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• Penalties & Remedies

• Financial Sector Policy

• Securities Law, Securities Markets Law and Settlement Systems

• Review of Securities Legislation

• Discussion Documents

• Criminal Penalties
• What "Fault" Element Is Required?
• Insider Trading Offences
• Market Manipulation Offences
• Burden and Standard of Proof
• Insider Trading Offences
• Market Manipulation Offences
• Which State Agency Should Be Responsible for Investigating and Prosecuting Criminal Offences?
• The Securities Commission
• Serious Fraud Office
• Registrar of Companies
• Protections for the Accused in Criminal Trials
• Level of Criminal Penalties
• Civil Remedies
• Who Should Have a Private Cause of Action for Breaches of Insider Trading Laws?
• The Public Issuer
• Market Manipulation
• Calculating Damages for Loss
• Civil Pecuniary Penalties
• Administrative Financial Penalties
• Remedial Orders
• Bounties
• Whistleblowers

156. An important question when considering the content of an insider trading or market manipulation regime is what penalties should apply for breaches of the provisions. Appropriate and effective penalties that promote deterrence and that are effectively enforced need to be developed. There are two possible types of penalty, civil and criminal, of which either or both may be imposed. There are also possible civil remedies and administrative remedies that remedy breaches of the law, rather than penalise behaviour.

157. There are diverse attitudes to compliance with the law within any society. At one extreme, a person may value the rule of law and their reputation for complying with the law so highly that they will always comply with every law. At the other extreme, a person may place no value on the rule of law or the risk that their reputation might be adversely affected should their offending be subsequently detected. Between those extremes people will attach a greater or lesser weighting on those factors when deciding whether to comply with the law.

158. Whether done consciously or not, all three approaches amount to a cost-benefit analysis. A risk-neutral person will not offend if the expected costs of doing so are no less than the expected benefits. For the first group the benefits of compliance with the law are so high that no cost associated with non-compliance is worth bearing. For the second and third groups their social attitudes towards compliance with the law are largely fixed at any one time. It is the nature and scale of the likely penalties combined with the likelihood of detection and punishment that determines whether there are adequate incentives for them to comply with the law.

159. When it comes to securities law offences, the degree to which general deterrence will be promoted will be affected by whether:

• the evidential burden to prove an offence can be practically met;
• the detection systems are adequate;
• the systemic arrangements and resources of the enforcement agency are adequate; and
• the penalties are sufficiently high to deter the behaviour.

160. This part of this discussion document discusses:

• Criminal penalties
• Civil penalties; and
• Civil remedies.

161. It asks submitters to identify what types of penalties are needed and what level they should be set at to ensure that potential offenders will take into account the damage they may cause when they consider taking actions that may be illegal. When determining the level of fines and civil penalties the factors that need to be considered for each substantive offence include the potential scale of the illegal gains to the offender or losses to market participants and the likelihood that the conduct will be detected and punished. In addition the harm caused to the market may be taken into account.

Criminal Penalties

162. In criminal proceedings the standard of proof usually required to convict is "beyond reasonable doubt". In civil cases a party succeeds on the "balance of probabilities". Criminalising insider trading, continuous disclosure or market manipulation will necessarily impose a higher standard of proof. Opponents of criminalising insider trading, continuous disclosure and market manipulation argue that proving beyond a reasonable doubt that someone has conducted market manipulation or insider trading activity could be an insurmountable task in an area of the law where the conduct in question is necessarily secret and detection is difficult. For example, proving tipping may be very difficult as the only evidence may be the oral evidence of the parties. Further, the complexity of the justice system itself may make successful prosecutions for insider trading relatively infrequent. Internationally there have been few successful criminal prosecutions for insider trading, continuous disclosure and market manipulation each year.

163. Those that support criminal convictions do so because such convictions are generally regarded as resulting in more "stigma" than an adverse judgement in civil proceedings. The fact that a prosecution is brought may, in itself, have significant reputational effects. The consequences of a conviction may be quite broad-ranging, for instance criminal convictions can result in imprisonment, an inability to obtain a visa to enter a foreign country, to be considered for some kinds of employment or positions, or to take part in the management of a company.

164. The deterrent effect of criminal liability is therefore likely to be more significant than the possibility of a civil action. While insiders may be prepared to risk the consequences of civil liability, they may be less prepared to risk imprisonment and the reputation and other broad-ranging effects of a criminal prosecution or conviction.

165. Many regimes have moved towards adopting regimes that have both civil and criminal penalties (for example the United States and Australia). Under these regimes criminal penalties provide deterrence and the civil penalties provide a recourse for individuals who have suffered loss or where the standard of proof of criminal proceedings is too hard to meet. This dual regime gives some flexibility.

"The argument for a cogent structure of cumulative sanctions incorporating civil remedies at the base, criminal sanctions at the apex and civil penalties filling the middle ground is compelling."¹⁵

166. It has been argued that it is not advisable to only have criminal penalties for breaches of securities law. Because the criminal standard of proof is hard to meet for insider trading, continuous disclosure and market manipulation, there may be a risk that few successful actions would be bought. With few successful prosecutions potential insider traders or market manipulators may not be deterred from breaching the law. In addition, it has been argued that it is not advisable to have criminal penalties alone as it denies the individual the opportunity to recover the losses incurred by the breach of the law.

What "Fault" Element Is Required?

167. Generally criminal offences are categorised into three categories:

• Mens Rea: those requiring the prosecution to prove elements of intention or fault or recklessness;
• Strict Liability: where the prosecution does not need to establish any mens rea with respect to the contravention, but it is a defence for the accused to prove total absence of fault on the balance of probabilities; and
• Absolute Liability: those of absolute liability, where mens rea is not required and there is no absence of fault defence.

168. Unless there is sufficient reason to the contrary, where the offence is for a serious crime, there is a strong presumption that mens rea is an essential element and will be implied as an ingredient of the offence. This follows the common law approach to the criminal law that the accused's state of mind is relevant and that their moral position should be taken into account when determining criminal guilt. The usual fault element required is intention or knowledge. These fault elements usually require intentional conduct, with awareness of the essential circumstances and intended or foreseen consequences. Sometimes recklessness can suffice (this usually requires awareness of the risk and the taking of the risk which is unjustifiable under the circumstances). Usually, negligence is not sufficient (a falling short of the standard of care that a reasonable person would expect in the circumstances).

