The court’s decision merely transfers illicit profits to a select group of individuals who were “lucky enough to have traded with the insider”, says Tom Fyfe.
Among all the gift-giving on Valentine’s Day 2022 you might have missed the gift received by a select group of 63 former shareholders in TeleEye Holdings Limited (8051.HK), for it was on that day that these 63 benefitted from compensation orders made by the court. The orders were against two individual defendants in a High Court action brought by the SFC (Securities and Futures Commission) under Section 213 of the SFO (Securities and Futures Ordinance).
The two had been found to have committed insider dealing offences when, possessed of inside information relating to a proposed takeover of TeleEye in 2016, they purchased in the market 22,540,000 shares in TeleEye from 63 counterparties. Shortly after the takeover was announced and trading had resumed, the two defendants proceeded to sell 15,650,000 TeleEye shares for a net profit of approximately HKD 12.9 million.
Compensation orders under section 213 are nothing new. Since the decision in SFC v Tiger Asia Management LLC in 2013, a variety of such orders in relation to various forms of market misconduct have been handed out. But when it comes to insider dealing, the conceptual challenges to making such an order do not appear to have been fully recognised.
In numerous prior cases, the SFC has sought (and invariably obtained) orders that the profits derived by the insider dealers be disgorged to the counterparties who traded with the insiders. The rationale offered has been that, had these counterparties known that they were trading with someone possessed of inside information, those counterparties would not have traded, at least not at the price they did.
This was basically the same approach taken by the court in the TeleEye case, the idea being that this compensates the 63 counterparties, by returning each of them to the position they were in prior to trading. But this is a fallacy. First of all, it makes a huge assumption that these counterparties would not have traded with the insider had they known he was possessed of inside information, or at least not at that price. In truth, there could be any number of reasons someone traded their shares. It might, for example, be to hedge another exposure.
Secondly, it merely transfers the illicit profits from the insider to this select group of people who were lucky enough to have traded with the insider. It is therefore the counterparties that profit from inside information, instead of the insider. The rest of the market, who merely traded with each other at the prevailing market price, and who might also not have traded (or traded differently) had they known there was undisclosed MNPI (material non-public information) out there, are left where they are.
To be fair to the SFC, in the present action it did try a different approach, which attempted to “re-rate” the price of the shares to what it would have been had the inside information been available to the market on the relevant trading days. However, this isn’t really the solution and, in any event, the court dismissed this as an artificial exercise and plumped for the tried and trusted remedy of profit redistribution, pioneered by the SFC in previous Section 213 actions. Putting the cat back in the bag was never going to be easy.
This is not to say that the insiders should be allowed to keep their profits, far from it. The point being missed is that insider dealing affects the integrity of the market. It is not a personal crime with one or more identifiable individuals (or counterparties) being the victims. At most, one might offer the counterparties the right to effectively unwind the trade, provided the counterparty can, when looked at together with its other positions, show some loss. The remainder of this profit could be donated to some public purse from which the market might benefit.
In the meantime, all those day-traders out there can carry on hoping that one day they have the (mis)fortune to trade with an insider and get to ‘feel the love’ of the SFC. Will you be their Valentine?