Curbing the tendency of insider trading

Almost all countries have enacted laws prohibiting insider trading based on price sensitive information (PSI). However, such laws do not specifically mention what types of information related to company affairs should be identified as price sensitive. This opacity in the laws is considered to be a main challenge in dealing with the problem of insider trading.

In Bangladesh, any secret information regarding a company's financial statement or dividend declaration is considered as PSI. In the developed world, acquisition, merger, takeover of any company or new investments also fall under the purview of PSI. Besides, the world economy and business operations are also constantly changing. Hence, the nature and scope of PSI is also widening. Of late, Amazon.com Inc. has accepted bids from different cities for their second Headquarters, and selection of the city has probably been finalised; but strict confidentiality is being maintained as this news is being considered as PSI.

DEFINITION OF PSI: A comprehensive definition of PSI, detailing its features, nature and scope, is required to deal with the complicated problem of insider trading in the capital market. While identifying PSI, some key issues like material and immaterial information, public and non-public information and the person responsible for PSI should be taken into consideration. Besides, the time of dissemination should also be considered as a factor in determining PSI. All PSIs, however, do not violate rules. Therefore, prior to establishing the allegation of insider trading based on PSI, all company information must be categorised as public information and non-public information.

Public information is known to everybody, so action based on public information does not cause any violation of rules. However, dealing with non-public information is very sensitive and as such it must be handled with strict confidentiality. Action based on non-public information will definitely invite violation of securities laws. Leaking of non-public information and share trading based on this leaked information are treated as insider trading in securities law. As for example, the retirement of CEO (Chief Executive Officer) in due course is known to everybody, and therefore, considered as public information. However, if the authority takes instant decision to fire the company's CEO on any specific ground, it may be considered as non-public information. Hence, such information must be handled with strict confidentiality.

Similarly, the role of the person responsible for handling PSI is also a factor in establishing allegation of insider trading based on PSI. To illustrate, the CEO of a company while travelling by car was discussing with his deputy about the success story of the company's acquisition bid that was considered as most attractive investment. The driver overheard it and shared it with one of his cousins who was in possession of substantial amount of investable fund. Acting on this privileged information, the cousin purchased considerable number of shares, the price of which went high after the announcement of that acquisition move. Now, question arises whether the driver will be charged for leaking PSI, or whether that investor will be charged under insider trading rules.

This is a very difficult situation to handle as the driver had no role with this PSI, and the investors did not have any access to that privileged information. He came to know about it by chance. Hence, this kind of ambiguous situation in dealing with PSI and insider trading must be made very clear in relevant laws and regulations.

One has to keep in mind that any material and non-public information from any quarter, irrespective of the company or government agency, will definitely have impact on the share price of that company. So, this must be considered as PSI and thus should be handled with utmost confidentiality. The rules and regulations that deal with insider trading should conspicuously elaborate on the scope and nature of material non-public information, the means of handling thereof and specific punitive measures for mishandling or acting on such information.

INFORMATION FROM OTHER STAKEHOLDERS IS ALSO PRICE SENSITIVE: In our capital market, company's own information that is likely to have impact on its share price is considered as PSI. However, information of other stakeholders, including the government agencies and regulatory bodies, may also have equal impact on the movement of share prices of listed companies. Therefore, such information is also considered as PSI. This practice, which is a very common phenomenon in the developed world, has not yet started in Bangladesh. In the USA, the education department declared that they would no longer provide student loan data to Consumer Financial Protection Bureau, which was going to sue Navient Corp that extends student loans. This information was somehow leaked before official announcement, and unusual trading of Navient's share was detected. Thus, insider trading of Navient's share was detected based on the information related to the decision of the government agency.

This kind of malpractice is very common in hedge fund operations in the USA, as they have some privileged access to various government agencies. Recently, some executives of two hedge funds have pleaded guilty for allegedly trading on information received from the government insiders related to healthcare companies. In Bangladesh, people cannot think that information from other stakeholders, particularly the government agency or regulator, may equally have price sensitive impact, although it happens pretty often. For example, if the Ministry of Finance or Bangladesh Bank issues directives to all banks making certain percentage of cash dividend mandatory, this decision will certainly have positive impact on the banking sector share prices. This type of information must be considered as price sensitive, and therefore, should be dealt with strict confidentiality. At the same time, these issues will have to be properly addressed in the insider trading rules.

PREVENTIVE MEASURES: Preventing insider trading is not an easy job at all. It is rather a very difficult and complicated task. Collective work along with adequate rules and regulations, strict enforcement, role and responsibility of all stakeholders, practice of professional ethics of the share traders, brokers, dealers and financial advisers and due diligence applied by the persons responsible for share trading may help substantially reduce insider trading based on PSI. Introducing technologically advanced trading system may substantially reduce the tendency of insider trading in the stock exchanges.

Adequate rules and regulations make people aware of the situation while strict enforcement ensures punishment to the violators, which keep people away from such malpractice. However, practice of professional ethics and application of due diligence together can considerably reduce the incidence of insider trading. Similarly, the use of technology at every level of share trading can help monitor and control insider trading. Therefore, emphasis should be given to expanding the use of technology in the trading activities. Besides, priority must be given to practising ethical standards and applying due diligence.

Nironjan Roy, CPA, CMA, is a banker based in Toronto, Canada. [email protected]