169. Offences of strict or absolute liability are more likely to be considered "public welfare" or "regulatory" offences. For example, a strict liability offence may be created if the offence involves a protection of the public from those undertaking risk-creating activities. The threat of criminal liability supplies the motive for persons in those activities to adopt precautions in order to ensure that mishaps and errors are eliminated. Further, the accused is often best placed to establish absence of fault because of matters primarily within the accused's knowledge. Absolute liability offences have been the subject of critical comment on the basis that some people believe that it is completely inappropriate to subject citizens to the criminal process in any circumstance if they can demonstrate absence of fault.

170. More "serious" offences are more likely to be considered to require mens rea, as these offences could open the defendant to significant imprisonment or fines and so a higher level of proof is considered necessary.

Insider Trading Offences

171. The possible elements of insider trading provisions are discussed in the Insider Trading discussion paper. This section is relevant to, and should be read in conjunction with, the discussion on knowledge in the Reform of Securities Trading Law: Volume One: Insider Trading: Fundamental Review discussion paper. See paragraphs 247 to 278.

172. The mental or fault element for the insider trading offence might relate to:

1. the accused's knowledge of any connection required to be an insider, (e.g. that information came from an insider);
2. the insider's possession of the information;
3. the insider's knowledge that the information is "inside" information; and/or
4. the intention of the insider to trade.

173. The additional mental or fault elements of the tipping offence might relate to the insider's knowledge about the likelihood that the third party will trade.

174. A mens rea requirement could apply in two stages: first to the possession of the information; and secondly to the knowledge that the information is "inside information".

175. Where possession is an element of a criminal offence, the relevant provision will often be interpreted to require the accused to have been aware of the relevant thing and to have intended to exercise possession.

176. It may be appropriate to infer or presume awareness of information in particular circumstances. The accused could then have a defence if they could show they were not aware of the information. For example, a director or others involved in the management of an issuer may be presumed to possess information by reason of their position.¹⁶ This could place an evidential burden on the accused that could lead to a finding that the prosecution did not prove the offence beyond reasonable doubt or it could reverse the burden of proof on this point, requiring the accused to prove on a balance of probabilities that they were not aware of the information.

177. Under the current provisions of the Securities Amendment Act 1988 it is not necessary to prove that the insider had any knowledge that the information was inside information.¹⁷ If mens rea is to be a requirement for an offence of insider trading, then some element of knowledge that the information is inside information may be required. The fault element could be:

• Knowledge: This could require the prosecution to prove actual knowledge, or that the accused ought to have known; or
• Recklessness. Under New Zealand law, the concept of "recklessness" usually has a subjective element, requiring the accused to have a conscious appreciation of the relevant risk, although sometimes awareness of an obvious risk is inferred.

178. The approach taken by a number of jurisdictions on the question of knowledge is discussed in paragraphs 247 to 278 of the insider trading discussion paper.

179. The Australian provisions currently require the prosecution to prove that the accused knew or ought reasonably to have known that the information was not generally available and was materially price sensitive (section 1043 Corporations Act 2001).

180. In other jurisdictions, "actual" knowledge must be proved. For example, under section 57 of the United Kingdom Criminal Justice Act 1993, a person has information as an insider "if and only if, it is, and he knows that it is, inside information, and he has it, and knows that he has it, from an inside source". The section goes on to specify the circumstances in which a person will have information from an inside source.

181. Mens rea may also be relevant to the disclosure of inside information. See paragraphs 226 to 233 of the insider trading discussion paper.

182. Section 9 of the Securities Amendment Act 1988 requires an insider to have knowledge or belief that another person will or is likely to trade.

183. The Australian provisions currently require a person to "know or ought reasonably to know" that another person will trade.

184. Other jurisdictions do not require "knowledge" where disclosure amounts to breach of a fiduciary or like duty.

185. Criminalisation of insider trading brings special considerations. One of the important considerations is whether there should be a distinction between what the prosecution is required to prove in a criminal matter and what is required in a civil matter. In Australia, the United States and the United Kingdom the legal content of what is required to be proven in a criminal prosecution is different than that required to be shown in a civil case. Aside from a different standard of proof required in a criminal case, it is generally the case that the prosecution will be required to establish additional fault or mental elements in order to prove that an offence has been committed. For example, concepts of dishonesty, intention or purpose. It will be important to consider whether different fault elements should be adopted for criminal and civil proceedings.

Market Manipulation Offences

186. The types of conduct which might be regulated by market manipulation law are discussed in the market manipulation discussion document. The ways in which these activities are regulated in some other jurisdictions are also set out. There are five general categories of proscribed or restricted conduct:

• misleading and deceptive conduct in relation to dealing in securities;
• making false or misleading statements in relation to dealing in securities;
• conduct creating artificial prices;
• fictitious transactions; and
• short selling.

187. If these types of conduct are to be regulated by statute, then we need to consider whether criminal penalties should be imposed, and whether the offences should have an element of mens rea. It may be appropriate to make some market manipulation prohibitions criminal offences, for example the specific offences such as conduct creating artifical prices or fictitious transactions. However, it may be appropriate that others such as general prohibitions against false or misleading conduct in relation to securities give rise to civil liability only. A mens rea requirement may be appropriate for the former but not the latter.

188. The purpose of market manipulation law is by definition to protect the integrity of the market for securities by prohibiting conduct that is likely to distort prices and other indicators of market activity. Individuals who participate in the market benefit from this protection indirectly. Prohibitions against misleading conduct and making misleading statements may protect individual market participants directly.

189. The actual physical elements or actus reus of market manipulation would comprise the particular prohibited conduct and its effect. The mens rea element could relate to the person's purpose or intention when engaging in the proscribed conduct, or in the case of misleading statements or conduct, their knowledge or belief of the misleading nature of the statement or conduct. There are a number of ways the law could deal with this.

