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Chapter 11 - Insider trading law reform

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 127-141

The development of a coherent set of sanctions and remedies presents the newest difficult task in drafting insider trading legislation, for the implications of coverage reflected in the definition of "insider" and in the standards of conduct, both prohibitive and defensive, are clarified by the determination of the consequences that may flow from them and must be weighed against the practicality of their implementation.
(Anisman 1986, p. 100)

For at least the last twenty years insider trading has been the subject of intermittent official and community concern in Australia. Such concerns seem to have been accentuated during periods of booming market conditions and have led to some fairly modest official responses. To date, none of these responses to insider trading have significantly affected the extent of insider trading activity or led to more effective law enforcement procedures for dealing with securities market practices of this kind. In its 1974 report, Australian Securities Markets and Their Regulation, the Senate Select Committee on Securities and Exchange (the Rae Committee) was highly critical of the extent of insider trading activity in Australia. Some limited legislative changes resulted from the concerns of this period. Most importantly, this period saw the passage of s 75A of the Securities Industry Act 1970 (NSW), the predecessor of s 128 of the Securities Industry Act 1980 (Cwlth).

The 1980s again witnessed renewed expressions of community and official concern about insider trading. One of the major reasons for this concern seems to have been the perceived undesirable impact that the widespread presence of insider trading has had upon the international reputation of Australian securities markets. After the October 1987 share market crash, in February 1989, the Federal Attorney General requested the House of Representatives Standing Committee on Legal and Constitutional Affairs (the Griffiths Committee) to conduct an inquiry into insider trading and other forms of market manipulation. The report of that Committee was tabled in October 1989.

Like the Rae Committee, the Griffiths Committee confirmed the widespread nature of insider trading and called for legislative reform. A year later, in October 1990, the Federal Government released its response to the Griffiths Committee Report in which the Government largely endorsed the recommendations of the Committee. In December 1990, the Federal Attorney-General released an exposure draft of proposed new insider trading legislation. This draft proposed that s 1002 of the Corporations Law, the successor to s 128 of the Securities Industry Act, be repealed and replaced by twelve new sections which would have the effect of more than doubling the length of the original s 1002. A number of other consequential changes to the civil remedy provisions in s 1005 and s 10 1 3 were also proposed.

During the 1980s, the courts have continually shown that the existing legislative provisions were quite unsatisfactory. For a variety of reasons which go beyond the courts themselves, it proved to be almost impossible to convict alleged insider trading offenders under this legislation. This is not because efforts were not made by regulators to seek to bring actions, but largely because of the complexity of the legislation and because prevailing judicial attitudes were such that the chances of conviction were perceived to be very slim. Ironically, at the end of the decade it appears that this somewhat depressing picture may be beginning to change. One illustration of this is to be found in the Keygrowth case (Unreported, Supreme Court of Victoria, 30 November 1990) and possibly in three insider trading trials related to Tricontinental in Victoria (see also Stretton 1991). It is worth noting, however, that in the Sun Securities case in Western Australia, an insider trading prosecution against Kenneth Smith failed after Smith was acquitted by a District Court jury in February 1991 (see Shaw 1991, p. 36). However, one of the Tricontinental related trials has led to an acquittal of the accused.

The Griffiths Committee Report: Fair Shares for All: Insider Trading in Australia

As has been seen in earlier chapters, following widespread public and media concern about the prevalence of insider trading during the boom years of the 1980s, the Federal Attorney-General asked the House of Representatives Standing Committee on Legal and Constitutional Affairs to report on the adequacy of existing legislation in this area. In seeking this reference, the Griffiths Committee was influenced by research which had suggested that insider trading in Australia was extensive and that the law was largely inadequate (see Tomasic & Pentony 1989a, 1989b, 1989d, 1989e, 1990a). The recommendations of the Committee were in many respects far too limited. However, the main thrust of its report reflected a significant departure from previous governmental approaches to insider trading. What follows is a discussion of the findings of the Griffiths Committee and the Government's response to these findings. This includes a discussion of the draft insider trading legislation which was released by the Attorney-General on 20 December 1990, namely, the Corporations (Insider Trading) Amendment Bill 1990 (hereinafter referred to as the "Exposure Draft" ). The Griffiths Committee made 21 recommendations in Fair Shares for All:

Recommendation 1: The first and most important recommendation was that "the existing insider trading provisions be redrafted and simplified, with clear and practical definitions of the offence of insider trading" (Griffiths Committee 1989, p. 22). In this regard, the technicalities surrounding the need to show that the alleged insider trader was connected with the company whose securities were traded was seen as being too restrictive. The Committee concluded that:

The offence of insider trading must have its genesis in the use of information derived from within a company. The existing prohibition requiring a person to be connected to the corporation which is the subject of the information unnecessarily complicates the issue. It is the use of the information, rather than the connection between a person and a corporation, which should be the basis of determining whether insider trading has occurred (Griffiths Committee Report 1989, para. 4.3.5).

