Compliance: Theory and Practice in the Financial Services Industry

3. Insider Trading and Chinese Walls

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Outline

	The Insider Trading Prohibitions
	The Chinese Wall Defence
	Other Exceptions and Defences
	ASX Market Rules
	The Position in the US
	Research Analysts
	Front Running
	Continuous Disclosure Rules
	Issues for Discussion

The Insider Trading Prohibitions

Without limiting the meaning that the expression "procure" otherwise has, if a person incites, induces, or encourages an act or omission by another person, the first-mentioned person is taken to procure the act or omission by the other person (s1042F).

Note that anyone can be an insider. The notion that applies under the laws of many other jurisdictions, and that used to apply under our law prior to 1991, that an insider must be someone connected with, or acquire the relevant information as a result of a connection with, the relevant body corporate (ie someone "inside" the body corporate), has not applied under our law since 1991.

Once you are an insider in relation to particular securities, as defined, you cannot trade or procure someone else to trade in those securities, either as principal or as agent. So if you are a broker and come into possession of inside information about a security, you cannot trade that security for yourself or for clients, even if they don’t know the information and you don’t pass it on to them. It doesn’t matter that you or your clients are trading against the inside information (ie you have "good" information but want to sell or you have "bad" information but want to buy).

On the meaning of "agreement to acquire", see R v Evans and Doyle (1999) VSC 488.In that case, Doyle, an institutional dealer, was aware from a client relationship that company X was going to announce a major nickel discovery that day and that the announcement was due to take place at 2pm. Company Y had a nearby mining tenement and the effect of the announcement would be likely to increase its market price. He passed that on to Evans, a director of two private companies, and they agreed that Doyle would instruct his SEATS operator to buy shares in Y for those companies shortly after 2pm. The announcement was delayed but the instructions were issued to the SEATS operator as planned shortly after 2 pm. Evans and Doyle were both indicted for insider trading. In a post-trial action to strike out the indictment, the court found that the indictment had been wrongly drawn. It had assumed that an agreement to buy was made when the instructions were given to the SEATS operator and the trial had focussed on people’s state of knowledge and whether information was generally available at that time. The court said that this was wrong and that the agreement to buy was entered into at the time the SEATS operator executed the order on-market and it was knowledge and price sensitivity at that time that needed to be established. As there had been such a delay in the trial, the court, in the exercise of its discretion, declined leave to allow the prosecution to amend the indictment.

DPP v Fysh [2010] QSC 216

Particular Division 3 financial products that are ordinarily able to be traded on a licensed market are taken to be "able to be traded" on that market even though trading in those products on that market is suspended by action taken by the market licensee, or is contrary to a direction given to the market licensee by ASIC under s794D(2) (s1042E).

ICAL Ltd v County Natwest Securities Aust Ltd (1988) 6 ACLC 467 demonstrates the potential breadth of the tipping prohibition. In that case, Transfield made an on-market takeover bid for ICAL through County Natwest Securities. ICAL challenged Transfield’s disclosure statement for the bid. Transfield counterclaimed for an injunction against ICAL to restrain it from seeking rival bidders while certain allegedly price sensitive information that it had given to a potential "white knight" was not generally available. The information in question comprised ICAL profit projections, information that the market value of some of ICAL's assets significantly exceeded their book value and information about the selling intentions of a major shareholder. The basis for the injunction was supposedly to prevent a breach of the tipping prohibition (the implication being that ICAL would give potential rival bidders access to this allegedly price sensitive information in order to encourage them to buy ICAL shares and defeat Transfield's bid). The court appeared to accept that passing on non-public information to a potential white knight in a takeover situation, who could then be expected to use the information to buy shares in the target, technically would breach the prohibition. However, it expressed some doubts about whether the information in this case was in fact price sensitive. It also noted that the information probably had been made public already by having been filed in court. In any event, the court said that in the exercise of its discretion it would decline to issue an injunction in these circumstances because the directors, by seeking alternative bidders, were acting in the interests of ICAL's members.

