To what extent is it a criminal offence for a person with inside information about the affairs of a company to use that information for his financial advantage?
A person may come into possession of inside information about the affairs of a company because he is, himself, an “insider” (for example, a director, an employee or an auditor of that company), or because he is an “outsider” who has somehow seen, overheard or otherwise acquired the information in question — whether or not he has gone out of his way to do so.
In the first situation there is a straightforward breach of confidence or the abuse of a position of trust. Similar transgressions in the Civil Service would be punishable under the Official Secrets Acts 1911-1989. In the second situation, the outsider (or “tipee”) often commits no breach of confidence reposed in him, and abuses no position of trust if he makes a profit out of the “tip” which he has been given. It is, therefore, less easy to rationalise why the criminal law should be involved in such a situation. Indeed, justification has been put forward for both “primary” and “secondary” insider dealing (to use the terminology most often adopted). In both these cases the argument has been put forward that insider dealing is a “victimless crime”.
This argument misunderstands the nature of the criminal law. It is the civil law, not the criminal law, which requires victims (ie people who have suffered, or who stand in danger of suffering, some form of loss or injury at the hands of another). One of the more useful purposes of the criminal law is to provide a mechanism for stigmatising, punishing and (it is to be hoped) deterring anti-social conduct which, if committed, gives no particular individual any personal right of action. Obscenity, smuggling, careless driving, tax evasion and public nuisance are all examples of offences which are, more often than not, victimless. To this catalogue can be added insider dealing, for Parliament now seems to subscribe to the view that it is:
the supreme and fundamental purpose of the law, to conserve not only the safety and order, but also the moral welfare, of the state, and that it is [the duty of the courts] to guard it against attacks which may be the more insidious because they are novel and unprepared for.
— per Viscount Simonds in Shaw v Director of Public Prosecutions [2] AC 220.
This raises the question of what it is that Parliament has perceived to be the essential mischief to the State in the perpetration of insider dealing. The answer to this seems to be twofold: (1) the danger to confidence in the market among ordinary and potential investors; and (2) the absence of effective civil remedies. The first of these factors is naturally important to a government which has championed the cause of wider share ownership, the privatisation of state industries and believes in an enterprise culture. All these ambitions would come to dust if potential investors came to believe that the Stock Exchange was a private club and that buying and selling shares was a near-fraudulent activity. As to the absence of civil remedies, this rests upon the fact that, no matter how much confidence in the market may be shaken generally by insider dealing, there is seldom any identifiable victim with a loss to redress at law. Nevertheless, in the case of insider dealing by a company director or other insider (primary insider dealing), the company itself will be able to sue that person for breach of trust and/or breach of contract. The company will be able to claim any secret profit made by the director etc in breach of his fiduciary duty to the company. However, problems will arise if the wrongdoer is in control of the company, on his own or with others. This is because of the rule of company law known as that in Foss v Harbottle (1843) 2 Hare 461 (see “Mainly for Students”, June 23 1990 at p 85). This rule will prevent minority shareholders from suing in their own names or using the name of the company against the controllers of that company. (There are exceptions to this rule, but they are outside the scope of this article.)
So far as outsiders are concerned (secondary insider dealing) it is difficult to envisage any civil action which is likely to be brought against them. The fact that a “tipee” may become unjustly enriched does not, of course, mean that the company whose shares he has bought or sold has, correspondingly, become the poorer. It is probably open to the company to seek to obtain an account of the profits which the tipee has made — if the company can prove that the tipee was knowingly party to a breach of confidence committed by a director, employee or some other insider. But there seems to be no precedent for such a cause of action in a simple case of insider dealing. In all these cases the nearest thing to a real victim is some other (innocent) participant in the market who buys or sells his shares more disadvantageously than he otherwise would have done because he did not share the same price-sensitive information as the privileged insider or the well-connected tipee. Such a market loser has no civil remedy against those who have committed insider dealing to their profit and, indirectly, to his loss.
Company Securities (Insider Dealing) Act 1985
The criminal offence of insider dealing (in fact, many different offences) is contained in the Company Securities (Insider Dealing) Act 1985, as amended by the Financial Services Act 1986. Additionally, the maximum punishment for several offences under the Act was increased from two years imprisonment to seven years by the Criminal Justice Act 1988. (The Crown Court also has a power to impose a fine, and the 1985 Act does not stipulate any limit to this power.)
Two basic concepts lie at the heart of the new offences: (1) that of being “connected with a company”; and (2) “unpublished price-sensitive information”.
Section 9 states that an individual is “connected with a company” if, but only if:
- he is a director of that company or a related company, or
- he occupies a position as an officer (other than a director) or employee of that company or a related company or a position involving a professional or business relationship between himself (or his employer or a company of which he is a director) and the first company or a related company which in either case may reasonably be expected to give him access to information which, in relation to securities of either company, is unpublished price-sensitive information, and which it would be reasonable to expect a person in his position not to disclose except for the proper performance of his functions.