It is difficult to disagree with this basic recommendation regarding greater simplification, indeed, the Hawke Government has accepted this recommendation "in principle" (Duffy 1990, para. 26). Having accepted this basic recommendation, the "Government Response" to the Griffiths Committee then qualified this broad principle in the following terms:

27. Simplicity in the language of statutes is certainly the aim but when it is inconsistent with certainty, certainty has usually been preferred. 'Me tension between simplicity and certainty in drafting is exacerbated when the subject matter is itself complex. Ultimately, it is for specialist draftspersons to decide on the most effective wording, but the Government welcomes the Committee's suggestions as to how the legislation can be simplified (Duffy 1990, p. 7).

By this sleight of hand, the issue of fundamental insider trading reform has been avoided by resort to a somewhat spurious argument about the virtues of certainty. It is clear that attempts in the area of securities and taxation law to provide certainty have often only created greater complexity. There is much to be said for simpler legislative statements such as those found in what was s 229 of the Companies Code (Corporations Law s 232) and s 52 of the Trade Practices Act 1974 (Cwlth). As it is inevitable that insider trading laws will be dealt with through the courts, there is little reason to suggest that judges are not sufficiently robust to deal with the application of general principles in particular cases, once the legislature has clearly stated its purpose for legislating in an area. Indeed, the failure of the legislature to state its purposes in regard to Australian takeover law and its reliance on complex provisions aimed at creating certainty has only bewildered the judiciary (see Tomasic & Pentony 1989h, 1990b; 1990c). Moreover, some leading practitioners in this area have extolled the virtues of what has been called "fuzzy law" (Green 1990). Reliance upon more general principles in relation to insider trading legislation has of course been long established in the United States where s 10b of the Securities Exchange Act 1934 makes it unlawful

To use or employ, in connection with the purchase or sale of any security registered on a national Exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may proscribe as necessary and appropriate in the public interest or for the protection of investors.

Rule 10B-5 is the main rule made under this section which relates to insider trading. There is scant justification in Australia for the adoption of new insider trading legislation which is any more complex than existing provisions. Yet, the Exposure Draft of the new insider trading legislation is at least twice as long as the existing s 1002 and, arguably, only marginally less complex. One explanation for this complexity seems to be that the drafters of this legislation have been accustomed to drafting taxation legislation. There is little excuse for such verbosity in the name of the unconvincing achievement of certainty. Having said this, it is important to recognise that, as Philip Anisman has pointed out:

Any attempt to develop legislation, therefore, must involve both a balancing of the various policy underpinnings to take into account a large variety of potential factual patterns and a number of compromises to accommodate them to a Context that defies a simple resolution in terms of traditional legal categories, if the desired goals are to be achieved (Anisman 1986, p. 10).

Recommendation 2: The Griffiths Committee's remaining recommendations were fairly technical in nature. In its second recommendation, the Committee sought to clarify the concept of inside information and the related notion of materiality. It urged that the concepts of materiality and inside information be legislatively defined. It suggested that "materiality" be defined by reference to a reasonable person test.

In Recommendation 2, the Committee stressed that the focus of the insider @ng provision should be upon the use of the inside information to trade, subject to an exception for underwriters. In the Government's response, the Attorney-General observed that "The Government considers that, once the prosecution has proved that the person was in possession of the information and that the person traded in the relevant securities, it is reasonable to assume that the person was motivated by possession of the information" (Duffy 1990, para. 29).

There is a lot to be said for some clarification in the definition of key aspects of the offence of insider trading in view of the failure of Australian courts adequately to define these matters. However, beyond the enactment of such definitions, an insider trading prohibition should be expressed in terms of a general legislative principle supplemented by an explanation of the broad purposes of the legislation.

Recommendation 3: In Recommendation 3, the Committee called for the inclusion of a definition of inside information which "should provide that inside information is information which is not generally available, but, if it were, a reasonable person could expect it to have a material effect on the price or value of the securities issued by the company which is subject to the information". Exposure Draft s 1002D is as follows:

(1) Subject to this Division, where:

  • a person (in this section called the "insider") possesses information that is not generally available; and
  • if the information were generally available, a reasonable person could expect it to have a material effect on the price or value of securities of a body corporate;

the following subsections apply.

(2) The insider must not (whether as principal or agent);

  • subscribe for, purchase or sell, or make an agreement to subscribe for, purchase or sell, any such securities; or
  • procure a second person to subscribe for, purchase or sell, or to make an agreement to subscribe for, purchase or sell, any such securities.

(3) Where trading in the securities referred to in subsection (1) is permitted on the stock market of a securities exchange, the insider must not, directly or indirectly, communicate the information, or cause the information to be communicated, to a second person if the insider knows, or ought reasonably to know, that the person may or would be likely to:

  • subscribe for, purchase or sell, or make an agreement to subscribe for, purchase or sell, any such securities; or
  • procure a third person to subscribe for, purchase or sell, or to make an agreement to subscribe for, purchase or sell, any such securities.

The section uses the concept of "inside information" and provides the basic prohibition against the use or communication of inside information, following the suggestions made by the Committee. The section also largely adopts the Griffiths Committee's suggested definition of materiality in the proposed s 1002D(l)(b). This at least provides some much needed clarification of the problematic concept of materiality.