In Exicom Pty Ltd v Futuris Corporation Ltd (1995) 13 ACLC 1758, the court expressed the view that the references to securities in the insider trading regime that preceded s1043A meant securities that had already been issued and therefore the insider trading prohibition did not extend to an issue of securities. In that case, Exicom needed new equity capital and approached 2 parties X and Z, supplying them with confidential information about its financial affairs. X used the information to buy shares on market with a view to acquiring a pre-bid stake. Exicom sought and was granted an interim injunction against X to stop it acting in breach of the predecessor to s1043A. Exicom then proposed issuing shares to Z. X sought an injunction restraining the issue to Z arguing that Z was also an insider and that what was sauce for the goose should also be sauce for the gander. The court refused to grant the injunction. It said that a company could not be an insider in relation to its own securities for the purposes of the predecessor to s1043A. That is probably correct in relation to subscriptions when you look at the prohibition in s1043A(1) (there is no express prohibition against issuance) and the recovery regime in s1043L (there is no express right for an applicant to recover against the issuer). Query whether it is correct in relation to buy-backs. The court also said that shares that have not yet been issued are not securities for these purposes. This latter ruling made the references to "subscriptions" in the predecessor to s1043A (and, if it is followed in relation to s1043A, would make the references to "applications" in that section) otiose and for that reason must be doubted.

In ASIC v Citigroup Global Markets Australia Pty Limited (No. 4) [2007] FCA 963, the court held that an uncommunicated supposition can constitute "information" for these purposes but found that the alleged supposition that underpinned the first insider trading allegation against Citigroup (namely, that Manchee, its proprietary trader, had traded in Patricks shares after he had made the supposition that Citigroup was acting for Toll in relation to the takeover of Patricks) had not been made out on the facts.

What is readily observable for the purposes of (a) above? In R v Firns, a subsidiary of a listed company with a mining tenement in PNG challenged a regulation that had the effect of limiting the minerals the subject of its tenement. The PNG Supreme Court upheld the challenge in a judgment delivered on a Friday morning. E, an executive present at the court hearing, bought shares in the company shortly after the judgment was handed down. Another executive director of the company, upon receiving news of the judgment, conveyed the news to his son, F, who immediately bought shares in the company using his wife’s maiden name. Information about the judgment was not released by the company to the market in Australia until the following Monday morning. E and F were both charged with insider trading. E was acquitted with the judge directing the jury that readily observable meant observable anywhere. In a separate trial, F was convicted with the judge directing the jury that readily observable meant observable by someone in Australia. F appealed and his conviction was overturned. The court said that there was no warrant for introducing a territorial component to this section. It said that readily observable meant readily observable by anyone anywhere. While not relevant to this case, the court said that information did not have to be readily observable by the human senses unaided and that you could take account of information available via the web, TV, telephone, fax etc. It also said that information could be readily observable even if no one in fact observed it. In this case, the court said that the information embodied in the PNG Supreme Court judgment was available, understandable and accessible to a significant group of the public – ie those present in open court. The fundamental principles of open justice are based on the assumption that everything that happens in open court is capable of being observed and reported upon, thereby ensuring continuing accountability. Accordingly, a judgment is readily observable even if time will inevitably elapse before the profession or the market generally learns about it and absorbs its effect.

Given the views of the court on what was readily observable, under the law as it now stands, the case would have been better run as a continuous disclosure case rather than an insider trading case. Those executives of the company responsible for delaying until Monday morning the announcement of the Friday judgment would potentially have been liable to compensate any shareholders who sold in the interim without the benefit of the information contained in the announcement.

When is information brought to the attention of investors, as per (b)(i)? In Kinwat Holdings Pty Ltd v Platform Pty Ltd, P, which held 28.3% of the shares in W and had 4 common directors, had made a takeover bid for W. The common directors were aware of a valuation of W’s real estate assets indicating that they were worth much more than their book value. The plaintiff sued for an order restraining the bid on the basis that it would breach the insider trading prohibition. Before the hearing of the case, P’s parent wrote to the Sydney Stock Exchange disclosing the plaintiff’s allegations of under-valuation and this was then the subject of an article in a Brisbane newspaper the next morning. The court held that the letter to the Exchange plus the news article meant the information was now generally available and therefore there was no point granting the injunction.

