The first criminal prosecution for insider misconduct in New Zealand shows the Courts are prepared to imprison offenders in order to provide a strong deterrent to insider trading.
Last week, the District Court sentenced a former employee of NZX-listed transport technology company EROAD Limited, Jeffrey Honey, to serve six months’ home detention for disclosing inside information and tipping a former employee to sell shares in the company.1 It is the first prosecution and sentence since the introduction of criminal liability for insider trading and tipping in 2008. The Court reduced the sentence and exercised its discretion to apply home detention in this case because the defendant didn’t gain personally, and it was a one-off and uncoordinated incident, among other factors. However, its start-point in sentencing the offence was to consider 12 months’ imprisonment.
The case will also draw interest as it confirms the Financial Market Authority’s public indications that insider trading and market manipulation are a key strategic risk to efficient markets, and it will be prepared to use criminal proceedings to deter and sanction serious misconduct that is either intentional or reckless.
We summarise below the relevant legal principles, the Court’s decision, and the key takeaways.
The insider trading laws
In general terms, a person who holds non-public materially price sensitive information about a listed issuer is subject to prohibitions on trading in the financial products of the issuer or tipping another person to trade. Tipping occurs when the information insider advises or encourages another person to trade or hold financial products.
Until 2006, the Securities Markets Act 1988 imposed only civil liability for insider trading and tipping. That approach was underpinned by the policy view that the harm caused by insider misconduct principally consists of the misappropriation of information belonging to the issuer for personal gain.
Since 2006, and with effect from 2008, the Securities Markets Act and now the Financial Markets Conduct Act 2013 (FMCA) have imposed criminal as well as civil consequences. The change was driven by Australian reforms and reflected the Government’s view that insider misconduct undermines the efficiency and fairness of securities markets and therefore criminal sanctions ought to be available, as well as civil remedies.
Like the Securities Markets Act, the FMCA creates civil liability on a strict basis for breaches of the insider conduct prohibitions and criminal liability for an insider who has knowledge of each of the elements that make up the relevant prohibition.
The civil and criminal sanctions for insider conduct are significant. The criminal penalties include up to five years’ imprisonment and a NZ$500,000 fine. The civil consequences include pecuniary penalties for up to the greater of the total consideration for the transaction that constituted the contravention, three times the amount of the gain made, or the loss avoided, or NZ$1 million for individuals and NZ$5 million for companies.
The District Court’s decision
The defendant had pleaded guilty to advising or encouraging another person to trade EROAD’s shares by sending text messages containing an image of confidential financial information and asking whether it was time to “sell up”. The recipient of the information sold his EROAD shares prior to the company’s market update and therefore avoided a loss of approximately NZ$5,000. The recipient who traded on the information is facing charges.
The Court considered sentencing decisions from Australia, Canada, and the United Kingdom regarding sentencing for insider trading.
In its oral sentencing decision, the Court concluded:
There is a strong public interest in deterring insider misconduct and protecting the integrity of the securities market.
The nature of the tipping justified a starting point of 12 months’ imprisonment.
The sentence should be adjusted for mitigating factors including the defendant’s early guilty plea, the one-off and unplanned nature of his actions, and that he appeared to have acted out of a misguided sense of loyalty rather than for financial reward. Taking those factors into account, a sentence of seven and a half months’ imprisonment would be appropriate.
However, applying the provisions of the Sentencing Act 2002 relating to home detention as an alternative to short-term imprisonment, the Court sentenced the defendant to six months’ home detention.
Relevance of Australian authorities
Although the Court considered a number of Commonwealth authorities, the Australian precedents were the most influential. New Zealand’s insider trading and tipping laws are similar to the Australian regime in terms of their scope and underlying philosophy. Judicial guidance in Australia will therefore continue to be an important guide for how the New Zealand Courts will interpret and apply the law.
Insider trading convictions can be expected to result in imprisonment
In this case, the Court considered that a sentence of seven and a half months’ imprisonment would be appropriate (before exercising its discretion to apply a lesser period of home detention) in circumstances where the defendant did not obtain a personal gain, the tipping was a one-off and uncoordinated action, the amount of trading involved was relatively low, and there were material mitigating factors.
The sentencing guidance in this decision suggests that those involved in more serious insider trading or tipping will face a substantial risk of imprisonment. In Australia, there have been a number of insider trading prosecutions resulting in terms of imprisonment.
FMA enforcement approach
The case represents a further indication of the FMA’s enforcement philosophy. FMA enjoys considerable statutory powers to enforce securities laws. The FMA’s publications and public remarks indicate that it will use the full range of tools at its disposal but will adopt what it considers to be the right tool for each enforcement scenario.
The FMA’s enforcement policy indicates that criminal proceedings will be used to deter and sanction serious misconduct that is either intentional or reckless. Its approach in this case is consistent with that philosophy.
Looking to another case on the civil side of the FMA’s enforcement strategy, the judgment of the High Court is now pending on the civil pecuniary penalties to be ordered against Mark Warminger. This follows a trial in which the FMA established liability for market manipulation relating to two sets of trades that created a false appearance of trading. In that case, the FMA has asked the Court to fix the starting point at NZ$1.6 million, which is an indication of the seriousness of such conduct in the FMA’s view and its approach to sanctions.
If you would like to discuss the implications of this case and what it means for your business, please contact one of our specialists, or your usual Bell Gully adviser.
This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.