190. The law could require the accused to have intended the particular effect to be convicted. Another option would be for the law to allow a defence if the accused could show that they did not have the intention to create the necessary effect, or if they acted for some other purpose. In terms of making false or misleading statements, the law could require that the accused must know that a statement published is misleading, false or deceptive, or must recklessly publish such a statement.

191. The Australian short selling provisions contained in sections 1020B and 1020C of the Corporations Act 2001 have an element of mens rea.In order to avoid breaching the provisions, a seller of a security must believe on reasonable grounds that the seller or their principal has a currently exercisable and unconditional right to vest the securities in the buyer.

192. Section 58 of the Securities Act 1978, which provides for a criminal offence for distribution of an advertisement or registered prospectus that includes an untrue statement, gives a defence to persons who can prove that the statement was immaterial, or they had reasonable grounds to believe and did believe that the statement was true. Note that under this section the "materiality" of the untrue statement need not be proved by the prosecution, but must be "disproved" by the accused.

193. The Corporations Act provides a specific due diligence defence for prospectuses. A person will have a defence if they prove they did not know that the statement was misleading or deceptive or did not know that there was an omission. A person will also have a defence if they have place reasonable reliance on information given to them by certain other persons.

Burden and Standard of Proof

194. In any criminal prosecution, the Crown must prove all the elements of the offence beyond a reasonable doubt. Any "defences" that might attack the existence of the actus reus or mens rea must be negated by the prosecution once an evidential burden to support the defence has been met.

195. Where there is an "exonerating factor" stated in the legislation that alters what would otherwise be a criminal act into a lawful one, this can be characterised as an element of the offence, requiring its negation by the prosecution beyond reasonable doubt. Alternatively, it may be categorised as a "statutory defence" which the accused is required to prove on a balance of probabilities.

196. This categorisation can have a practical difference depending on whether the offence is tried under the Summary Proceedings Act 1957 or as an indictable offence. Under the Summary Proceedings Act, the accused has the burden of proving any statutory exception, exemption, proviso, excuse or qualification, where these are found without further enlargement, on a balance of probabilities. On an indictment, the accused has only an evidential burden to raise the issue of the defence. The prosecution must then negate the defence beyond reasonable doubt. However, this is a general rule only, and does not apply where the statutory provision requires differently. That is, a statute may, expressly, or by implication, place an evidential or persuasive burden on a defendant who wishes to take an advantage of a defence, even where the offence is tried on indictment.

Insider Trading Offences

197. If we make insider trading a criminal offence, then we need to consider whether the Crown must negate any defences, or whether these must be proved by the accused.

198. Professor Tomasic has suggested that the onus of proof should be reversed for insider trading on the grounds that "the matters raised by way of defence are usually peculiarly within the knowledge of the accused"; and that "spurious propositions" may be advanced by the defence which almost any amount of prosecutorial resources will not be able to negate."¹⁸

199. However, it has also been argued this suggestion should be treated with scepticism as it should not be assumed either that theories advanced by the prosecution are well founded, or that explanations offered by defendants are necessarily untruthful.¹⁹

200. The defences provided in law to a charge of insider trading will depend on how wide the offence is cast. A number of possible defences are discussed in the Reform of Securities Trading Law: Volume One: Insider Trading: Fundamental Review discussion paper in paragraphs 279 to 324. These include:

• Buybacks;
• Underwriting;
• Acquisitions pursuant to a legal requirement;
• Information communicated pursuant to a legal requirement;
• Chinese walls;
• Knowledge of own intention;
• Takeovers -
• due diligence
• white knights;
• Procedures to allow trading by company insiders; and
• Equal information.

201. Other aspects of the offence could amount to "defences" for example:

• Non-use of inside information in trading;
• Trading contrary to inside information;
• Lack of possession of inside information in situations where possession is presumed; and
• Lack of knowledge that information is inside information in situations where knowledge is presumed.

Market Manipulation Offences

202. If we introduce market manipulation offences into the law we must consider which elements must be proved by the prosecution beyond reasonable doubt and which defences must be negated by the prosecution or proved by the accused.

203. The law could require all the elements of the offence to be proved by the prosecution. Alternatively, some elements of the offences could be presumed and be rebuttable by the accused.

204. See the discussion above at paragraphs 186 to 193 concerning possible mens rea elements of market manipulation offences. See also Part IV of the Reform of Securities Trading Law: Volume Two: Market Manipulation Law discussion document.

Which State Agency Should Be Responsible for Investigating and Prosecuting Criminal Offences?

205. If a decision is taken to introduce criminal offences for breaches of insider trading, continuous disclosure and market manipulation law, then an appropriate body must be identified to undertake investigation and prosecution on behalf of the State.

206. Any organisation which undertakes such investigations and prosecutions will need to be a specialist body with appropriate powers and expertise. Further, the organisation will require appropriate working and information sharing relationships with stock exchanges, as well as regulators and market operators offshore. The following agencies are considered:

• The Securities Commission;
• The Registrar of Companies; and
• The Serious Fraud Office.

The Securities Commission

207. The Government has announced an intention to make the Securities Commission a civil enforcement body for insider trading. The Securities Markets and Institutions Bill, which is currently before Select Committee, proposes to give the Commission this role for insider trading. This legislation also proposes new inspection powers for the Commission and powers that will enable it to carry out this role effectively.

208. The Commission's past experience with insider trading inquiries, its proposed new civil enforcement role and the new powers the Commission will receive mean that the Commission will have experience investigating insider trading activity and may be best placed to identify when a criminal action should be taken. Further, the Commission has the appropriate working and information sharing relationships with stock exchanges and market operators and regulators offshore.

209. This, it may be argued, makes it appropriate to give the Commission a criminal enforcement role either in investigating criminal breaches or taking actions itself.

210. In Australia, the Australian Securities and Investments Commission is responsible for investigating all civil and criminal breaches of the insider trading laws. ASIC has powers which enable it to bring civil proceedings. However, the decision to take criminal proceedings in particular cases is taken by the Office of the Commonwealth Director of Public Prosecutions.

211. Such a structure could be implemented in New Zealand with the Commission investigating criminal breaches and another body with more experience in conducting criminal proceedings taking the prosecution. For such a structure to work the Commission would have to have adequate powers of investigation and appropriate information sharing arrangements with the prosecutor.

