The Legal Landscape of Insider Trading
Insider trading remains a pertinent problem in corporate law with massive effects in market and investment. In Australia, insider trading is regulated by the Corporations Act 2001 (Cth) which provides for civil and criminal sanctions for violations. This article discusses the legal risks of insider trading, the requisite fault elements to be established for liability, and available defenses to natural persons and corporations. It further analyses the scope of corporate liability for insider trading and the concept of mens rea (guilty mind).
What is Insider Trading?
Insider trading is when an individual executes trades in financial instruments such as stocks or shares while possessing critical inside information that is not publicly available. Section 1043A – Offences Defences of the Corporations Act 2001 (Cth) prohibits this conduct and describes its elements. These include the following:
1. Possession of inside information: The person must possess information that is not publicly disclosed or available.
2. Knowledge of materiality: The person must know, or ought reasonably to know, that the inside information is significant enough to have an impact on the price of the financial instrument.
3. Strategy or Acquiring an Execution: The Subject should either execute a transaction in the given financial instrument by himself/herself or have someone else do it on his/her behalf while in possession of the inside information.
If an individual or a legal entity commits a violation of this kind, there are sanctions, including fines, imprisonment, and even civil penalties against them.
Corporate Liability for Insider Trading
An important question in the context of insider trading within the corporation is how a corporation will meet the required fault element (mens rea). Corporations are abstract legal entities, and unlike natural persons, they cannot know things or intend things on their own. However, there are ways in which law provides for attributing knowledge to a corporation, and the actions of its employees are allocated to it.
Assumption of the Risk of Knowledge
A company is liable for insider trading under the provisions of the Act if the offending act emanated from a director, other employee, or agent acting within their actual or ostensible authority – S769B(3) of the Corporations Act 2001 (Cth). This particular provision allows the state of mind of an individual (e.g. possession of insider information) to be attributed to the company. Moreover, Paragraph 1042G(1)(b) assumes that a corporation has, or has access to, information that its officers are privy to. An officer’s inside information is understood to be possessed by the corporation as well.
General Law Principles: The “Directing Mind and Will”
At common law, and referring to the “directing mind and will,” the actions and knowledge of senior personnel are attributed to the corporation. This principle was established in cases like Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915], Lennard’s Carrying Company Limited was held to be responsible for the acts of its managing director who was empowered to control the business of the company and in Tesco Supermarkets Ltd v Nattrass [1972], the house had decisively judged that the rest of the employees ought to be sufficiently capable and qualified to take responsibility for management, including executing the business on behalf of the corporation.
However, the statutory provisions in the Corporations Act are more comprehensive than that as they allow the knowledge of employees and agents to be attributed to the company regardless of whether they are a part of the controlling body.
Legal Risks of Insider Trading
The legal exposure that follows insider trading can be overwhelming. Individuals can face consequences such as:
1. Criminal penalties: imprisonment for a term not exceeding ten years, or substantial monetary fines, or both.
2. Civil penalties: fines and being banned from serving in management positions within corporations.
3. Reputation: one’s professional image can be greatly stained because of claims of insider trading.
For corporations, the risks include:
1. Financial Penalties: Companies could pay fines of $1.1 million for breaches related to insider trading.
2. Regulatory Scrutiny: Companies are likely to be investigated by ASIC, Australia’s Securities and Investments Commissions.
3. Loss Of Investor Confidence: Investors’ trust can be withdrawn due to alleged insider trading activities of a company’s management.
4. Defences to Insider Trading Allegations
Individual and corporate defendants have a number of defenses to choose from when accused of insider trading. These defenses include:
1. Lack Of Knowledge: The defendant may argue that they did not know, and could not reasonably have known, that the information was material and non public.
2. Chinese Walls: In order to protect a flow of inside information, corporations can establish effective “Chinese walls” and rely on section 1043F of the Corp Act, which provides a defense.
3. Trading Plans: Individuals can engage in pre-determined trading altered by section 1043M, which permits trading without breaching insider trading laws.
4. No Material Effect: The defendant could argue that the information, even if made public, would not have had a material effect on the price or values of the financial product.
Special Rules of Attribution for Insider Trading
It is possible that certain statutory provisions and common law practices related to attribution may not be sufficient for addressing the issue of insider trading. The Privy Council’s decision in Meridian Global Funds Management Asia Ltd v Securities Commission [1995] broadened the meaning associated with the above phrase and came up with the term “special rules of attribution,” which enable the courts to apportion knowledge or actions taken by a member of a company to the company based on the underlying purpose of the relevant law.
In the context of insider trading, it may mean assuming the knowledge of junior employees or agents of the company who are legally permitted to deal on the company’s behalf. This is consistent with the overriding policy intention to protect the market and ensure that companies do not escape liability by putting such functions into the hands of the junior employees.
Key takeaways on Insider Trading Law
According to Australian law, insider trading is an ultimate crime with a massive range of penalties, both for the natural and legal persons. The question of a corporation’s liability for insiders dealing is one that depends on the specific rules and frameworks in statutes and common law particularly the rules of attribution and about the mens rea. There are, however, evidential and procedural defences which might make obtaining a conviction more difficult, however, at the end, the consequences of noncompliance are dire, which include but are not limited to significant monetary fines, reputational harm, and diminished trust from the investing public.
The shifting of the legal terrain calls for the establishment of an effective compliance strategy with adequate information barriers that tailors to the level of insider trading risk involved. Knowing the legal risks as well as the defences available to them helps persons and corporations manoeuvre through this difficult area of law and safeguard the Australian financial markets.
This document is crafted for general provisions only and should not be regarded as an expert’s view. For concrete legal matters about insider trading or corporate negligence, speak to a legal practitioner that specialises in this field.
Contact OpenLegal today at enquiries@openlegal.com.au or 1300 982 068 for a confidential consultation to discuss your situation and explore the best path forward.
Desiree Liu, Intern at OpenLegal