Recommendations 4, 5 and 6: The Griffiths Committee, in Recommendation 4, also suggested that the circumstances in which information is generally available be defined by reference to the reasonable investor and the availability of a reasonable period of time for its dissemination. This has largely been incorporated in Exposure Draft s 1002B. This draft section is as follows:

For the purposes of this Division and section 1013, information is generally available if:
(a) it has been made known in a manner that would, or would be likely to, bring it to the attention of persons who commonly invest in securities of a kind whose price or value might be affected by the information; and
(b) since it was so made known, a reasonable period for it to be disseminated among such persons has elapsed.

The Committee also recommended that the Commission issue guidelines to the commercial community to assist in determining suitable methods for the disclosure of information (Recommendation 5). Similarly, the Committee's recommendation that the definition of the term "securities" should be clarified to overcome doubts expressed in some quarters as to whether this term included exchange traded options (Recommendation 6), was largely adopted by the Government. This was reflected in Exposure Draft s 1002A. The Griffiths Committee had earlier concluded that:

While the NCSC is of the view that the existing legislation already extends the insider trading prohibition to prescribed interests, exchange traded options and convertible securities, advice from Attorney-General's raises doubts in this regard. Given the serious implications of being able to avoid the insider trading prohibition in this respect, it should be put beyond doubt that the prohibition does apply to unit trusts and other prescribed interests, exchange traded options and convertible securities (Griffiths Committee Report 1989, para. 4.9.7.).

The Explanatory Memorandum to Exposure Draft s 1002A largely adopts this commendable reasoning in the following terms:

1002A. In this Division and in section 1013:

"securities", in relation to a body corporate, means any of the following:

  • shares or units of shares in the body corporate;
  • debentures (including convertible notes) issued by the body corporate;
  • prescribed interests made available by the body corporate or units of such interests;
  • options or rights, exercisable at or before a specified time, to buy from, or sell to, a per-son a number of securities of a kind referred to in paragraph (a), (b) or (c) at a price specified in, or to be determined in accordance with, the contract under which the relevant option or right was acquired, being options or rights trading in which is permitted on the stock market of a securities exchange.

Recommendations 7 and 8: There is no doubt that the tippee provisions of the old legislation were largely unworkable. The somewhat complex legislative requirement in Securities industry Act (SIA) s 128(3) for the proof of an association or an arrangement for the transmission of information between the insider and the 6ppee was quite unsatisfactory in practice. As the Griffiths Committee observed:

The existing provision is inadequate. The need to demonstrate an association or arrangement is an unnecessary and complicating factor. It detracts from the objective of the provision, which is to prohibit persons from using inside information received from insiders to trade in or subscribe for the securities of the company which is the subject of the information (Griffiths Committee Report 1989, para 4.7.8; see also Cox 1990).

The Committee concluded (Recommendations 7 and 8) that tippees should be caught by the basic insider trading provision and, as is currently the case, that tippees only be precluded from dealing in listed securities. Arguably, insider trading in unlisted securities is covered by the Corporations Law s 232 (Code s 229). However, for reasons of internal consistency, the exclusion of trading by tippees in unlisted securities is questionable as no similar limitation exists upon insider trading by persons who are not tippees. No such limitation exists in s 10b of the US Securities Exchange Act.

Exposure Draft s 1002D does not seem to follow this recommendation of the Committee. However, in regard to the communication of inside information, s 1002D(3) only proscribes communication of inside information in regard to listed securities. This is in very similar terms to the original s 1002(5). If it is agreed that the insider trading provisions should not apply only to listed companies, then the justification for limiting the prohibition on the communication of inside information to listed securities is unnecessarily restrictive in a context in which corporate groups deliberately operate in networks of listed and unlisted companies. Excluding the securities of unlisted companies is unrealistic and ignores the group corporate structure of much of contemporary business.

Recommendation 9: The Griffiths Committee recommended the retention of a number of major insider trading related exceptions and defences. One of these is the Chinese Wall defence (Recommendation 9). In evidence before the Committee, there was a difference of opinion concerning the reliability of Chinese Walls. Many corporate advisers derive substantial fees from the establishment of Chinese Walls so that the abolition of the Chinese Wall defence could be costly to them. However, practitioners within the securities industry are not as uncritical of the effectiveness of Chinese Walls as industry submissions to the Griffiths Committee suggested (see also Tomasic & Pentony 1989i). As the Committee observed, "While some doubts have been expressed about the integrity of Chinese Walls, the Committee is swayed by the confidence of participants in the securities industry that Chinese Walls can and do work" (Griffiths Committee 1989, para. 4.9.7.) This conclusion is simply not sustainable upon the basis of the, admittedly limited, empirical research which has been conducted into this aspect of the Australian securities industry.

There has also been a judicial lack of enthusiasm for the capacities of Chinese Walls to avoid conflict of interest problems for professionals working in advisory firms. This has been well illustrated in the recent decision of Mr Jusfice Ipp of the Supreme Court of Western Australia in Mallesons Stephen Jaques v KPMG Peat Marwick and Others (unreported, Supreme Court of Western Australia, 19 October 1990). The finding in this case should lead to a reassessment of the Chinese Wall defence in the securities industry, despite the fact that Exposure Draft s 1002F seeks to preserve this questionable mechanism.

