Courts get tough on insider trading

Professor Bob Baxt explains how the courts are getting tougher on “white collar” crime and advises directors to ensure they understand their legal obligations, especially the prohibitions against insider trading.

There is little doubt that increasing focus is being placed on the performance of companies in the wake of more corporate collapses, unfavourable reports (such as the recent administrators’ report on the Hastie Group) and major court cases initiated by the Australian Securities and Investments Commission (ASIC) against directors (for example, that against James Hardie’s non-executive directors).

As a direct consequence of these actions, judges are being asked – or perhaps being subtly forced – to pay more attention to the penalties they impose where directors and officers are held to be in breach of their duties or relevant statutes.

With the increase in ASIC’s success rate in prosecuting breaches of the provisions dealing with insider trading or misleading or manipulative market practices, our judges are being asked to consider more serious penalties, including custodial sentences in relevant and appropriate cases.

In my column last month (Company Director, February 2013), when commenting on the decision of Gilfillan v ASIC, I emphasised the sombre, yet very telling, comments of Acting Justice Sackville reminding all James Hardie’s directors (and other officers by extrapolation) to recognise that the duties imposed on them under the relevant legislation and general law were very significant, and that careful attention needed to be given to adherence to these duties.

Insider trading provisions of the law have now come under the spotlight in two new and interesting cases.

In the first case, Mansfield v The Queen [2012] 293 ALR 1, the High Court of Australia has emphasised it will interpret this legislation in an expansive fashion if necessary to ensure the registered legislation is effective.

The High Court of Australia upheld a decision of the Western Australian Court of Appeal that a breach of the insider trading provisions of the relevant legislation could be pursued by ASIC or the Director of Public Prosecutions (DPP) even though the information those accused of breaching the insider trading provisions had allegedly improperly relied on was, in fact, inaccurate.

In two separate judgments – Justices Hayne, Crennan, Kiefel and Bell in a majority decision, and Justice Heydon in a separate judgment – the High Court judges all agreed the legislation should not be read merely so as to prevent ASIC from pursuing a claim where it could otherwise prove someone had relied on information inappropriately. The fact that the information was false was irrelevant.

The majority judges emphasised that one of the purposes behind insider trading law was to prohibit anyone who received any information relating to the price or value of shares, whether it was accurate or false, from being allowed to trade in those shares, thus allowing "the market to operate freely and fairly".

A new trial has now been ordered to ascertain whether ASIC can prove the remaining elements of the insider trading charges, but the more expansive interpretation of the legislation reflects the willingness of the courts to give the regulator an opportunity to pursue these areas more effectively.

In the second interesting decision dealing with breaches of the insider trading provisions, R v Fysh (No. 4) [2012] NSWSC1587, Justice McCallum of the New South Wales Supreme Court has recognised that sometimes custodial sentences need to be imposed on directors who breach the insider trading provisions, notwithstanding internal and personal hardship.

Justice McCallum had the unenviable task of deciding what penalties, including the possibility of a custodial sentence, should be imposed on a director who had been found guilty by a jury on two counts of insider trading, infringing under sections 1043A(1)(c) and 1311(1)(a) of the Corporations Act 2001.

The alleged offences arose out of Fysh’s purchase of 250,000 shares in two separate tranches in the Queensland Gas Company while allegedly in possession of inside information. It was further alleged that the information possessed by Fysh was obtained from different sources at different times.

Justice McCallum reminded us, as judges will from time to time, of the concepts behind the insider trading prohibitions contained in the legislation.

She noted: "[These] provisions were enacted with the modest object of promoting fair, orderly and transparent markets for financial products … The acquisition or disposal of shares by people having the unfair advantage of inside information is not only inimical to the object … but is criminalised because it has the capacity to unravel the public trust which is the lifeblood of the market" (at [11]).

Her Honour recognised it was necessary in considering any punishment to emphasise the need for deterrence in future dealings by those faced with the opportunity of trading in the market in these circumstances.

As it is not unusual in cases where people are found liable for a breach of a criminal statute, mitigating factors will play a significant part in influencing the penalty or sentence that may be imposed. Such matters also come into play in cases where penalties are judged in civil cases.

Justice McCallum had been influenced by the cooperation of Fysh, his agreement to forfeit the profits he was allegedly said to have made and his general good character. She was also influenced by the fact that Fysh suffered from a fragile mental state, had to relocate himself to Australia to face the criminal charges being pursued and that cases of this kind often take a long time to conclude.

In addition, she recognised that his wife and children would suffer hardship in the event of a custodial sentence, but she felt that such hardship was not an exceptional matter to warrant her departing from imposing a custodial sentence.

As is usually the case in a matter of this kind, a number of legal authorities were cited as to the criteria a judge would take into account in imposing a custodial sentence. While the judge recognised the usefulness of these cases, she felt she should be guided by her own assessment of the matters in the case and acceded to the Crown’s submission that "none of the alternatives to a custodial sentence was appropriate". She therefore imposed an aggregate sentence of two years, with the two sentences to be served concurrently.

I bring these cases to the attention of readers because it is quite clear that ASIC is pursuing the prosecution of breaches of insider trading and other market manipulation cases more vigorously and with greater success than perhaps has been the case in the past.

Regular reports issued by ASIC have shown that the success rate being enjoyed by ASIC in such matters has increased quite significantly recently.

In earlier years, the courts have been perhaps a little more generous in their interpretation of legislation on behalf of defendants. In some cases, the regulator itself (either ASIC or the DPP) has been more cautious in entering into criminal prosecutions where ASIC has had to establish the guilt of the relevant person being sued before a jury, and where community reaction to breaches of legislation broadly described as "white collar crime" may have been more sympathetic than it is today.

It is likely we will see further major cases in which insider trading breaches are alleged – the daily news and financial media writers are certainly discussing and considering an increasing number of cases that are either being brought or about to be launched.

All of these matters together contribute to the way in which our judges evaluate the important statutory duties in the Corporations Act, whether they are criminal or civil.

I suspect we will see many more cases being brought and heard by the courts on alleged breaches of duty, whether civil or criminal. The penalties and sentences are likely to be modest, but they be may slowly be influenced by the very heavy penalties being imposed in these matters in the US in addition to what is happening in Australia.

Director education is an essential aspect of the ongoing responsibilities of company directors and officers of both public or private companies in carrying out their obligations. As part of this, they need to be informed not only about the broad obligations required of them under the general provisions of the legislation, but more specifically about the prohibitions against insider trading, market manipulation and related offences.

Professor Bob Baxt AO FAICDLife is an emeritus partner of Freehills, chairman of the Australian Institute of Company Directors’ Law Committee and author of the 20th edition of Duties and Responsibilities of Directors and Officers