Prior to the publication by the FMA on Monday of a report, I hadn’t heard the term ‘shadow insider trading’:
Insider trading typically involves trading or tipping in the [quoted] securities of a listed issuer directly associated with the non-public, price sensitive information.
According to the FMA ‘shadow insider trading’ means:
| Using material information about one listed issuer to inform trading in the quoted financial products of another listed issuer, where the two listed issuers are connected in some way that means information about one may have a material effect on the other’s share price. |
In the aftermath of the US decision referred to at the end of this note, but not mentioned in Monday’s report, the SEC referred to corporate insiders exploiting information about their own companies to profit by trading in the securities of “economically linked” companies.
The FMA’s report begins with the rather surprising statement that [the FMA] understands from market participants that shadow insider trading is common industry practice. From where I sit, I would have thought that the incidence would have eroded since the 1980s, when the market did feature a number of listed issuers with stakes in other listed issuers.
However, Monday’s report is framed as educating market participants about the FMA’s expectations (of behaviour and standards). Some might say that they have used a controversial US decision, which was not mentioned in the report, to jump the shark.
Application of the FMC Act to shadow insider trading
Monday’s report states that the FMA’s view is that information about a listed issuer, or about a particular sector, industry, or other matter that relates to a listed issuer, is capable of constituting ‘material information’ about another listed issuer for the purposes of Part 5 of the FMC Act.
The FMA gives as an example: Where a person possesses information about Issuer A that is material to Issuer B, they may be considered an information insider to Issuer B. This applies where the person either has actual knowledge that the information is material and not generally available to the market, or they ought reasonably to know that the information is material and not generally available to the market.
This is subject to the requirement that the information cannot be so general that it relates to securities generally or listed issuers generally – and must be narrow enough to apply to a class of securities or listed issuers.
To constitute insider trading under the FMC Act, a ‘reasonable person’ (one who commonly invests in shares and holds them for a period of time based on their view of the inherent value of those shares) must expect that the information regarding one listed issuer, if generally available, would likely have a material effect on the price of quoted financial products of the other listed issuer. (Note also that materiality is assessed on whether a reasonable person would expect a material impact on price at the time the information was held – not with the benefit of hindsight.)
Monday’s report gives two example scenarios of shadow insider trading:
- Capital raise: Knowledge of anupcoming capital raise by a listed issuer in a sector which is dominated by a small number of listed companies may influence the share price of peers. As a result, the FMA says that trading [or tipping] in a peer listed issuer within that market, armed with that information, such as selling down holdings in a peer issuer ahead of the announcement and subsequently buying at a lower price – may indicate the use of such information for strategic gain. Where the issuers operate within a small sector, the link between one issuer’s capital raise and a peer’s share price may be sufficiently material – for this to be [shadow] insider trading.
- M&A: A shadow insider trading risk may arise where a person becomes aware of confidential information about an M & A transaction involving a listed issuer, and uses that information to trade [or tip?] in a closely comparable peer [listed issuer]. For example, if that information causes them to revalue the target company – does it also infer a similar uptick in value of similar listed issuers in the same sector? The FMA suggests that trading [or tipping] in the peer issuer, while the information remains confidential, may constitute insider trading.
Regulatory expectations
Monday’s report notes the FMA’s expectations individuals and institutions in possession of non-public material information assess the potential implications of their trading activity across all related quoted financial products. When trading in correlated shares or within concentrated sectors, decision-makers must consider whether the information they hold could be viewed as material to the broader market or related issuers.
The FMA encourages:
- vigilance in documenting and reviewing trade rationales – particularly for significant transactions outside of normal trading patterns / one which coincide with known market-moving events;
- maintaining robust internal governance and compliance frameworks – including clear policies for handling and using non-public information (including for sector peers); and
- fostering a culture of ethical decision-making.
Comments
At a glance, the small size of our market, when coupled with the FMA’s framing of the conversation serves as a fair warning. For example, the FMC Act (and its predecessor) do not require that the non-public, price sensitive be sourced from the relevant issuer. And there is no need to prove an [improper] motive.
Whilst the challenge posed by the FMA’s expansion of what constitutes insider trading [and tipping] is likely to impact active fund managers, particularly, conceivably a range of intermediaries could be impacted.
Monday’s report does not mention that the authority for the FMA’s view of ‘shadow insider trading’ is a controversial US decision from 2024, SEC v. Panuwat, in which the SEC successfully argued that trading in the securities of one company based upon material non-public information about another company was insider trading. In that case, an employee of a listed biopharma company receiving material non-public information that his employer was going to be the subject of a takeover. The defendant purchased short-term options in a competitor biopharma company that was not a party to the takeover (and had no direct connection to it). When the takeover was announced, the competitor’s share price increased, and, through those short-term options, the defendant realised a profit of approx. US$110k.
The Panuwat decision sent some overseas commentators into a bit of a frenzy – extrapolating about what it might mean for a range of intermediaries (and not just active fund managers). And that it shed light on the regulator’s scrutiny of company internal policies. In that case, the SEC used the defendant’s violation of his employer’s insider trading policy as proof of a breach of duty to the company, which was a crucial element of the SEC’s case.
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