In the Mallesons case the Court was unconvinced by arguments that a Chinese Wall had been successful in achieving its aim. As has been seen above, in finding against Mallesons, Ipp J concluded (at p. 32) that despite the existence of a Chinese Wall, "there is more than a real and sensible possibility that Mallesons have placed themselves in a position of conflict of interest". There is no reason why the observations made in this case should not be applied to other professional-client relationships, such as those found in the securities industry (some of the complexities surrounding the Chinese Walls defence were also illustrated in Ex parte Sun Securities Limited (1990) ASLR para. 76-195). If this is done, then the Chinese Wall defence in relation to insider trading should logically also be abandoned. It is therefore difficult to understand why Exposure Draft s 1002F has proposed to preserve the Chinese Wall1 defence and s 1002G(l)(b) also proposes that the defence be extended to partnerships2.

Recommendation 10: One of the most controversial issues to arise before the Griffiths Committee was whether the onus of proof for insider trading should be reversed once a prima facie case has been made out. In Recommendation 10, the Committee declined to accept arguments put to it by the Attorney-General's Department and others (see Griffiths Committee Report 1989, para. 4.10.2) that there were situations where the reversal of the onus of proof was appropriate, even though the reversal of the onus in some insider trading situations largely appears to fall within the current Commonwealth criminal law policy on the reversal of the onus of proof. The only argument presented by the Committee in favour of this conclusion was that existing principles of Australian law, such as that a person is innocent until proven guilty, should be preserved. It was also felt that the adoption of other recommendations made by the Committee would make the introduction of such a reverse onus unnecessary. One of these other recommendations was that the insider trading provisions be simplified. However, as noted above, this seems unlikely to occur, if the Exposure Draft insider trading reforms are any guide.

The Government accepted Recommendation 10 (Duffy 1990, para. 38), despite the fact that the Attorney-General's Department pointed out to the Griffiths Committee that there were a number of situations, especially in regard to the communication of inside information and in tippee situations, where it was very difficult for the prosecution to provide independent evidence, but that it was relatively easy in these situations for the defendant to give evidence which would deny charges made. The basis for the Committee's rejection of these arguments was not explained in its report (Griffiths Committee Report, pp. 34-6). The failure of the proposed insider trading provisions significantly to simplify the law in this area will inevitably mean that there are real dangers that the almost impossible evidentiary burdens currently placed upon the prosecution will not be readily overcome. As has been seen earlier, some of these burdens were well summarised by the evidence before the Griffiths Committee of one of the most experienced insider trading investigators in Australia, John O'Dea of the NSW Corporate Affairs Commission. It is worth repeating the following observations made by O'Dea in his evidence:

It is quite easy, a broker having got in touch with his client, for the person to come up with any sort of excuse at all and there is nothing you can do about it. So unless you get a person cold, that path is a useless one to walk because you go to a lot of trouble and have a lot of interviews and get answers that will not take you anywhere. You get to the stage of being very selective about what matters you investigate (Griffiths Committee 1989, Hansard, pp. 184-5). (Emphasis added)

Short of a radical simplification of the insider trading provisions, it seems that the only other realistic means of dealing with problems such as these lies in the reversal of the onus of proof as the matters raised by way of a defence are peculiarly within the knowledge of the accused and almost any amount of prosecutorial resources will not be able to negate spurious defence propositions of the kind referred to by O'Dea.

Interestingly, in regard to claims for the recovery of losses sustained from insider trading conduct, s 1015(2) and s 232(10) of the Corporations Law already make provision for the reversal of the onus of proof.

Recommendations 11 and 12: Due to the difficulties of proving the main elements of the offence, probably the least important deficiency of current Australian insider trading laws involves the existing monetary penalties. The existing penalty of a term of imprisonment of five years is a significant deterrent, where a case is made out. The Griffiths Committee all too readily accepted arguments concerning the need to increase the maximum fines in this area and recommended that there be a five-fold increase in the fines for insider trading (Recommendation I 1). Not content with this largely symbolic gesture, the Government has suggested a ten-fold increase in fines for a breach of the proposed s 1002D. This seeks to impose a penalty of $200,000 and/or five years gaol for individuals and a fine of $1,000,000 for corporations convicted of insider trading. The Griffiths Committee had argued that:

>... a truly effective deterrent to insider trading must strike at the objective of that trading, i.e. the profit realised or the loss avoided. Those who would contemplate insider trading must be put on notice that they risk losing everything which could be gained from the transaction in question, as well as damaging their capacity to operate within the securities industry. They should also suffer an additional loss as a penalty for committing the offence. That additional penalty should have some correlation with the profit realised or the loss avoided ... Accordingly, the Committee favours the adoption of a pecuniary penalty which is a multiple of the profit realised or the loss avoided (Griffiths Committee, Hansard, p. 40).

