Insider Trading in Australia

1
Insider Trading in Australia

• Is the regulation of insider trading in Australia
  necessary or even desirable?

Invaluable Reference Lyon, G. and du Plessis, J.
(2005) The Law of Insider Trading in Australia,
Sydney The Federation Press.
2

• Knowledge is power.
• Advance knowledge is profit.
• Attributed to the Rothschild Family.
• Almost 200 years ago the Rothschild Family
  secured their fortune by accumulating British
  Government securities on the basis of advance
  knowledge of Wellingtons victory over Napoleon
  at Waterloo.
• While this quote identifies the benefits of
  inside information, is this truly a case of
  insider trading?

3
What is insider trading?

• Trading by a trader who possesses information
  that is material to the price of securities
  which are traded, which is not already known to
  other traders in the market, and which is not the
  product of the analysis of publicly available
  information by that trader.
• Baxt, Black and Hanrahan, above n 5, 503.

4
Who is an insider?

• A person is defined as an insider if he, she or
  it possesses inside information (defined on the
  next slide) about the securities of a body
  corporate and knows or ought reasonably to know
  that the information is not generally available
  and, if it were, a reasonable person would expect
  it to have a material effect on the price or
  value of those securities.
• There is no longer a requirement for a person
  connection to exist between the insider and the
  company whose securities are traded.
• An insider is defined by the bare requirement of
  trading whilst in the possession of inside
  information e.g. a person who hears inside
  information in passing and trades on the
  information is just as liable to prosecution as a
  company director who learns of inside information
  due to their position.

5
What is inside information?

• Information that is not generally available, but
  if it were generally available, a reasonable
  person would expect that information to have a
  material effect on the price or value of
  securities of a body corporate. Corporations Act
  s 1042A.
• Information includes matters of supposition and
  matters insufficiently definite to warrant being
  made known to the general public and matters
  relating to the intentions or likely intentions
  of a person. Corporations Act s 1042A.

6
When is information generally available?

• Information is generally available if
• it consists of readily observable matter or
• without limiting (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 and value might be affected by
  the information and
• a reasonable period of time has elapsed after it
  has been made known for it to be disseminated
  among such persons or
• it consists of deductions, conclusions or
  inferences drawn from (a) or (b)(i).
• Corporations Act s 1042C.

7
The Australian experience

• 19 insider trading cases from 1985 2005 led to
  criminal prosecutions.
• Of these cases, about half were acquitted or did
  not go to trial, although less so in recent
  years.
• About the same number of civil actions again
  with mixed results.
• Possible reasons why so few convictions
• Low occurrence of insider trading (unlikely)
• Hard to detect
• Inefficient regulator (ASIC)
• Complexity of legislation

8
A prominent case R v Rivkin (2003)

• Rivkin received information about the prospective
  merger of Impulse Airlines with Qantas after the
  CEO of Impulse sought to convince Rivken of his
  financial worth during unrelated business
  negotiations. The Crown alleged that the profit
  made from the sale of shares based on this
  information was 2664.94.
• Convicted and a custodial sentence of 9 months
  weekend detention and a fine of 30000 were
  imposed.
• The conviction also disqualified Rivken from
  managing a corporation for 5 years and made it
  possible for ASIC to disqualify Rivken from
  holding his Security Dealers Licence.
• Although Rivken did not make a huge monetary
  profit, the judge viewed the crime as serious
  because of Rivkens position as a trader and
  because Rivken knew full well the price
  sensitivity of the information and had been
  warned not to trade in the shares.

9
Insider trading in Australia should not be
regulated.
Mark Christensen
10

• Definition of insider trading, effectiveness of
  legislation, other laws
• Difference between OTC and Exchange Traded
  issue is probably liquidity
• Regulation hinders market efficiency
• Who are the players investors who buy and hold
  or traders who are not forced to sell and who
  willingly buy and sell.
• Market efficiency price discovery process
  information reflected in price speed of
  incorporation - efficiency reflects information
  and speed of response

11
Trading

• The concept of an efficient market is a special
  application of the no free lunch principle. In
  an efficient financial market, costless trading
  policies will not generate excess returns. the
  connection between information not reflected and
  prices is to subtle and tenuous to be easily or
  costlessly detected. Relevant information is
  difficult and expensive to uncover and
  evaluatethe existence of such traders (seeking
  relevant information) is actually a necessary
  precondition for markets to become efficient
  Richard Roll

12

• Creation of equity and not efficiency
• Loss of Profits
• Harm to Market confidence
• Unfair/wrong
• Value of regulation
• Equality of opportunity v equality of outcome

13
Insider trading in Australia should be
regulated.Or why economist (who run the RBA,
Treasury, IMF, Central Banks and the other top
regulatory bodies) dont support the idea of
unrestricted trading.

