Australian Institute of Criminology

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Chapter 9 - Insider trading regulation and law enforcement

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 99-113


There are no long lunches in gaol.
(Sydney broker)

Why prohibit insider trading?

Interviewees were asked what they believed were the policy justifications for the regulation of insider trading. The reasons given by brokers for having insider trading laws covered much the same range as those which have emerged from the US debate, namely, market efficiency, fiduciary duty and fairness. Those who thought that the purpose of insider trading legislation was to protect the market, typically said that it aims "to provide fairer markets by promoting equal treatment and to stop illegal gains. In short, to provide a level playing field". The laws are seen to have the goal of seeking "to protect small investors-the non professionals; [and they] aim at the big insider trader". Several others also described insider trading as a form of theft. The fiduciary principle was only occasionally recognised by those in the securities industry. As one broker explained, "the law is trying to eliminate the wrongful use of information for personal advantage. The practice of making personal profit before company gain must be regulated".

Stock Exchange officials and financial advisers offered several explanations for the regulation of insider trading of which fairness, equality of access, and the maintenance of a level playing field were the most commonplace. In the words of an adviser, "the fundamental reason is fairness. An efficient market requires equal access to information. The theory of fiduciary duty is not understood by brokers so we need a simple statute that is understood by potential insider traders". But a different explanation was offered by one of the merchant bankers who said "there isn't any reason. The law is a result of the State governments' responses to the Rae report [a report by a Senate Committee on conduct within the securities markets in the early 1970s]. The lack of financial and political support of the CACs shows that insider trading is not important to governments". This cynical view was shared by several of the interviewees. The most representative explanation from the market observers was that "with our system of limited liability companies it is unjust that some should have access to information while others do not. This is not fight in a system of Stock Exchanges. It is also necessary to have a level playing field". It was perhaps significant to note how infrequently amongst the non-lawyers the fiduciary principle was referred to.

Lawyers most commonly identified the policy justification as "fairness". Some adopted the level playing field metaphor and saw insider trading regulation as being based upon notions of fiduciary obligations. One Sydney lawyer explained that "the conventional view is to provide equal access to information in the market. Traditionally there has been an emphasis upon fiduciary duties". The fiduciary duties argument was not supported by a Melbourne lawyer who observed that "the policy justification for regulation is based upon fiduciary obligations to shareholders. This is unrealistic today and reflects a paternalistic attitude". The same view was also put by a number of other respondents some of whom pointed to the artificiality of this policy rationalisation. For example, several lawyers shared the view of one who said that "there is no justification for the regulation which we now have. But if there were effective regulation the policy would be to provide a level playing field and equality of knowledge. Also, people just shouldn't cheat".

The regulators also saw the policy justification for regulation in terms of the protection of the small investor and the creation of a fair market by keeping investors fully informed. The rhetoric of the level playing field was often also applied to this ethos of fairness, although one senior regulator thought that this metaphor was not very appropriate to insider trading. Another regulator characteristically saw it in these terms: "fairness and equality in the marketplace is the policy behind the regulation of insider trading. This is akin to ensuring that the horse race has not been fixed".

On the whole, there was a generally uniform expression of hostility to insider trading and a shared belief that such conduct should be prevented. Most people within the industry felt that insider trading was at least unfair and possibly even harmful. Although the precise reasons for prohibiting insider trading were varied, the sentiment was almost universal - it should be outlawed in order to protect the integrity of the securities market.

Insider trading and the criminal law

If insider trading is to be prohibited, the next logical question is to ask what is the most appropriate means of achieving that goal and, in particular, is the criminal law the most appropriate means. Most lawyers thought that there was a place for both criminal and non-criminal remedies, but the threat of imprisonment was seen as an especially powerful deterrent. Lawyers thought that civil remedies should supplement the existing criminal penalties, although all recognised the problems of proof involved in using the criminal law. One Sydney lawyer put the case for resort to the criminal law by saying: "the threat of gaol is an enormous threat, more today than before due to the state of the prisons! But insider trading need not exclusively be dealt with by the criminal law. The use of licensing powers is also an effective remedy". Perth interviewees were particularly impressed by the suitability of the criminal law. One of them observed "What are the alternatives? For the law to have effect, it has to have a credible punishment".

A small group of lawyers thought that civil remedies would be more appropriate. Typical of this group was the view that "it would be better if the emphasis of sanctions was on compensation to recover ill-gotten gains plus some penalty". A more reflective view was offered by a Sydney lawyer who observed that "we have to make up our mind if prison is appropriate or whether we should introduce more realistic fines. People don't take seriously monetary penalties of the type we presently have but they do take prison seriously. Also, they do take multiple fines seriously. I don't believe that just because some people get away with it, the section is a waste of time".