However, the Government decided to reject the Griffiths Committee's recommendation that double damages be available on the grounds that adequate provision was made for such civil actions under the Proceeds of Crime Act 1987 (Cwlth) and under the Corporations Act 1989. This is not entirely convincing as similar legislation has existed in the United States for a number of years (Langevoort 1984). Moreover, these Australian legislative provisions have yet to be shown to be effective in this area. The Government did, however, accept the Committee's recommendation that a review of penalties under the Corporations Act take place (Recommendation 12). This was a fairly uncontroversial course of action for it to take.

Recommendations 13 and 14: The nature of civil remedies for insider trading was a matter of some debate before the Griffiths Committee. It is clear from the lack of any reported cases and from discussion with practitioners that actions under s 130 of the Securities Industry Act (see now s 1013 and s 1015 Corporations Law) have been virtually non-existent. It is astonishing that the Griffiths Committee simply accepted the hastily prepared recommendation of the Edwards Committee on the Corporations Law (Australia 1989) that ss 1013 and 1015 of the Corporations Bill would prove adequate. These provisions require that a contravention for insider trading occur before a claim is made for the recovery of losses. Experience has shown that this is quite unrealistic, although the questionable Keygrowth (Unreported, 30 November 1990, Nathan J, Supreme Court of Victoria) insider trading decision may possibly prove to be an exception to this if the appeal against this decision is not successful.

The availability of civil penalties has been one of the key explanations for the success of the US Securities and Exchange Commission in dealing with insider trading. However, the Griffiths Committee was also influenced by the reservations of the Attorney-General's Department about what it saw as the practical difficulties regarding the introduction of civil penalties in Australia. The distribution of damages and the punitive nature of civil penalties particularly concerned the Department. Consequently, the Committee adopted a compromise position and observed that:

... as there was wide suppose for increasing the deterrence value of civil remedies, it would be appropriate to empower the courts to make a wider variety of orders in relation to insider trading manet's. The orders should be similar to those available where a person is found guilty of unacceptable conduct in relation to a takeover (Griffiths Committee 1989, Hansard, para. 4.13.13).

The Government has accepted the recommendation of the Griffiths Committee (Recommendation 13) that a range of additional powers be given to the court in insider trading cases. In particular, it was suggested that powers similar to unacceptable conduct declaration powers in the takeover context be available to the court. This recommendation has been picked up in Exposure Draft s 1002L3. The orders provided for in s 1002L are in addition to any other orders which are available to the court, such as those made under ss 1323 to 1325 of the Corporations Law. Arguably, s 1002L is unnecessary in view of the range of powers already found in these other sections. Nevertheless, if the Exposure Draft provisions are to be seen as an attempt at providing a definitive legislative response to insider trading, the presence of s 1002L is likely to be appropriate.

The influence of the Attorney-General's Department was also reflected in the rejection by the Committee of the suggestion that the payment of bounties might be an effective means of obtaining evidence of insider trading. Such a provision exists in United States law regarding insider trading4. Similarly, such provisions exist in US revenue law (see also Internal Revenue Manual-Administration). However, the Australian Attorney-General's Department seems to have regarded such a provision as being un-Australian and as likely to affect the credibility of sworn evidence by an informer in court (Griffiths Committee, Hansard, pp. 44-5). Regarding the first of these odd claims one need only point to the regular activities of Australian law enforcement agencies in using Operation Noah drug phone-in campaigns. From time to time there have also been calls for the use of similar campaigns in other areas, such as in the area of welfare fraud (see Daily Mirror, 2 January 1986; Morrison 1986). In regard to the second of these claims, namely that it would affect sworn evidence, it may be true that the credibility of such evidence may be challenged, but this challenge need not be determinative. In any event, provisions of this kind may bring matters relating to insider trading to the attention of the regulatory authorities which would not have surfaced previously. This is surely desirable, as is suggested by the following extract from the submission of the Victorian Corporate Affairs Commission to the Griffiths Committee:

ecause of the nature of these types of offences, it cannot be left entirely to the enforcement agencies to deal with the problem [of insider trading] and the problem can and will only be readdressed with full co-operation from within the industry. The recent arrests in Melbourne [for insider trading] are an example of this type of co-operation where a person has come forward and volunteered information and documents from which the investigation has been able to flow, leading to those arrests.

The following example may demonstrate the point.

A works for a mining company and through his employment becomes aware of a mining analyst's report of a high grade mineral find which when announced will no doubt cause a rise in the market price of the relevant share through a friend who is completely unconnected with the company. In those circumstances, in the absence of someone coming forward with evidence, it would be impossible to detect or prove any offence in the matter (Griffiths Committee, Submissions, ss 481-2).

Nevertheless, as the Griffiths Committee concluded:

The Committee rejects any suggestion that a system of rewards for informers or bounties be introduced in Australia. Such a system is incompatible with current attitudes in relation to the credibility of evidence. It is also incompatible with accepted principles and practice within Australian society (Griffiths Committee Report 1989, para. 4.14.4).

This conclusion reflects the strong undercurrent of pragmatism running through many of the recommendations of the Griffiths Committee's report and the inability of Australian government agencies to take insider trading as seriously as it has been taken in the United States or as seriously as street crimes are treated in Australia. All too many insider trading prosecutions have failed due to the superior advocacy skills of defence lawyers, rather than the non-existence of evidence of insider trading.