Serious Fraud Office

212. The Serious Fraud Office has investigators, forensic accountants and prosecutors who carry out investigations of potential criminal offences and present cases before a court.

213. The Serious Fraud Office Act 1990 gives the Serious Fraud Office extensive powers which it is able to use in cases where serious or complex fraud is suspected. These powers include the:

• Power to require production of documents;
• Power to obtain search warrants; and
• Power to require attendance before director, production of documents, etc.

214. The Act also provides that the privilege of self incrimination cannot be claimed as a reason for not answering questions or providing information or documents where these are required under these powers.

215. The involvement of the Serious Fraud Office in prosecuting insider trading offences would enable the utilisation of existing expertise in a specialist body with experience of exercising the types of powers which would be required for the detection and investigation of insider trading and market manipulation offences.

Registrar of Companies

216. The Registrar of Companies is responsible for the Companies Office, which maintains the registry for all corporate bodies in New Zealand.

217. The Securities and Corporate Compliance Unit of the Companies Office undertakes some market enforcement through the analysis and vetting of financial reports, investment prospectuses and other information disclosed under the Securities Act, Financial Reporting Act and related legislation. Where issues of statutory non-compliance arise the Unit has the power to investigate cases and may pursue civil or criminal sanctions. The Registrar has investigating accountants and solicitors who carry out this enforcement work.

218. The Registrar has powers of inspection which are able to be used for detecting offences under the Companies Act 1993 or the Financial Reporting Act 1993. These powers enable the Registrar to require the production of documents, to inspect and take copies of documents and to retain documents if there are reasonable grounds for believing that they are evidence that an offence has been committed. The Registrar also has powers of inspection under the Securities Act 1978 and Takeovers Act 1993 which may only be exercised with the request of the Securities Commission.

219. There may be benefits from using the same body to carry out prosecutions under a range of related legislation. The Registrar already deals with offences under the Securities, Companies and Financial Reporting Acts. On the other hand, insider trading and market manipulation may be more similar to the features of "serious fraud" because of their secretive nature and associated problems of detection. The Serious Fraud Office has the role and associated expertise to investigate serious fraud offences.

Protections for the Accused in Criminal Trials

220. There are significant differences in the law relating to the prosecution of civil wrongs and criminal offences. These arise because criminal offences are almost always prosecuted by the state, whereas private individuals enforce civil wrongs. Greater protections for the accused are provided in the criminal law context to balance the usually superior resources of the state, and also to guard against unjustified intrusion into individuals affairs by the state.

221. The main difference between a civil and criminal prosecution will be the standard of proof that the plaintiff and the Crown, as the case may be, must meet in order to secure a judgement or conviction. In the former, the plaintiff must prove the case on the balance of probabilities, in the latter the Crown must prove the case "beyond reasonable doubt". As a result, it will be more difficult for the Crown to prove a criminal offence has been committed.

222. Another fundamental difference between a criminal and civil prosecution is that in the former the accused has an absolute right to silence, whereas any person is compellable as a witness in civil proceedings. However, if an accused chooses to give evidence, then they must answer all questions notwithstanding that they may incriminate themselves. In civil proceedings, witnesses can refuse to answer questions on the grounds that they would incriminate themselves.

223. If criminal liability is to be imposed for insider trading, market manipulation, and continuous disclosure, then we must consider how the law relating to self- incrimination is to apply. This is also important if the Securities Commission is to have a role in taking civil action in these areas and if a civil penalties regime is to be introduced.

224. Under current New Zealand law, a person claiming the privilege against self-incrimination may refuse to answer questions or give information that would expose the person to risk of a criminal charge, put the person in danger of a civil penalty or that might lead to a forfeiture. The privilege can be claimed by individuals and corporations. It applies to oral testimony. The privilege can also be claimed for the content of documents, except where the contents can be proved by independent means. In some cases, the privilege has been held to extend to the compelled production of real evidence.

225. The privilege can be claimed by witnesses in civil and criminal proceedings. However, the accused in a criminal trial who chooses to give evidence cannot claim the privilege in response to questions relating to the charges that are the subject of the proceedings.²⁰

226. The privilege can be preserved or removed by legislation, in the context of information gathering powers conferred on state agencies.

227. Because the privilege can be claimed on the basis that providing the information may lead to the imposition of a penalty, it is arguable that a person could claim the privilege for information that might lead to the imposition of a pecuniary penalty under Part I of the Securities Amendment Act 1988. However, there is no judicial authority on this point.

228. The circumstances when a person would be most likely to claim the privilege is on being summoned by the Securities Commission to give evidence or produce documents under section 18(3) of the Securities Act 1978. The Commission has used this power frequently for the purposes of inquiries it has made into insider trading. The privilege is not specifically mentioned in the statute. Under section 32 it is an offence to refuse or wilfully neglect to appear before the Commission in pursuance of a summons or to answer any question or provide any document required to be produced. Whether the privilege is preserved, has never been tested in Court. In the absence of an express provision removing the privilege it is likely that the privilege can be claimed in response to a summons under section 18.

229. It seems that when individuals claim the privilege, the Securities Commission usually makes confidentiality orders under section 19(5)(b) of the Securities Act.²¹ Orders under this section can prevent the publication or communication of any information document or other evidence until the determination of the inquiry. On the basis of these orders, the privilege is usually waived.

230. Once the Commission's inquiry has been completed, the information subject of the confidentiality order can be obtained under the Official Information Act 1982 unless there are reasons for not releasing the information under that Act. Furthermore, some information can be obtained by non-party discovery in proceedings brought for breach of Part I of the Securities Amendment Act.²²

231. The Securities Markets and Institutions Bill contains amendments that will provide that testimony given before the Commission will not be admissible in criminal proceedings (other than a proceeding in respect of the falsity of the testimony, e.g. perjury or an offence for false statements under the Act).

232. The Law Commission has proposed reform of the privilege against self-incrimination in its Report 55. Under the provisions of the Law Commission's proposed Evidence Code, the privilege will be restricted and only be available to individuals (not corporations) to resist compulsory disclosure of information that, if disclosed, would expose him or her to the risk of prosecution for an offence punishable by imprisonment. It would not be enough if the information would expose the person to a civil penalty. The privilege will not be available to the accused in a criminal trial who chooses to give evidence in relation to information about a matter to which the accused is being tried.

