Controlling Insider Dealing — The ‘Civil’ Approach in New Zealand

Pages309-327
Published date01 February 1997
DOIhttps://doi.org/10.1108/eb025797
Date01 February 1997
AuthorPeter Fitzsimons
Subject MatterAccounting & finance
Journal of Financial Crime Vol. 4 No. 4 Analysis
Controlling Insider Dealing The 'Civil' Approach
in New Zealand
Peter Fitzsimons
This paper discusses New Zealand's attempt to
deal with insider trading by statutory means. New
Zealand's attempt is of particular interest since it
has two features which distinguish it from other
jurisdictions. The first feature is the decision to
reject the criminalisation of insider trading and to
instead rely upon civil enforcement of insider trad-
ing alone. The second feature is the failure to pro-
vide a state agency with powers to take action
(whether civil or criminal) against insider trading.
The New Zealand legislation, the Securities
Amendment Act 1988 ('the Act'), was put in place
after the stockmarket crash of 1987 in response to
outcries against perceived abuses in the market.
The Act has been in force for seven years, yet no
case involving allegations of insider trading has
been taken to completion. The basis of the insider
trading regime is private enforcement which, in
the light of its failure to provide effective remedies
and control, needs to be reviewed.
The first part of this paper examines the passing
of Part I Act 1988,1 which contains the insider
trading provisions, and also deals with the limita-
tions of the enforcement provisions, and the two
New Zealand cases that have dealt with these pro-
visions. The second part of the paper will deal
with the activities of the New Zealand Securities
Commission ('the Commission') relating to
insider trading, the reactions of companies whose
shares are the subject of insider trading claims and
reform proposals.
THE ENACTMENT OF PART I OF THE
SECURITIES AMENDMENT ACT 1988
Although New Zealand provided one of the most
significant common law cases on insider trading in
the Commonwealth,2 it did not have a statutory
prohibition of insider trading until the late 1980s.3
The move to provide statutory remedies for insider
trading was prompted by the Government's con-
cern about the state of the securities markets
during the mid-1980s, which followed on from the
deregulation of the New Zealand economy.4 The
New Zealand Stock Exchange's market capitalisa-
tion rose from $17.6bn at the end of 1985 to
$42.4bn by the end of 1986.5 The market reached
a high of $42.8bn just prior to the stockmarket
crash in 1987, but had fallen by December 1987 to
$24.2bn.6 In the light of this significant market
activity the Minister of Justice requested the Com-
mission to consider insider trading and takeover
law reforms in 1986.7 Not surprisingly, when the
Commission presented its report soon after the
stockmarket crash in 1987 the Government was
quick to take up its recommendations.8
The Commission's report recommended that
legislation should be introduced to provide for
civil remedies against persons who engage in
insider trading, and suggested that 'the best
method of preventing insider trading is to equip
companies and shareholders with the legal rights
and powers to detect and deal with it'.9 It was less
enthusiastic about the introduction of criminal
provisions in relation to insider trading, as overseas
experience had indicated that prosecutions were
difficult in the face of the 'right to silence' and
could interfere with any attempt to take civil
actions.10 It perhaps also reflected the fact that
members of the Commission, with the exception
of the chairperson, were part-time members who
came from diverse professional backgrounds
(accountants, stockbrokers, lawyers, investors and
company directors), and who had been chosen for
their knowledge of the capital markets rather than
their abilities as regulators. These persons would
possibly have been reluctant to advocate criminal-
isation of market practices, and even less inclined
to push themselves forward as the enforcers of
such laws.
In the absence of a state agency to undertake
civil actions for insider trading (which existed in
overseas jurisdictions such as Ontario and Quebec
in Canada),11 the conduct of these actions would
necessarily fall either to the companies or to the
shareholders in those companies.12 The Commis-
sion recognised that actions by shareholders might
be limited and that there was a need to provide for
Page 309
Journal of Financial Crime Vol. 4 No. 4 Analysis
the companies concerned to have appropriate
causes of action.13
The Commission, however, realised that reli-
ance upon companies to bring these actions, and
therefore to control insider trading, had its limita-
tions as a result of the connection that often exists
between those who engage in insider trading and
those who determine whether or not an action is
commenced:14
'The power to bring an action for the benefit of
a company is usually vested in the directors of
the company. The occasions on which a share-
holder may bring a "derivative" action [at
common law] are quite limited. There is, there-
fore,
a problem where the directors (who may in
some way be beholden to the insider) do not
wish to sue the insider. That could deprive the
shareholders of
relief.
We think that the bring-
ing of responsible claims against insiders is a
proper corporate function to be carried out at
the expense and for the benefit of the company
concerned. If the directors let the matter go by
default, we think a shareholder or former share-
holder should be entitled to intervene and take
the conduct of the proceedings out of their
hands,
and to do so at the expense of the com-
pany.'
On the other hand, the Commission also recog-
nised that allowing some shareholders to engage in
this type of action at the company's expense where
the directors and other shareholders were 'bona
fide' against the action had its own problems. The
Commission suggestion to overcome these prob-
lems was for a Queen's Counsel to provide an
opinion as to whether or not there was an arguable
case of insider trading, the cost of which would be
borne by the company, and if counsel found a
cause of action the company would be required to
commence an action.l5
When the proposed legislation came before Par-
liament a significant amount of discussion centred
on the corporate climate that had prevailed during
the mid-1980s, and the necessity of dealing with
insider trading in the New Zealand context.16 For
example Kyd, a member of the Opposition, com-
mented:17
'The Bill is a feeble response to the problems of
corporate crime, fraud, and the collapse of the
stock market. The Government is seen as being
soft on corporate crime and company matters.
The stock market is unsafe, unfair, and uncom-
petitive, and the legislation does very little to
solve those problems ... Legislation of this type
has given rise to very little litigation overseas,
and has done very little to stop insider trading
and to control futures trading.'
Despite comments such as these the Commission's
rationale for the legislation was generally accepted
by Parliament, as was its argument that the crim-
inalisation of insider trading would not be appro-
priate in the light of overseas experience.18
However, the Bill introduced into Parliament did
not follow the Commission's proposals.19 The Bill
provided that the opinion obtained from the
Queen's Counsel would not be binding on the
company, and if the company refused then a com-
plaining shareholder (or former shareholder)
would need to commence an action in order to
obtain a court approval for the taking of the com-
pany's action. The Bill also required that the Com-
mission approve the obtaining of an opinion. In
effect the Bill moved the process from a two-stage
approach (obtaining a favourable opinion and com-
mencing an action) to a four-stage approach (con-
vincing the Commission that an opinion was
warranted; obtaining the opinion; if the public
issuer did not commence an action, applying to the
court for approval to take the action in the public
issuer's place; and, if approval was obtained, com-
mencing the action). No mention was made in
Parliament of this significant change to the Com-
mission's proposals.
The reliance upon shareholder litigation by the
legislature misread the New Zealand position
compared with overseas jurisdictions. These jur-
isdictions combine civil remedies with criminal
prosecutions, or provide for a state agency to inter-
vene and either take an action in the company's
name or obtain civil penalties which may or may
not be paid to the company or shareholders.20 New
Zealand did not have a strong regulatory agency in
the securities markets, and the lack of such a body
required the encouragement of shareholder litiga-
tion. The introduction of the derivative action was
a positive step, necessitated by the absence of a
state agency, but the introduction of multiple steps
into the process worked against its effectiveness.
When the Bill came back from its second read-
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