Brian Gaynor: Outside chance of insider action

COMMENT

One doesn't have to go any further than the Securities Commission's web site to get a clear understanding of the effectiveness of our insider trading regulations and enforcement.

The commission's news page includes these items on insider trading:

* July 22 - no further action will be taken in the Sky City case.

* May 28 - no further action will be taken in the Fletcher Challenge Forests inquiry.

* May 28 - no further action will be taken in the Rubicon Case.

* March 25 - no further action will be taken in the Vertex inquiry.

* February 10 - The market surveillance panel has asked the commission to consider whether insider trading may have taken place in relation to Tranz Rail. Commission chairman Jane Diplock is quoted as saying: "We expect that much of this information from the panel is pertinent to our insider trading inquiry and will enable us to complete our work more quickly.

"There has been no further news on the Tranz Rail inquiry."

The Commission's web site also contains a list of insider trading inquiries before this year.

These were in relation to Arthur Barnett, Air New Zealand, National Mail, Contact Energy, E-Phone, Spectrum Resources, Force Corporation, Fletcher Challenge (Kerry Hoggard), Strathmore, Fletcher Challenge (Paul Hyslop), Brierley Investments, McCollam Printers (Eric Watson), Fay, Richwhite, Regal Salmon and Gulf Resources Pacific.

None went beyond the inquiry stage and there hasn't been a single prosecution for insider trading since the regulations came into force in December 1988.

How can we have so many official inquiries and not one prosecution? If the inquiries are baseless, why isn't the Stock Exchange, which has referred many of the cases, charged with wasting the commission's time?

The latest inquiry, on Sky City Entertainment, is a typical example of the inadequacies of our insider trading regulations.

On December 4, Malcolm Davidson, a research analyst at stockbrokers UBS Warburg, had a meeting with Brook Asset Management that included a discussion on Sky City Entertainment.

Davidson is reported to have produced detailed monthly figures showing that Sky City Auckland and the Adelaide Casino performed strongly over the first five months of the year to June.

Brook Asset Management immediately expressed its concern to Sky and UBS Warburg about the source of these figures.

The next day, the Australian Financial Review speculated that analysts' consensus forecast of $93 million for Sky City could be "on the low side" and "there is a suggestion that the top forecast - $105 million - may be beaten".

On December 6, Sky told the stock exchange that revenue at Sky City Auckland for the first five months of the year was 15 per cent ahead of the same period last year. The Adelaide Casino was 18 per cent up.

The company advised that it was "comfortable with the expectations ... for a net surplus in the range of $95 million to $105 million for the year to June 30, 2003".

Sky City's share price rose from $7.42 to $8.09 during December, and the stock exchange referred the Davidson case to the Securities Commission.

AT THIS stage the shutters went up, the usual occurrence with sharemarket inquiries in New Zealand.

Last week, the commission said in a 90-word statement that it had "undertaken a thorough inquiry" into the Davidson case, and after taking legal advice "is not proposing to take any further action in this matter".

That's it. No explanation and no attempt to keep the market fully informed on the issue. Did Davidson have internal Sky City information? Did he show this to investors? Is there a loophole in the law or did the commission find no evidence of insider trading or tipping?

Davidson has left UBS Warburg and his brother, who was a Sky City employee with access to its financial information, has also moved on.

[The Davidson Case raises another important issue. Sky City has a large number of employee shareholders who are given updated financial information as part of the company's employee motivational strategy. This is an important policy for many companies, but it places a huge onus on them to comply with the new continuous disclosure regulations.]

It would be wrong to suggest that insider trading is a major problem in New Zealand, but it has occurred and no one has been prosecuted. Investors' perceptions are important, and huge sums of money are flowing into high-risk finance companies and fixed interest securities because a large number of investors don't believe the sharemarket is safe. Insider trading is one of the reasons for this.

The Government is aware of the problem and submissions on two Ministry of Economic Development insider trading discussion papers indicated that the NZ Exchange, the Securities Commission, law firms, stockbrokers, investors and other interested groups believe that insider trading occurs in New Zealand.

They all agree that insider trading damages financial markets and should be legislated against.

Overseas studies show that countries gain an extra 5 per cent market liquidity if they have effective and enforced insider trading rules.

The NZX is missing out on this because we do not have those effective and enforced rules.

The Government has responded and is proposing to introduce new legislation. This will focus on the impact of insider trading on market confidence and integrity instead of the emphasis on fiduciary duty under the old regime.

THE current legislation is based on the idea that a person who owes a fiduciary duty to a company should not make a personal profit or avoid a loss by using a company's price-sensitive information to trade in securities.

As a result, listed issuers, or individuals acting on behalf of listed issuers, are required to take legal action.

The Securities Commission was granted the power to prosecute from December last year.

Up to then, it could only hold insider trading inquiries that would recommend whether public issuers, or individuals acting on their behalf, had a strong legal case.

The new system has been almost totally ineffective because companies are reluctant to take, or pay for, action against their own directors and executives.

In a recent High Court judgment, Justice Fisher said the language of the legislation was "absurd" and "it is difficult to escape the conclusion that the drafter of this unfortunate statute nodded off again".

The proposed legislation will make insider trading a criminal as well as a civil offence. At present, it is only a civil offence.

The penalty will be up to five years' imprisonment or a fine not exceeding $100,000 for individuals, and a fine of up to $300,000 for a corporate body.

Current regulations allowing a company, or an individual on behalf of a company, to take civil action will remain.

But one of the most important aspects of any securities legislation is its enforcement, and a big question mark hangs over the Securities Commission's willingness to use its new powers.

Market participants know there is a certain amount of insider trading in New Zealand.

This is one reason investors shun the share market and rush into high-risk fixed interest securities offering relatively low returns.

The Stock Exchange has referred a number of cases to the commission, which has made nearly 20 full insider trading inquiries. Not one has resulted in a prosecution.

The commission will have to have a much higher batting average if investors' confidence in the sharemarket is to be restored.

Government officials are drafting a Securities Trading Law Reform Bill, which will include the new insider trading regulations. Interested parties will be able to make submissions on the bill this year.

* Email Brian Gaynor