(b)(ii) follows the principle established in the leading US insider trading case of SEC v Texas Gulf Sulphur Co. That case involved officers of a corporation purchasing shares and options in the corporation knowing that it had made a very significant mineral discovery. An announcement of the discovery was made to a press conference starting at 10 am, which was reported on  Merrill Lynch’s private wire service at 10.29 am and the Dow Jones ticker tape at 10.54 am. One of the officers placed an order to buy with a broker immediately before the announcement, and another immediately after the announcement, at 10 am. It was held that the information was still inside information at the time the trades were done. The minimum the officers should have waited was until the information was disseminated over the Dow Jones ticker tape.

CA s1042G(2) provides that s1042G does not limit the application of s769B in relation to Division 3. The latter section deals generally with the liability of principals (including bodies corporate) for the conduct of their agents, officers and employees.

The intention and effect of s1042G is to preclude a body corporate from trading in Division 3 financial products where any "officer" of the body corporate is in possession of inside information about the products, unless the body corporate can rely on the Chinese wall defence in s1043F or one of the other exceptions or defences mentioned below. There is a serious problem, however, with the changes made to the definition of "officer" by the CLERP 9 amendments in 2004 and their impact on s1042G. Those changes were intended to delineate better the legal responsibilities of corporate officers from employees. The definition of "officer" of a corporation in s9 was changed so that it only applied (relevantly) to a director, secretary or a person who: (a) makes, or participates in making, decisions that affect the whole, or a substantial part, of the business of the corporation; (b) has the capacity to affect significantly the corporation’s financial standing; or (c) in accordance with whose instructions or wishes the directors of the corporation are accustomed to act. Previously, "officer" had been defined in s82A in relation to a body corporate to include a director, secretary, executive officer or employee of the body. In making this change, the draftsperson appears to have forgotten about s1042G and so the result is that the section no longer works as intended.

Prior to the CLERP 9 amendments, s1042G operated so that if, for example, employees of a financial services organisation's corporate advisory team were working on a material non-public transaction in particular securities (eg a takeover), the entire organisation, including the stockbroking arm, would be precluded from trading in those securities, both for the house and for clients, unless there was a proper Chinese wall around the corporate advisory team.

With the CLERP 9 amendments, this now only applies where an "officer" of the body corporate is in possession of the inside information.

This issue was highlighted, without counsel or the court seemingly recognising it as a drafting error, in ASIC v Citigroup Global Markets Australia Pty Limited (No. 4) [2007] FCA 963. In that case, one of the number of grounds on which the first insider trading allegation against Citigroup was dismissed, was that the employee alleged to be in possession of insider information (Manchee, the proprietary trader) was not an "officer" of Citigroup and therefore his knowledge could not be attributed to Citigroup. However, the second allegation of insider trading passed that hurdle (although it failed on others) because the persons alleged to be in possession of inside information included persons who were plainly officers of Citigroup (the CEO and the Heads of Equities and ECM).

The fact that this is a drafting error is more than amply demonstrated by the continuing references to employees in both the body corporate Chinese wall defence in s1043F and in the body corporate "own intentions" defence in s1043I(2), as if the knowledge of mere employees was still imputed to a body corporate.

At some point, presumably, Parliament will get around to fixing up this drafting error.

This has the same effect as s1042F except in relation to partnerships. Essentially, a partnership will be precluded from trading in securities where any partner or employee is in possession of inside information about the securities unless it can rely on the Chinese wall exception in s1043G or one of the other exceptions or defences mentioned below.

On criminal penalties, see R v Rivkin [2003] NSWSC 447 and compare R v Doff [2005] NSWSC 50.

