Insider Trading in Developing Jurisdictions

Achieving an effective regulatory regime

Wunmi Bewaji

• Publisher: Routledge
• Year: 2012
• ISBN:
  9781136295386
• Edition: 1
• Topic: Jura
• Subtopic: Strafrecht

The book examines the regulation of insider dealing in the developed jurisdictions, using three of the G7 countries as guides with the aim of knowing how they have regulated insider trading and what lessons can be learnt from their failures and achievements. It looks at regulatory regimes in the US, the UK and Japan in order to consider whether these regimes can be successfully transplanted to developing countries.

In order to explore insider dealing in the developing world the book focuses on Nigeria, Africa's most populous nation and second largest economy. This book examines in theoretical and empirical terms the law on insider trading away from the dogmatic approach of Western literature by presenting the subject from the prism of a developing jurisdiction in post-colonial Africa with a divergent cultural, historical, social, political and economic background. The author analyses what shape insider dealing takes in Nigeria, a predominantly illiterate society, and considers the groups involved. The books also explores how the concept of insider dealing regulation is understood amongst parties integral to its administration and enforcement such as lawyers, judges, stockbrokers, and ordinary investors. The legislation governing insider dealing regulation in Nigeria is critically examined to expose its strengths and weaknesses, and to see how foreign provisions and legislation have been incorporated. The book uses Nigerian experiences to consider its implications for other developing nations, arguing that regulatory regimes need to take into account the specific social, political, historical and economic factors of a particular locale rather than importing regulations wholesale from developed jurisdictions.

1Introduction

In the last half century, few aspects of corporate life have been the subject of as much frenzied global debate and discourse amongst lawyers, economists, academics and bureaucrats as the law and practice relating to the regulation of insider dealing.¹ This is symptomatic of the underlying phenomenal emergence of the capital market as an undisputed catalyst for national and global economic growth in the modern world. The dynamism inherent in the operation of the market itself has led to the gradual disappearance of traditional distinctions between financial institutions with the attendant opening up to competition of previously cartelized equity and bonds markets.²

The dialectics between free market and centrally planned economy has long been settled in favour of the thesis propounding market forces as the means of achieving social and economic change and objectives.³ The rapid innovations in the operations of securities markets have brought about changes that could cause problems for regulatory regimes through over-exposure and risk. This is further aggravated by the integration of computer power with modern communications systems, particularly the internet, which in turn allows securities houses a global field of operations around the clock. Therefore, if the securities market is to perform effectively, its basic fundamental role as an arbitral allocator of scarce funds, the liquidity, transparency and integrity of the market must be unassailable for investors' confidence to be guaranteed.⁴

The research in this book conceives of insider dealing as having occurred when there is a purchase or sale or avoidance of purchase or sale of an issuer's securities effected by or on behalf of a person with knowledge of relevant nonpublic material information.⁵ The information is privileged and outsiders do not have it.⁶ The informational advantage is attained not by research, hard work or expenses but by the exploitation of the insider's privilege or relationship with the issuer or persons connected with the issuer. The insider is able to exploit his advantage when the information becomes public. Sometimes, disclosure can practically drive up or pull down the price of the security, whereupon the insider is able to make a profit or avoid a loss.⁷ The insider may not be an insider in the literal sense of the word. He could simply be the one privy to basic information that could be cashed upon to outsmart prospective competitors.⁸ In some contexts, he could be a government official who is aware of official moves that are likely to affect the reputation or prospects of a company, and this might lead to the shares of the company nose-diving or sky-rocketing in value. The dealing could also go beyond the confines of securities issued by companies, as it is equally applicable to markets for government bonds.⁹

