11

INSIDER TRADING INSIDER TRADING REGULATIONS IN U.S. AND REGULATIONS IN U.S. AND A PROPOSAL FOR TURKEYA PROPOSAL FOR TURKEY

22

WHAT IS INSIDER TRADING ?WHAT IS INSIDER TRADING ?

There is no statutory definitionThere is no statutory definition Encompasses both legal and illegal Encompasses both legal and illegal

activityactivity Our discussion: illegal oneOur discussion: illegal one When those with confidential information When those with confidential information

use that special advantage to gain profit or use that special advantage to gain profit or avoid losses on the stock marketavoid losses on the stock market

Damages the source of information and Damages the source of information and other typical investorsother typical investors

33

WHO ARE INSIDERS?WHO ARE INSIDERS?

Not just corporate directors, officers or major Not just corporate directors, officers or major shareholders shareholders

A broader range of individuals;A broader range of individuals; A partner in a law firmA partner in a law firm representing the acquiring company in a representing the acquiring company in a

hostile takeover bid who traded in target company stock.hostile takeover bid who traded in target company stock. A Wall Street Journal columnistA Wall Street Journal columnist who traded prior to publication of who traded prior to publication of

his column in the stock of companies he wrote about.his column in the stock of companies he wrote about. A psychiatristA psychiatrist who traded on the basis of information learned who traded on the basis of information learned

from a patient.from a patient. A financial printerA financial printer who traded in the stock of companies about who traded in the stock of companies about

which he was preparing disclosure documents.which he was preparing disclosure documents.

44

WHY US REGULATIONS?WHY US REGULATIONS?

Insider trading has started to cross Insider trading has started to cross bordersborders

EC Directive provides that members may EC Directive provides that members may enact laws more stringent than set out in enact laws more stringent than set out in the Directive the Directive

U.S. has the most comprehensive and U.S. has the most comprehensive and detailed regulations against insider trading detailed regulations against insider trading

55

INSIDER TRADING DEBATEINSIDER TRADING DEBATE

Opposing Views Opposing Views Form of compensation for employees Form of compensation for employees No statutory definition, unfairly penalize No statutory definition, unfairly penalize

traderstraders Enforcing insider trading not cost effectiveEnforcing insider trading not cost effective Smooth prices and more efficient marketSmooth prices and more efficient market Companies may prohibit it in the contractCompanies may prohibit it in the contract

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REASONS FOR REGULATING REASONS FOR REGULATING INSIDER TRADINGINSIDER TRADING

Unfair practice to public investorsUnfair practice to public investors Prohibiting it promotes efficiency of Prohibiting it promotes efficiency of

marketsmarkets Property of material information belongs to Property of material information belongs to

the corporation for business purposes. the corporation for business purposes.

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US REGULATION OF INSIDER US REGULATION OF INSIDER TRADINGTRADING

Section 16 of the 1934 Securities Section 16 of the 1934 Securities Exchange ActExchange Act

SEC Rule 10b-5SEC Rule 10b-5 Classical TheoryClassical Theory Misappropriation TheoryMisappropriation Theory

SEC Rule 14e-3SEC Rule 14e-3

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Section 16 of the 1934 ActSection 16 of the 1934 Act

Designed to watch more closely the trading of Designed to watch more closely the trading of corporate insiders on their corporation’s stock. corporate insiders on their corporation’s stock.

Covers officer, directors, and 10% equity holdersCovers officer, directors, and 10% equity holders §16(a) -> §16(a) -> Disclosure ProvisionDisclosure Provision ->Every corporate ->Every corporate

insider should report holdings and transactions. insider should report holdings and transactions. Facilitates §16(b)Facilitates §16(b)

§16(b) -> §16(b) -> Recovery of Short-swing ProfitsRecovery of Short-swing Profits ->These ->These insiders must disgorge profits from selling stock held insiders must disgorge profits from selling stock held less than six monthsless than six months