233. "Information" in this context is defined to mean a statement of fact or opinion which is given, or is to be given orally, or newly created documents admitted as testimonial statements rather than exhibits. Thus real evidence admitted as an object rather than as a statement and all documents existing prior to the request to produce the information cannot be withheld by claiming the privilege.

234. The accused retains a right to silence at criminal trial. The suspect could claim the privilege at the investigative stage, and in respect of information that may incriminate him or her in relation to an offence other than the one for which he or she is being tried.

235. The privilege would be able to be removed explicitly by statute.

236. Where a person volunteers self-incriminating evidence in Court proceedings, a certification procedure would ensure that the information given and any evidence obtained as a result, cannot be used against that person in any other proceedings in New Zealand.

237. The Ministry of Justice is currently considering the Law Commission's Report and draft Evidence Code.

238. If the Serious Fraud Office is to be the state organisation to be given the task of prosecuting insider trading offences, then its powers of information gathering will be available. The Serious Fraud Office Act 1990 removes the privilege and replaces it with a partial use immunity for oral disclosures. Oral disclosures made prior to trial cannot be used, except where the person gives inconsistent evidence.²³

239. In Australia, ASIC has a role to investigate where it has reason to suspect there has been a contravention of the Corporations Act.²⁴

240. ASIC has powers to require the production of records and to require individuals to answer questions.²⁵ A person cannot refuse to give information, sign a record or produce a book if required to do so on the grounds that to do so might tend to incriminate the person or make the person liable to a penalty. However, if a natural person claims the privilege before making an oral statement, giving information or signing a record, that statement or record is not admissible in evidence against the person in a criminal proceeding or a proceeding for the imposition of a penalty except in proceedings relating to the falsity of the statement.²⁶ The privilege cannot be claimed in respect of the production of books. The evidence may be used against that person in a civil proceeding.

241. The Corporations Act also allows ASIC to seek pecuniary penalties for breach of certain provisions of the Corporations Act 2001.²⁷ Under current proposals, ASIC will be able to seek pecuniary penalties for breach of insider trading law and market misconduct law. The procedures for these proceedings are a hybrid of civil and criminal law. The Corporations Act provides for civil procedures and rules of evidence,²⁸ and requires the matter to be proved "on a balance of probabilities".²⁹

242. Information given by an individual in a civil case for a civil penalty or pecuniary penalty order is not admissible against that individual in a criminal case. However, the evidence can be used in criminal proceedings in respect of the falsity of the evidence given by the individual in those proceedings.³⁰

243. The Commission has the power to require certain persons to assist in the prosecution.³¹ Bodies Corporate cannot claim the privilege against self incrimination in criminal proceedings.³²

Level of Criminal Penalties

244. If we are to make breaches of insider trading and/or market manipulation criminal offences, we need to consider what penalties are appropriate. Related issues are whether the charges could or should be laid summarily or indictably, should the matter be tried in the District Court or the High Court, and whether trial should be before a judge alone, or before a judge and jury.

245. Under New Zealand law there are currently six categories of offences in respect of which charges can be laid:³³

• Purely indictable offences that can only be tried in the High Court, such as treason, murder and manslaughter;
• Purely indictable offences that may be transferred to a District Court from the High Court pursuant to section 168AA(2) of the Summary Proceedings Act 1957 - these are also known as the "middle band" offences. These offences are listed in Part II of Schedule 1A to the District Courts Act 1947;
• Purely indictable offences that can be tried before a jury in the District Courts. These offences are listed in Part I of Schedule 1A to the District Courts Act 1947;
• Indictable offences triable summarily, which are listed in section 6(2) and the First Schedule to the Summary Proceedings Act 1957;
• Summary-indictable offences, which are summary offences punishable by more than three months imprisonment; accordingly the defendant can elect for trial by jury pursuant to section 66 of the Summary Proceedings Act 1957; and
• Purely summary offences, which have a maximum sentence of three months imprisonment or less. Most of these offences are listed in the Summary Offences Act 1981.

246. This table shows how comparable offences fit within these categories and what their penalties are.

247. If a defendant is to have the right to elect trial by judge-alone or jury, the offence will have a maximum penalty of more than three months imprisonment, or be listed in the First Schedule of the Summary Proceeding Act. If the offence is considered "serious" so it must be considered in the High Court, then it would be included in the "middle band" of offences. This would give the High Court jurisdiction to try more serious cases and to transfer others to the District Court. Unless the maximum fine is specified, section 7 of the Summary Proceedings Act will limit the fine to a maximum of $10,000.

Civil Remedies

Who Should Have a Private Cause of Action for Breaches of Insider Trading Laws?

248. The policy justifications behind an insider trading regime are also important when considering the appropriate penalties or remedies that should be implemented. Civil remedies connected to loss may be considered a more appropriate remedy for an insider trading regime based on the fiduciary duty or misappropriation rationales, while civil or criminal penalties may be more appropriate for the market efficiency or fairness rationales, as they focus on wrong to the market rather than the individual.

249. Overseas and New Zealand experience suggests that private enforcement of insider trading prohibitions is not an effective means of deterrence. The effort required in detecting and proving breaches of the prohibitions means that private actions are only likely in very serious cases where public action is not being taken. However, it seems generally accepted that a counter-party to a trade with an insider should have a cause of action.

250. Under current law the counter-party to a transaction with an insider has a cause of action against the insider. Under section 18 of the Securities Amendment Act, the Court may also give leave to a member of the public issuer or a person who was a member of the public issuer at the time the securities were sold or purchased to bring a derivative action. Australian law also gives the counter-party a right to bring an action.³⁵

251. Where the relevant transaction takes place off market, it may be easy for a plaintiff to show a sale or purchase to which the plaintiff is a party. In Wilson Neill³⁶ Cooke P stated that beneficial ownership would appear to be enough to attract the obligations of a seller under the legislation. This case indicates that the courts may be willing to take a wide view of what constitutes a "sale" or "purchase", but where the insider has sold on market it may be more difficult to prove the necessary connection. There may be no direct contractual nexus between the insider and the ultimate purchaser. Both may have transacted through members of the New Zealand Stock Exchange who will have acted as principals in the transaction.