Note that the Government proposes to increase the criminal penalties for insider trading. In the case of an individual, the new penalty will be imprisonment for 10 years and/or a fine equal to the greater of: (a) 4,500 penalty units; or (b) if the court can determine the total value of the benefits that have been obtained by one or more persons and are reasonably attributable to the commission of the offence, 3 times that total value. In the case of a body corporate, the new penalty will be a fine equal to the greatest of: (a) 45,000 penalty units; or (b) if the court can determine the total value of the benefits that have been obtained by one or more persons and are reasonably attributable to the commission of the offence, 3 times that total value; or (c) if the court cannot determine the total value of those benefits, 10% of the body corporate’s annual turnover during the 12-month period ending at the end of the month in which the body corporate committed, or began committing, the offence.

ASIC celebrated its first successful civil penalty prosecutions for insider trading in 2005 - ASIC v Petsas [2005] FCA 88.

On civil damages, under s1043L, the amount in question can be recovered from the insider, anyone the insider procured to trade or anyone else "involved in the contravention". This phrase is defined in s79 to mean any person who has (a) aided, abetted, counselled or procured the contravention; (b) induced, whether by threats or promises or otherwise, the contravention; (c) been in any way, by act or omission, directly or indirectly, knowingly concerned in, or party to, the contravention; or (d) conspired with others to effect the contravention. So if a body corporate breaches the insider trading rules, any officers or employees who were knowingly concerned in the contravention may also be liable to compensate the other party to the trade.

ASIC may bring an action under s1043L(2) or (5) on behalf of the corporation which issued the products that were insider traded if the corporation declines to do so and ASIC considers that to be in the public interest (s1043L(6)).

Note the possibility for double liability under s1043L(3/4) and (5). Under the former (pre-FSR) law this was precluded by s1015. That section does not appear in the new (post-FSR) law.

The heading to s1043L is: "A specific situation in which a compensation order under section 1317HA may be made". S1043L(10) also provides that the right of action under s1043L is in addition to any right that any other person has under the civil penalty regime in s1317HA. These two factors together seem to imply that an action can be bought for other types of losses under s1317HA over and above the specific losses that can be claimed under s1043L. This was doubted in respect of the former (pre-FSR) law in Ampolex Ltd v Perpetual Trustee Company (Canberra) Ltd (No 2). In that case, Ampolex originally sued under the predecessors to both s1043L(5) and 1317HA (ss1005 and 1013(5) respectively) but subsequently dropped the s1013(5) action. All of the parties to the trades in question were aware of the inside information and therefore they were not entitled to make a claim under s1013(3) or (4) (the predecessors to ss1043L(3) and (4)). That necessarily precluded any derivative claim that Ampolex might assert under s1013(5). The issue therefore arose whether Ampolex could have an independent claim for damages under s1005 even though it could not make out a claim under s1013(5). The court, while not expressing a concluded opinion, seemed to suggest quite strongly that it could not and that dropping the s1013(5) action would therefore prove fatal at the final hearing to Ampolex's claim for damages. The reasoning by which the court arrived at this conclusion is questionable and turned very much on the drafting of section 1005 and the fact that it was prefaced with the words "subject to the following sections of this Division" (ie s1005 was expressed to be subject to s1013). Even if, as a matter of statutory construction, the decision was correct in relation to the former (pre-FSR) law, it is not clear that it can survive the legislative changes made by the FSR reforms. Having said all this, if a plaintiff can’t show the type of loss referred to in s1043L, the legal principles around causation and remoteness of damage are likely to present significant hurdles to a claim for any other form of loss under s1317HA succeeding.

An example of the third last bullet point - a former CEO of a Queensland government-owned energy corporation was charged with dishonestly using his knowledge of its business dealings for personal gain. It was alleged that he applied for 60,000 shares in the float of Perth-based company when he was aware that the board of the energy corporation had resolved to enter into a material contract with a subsidiary of the floating company. See ASIC Media Release 08-147.

