INSIDER TRADING REGULATIONS IN U.S. AND A PROPOSAL FOR TURKEY

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INSIDER TRADING REGULATIONS IN U.S. AND A
PROPOSAL FOR TURKEY
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WHAT IS INSIDER TRADING ?

• There is no statutory definition
• Encompasses both legal and illegal activity
• Our discussion illegal one
• When those with confidential information use that
  special advantage to gain profit or avoid losses
  on the stock market
• Damages the source of information and other
  typical investors

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WHO ARE INSIDERS?

• Not just corporate directors, officers or major
  shareholders
• A broader range of individuals
• A partner in a law firm representing the
  acquiring company in a hostile takeover bid who
  traded in target company stock.
• A Wall Street Journal columnist who traded prior
  to publication of his column in the stock of
  companies he wrote about.
• A psychiatrist who traded on the basis of
  information learned from a patient.
• A financial printer who traded in the stock of
  companies about which he was preparing disclosure
  documents.

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WHY US REGULATIONS?

• Insider trading has started to cross borders
• EC Directive provides that members may enact laws
  more stringent than set out in the Directive
• U.S. has the most comprehensive and detailed
  regulations against insider trading

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INSIDER TRADING DEBATE

• Opposing Views
• Form of compensation for employees
• No statutory definition, unfairly penalize
  traders
• Enforcing insider trading not cost effective
• Smooth prices and more efficient market
• Companies may prohibit it in the contract

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REASONS FOR REGULATING INSIDER TRADING

• Unfair practice to public investors
• Prohibiting it promotes efficiency of markets
• Property of material information belongs to the
  corporation for business purposes.

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US REGULATION OF INSIDER TRADING

• Section 16 of the 1934 Securities Exchange Act
• SEC Rule 10b-5
• Classical Theory
• Misappropriation Theory
• SEC Rule 14e-3

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Section 16 of the 1934 Act

• Designed to watch more closely the trading of
  corporate insiders on their corporations stock.
• Covers officer, directors, and 10 equity holders
• 16(a) -gt Disclosure Provision -gtEvery corporate
  insider should report holdings and transactions.
  Facilitates 16(b)
• 16(b) -gt Recovery of Short-swing Profits -gtThese
  insiders must disgorge profits from selling stock
  held less than six months

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Rule 10b-5

• Promulgated in 1942 under 10(b) of the
  Securities Exchange Act of 1934
• Covers
• material corporate misstatements or non
  diclosures,
• insider trading, and
• corporate mismanagement cases
• regarding transactions in shares or other
  securities
• Today a major weapon to curb insider trading, as
  a catch-all anti-fraud provision

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Rule 10b-5

• It shall be unlawful for any person, directly or
  indirectly, by the use of any means or
  instrumentality of interstate commerce, or of
  mails, or of any facility of any national
  securities exchange,
• to employ any device, scheme, or artifice to
  defraud,
• to make any untrue statement of a material fact
  or to omit to state a material fact necessary in
  order to make the statements made, in the light
  of the circumstances under which they were made,
  not misleading, or
• to engage in any act, practice, or course of
  business which operates or would operate as a
  fraud or deceit upon any person,
• in connection with the purchase or sale of any
  security.

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Rule 10b-5

• Legal Theories of Rule 10b-5
• Traditional Theory
• Misappropriation Theory

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Traditional Theory of Insider Trading

• Also known as disclose or abstain rule
• Insiders, acting on behalf of their company or on
  their own behalf, have a fiduciary duty to the
  companys shareholders either to
• disclose material, nonpublic information before
  trading or
• to abstain from trading.
• Developed through major cases of
• In re Cady, Roberts Co (1961)
• SEC v. Texas Gulf Sulphur Co. (1968)
• Chiarella v. United States (1980) -gt Rule 14e-3
• Dirks v. SEC (1984)-gt Regulation FD

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Traditional Theory of Insider Trading

• A person violates Rule 10b-5 by buying or selling
  securities on the basis of material nonpublic
  information if
• she owes a fiduciary or similar duty to the other
  party to the transaction
• she is an insider of the corporation in whose
  shares she trades, and thus owes a fiduciary duty
  to the corporations shareholders
• she is a tippee who received her information from
  an insider of the corporation and knows or should
  know, that the insider breached a fiduciary duty
  in disclosing the information to her

