large scale insider trading in 1974. The reputation of Australian corporate players and the bullish state of the stock market in the late 1980s presented an ideal opportunity to examine the extent to which insider trading occurs in Australia. Although insider trading has been an offence under various Securities Industry Acts since 1970 (for example, section 75A Securities Industry Act 1970 [NSW]), there has not been a successful prosecution, and there has been no substantial body of judicial commentary on insider trading. It was against this background that in 1988 the research project on which this book is based was undertaken.

Coincidentally, the study arose in the context of increasing concern in Australia about the incidence and implications of insider trading and its possible impact on the securities market. There was also concern about the effectiveness of law enforcement in the securities market and corporate sector. Following the publication of the Anisman Report by the National Companies and Securities Commission (NCSC) in 1986, there was a call for more evidence about the nature and extent of insider trading as a problem in Australia. The publicity surrounding enforcement of insider trading laws in the United States, and to a lesser extent in Britain, led many to believe that insider trading could also be a problem facing the Australian securities market. With financial support from the Australian Criminology Research Council the research project set out to obtain and inject more concrete evidence into the Australian insider trading debate.

The lack of useful case law in the country on this topic meant that at least one of the traditional responses available to legal researchers was not available. Such case analysis as was undertaken was limited to overseas cases and to the few unsuccessful prosecutions which had been launched in Australia. The other traditional approach to legal research was to engage in that abstract and sterile debate concerning the policy issues surrounding the enforcement of insider trading which has particularly characterised the North American law review literature. A survey of this and jurisprudence was undertaken, but it was not felt that it would be productive to add to it without some more tangible evidence. For these reasons it was decided to adopt what for many lawyers would be seen as an unusual approach, an empirical study of the attitudes and experiences of key players in the securities industry with a view to systematically collecting more reliable evidence than the impressionistic material that had previously served as the basis for policy debates on insider trading in Australia.

The project involved a series of interviews with officials and professionals in Canberra, Melbourne, Perth and Sydney. Mail responses were also obtained from officials in other capital cities1. Access was obtained to principals and staff in broking houses and to partners undertaking corporate and takeover work in the four largest law firms in Australia. The study also included merchant bankers, financial advisers, representatives of industry groups and financial journalists. The level of co-operation received was uniformly high and, in view of the sensitivity of some of the issues, it was sometimes surprisingly high. Interviews often took up to two hours and occasionally even more.

The project generated about 2000 pages of questionnaire responses. The questionnaire contained 66 questions and was open ended in design to allow exploration of related issues as they arose during the course of the interview. There was a core group of 30 questions that all interviewees were asked to answer and the remaining questions were designed for particular industry groups, such as brokers, lawyers and enforcement officials. I spoke to, or received responses from, a total of 99 persons and conducted a total of 79 interviews in Australia. Also interviewed for this study were enforcement and stock exchange officials and insider trading researchers in London, Toronto and Washington to obtain comparative insights for the Australian study (see Appendix for methodological data concerning this study). Throughout the study, use was made of the statutory definition of insider trading from s 128 of the Securities Industry Act 1980 (Cwlth) which is now repeated in s 1002 of the Corporations Act 1989 (Cwlth).

A common observation by both the regulators and the regulated was that the law was uncertain and that the lack of case law in Australia has compounded the uncertainty. Regulatory authorities are reluctant to bring insider trading charges unless they have an extremely good chance of success in the courts. For this reason, much of the regulatory effort in respect to insider trading has been directed to informal enforcement by seeking to drive offenders out of the industry without resort to the courts. The reliance on informal settlement of insider trading law violations has meant that the law has little if any deterrent effect. Informal settlements, by their very nature, tend not to be publicised and the result is that the agencies have resorted to a most unsatisfactory system of enforcement. Of course, the notion of enforcing criminal law informally leaves much to be desired as a matter of principle.

Insider trading conduct has to be seen in the wider context of the literature on regulation. In Australia there has been relatively little socio-legal research dealing with the problems of regulation and law enforcement generally, let alone in respect of the securities industry. Some notable exceptions can be found in the work of Grabosky and Braithwaite (1986), Hart (1980), and in the case studies collected in Tomasic (1984) and Tomasic and Lucas (1986). The Australian literature on insider trading is virtually non-existent but there has been some work undertaken by Hogan (1988) and Tomasic (1988), as well as the literature from the Securifies Law Seminar (1986) held at Monash University. The Rae Committee (1974) collected much useful data on the extent of insider trading in Australia during the nickel boom of the late 1960s and the early 1970s. More recently, the House of Representatives Standing Committee on Legal and Constitutional Affairs (the Griffiths Committee), in its 1989 report on insider trading, and in the evidence collected in its hearings, provides further data and analysis of insider trading in Australia and evidence of the limitations in the law and its administration. An excellent historical perspective on the ethics of the Australian marketplace is provided by Sykes (1988).

Although academic analysis and research on insider trading is not well developed, there have been some significant contributions. The important work of Rider (1983) in the United Kingdom is one example. Empirical studies of attitudes to insider trading were undertaken by Rosenbaum et al. (1983-84) and by Tidwell and Aziz (1988). American research on insider trading has tended to fall into three very broad categories. First, there is the abstract body of law review literature which has done little more than to comment amid upon American cases. Some of this work has, however, inspired subsequent empirically based research efforts. In this tradition is the work of Brudney (1979), Cox (1986), Dooley (1980), Haft (1982), Schotland (1967) and Wang (1981). Another body of abstract writing emanating from the United States is the law and economics literature which has had a more empirical orientation. This style is characterised by studies such as those by Manne (1966a; 1970a), Carlton and Fischel (1983) and Easterbrook (1981). In contrast, the empirical evidence presented by Givoly and Palmon (1985) is based upon a less ideological perspective than that coming from some in the law and economics movement. A third strand is the occasional sociology of law inspired monograph which has been derived from the American literature on corporate regulation and which has served as useful background material for this study of insider trading. Examples of this are the work of Shapiro (1984) and Stone (1975). A useful case study on one aspect of the Boesky affair in the United States has been written by Frantz (1987). Other more theoretical work is that of Coffee (1984), Bardach and Kagan (1982), Hawkins and Thomas (1984), and Wilson (1980).

The term "insider tradng" in this book refers to the situations specifically referred to in s 128, namely situations where a person deals on the basis of price sensitive information which she or he possesses because of a connection with a corporation and at the time of the dealing, the information is likely materially to affect the price of the securities being traded. There is no need for the insider trader to make a profit. The critical factor is obtaining the price sensitive information from a source connected with the corporation. This source can range from employees of the corporation and its officers (directors and executives) to sources more removed from the corporation such as its professional advisers (lawyers, bankers and brokers). Genuine market analysis is not caught by the insider trading prohibition, except where it relies upon the receipt of price sensitive information from the source connected with the corporation. There may sometimes be a fine line to be drawn here, but then the law itself might be seen to be largely concerned with the drawing of fine legal and factual distinctions. Insofar as the legislative prohibition of insider trading is concerned, the problem is not so much one of determining its meaning, but of proving the major elements of the offence of insider trading.

Endnote

1. This research was assisted greatly by the support received from the Federal and State Attorneys-General and Commissioners for Corporate Affairs and their staff in each jurisdiction other than the state of Queensland. Considerable help was received from the Australian Stock Exchange branches in each city that was visited and the National Companies and Securities Commission was also very helpful during the course of the research.