Insider Trading Explained

By Robert P. Kinghan
April 21, 2009

The current uncertainty of the global market has heightened public awareness of the stock-market and its players.  In this vein the rules prohibiting “Insider Trading”, or the buying and selling of securities with material information that has not been generally disclosed, have once again been thrown into the forefront.

Insider Trading is unlawful because our society adopts a presumption in favour of market outcomes.  Most legal rules, including the insider trading laws, would fail to pass any cost-benefit analysis, but there is no theoretical doubt about our society requiring firms to take account of the effects their acts have on third parties.  Some commentators argue that it is acceptable to allow insiders to profit from trades made using inside information.  They support their arguments through cost-benefit analyses, the moral hazards involved, and the adverse selection theory.  However, these arguments remain inconclusive.  In the meantime the law, in taking pro-active measures, will not wait for scholars and economists to resolve all uncertainties.

Proving Insider Trading on a balance of probabilities can be extremely difficult.  The elements of the Insider Trading offence are; the person must be in a special relationship with the company in question, the person must buy or sell securities of that company, the person must have knowledge of inside information, and the information must not have been generally disclosed.  The elements of the Insider Trading offence for tipping are similar with the added criteria that the person informs another of the inside information.

Insider Trading is regulated by the Ontario Securities Commission pursuant to the Ontario Securities Act.  The Act should be consulted where a public or reporting issuer corporation is concerned.  The securities regulatory system imposes harsh sanctions on Insider Trading including; imprisonment (maximum of 10 years), fines (the greater of $5 million or 3 times the profit made or loss avoided), cease trading orders, and compensation to investors.

Steps must be taken to insulate a company from charges of Insider Trading liability in circumstances where trades are being made with inside information, but the company clearly does not make use of such information in connection with the impugned trade.  Putting an insider trading policy in place is good corporate governance.

Four specific defences are available to a company accused of insider trading.  The first is where the purchaser or seller acts as agent for another person or company pursuant to a specific unsolicited order.  Another applies where the purchase or sale is made pursuant to an automatic plan entered into by the purchaser or seller prior to the acquisition of the inside information.  The third is where the purchase or sale is made pursuant to a legally binding obligation prior to the acquisition of the inside information.  The final defence, known as the “Chinese Wall” defence requires a trader to prove that the participants in the trade had no actual knowledge themselves nor were given advice from someone with the knowledge of inside information.

The Insider Trading laws have been established with the objective of making the playing field as even as possible with equal information being provided at the same time to all investors.  The regulation of Insider Trading plays an important part in ensuring a public confidence in our market that is tumultuous at best.  Companies and its insiders must ensure that they take the proper precautions in avoiding Insider Trading liability.

This article was originally published in the April 21, 2009 edition of the Ottawa Business Journal.


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