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• Insider Trading
• 6. Existing Law Enforcement

• Financial Sector Policy

• Securities Law, Securities Markets Law and Settlement Systems

• Review of Securities Legislation

• Discussion Documents

• Introduction
• Option 1: Improve the Private Enforcement Regime
• Option 2: Enable the Commission to Undertake Civil Enforcement Actions
• Questions for Submissions

Introduction

6.1 At present, the only recourse in New Zealand for insider trading is through private legal action. While specific provision is made under the SA Act for current and previous shareholders to undertake legal action on behalf of a public issuer, it is not always practicable for shareholders to do this.

6.2 Two potential options have been identified as ways of assisting with effective enforcement of insider trading in New Zealand. These options are:

Option 1: Improve the private enforcement regime provided for under the SA Act;

Option 2: Enable the Commission to undertake insider trading enforcement actions under the SA Act.

Option 1: Improve the Private Enforcement Regime

Introduction

6.3 This option involves improving the existing private enforcement regime for insider trading. The following possible changes to the law are raised for consideration:

• class actions;
• court approved settlements; and
• applicant for leave under section 18 not to be liable for costs.

Class actions

6.4 Interest in USA style "class actions" commonly arises when an event occurs that disadvantages a large number of people, but only to the extent that does not warrant any individual person taking legal proceedings against the wrongdoer⁸. The principal concern is usually one of money - how to fund legal proceedings by people of limited means against, usually, big business, and how to protect those people from costs awards if they lose. Concerns about the rules as to maintenance and champerty are often also raised in this context.

6.5 In the USA, a class action is a procedure in which one or more persons sue in court as the representatives of a large class of people who have suffered the same harm - for example, electric power outages. The judgment obtained in the litigation binds everyone in the class. The procedure is commenced by a person asking the court to certify a class, which needs to be defined precisely. Once a class is certified, only the representative plaintiff appears in court. The members of the class do not generally participate in the litigation, but are bound by the final decision. Two other aspects of USA law are relevant in this context

• the usual practice in the USA is for each party to bear its own costs - the losing party is not subjected to having to pay the successful party's costs;
• contingency fees are permitted in the USA. These involve lawyers undertaking an action on the basis that they will be paid only if successful but, if they are successful, will be paid an amount that exceeds a normal time based fee. The ability to earn large contingency fees encourages lawyers to conduct legal proceedings on the basis that they take the financial risk.

These two aspects of USA law significantly reduce the financial risks of claimants in legal proceedings.

6.6 While New Zealand does not have class actions as such, it does have a similar procedure known as a "representative" action. A person may issue representative proceedings if the person has the consent of all members of the class to be represented, or the court orders that the plaintiff may represent all those members. All members of the class must have the same interest in the subject matter of the proceedings.

6.7 As to the funding of proceedings, it is permissible under New Zealand law for persons having an interest in legal proceedings to contribute to the cost of those proceedings. This does not contravene the rules against maintenance and champerty⁹. There is nothing in New Zealand law to prevent shareholders of a company, each of whom has a claim against an alleged insider, from contributing to a "fighting fund" to fund proceedings taken by one or more of the shareholders against the alleged insider trader.

6.8 If a person who has taken a representative action loses the case, that person will be liable for any costs awarded against him or her by the court. The person has no right to recover a share of the costs from other members of the class represented, unless those members have individually agreed to indemnify him or her. Furthermore, contingency fees are prohibited in New Zealand (although this does not prevent lawyers agreeing to undertake a case for no fee or for a fee lower than normal). Accordingly, a person who takes a representative action in New Zealand is exposed to greater financial risk than someone taking a class action in the USA.

6.9 As noted in paragraph 2.6 et seq, under the SA Act an insider trader is liable both to a person who bought or sold the securities for any loss incurred by that person, and to the public issuer for the amount of any gain made or loss avoided by the insider plus a pecuniary penalty. As noted in paragraph 2.13, a public issuer's right of action against an insider may, with the leave of the High Court, be exercised by a shareholder or former shareholder of the public issuer. The public issuer must pay the costs of a person to whom leave is given, including any costs that are awarded against that person. The fact that, if the leave of the High Court is obtained, a shareholder can take proceedings against an insider at the expense of the public issuer means that this option will usually be chosen. However, the other option of the shareholder, or a group of shareholders, taking proceedings against an alleged insider on their own account (rather than the public issuer's) remains open.

Court approved settlements

6.10 It is often desirable that claims brought against an alleged insider can be settled by agreement between the parties, thus avoiding lengthy and expensive litigation. However, in the case of a public issuer's rights against an alleged insider, the possibility has been raised that a settlement of those rights may occur without all shareholders' interests being sufficiently taken into account or, in extreme cases, the settlement may be a sham.

6.11 The following special features of a public issuer's rights against an alleged insider may distinguish settlements of insider trading proceedings from settlements of more usual proceedings:

• the public issuer may be controlled by the insider;
• the insider trading proceedings may arise irrespective of any conventional loss by the public issuer;
• the public issuer may be obliged to obtain legal advice on the initiative of a shareholder;
• the right of action of the public issuer may in certain circumstances be exercised by a shareholder;
• a pecuniary penalty may be imposed at the discretion of the court if the matter proceeds to trial;
• a shareholder may be entitled to share in the distribution of any amount recovered by the public issuer from an insider.

6.12 A doubt has also been raised as to whether section 19 of the SA Act applies to money recovered by a public issuer from an insider under a settlement. This section gives the court the power to direct how the money recovered is to be distributed or applied.