While most regulators had no doubt that the criminal law was an appropriate mechanism for dealing with insider trading, others seriously doubted the appropriateness of criminal sanctions. One such view was that "a negotiated settlement, with associated publicity may be more appropriate". The main reason for the criminal law being seen as inappropriate seemed to be practical. Some regulators firmly believed that "magistrates just won't send prominent businessmen to gaol". There was also some agreement that insider trading should not be dealt with in the same way as other criminal offences. One regulator explained that view by stating that "our criminal justice system is not appropriate for these market related crimes. A better system would be to use injunctions to 'undo' the transactions". There was wide support amongst regulators for a combination of criminal and civil penalties for insider trading.

The universal view among brokers was that criminal sanctions were appropriate for dealing with insider trading and that the only qualifications to this should be some discretion according to the scale of conduct. One group of brokers felt that the criminal law was the only mechanism which could realistically be applied. This feeling was summed up neatly by the statement of one broker who observed that "insider trading goes beyond the civil law and it therefore is appropriate to use the criminal law". A practical assessment was that the criminal law "frightens the white collar operator. The prospect of gaol is the ultimate deterrent". The brokers who qualified their support for the use of criminal sanctions did so by reference to the circumstances surrounding the conduct. It was accepted as appropriate to apply criminal sanctions to "large operators".

The Stock Exchange officials were mainly in favour of continuing to criminalise insider trading. A surprising answer was that insider trading should continue to be criminalised "because of the lack of class actions. It is a criminal act-there is a social responsibility to prosecute". This comment reflects poorly on the perceived value of other legislation which provides for compensation for the victim of insider trading, and also illustrates the practical exclusion of small investors from the remedies offered in the Australian companies and securities legislation. Some financial advisers agreed without any qualification that the criminal law is appropriate because "insider trading is fraud". The qualified affirmative answers included these: "as a deterrent yes [it is effective], but as a mechanism, no"; "the criminal law is appropriate where inside information is withheld in order to perpetrate a fraud as in the 1969-70 mining boom, but not other-wise". Of those who did not agree that the criminal law was suited to this area, the view that "white collar criminals do not go to gaol" reflected a realistic grasp of the limitations of the criminal law.

The market observers' answers fell into three categories. The strongest positive view was that "it is hard for any civil remedy to be used by shareholders and therefore the criminal law is appropriate-the authorities are best able to prosecute". The "no" group offered a variety of reasons, such as that the criminal law was of doubtful value and that, "it is better to divest"; "I would prefer to see it as a civil matter and I particularly like the section 16 approach used in USA". Those who were ambivalent also had different reasons. As one explained, "at times the criminal law is appropriate. There are different classes of insider trading-deliberate or calculated (Boesky style) and deliberate without full knowledge of what is being done. These should be treated differently". Another's view was that "by itself-the criminal law is inadequate. A full armoury is needed".

Despite some reservations about the problems of actually seeking to apply the criminal law against insider traders, there is no doubt that for one reason or another it is essential that the criminal sanction continues to be available in this area. This view was enhanced by the strong criticism of the illusory nature of civil remedies as a sole means of response. Fines were generally seen as being of little significance but imprisonment was seen as a real deterrent. The practical difficulties involved in using criminal sanctions was a genuine basis for ambivalence about their effectiveness as the sole device. Most agreed that the criminal sanctions had to be coupled with stronger civil remedies. A good case can be made for continued resort to negotiated settlements and quasi-criminal sanctions either to get actors to leave the industry or to undo transactions. So long as the problems of proof continue to present such considerable obstacles, these alternatives need to be looked at more seriously.

The adequacy of penalties

The next question to be answered was whether the long standing maximum criminal penalties for insider trading of $20,000 and/or five years imprisonment were appropriate. Most lawyers thought that five years gaol was credible as a deterrent, provided "someone were convicted. It would then be brought home to people that imprisonment was possible". Realistically, however, the gaol sentence can hardly be a deterrent if it is not applied. Almost all lawyers were of the view that the $20,000 fine was far too low. One pointed out that, "$20,000 of itself-is not a big deterrent. There is a mismatch between the $20,000 fine and five years gaol". Many thought that the fine should be a lot higher, but only if the law is enforced. As one respondent noted, "if you increased the penalties to $100,000 and/or seven years gaol it would not make a difference" unless the law is enforced.

A few of the regulators were, however, of the view that the existing penalties for insider trading were sufficient. According to one of them "the penalties are adequate, the difficulty is in proving the offence". The problem with the penalties was that because "these are maximum penalties only, judges won't impose the gaol sentence, and the fines mean nothing to insider traders". Indeed, one regulator thought that there should be a "minimum gaol term of five years", if gaol was to be seen as an effective deterrent. As this experienced regulator went on to remark, "since it is difficult to find a victim the courts regard insider trading as a technical offence and so won't impose the maximum penalty". The long-standing fine of $20,000 was regarded as quite inadequate by most regulators. It was described as "a parking fee". Some regulators also saw value in measures such as the introduction of the power to name insider traders, relying on the belief that, "adverse publicity is an effective deterrent". If the regulators' views are to be accepted, and there seems to be no reason not to do so, the penalty regime presents the worst of all possible situations. Not only are the courts most unlikely to impose prison sentences on insider traders, but in the unlikely event of fines ever being imposed they are seen as trivial imposts and no more than acceptable overheads. The approach to penalties seems to be unrealistic and has undermined the effectiveness of the regulatory institutions. At the very least, it has undermined the confidence of these institutions in the value of insider trading laws and perhaps as a result their commitment to enforcing the laws.