252. There may be a practical problem in determining the identities of those who were indirect counter-parties to the insider's sale or purchase. There may be a number of counter-parties if a large number of securities are purchased or sold by the insider. Where there has been active trading in the securities there may have been other contemporaneous trades at a similar price with non-insiders.

253. Current law gives a direct cause of action only to the direct counter-party. Other contemporaneous traders must use the right to take derivative action under section 18 if they are a member of the issuer, or were a member at the time of the transaction. Contemporaneous traders may benefit under section 18 from action taken by or in the name of the issuer. However, section 19 contemplates a judgement being obtained. Where the proceedings are settled without court involvement, contemporaneous traders may not receive any compensation.

254. It could be argued that a wider class of counter-parties should have a direct cause of action. In the United States and Singapore, contemporaneous traders have a cause of action. Under Singapore provisions the court can consider a number of factors in determining whether contemporaneous trading has occurred. These include:

• the volume of the relevant securities or other financial products traded between the date and time of the contravention and the date and time of the alleged contemporaneous trading;
• the date and time of the contravention;
• whether the alleged contemporaneous trading took place before or after the contravention;
• whether the alleged contemporaneous trading took place before or after the information that relates to the inside dealing became generally known; and
• such other factors and developments, whether in Singapore or otherwise, as the court may consider relevant.

255. By contrast the United States legislation does not define what contemporaneous trading is. This has been left to the Courts to determine.

The Public Issuer

256. Under the Securities Amendment Act 1988, the public issuer of which the insider is an insider has a cause of action. This right may, with the leave of the court, be exercised by a member of the public issuer or a person who was a member at the time of the transaction.³⁷

257. Section 17 of the Securities Amendment Act allows a member person who was a member at the time of the trade to require the issuer to obtain a legal opinion as to whether the issuer has a cause of action against an insider.

258. The Securities Markets and Institutions Bill proposes to give the Securities Commission the power to bring a civil action under Part I of the Securities Amendment Act 1988 if it considers it is in the public interest to do so. Where a proceeding was commenced or continued by the Commission the Commissions costs will be paid out from the amount recovered.

259. In practice the right of the public issuer to bring an action may not be a significant deterrent to insider trading. Exercise by the issuer of this right may be unlikely for a number of reasons. The insider may be in a position of influence within the issuer. In addition, except where the issuer is a counter-party, there is arguably no loss for the issuer to be compensated. Any harm will be caused to the counter-parties or the market in general. New Zealand law deals with this point under section 19 by requiring the public issuer to distribute any proceeds in accordance with the directions of the court.

260. The right of the public issuer to take action can be justified as a response to a breach of fiduciary duty to the issuer, or misappropriation of proprietary information.

261. Australian law gives the issuer a cause of action³⁸ but does not require it to distribute the proceeds. The ASIC has the power to bring a civil action in the name of the issuer to recover amounts the issuer is entitled to recover under the legislation.³⁹ The Company and Securities Advisory Committee has suggested that a provision similar to section 19 of the Securities Amendment Act 1988 requiring distribution of proceeds recovered by an issuer be introduced into Australian law.

262. It could be argued that the problems associated with an issuer's cause of action can be overcome by allowing derivative actions by shareholders under section 18 of the Securities Amendment Act 1988. However, this provision may not be used where the Securities Commission has a role to bring civil actions and if contemporaneous traders are given a cause of action. It could also be argued that a right for the issuer to bring proceedings is not necessary if the Commission is given the task of bringing civil actions, and may cause confusion as to which body should or will bring an action.

Market Manipulation

263. The theoretical basis for regulation of market manipulation is that the prohibited conduct harms the efficiency and integrity of the market. It could be argued that only state enforcement of these laws is appropriate in the public good.

264. The counter argument is that the identity of the party taking the action is not the key issue. What matters is whether enforcement, whether public or private, will usefully contribute to deterring illegal conduct. Private enforcement could make such a contribution if a person can prove that they have suffered loss by reason of breach of market manipulation laws and has a cause of action against a person who has breached the law.

265. New Zealand law provides for compensation for loss in securities related areas under the Fair Trading Act 1986,⁴⁰ the Securities Act 1978 in relation to public offers of securities⁴¹ and the Securities Amendment Act 1988 in relation to insider trading and substantial security holder disclosure.⁴²

266. Australian law provides for compensation for loss for breach of the market misconduct provisions.⁴³

Calculating Damages for Loss

267. Damages for loss may not be an effective deterrent to insider trading or market manipulation if all that the insider or manipulator may lose are the "illegal profits". However, where there is a counter-party loss in relation to an insider trade or caused by market manipulation, then damages for loss may be appropriate as a means of compensation.

268. Currently our insider trading law determines the loss avoided or the gain made as to the difference between the consideration and the value of the security had the inside information been available (section 15). The section seems to require an objective assessment of the value of the security at the time of the trade, but does not specifically require consideration of other information which might affect the price but which had not been disclosed at the time. For example, if the release of the inside information would depress the price of the securities, but there was other non-public price sensitive information unknown to the insider, the release of which would increase the price, then the insider may not have avoided any loss by selling the securities.

269. Under section 149 of the Companies Act 1993 which restricts share dealing by directors of companies, a "fair value" test is adopted. Fair value is to be determined on the basis of all information known to the director or publicly available at that time. This definition arguably does not allow consideration of information unknown to the director and not publicly disclosed.

270. Under Australian insider trading law, the test is the difference between the cost of the securities and the price at which they would have been likely to have bought or sold or subscribed if the information had been generally available (Section 1013 Corporations Act). Under the market manipulation provisions the test for loss is the difference between the price at which the securities were dealt in in that transaction and the price at which they would have been likely to have been dealt in in such a transaction when the first-mentioned transaction took place of the breach had not occurred (section 1014 Corporations Act).

271. Canadian insider trading legislation uses an "average market price" formula to determine the measure of damage suffered by the counterparty where the affected securities are publicly traded. In determining the amount of damages the Court may consider the difference between the price paid or received and the average market price in the 20 days following general disclosure of the information.

