The regulator investigates

Insider trading is back in the news. Recent investigations involving EADS, the European aerospace company, reflect a growing trend of regulators taking enforcement action in cases of suspected insider trading or unlawful disclosure of inside information. In the case of EADS, where the investigations have so far been brought by the French Market Authority, AMF, and have also involved an inquiry by the French government, the shock waves of the investigation go beyond the territorial boundaries of particular markets. The reputational risk is global.

The theme is familiar. Where stakeholders in a business span multiple jurisdictions, and relevant trading can take place in a number of different financial markets simultaneously, a huge number of regulators can become engaged in investigating suspected wrongdoing. It is not uncommon to learn that investigations by regulators in different jurisdictions are running in parallel, and for companies to face enquiries and requests for information from numerous agencies at any one time. The jurisdictional headache for compliance is obvious.

As with many areas of regulatory risk, there is an increasing international dimension to the investigation of insider trading. Different approaches to the regulation of inside information creates uncertainty for those managing compliance across global operations.

But there are some clear lessons for corporate compliance. Where insider trading is suspected, boardrooms will need to take speedy, proactive steps to investigate potential wrongdoing and assess any notification obligations to the regulators. Equally importantly, companies need to demonstrate that their systems and controls are sophisticated enough to prevent wrongful use of inside information, and monitor trading appropriately.

Secondly, the appetite for enforcement in the area of insider trading among regulators is growing. This is likely to be driven by increased harmonisation of markets across the world and increased emphasis on all markets adopting common or equivalent standards of compliance. Anti-money-laundering is an example of how such regulations have developed on an international basis in recent years. The same can be seen in the arena of insider trading and regulation of inside information. For example, the FSA and SEC are both facing similar concerns regarding suspicious trading activity in advance of takeover announcements or profit forecasts.

The process is slow-burning. In the first instance, allegations can emerge of insider trading activity which are historic, or which come to the attention of a regulator some time after trading activity has occurred. An organisation must have systems in place which retain relevant information and preserve it for later analysis. Furthermore, investigations can take many months or years to reach a stage where decisions to prosecute or pursue civil enforcement measures are taken. Regulators in different jurisdictions have powers under various mutual assistance provisions to share information and this can trigger new layers to enquiries.

The FSA’s approach

In the UK, market regulation by the FSA has been the subject of much discussion. The FSA has an armoury of different powers to investigate suspected market abuse and insider trading, as well as to bring prosecutions in the appropriate cases.

Historically, the FSA has been described as adopting a light touch to regulation. However, the clear signal from the regulator has been that all options remain open in respect of insider trading. In a speech to the American Bar Association on 4 October 2007, Margaret Cole, director of enforcement of the FSA, spelt out the FSA’s approach to insider dealing. She made it clear that the absence of an actual prosecution for insider trading by the FSA to date should not indicate an unwillingness to prosecute in the correct case.

The FSA also has multiple tools at its disposal in the investigation of suspected insider trading or market abuse, including sophisticated software to monitor market movements and suspect trading. It should come as no surprise to see the FSA taking a more proactive role in probing trading activity, and this may well be in respect of activity that has occurred some time before an investigation is commenced.

The FSA has also firmly signalled its expectations for companies involved in transactions on the markets which it regulates, and is looking for regulated firms to lead by example. This has parallels with US regulators, who have for many years placed considerable importance on compliance programmes and the ability of such programmes to spot and deal with red flag issues.

In her speech to the ABA, Cole stated that the proper conduct of relevant entities would include market participants being able to show:

“There is an increasing international dimension to the investigation of insider trading

- appropriate and effective systems and controls in the form of robust internal procedures

- an insider list that is short as possible and based on need-to-know

- a willingness to undertake a thorough internal review following a leak

- effective and targeted training of staff, including support staff

- monitoring of staff personal account dealing

- robust controls when dealing with third parties

- effective information technology controls

- an awareness of the limitation of code words as an effective tool to keep information confidential, especially if used in isolation.

This list should not necessarily be taken as exhaustive. Other warning signs will be familiar to compliance departments and money laundering reporting officers, and the specific risks relating to one’s own business will need to be identified.

