Saturday, 6 October 2012

What is Insider Trading?

This story broke on Monday 1st October 2012. The linked article talks of intrigue involving senior bankers, stock brokers, foreign businessmen and an investigative operation codenamed ‘Tabernula’. A tabernula, apparently, is a small booth. Welcome to the small booth, in the back of a City tavern, wreathed in cigar smoke, and to the murky world of insider dealing.

Insider dealing is bad. But what is it? Quintessentially, it is the trading of shares based on secret ‘inside’ information. If I work for Fyodor plc, and I know that Fyodor is about to announce huge profits, or a potential acquisition, or the resignation of its charismatic chairperson, and I trade my shares on the basis of that knowledge, I am guilty of insider dealing. The regime exists to create parity in share trading – how can Mr Droog hope to compete in the stock markets with me (and others like me) when we know so much more than he does?

Interestingly, insider dealing is subject to two parallel sets of rules. One is criminal (and is in s52 of the Criminal Justice Act 1993), and one is civil (set out in s118 FSMA).
This is a curious situation. The rules that these contain are, whilst not identical, substantially similar. Yet, a breach of s52 is a criminal offence, punishable by up to 7 years in jail; whereas a breach of s118 is only punishable by a fine.

So why the difference? As I’ve mentioned before, it is up to us as a society what we consider ‘criminal’, and what we regulate in other ways. Here, we have a rather pragmatic fudge. Insider dealing is a dishonest way of me taking money out of Mr Droog’s pockets. It is pretty much the same sort of thing as theft, and should be criminal. But, as the linked article implies, catching and prosecuting insiders who deal is hard. Shares are traded often, and their price necessarily fluctuates. How to spot the insider needle in the haystack of trades? And, critically, how to prove that to the criminal ‘beyond reasonable doubt’ standard?

This gets to a point key to ‘white collar crime’. It is often hard to spot, hard to investigate and hard to prove. To do so costs money. The resulting rarity of enforcement means the deterrent effect of punishment is unlikely to be high. High-rollers don’t think they’ll get caught. That’s where the civil regime comes in. A lower standard (‘on balance of probabilities’) allows for more successful enforcement, but the trade-off (‘scuse the pun) is that we can’t punish the insiders so harshly.