Tuesday, December 06, 2005

Business Day OnlineBusiness Times
11 December 1998
New law must ensure that the crooks get out, or pay dearly
A shocking number of SA investors seem incapable of playing by the rules. And why not? While practices like insider trading remain uncurbed, there's money to be made through dishonesty. It's fairly simple to pick up some price-sensitive company news, check the information and buy the share. What's more, insider-trading laws seem lax, at best. No one has yet been convicted. In fact, no-one has ever been charged.
But there's good reason, leaving morality out of it, to enforce laws more strictly and make penalties more severe. Honest trading on the JSE needs to be upheld because it's the only way the local exchange will prosper in the long term. It makes straight financial sense.
It's all very well to restrict forward thinking to the next lucrative punt, but most local and international investors just aren't attracted by fraud.
Global portfolio managers don't like the lack of effective regulation against insider trading and similar practices on SA's markets. The country wants and needs their investment, but foreigners are not starved for choice. And our insider trading law is treated with contempt locally and offshore.
"Undoubtedly this is a factor deterring offshore investors," says JSE president, Russell Loubser.
Neither does this lack of control encourage local investors, who can now place funds in markets worldwide. For those not privy to the inside track on corporate wheeling and dealing, insider trading makes the JSE a risky and less desirable investment avenue. Worst of all, it perpetuates South Africa's image abroad as a haven for pirates and crooks.
And this doesn't apply only to the smallest of private shareholders. Larger institutional investors, too, are often unable to give attention to - or act on - market gossip. Overall, the majority loses out.
Take the notorious case of life assured Crusader Life. Odd trading patterns around the time of its 1993 liquidation are still under investigation by the Office for Serious Economic Offences (Oseo). It's one of only two cases that now face prosecution - two others were discarded recently by the attorney general - though there are more in the pipeline.
And a new Insider Trading Bill is on its way to becoming law. It will hand authority for insider trading regulation from the Securities Regulatory Panel (SRP) to the more powerful and better-funded Financial Services Board (FSB).
Insider trading became an issue when Crusader issued a healthy and encouraging interim report, yet had a R77m deficit by year-end. In the interim, Crusader directors and brothers Bob and Don Rowland had offloaded their family trust shares near the top of the market. A few months later, Crusader's controlling shareholders admitted the shares were almost worthless.
A look at Crusader's share graph is all it takes to see that shareholders, a mixture of individuals and institutions, had good reason to be unhappy. The share price plummet after Crusader's predicament was revealed was dramatic - from 375c in February to 135c only two months later.
No wonder JSE shareholders are irate that the case has taken so long to finalise. But it would be unfair to accuse either the SRP or Oseo of procrastination. The delay is caused in part by problematic legislation.
So far, insiders trading laws and regulators have been hopelessly ineffectual. Current legislation - Section 440(f) of the 1973 Companies Act - has the right aims but three important problems: the legislation deals only with shares and not with other financial instruments; it requires almost unrealistic proof that traders bought or sold shares on inside information; and the imprecision of some definitions makes them difficult to apply.
True, says SRP executive director Richard Connellan bitterly. "I admit I am as biased as hell. We haven't convicted anyone but the law made it almost impossible. We will gladly co-operate with the FSB. But I am disappointed we didn't retain the insider trading regulatory function; the changes we initiated are imminent and only now is effective action possible."
In the past, says Connellan, the SRP could frequently prove the trader had the knowledge, and that he dealt in the shares. "But we had to prove indisputably that he dealt on the basis of the knowledge. That was one difficult part. The other stumbling block was the attorney general's office. He never wanted to take on the cases. Our files went to the bottom of the pile and were forgotten."
Loubser admits regulators had to cope with toothless laws and too few staff. Whatever the reason, enforcement has been patently ineffective. "Why should I give a stuff about new legislation?" asks a broker understandably not wishing to be named. "Current law is a joke. No-one will take it seriously until there's been one successful prosecution."
The examples are numerous. What has happened to the investigation of Automakers, the Sanlam-controlled car manufacturer that had a disastrous and short-lived listing in 1996 and 1997? It seems there were market players who knew something about Automakers' fate before the rest of us learnt of it.
