Insider dealing v insider trading

This month the headline grabbing case for the FSA was that of Ian Hannam, the former banker at JP Morgan, who was fined £450,000 for relaying inside information about his client Heritage Oil to a prospective client in 2008. Hannam’s case is one of several, including David Einhorn and Nicholas Kyprios, which over the course of the last few months alone have been publically paraded by the FSA in order to demonstrate their stringent enforcement policy. Whilst those who work in the finance and banking sector can be left in little doubt that the FSA will vigorously pursue individuals who they believe may have engaged in market abuse or insider dealing, the threat in reality is that of a civil penalty rather than a criminal sanction.

Although the FSA has undoubtedly stepped up several gears in respect of its criminal prosecution of insider dealing, this increased effort has yet to be rewarded with the level of convictions that are being enjoyed by prosecutors in the US. Since 2009 the US Attorney’s Offices in New York alone have prosecuted 66 people for insider trading and have obtained 57 convictions and guilty pleas. In contrast, as of February 2012, the FSA had secured only 11 convictions.

The offences

A comparison of the law of insider trading in the US to that of insider dealing in the UK does not offer an obvious explanation for the higher success rate across the Atlantic. In the UK, a person may be guilty of insider dealing if he knows he has inside information from an inside source and he trades in the relevant securities (contrary to section 52 of the Criminal Justice Act 1993 (CJA 1993)).

In the US, insider trading is prohibited by common law and federal securities laws (Securities Act 1933 and Securities Exchange Act 1934). Whilst similar in most respects to the UK offence, a crucial difference is that the Department of Justice (DOJ) must prove that the suspect traded in breach of a fiduciary duty or a duty of trust or confidence owed either to the company shareholders or to the source of the inside information. This is a much more narrow definition of insider dealing than in the UK (there is no such pre-requisite contained in the CJA 1993). Under section 57, the test is much easier as the FSA must only prove that the person had the information directly or indirectly from a company officer, employee or shareholder or from someone who has access to it by virtue of his employment.

Powers of investigation

As the case of Rajaratnam last year highlighted, the US authorities do however have greater investigative powers at their disposal. The prosecution of Raj Rajaratnam attracted an unprecedented amount of publicity not only because it was the largest hedge fund insider trading case in American history but also because it was founded on, and reliant upon, evidence obtained by wire tapping. By the time of his arrest in October 2009, the government had listened in to and recorded thousands of telephone calls between Mr Rajaratnam and others and in May 2011 Mr Rajaratnam was found guilty of 14 counts of insider trading and conspiracy to commit insider trading. Whilst wire tapping has been frequently used by the FBI and US prosecutors in order to gather evidence in other types of fraud, this was the first time it had ever been undertaken in respect of insider trading and it was made possible because the FBI found a co-operating witness early on in the investigation.

In the UK, the power to intercept communications is limited to the police and intelligence services only (pursuant to the Regulations of Investigatory Powers Act 2000). The FSA can conduct covert surveillance, use informants and review calls recorded by regulated companies but it cannot avail itself of wire tapping as the US investigators are able to. Even if the FSA had access to intercept evidence gathered by other investigating bodies, it would not generally be admissible in the actual court proceedings.

Sentencing

The other likely explanation for the proportionately greater number of convictions for insider trading in the US must be the very real threat of a lengthy custodial sentence underpinning all such prosecutions. A conviction for insider trading carries a theoretical maximum sentence of 20 years’ imprisonment which is in stark contrast to the maximum sentence available in the UK of seven years. Whilst it is unlikely that anyone convicted in the US will receive anywhere near the maximum sentence, the US courts are clearly capable of ordering lengthy sentences such as the 11 years Mr Rajaratnam received last year (his co-defendant also received 10 years). Indeed on Friday 13 April the US Sentencing Commission voted for amendments to the federal sentencing guidelines which will recommend that federal judges impose greater criminal penalties on Wall Street professionals convicted of insider trading.

The FSA is clearly alive to the need to strengthen their position as criminal prosecutor and last year it called on the government to increase the maximum sentence available to ten years so that insider dealing would be more akin to other offences of fraud in the UK (offences under the Fraud Act 2006 carry a maximum sentence of ten years). The FSA was also able to obtain its highest sentence yet when Christian Littlewood (a former banker at Dresdner Kleinwort) pleaded guilty to eight counts of insider dealing and received a 40 month custodial sentence. Notwithstanding its efforts, the FSA is likely to remain in the DOJ’s shadow for the foreseeable future – in February 2012 the FBI announced that it is investigating a further 120 individuals suspected of insider trading.

Corker Binning is a law firm specialising in fraud, regulatory and general criminal work of all types.  For more information about our expertise, call us on 0207 353 6000.