The effect of non-public price-sensitive information on the market is well acknowledged.¹⁰ The insider is able to use his privileged position to make abnormal profits.¹¹ This exploitation of lawful privilege is unfair and inequitable, making the insider dealer a supposedly contemptuous person. However, to what extent can this view be substantiated? The individual with non-public price-sensitive information may sell if he is aware of some impending bad news that may drive down prices, and thereupon devalue holdings.¹² Similarly, he can buy up shares if he is aware of imminent favourable information likely to shore up prices, as it could translate into good yields. Studies in developed markets, for example the United States,¹³ the United Kingdom¹⁴ and Canada¹⁵ have proved profitability of dealings by insiders through the earning of abnormal returns. It is taken for granted that dealings in securities are about gaining and losing, therefore, it is a form of gambling. However, the price of securities will gradually cease to reflect the true market price which will make a victim of the outsider, particularly in markets where insider dealings are prevalent.¹⁶ This could eventually rub off negatively on the concerned issuer, mutating ultimately to discouraging investors from investing, given the prevalent high risk.¹⁷ This will also adversely affect the issuer's cost of capital, as well as other effects that may multiply the process.¹⁸ The dimensions of this multiplication are an invitation to empirical investigations as this book partly seeks to do within the context of an emerging market. As far as the consequences of insider dealing, studies of developed markets have established that the following can occur: evidence of portfolio adjustment,¹⁹ bid-ask spreads,²⁰ increased cost of capital²¹ and erosion of investors' confidence.²²

As shown in Chapter 2, most developed jurisdictions have found the need to regulate insider dealing at different times in their history and elected the appropriate legal framework for achieving same. The United States developed most of its case law on the subject based upon the Securities Act 1933 and the Exchange Act 1934. France joined in 1970; the United Kingdom in 1980; Sweden and Norway in 1985; Denmark in 1987; Greece, Finland and Switzerland in 1988; the Netherlands, Austria and Belgium in 1989; Ireland in 1990; Italy, Luxembourg, Spain and Portugal in 1991 etc. Japan came on board most reluctantly with the 1988 Amendment replacing the 1948 Securities Exchange Act. What about a developing jurisdiction? Does it have a choice when it comes to regulating?

What has been the effect of regulation in the developed markets? Bhattacharya and Daouk²³ have found that regulation might prove counterproductive if not properly enforced, though in an earlier work²⁴ they found that enforcement can actually lead to a reduction in the cost of capital. Beny²⁵ has argued that liquidity and price accuracy are enhanced by regulation. Garfinkel,²⁶ in a study of the US market, found evidence of deterrence from trading by insiders, particularly around corporate announcements. On the flip side, Banerjee and Eckard²⁷ have argued that regulation has no impact on insider dealing. Seyhun²⁸ has even found evidence of increase in volume and profit from insider dealing as a result of regulation. Bris²⁹ has also argued that enforcement has led to increased incidence of insider dealing.

Virtually every piece of evidence presented in favour or otherwise of the need to prevent or curb the incidence of insider dealing is based on studies conducted in relation to developed economies, while little or no work has been done on the emerging markets from developing economies, particularly in Africa with its different cultural, historical, political, technological and economic background and setting. This is unacceptable in a global economy that is becoming more and more inter-related and entwined together in fortune and failure, due to the internet and other technology.

Is insider dealing evidence of the decadence of opulence of Western capitalism? Should regulatory schemes be a case of one-size-fits-all, like Western democracy whose not so impressive performance on the continent makes further ‘importation’ of values less attractive? Can an emerging market from a developing economy still compete favourably in a global economy without imbibing the ‘culture’ of a Western values-denominated market? Nigeria offers a fertile opportunity to examine, in relation to a developing economy, the existence and extent of insider dealing and the role of regulation on various aspects of the market as far as, for example, profitability, price volatility, liquidity, cost of equity and bid-ask spreads. Does an emerging market from a developing economy with a surrogate legal system have to imitate the regulatory regimes of its donor systems or must it acquire motivation for regulation from domestic realities and peculiarities without ignoring global practices and trends?