Problems with existing UK law

There has been substantial criticism regarding the difficulties of prosecuting insider trading cases. This in part led to the introduction of a civil offence of market abuse under the Financial Services and Markets Act 2000 (FSMA). Nonetheless it is worth recalling the constituent elements of insider trading under criminal provisions in the Criminal Justice Act 1993. There are three basic offences under the Act. In summary these are as follows:

- an individual who has information as an insider is guilty of insider dealing if he deals in securities that are price-affected securities in relation to the information, on a regulated market or through any professional intermediary (such as a stockbroker)

“Corporate observers should be careful not to be complacent about the risk of any investigations occurring in the future.

- where a person has information as an insider, it is also an offence to encourage another person to deal in price-affected securities in relation to the information, on a regulated market or through any professional intermediary (such as a stockbroker)

- where a person has information as an insider, it is an offence to disclose the information to someone else, otherwise than in the proper performance of functions of the person’s employment, office or profession.

The offences are complex and there are also a range of statutory defences. Aside from the complexity of the law, prosecution authorities have in the past faced evidential difficulties proving an offence has occurred. This has often been cited as a reason why there are not more prosecutions for offences under these provisions.

As electronic evidence gathering techniques become more sophisticated, some of the previous evidential difficulties may be less significant than they were previously. Advances in investigative techniques allow authorities to pinpoint with greater accuracy, for example, the timing of disclosures and subsequent trades, gather evidence of a person’s state of mind from email communications, and sift through transactional data to see trends and patterns of suspected dealings. In addition, mobile phone records, text messages, and various forms of instant messaging are also areas of evidence likely to increasingly feature in proceedings taken by a regulator.

Potential future changes

As stated, the FSA already has a number of tools to investigate potential criminal acts. It has a close relationship with the police in connection to the execution of warrants under section 176 of FSMA. The powers allow entry onto premises under a warrant accompanied by the police. A search can then take place and relevant material be removed by police officers. These seizures can include computerised material. Where necessary, seizures of entire systems can be made, if those systems are believed to contain relevant information and if it is not possible during a raid to separate relevant and irrelevant material on site.

In addition, under powers exercisable under FSMA, persons on premises can be required to provide explanations about documents or provide relevant information or state where relevant materials can be found. Failure to comply with these requirements can give rise to criminal liability. Offences under FSMA arise, for example, if documents are concealed from a regulator, if a person knowingly or recklessly provides false or misleading information, or if the FSA is intentionally obstructed when it executes a search warrant under the Act.

In addition to the existing powers of investigation where criminal liability is suspected, the FSA has indicated that it is keen to gain increased powers to enter immunity agreements with witnesses in return for evidence. While such powers are not yet available to the FSA, similar powers exist for other regulators and it is possible that they will be extended to the FSA in due course. Currently, under section 71 of the Serious Organised Crime and Police Act 2005, an immunity notice can be given to a person where a specified prosecutor believes it is appropriate, for the purposes of an investigation or prosecution, to offer the person immunity from prosecution. Specified prosecutors for England and Wales are the Director of Public Prosecutions, the Director of Revenue and Customs Prosecutions, and the Director of the Serious Fraud Office.

More controversially, the FSA have stated publicly that they are considering issues such as plea bargaining as a means of obtaining sufficient evidence for prosecutions. This would be a significant departure from the current approach in the English courts to plea bargaining, and exemplifies how US regulatory approaches are likely to be mirrored in the UK. This debate reflects the FSA’s frustration over the difficulties it faces in market abuse and insider trading cases to gather sufficient evidence to mount a successful prosecution.

Corporate observers should be careful not to be complacent about the risk of any investigations occurring in the future.

Demonstrating compliance

The reputational damage caused by a criminal investigation, in addition to the penal sanctions that arise where insider trading is proven, gives added impetus to corporate compliance departments to ensure they are policing their organisation adequately against possible insider dealing. Corporates must ensure that there are systems and controls in place to prevent unauthorised disclosure of information and to guard against anyone using information or systems within their organisation for the purposes of insider trading or market abuse.

The ability of a corporate to demonstrate to a regulator that their compliance programmes and preventative measures were adequate can be vital. The recent cases of Pignatelli and Casoni were both instances where the respective firms involved self-reported the misconduct of the individuals to the FSA. The FSA in those cases was satisfied that the systems and controls in place were appropriate and the firms themselves avoided enforcement action.