In relation to the last bullet point, Singh v Crafter was 2/1 split decision of the Full Court of the WA Supreme Court holding that a contract entered into in breach of the insider trading prohibition was voidable for illegality, overturning a decision of the lower court on this point. So you have 2 judges going each way on the issue of voidability.

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The Chinese Wall Defence

Most of our case law on Chinese walls relates to their use in law firms to isolate teams acting for different parties in litigation. The courts have shown themselves to be extremely reluctant to accept the efficacy of Chinese walls in that context – see, for example, Mallesons Stephen Jacques v KPMG Peat Marwick (1990) WAR 357 and Bolkiah v KPMG [1999] 2 AC 222.

S1043G also provides that a member of a partnership does not contravene s1043A(1) by entering into a transaction or agreement otherwise than on behalf of the partnership merely because the member is taken to possess information that is in the possession of another member or an employee of the partnership. This would cover trading by a partner on his or her personal account.

"Associate" here takes its meaning from ss11, 13 and 15. In the case of a body corporate, its related bodies corporate and its and their directors and secretaries are "associates" and therefore trades done on their behalf by the body corporate fall outside the protection of this rule. Similarly, in the case of partnerships, their partners are associates and therefore trades done on their behalf by the partnership fall outside the protection of this rule.

But what are "arrangements that can reasonably be expected to ensure" that inside information is not passed on and advice is not given to those who should not have it. There is no guidance on this in the Corporations Act or ASIC Regulatory Guides and only limited guidance in Australian and UK case law.

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Other Exceptions and Defences

Without this exception, the responsible entity of a registered managed investment scheme could be guilty of insider trading when it pays over the redemption amount owing to a withdrawing scheme member, if it possesses materially price sensitive information about the scheme that is not generally available at the time. Note that this only applies to the responsible entity of a registered scheme. There is no equivalent defence for responsible entities of unregistered schemes. Note also the restrictions on the withdrawal price. If the responsible entity were to charge an unreasonable amount for acquiring the member's interest or factor in anything unrelated to the underlying value of the assets of the scheme, the exception would not be available. It is submitted that the drafting of this exception is unduly restrictive.

Note that the definition of "managed investment product" in CA ss9 and 761A effectively limits this exception to registered managed investment schemes. There is no equivalent exception for unregistered schemes.

An example of an acquisition pursuant to a requirement imposed by the Corporations Act would be a compulsory buy-out following a takeover under Chapter 6A. An example of a communication pursuant to a legal requirement would be an announcement by an issuer to the ASX under the continuous disclosure regime in Chapter 6CA (see below).

The "own intentions" exceptions in this section and in ss1043I and 1043J below are intended to operate so that a person who has, for example, decided to make a takeover offer for a company (which in almost all cases would be materially price-sensitive, and therefore "inside", information while it was not generally known) is not precluded from buying a pre-bid stake in the target because they have knowledge of their own intentions in this regard.

Note that this section only applies to dealings by the body corporate with the relevant intention. It will not apply to protect dealings by, say, a related body corporate or associate.

The heading to s1043J is possibly misleading – it speaks of officers and agents of a body corporate but the section itself can clearly apply to an agent acting on behalf of a natural person.

Note again that this section only applies to dealings by an agent for the principal with the relevant intention. It will not apply to protect dealings by an agent for, say, a related body corporate or associate of the principal.

The first bullet point means that a person seeking to rely on, say, the Chinese wall defence has to be able to prove, on balance of probabilities, that its arrangements could reasonably be expected to ensure that any inside information about Division 3 financial products in the possession of an insider was not communicated to the relevant employees who effected the dealing in those products and that no advice with respect to the dealing was given to those employees by the insider.

The first indented bullet point is the so-called "diligent investor" defence. It is there to protect a person who trades having obtained inside information as part of the process of it being released to the market but before it becomes "generally available" within the meaning of s1042C. Note that technically this defence does not apply to the first person in the chain who starts the process of releasing the information to the market. In the case of an issuer announcing information to the ASX, its actions ought to be covered by s1043E – information required to be disclosed under a legal requirement (the continuous disclosure rules) - although to rely on that exception the information would have to be announced to the ASX before, or at least simultaneously with, its dissemination in any other way (eg through a press conference or press release).