It should be noted from the above definition that a professional man who is not a director or an employee of the company may nevertheless be “connected” with that company if his position involves a “professional or business relationship” with it. For example, a surveyor might be retained by a company to carry out a valuation of land or other assets. The effects of this valuation (when published) may affect the value of the company’s shares. The surveyor will, therefore, be an insider with access to price-sensitive information before that valuation is made public.
Unpublished price-sensitive information is defined by section 10 of the 1985 Act as follows:
Any reference in this Act to unpublished price-sensitive information in relation to any securities of a company is a reference to information which —
- relates to specific matters relating or of concern (directly or indirectly) to that company, that is to say, is not of a general nature relating or of concern to that company, and
- is not generally known to those persons who are accustomed or would be likely to deal in those securities but which would if it were generally known to them be likely materially to affect the price of those securities.
Primary insider dealing
Section 1(1) of the 1985 Act creates a duty not to commit primary insider dealing. Breach of this duty (and of various other duties created by the Act) is made a criminal offence by section 8 (as amended) with a maximum punishment of seven years imprisonment and/or a fine.
Section 1(1) reads:
Subject to section 3, an individual who is, or at any time in the preceding six months has been, knowingly connected with a company shall not deal on a recognised stock exchange in securities of that company if he has information which —
- he holds by virtue of being connected with the company,
- it would be reasonable to expect a person so connected, and in the position by virtue of which he is so connected, not to disclose except for the proper performance of the functions attaching to that position, and
- he knows is unpublished price-sensitive information in relation to those securities.
It should be noted that the word “securities” is wider than just the shares of a company. Section 12 defines securities so as to include debentures, among other things.
Section 1(2) of the 1985 Act is similar to section 1(1), but it covers the situation which may arise when an insider, connected with company A, learns of certain information about company B which is unpublished price-sensitive information about B.
For example, he may learn that a contract between A and B is contemplated, is going to be broken or is not going to be transacted despite widespread expectations that it would be. It will be a criminal offence for that person to make use of that information with regard to securities of company A (under section 1(1)) or company B (under section 1(2)).
Secondary insider dealing
Secondary insider dealing arises where a person (known as the tipee) deals on a recognised stock exchange in the securities of a company (it can be A or B, in the parlance of the example used above) after the circumstances described in section 1(3) have occurred. These circumstances are:
- an individual has information which he knowingly obtained (directly or indirectly) from another individual who —
- is connected with a particular company, or was at any time in the six months preceding the obtaining of the information so connected, and
- the former individual knows or has reasonable cause to believe held the information by virtue of being so connected, and
- the former individual knows or has reasonable cause to believe that, because of the latter’s connection and position, it would be reasonable to expect him not to disclose the information except for the proper performance of the functions attaching to that position.
In Attorney-General’s Reference (No 1 of 1988) [9] 2 All ER 1 the House of Lords considered the meaning of the word “obtain” in the context of this subsection. The case was referred to the Court of Appeal by the Attorney-General after a defendant had been acquitted of secondary insider dealing on a restrictive interpretation of the word obtain. The trial judge had directed the jury that a person could not be guilty of “obtaining” information unless he had actively sought out that information or had procured it “as the result of purpose and effort” (see The Times, April 15 1988). In adopting this interpretation the trial judge had been influenced by the primary definition of the word “obtain” in the Oxford English Dictionary. The Court of Appeal and, subsequently, the House of Lords overruled this literal interpretation and adopted the “mischief rule” of statutory interpretation. In accordance with this principle it did not matter how the defendant had come by the information, but rather what he had done with it afterwards. (This decision did not make any difference to the defendant’s acquittal, but it clarified the law for the future.)
Permissible dealings
The new criminal offences of primary and secondary insider dealings are subject to the exceptions contained in section 3 of the 1985 Act, as amended by the Financial Services Act 1986. The following two exceptions are noteworthy:
Sections 1 and 2 do not prohibit an individual by reason of his having any information from —
- doing any particular thing otherwise than with a view to the making of a profit or the avoidance of a loss (whether for himself or another person) by the use of that information.;
- entering into a transaction in the course of the exercise in good faith of his functions as liquidator, receiver or trustee in bankruptcy.
Section 2 of the 1985 Act deals with the abuse of information obtained in an official capacity (Crown servants, former Crown servants and persons who have knowingly obtained information from them). It is, therefore, the section which most closely mimics the Official Secrets Acts. However, as with section 1, the essential criminality of the section is for the individual to deal (or to enable others to deal) on a stock exchange, making use of the information in question.
