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CMA URGED TO TIGHTEN NOOSE ON INSIDER TRADERS
BY GEOFFREY CRAIG
When several high-profile cases of insider trading surfaced earlier this decade, the country’s market regulator, the Capital Market Authority (CMA), vowed to get tough. Corporate insiders caught trading in their own company’s stocks based on undisclosed company information, or passing along this information to their cronies, would be severely punished, CMA officials said.
Stern warnings were issued and the CMA implemented new rules on disclosure in 2002 requiring companies to present complete information about their boards and executives. But while the regulator acknowledged that the legal system needed a few criminal trials to deliver the message, it has so far sought only out-of-court settlements. “There haven’t been any serious penalties,” says a local investor. “You don’t see anyone going to jail.”
Capital Market Law 95/1992 criminalizes insider trading, defined as the purchase or sale of shares using non-public information. Violators are liable to a fine of up to LE 20 million and a minimum prison sentence of two years. The fine was previously LE 20,000 to LE 50,000 – a mere slap on the wrist – until parliament passed an amendment in June raising the amount. The same amendment also broadened the statute to include receiving insider information and then trading to profit or prevent losses, whereas previously the law only covered the person who divulged company secrets.
Yet the law has never been tested. Despite plenty of investigations, in the 16 years since the legislation was passed there has not been a single conviction. A few successful cases could send a strong signal to the market and discourage illegal trading practices, market experts say. “The only way to control such a thing is to apply the law seriously,” argues Ashraf Safy El Din, a board member of Al Shorouk Brokerage. “Just one or two cases in the newspaper that someone is charged with [insider trading] and goes to prison for 5 to 10 years [will discourage white-collar crime].”
A company’s officers, board members and other “insiders” may own shares in their firm, but capital market regulations require that they buy and sell on the basis of information that is available to the general public. A CEO, for example, cannot buy shares ahead of a merger he is about to announce. It would also be illegal to “tip” his cousin to buy shares.
According to CMA officials, company insiders are barred from trading their own stocks 15 days before and three days after the disclosure of information that could move share prices. Trades outside this window require that they notify the Cairo & Alexandria Stock Exchanges (CASE), which compiles this activity into a daily report published on its website, a common international practice.
Investors scrutinize these reports, viewing them “as an indication of how things are going within a company,” says Mohamed Taymour, head of Egypt’s Capital Market Association, a local NGO representing the securities industry.
So what’s all the fuss over insider trading? Stock markets function with the implicit understanding among parties involved that everyone has access to the same information. Illegal insider trading, on the other hand, stacks the deck against one party. “If I have a piece of information that I use to buy a stock because I know about the good news that’s going to be published, and then the stock goes up, the person I bought it from lost money,” Safy El Din says. “It’s basically stealing.”
A pattern of bad behavior and lack of transparency can sully a bourse’s reputation, causing investors to leave rather than play the odds.
Nevertheless, punishing white-collar crime is notoriously tricky, experts concede. “The problem is not with the definition or the penalties involved. Proving insider trading is a difficult task, and this is true at stock exchanges all over the world,” CASE chairman Maged Shawky told Business Monthly.
Prosecutors must link the defendant to leaked company news, and prove that they were trading based on this non-public information. “You have circumstantial evidence,” says Taymour. “Someone bought shares and the next day the price went up. It’s not proven unless there is a phone call record. You have to know that it wasn’t sheer coincidence that someone bought or sold before information was released and there was a big change in the price.”
Convictions for insider trading are rare, even in the US, where the court system is familiar with sophisticated financial crimes. “A major challenge [in Egypt] is that when [such a] case goes to court it goes to a normal court, where not all of the judges have a background in the capital market,” Shawky adds.
In April 2008, the parliament approved legislation establishing economic courts, a special circuit with judges who specialize in financial crimes. These special courts should make trying an insider trading case easier, Shawky says. In the meantime, the CMA and CASE have adopted a strategy that mostly bypasses the courts, pursuing internal investigations that can ultimately lead to administrative sanctions, such as suspending individuals and reversing trades.
