BY IAN ONDARI
Insider trading is defined conventionally as the buying or selling of securities by a person who is reasonably expected to have access to unpublished information by virtue of their connection with a company. It is a per se prohibited practice, especially if it involves breach of a fiduciary duty, or a relationship of trust and confidence.
Enforcing regulations on insider trading has been recognized as the primary goal by regulators because the informational asymmetry undermines investor confidence in the fairness and integrity of the securities markets. Insider trading and market manipulation also continually poses a threat to the stability and growth of capital markets. To what extent has the current legal framework been organized to effectively address this practice? Has it been achieved? Should reforms ensue?
A cursory glance at the Capital Markets Act (Cap 485A) reveals that insider trading has been substantively provided for. The provisions in Cap 485A are twofold; at the outset there are specific provisions and from then on, indirect broader provisions which relate to remedial action ex ante and ex post insider trading. While they don’t expressly speak for insider trading, it is these broader provisions in the statutory law that has reinforced the initial gaps and policy uncertainties.
In Kenya, insider trading is designated as a strict liability offense: there’s no state-of-mind element to prove. The enforcement includes both civil and criminal prosecution of insider trading cases. Direct evidence of insider trading is rare since it is shrouded by an environment of legal buying and selling, all which are legal. This makes it a very difficult offense to prove. It is only what is in the mind of the trader that can make this legal activity a prohibited act of insider trading. As a result it has been given a criminal and civil liability through Section 32E which proposes a fine and jail-term for offenders (for natural and corporate persons).
Additionally the Finance Act (No. 9 of 2007) amended section 25A to give the CMA powers to impose or levy sanctions and financial penalties for any breaches. Holistic interpretation of this provision if applied to the context of insider trading means that anyone who is found guilty of this offense would have their trading license suspended, suffer certain prescribed penalties, double recovery of amount in subject, be publically reprimanded among others.
Republic v. Terrence Davidson
The difficulty Kenya has despite these very comprehensive provisions has been lack of successful prosecutions brought under Section 32E. The ‘precedent’ setting case of Republic v. Terrence Davidson (Nairobi CMCC 1338 of 2008) highlights the policy uncertainties, which led to the acquittal of the Terrence Davidson and Bernard Kibaru who had been charged with insider trading, under the Section 33(now 32E). The prosecution presented evidence that the accused was privy to “price sensitive information” in addition to material information, which was unknown to the general public, which the accused persons acted on to their benefit. The acquittal has arguably been blamed on the restrictive interpretation, at that time, of the offence under then Capital Markets Act.
However the provisions on insider trading and other market abuses are now well-defined and have been further categorized into market manipulation (section 32F), false trading and market rigging (section 32G), fraudulently inducing trading of securities (section 32H), use of manipulative devices (section 32I) and making false or misleading statements (section 32J) that carry severe penalties including liability to pay for damages. The amended legislations cured the vague provisions that existed before. The amended Act also defines all the concepts that surround inside trading including; what constitutes inside information, public information, two aspects whose opacity led to the acquittal of Terry Davidson and Bernard Kibaru.
The strict liability approach therefore means that once it is established that inside trading has occurred, the burden of proof lies with the offender to prove that the motive of carrying out the subject trade do not touch on inside trading.
Capital Markets Authority (CMA) has also been broadening disclosure requirements (Section 30F) by exercising section 12A (1) (a) (iii). The reformed takeover rules of listed firms, enacted by CMA, compel that formal disclosure for any acquisition or disposal to be made to the Authority within the stipulated timescales; this includes the management’s discussion and analysis of material events and factors likely to have an impact on the issuer.
Insider trading regulations have been updated to reflect contemporary market realities; there is no doubt about that. The only prevalent concern, as it is with different jurisdictions has been the effective enforcement of this legal infrastructure. The appreciation that insider trading is multi-sectoral has led to promulgation of an array of guidelines to include provisions on money laundering. Establishment of the Capital Markets Fraud Investigation Unit in 2009 through collaboration by the Kenya Police and CMA reflects the urgency to consolidate investigations of all securities related fraud cases. However, the prosecutorial powers for offences remain fall under Office of Director of Public Prosecutions (ODPP).
Concerns on the Current Framework
Noticeably absent from the amended capital markets laws are provisions on enforcement. In other developed jurisdictions, for instance the US, the enforcement infrastructure is clearly set out. The problem with Kenya seems to be the sector-by-sector regulation, which results in overlapping of mandates. Therefore, a case is being made, through the Financial Services Authority Bill (2016), for a unified financial services sector regulator to address the existing gaps.
Another priority area is strengthening the corporate governance code. There is a limit to the number of directorships a member of the Board holds at any given time. A director of a listed company except a corporate director shall not hold more than three public listed companies at any one time as spelled out in the Code Of Corporate Governance Practices For Issuers Of Securities To The Public (2015). This is a mechanism to protect against conflicts of interest presented by related-party transactions.
The amended legislation has tried to address the loopholes witnessed in the case of Republic v. Terrence Davidson. There are clearer provisions that would aid prosecution of an offense of inside trading, however, the enforcement and prosecution framework leaves a lot to be desired.
There is need for an all-inclusive viewpoint especially with regards to regulatory synergy. This sharing of information would liberate regulatory tools across the financial services sector to mitigate fraudulent activity in the capital market. Perhaps CMA should consider incentivizing whistle blowing, similar to what the UK has done.