By the time Automakers had announced its delisting in early 1997, the share price had started to rocket. Trading volumes, having dwindled in late 1996, suddenly jumped.
Still, it's not always easy to prove insider trading played a part in unusual share price movement. Hoechst financial director Johan Kok agrees that the group's share movements were unusual before its German holding company announced this year its intention to buy out minority shareholders and delist the SA company.
But, he says, the combination of a cautionary that had been announced in March and an article in the FM speculating on Hoechst's likely delisting and the sale of a local division were the main causes of the counter's rise. "Some analysts started putting two and two together, and speculated that Hoechst would be delisted," he says. "There was a hell of a lot of speculation in the market."
He may well be right - at least partly. But it's well known that merger and acquisition activity is a popular time for unusual trading patterns on the JSE. FSB staff at the SRP during the transition of authority is already working on recent suspicious cases. They are, of course, limited in their work by current legislation.
Still, only the naive would imagine that new legislation will result in immediate convictions. But market players not yet aware of the potential of new law had better wake up. Things are about to change.
"Any broker who imagines that life will continue as normal after the new law is implemented will be sorely tested," says JSE legal counsel Nicky Newton-King, who took part in drawing up the new law.
The Insider Trading Bill is much stricter than current legislation. Probably the most significant change - and the most controversial - is that the FSB can apply civil rather than criminal procedures to enforce the legislation.
In short, this makes it more likely that the court will be able to convict and penalise wrongdoers than the current criminal remedy accepted by the courts for insider trading. Civil penalties are a maximum of triple the insider trading profit. Powers of investigation are boosted. And, says FSB deputy head Rob Barrow, "through powers of subpoena we will be able to identify the beneficiaries of nominee accounts."
With these new laws, it will also make a difference that enforcement shifts from the much-maligned SRP to the FSB. It has more staff, better technology and more funds. The new law allows the FSB better communication than previously with the JSE's surveillance team.
Contrarians regularly come up with arguments defending the theory of inside information. Allowing news to spread uncurbed, they say, is in the best interests of investors who are able to gain swift access to company information. The spread of news along market networks doesn't take long. This increases market efficiency. Don't legislate; in fact, encourage it.
In practice, theories mean little to investors who realise they are losing out because of the inside knowledge of others. The effects of insider trading - particularly for the losers - sound good in theory only. Pro-insider traders are willing to acknowledge that "outsiders" lose out. That's a pity, they agree. But inevitable, and good for the JSE in the long run.
Unfortunately, this argument misses the point. Investors have a choice. Markets in the most developed countries legislate severely against insider trading. The result is simple: it happens much less than in SA.
Even then, the latest changes to the law, however laudable, aren't sufficient. Regulators of SA markets still face tremendous difficulties. Take the unnecessary complication of having two ministries responsible for financial regulation, for example. Trade & Industry controls the Companies Act, while Finance is responsible for other market legislation.
To eliminate the gaps in the system, this must urgently be simplified. Finance, now responsible for the bulk of financial market regulation and administration, seems the obvious choice.
For whatever reason - the allegations are many - those few cases referred to attorneys-general's offices don't seem to go much further than that. This is extremely frustrating to market regulators who argue that only watertight cases are submitted. Problems may include lack of interest from attorneys-general or insufficient evidence for prosecutions.
Whatever the case, communication and working structures between offices of attorneys-general and the FSB must still be improved.
Jurisdiction over the Internet, a useful site for insider traders, needs to be considered in legislation.
The shield of anonymity given to traders who deal through nominee companies must also be removed. That kind of protection complicates detection of trading fraud. An upcoming amendment to the Companies Act reduces the legal holdings of nominees in any company to 5%. Not bad. But it is still 5% too far. Where, when they are needed, are the DTIs transforming teeth?
On a similar theme, the FSB must communicate with investors. Regular bulletins or published announcements should detail the number of cases under investigation and progress in bringing offenders to book. Until they are proven guilty, no names need be mentioned. Communication will, however, act as a warning of the FSB's presence.
Take note: there will be no possibility of anonymity for convicted offenders. "That's one of my contributions," says Barrow with some satisfaction.
By: Michelle Joubert
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