Curb insider trading and make Kenya an attractive capital market

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BY MULEI MUTAVA MICHAEL

Investors familiar with Wall Street lingo know the popular phrase, “Bulls make money, bears make money, pigs get slaughtered.”  In effect, this phrase cautions against excessive greed and impatience in the market.

Bulls make a kill when the market is on the rise while bears take their harvest when it’s on a decline. The success in both strategies is predicated on impeccable timing for jumping on and off the ship as it sets sail, the direction notwithstanding. A pig comes late to the party, stays long or misses it altogether whichever the case may be, and in some cases might be the be stew for the bull or bear.

The above categorization, thus, begs an all-important question of how to tell apart a shrewd investor from an ingenuous one, to which the simple answer is interpretation of market information and sentiment.   

There is no denying that a significant portion of asset prices derive their value from prevailing market information, and people that succumb to their greed, impatience and or misreading of such information only have themselves to blame when they suffer losses. Regrettably, there is an alternative and more painful route to becoming a stock market pig i.e. insider trading.

This malpractice is a crystal born out of monopolizing information and subsequently acting on it to the exclusion of other participants. Formally, it is the act of buying or selling securities based upon access to confidential or proprietary information which is not available to the general public. Such traders use this monopolistic, price sensitive and material non-public information to their advantage, the sole aim being to make supernormal returns.

In most cases, such information is considered privileged and its holders have a fiduciary duty to protect it but ignorantly proceed to violate public trust by acting on it before it gets to market or by tipping their acquaintances and proxies for a kick back. Such crucial information may also be fraudulently obtained through corporate espionage, in which case it’s not a violation of the trust relationship, but still remains a quintessential case of insider trading, if such stolen information is acted upon.

The Capital Markets Authority (CMA) recently flagged suspect Kenol Knobil deals alleged to have taken the form of insider trading. This brings to memory a similar high-profile case in 2010, involving a former Commercial Bank of Kenya manager Terrry Davidson and his then counterpart in Uchumi Supermarket Mwangi Kibaru, two of whom were accused of insider dealings with Uchumi Supermarket shares.

The impact of these allegations is debilitating to the capital markets space in Kenya and defeats the motive of growing Nairobi into a robust international financial centre. It paints a negative picture on the credibility of the market. Having insider information predisposes illegitimate traders to an undue advantage of front running and to sit at the dining table waiting to devour the late coming pigs.

For example, if an investor has information that the dividend of a certain company will rise, he is certain that the share price will make a leap frog.  All he has to do is assume a bullish attitude, go long on shares and expect to short them when the information becomes public. 

It is important to note that this action may not necessarily lead to a direct loss on the late comers, but it inhibits the efficient functioning of the market leading to its failure in key roles such as price discovery and inevitably misplacing opportunities and risks. Should such cases persist, more market participants will view the market with scepticism, suspicion and mistrust. Other than eroding confidence, the biggest casualties of this malpractice are the small traders who are generally price takers in the market.

There is no one-size-fits-all solution to this menace as it is cross cutting between corporate governance and corporate finance policies of institutions. It is also difficult to prove since its implementation is shrouded in secrecy.   The government has however been aggressive in trying to combat it legislatively.

In 2013, the National Treasury proposed and subsequently adopted an amendment to the Capital Markets Act, which redefined the offence of insider trading as an offence of ‘strict liability.’ By imputing such liability, the government recognizes the perilous nature of insider trading and demonstrates its efforts to stamp it out.

On the flip side, there has not been any successful prosecution to serve as an effective precedent for subsequent litigation and a deterrent to those who harbour such thoughts. CMA also plays an oversight role and has the power to prescribe and impose penalties on errand participants.