UK: Too soft on the inside.

UK: Too soft on the inside. - The new law to clamp down on insider dealers has averaged just over one conviction a year since 1993. It's little wonder there are plans afoot for a change in tack.

by Chris Blackhurst is assistant editor of the Independent onSunday.
Last Updated: 31 Aug 2010

The new law to clamp down on insider dealers has averaged just over one conviction a year since 1993. It's little wonder there are plans afoot for a change in tack.

On 24 June 1994, Professor Stephen Littlechild, the electricity regulator, wrote to the directors of the 12 regional electricity companies with a report setting out his proposals for price controls in the industry. The speculation about his plans had wiped millions of pounds off the value of shares in the electricity companies. But the deal the professor was outlining was much better than the directors had expected.

At Eastern Electricity, the firm's then director of strategy Douglas Swinden received the letter. He had a cash pile of £15,000 from a bonus paid to him as a director and decided to use part of it. Between 24 June and 1 August, Swinden went ahead and purchased 2,000 shares at 350p each in Seeboard, a rival of Eastern. When Littlechild went public with his report on 11 August, electricity shares soared. In the month after publication of the report, Seeboard shares climbed 100p.

Swinden was promptly arrested and charged with insider dealing. Some 18 months after he bought the shares, he walked free from Snaresbrook Crown Court in east London, after the jury failed to reach a verdict. Eight hours' deliberation saw the jury unable to agree whether Swinden had committed an offence.

On the face of it, this was a clear-cut case: Littlechild's letter was private; Swinden's reaction was to buy electricity shares; they climbed in price; he was caught bang to rights. Yet Swinden was not convicted.

This was because before he bought the shares, he sought the advice of Eastern's company secretary who told him the information was not unpublished (since the letter had been so widely distributed) and was not price-sensitive.

There was no reason, the company secretary told Swinden, why he could not buy shares in Seeboard.

Swinden also argued, in his defence, that there was no evidence that share prices would rise on the back of publication of Little-child's report.

Not for the first time, where insider dealing prosecutions are concerned, the Department of Trade and Industry was left with a hefty legal bill for the taxpayer to foot and nothing to show for it.

Over the last decade, the number of successful insider trading convictions has been tiny. Between 1981, when insider dealing became an offence, and 1993, when the law was simplified (ostensibly to make prosecutions easier), 51 people in Britain were charged with insider dealing, of whom 14 pleaded guilty. Of the remaining 37, just nine were convicted. Since 1993, and the implementation of the Criminal Justice Act (CJA), there have been only five convictions. To put that into context, each day in Britain sees on average between 35,000 and 40,000 share trades. That does not include a further 10,000 trades in international shares which are also listed in London.

On the fifth floor of the Stock Exchange tower in the City, the 55 members of the market's share surveillance unit try to keep order. Within three minutes of completing a trade, market-makers are obliged to log it with the Exchange. Details as to who sold, who bought, at what price and when, go into the Exchange's computer where the data undergoes 28 in-built checks, any one of which could trigger an insider dealing alert. If a deal is suspicious, details flash up on the unit's screen. Each day, on average, 3,000 are highlighted in this way. Every one of the 3,000 must be examined by the end of the working day, and if not suspicious, cleared. Those left over - 20 to 30 on average - are referred for further investigation.

Yet only a handful ever result in a conviction. In theory, there should be many more. The CJA lays down three simple offences: dealing, encouraging dealing and disclosing inside information. The first makes it an offence for 'an individual who has information as an insider to deal on a regulated market in securities whose price would be significantly affected if the inside information were made public'. Second, it is an offence where 'an individual who has information as an insider encourages dealing in price-affected securities by another person - regardless of whether the other person knows the individual has inside information'.

Third, it is an offence for 'an individual who has information as an insider to disclose the information to another, except in the proper performance of his employment, office or profession'. In CJA terminology, an 'individual' is defined as a person: a company cannot be charged with insider dealing.

'Inside information' must be 'specific' or 'precise' and must not have been 'made public'. 'Made public' is defined as an announcement through the Stock Exchange, or in a record which is open to public inspection or can be readily acquired by anyone looking to deal in the shares. Information communicated only to a section of the public, City analysts, for example, or obtained by 'diligence or expertise' may be treated as 'public'.

For all three offences, according to section 53 of the CJA, it is a defence for the individual to show - as Swinden argued - that he or she did not expect the use of the inside information to lead either to profit or avoidance of a loss. The dealing and encouragement offences have two further defences: that the accused thought the information was disclosed widely enough so it was not 'inside'; and that the individual would have done what he did even without the information.

What this amounts to is a far-reaching and easily understood insider dealing regime. The small number of prosecutions, says Professor Barry Rider, dean of the Institute of Advanced Legal Studies in London, arises not because the law is unwieldy and confusing but because the DTI pursues 'only the most egregious cases'. Certainly there is no shortage of suspected cases: last year the number of potential insider dealing breaches referred to the DTI by the Stock Exchange climbed 115%, from 13 to 28. Of these, however, only a small number, if any, will actually come to court. The reason that only the most flagrant alleged breaches end up in court is the need for the prosecution to prove 'beyond reasonable doubt' that an offence took place. The number of trades may be huge, the policing may be scrupulous, the definition of the crime may be easily understood but securing a conviction is another matter.

