Investors need to understand the facts and rules governing insider dealing to avoid falling foul of this area of the law, says Irwin Mitchell.

Insider dealing might sound like a topic that belongs in racy Hollywood films. It is not, some might think, an issue likely to affect the private client investor. However, it is a topic wealth managers and their clients need to be aware of. Recent rulings from the UK’s financial regulator, for example, have thrown the issue into sharper relief. This article explores the state of play. It is written by Sarah Wallace, partner and head of the regulatory and criminal investigations group of Irwin Mitchell, the law firm. The editors at this publication welcome this informed contribution to debate and invite responses. Email the editor at tom.burroughes@wealthbriefing.com.

“Insider dealing” is not likely to be the two words at the very forefront of every investor’s mind. However, as 2017 comes rolling in it should become something investors are more conscious of. Looking back into 2016, we had a big year for the Financial Conduct Authority, who showed that they are dedicated to combatting insider dealing and that they are tough in their pursuit. In 2016, the FCA obtained convictions against five individuals for insider dealing, and the court handed down the longest ever sentence for insider dealing – 4.5 years to Martyn Dodgson, former senior investment banker at Morgan Stanley. The FCA will continue to pursue more cases this year. 

The individuals charged and convicted range from employees of the companies in which they traded, a senior investment banker, and even friends and family of the individuals with access to insider information. This raises the questions: what is insider dealing; who is vulnerable to being an insider; and how can one avoid the risks?

What is insider dealing?
Insider dealing has two legal meanings and can be dealt with by the FCA in two different ways. The first is the criminal offence under Part V of the Criminal Justice Act 1993. The second is the civil offence in the Financial Services and Markets Act 2000 (Market Abuse) Regulations 2016.

The criminal offence
An offence is committed if you are an insider who deals in (acquisition or disposal or procuring such acquisition or disposal), encourages another to deal in, or improperly discloses inside information in a price-affected security. (Price-affected securities are those that are officially listed on an EEA exchange or admitted to dealing or have their price quoted on a regulated market). This means that you do not have to personally deal in the stock to fall foul of the rule. Contrary to common belief, you do not need to make a profit or make any gain to be found guilty of the offence, one simply has to deal in the security using insider information.

Who is an insider?
An insider is someone who knowingly holds insider information that is obtained by being a director, employee or shareholder of an issuer of securities or obtained through one’s employment, office or profession (not necessarily at an issuer of securities). An investor can also be liable for prosecution even if they obtain the information indirectly as a third or fourth party, be it from a friend, their second cousin or their barber, so long as they know that it is inside information and they know they have it from an inside source (by reference to the definition of insider above).

What is inside information?
Inside information is information which:
a) relates to particular securities or issuers;
b) is specific or precise;
c) has not been made public; and
d) if made public would likely have a significant effect in the price of any securities.

Unfortunately, there is little guidance on what these terms mean in practice. There are some guiding principles investors can follow. General tips on a certain sector or industry, general chatter of a company, and any information that is in the public domain or that can be readily acquired by someone likely to deal in the securities will not fall under the legislation. There is also no hard and fast rule as to what constitutes “significant effect on the price”.

Neither the legislation nor the FCA have set a specific percentage as the threshold. It depends on the type and size of the issuer, the type of news or information, and the state of the market or the sector at the time. A helpful exercise is to consider whether a reasonable investor would make an investment decision based on that information. If you are trading on information unknown to the public which indicates that you would make high profits (especially in the short term), you are likely be stepping into dangerous territory. 

The defences
There are several defences for criminal insider dealing:
a) no intention to make a profit or avoid a loss based on the information;
b) reasonable belief that the information was widely disclosed and that no one dealing would be prejudiced by not having the information; and
c) the individual would have traded anyway, even if he had not had the information. (There are separate defences for the encouraging and disclosing offences.)

The consequences
Falling foul of insider dealing rules can result in hefty fines and serious penalties. For the criminal offence, the court can issue custodial sentences of up to seven years and unlimited fines. The FCA is also vigilant in enforcing such sentences. In April of last year, the court handed down a 528-day sentence to Pardip Saini for failing to comply with its confiscation order from a 2012 conviction.

The civil offence
Article 14 of the Market Abuse Regulation prohibits dealing on insider information, attempting to, or inducing another to do so, and the unlawful disclosure of inside information. There are some key differences between the civil and the criminal offence. The Market Abuse regime has a lower standard of proof. The offence is also much broader, as market abuse covers insider dealing, improper disclosure of inside information and market manipulation. Market abuse also includes unintentional behaviour.

Inside information
For the civil offence, inside information relates to commodity derivatives as it does to financial instruments in general, and expands the definition to emission allowances and products based on emission allowances. As with the criminal offence, the civil offence requires the information to be precise, but it actually specifies that information is precise if it indicates that something has or is reasonably expected to have occurred, or that circumstances exist or can be reasonably expected to exist.

The defences
A possible defence is being able to show that on reasonable grounds you did not believe that the behaviour was market abuse, or where you took all necessary precautions and exercised all due diligence to avoid market abuse.

The consequences
For the civil offence, the FCA can impose unlimited fines, order injunctions, and prohibit regulated firms or approved persons. In May of last year, Mark Taylor, a former financial advisor at Towry, was banned by the FCA for 2.5 years and fined £36,285, which would have been even higher at £78,819 had it not been for evidence of serious financial hardship. It should be noted that the profit Taylor made on the trade was only £3,498.

How to avoid insider dealing
Directors and officers of smaller and newly-listed companies should be careful of any dealing in shares in their own companies. While FTSE 100 companies may provide extensive training and protection through technical safeguards and strictly monitored closed periods, newly-listed companies on alternative markets may not have those procedures in place yet. Non-executive directors should be especially cautious as they may become exposed to insider information without the benefit of being employed and supported by the company. 

Whenever you trade in the company in which you hold a substantial office or directorship you should follow all the company procedures and obtain approval from the legal department prior to trading. Trading prior to announcements, publication of accounts and reports and obviously mergers are especially sensitive and likely to pique the interest of the FCA.

Individuals with friends and family working in listed companies should be wary of any information they gain from such connections. Employees do not need to be in executive or managerial positions to come into contact with insider information. Information gleamed from the printing room can equally fall under the offence. Many companies will add such employees to an insiders’ list. However, this is not always the case, and even if they are on such a list you may not find out about it. While this is a very broad warning, it is a very real one. As last year was coming to a close, two men pleaded guilty to insider dealing in relation to the 2012 Logica takeover. One was an employee of Logica but was not on the list of insiders. The other was his neighbour. If you are dealing on information gained from an individual, it is pertinent that you make sure the information is publicly available. If you are in doubt of whether you might be trading on insider information, seek legal advice.

Looking ahead
In their 2015/2016 performance account, the FCA stated that they are “dedicated to eliminating market abuse in all of its forms, which includes bringing criminal prosecutions against City professionals that abuse the trust that is placed in them”. The statement sends a clear message that the convictions, high fines and record-breaking sentences we saw in 2016 are not about to come to an end. At the risk of becoming a peer to those convicted and fined last year, investors, especially City professionals, might consider it a good time to review their trading habits to ensure regulatory compliance.