There is much to be said for the use of reforms which seek to make greater use of positive incentives or rewards in corporate and securities law enforcement. In the past we have resorted to an almost exclusive reliance upon negative disincentives, such as terms of imprisonment and fines. The limited value of negative disincentives is, however, all too apparent in regard to corporate crime and securities fraud. It is crucial that more incentives be made available to break down peer group attitudes which undermine law enforcement activities in the face of clear securities law violations. Rewarding informers is but one of these kinds of positive incentives which a well developed law enforcement package should contain.

If it is considered acceptable to rely upon such measures for drug offences, there is little justification for not doing likewise in regard to securities law violations. The Federal Government has implicitly equated insider trading with drug trafficking if the recommended penalties for insider trading are any indication. As Attorney-General Duffy observed in his press release accompanying the Exposure Draft of the new insider trading legislation, "Insider trading is an exceptionally insidious and damaging form of market manipulation" (Duffy 1990b). If this statement is to prove to be more than convenient rhetoric it is important that corporate regulatory agencies be equipped with the best possible legal mechanisms for dealing with so serious a problem.

The Griffiths Committee also recommended (Recommendation 14) that it should be more clearly provided that the lack of a criminal conviction for insider trading should not be a barrier to a successful action for damages. Exposure Draft s 1013 reflects the Government's acceptance of this basic proposition. The new s 1013 is longer than and different from the original s 101 3. This in part reflects changes which have been proposed to s 1002. As the Commentary to Exposure Draft s 1013 points out: "Section 1013 is to be redrafted in line with the Committee's recommendation to redraft and simplify. A number of technical changes have been made to the provision" (Insider Trading - Proposed Amendments to the Corporations Law 1990).

The section is set out quite logically with s 1013(l) providing the pre-conditions to the application of the remaining sub-sections. Sub-secfion (1) sets out three conditions for civil liability to arise. Firstly, an insider must possess information that is not generally available; secondly, the information must be such that a reasonable person could expect it to have a material effect on the price or value of securities of a body corporate if it were generally available, and thirdly, the insider enters into a transaction or agreement in relation to any such securities, or procures a second person to do so, in contravention to s 1002D(2). It is therefore necessary to show that there has been a contravention of s 1002D before an action under s 1013 can arise.

Sub-sections (2) to (5) of s 1013 contain the principal provisions. Unlike the original s 1013, the new section now covers the situation of subscribing for or agreeing to subscribe for securities. Actions may be brought by the body corporate that issued or agreed to issue securities; by a seller who did not possess the inside information; by a buyer who did not possess the inside information and by the Commission. These actions may be brought against the insider who subscribed for or agreed to subscribe for securities, the insider who purchased securities or who sold securities, as well as against "any person involved in the contravention".

Action may also be brought to recover the loss suffered by the buyer or by the seller of securities or by the corporation that issued the securities which were subscribed for or agreed to be subscribed for. In addition, under s 1013(5), the corporation may also seek to recover any financial benefit that has or is likely to accrue to the insider from the sale or purchase of the securities, even if the insider has not on-sold the securities to realise a profit. Any fights of action under s 1013 are independent of rights of action under s 1005. The new s 1013 is to be commended for its relative simplicity. In practice, however, civil action under this provision, as was the case under SIA s 130, will still be dependent upon a prior insider trading conviction being recorded under s 1002.

The remaining recommendations of the Griffiths Committee are largely administrative in nature aimed at ensuring that insider trading law enforcement remains a governmental and regulatory priority. The Committee also recommended that co-operation between national corporate regulatory bodies be enhanced by the signing of Memorandums of Understanding between countries with active securities markets. This is an important aspect of insider trading control in view of the globalisation of securities markets (see Tomasic 1990c). The Committee recommended a more vigorous market surveillance role for the Australian Stock Exchange, and it is interesting to note that as soon as the ASX began to monitor insider trading and related securities market conduct more vigorously, it became obvious that the extent of insider trading has continued to be prevalent (see Berry & Yanco 1990). The Committee also recommended the development of codes of conduct on an industry-wide basis. These are all fairly commendable recommendations and most of these have been acted upon to some extent.

Insider trading exceptions and defences

If insider trading legislation were to be truly simple and principled in its assumptions, it would be unnecessary to have complex exceptions and defences. Such exceptions and defences are a product of complexity in legal drafting and the resultant black letter law approach to this area. The Exposure Draft's preservation and extension of the insider trading exceptions and defences found in SIA s 128 is a clear indication that this legislation will in practice be more complex to enforce than the existing law. This is an unfortunate likely consequence of well intentioned reform efforts.

The Exposure Draft contains a number of innovations in regard to the defences and exceptions available under the legislation. Reference has already been made to the Chinese Wall defence. Exceptions are also made, by ss 1002E and 1002F respectively, in relation to underwriters and partnerships. Also, s 1002D(2) is rendered inapplicable by s 1002H to transactions, such as a takeover, between corporations where one corporation enters into an agreement with another body corporate in relation to the securities of the other corporations. The circumstances in which a body corporate is taken to be in possession of information are set out in Exposure Draft s 1002C which provides that

(a) a body corporate is taken to possess any information that an officer of the body corporate possesses; and
(b) if an officer of a body corporate ought reasonably to know any matter or thing, it is to be presumed that the body corporate ought reasonably to know that matter or thing.