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Misappropriation Theory of Insider Trading

• First mentioned in Chiarella case
• In Carpenter v. United States (1986) case Supreme
  Court split 4 to 4
• Clearly accepted by the Supreme Court in 1997,
  United States v. OHagan case

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Misappropriation Theory of Insider Trading

• A person violates Rule 10b-5 if
• Misappropriates material nonpublic information
• by breaching a duty arising out of a relationship
  of trust or confidence to the source of
  information
• and uses that information in a securities
  transaction
• regardless of whether he owed any duty to the
  shareholders of the traded stock

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Misappropriation Theory of Insider Trading

• Misappropriating information is
• obtaining by improper means or
• converting it to his/her own benefit even if
  properly obtained
• According to Rule 10b5-2 a duty of trust or
  confidence exists when
• a person expressly agrees to maintain information
  in confidence
• the facts and circumstances of the relationship
  as a whole show a history, pattern or practice of
  mutual sharing of confidences or
• a person receives information from a spouse,
  parent, child or sibling, unless the person
  receiving the information can show that, under
  the facts and circumstances of the family
  relationship, no reasonable expectation of
  confidence existed.

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Scope of Rule 10b-5

• Applies to any purchase or sale by any person of
  any security
• Fall within the jurisdictional reach
• In connection with the purchase or sale of a
  security
• To recover damages reliance (transaction
  causation) must be established (not for SEC)
• The plaintiff must also be able to prove loss
  causation
• Rule 10b5-1 presumes that someone who trades
  while in possession of material non public
  information has in fact used the information in
  making the trade.
• Statute of limitations is one year after
  discovery and three years after violation.
• Tipper Tippee liability applies to both
  theories. Contact between them should be
  established.

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Rule 14e-3

• Prohibits insider trading during a tender offer
  and thus supplements Rule 10b-5.
• Rule 14e-3(a) prohibits anyone, except the
  bidder, who possesses material, nonpublic
  information of a tender offer, from trading the
  targets securities
• Rule 14e-3(d) is a preventive provision
  complementing Rule 14e-3(a). Prohibits anyone
  with any form or connection to a tender offer
  from tipping material, nonpublic information.
• Is not premised on breach of a fiduciary duty

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SEC Enforcement of the Rule 10b-5 and Rule 14e-3

• Permanent or a temporary injunction
• Disgorgement of profits (most commonly used)
• Correction of misleading statements
• Disclosure of material information
• Cease and desist orders
• Disciplinary sanctions and civil penalties for
  securities market professionals
• Bounty provisions by the 20A of ITSFEA
• 21A -gt civil monetary penalty of up to three
  times the profit gained or loss avoided by a
  person who violates Rules 10b-5 and 14e-3

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Private Enforcement of the Rule 10b-5 and Rule
14e-3

• Under 20As express remedy, contemporaneous
  traders are permitted to sue for a disgorgement
  of the improper profits (or loss avoided).
• SECs power increased with private actions.
• A plaintiff in a private damage action must have
  been purchaser or seller of the security forming
  the basis of the complaint and transaction
  causation usually presumed but loss causation is
  required.

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FRONT RUNNING

• A broker trades on a security while in possession
  of material non-public information concerning the
  imminent block transaction of one of his
  customers
• The SEC has suggested that the exchanges
  designate front-running as a practice
  inconsistent with just and equitable principles
  of trade
• SECs current regulation is through its oversight
  authority over the self-regulatory organizations
  (SROs) NYSE, AMEX, NASDAQ.

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INVESTIGATION, REGULATION, ENFORCEMENT COMPARED

• Comprise at least about 10 of the enforcement
  actions of SEC.
• As of 24.02.2003 only 10 out 820 suits of Capital
  Markets Board of Turkey were related to insider
  trading.
• Development of capital markets is usually matched
  with new insider trading schemes
• Transnational insider trading cases
• United States has the most extensive insider
  trading regulations

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INVESTIGATIONS COMPARED

• The same for both companies
• Sources of cases
• Informants
• Anonymous Calls
• Market professionals
• Disgruntled employees
• Competitors
• Market Surveillance
• Investigative Steps
• Analyze market trading records
• Obtain chronologies
• Conduct Interviews
• Analyze Monthly Account Statements
• Analyze Telephone Records
• Chart Out Connection b/w Insiders Traders
• Take Testimony
• Follow the Money
• Create and Update Names and Phones Databases