For the majority of brokers it might well be the case that a conviction is the most feared punishment. On the subject of the fine, brokers said that $20,000 was not credible. One broker felt that the fine should be "huge - more than just what was stolen. It should be one and a half times the gain". As to the term of imprisonment, the views of brokers were mixed. For example, it was said that "the threat of gaol is adequate"; "the threat of gaol is terrifying - the length of sentence is irrelevant"; "gaol especially [is feared]. Money is not a deterrent".

Of more significance was the widely expressed opinion that, whatever the fine or the risk of imprisonment might be, "once convicted you are finished" because "you lose your licence and job". Imprisonment was seen as "the ultimate punishment-there is a loss of money, humiliation and loss of career". It was also said that: "the real deterrent is what the market will do to you". The words of another broker who said that "the threat of career damage is the deterrent," typified the attitude of the broking community. Stock Exchange officials thought that imprisonment was a credible deterrent but that the fine was far too low. Some wondered whether the lack of prosecutions affected the impact of the penalties. Only one official regarded the current penalties as credible and adequate.

Most financial advisers thought that the penalty of imprisonment was credible and adequate but that the fine was not. Some, however, expressed qualifications such as, "they are not adequate but does it matter if no one is being caught?" A different approach was taken by one of the merchant bankers who said that the penalties are "entirely adequate but the real deterrent is the loss of a career. Penalties are not the point-it is lack of enforcement". There was very little said in favour of the current level of the fine. A funds manager described the $20,000 fine as comic, and remarked that "the best punishment is loss of livelihood, suspension of licence and adverse publicity". Merchant bankers were also not impressed by the penalty system and some referred to the notional nature of imprisonment as a penalty. As one said, "corporate criminals are never sent to prison, the fine should be half a million dollars". The reaction was generally the same from each of the market observers but a sizeable number of them agreed that the lack of prosecutions and enforcement was a limiting factor in deterring insider trading. As one said of the deterrent value of the penalties, "if they hit they do [deter]. A big hit on somebody would make a big impression". There seemed to be widespread agreement that the fine is too low, but that the prison sentence is appropriate.

It was interesting particularly to note the answers of brokers to a question about the significance of a prison sentence. As noted above, the brokers believed that the real punishment is not being sent to prison or being fined but career destruction, and the Stock Exchange officials said precisely the same thing, "conviction is the end of your career, you can no longer get access to confidential data". The responses to these questions suggest that there is scope for a more innovative approach to setting penalties with an emphasis on increasing their deterrent value but perhaps the most effective deterrent, for brokers at least, would be a more credible enforcement effort.

Imprisonment is clearly feared by brokers, but the knowledge that it is not used undermines its deterrent value. The mildest response was that it was "a significant punishment". Other terms used to describe the effects of imprisonment included "stigma", "shame", "disastrous", "the ultimate punishment" and "terrible". Some brokers were particularly frightened at the prospect of being in a prison but the more common references were to the consequences of imprisonment-the loss of licence and the destruction of a career. This view was shared by all licensed professionals interviewed. There was a strong suggestion that merely to be convicted would achieve the same result. There seems to be an ambivalent attitude to being known as an insider trader, but it is different and much more serious to have been convicted. The financial advisers all said that imprisonment would be serious mainly because of the stigma involved. It is interesting to note that the Business Council of Australia in its submission to the Griffiths Committee observed that "While some thought should be given to providing civil remedies it should not be forgotten that the real sanctions are the social disgrace and the effect on an insider trader's ability to work effectively in the financial markets" (Griffiths Committee, Hansard, p. 210).

The long-standing Australian criminal penalties of five years imprisonment and/or a fine of $20,000 were clearly not credible deterrents for insider trading and the main reason for this is the lack of enforcement of the legislation. Were the law to be enforced, the fear of imprisonment would constitute a serious deterrent. The fine of $20,000 is, however, a different matter. It was frequently described as a joke or at least quite unrealistic in comparison with the likely gains to be made, especially by the big players.

There seems to be a compelling case for an increase of fines up to at least $100,000 for each offence. Such an increase is in line with recent international developments though, by some international standards, it would be a modest penalty. However, even this higher fine would be irrelevant if it were not to be applied. The Federal Government's acceptance in October 1990 of the need for a five-fold increase in insider trading fines is in line with this conclusion. It is clear that money, reputation and freedom of movement are highly regarded values in the securities industry and if insider trading penalties are to be taken seriously, then they must impact upon these values. To date this has not occurred and has been all too widely perceived as not having occurred. Unless the law is properly enforced, the level of penalties will be of academic interest only.