Query how this defence operates in relation to the dissemination of research reports. From a policy standpoint, an analyst should be able to disseminate research reports in order to promote an informed market. It is submitted that if this issue ever comes before a court, it ought to find that general dissemination to investors of a research report containing hitherto inside information does not involve a breach of the tipping provisions even though some of those investors might be expected to trade on the basis of the report. It could do this either by taking the person who gave the analyst the information as step 1 in the chain so that the analyst can qualify as a person receiving information under the "diligent investor" defence or by taking a purposive approach to the tipping provision and reading it down (as the courts have done with a number of other insider trading provisions). Of course, this should only happen where the information is "made known as mentioned in s1042C(b)(i)" - ie the research report is broadly disseminated to market participants. It should not happen if the report receives only limited dissemination or some investors are given preferential disclosure.

Note that in relation to the second indented bullet point (the so-called "insider-to-insider" defence), there is no equivalent express defence to civil liability under s1043L. However, s1043L predicates the right of a plaintiff who has sold products to, or purchased products from, an insider on the plaintiff not actually knowing the inside information at the time of the sale/purchase. If the person does not know, but ought reasonably to have known, the information, then the court has a discretion to relieve the insider from civil liability under s1043N (see next slide).

One might be tempted to argue that the courts ought to interpret s1043M(2)(b) as meaning that where that defence is made out, s1043A has not been contravened and so it also provides a defence to civil recovery under s1043L (one of the conditions to recovery under that section is a contravention of s1043A – see s1043L(1)(c)). Ampolex Ltd v Perpetual Trustee Company (Canberra) Ltd (No 2), discussed earlier, held differently however. There the defendants argued that the plaintiff's claim should be summarily dismissed because all parties to the trade were aware of the information and the precursor to s1043M(2)(b) was a complete defence to both a criminal claim and a civil action for damages. The court disagreed, saying that this section only applied to a criminal prosecution and that the precursor to s1043L set out its own defences to a civil claim. (See also the dissenting judgment in Singh v Crafter, discussed later). This finding is also supported by the language used in s1043M(1) – exceptions are not a contravention and also constitute a defence – whereas s1043M(2) only constitutes a defence.

The reference in (a) to the exemption sections mentioned in s1043M(1) makes no sense – if one of those sections applies, there is no contravention of 1043A.

There is also provision in s1317S for the court to relieve a person either wholly or partly from a liability to which the person would otherwise be subject for contravening a civil penalty provision if it appears that they have acted honestly and, having regard to all the circumstances of the case, they ought fairly to be excused for the contravention.

Under the former law, this used to be a complete defence to a civil liability claim. It is now only a factor allowing the court to grant relief in its discretion. It is unclear how this section relates, and what this adds, to s1043N. S1043L makes it clear that it is a sub-species of a s1317(HA) action and so s1043N, allowing the court generally to grant relief from s1317(HA), would seem to cover the point.

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ASX Market Rules

ASX MIR 3.6.1 defines "client" to include a shareholder in a company which constitutes the market participant.

ASX MIR 3.6.4 provides that, for the purposes of MIR 3.6.2, a market participant or an employee or partner of a market participant advising a client that the market participant is precluded from giving the client advice will not be regarded as giving advice.

Note that this rule only applies to information in the possession of a market participant as a result of its relationship to a client. This does not sit that comfortably with the usual corporate group structure where, for regulatory capital reasons, the broker typically is in a separate legal entity to other parts of the organisation, such as the investment bank. So, if the investment bank comes into possession of inside information as a result of its relationship with a client then, if the client is not also a client of the broker, then that would appear to fall outside of the rule even if the investment bank passes the information across to the broker!