272. In the United States, the Court will calculate the difference between the price paid or received by the insider and the trading price of those securities within a reasonable time after public dissemination of the information. The rationale is that the insider is free to enter the market after the information is released and any profit or loss occurring after that point is not unjustly obtained.

Civil Pecuniary Penalties

273. Pecuniary penalties for breach of the insider trading prohibitions can be obtained by a public issuer under Part I of the Securities Amendment Act 1988. These could be sought by a member or former member when taking a derivative action in the name of the issuer. If the proposals to give the Securities Commission the ability to take an action are adopted, then the Commission could also seek a pecuniary penalty.

274. The pecuniary penalty obtainable under the Securities Amendment Act 1988 is three times the amount of the gain made or the loss avoided by the insider in buying or selling the securities, whichever is greater.⁴⁴

275. The Australian regime also has civil penalties however, these are not connected to the gain made or the loss avoided. These civil penalties for market misconduct, continuous disclosure and insider trading provisions have been introduced by the Financial Services Reform Act 2001.

276. The provisions empower a court to make various civil orders including:

• a declaration of contravention;
• a pecuniary penalty order of up to $200,000;⁴⁵ or
• a compensation order for the corporation or registered scheme which has suffered damage through a contravention.⁴⁶

277. A breach of a civil penalty provision is not, without more, a crime. This requires proof of additional mental (or fault) elements.

278. Penalties can be imposed by a court upon application of the Australian and Securities Investment Commission (section 1317). The court "must apply the rules of evidence and procedure for civil matters" and a civil penalty order can only be imposed if the contravention:

• materially prejudices the interests of acquirers or disposers of the relevant financial products; or
• materially prejudices the issuer of the relevant financial products, or if the issuer is a corporation or a scheme, the members of that corporation or scheme; or
• is serious.

279. When the civil penalty provisions were first introduced, the bringing of a civil penalty action precluded criminal action. Subsequently, the Corporations Act was amended so that a criminal action would not be barred by bringing a civil penalty action.⁴⁷ However, civil penalty proceedings against a person must be stayed if a person has been charged with a criminal offence in relation to the same conduct,⁴⁸ but may be resumed if there is no conviction. If there is a conviction, the civil proceedings must be discharged. Civil penalties cannot be imposed in respect of conduct for which a person has been convicted of an offence.⁴⁹

280. Civil penalties can be recovered for breaches of the insider trading and market manipulation provisions and for breaches of the continuous disclosure regime.⁵⁰

281. There has been criticism of these provisions for a number of reasons. First, the maximum amount obtainable is $200,000. This it has been argued may not provide a significant deterrent. Further, it has been argued that there should be no middle ground between civil and criminal remedies. The argument is that there is a fundamental distinction between the purposes of the criminal law, and the procedure by which it achieves its objectives, on the one hand and the compensatory functions of the civil remedies and the procedures by which that objective is achieved on the other. This view holds that it is an inappropriate function of a court exercising a civil jurisdiction to be given the power to impose punishment, without the procedural and other safeguards of the criminal justice system.

282. However, the argument for a similar civil penalties regime to that in Australia is that it provides a "middle ground" between private civil action and criminal prosecution for enforcement of the law. It provides for State enforcement, but in the civil courts, with the standard of proof on the balance of probabilities instead of the criminal standard of "beyond reasonable doubt". It also deals with the issue that counter-parties (people that have suffered loss) are often difficult to identify. Further, it may be difficult to calculate compensation for a wrong which has harmed the market as a whole, particularly when, for example, the insiders profit may be relatively small, not otherwise justifying commencement of a civil action to recover. This, it is contended, makes enforcement easier.

283. Civil penalties are awarded in the New Zealand context. Examples in the Commerce Act 1986 include:

• Under section 83 the Court may award a pecuniary penalty not exceeding $500,000 in the case of a person and $5,000,000 in the case of a body corporate for breaches of the business acquisition provisions;
• Under section 74D the Court can award a pecuniary penalty not exceeding $500,000 for contravention of a cease and desist order; and
• Under section 80 a penalty not exceeding $500,000 for an individual and either a sum not exceeding $10,000 or 3 times the value of the commercial gain or 10% of the body corporate and all inter-connected body corporates turnover for a contravention of the restrictive trade and practices provisions.

Administrative Financial Penalties

284. The United Kingdom has given its securities regulator, the Financial Services Authority, the power to impose financial administrative penalties. The grounds for imposing these financial penalties are designed to reflect market behaviour and expectations. The tests employed are different from those that impose criminal liability. The four requisites for administrative penalties are:

• The person must possess information that is not generally available to the market at large;
• The information would be likely to be regarded by a regular user in the market as relevant when deciding the terms on which transactions in investments of the kind in question should be effected;
• The information must relate to matters which a regular user would reasonably expect to be disclosed to other users of the market on an equal basis, whether at the time in question or in the future;
• The person's behaviour must be based on the information, and not be required for other reasons.

Remedial Orders

285. There may be other remedial or punitive orders that could be made by a court for breach of the insider trading law, continuous disclosure or market manipulation law.

286. The following are examples of orders that may be appropriate:

• declaring the exercise of any rights attached to any securities to be void and of no effect;
• restraining the exercise of rights attached to any securities;
• restraining the acquisition or disposal of securities;
• directing the disposal of securities or any relevant interest in them;
• directing the forfeiture of securities;
• vesting securities in a person as trustee to be dealt with as ordered;
• restraining engaging in conduct that would breach the law;
• cancelling an agreement for the acquisition or disposal of securities;
• directing a person to do or refrain from doing a specified act;
• declaring the whole or any part of a relevant contract to be void or void ab initio;
• varying a contract or arrangement;
• directing a person to refund money or return property to a person who suffered the loss or damage;
• directing a person to pay to a person who suffered loss or damage the amount of the loss or damage;
• refusing to enforce any or all of the provisions of a contract;
• prohibiting a person from being a director or promoter of a company or being concerned in the management of a company;
• cancelling a licence issued under the Sharebrokers Act 1908; and
• directing a person to pay the Commission's costs of bringing an application.