Civil penalties

In view of the problems associated with criminal sanctions it is useful to consider whether civil penalties, such as treble damages and the disgorgement of profits would constitute a more credible deterrent. Civil penalties were generally not seen as being a viable replacement for criminal penalties, but rather as a supplement to them. A not uncharacteristic view was that "we already have enough penalties, but we don't have enough enforcement. Huge penalties are not worth it unless someone is doing something about applying them".

Most regulators were disheartened by the negligible use which had been made of the criminal law in this area and it was not surprising that they went on generally to agree that the use of civil penalties such as treble damages and the disgorgement of profits would be more effective deterrents than the existing criminal law sanctions. Most of them felt that the use of the criminal law would still be needed, despite greater use being made of civil sanctions. The few regulators who were sceptical about the use of the civil sanctions believed that gaol is the only realistic deterrent and only a small minority of the regulators saw civil penalties as a viable replacement of the criminal sanction. The regulators pointed out that, ultimately, the real issue is the detection and prosecution of insider traders. Unless there are convictions, the introduction of civil remedies has little value as an alternative. There was some support for introducing civil remedies to supplement existing sanctions. As one regulator said, "the US experience shows that a negotiated civil settlement has some advantages; it is quickly done and allows a flexible approach plus publicity".

The brokers were generally in favour of profit disgorgement but were not as enthusiastic about treble damages. According to a Melbourne broker, "the basic starting point is to be forced to shed profits". One broker felt that "the gain should be removed" but he was "not sure about the damages going to the government". This theme was taken up by another broker who said, "it is a much fairer system. But where does the profit go-the other party was going to sell anyway. Double profit would be okay and it could be used to fund NCSC surveillance". One broker explained that, "disgorgement makes better sense but how do you compensate the victim? If there were treble damages who could pay? The usual insider trader is a slime-bag who will ensure that he is properly organised and will not be able to pay.

"The person you catch will not be the one you want". A Melbourne broker thought that "an increase in penalties of this order would kill market research". This expression of fear appears to be an over-reaction but, as was later revealed, market research is often a euphemism for being given price sensitive information by companies in selective briefings. The view which seems to sum up the position of brokers was that "a combination of civil and criminal penalties would be terrific. The right sort of civil penalty would be appropriate".

There was a general feeling among Stock Exchange officials that there should be some pain associated with the penalty and there was no opposition to the idea of profit disgorgement. Concern was, however, expressed about where the money went. One official suggested that it should go to the loser. Another suggested that it go into a fund for the benefit of the persons who were the victims of the insider trading.

The tendency within the financial adviser group was to favour the use of both treble damages and disgorgement, although disgorgement had more support. This group reflected the views of others in this study who argued that there must be some pain associated with the penalty. On the subject of disgorgement, there were several points made by members of this group, such as that "[it] would be an effective deterrent but it is necessary to define who should be compensated"; "we need both civil and criminal penalties and any profits that are disgorged should be used to fund the Commission". Some difficulties were identified with disgorgement - "it is often difficult to identify any party who has been hurt. Disgorgement of profit really amounts to a fine". One of the merchant bankers confirmed the widespread opinion that, "section 130 of the Securities Industry Act was a joke. It is unlikely that the hurt party can be identified. Any person who has suffered damage would find the legal costs prohibitive". The suggestion of treble damages was not met with hostility. Indeed, one merchant banker felt that "disgorgement of profits is not enough, multiple damages are needed to provide some pain". There was some fear of the consequences of introducing treble damages. A financial adviser identified an undesirable consequence in that "treble damages plus compensation could lead to class actions which are not appropriate in this area". This view repeats the standard opposition to class actions and is questionable because class actions are probably the only way of making the section 130 civil remedies effective. Of the observers, only one rejected the idea of civil penalties. In his view criminal sanctions are needed. The notion of disgorgement was acceptable to the others but one made the point that it is painless. There were, as with other groups, reservations about disgorging the profit into the hands of the government. There was not a great deal of support for treble damages - some said that double damages would be enough, while others were just against treble damages.

Although greater use of civil remedies such as the disgorgement of profits and the use of multiple damages received widespread support, the predominant view was that civil remedies of this type should only supplement the criminal sanction and not replace it. Disgorgement of profits was especially approved of although most felt that if it were to be a deterrent there should be some pain in addition. This applied especially to multiple offenders. A widely held view was that disgorged profits from insider trading should not go into general revenue but rather should be used to support insider trading regulation and enforcement. There were frequently stated reservations about the introduction of treble damages but double damages seemed to be acceptable. Some of the more sophisticated interviewees argued that there is a strong case for the introduction into Australia of a version of the short-swing profits rule for all trades made by persons connected with a corporation within six months of an announcement affecting that company's securities. The rule exists in the United States as Rule 16b, made under the Securities Exchange Act, and it requires that such profits be returned to the company.