Nigeria is a former British colony and was only given its independence on 1 October 1960. Nigeria consequently inherited the English common law system and the Companies Act 1862, consolidating the Joint Stock Companies Act 1856 and subsequent amendments. Ordinance No 3 of 1863 formally introduced English law into the colony of Lagos providing that

all laws and statutes which were enforced within the realm of England on the 1st day of January, 1863, not being inconsistent with any Ordinance in force in the Colony, or with any rule made in pursuance of any such Ordinance, should be deemed and taken to be in force in the Colony, and should be applied in the administration of justice, so far as local circumstances would permit.

The end of colonization and the sudden violent overthrow by the military of the civilian administration that succeeded the colonial government saw the advent of military rule in Nigeria. Nigeria's long years of oppression under successive military rule since the first military coup in 1966 had adversely affected its economy, including the capital market. Political instability meant policy inconsistencies and consequently an almost comatose capital market. The long-awaited return to democratic rule in May 1999 signalled a new beginning in all the facets of national life, thereby opening up the economy to both foreign investors and the investing public. As one of Africa's biggest economies, second only to South Africa and the most populated country in Africa, it is no surprise that the integrity and stability of its market is of interest to the corporate world. The interest is further reinforced by the phenomenal growth of its capital market in the last few years of its democracy.³⁰ It is against this background that the research is conceived.

1.1 Aims

This book, in presenting insider dealing regulation from the prism of a developing jurisdiction, postulates that the fate of autochthonous regulatory regimes extrapolates from the peculiarities of the social, political, historical and economic factors of a particular locale rather than the bare letter of the law or the popular precepts of alien doctrines. The book therefore seeks to make the following contribution to the existing body of work in this intellectually stimulating area of the law. The first will be to add the experiences of the legal regime of a developing jurisdiction in Nigeria, to the body of literature on this subject. In doing so, the book analyses some of the pieces of legislation that touch on the capital market and provisions (if any) for the regulation of insider dealing contained therein. Are provisions of the law relating to insider dealing effective? Are such laws being enforced? What are the strengths and weaknesses of such laws? It must immediately be remarked that most of these so-called pieces of legislation were Decrees promulgated under the brutal dictatorship of successive military regimes and not necessarily enacted by Acts of an elected democratic Parliament.³¹

Secondly, the book seeks to explore the regulatory regimes of developed jurisdictions within the framework of the G7, and particularly the advanced economies of the United States, the United Kingdom and Japan in order to understand what has worked and what has not worked, and what lessons developing jurisdictions like Nigeria can learn from their mistakes and achievements. Thirdly, the book will investigate whether or not insider dealing exists in Nigeria, a developing jurisdiction in the so-called Third World, or whether insider dealing is a mere evidence of opulence or greed of Western capitalism. Fourthly, the book will seek to establish the understanding of the concept of insider dealing regulation amongst parties integral to its administration and enforcement, ie lawyers, judges, stockbrokers, financial journalists, self-regulatory organizations, public regulatory agencies, market participants and ordinary investors within the framework of a developing jurisdiction with a high level of illiteracy, ignorance and poor infrastructure. Fifthly, the book will investigate what sort of insider dealing is taking place in Nigeria, what instruments are involved and at what times and events do the Nigerian insiders strike. Sixthly, the book will seek to answer the crucial questio...

Table of contents

• Front Cover
• Half Title
• Title Page
• Copyright
• Dedication
• Contents
• Preface
• Table of cases
• Table of statutes
• Table of statutory instruments
• European Economic Community Directives
• Rules and directives of regulators
• 1 Introduction
• 2 Insider dealing: The crime of information
• 3 Fighting a common enemy: Anglo-American and Japanese attitudes on insider dealing
• 4 Flags of confusion: The limitations and frustrations of imitation
• 5 A critical expedition into the Kingdom of Nigeria's insider dealers
• 6 Fixing the leaking roof of Nigeria's insider dealing regulation
• 7 Conclusion
• Bibliography
• Appendix: Pertinent Sections of the Investments and Securities Act 2007 (ISA)
• Index