Again this definition, in referring to "parts of the business of the Market Participant", does not sit that comfortably with the usual corporate group structure where the broker typically is in a separate legal entity to other parts of the organisation, such as the investment bank.

The predecessor to ASX MIR 3.6 (ASX Market Rule 7.18) required Chinese walls to accord with the guidelines prescribed by the ASX. ASX Market Rules Guidance Note 13 set out the procedures prescribed by the ASX for the establishment of Chinese walls for the purposes of that Market Rule.

ASIC has said that it will seek to follow the published interpretations contained in pre-existing ASX Market Rules guidance notes, including Guidance Note 13, but will look to review them and issue replacement ASIC Guidance Notes in due course (see ASIC Regulatory Guide 214 - Guidance on ASIC market integrity rules for ASX and ASX 24 markets, at para 57-58).

To be consistent with global best practice, Guidance Note 13 should have imposed requirements for the maintenance of restricted and watch lists and for the monitoring of employee trades (compare the position in the US mentioned below).

"Trading Best" was a joint ASX and ASIC awareness and self-assessment program conducted in 2001. The Trading Best self-assessment questionnaire was structured to highlight areas where the ASX and ASIC thought that compliance policies and procedures were required. In addition to the requirements outlined in then ASX Business Rules Guidance Note 7/97 (the precursor to Market Rule Guidance Note 13), the ASX and ASIC identified these additional "best practice" requirements that they said market participants should comply with. Given that statement, it is somewhat surprising that, when ASX Business Rules Guidance Note 7/97 was re-issued in March 2004 as ASX Market Rules Guidance Note 13, the ASX did not take the opportunity to include these additional "best practice" requirements.

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The Position in the US

This refers to the SEC Report entitled "Broker-Dealer Policies and Procedures Designed to Segment the Flow and Prevent the Misuse of Material Non-public Information" [1990] Fed Sec Law Reports ¶84,520. A copy is included in your reading materials for the course.

Click here for a copy of NYSE/NASD Info Memo 91-22 (1991 NYSE Info. Memo LEXIS 40). This Info Memo was created to give guidance to brokers on the procedures to be implemented to comply with s3(b) of the Insider Trading and Securities Fraud Enforcement Act 1988.

This involved disciplinary proceedings by the NYSE against Barings in relation to an employee who had executed an order on his personal account against the firm’s proprietary trading account, jumping an unexecuted client order and receiving a more favourable price. Action was taken against Barings for failing to reasonably supervise or control employees. Adverse findings against Barings included that it failed to do the things mentioned above. A transcript of the disciplinary proceedings is available on the NYSE web site at: http://www.nyse.com/pdfs/98-069.pdf.

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Research Analysts

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Front Running

A failure to act "efficiently, honestly and fairly" by a licensee may result in the cancellation or suspension of its financial services licence (ss915C(1)(a) and 912A(1)(a)) or by a representative of a licensee may result in a banning order against the representative (s920A(1)(e)). Breach of s183 gives rise to a liability for corporation/scheme civil penalties and compensation orders for improperly using information acquired in that capacity (ss1317G(1) and 1317H). Breach of fiduciary duty may result in the front runner being liable to disgorge any profits made from the breach to their principal (ie their client/employer).

Apart from ASX MIR 5.8.4, the only references that I can find to front running in the ASX Market Integrity Rules is a tangential reference in MIR 5.1.4(e) to a market participant acting in accordance with its "procedures to ensure that a person initiating, transmitting or executing an order who is aware of instructions of a client ... to deal in the relevant products ... does not use that information to the disadvantage of that client" as being a relevant factor in determining whether allocations are fair and reasonable.

ASX 24 MIR 3.1.15(3) provides that a market participant which executes a trade to cover an error trade is not in breach of MIR 3.1.15(1).

Note that for these purposes, "client" includes a related body corporate of the market participant or a division of the market participant which is separate from the market participant’s futures division (MIR 3.1.15(4)(a)) and "house account" means an account operated by a market participant for principal dealing only. It excludes dealings by the market participant on behalf of a corporation related to the market participant or another division within that market participant’s corporation which is separate from its futures division (MIR 3.1.15(4)(b)).