Of all the securities market crimes, insider trading is the most high profile and the most easily understood in its basic form by the public. It has also been the most difficult to police. As the discussion above has shown, securities market professionals have well developed ideas about penalties and are receptive to new approaches. Regulators were asked about the extent to which discussion takes place within their community about the relative merits of different types of penalties. Most of them responded that there had been "none" or "not much" debate on this topic. Such debate as is occurring is taking place in a sporadic and limited way. It was reported that "there was a consistent debate until the Anisman report, which slowed things down. Also, the emerging Commonwealth control of the corporate area has frozen the debate". Another official said that "civil penalties are quicker but criminal penalties have more deterrent effect. Most CACs follow the criminal route but the NCSC prefers the civil route for reasons of speed". The chairman of the Australian Securities Commission (ASC) has made it clear that he is interested in using civil penalties as widely as possible to achieve his goal of cleaning up the market.

The enforcement of the law

A feature of the insider trading debate in Australia has been constant references to the paucity of cases and the lack of convictions for insider trading. Several factors could explain this state of affairs. Among them are a very low level of insider trading, inadequate enforcement and inadequate deterrence all of which were mentioned when we asked respondents about enforcement of the law. The overwhelming attitude, particularly of the large law firm lawyers, was that insider trading laws were not adequately enforced, although some agreed with the Perth lawyer who said "the laws are adequately enforced and one can't do any better. The difficulties of detection and identification are great and there is no help from the courts". Most took a much more negative approach, such as one lawyer who said:

The laws in this area are a joke. You have to establish a credible enforcement record before people believe that there is anything to fear. It is only honest people who worry about the law. Section 128 is only a constraint upon the honest. The CAC will sometimes have a go to enforce the law, but they usually bugger it up. There is a basic belief in the industry that there are no rules, because there is no enforcement. The NCSC and CAC can't do it and shareholders can't afford to litigate. There are virtually no cases on section 128 and no attempt is made to recover damages. It is almost impossible to win a case. The prosecution has to be kept simple to succeed.

This comment sums up many of the other views that were expressed. For example, one Melbourne lawyer elaborated on this theme in the following way: "the laws are not adequately enforced. It is difficult to know what problems the CACs have had. I suspect that the problem has been a lack of energy and funds and not due to any defects in the legislation". A related problem is that while the surveillance of the market tends to take place at the national level it is the state and territory CACs which are required to act. Surprisingly, however, there was general satisfaction among lawyers with the legislation itself. The key problem was the enforcement of the legislation.

Most of the regulators thought that the insider trading laws were adequately enforced. A different answer would have been damaging to them, but most qualified their answers in some way. Of the two who provided an unqualified negative answer to this question one explained that "it is difficult to prove the elements of the offence, especially the price sensitivity of inside information". Most noted that whenever insider trading was brought to the attention of the CAC, it was dealt with. One regulator characteristically observed that "on the basis of the complaints and allegations received by CACs the law has been adequately enforced; the problem is in identifying the instances of insider trading". Another remarked that "an effort is being made, but the CACs are hampered by the lack of appropriate technology and the lack of political support". The lack of resources issue was constantly alluded to by the regulators, as was their feeling that insider trading prosecution was not given much priority by their political masters who provided the funds. It was surprising, to say the least, to learn that the NCSC relied on donated equipment and that NCSC officers waived travelling allowances in order to provide resources.

Only one broker said unequivocally that the law was adequately enforced. In his view "the NCSC is very quick to act. Brokers will quickly sort out a person who is out of step. Brokers are trenchantly and sometimes unfairly policed by the CAC and the Stock Exchange". The majority, however, did not think that enforcement was adequate and one of them commented that, "it is very difficult to say how it can be improved". Another asked "how can it be enforced? It is a bad law". This was contradicted by a Perth broker whose view was that "the law is adequate but the enforcement is dubious". An understanding broker said that "the CAC has a tough job and personally I think they do a good job but they cannot do the job - They need better laws. The NCSC does a pretty good job but the reactive style of operation is a problem". Not all the brokers were sympathetic. One broker for example offered this commentary on insider trading laws when he asked, "have they ever been enforced? Who has been nailed? Rumour is that the NCSC will strike for the sake of it. The law catches the wrong person-the minor insider". Several brokers were not so definite in their response to this question. One Sydney broker said, "if they are there one presumes that the agencies are trying to enforce the law. Maybe the law is too hard to prove. They are trying without luck to enforce the law. That is not a great deterrent".

Apart from responses of "yes" and a "do not know" there were no direct answers from the Stock Exchange officials. Typical of the responses from them were that "the laws are respected and regulators have not ignored the law" and "they need test cases even if they lose. Maybe even by going to a higher court". One of the officials clarified the position by saying, "I cannot say. I do not know about the level of activity. The NCSC reacts to the information from the Stock Exchange by contacting the brokers".

The experience of the financial advisers suggests a perception that the laws are not being adequately enforced. Those who take this view did not, however, express any criticism of the agencies. They attributed the inadequate enforcement to such things as "a lack of any monitoring system"; "a shortage of resources in the NCSC and CACS"; and to the fact that "insider trading is not adequately supervised because they probably believe that they will never get a prosecution. The civil remedy is useless".