287. The above are examples or orders that are available under the Securities Amendment Act 1988 in relation to substantial security holders, the Takeovers Act 1993 and the Australian Corporations Act 2001.

288. They may not all be appropriate for breaches of insider trading law, continuous disclosure law and market manipulation law. However, it may be appropriate to give the court flexibility to make orders that suit the particular circumstances.

289. It may also be advisable to give the Securities Commission the ability to make an application to the court for any of the orders that can be awarded for a breach of the insider trading and market manipulation provisions. This is because the Commission will be investigating infringements and will be the body best placed to identify when a contravention of the law has occurred.

290. When these orders should be available will also need to be considered. Orders could be given at the court's discretion, where there are reasonable grounds to believe certain matters have occurred, or where there are reasonable grounds to believe such orders may be necessary to prevent an undesirable market situation.

Bounties

291. In the United States the Securities and Exchange Commission has been empowered to award a bounty to a person who provides information leading to the recovery of a civil penalty from an insider trader, from a person who "tipped" information to an insider trader or from a person who directly or indirectly controlled an inside trade.

292. The Commission may award bounties from the civil penalties that are actually recovered from violators. The total amount of bounties that may be paid from a civil penalty may not exceed 10% of that penalty.

293. The SEC does not disclose the identity of the confidential source unless the disclosure is legally required, or will be essential for the protection of the public interest.

294. An ability to pay bounties may provide a tool to overcome the perceived problem of obtaining information about insider trading by providing incentives for people to come forward with information. However, some would argue that this may deter people from within an organisation from reporting or preventing insider trading before it occurs in the hope of receiving a bounty.

Whistleblowers

295. The Protected Disclosures Act 2000 protects employees who disclose "serious wrongdoing" in accordance with the provisions of the Act. The Act provides for disclosure within organisations and for referral of protected disclosures to appropriate authorities for investigation. A person who makes a protected disclosure or refers one to an authority is immune from civil, criminal or disciplinary proceedings in accordance with the Act by reason of having made that disclosure or referral.

296. Currently, insider trading is not specifically included in the definition of "serious wrongdoing" in the Protected Disclosures Act 2000. The definition is inclusive, so may include insider trading of a serious nature. However, there is doubt whether or not a person who disclosed information about insider trading will have the protection of that Act.

297. It is less likely that market manipulation would amount to serious wrongdoing within the meaning of the Act, given there is no clear statutory definition of such conduct. The only type of market manipulation that would clearly be serious wrongdoing under the Act would be an act, omission, or course of conduct that constitutes an offence of conspiracy to defraud under section 257 of the Crimes Act 1961.

298. If insider trading or market manipulation is made a criminal offence, then the Protected Disclosures Act would apply, as "serious wrongdoing" includes "an act, omission, or course of conduct that constitutes an offence". We should consider whether the Protected Disclosures Act 2000 should apply to insider trading or market manipulation, even if they are not made a criminal offence.

¹⁵Goldwasser, "CLERP 6- Implications and Ramifications for the Regulation of Australian Financial Markets" Company and Securities Law Journal 17 (1997): 210.

¹⁶For example, sections 3(2), 3(3), and 3(4) of the Securities Amendment Act 1988 presume certain persons to have information by reason of their position.

¹⁷Under the current provisions, to be liable, an insider must "have" inside information. The Court of Appeal in Wilson Neill [1994] 2NZLR 152, 161 formed the view that the test is not subjective knowledge, but the objective possession of information. It was enough that the relevant insiders had in their possession board papers that contained the relevant information, even though it had not been proved that they had done an analysis of the material. It was not considered necessary to prove knowledge that the information was inside information.

¹⁸R Tomasic and B Pentony, "The Prosecution of Insider Trading: Obstacles to Enforcement" aust abd New Zealand Journal of Criminology 22 (1989): 136.

¹⁹Ashley Black, "The Reform of Insider Trading Law," UNSW Law Journal 15, no. 1: 250.

²⁰Section 5(4)(a) Evidence Act 1908.

²¹The description of the Securities Commission's practise and experience in this area is taken from the Law Commission's Preliminary Paper 25. The Privilege against Self-Incrimination, paras 372-379.

²²Franks v Hoggard (2001) 9 NZCLC, 262, 530.

²³The Law Commission Preliminary Paper 25 considers the provision in the Serious Fraud Office Act 1990 relating to the privilege against self incrimination.

²⁴Section 13 Australian Securities and Investments Commission Act 1989.

²⁵Part 3, Division 2 Australian Securities and Investments Commission Act.

²⁶Section 68 Australian Securities and Investments Commission Act 1989

²⁷Section 1317E Corporations Act 2001.

²⁸Section 1317L Corporations Act 2001.

²⁹Section 1332 Corporations Act 2001.

³⁰Section 1317Q Corporations Act 2001.

³¹Section 1317Corporation Act 2001.

³²Section 1316A Corporations Act 2001.

³³Excluding minor offences and infringements. New Zealand Law Commission, Simplification of Criminal Procedure January 2001 NZLC SP7. The Law Commission makes various proposals in this advisory report to avoid the complexities of the current legislation.

³⁴Summary proceeding in respect of an offence under section 58 can also be brought.

³⁵Section 1043L Corporations Act 2001.

³⁶[1994] 2 NZLR, 152, 162.

³⁷Section 18 Securities Amendment Act 1988.

³⁸Section 1043L Corporations Act 2001.

³⁹Section 1043L Corporations Act 2001.

⁴⁰Section 43 Fair Trading Act 1986.

⁴¹Section 56 Securities Act 1978.

⁴²Part I and section 32 Securities Amendment Act 1988.

⁴³Section 1005 Corporations Act 2001.

⁴⁴Sections 7(4), 9(4), 11(4), 13(4).

⁴⁵Section 1317G Corporations Act 2001.

⁴⁶Section 1317H Corporations Act 2001.

⁴⁷Section 1317 P Corporations Act 2001. Goldwasser, "CLERP 6- Implications and Ramifications for the Regulation of Australian Financial Markets", 206.

⁴⁸Section 1317N Corporations Act 2001.

⁴⁹Section 1317M Corporations Act 2001.

⁵⁰Section 1317P Corporations Act 2001.