How to: The rules against insider trading

What is "insider trading"?

"Insider trading" refers to a situation where a person is considered to have "inside information" about an issuer of public shares or other securities, and acts on that information to his or her advantage. Under the SECURITIES ACT 1978, you are prohibited from gaining an advantage through having this information.

"Inside information" means information about a public issuer that is not publicly available, and that would, or would be likely to, materially affect the price of the public issuer’s securities if the information were publicly available.

Securities include shares, debentures, investment-linked life insurance policies, and interests in unit trusts, group-investment funds and superannuation schemes.

What are the liabilities and penalties for insider trading?

If a person has inside information about a public issuer of securities, and buys or sells securities of the public issuer, this person (the "insider") is liable to the following people:

• to anyone who suffers a loss through selling those securities to the insider or buying them from the insider
• to the public issuer of the securities, both for the amount of any gain made or loss avoided because of the insider trading, and also for any amount that the court considers to be an appropriate penalty

The maximum combined amount for which an insider can be liable to the buyer or seller and the public issuer (not including any penalty) cannot be more than the greater of the separate amounts for which the insider is liable.

Similarly, the amount of any penalty ordered by the court must not be more than whichever is the greater of the following two amounts:

• the consideration (the money or other thing of value offered in exchange) paid for the securities, or
• three times the amount of the gain or loss made or avoided by the insider in buying or selling the securities

Any money recovered by a public issuer from an inside trader must be held on trust until it is distributed in accordance with the court’s directions.

Exceptions to the rules against insider trading

There are several exceptions to the rules against insider trading:

• No director, company secretary or employee of a public issuer will be held liable if the securities are sold or bought in the insider’s own name or in the name of, or on behalf of, the insider’s spouse or child. However, for this exception to apply the person must have complied with a procedure operated by the public issuer, and approved by the Securities Commission, to ensure that no director, secretary or employee with inside information uses it for personal gain.
• No action may be brought against an insider for the purchase of securities resulting from a take-over offer.
• No action may be brought against an insider in relation to the sale or purchase of securities in a public issuer if:
• arrangements existed to ensure that no person who participated in the decision to buy or sell the securities received or had access to the inside information, or was influenced by anyone who had the information, and
• no person who participated in the decision did in fact receive or have access to the information, or was in fact influenced by a person who had the information

Rules against "tipping"

An insider will also be liable to those incurring losses and to the public issuer if he or she:

• advises or encourages a person to buy or sell securities of the public issuer, or
• communicates or discloses the inside information to someone, while knowing or believing that that person or someone else will, or probably will, buy or sell the public issuer’s securities or advise or encourage another person to do so

The limitations on the insider’s liability and on any penalty ordered by the court are the same as in the case of inside trading (see above).

Shareholders of a public issuer may require it to obtain legal advice

If shareholders of a public issuer believe that the public issuer has, or may have, a cause of action against an insider for insider trading, they may require the public issuer to obtain legal advice on this, provided the shareholders have the approval of the Securities Commission.

With the court’s permission any shareholder may exercise the public issuer’s right of action against an inside trader.

Cautionary notes

• Whether you are a director, shareholder, company secretary or employee, the law in this area can be particularly complex and often involves large amounts of money. Therefore it is in the best interests of everyone that at the earliest possible stage you seek legal advice from a lawyer experienced in securities law.
• Because of the possible consequence it is advisable that employees are made fully aware from the outset of what insider trading means and the possible consequences of engaging in it.