6.13 It would appear that the only avenue for a shareholder unhappy with a settlement by or on behalf of a public issuer would be to apply under section 18 to take up the public issuer's cause of action. However it may be that where a settlement has occurred there is no cause of action to take up - there would likely be a plea of issue estoppel from the insider.

6.14 To overcome these uncertainties it has been suggested that the High Court could be given the power to approve a settlement of any claim by a public issuer against an insider. In addition, it could be made clear that the power of the court under section 19 to give directions as to the distribution or application of money recovered by a public issuer from an insider can apply to money recovered under a settlement, as well as money recovered under a judgment. These powers of the High Court could be exercisable on the application of either the public issuer or the insider. It is also suggested that, if the High Court has not given its approval to a settlement, shareholders could be given the right to bring proceedings for a review and determination on the merits of any settlement. A time period may need to be established within which such proceedings could be brought, as the settlement would in effect not be final and binding until either that period had expired or the Court had ruled on any proceedings brought by a shareholder.

Applicant for leave under section 18 not to be liable for court costs

6.15 An application under section 18 for leave to exercise a public issuer's right of action against an alleged insider may be a prolonged and expensive matter. While applicants may be willing to meet their own costs of the application, they may be unwilling to subject themselves to the risk of having costs awarded against them if the application is not successful.

6.16 It has been suggested that section 18 be amended to exclude the power of the court to award costs against an applicant under the section where the applicant is seeking to advance a cause of action identified in an opinion obtained from a barrister or solicitor under section 17.

6.17 However, the ability of a court to award costs against an unsuccessful party to proceedings is a guard against vexatious or frivolous actions. In deciding whether to award costs, a court is likely to take into account whether an opinion has been obtained under section 17 and the contents of any such opinion.

Option 2: Enable the Commission to Undertake Civil Enforcement Actions

Introduction

6.18 At present, the Commission has no power to undertake any form of enforcement action against an alleged insider, other than the power to give its approval under section 17 to a person requiring a listed issuer to obtain an opinion from a barrister or solicitor approved by the Commission.

6.19 This option involves amending the SA Act to authorise the Commission, in its discretion, to undertake an action under the SA Act on behalf of a public issuer or other person who has a right of action under the Act.

Comment

6.20 Securities regulators in various overseas jurisdictions, for example the ASIC and the SEC, have power to bring proceedings against alleged insiders. However, in those jurisdictions the role of the regulator differs significantly from that of the Commission in that, unlike the Commission, the regulator is generally given wide enforcement powers in relation to securities matters and the resources to match.

6.21 At present, the Commission's enforcement powers are limited to matters such as suspending and cancelling prospectuses, investment statements and advertisements under the Securities Act, and bringing proceedings under the substantial security holder requirements of Part II of the SA Act 1988 and other relatively minor matters. Enabling the Commission to undertake enforcement actions against alleged insider traders would be a significant expansion of the Commission's role and, as a result, it may be necessary to increase the Commission's resources accordingly.

6.22 An issue that requires consideration in the context of this option is whether the Commission should have the right to take an action on behalf of a public issuer or shareholder in its own discretion, or whether the Commission would first need to obtain the consent of that issuer or shareholder. In view of the large number of shareholders of every public issuer, it would seem that, if neither the public issuer nor any shareholder was willing to agree to the Commission taking legal action against an alleged insider trader, then such action should not be taken.

6.23 Advantages of providing the Commission with enforcement powers in respect of insider trading are likely to include -

• the provision of a public enforcement agency for insider trading activity could act as a deterrent for potential insider traders;
• the provision of cost-effective enforcement of the SA Act, having regard to the significant savings that may accrue in using the existing Commission infrastructure;
• the effective use of existing Commission expertise developed through previous inquiries into insider trading activity.

6.24 A potential disadvantage of providing the Commission with additional enforcement powers in this area is that it may inhibit the use of procedures already currently available under the law.

6.25 If any such powers are to be given to the Commission, they will need to be accompanied by some mechanism, statutory or otherwise, to fund enforcement proceedings undertaken by the Commission. There are a number of possible options for this:

1. At present where a public issuer's right of action against an alleged insider is exercised by a shareholder, the public issuer must pay the costs of the action. This could be extended to actions brought by the Commission.
2. The SA Act could provide for the Commission's costs to be paid first from any compensation or penalties recovered. This would have the attraction that the insider would pay the costs. However it may also mean that there would be less money available for distribution among the public issuer and its shareholders (or to charities). The possibility of the Commission receiving a preferential reward for proceedings undertaken by it may also raise questions of there being an inappropriate incentive for the Commission to commence proceedings. This concern could be alleviated by making the consent of the person in whose name the proceedings are taken a pre-requisite, and by limiting the costs that could be recovered by the Commission to expenses incurred by it solely for the purposes of the proceedings.
3. The Commission could simply rely on the discretion of the courts to award costs in appropriate cases, and seek extra funding from the Government to cover the likelihood that the Commission would not be able to recover all of its costs. In other words, the Government would need to provide the Commission with a "fighting fund".

Questions for Submissions

⁸A recent example was the recent Auckland power crisis which resulted in threats of legal actions against Mercury Energy.

⁹  Maintenance occurs where a person, without lawful justification, assists a party to a civil action to bring or to defend the action, thereby causing damage to the other party. Champerty is that form of maintenance in which the person giving the assistance does so in consideration of his or her receiving a share of anything that may be gained as a result of the proceedings.