Insider trading tough to police - Bre-X officials' share sales latest to face scrutiny
By Jade Hemeon - Toronto Star Business Reporter
Illegal insider trading.
It's insidious. Tough to catch and even tougher to prove.
That's why there have been few convictions for illegal insider trading despite regulators' efforts to nail the offenders.
``Illegal insider trading is one of the most serious securities offences,'' says Joe Oliver, president of the Investment Dealers Association of Canada. ``It goes right to the heart of public confidence and the fairness of capital markets.''
The latest company to face questions on the timing of trading by insiders is Bre-X Minerals Ltd. - the Calgary-based exploration company which has fought a hard battle to hang on to the massive gold hoard it discovered in Indonesia.
Bre-X president David Walsh, his wife and other insiders sold almost $38 million worth of Bre-X stock in August and September after the Indonesian government cancelled the company's preliminary licence to work the Busang property.
Although the sales were only a fraction of their holdings, the sales were made before problems concerning Bre-X's title to the property were fully disclosed. There are also questions about when Walsh knew Bre-X would not be awarded as big a piece of the deposit as it had originally factored into its valuations.
``Matters of disclosure and insider trading are something we are interested in,'' said Larry Waite, director of enforcement at the Ontario Securities Commission. He declined comment on whether the Bre-X trades are under investigation.
Insiders trade frequently, and most of their trading is perfectly above board - as long as it's reported to the appropriate provincial securities commission in a timely fashion.
But when insiders or others make use of confidential information - for their own securities trading ahead of the public - that is illegal. It creates a total disadvantage for other investors who are not privy to the same confidential information.
Insider trading is also illegal when it applies to those who are ``tipped'' about confidential information in advance of a general release to the public - even if those who receive the hot tips are not directly connected to the company involved.
Insider rules reach beyond those in a special relationship with a company. People with knowledge may not tip someone else on a material fact or change that has not been publicly disclosed - if it can be used for making a profit in the stock market.
For example, if a secretary in a company learns about a fantastic new product the company is developing and tells a neighbor who trades on the information - that's illegal.
Insiders fall into various categories. They include a company's senior officers, directors and owners of more than 10 per cent of a company's stock.
Those in a ``special relationship'' include directors, officers or employees of affiliated or associated companies, or a company planning a takeover bid or business deal or other professionals and business associates who might have insider information.
In Ontario, the penalties for illegal insider trading may exceed $1 million in fines or imprisonment of up to two years.
But convictions are rare. There's been only one case of a person going to jail for insider trading.
Independent stock analyst Larry Woods was found guilty in Ontario Court of insider trading relating to short-selling of shares in Plastic Engine Technology Corp., or Petco, in 1989. He was a director of the company at the time.
In short selling, an investor sells borrowed stock, intending to repurchase it later at a lower price. The farther the stock falls before the shares are repurchased, the greater the profit.
Woods arranged for sales of a significant number of Petco shares for the benefit of a long standing business associate, former Liberal cabinet minister and prominent Winnipeg businessman James Richardson.
Although Woods was the one who spent time in jail, he did not receive a major financial benefit from the shares traded by Richardson.
Richardson, who decided not to fight the case and made a private settlement with the commission without going to provincial court and risking conviction, was fined $550,000 and banned from trading for three years.
Michael DeGroote, the prime architect of waste management and trucking firm Laidlaw Inc., and his associates were also charged with insider trading by the OSC. They avoided a public airing of the details by paying $23 million to settle the case privately in 1993 and agreeing to a five-year trading ban.
It was the largest settlement in OSC history and $17 million of it was used to repay investors who had suffered losses in the transactions in question.
The insider charges related to short-selling of Laidlaw stock in advance of the public release of disappointing financial results.
DeGroote and two associates made no admission of guilt, but the OSC staff stood by its allegations that trading had violated securities laws by taking advantage of insider information.
Ed Waitzer, former chairman of the Ontario Securities Commission, says there is ``no question'' the commission is short of resources to track down and successfully nail insider trading culprits.