There was an overwhelmingly negative response from the market observers. Not one of them was prepared to say that the law was adequately enforced. The nearest they came to saying that it was, was to say that it is "probably not". The strength of these responses reflects poorly on the perception of the agencies but it should not, however, be interpreted as a wholesale attack on the agencies as many also offered explanations as to why the enforcement effort seems to have missed the mark. One view was that the inadequate enforcement arose:

not from a lack of will but due to a lack of resources. It is hard to deal with insider trading other than through the criminal system but it takes years to get to court and there are risks of witnesses being no longer available. They should be given resources matching the revenue they generate. The NCSC's informal approach of encouraging retirement is effective.

While most of the market observer group identified lack of resources as a problem for the agencies one of them was not as charitable when he remarked that "the NCSC whinges about lack of resources". He also noted that "a determined abuser can afford a better QC". More pungent criticism came from a financial journalist who said that the laws are "grossly neglected. The CACs have inadequate numbers and low quality staff". One commonly made suggestion as to how the law could be more vigorously enforced was that there be a different style of procedure-instead of using the court system "use QCs to investigate and impose penalties with a right of appeal to the courts". This suggestion was supported by references to several special enquiries into corporate matters which were described as "excellent performances by QCs who are better historically than judges at this sort of thing".

Apart from the naturally defensive answers of the regulators, the vast majority of respondents showed little confidence in the adequacy of insider trading law enforcement. It is clear that the agencies face real problems in the areas of staffing and market surveillance and it is clear that sufficient political support, in the sense of long-term funding, has been lacking. The prosecution of an insider trading case can be an extended process and politicians need to understand that in this area quick and spectacular results are not always possible. In 1990, the Commonwealth government provided a significantly increased budget to the ASC but the real test of the Commonwealth's commitment will be judged by its long-term financial support.

Should there be more vigorous enforcement?

Most of the industry professionals think that for all the impact of section 128, there might as well have been no law. It has been a popular argument of many in the securities industry and in the regulatory community that existing laws should be More fully tested in the courts, to identify their weaknesses, before they are changed. Most of the lawyers interviewed agreed that existing laws should be more vigorously enforced. A few, however, thought that this was not necessary as they did not think that there was a lot of insider trading. Most lawyers took a positive perspective on the issue of more vigorous enforcement. Many took the view that it was not necessary to reform the insider trading laws but rather to apply them more effectively. One Melbourne lawyer noted that "it is amazing for people to say that insider trading laws are inadequate if they are never tested. Even an unsuccessful prosecution will damage offenders". This theme was continued in Sydney where another lawyer agreed with more vigorous enforcement, "even if the regulators lose. The CACs have lost a lot of credibility and power. People don't worry about CACs any more". One reason to justify more vigorous prosecution of insider trading offences was to publicise the existence of insider trading laws. In the words of a Sydney lawyer, "it has been so neglected that some money must be spent initially on it to remind people [that it is an offence]". The financial advisers also expressed the view that the law should be more vigorously enforced.

The picture presented by the reactions of respondents does not show the securities law enforcement effort in a very good light. It is perhaps significant that there was little direct criticism of the agencies. Indeed, there were some comments that suggested that the agencies were labouring under a heavy burden given their lack of resources and the law they had to enforce. It seems reasonable to conclude that if governments are to be taken seriously about their views on the securities industry they must support their rhetoric with some tangible commitment. Otherwise the risk is that the law will fall further into disrepute, the agencies will lose the respect that they are working to develop and the market will become as lawless as it was in the late 1960s. The final result will be serious damage to an important feature of the economy which Australia cannot afford.

The effectiveness of the agencies

There was a widely held negative view about the agencies and this view was pursued further by asking how effective the agencies were in dealing with insider trading. The responses confirmed the original picture. Only one of the financial advisers, for example, said that they were effective, the majority view was that they were not effective but some said that they were improving. One view that summed up the position of many was that:

they are not at all effective; at the top level, the CAC is highly regarded but the companies legislation lacks teeth, there is little pressure from the public, stockbrokers do not co-operate and the lack of success must be a factor.

Most brokers also thought that the agencies were not very effective, but some said that considering the budgetary restraints facing the agencies they did a good job. A lack of market skills was identified as their major limitation. As one broker put it: "to date they are not all that effective. They probably do not understand the industry and need industry experience". The more detailed comment of a Sydney broker was that:

the NCSC is relatively ineffective. It has lost its way. It is too obsessed with the notion of victory. It is not impartial and is in conflict with the industry and loses the market's confidence. The CAC is even worse-it cannot hold its staff. The NCSC should be replaced with a panel made up of a practising lawyer as chairman, 2 merchant bankers and a broker with a levy on the top 50 companies to pay the chairman's salary".