So the Stock Exchange and the Securities and Investments Board (SIB), with the backing of key City opinion formers like the Foundation for Business Responsibility, is seeking a lower level of proof. They argue that the offence should be decriminalised and that civil actions, where the burden of proof is less onerous, be brought.

Andrew Winckler, SIB's chief executive, admits that too many cases are slipping through the net. He has taken his plea for 'a stronger and more effective regulatory or civil alternative' to the CJA, to the House of Commons. Likewise, Richard Kilsby, the Stock Exchange's head of market services, maintains that a lower civil burden of proof, coupled with the ability to extract hefty damages from insider dealers, would make such people think twice.

The momentum for change has probably reached a point of no return. When heavyweights like Sir Andrew Large, chairman of SIB, openly admit that the record of successful prosecutions has provoked criticism, it is clear something will be done. It would be wrong, though, to imagine a new get-even-tougher policy is solely dependent on a change in the law.

There are other steps that can be taken, and are being taken, to try to clamp down. Last month, the Stock Exchange went online with the Intelligent Alerting System, a piece of software billed as the most sophisticated of its type in the world.

Officials are confident it will boost their ability to analyse the 3,000 suspicious trades a day across the market, not just looking at a day's deals but over weeks as well.

Should that fail, the Stock Exchange may have another ploy. After the Lord Archer case, where the DTI went public with an investigation into his purchase of shares in Anglia TV, serious thought is being given to publicising all insider dealing inquiries. This would remove the present anomaly where the most high-profile investigations occasionally attract publicity while other equally serious inquiries involving less well-known figures remain hidden.

Whatever happens, regardless of a change in the law and more cases, one thing is certain: insider trading will be even more heavily policed than at present. This is little consolation for company managers and compliance officers charged with trying to manage the rules, trying to avoid a situation where one of their colleagues and the firm's good name is dragged through the mire. Their solution in this supposed age of open internal communication is to restrict access to the relevant information to as few people as possible. Glaxo Wellcome employs 55,000 staff worldwide, for example, but only 15 people are privy in advance to forthcoming results.

The Swinden case, where he consulted his company secretary and received questionable advice, probably could not happen at Glaxo Wellcome. There, every director and senior employee is required to have their share dealings checked by the company's dealing clearance committee. Below that top tier, other employees must consult their bosses if they are trading in shares.

All employees are also circulated with notices reminding them they must not buy or sell shares in the closed period ahead of a results announcement, regardless of the fact that they are outside the group, described as 'very tight' by a company spokesman, who have access to the figures. Similarly, all employees are constantly warned they cannot trade if they are in possession of any information which could be price-sensitive. This gets round the problem of information appearing in internal newsletters or employees coming across or overhearing something while they move around the company.

To guard against information leaking - and the second and third offences on the statute book, of encouraging insider dealing and disclosing inside information - Glaxo, like other large companies, has a mandatory rule for all employees: all callers must be identified; all press contact must be routed through the press office; and all communication with stockbrokers' analysts must be directed towards the investor relations department.

For their part, City analysts are exposed by the CJA if they trade while in receipt of information from an insider. Their solution - or at least, the solution of those who want to stay within the law - is to contact the company concerned and check. One analyst was at an airport when he overheard two people deep in a huddle having a conversation. One said to the other, 'This will make the price go up'. The other said, 'What, General Electric's?' Back came the reply, 'No, Rolls-Royce's'.

It was obvious to the analyst that these two, dressed in suits, sitting in the business lounge of the airport, knew what they were talking about.

At that point, if the analyst had recommended Rolls-Royce shares to his dealers, he could have been committing an offence, assuming the pair was discussing an impending deal and not a press cutting. But before trading, he phoned Rolls-Royce. Were they close to an order? Yes, they were, came the answer.

Then he issued a buy notice on Rolls-Royce. By telephoning the company, the analyst believed he had covered himself, that the information was made public. It is questionable, however, whether this was the case: his colleagues and clients still enjoyed an advantage over the rest of the market and it is hard to see how giving one person an answer to a question can count as making public.

A senior compliance officer at a leading firm of stockbrokers says another grey area and one that has caused her firm problems is the star analyst. A change of mind from one of these influential pundits can be enough to move a share price so the firm has had to go to great lengths to ensure that nobody buys or sells ahead of their decision becoming public.

Yet another difficulty is that of analysts simply going about their research.

If they meet, say, a director of a company and subsequently tell someone about the meeting, who, on the back of what has been said, buys some shares, the analyst is caught by the legislation. Again, as with large companies like Glaxo, staff are under strict orders: if in doubt, check with the compliance department.

The risk to brokers is, however, greater than to Glaxo Wellcome employees since they face another threat, apart from criminal prosecution. Cases that might not make it through the courts are frequently passed to City regulators. If the case is proven, the regulators, such as the Securities and Futures Authority, have sweeping powers to fine and expel the rogue trader from the market and to censure, fine and expel their firms.

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