New Zealand's record of enforcement against alleged insider traders speaks for itself - not a single conviction and only two cases of insider trading ever brought to trial. A third case is currently pending. But will the introduction of criminal penalties improve the effectiveness of NewZealand's insider trading regime?
New Zealand's solely civil insider trading regime is in the global minority. Implementing criminal penalties is likely to increase the confidence of overseas investors to a degree. When investigating the possibility of investing in New Zealand securities markets, overseas investors would see an enforcement regime with which they were familiar and understood. Any resulting increased confidence could in turn lead to greater investment in New Zealand.
However, even if New Zealand legislation were to impose criminal penalties on those convicted of insider trading, it is questionable whether this in itself would be sufficient to increase both local and overseas investor confidence, given the argument that investors are ultimately attracted to jurisdictions with insider trading regimes that are seen to be effective, regardless of the sanctions that could be imposed.
How effective are criminal penalties in regimes in which they are used?
Despite the possibility of custodial sentences, the higher requirements in relation to standards and burdens of proof, together with the right not to give evidence, in a criminal proceeding have led many commentators to consider that criminal penalties do not have a significant deterrent effect. This is also supported by the complete lack of prosecutions for insider trading in jurisdictions which have only criminal penalties, such as South Africa, and by the predominant use of civil penalties in countries such as the US, which has both civil and criminal penalties available to enforce insider trading laws.
Will jurisdictional difficulties pose problems?
Several jurisdictional difficulties will arise with the introduction of criminal penalties. One of the most significant will be the higher standard of proof required. Alcock comments in his article Insider dealing - how did we get here? (Comp.Law 1994) that:
"Rogues know that unless they carelessly leave a trail of paper to follow it will be virtually impossible to prove beyond a reasonable doubt that they have dealt on insider information...."
Furthermore, in a civil proceeding the legislature can require that an insider must testify. However, given the rights entrenched in New Zealand's Bill of Rights Act, no such requirement would be tolerated in a criminal proceeding. This would deprive the prosecution of an invaluable source of evidence.
Jurisdictional problems extend to the relationship between civil and criminal proceedings. The interaction between the two regimes would have to be strictly controlled, as would rules relating to the admission of evidence. While there are numerous examples of New Zealand legislation with both civil and criminal penalties, the unique aspects of the crime of insider trading and special considerations in relation to its enforcement, mean that it is difficult to directly compare insider trading to any other action where dual liability has been successfully implemented.
A significant disadvantage of having both civil and criminal penalties in place is the likely delay to civil proceedings that would result while criminal proceedings were concluded. This could be a disincentive to public issuers and investors undertaking civil actions.
What practical difficulties are likely to arise?
There are numerous practical difficulties involved in implementing criminal penalties for insider trading. Initially major legislative change would be required. This process would be lengthy, and the effectiveness and/or scope of the legislation could be reduced by the time it had completed its passage through Parliament. Either an existing or a new body would need to be given responsibility for the enforcement of the criminal penalties, with either option resulting in significant issues which would need to be resolved, such as funding and suitably qualified and experienced personnel.
What alternatives to criminal penalties could improve the insider trading regime?
There are several other options available which would strengthen New Zealand's insider trading regime and which could be implemented with much less difficulty than criminal penalties. The continuous disclosure regime recently initiated by the New Zealand Stock Exchange has improved New Zealand's insider trading regime by reducing the amount of inside information and therefore an insider's opportunity to trade. Another welcome change has been the amendment of the Security Markets Act 1988 to grant the Securities Commission the ability to exercise a public issuer's right of action against an insider. Funding issues have been addressed by allowing costs incurred by the Securities Commission in conducting proceedings to be recovered from any award made against the insider. This is likely to be an effective method of strengthening the existing regime. It has the advantage of providing public issuers or investors with the ability to use the current legislation to commence their own proceedings. It also provides a dedicated body with the opportunity and the mandate to prosecute insiders using the lower civil proof requirements (without any of the restrictions imposed in criminal proceedings).
More radical changes such as allowing insider trading proceedings to be brought against the employer of an insider trader, or allowing class action suits based on contingency fees, could also be implemented. These, however, are likely to require a change in the basic psychology of the average investor.
A further alternative would be to create incentives for shareholders to take actions in their own name against insiders by, for example, allowing them to seek and be awarded pecuniary penalties. Such a change would be relatively simple to enact and would require little, if any, practical alterations to the present regime. The existence of an unknown number of disaffected and motivated shareholders should be a powerful deterrent to insiders who are considering trading on inside information, and may also lead to more prosecutions, as the possible reward for the investor becomes more fairly comparable to the risk and expense of undertaking the litigation.