Brokers recognised the restraints under which the agencies work. One explained that "they do a pretty good job considering the budgetary and staffing limitations and the flawed laws they have to work with". Another's view was that, "the NCSC have some surveillance capacity but the system needs an overhaul. The CAC might come down about something but they are not seen in surveillance. They do a good job with the resources they have - they are understaffed and have lost lots of people. The Stock Exchange is excellent in self-regulation".

Some brokers were, however, prepared to say more directly that the agencies are effective. In the words of one, "the Stock Exchange is able to react quickly. I am impressed by the NCSC-it understands the market better than the old CACS. There is now much more co-operation". Another endorsement was that "they are effective and growing in standing. Their standing is very important for their effectiveness". But others were not so sure. One broker wondered "why there are no prosecutions for insider trading". Another reflected on the structure of the regulators saying that "they have an impossible task under the way they are set up and their structures. A legalistic basis leads to a legalistic response and they lose their moral leadership and ability to influence". Most of the financial advisers thought that the agencies were not effective in dealing with insider trading. One expressed the opinion that they are not effective in that "the follow through is not good enough and they get bogged down in investigations and in court. Perhaps there should be a market court".

More critical comments were that the agencies "are most ineffective-insider trading is widely known yet they cannot get a prosecution" and, from a merchant banker, "they are incompetent, the quality of staff is low and they do not have sufficient resources". This view was often repeated by professional advisers. Stock Exchange officials reacted more favourably towards the regulators, probably because at the time of the project they were even worse off than the CACS. The agencies were described as "very effective" and it was said that "there has been a significant improvement in their effectiveness". Another Comment was that "overall they are quite good. The Humes case [see Humes Ltd v. Unity APA Ltd and the related legal actions reported at (1987) 11 ACLR 641] was the turning point. It would be nice for them to have a win. They need experience to develop skills". Perhaps the most enthusiastic response was that "the NCSC is lean and mean and I am quite impressed by it. It works under difficulties with a lack of resources. The CACs are a bit tired and too concerned about trivial matters".

The lawyers' impressions of the agencies were similar to those expressed by the brokers. A Sydney lawyer thought that "the regulatory agencies can't be effective. Even if insider trading is rare, four cases in twenty years is bad". Another lawyer observed that "they are ineffective. The record speaks for itself. This is a reflection of the political perception of insider trading and of other priorities". A different perspective was that "the NCSC is too concerned with self-publicity and law reform, rather than doing its job of enforcement. The heavy NCSC law reform role is inappropriate". A Perth lawyer expressed a common view when he remarked that 1. there is a need for better personnel, of a higher quality. There is also a need for more money, real capacity and dedication. You have to realise that you will lose the first few prosecutions. You need moles. I have no optimism about the ability of our regulatory agencies to deal with insider trading". Not all lawyers were as pessimistic. A Sydney lawyer believed that "regulatory agencies are more effective than people think, even though they have not been to court. I feel that there is a healthy respect for the NCSC, even though no one will admit to it. It is good to keep brokers on their toes. The NCSC often uses informal means of enforcement. This is quite effective".

Among professional advisers and traders in the securities industry the regulatory authorities, particularly the CACS, have a poor image. Perhaps this is undeserved in view of their serious resource constraints. The agencies are perceived to lack teeth, competent staff and sufficient resources to do the job that is being asked of them. Many respondents pointed to the lack of market sense on the part of the regulators, although the courts were also criticised for failing to take commercial realities into account. There were frequent references to the need for a more market oriented court comprising experts from industry, although ultimately the retention of the full sanction of the criminal law was seen as essential. The introduction of the ASC, its commitment to technology and more favourable government funding arrangements provide the opportunity for a greatly improved performance and a correspondingly greater impact on the market by the regulators. These developments coincide with a more dedicated effort by the ASX in compliance and the combination could lead to a new era of enforcement.

Detection mechanisms

An insight into the detection methods used by regulatory agencies to identify insider trading activity is provided in the following exchange between the Griffiths Committee Chairman and Mr John O'Dea, then a Special Investigator with the NSW Business and Consumer Affairs Agency:

Chairman: You had been notified via what mechanism that insider trading may be taking place?

Mr O'Dea: Potenfiafly because of variations in price and volume on a particular stock.

Chairman: What is the mechanism to advise you of that? Is it an analyst at the Stock Exchange or your own internal process?

Mr O'Dea: The Stock Exchange has parameters built into the computer that will highlight price and volume movements. It looks initially at the matter.

Chairman: That would be the primary source of information?

Mr O'Dea: It is one of the sources.

Chairman: What are the others?

Mr O'Dea: Not very often, but sometimes, it is an anonymous tip-off. Sometimes a matter is referred from the NCSC and one does not know the source of its information. It may be something appearing in a small column of the Sydney Morning Herald such as CBD. CBD has been a source of many an investigation over the years that I have been looking into it....

Chairman: So you have that information. What is your next step?

