Using Financial Incentives and Income Contingent Penalties to Detect and Punish Collusion and Insider Trading
| Author | Bruce Chapman,Richard Denniss |
| Date | 01 April 2005 |
| Published date | 01 April 2005 |
| DOI | 10.1375/acri.38.1.122 |
Contingent Penalties to Detect and Punish
Collusion and Insider Trading
Bruce Chapman
The Australian National University, Australia
Richard Denniss
The Australia Institute, Australia
Collusion and insider trading, being white collar crimes, are often
characterised as being victimless crimes. The absence of identifiable
victims makes the detection of these crimes particularly difficult. This
paper proposes that, in order to increase the flow of information about
collusion and insider trading, parties engaged in these crimes should be
offered financial incentives to provide evidence against their co-conspira-
tors. In order to provide greater certainty that rewards will be paid, and
also to increase the probability that any fines are paid, it is also proposed
that an income-contingent fine collection mechanism be utilised. The
paper presents two case studies to illustrate how the fine collection
mechanism could be used.
Collusion and insider trading, being white collar crimes, are often characterised
as victimless crimes. However, despite what the name suggests, such victimless
crimes impose large costs on individuals and the economy. They are only victimless
to the extent that those harmed by crimes such as collusion and insider trading are
often unaware that they have been victimised. The absence of identifiable victims
makes the detection of collusion and insider trading much more difficult. As the
Australian Competition and Consumer Commission (ACCC) has stated,
‘Collusion is extremely harmful to both businesses customers and consumers. The
gains can be large and difficult to detect. The incentives for collusion are high in
important areas of the modern economy’ (ACCC, 2002, p.8). Similarly, the US
Securities and Exchange Commission has stated that ‘[b]ecause insider trading
undermines investor confidence in the fairness and integrity of the securities
markets, the Commission has treated the detection and prosecution of insider-
trading violations as one of its enforcement priorities’ (USSEC, 2003).
Address for correspondence: Professor Bruce Chapman, Economics Program, Research
School of Social Sciences, HC Coombs Building, The Australian National University,
Canberra ACT 0200, Australia. E-mail: bruce.chapman@anu.edu.au
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VOLUME 38 NUMBER 1 2005 PP. 122–140
DETECTING AND PUNISHING COLLUSION AND INSIDER TRADING
This paper outlines a new approach to both detecting and punishing the crimes
of insider trading and collusion. The paper proposes that financial incentives be
offered to individuals or firms participating in illegal activity in return for the provi-
sion of evidence against other participants. In order to ensure that large incentives
can be offered, and large fines levied, it is also proposed that a revenue-contingent
payment mechanism be utilised to extract both incentive payments and fines from
firms and individuals convicted of these offences. The use of a revenue-contingent
penalty payment increases the certainty of collecting penalties while reducing the
incentive for recourse to bankruptcy.
The paper is structured as follows. Section 2 outlines the dimensions of the
problems of collusion and insider trading. Sections 3 and 4 provide more detail on
the nature of collusion and insider trading. Section 5 provides a discussion of the
reform proposal and Section 6 provides a more detailed discussion of the income-
contingent collection mechanism. Section 7 provides an overview of the role of
incentives to report criminal conduct. Sections 8 and 9 provide worked examples of
how the scheme might work in practice, while Section 10 provides some conclud-
ing remarks.
The Dimensions of the Problem
Collusion and insider trading impose a wide range of costs on both society and the
economy. Both forms of criminal conduct deliver an inequitable distribution of
gains and impose a range of negative externalities, such as reduced economic
efficiency, reduced faith in the structure of markets and financial costs to govern-
ments.
For regulators, a major problem associated with collusion and insider trading is
the lack of information available to investigators. Without evidence from partici-
pants, the tasks of detecting criminal activity and achieving successful prosecutions
are made particularly difficult.
While it is difficult to determine accurately the extent of collusion and insider
trading, some estimates are available. In recent years it has been argued that reduc-
tions in trade barriers and increased globalisation have resulted in increased collu-
sive activity (ACCC, 2002), with the OECD estimating that the value of
commerce affected by collusive conduct in 16 large cartel cases that had been
examined was greater than $55 billion (OECD, 2002).
