According to the Investment and Securities Act (ISA) 2007, “insider dealing includes insider trading and occurs when a person or group of persons who being in possession of some confidential and price sensitive information not generally available to the public, utilizes such information to buy or sell securities for the benefit of himself, itself or any person”. For the avoidance of doubt, the ISA’s definition of an “insider” includes an Audit Committee member of a company, a director, officer, employer or employee of the company or a related company, as well as a shareholder who owns at least 5% of any class of securities or any person who is or can be deemed to have any relationship with the company.
Insider trading is legal when the trading is conducted on information that has been made public; at which time the insider has no direct advantage over the other investors. Furthermore, an insider can be legally permitted to buy and sell shares of the company – and any subsidiaries – that employs such a person. However, it is illegal for anyone considered an insider to use undisclosed material information for profit. It is in this regard that the Securities and Exchange Commission (SEC) Code of Corporate Governance requires directors to disclose transactions in the Company’s stock and also notify the Company of changes in their holdings.
For this purpose, brokers, family members, friends and employees can be considered insiders.
The Investment and Securities Act empowers the Securities and Exchange Commission to act in the public interest with due regard to the protection of investors, to protect the integrity of the securities markets against abuses arising from the practice of insider trading and to prevent fraudulent and unfair trade practices relating to securities
As a former Chairman of the United States Securities and Exchange Commission observed “Our markets are a success precisely because they enjoy the world’s highest level of confidence. Investors put their capital to work – and put their fortunes at risk – because they trust that the marketplace is honest. They know that our securities laws require free, fair, and open transactions”.
In re Cady Roberts & Co, the US SEC based its decision to prohibit insider dealing on grounds of ‘fairness’ and it was the same outcome in SEC v. Texas Gulf Sulphur. The court’s finding was“…to prevent inequitable and unfair practices and to ensure fairness in securities transactions generally, whether conducted face-to-face, over the counter, or on exchanges …the Rule is based in policy on the justifiable expectation of the securities marketplace that all investors trading on impersonal exchanges have relatively equal access to material information.
Equality of information (Market Egalitarianism) requires that all investors trading on exchanges should have relatively equal access to material information. When one person trades with the benefit of nonpublic information, he or she gains an advantage over the rest of the investing public. This is not only unfair but considered criminal and disruptive to the stock market. Insider trading if not curtailed engenders opaque exchanges and loss of confidence in the Capital Market. “…the main (if not only) convincing justification for controlling insider dealing is that it has a perceived, adverse impact on confidence”. (Rider and Ashe). For financial markets to function efficiently, confidence and integrity are essential. If the public perception of the capital market is negative, investors will direct liquidity to other markets.
While there have been some successful prosecution for insider trading, the guilt of an alleged ‘Inside dealer” is usually difficult to establish. Indeed, it has been argued that insider trading is a victimless offense and that enforcing insider trading prohibitions is simply not cost effective; the amount of money recovered does not justify the money and human capital spent on investigating and prosecuting insider traders. To succeed in criminal proceedings under the ISA Rules, the prosecution must, in addition to proving the fact of insider trading, prove the defendant’s intention to profit from the act. Transactions made in violation of Section 111 of the ISA are voidable at the instance of SEC and could also give rise to criminal prosecution. A natural person is liable on conviction to a fine of NGN 500,000 or an amount equivalent to double the amount of profit derived by him or loss averted by the use of the information or to imprisonment for up to seven years. An offending body corporate is liable on conviction to a fine of NGN 1 million or an amount equivalent to twice the amount of profit derived by it or loss averted by the use of the information.
One way of preventing insider trading is for regulators to enforce rules relating to the timely disclosure of material information. Disclosure requirements should keep to a minimum non-public price sensitive information in a way that the opportunities for abusing such information would be reduced. It is also recommended that companies should have policies that regulate access to non-public material and price sensitive information. Indeed the amended Listing Rules of the Nigerian Stock Exchange requires a listed company to establish a Securities Trading Policy which shall apply to all employees and Directors and shall be circulated to all employees that may at any time possess any inside or material information about the company. The trading policy shall also include the need to enforce confidentiality against external advisers.