Mr O'Dea: The thing then is to request in our case the Sydney Stock Exchange for a stockwatch broker report covering a particular period, So if there is an announcement, say, at the end of last month, 30 April, one might pick a period two months beforehand and a month afterwards to try to find people who bought before and sold afterwards. That stockwatch broker report will list the trading by each broker separately, showing all the trades by that particular broker in that particular stock over the whole of the period covering each trade that is done on the trading floor of the Sydney Stock Exchange or, if it is a SEATS [the Stock Exchange Automated Trading System] trading stock, each trade that is done by means of the SEATS terminals. That then is analysed to find who has been the most active broker or brokers simply by listing the brokers number and the volume number of shares traded by each broker. A pattern usually emerges and if one takes the Bain and Story matter the thing that prompted the looking at those two particular brokers - apart from any other information - was the volume of shares traded by those two particular brokers over the week immediately before the announcement compared to the other brokers in the market. They were the only brokers visited because of the abnormal volume of shares traded by those particular brokers. They stuck head and shoulders over everybody else . . . There is a lot of information to be got. One looks for associations which would tend to show a connection in the professional business relationship that we are talking about, and then target those people first.

As one regulator explained, and as the research project also found, "there is not much pro-active enforcement of insider trading". There has been little or no computer surveillance by the CACs of market transactions. In this regard, reliance has been placed on the Stock Exchange and the NCSC. The regulatory style of the CACs has been completely reactive in nature-in the words of one regulator, "we rely on tips, the press and references from the NCSC". This was confirmed when regulators were asked how frequently they undertook random audits of stock trading for the purpose of detecting insider trading. The answer to this question was singularly striking and simple. Such audits do not take place at all. There was not even a hint of pro-active enforcement.

Although information in the financial press can be very useful to regulators, because financial journalists are often better informed of market activity and rumours than the CACS, subscribing to a press clipping service is far from being an adequate basis for market surveillance. This approach is now changing, but there will need to be an injection of significant amounts of capital into the acquisition of computer equipment, improved staff training and the introduction of better programmes for market surveillance, before any improvement will take place. There is a need for a broad range of measures to improve the detection of insider trading. These include a more sophisticated approach within the agencies, the encouragement of more complaints from persons affected by transactions and more extensive surveillance by both the Stock Exchanges and the agencies.

Random audits

There was confusion amongst brokers about Commission enquiries and random audits. It seems that while insider trading related random audits have been rare, there is a considerable volume of regulatory enquiries. On the topic of NCSC enquiries, brokers confirmed that "there are quite a few enquiries from the NCSC" and that, "we are plagued by specific audits from the NCSC". Perhaps some of these enquiries are related to insider trading - "there are regular NCSC enquiries on trading in particular stocks. The diligence of the NCSC is surprising and impressive. This is so particularly in takeover code matters". One broker reported that, "if there is a hint of insider trading the NCSC raises questions and if not satisfied they will visit the broker. The NCSC will advise the Stock Exchange people who then come. The Stock Exchange will always give answers to complaints". Brokers also remarked about Stock Exchange enquiries and reported that "the Stock Exchange does not do many inspections. They are not related to insider trading-they are interested in the system of order taking". The Stock Exchange "[only] conducts audits of [brokers'] accounts". It appears that random audits of stock trading are not carried out by the regulators, "they rely heavily on the Stock Exchange". An interesting observation was that, "I don't think it is necessary and certainly not by the CAC". Not many of the financial advisers had knowledge of random audits carried out by the regulatory bodies for evidence of insider trading.

Have there been insider trading cases where no action was taken?

Only one lawyer knew of a case of suspected insider trading in which no action was taken by authorities. It was one that he had referred to the NCSC. The agencies reported that they receive many reports of insider trading, some from within the industry which are suspected to be motivated by spite. Each of them was reportedly taken seriously and was investigated but usually, on legal advice, was not taken to the prosecution stage. The decision to prosecute was made on the likelihood of success and unless the legal advisers assessed the likelihood as high, prosecutions did not proceed.

Nearly all of the brokers said that they were not aware of such instances. In the words of one, "[the regulators] show rare zeal in chasing up cases". Another was aware of two cases where no follow-through had occurred; "one where they could not make the case stick and in the other the person left the country". Another surmised that it was "probably lack of proof" when a case did not proceed. Others have been left wondering, "we get a lot of requests from the NCSC for information and wonder what has come out of them". Most of the financial advisers were not aware of any instances where a case of insider trading had been detected but not prosecuted. One regulator described the process within the agencies in this way:

all insider trading cases are pursued to an appropriate conclusion. It is important to realise that a prosecution of a person of substance would cost at least a million dollars; such cases always involve QCs and arc likely to go to the High Court.

When the conservative prosecution policy is added to the chronic problem of resource constraints and the perceived lack of political support for insider trading prosecution, the reason for the lack of prosecutions is plain to see. More often than not, there was a preference among the regulators to proceed in relation to other offences arising under some other provisions of the Code as these were seen as being easier to substantiate. It was interesting to note that no direct evidence came to light that agencies had been persuaded by political pressure to withdraw from a prosecution. However, the lack of financial support from government could have had an indirect effect in inhibiting agencies from taking too activist an enforcement stance.