After gathering sufficient evidence, an internal committee determines whether a party is guilty. They still must establish the connection between the trader and the company insider, as a prosecutor would in a criminal proceeding. But avoiding the courtroom expedites the process, says Khaled Serry, deputy chairman of the CMA. “This is [more efficient] than waiting four or five years until we have a final decision from the court.”
An investigation begins by monitoring transactions. Statistical software analyzes and flags abnormal trades, as measured by an investor’s trading history. Fortuitous coincidences are examined with a skeptical eye, Serry says, such as a large order to buy or sell just before a significant price fluctuation. “When our guys in surveillance see a problem, we need to know why there was this change in volume and price, why this one company, and why this one person, especially if he never made a transaction like this before,” he explains.
Next, investigators try to establish a connection between the investor and the listed company. The person could be a friend or distant relative of someone inside the company privy to confidential information that affects share value, such as a planned acquisition or better-than-anticipated earnings announcement.
Sometimes illegal information leaks are obvious, such as in cases where a firm issues few reports yet an investor seems spot-on in selecting the best time to buy and sell in volume. By contrast, Shawky admits, there were also “cases that we couldn’t really identify as insider trading because there was lots of information around a certain company for the [previous] three or four months, even though we sensed there was something irregular about the trading.”
The CMA can use its authority to subpoena e-mails or phone records in order to facilitate investigation. The regulator can authorize an administrative sanction, or if the case is more severe, turn the evidence over to the public prosecutor for a criminal trial.
That decision hinges on the preponderance of evidence, Serry says. “You have to be sure, more than 70 or 80 percent sure,” that you will win in court before proceeding. An acquittal, he says, would be “dangerous,” because it sends a message to the marketplace that the regulator is ineffective.
The range of punishments may deter some investors, but it has been equally important to spread awareness about what constitutes insider trading and why it’s wrong. “Ten years ago, people thought insider trading was part of being smart,” says Taymour. “Today, [Egypt’s transparency] is not as good as it is in London or New York, but much better than our peers.”
This progress has stemmed from better enforcement, Shawky believes, as well as the introduction of a code of corporate governance and disclosure for the first time in 2002. Even without any convictions, the regulator’s administrative sanctions have acted as a deterrent. The market is too big to identify every violation, he concedes. But the numbers can be reduced, as long as investors contemplating illegal trades always see the possibility of getting caught. “At the end of the day, we [must] send a message to the market that we can catch you,” Shawky says.
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TRADING GAMES
The days of getting a juicy stock tip from the shoeshine boy are long over, but the rumor mill hasn’t stopped churning altogether. It’s just moved online. Today, Internet chat rooms and forums are the preferred means for investors to share research, opinions and updates on the stock market.
There are about a dozen independent websites for the Egyptian stock market. Some have grown so popular that market-oriented chat rooms reach their occupancy moments after the market’s opening bell. The quality of chat and forum postings varies, from verified news stories to baseless rumors. It’s permissible to exchange such views in a free market. However, the stock exchange monitors these websites, and follows up rumors with company officials to verify their accuracy.
None of this constitutes illegal insider trading. While CEOs revealing new company information in a chat room without first informing the CASE might find themselves in violation of disclosure rules, the information being discussed in chat rooms exists in the public realm.
But another scheme, whereby investors work together to trade in heavy volumes to drive up a stock price in order to profit, is certainly illegal. People who are unaware of the conspiracy, or even those who suspect a plot and still buy what they perceive as a hot stock, usually get burned. Once the skyrocketing stock lures enough investor interest, the conspirators dump the stock, causing the price to plummet. Suddenly the stock is worth a fraction of the amount it was bought for, and scores of investors eventually sell their shares for a loss.
Manipulating a stock price for a blue-chip company is unlikely considering the huge volumes traded daily, but is more feasible for thinly traded “penny stocks.”
Securing a conviction is a matter of proving the suspect had the intent and capability to manipulate share price. Egypt’s capital market legislation allows the stock exchange to suspend the trading of individuals guilty of price manipulation. In addition, they can be imprisoned for a maximum of five years, and/or fined between LE 50,000 and LE 100,000.
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