Recent examples of collusion include the following:
• Hoffman La-Roche was fined €462 million for participation in an international
vitamin cartel in 2001.
• Lafarge was fined €250 million for participating in a cartel in the plasterboard
industry in 2002.
• TNT, Mayne Nickless and Ansett Freight express were fined more than A$11
million for cartel behaviour in the Australian freight industry.
• Six UK drug companies engaged in price-fixing of antibiotics are estimated to
have cost the public health system £400 million.
While there have been relatively few prosecutions for insider trading in Australia some
researchers have suggested that between 5% and 10% of all trades involve insider infor-
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BRUCE CHAPMAN AND RICHARD DENNISS
mation (Richards, 2000). Similarly, a study of Australian executives found that 52% of
respondents would be willing to buy shares before their own company made a
favourable announcement (Richards, 2000). It would therefore appear that the detec-
tion and prosecution of insider trading lags well behind its prevalence.
What is Collusion?
Collusion is defined as an agreement ‘between different firms to cooperate by
raising prices, dividing markets, or otherwise restraining competition’ (Samuelson
& Nordhaus, 1987, p. 900). Collusion imposes large, though difficult to quantify,
costs on consumers and businesses not involved in the collusive conduct. The result
is a mal-distribution of resources and income and a reduction in the allocative
efficiency of the economy. Estimates of the impact of collusion on market prices
range from 10% in the US (ACCC, 2002, p. 23) to between 15% and 50% (OECD,
2002a, p. 9). The OECD has referred to collusive practices as the most ‘egregious
violations of competition law’ (OECD, 2002, p. 5).
While examples of successful prosecutions for cartel activity can be found it is
widely considered that most collusion is undetected. The OECD has stated that:
The challenge in attacking hard-core cartels is to penetrate their cloak of secrecy. To
encourage a member of a cartel to confess and implicate its co-conspirators with first
hand, direct, ‘insider’ evidence about their clandestine meetings and communica-
tions, an enforcement agency may promise a smaller fine, shorter sentence, less
restrictive order, or complete amnesty (OECD, 2002b, p. 7).
Detection of collusion is made more difficult because of the absence of an apparent
victim. This is further complicated by the difficulty of proving, without access to
insider information, that firms suspected of colluding are doing so. In 2001–02 the
ACCC received 442 complaints of cartel and price-fixing, of which 61 were investi-
gated. On average, between three and five cases are taken to court each year
(ACCC, 2002, p. 24).
The Chairman of the ACCC, Graeme Samuels, has recently described cartels as
the ‘very worst form of violation of corporation law’ and plans to use a leniency
policy to encourage executives to ‘squeal on their fellow offenders’ (cited in Dodd,
2003). The potential for the provision of financial incentives to remove the ‘cloak
of secrecy’ that surrounds collusive conduct is discussed in below.
A Case Study in Collusion
In 1994 TNT Australia Pty Ltd, Ansett Transport Industries (Operations) Pty Ltd,
and Mayne Nickless Ltd, as well as a number of individuals, admitted to contraven-
ing sections 45 and 45A1 of the Trade Practices Act 1974 (Cth). They were fined
$4,100,000, $900,000 and $6,000,000 respectively.
In summarising the nature of the collusive conduct of the cartel, Justice
Burchett stated:
What was alleged, supported by voluminous evidence, and is now admitted, is that at
five primary meetings attended by representatives of the three companies, which took
place between 1987 and 1990, a series of agreements were reached, as follows:
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DETECTING AND PUNISHING COLLUSION AND INSIDER TRADING
1. That the companies would not ‘poach’ each other’s customers, by which the
admissions of Mayne Nickless Limited specified, and I understand the other
respondents to have meant, that if one was requested to quote by a customer of
another, it would either fail to do so or would submit a quotation above the price
charged by the other company, the existing supplier, a practice described as
‘giving cover’;
2. That if one received the custom of customers of another, compensation would be
made by returning customers of the same value by the process of up-rating them
or driving them away by the provision of poor service;
3. That there would be a balancing of accounts of customers lost and gained and
payment of compensation;
4. That no quotes would...
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