In certain circumstances, s 1002J also exempts the holder of a dealers licence from the effects of s 1002D(2). This largely parallels SIA s 128(7A). Similarly, Exposure Draft s 1002J parallels SIA s 128(9) in exempting the holder of a dealers licence from s 1002D(2) in certain specified circumstances.

The defence in SIA s 129(10) which allowed a person to claim that the other party to the transaction knew or ought reasonably to have known of the alleged inside information, has been repeated in s 1002K(c). However, this section expands the original provision by adding two other defences. Firstly, it is proposed that it be a defence for a person to claim that the inside information has become commonly known, a defence used in the unsuccessful Roger Bain prosecution in New South Wales in 1988. It is probably unnecessary to include this defence as it is implicit in the insider trading prohibition. Of greater concern is the suggested defence in s 1002K(b) which provides that "it is a defence if the court is satisfied that the first person did not know, and did not have reasonable grounds for believing, that the information was not generally available". It is difficult to see how, in most insider trading situations, the prosecution would be able to readily overcome a spurious defence of this kind. This defence provides an opportunity for considerable abuse and will make the job of the prosecution even more difficult than it presently is. Once again it is unnecessarily benevolent.

The underwriters' exception in s 1002E expands the range of insider trading exceptions and applies a recommendation of the Griffiths Committee to this effect. It also applies to sub-underwriters and extends this exception to 6ppee situations where information is communicated by underwriters for the purposes of subscribing to securities. This tippee extension goes beyond the recommendation made by the Griffiths Committee. It is also interesting to note that in the 1988 Roger Bain insider trading prosecution it was argued that as Bain and Co were underwriters for a share issue, Bain was merely trying "to help the market out" by purchasing the shares that were the subject of the insider trading charge. Bain reportedly claimed that he was "embarrassed" that the shares seemed to be undervalued (Weekend Australian, 6-7 May 1989, p. 28). In any event, the extension of the underwriters exception to tippee situations is an invitation to significant abuse as brokers have been shown to be more likely than other industry actors to be very prone to take advantage of inside information (Tomasic & Pentony 1989b).

An exception to s 1002D(2) is also provided in certain circumstances in the case of partnerships by s 1002G. These circumstances require that a Chinese Wall be in place, that a securities transaction or agreement is entered into by a partner who did not possess the inside information and establishing that the partner who did possess the inside information did not communicate that information to the partner who entered into the transaction or agreement. This is intended to avoid the implication that a partner possesses the information which another partner possesses. Ostensibly, s 1002G flows from a recommendation of the Griffiths Committee that both corporate and non-corporate dealers be able to rely upon the Chinese Wall defence (Griffiths Committee Report 1989, para. 4.9.8. and recommendation 9). Given what has already been said about Chinese Walls, especially in the light of the decision in Mallesons Stephen Jaques v KPMG Peat Marwick and Others (Supreme Court of Western Australia, unreported, 19 October 1990), the justification for this provision is questionable. It is yet another illustration of the consequences of a black letter approach which requires that every possible legal problem be dealt with in advance by the legislative draftsman. Like many of the other exceptions and defences provided for by the Exposure Draft, it is difficult to see the partnership exception as being little other than the product of special pleading.

Conclusions: a path forward?

Insider trading law reform has proved to be something of a quagmire for those who have sought to enter this arena. The Griffiths Committee Report and the Government's response to it, as reflected in the Exposure Draft insider trading legislation, are both worthy efforts. However, both have all too readily succumbed to arguments which seem to be based upon a philosophy of minimal legislative intervention in this industry, an industry that for so long has been largely self-regulatory. Following the appointment of the Rae and Griffiths Committees it was inevitable that some legislative action in this area would eventuate. However, the effect of insider trading reform efforts has been seriously blunted by the continued adherence to a narrow legalistic approach, despite the recognition that the simplification of this area of law is desirable.

The record of attempts to apply Australian insider trading legislation through the courts has not been very successful. The prosecutions discussed earlier in this work are illustrative of the difficulties. At least a dozen failed prosecutions can be referred to, although the number of alleged insider trading cases identified by the ASX and by the NCSC in recent years has been substantial. Australian courts faced with insider trading cases have failed to take a commercially realistic approach and have readily succumbed to the safe harbour of legalism. This is not entirely the fault of the judiciary as the Bar has had a vested interest in maintaining the aura of legalism, and in any event, the relevant legislation has virtually made narrow legalistic readings of this body of legislation inevitable.

The provisions in the Exposure Draft may make it easier for the prosecution to bring a successful prosecution against blatant insider traders. However, there are few really blatant insider trading cases, as most insider traders would seek to mask the nature of their illicit activity in some way. On the other hand, these provisions have probably made it easier for a determined insider trader to avoid the full force of the law due to the existence of overly generous concessions that have been provided through the exceptions and defences inserted in the draft legislation. Whilst the Exposure Draft provisions are a modest improvement on the pre-existing provisions, they nevertheless fall far short of what should have been possible in this area.