For these purposes, "client" includes a related body corporate of the market participant or a division of the market participant which is separate from the market participant’s futures division and "a person having a financial interest in an account" includes any benefit which that person may enjoy as the result of the operation of that account, or trading under that account (MIR 3.1.14(3)).

Note that the provisions in (2)(d) above are ridiculously wide. Applied literally, they would mean that if an employee happened to own a few shares in BHP Billiton and they did a trade for BHP Billiton, that trade would be considered a personal account trade for the purposes of this rule.

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Continuous Disclosure Rules

CA s676 defines when information is generally available in the same terms as s1042C. CA s677 defines "material effect on price or value of securities" in the same terms as s1042D. "ED securities" is defined in CA s111AD. For a listed entity it includes any securities to which the market’s listing rules apply (see s111AE).

ASIC v Southcorp Limited (No 2) [2003] FCA 1369 was the first successful prosecution for breaching CA s674(2). In that case, the executive general manager of corporate affairs of Southcorp, a listed company, sent an email to selected analysts containing information about the likely impact of the poor 2000 vintage for premium wines on Southcorp's 2003 gross profit without providing the information to the Australian Stock Exchange. In a negotiated settlement, Southcorp consented to a declaration that it had contravened CA s674(2) and was ordered to pay a pecuniary penalty of $100,000 plus ASIC's costs.

CA s674(2A) makes it a civil penalty for a  person to be involved in a listed disclosing entity's contravention of s674(2). There is a defence in CA S674(2B) if the person proves that they: (a) took all steps (if any) that were reasonable in the circumstances to ensure that the listed disclosing entity complied with its obligations under s674(2); and (b) after doing so, believed on reasonable grounds that the listed disclosing entity was complying with its obligations under that section.

Note that all 3 conditions must be satisfied to qualify for non-disclosure. ASX says that it will be likely to consider that information has ceased to be confidential if the information, or part of it, becomes known either selectively or generally, whether inadvertently or deliberately. Further, if information becomes known by others in circumstances where the entity does not retain control of its use and disclosure, rule (2) above is not satisfied regardless of whether the entity or a third party disclosed the information. For example, where there is a rumour circulating or media comment about the information and the rumour or comment is reasonably specific, this will generally indicate that confidentiality has been lost.

The obligation to give information under LR 3.1B arises even if an exception to disclosure under LR 3.1A applies.

Click here for a copy of ASX Listing Rules Guidance Note 8. See also ASIC Regulatory Guide 62 - Better Disclosure for Investors.

This section applies to unlisted disclosing entities and to listed disclosing entities where the applicable listing rules do not have continuous disclosure requirements (s675(1)). Again, the expression "ED securities" is defined in CA s111AD. "ED securities" for an unlisted entity include any securities or managed investment products that have been offered under a disclosure document, PDS or takeover offer where the number of holders exceeds 100 (see ss111AF, 111AFA and 111AG).

CA s675(2A) makes it a civil penalty for a  person to be involved in a disclosing entity's contravention of s675(2). There is a defence in CA S675(2B) if the person proves that they: (a) took all steps (if any) that were reasonable in the circumstances to ensure that the disclosing entity complied with its obligations under s675(2); and (b) after doing so, believed on reasonable grounds that the disclosing entity was complying with its obligations under that section.

The size of the on the spot fines that ASIC can impose varies, depending on the market cap of the offending corporation and whether it is a first or subsequent offence (see ss1317DAE).

ASIC issued its first infringement notice for a continuous disclosure breach in August 2005, resulting in a penalty of $33,000 being imposed upon Solbec Pharmaceuticals Limited. See ASIC Media Release 05-223.

See also Jubilee Mines NL v Riley [2009] WASCA, in which a civil action for damages for breaching continuous disclosure requirements was overturned on appeal.

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