• Paul Frijters

14
What would happen if you would have no
restrictions on insider trading?
Take an asset of which 90 is owned by outsiders
(who trade amongst each other at the going
price), 10 owned by an insider and where there
is a shock to the value, with the shock
anticipated by the insider..
Underlying value of the asset (share) price
Time
t0
t1
Time at which outsiders get to know the increase
in value
Time at which an insider gets to know the future
increase in price
15
What would the smart insider do?
The insider will attempt to buy the asset from
the outsiders at the old price. To prevent the
outsiders from being alerted to his inside
information, hell try to work through outsiders
(friends, family, traders, banks, etc. whatever
is needed to hide the tracks. Since in a free
system there is no obligation for openness, the
insider will find a way)
Underlying value of the asset (share)
Time
t0
t1
Result the insider will buy some outside shares
and sell them again when the value increase is
observed to outsiders, netting the difference.
The amount of money he makes depends on the
number he can afford to buy
16
What would the smart outsiders do?
The outsider would try to monitor the insiders,
each in essence replicating what regulators do
but more (because they have to know things when
they trade, not afterwards). Since there are many
firms and since insiders would have no
restriction on the many ways they can hide their
buying operations, outsiders will only very
imperfectly pick up the fact that an insider is
buying based on inside information. Hence the
result would be a gradual increase in price
Underlying value of the asset (share)
Time
t0
t1
Result the insider will buy some outside shares
and sell them again when the value increase is
observed to outsiders, netting a large slice of
the difference, but some smarter outsiders will
share in the profit.
17
What would happen with a downward shift in value?
The insider would try to sell his shares (or tell
his befriended traders and family to sell them),
and buy them again after the value change.
Underlying value of the asset (share)
Time
t0
t1
Result the insider will sell his shares and buy
them again when the value increase is observed to
outsiders, netting a large slice of the
difference, with again some smart outsider
picking up some crumbs.
18
What would the possibility of buying options mean
in this situation?
Options allow the insider to make a far greater
profit on his inside information because with the
same amount of money available he can effectively
multiply his winnings the insider buys the
option of outsiders to but the shares at t1 for
the old price, and then sells those options at
t1. In the extreme case of deep pockets, the
insider can buy 1 option for every share owned by
an outsider, leading to a complete appropriation
of the increase in value of the outstanding
shares.
Underlying value of the asset (share)
Time
t0
t1
19
How does market analysis, meaning the attempt at
using publicly available information to predict
the value change, fit into this?
Suppose market analysis allows you to know at
time t0.5, that the value of the stock will
increase. The insider still has an advantage but
needs to act quicker. The market analyst though
has made the market more efficient in the sense
of faster adaptation to fundamental shocks. The
success of the analyst can be copied by everyone,
whereas the actions of the insider cannot. Hence
while the market as a whole may learn from
analysis, it cant learn from insider trading.
Underlying value of the asset (share)
Time
t0.5
t0
t1
20
What happens with current restrictions?
The insider will still try to make a profit on
his information and will covertly and illegally
try to buy (or let friends buy) some shares,
leading to a slight increase in price. The better
the monitoring, the less the profit the insider
can make and the more the insiders actions have
to be covert. In the limit, all the insider can
do is to be the very first of the traders at t1
to buy the shares, sharing only slightly in the
additional value with the majority of the net
value increase going to the outside share owners.
Underlying value of the asset (share) and price
Time
t0
t1
21
Knock-on effect of inside information?
What would you as the insider do if inside
trading is allowed? Because youll make money on
price changes (both up and down), you will
deliberately create shocks to the real value.
This is most easily accomplished by running down
the company. Hence insider trading would lead the
insiders to deliberate mismanagement.
Artificially created negative shock to the value,
for instance via sabotage
Underlying value of the asset (share)
Time
t0
t1
22
So, what have we learned from this textbook
knowledge?

• 1. If you allow insider trading, the insider can
  appropriate the full value of the new
  information even though outsiders own the
  shares, the insider essentially owns the value of
  the shocks.
• 2. A market for options aggravates the insider
  information problem. Hence you can only have a
  market for options if you have a very
  sophisticated monitoring system. Indeed, you
  cannot have a market in stocks or options without
  regulation!!!!
• 3. Insider trading would lead to wilful sabotage
  of the companies by insiders.
• 4. Regulation against insider trading is a
  cat-and-mouse game of insiders trying to hide
  their activities and regulators trying to monitor
  them. With no regulation at all, the only outcome
  is where no stocks are traded anonymously which
  means the useful function of financial markets
  disappears and most of the students and staff
  here would have no job.
• 5. The clever insiders (crooks) and the most
  savvy traders will thus make money at the expense
  of the majority of traders. Whilst ignorant
  people may admire those wealthy crooks and dream
  of emulating them, the wealth of the majority and
  the value of having a stock market in the first
  place is due to the regulators. The crooks are
  not a necessary part of the system but the
  unfortunate amount of skimming that comes with
  imperfect monitoring.
• 6. Economic theory is useful financial market
  regulation (as well financial research) is justly
  based on a solid understanding of economics
  rather than the views of financial market
  practitioners whose world exists because of
  market regulation rather than despite of it.