It would be far better for adequate reform legislation to be put in place now, rather than merely to once again accord symbolic significance to official concerns about insider trading by resort to much heavier penalties. In practice, such penalties are meaningless because of the difficulties of proving a contravention of the legislation. It is difficult to avoid the conclusion that the Exposure Draft provisions do not significantly advance the cause of insider trading reform. Too much recent corporations legislation, such as the buy back provisions and the proposed loans to directors provisions, are unnecessarily complex and fall far short of the certainty that they purport to create. At best they are a boon for lawyers. Australia cannot afford to continue to enact such convoluted legislation and an important "macroeconomic" reform agenda should be the further simplification of our corporate and taxation laws. Until the Exposure Draft insider trading provisions are radically simplified by resort to general principles of the kind found, for example, in s 232 of the Corporations Law (s 229 of the Companies Code), there will continue to be little hope for effective law enforcement and successful civil actions in this area. It goes without saying that it is unlikely that the continuing resort to complex insider trading legislation will enhance the international reputation of Australia's securities markets, despite the Federal Government's hopes that this might be achieved through the insider trading reform process.

Having said this, the fact that there seems to be a wide degree of bipartisan support for the introduction of insider trading law reform must weigh heavily upon the mind of the Government. Presumably, it is felt to be preferable to improve the existing legislation even to some degree, even if this is not anywhere as significant a change as might have been originally hoped for. These are of course compelling political considerations, although they fall short of being persuasive from the point of view of the goal of achieving a significantly more satisfactory body of law. Perhaps only time will tell, although the weight of evidence to-date suggests that insider trading law reform in Australia has been largely symbolic in character.


1.  Section 1002 For the Exposure Draft is in the following terms:

1002F. A body corporate does not contravene subsection 1002D(2) by entering into a transaction, or making agreement to enter into a transaction, at any time merely because of information in the possession of an officer of the body corporate if-

  1. the decision to enter into the transaction, or to make the agreement , was taken by a person other than that officer; and
  2. it had in operation at that time arrangements reasonably designed Lo ensure that the information was not communicated to that person and that no advice with respect to the transaction or agreement was given to that person by a person in possession of the information; and
  3. the information was not so communicated and no such advice was given".

2.  Section 1002G of the Exposure draft is in the following terms:


  1. The members of a partnership do not contravene subsection 1002D(2) by entering into a transaction or making an agreement to enter into a transaction, at any Lime merely because one or more (but not all) of the members are in actual possession of information if-
    1. the decision to enter into the transaction, or to make the agreement, was taken on behalf of the partnership by a member or members who are taken to have possessed the information merely because another member or other members were in possession of the information; and
    2. the partnership had in operation at that time arrangements reasonably designed to ensure that the information was not communicated to the member or members who made the decision and that no advice with respect to the transaction or agreement was given to @ member or those members by a person in possession of the information; and
    3. the information was not so communicated and no such advice was so given.
    4. A member of a partnership does not contravene subsection 1002D(2) by entering into a transaction, or making an agreement to enter into a transaction, at any time otherwise than on behalf of the partnership merely because the member is taken to possess information that is in the possession of another member of the partnership.

    3.  Section 1002L provides as follows:

    1002L. Where, in a proceeding instituted under this Law, the Court finds that a Contravention of section 1002D has occurred, the Court may, in addition to any other orders that it may make under any other provision of this Law, make such order or orders as it thinks just, including, but without limiting the generality of the above, any one or more of the following orders:

    1. an order restraining the exercise of any voting or other rights attached to shares;
    2. an order restraining the exercise of any rights attached to securities other than shares;
    3. an order restraining the issue or allotment of shares;
    4. an order restraining the issue of securities other than shares;
    5. an order restraining the acquisition or disposal of securities;
    6. an order directing the disposal of securities;
    7. an order vesting securities in the Commission;
    8. an order calling an agreement for the acquisition or disposal of securities;
    9. an order cancelling a securities licence;
    10. for the purpose of securing compliance with any other order made under this section, an order directing a person to do or refrain from doing a specified act".

    4. &nbsp Pursuant to a 21 A(e) Securities Exchange Act of 1934 (US). This section provides:

    • [T]here shall be paid from amounts imposed as a penalty under this section and recovered by the Commission or the Attorney-General, such sums, not exceeding 10 percent of such amounts, as the Commission deems appropriate, to the person or persons who provide information leading to the imposition of such penalty. Any determinations under this subsection, including whether, to whom, or in what amount to make payments, shall be in the sole discretion of any member, officer, employee of any appropriate regulatory agency, the Department of Justice, or a self-regulatory organisation. Any such determination shall be final and not subject to judicial review.

    5.  Exposure Draft s1002H is in the following terms:

    • 1002H. A body corporate does not contravene 1002D(2) by entering into a transaction or agreement in relation to securities of another body corporate at any time merely because of information in the possession of an officer of the first-mentioned body corporate if the information was obtained by the officer in the course of the performance duties as an officer of the first-mentioned body corporate and relates only to proposed dealings by the first-mentioned body corporate in securities of the other body corporate.