``We need a steady flow of convictions to remind people we're paying attention and act as a deterrent,'' Waitzer says. ``While people may not be making out like bandits, at the margin, you can be sure it's going on.''
Waite says that despite record trading on Canadian exchanges, the financial resources available to detect insider trading have dwindled.
Three years ago, the OSC had 140 ongoing investigations of all types, including insider trading. Currently there are only 74. The number of professional investigation staff has dropped to 12 from 29 due to lack of money.
Unless a case is a blatant priority, it tends to sit in the waiting room, officials say.
``It's a matter of throwing more resources at the problem, and bringing out more cases,'' Waite says. ``Are we setting a strong deterrent? No. We've got to bring out more cases and win more.''
He says the OSC's current financial predicament is something like that of an ``orphaned child,'' waiting for a new funding arrangement from the provincial government.
But funding decisions are pending resolution on whether a national securities body will be introduced to replace the various provincial securities regulators.
Currently, the OSC is given a budget by the provincial government but it's only a fraction of what the commission is generating in filing and registration fees and cash settlements with securities offenders.
Meanwhile, many suspect that illegal insider trading is on the rise.
``Insider trading is absolutely enormous,'' says one securities lawyer. ``It's as common as cheating on income tax.''
Even the cases which are getting to court are proving unrewarding for the regulators.
Last September, the OSC lost a court case against former Cineplex Odeon director David Fingold, who was found not guilty of insider trading. The OSC had alleged that he improperly used confidential information received during a Cineplex board meeting in 1989. He later sold about $30 million worth of shares.
The judge ruled that Fingold probably didn't expect the information to affect the share price. He also ruled the OSC missed a deadline to file charges within one year after information came to its attention.
The OSC is appealing the case, claiming the judge erred in his decision and challenging the calculation of the one-year deadline, saying the countdown began later than the judge ruled.
``Insider trading is difficult to prove in a court setting,'' says Oliver. ``Typically, the evidence is circumstantial and it is difficult to establish beyond a reasonable doubt that inside information was the reason for the trade. You must prove that the insider not only had knowledge, but that the knowledge was the basis for a trading decision.''
After lengthy legal battles, former B.C. premier Bill Bennett, his brother Russell and lumber baron Herb Doman were found guilty of insider trading by the B.C. Securities Commission. They had previously been tried and acquitted in provincial court where the penalties are more severe.
The trio have been banned by the B.C. regulator from trading for 10 years and may not sit on the board of directors of any publicly traded B.C. company. They were also ordered to pay the cost of the 8-year securities commission inquiry, which could amount to as much as $1.5 million.
The B.C. commission found that Doman, head of Doman Industries, had tipped his friends, the Bennetts, that a potential takeover had fallen through before releasing the news to the public. The Bennetts sold their shares immediately, pocketing a profit of $2 million. When the news of the takeover's collapse became public, the shares fell by about a third.
Russell Bennett and Doman are appealing the commission's findings, but Bill Bennett has let the deadline for appeal pass.
Detection of inside trading begins with computer-run market surveillance. In Ontario, this work is conducted primarily by the Toronto Stock Exchange, although the OSC does some as well.
Computers are programmed to issue an alert when a stock breaks out of its normal trading pattern of volume or price changes.
Rob Cook, the TSE's director of market surveillance says exchange officials will look for an explanation of the unusual activity. Often it can be explained simply by a large block trade or company announcement.
``When there is no obvious explanation, we look deeper,'' he says. ``If there are unusual price or volume movements in advance of a news release, we may find out who the individuals are behind a trade and see if there is a connection to the company. We also get complaints and tips.''
Exchange officials will examine the chronology of events, to see if unusual insider trading took place in advance of material developments which were later disclosed. They will also attempt to determine if the trading was unusual for the particular parties involved, or if they frequently traded in similar amounts.
Once a connection between trading and events has been established that implies illegal trading, the case is passed to the OSC. |