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REGULATION AND ENFORCEMENT IN TURKEY

• Only specific regulation against insider trading
  is Article 47/A-1 of CML
• To benefit to his/her self-owned property or to
  eliminate a loss so as to damage equal
  opportunity among the participants in capital
  markets with the aim of gaining benefit for
  himself/herself or for third parties by making
  use of non-public information which will be able
  to affect the values of capital market
  instruments in insider trading. The chairman and
  members of the Board of Directors, directors,
  internal auditors and other staff of the issuers
  within the scope of Article 11, capital market
  institutions or of the subsidiary or dominant
  establishment, and apart from these the persons
  who are in a position to be have information
  while carrying out their professions or duties,
  and the persons who are in a position to have
  information because of their direct and indirect
  relations with these.

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REGULATION AND ENFORCEMENT IN TURKEY

• In summary according to the CML
• Scienter is required,
• The scope of possible defendants is very broad,
• A gain of profit or avoidance of loss is
  required,
• Materiality depends on the ability of the
  non-public information to affect the value of the
  capital market instruments,
• CMB may request a legal prosecution and/or may
  prohibit the violators temporarily or permanently
  from transactions on exchanges and other
  organized markets (According to Article 46/i of
  the CML).
• The criminal penalty for the violation of this
  Article is a prison sentence from two to five
  years and a heavy pecuniary fine from 10 billion
  TL up to 25 billion If 2 or more cases are
  combined then min 3 max 6 years of prison.
• No upper limit for pecuniary punishment, but not
  less than threefold of the benefits

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REGULATION AND ENFORCEMENT COMPARED

• Differences
• Philosophy different in U.S. definition deduced
  from court interpretations an emphasis on breach
  of fiduciary duty
• Bounty system
• In U.S. insider trading seen as a private fraud
  lt-gt In Turkey public fraud harming markets no
  civil actions only criminal
• Subpoena Power
• In Turkey no regulations like 14e-3, Regulation
  FD and no specific front-running rules.

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REGULATION AND ENFORCEMENT COMPARED

• Similarities
• In Turkey there is a public disclosure
  requirement similar to 16(a)
• Securities do not have to be traded or listed on
  an exchange in order to attach a liability to an
  insider trader, in contrast to the case in many
  European countries
• CMBs power to temporarily (for 2 years) or
  permanently prohibit the violator from
  transacting on exchanges and other organized
  markets

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WHAT IF FAMOUS CASES HAPPENED IN TURKEY?

    Turkey Turkey Conviction in
Case Subject Materiality Gain/Loss Turkey?
Cady Roberts Co. A registered broker-dealer directed his customers to liquidate their holdings in Curtis-Wright stock because he had advance knowledge of a dividend cut. v v v
Texas Gulf Sulphur Insiders of a mine company purchased company stock on the open market with knowledge of a valuable mineral find that had not been publicly announced and made a considerable profit after the announcement. v v v
Chiarella A financial printer deduced the names of the target companies in takeover bids from the documents he printed. He purchased the target companys securities before the announcement of bids and sold them after the bids, thus making a profit. ? v ?
Dirks A companys former officials selective disclosure of insider information to an analyst giving an unfair advantage to the analyst and the analysts clients over the public generally v v v
Carpenter A columnist of the Wall Street Journal traded the securities he wrote about and in turn gained a profit. In Turkey this case would be interpreted as manipulation. In Turkey this case would be interpreted as manipulation. v
O'Hagan The attorney, after having learned of the law firms clients planned tender offer, purchased call options in the target company prior to the announcement of the tender offer. ? v ?
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A PROPOSAL FOR TURKEY

• The word value in Article 47/A-1 can be changed
  as value and/or price
• The requirement for a profit gain or avoidance of
  a loss can be eliminated
• An addition may be made to Article 47/A of the
  CML, in order to provide CMB with pecuniary
  punishments for violations of insider trading
• Adding bounty provisions
• Under CMBs oversight, Association of the Capital
  Market Intermediary Institutions of Turkey may
  prohibit front-running by enacting a uniform rule
  to be applied in all exchanges and organized
  markets.
• CMB may promulgate a regulation similar to
  Regulation FD

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THANK YOU SENEM DEMIRKAN