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Rule 10b-5Rule 10b-5

Promulgated in 1942 under §10(b) of the Promulgated in 1942 under §10(b) of the

Securities Exchange Act of 1934Securities Exchange Act of 1934 Covers Covers

material corporate misstatements or non material corporate misstatements or non diclosures, diclosures,

insider trading, and insider trading, and corporate mismanagement cases corporate mismanagement cases

regarding transactions in shares or other regarding transactions in shares or other securities securities

Today a major weapon to curb insider trading, Today a major weapon to curb insider trading, as a catch-all anti-fraud provision as a catch-all anti-fraud provision

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Rule 10b-5Rule 10b-5

It shall be unlawful for any person, directly or indirectly, by the It shall be unlawful for any person, directly or indirectly, by the

use of any means or instrumentality of interstate use of any means or instrumentality of interstate commerce, or of mails, or of any facility of any national commerce, or of mails, or of any facility of any national securities exchange,securities exchange,

• to employ any device, scheme, or artifice to defraud,to employ any device, scheme, or artifice to defraud,

• to make any untrue statement of a material fact or to to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make omit to state a material fact necessary in order to make the statements made, in the light of the circumstances the statements made, in the light of the circumstances under which they were made, not misleading, orunder which they were made, not misleading, or

• to engage in any act, practice, or course of business to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit which operates or would operate as a fraud or deceit upon any person,upon any person,

in connection with the purchase or sale of any security.in connection with the purchase or sale of any security.

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Rule 10b-5Rule 10b-5

Legal Theories of Rule 10b-5Legal Theories of Rule 10b-5 Traditional TheoryTraditional Theory Misappropriation Theory Misappropriation Theory

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Traditional Theory of Insider Traditional Theory of Insider TradingTrading

Also known as “disclose or abstain rule”Also known as “disclose or abstain rule” Insiders, acting on behalf of their company or on their own Insiders, acting on behalf of their company or on their own

behalf, have a behalf, have a fiduciary dutyfiduciary duty to the company’s shareholders to the company’s shareholders either to either to disclose material, nonpublic information before trading or disclose material, nonpublic information before trading or to abstain from trading. to abstain from trading.

Developed through major cases of Developed through major cases of In re Cady, Roberts & Co (1961)In re Cady, Roberts & Co (1961) SEC v. Texas Gulf Sulphur Co. (1968) SEC v. Texas Gulf Sulphur Co. (1968) Chiarella v. United States (1980) -> Rule 14e-3Chiarella v. United States (1980) -> Rule 14e-3 Dirks v. SEC (1984)-> Regulation FDDirks v. SEC (1984)-> Regulation FD

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Traditional Theory of Insider Traditional Theory of Insider TradingTrading

A person violates Rule 10b-5 by buying or selling securities A person violates Rule 10b-5 by buying or selling securities on the basis of on the basis of material nonpublicmaterial nonpublic information if information if she owes a fiduciary or similar duty to the other party to she owes a fiduciary or similar duty to the other party to

the transactionthe transaction she is an insider of the corporation in whose shares she she is an insider of the corporation in whose shares she

trades, and thus owes a fiduciary duty to the trades, and thus owes a fiduciary duty to the corporation’s shareholderscorporation’s shareholders

she is a tippee who received her information from an she is a tippee who received her information from an insider of the corporation and knows or should know, insider of the corporation and knows or should know, that the insider breached a fiduciary duty in disclosing that the insider breached a fiduciary duty in disclosing the information to herthe information to her

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Misappropriation Theory of Insider Misappropriation Theory of Insider TradingTrading

First mentioned in Chiarella caseFirst mentioned in Chiarella case In Carpenter v. United StatesIn Carpenter v. United States (1986) case (1986) case

Supreme Court split 4 to 4Supreme Court split 4 to 4 Clearly accepted by the Supreme Court in 1997, Clearly accepted by the Supreme Court in 1997,

United States v. O’HaganUnited States v. O’Hagan case case

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Misappropriation Theory of Insider Misappropriation Theory of Insider TradingTrading

A person violates Rule 10b-5 ifA person violates Rule 10b-5 if Misappropriates Misappropriates material nonpublicmaterial nonpublic

informationinformation by breaching a duty arising out of a relationship by breaching a duty arising out of a relationship

of trust or confidence to the source of of trust or confidence to the source of informationinformation

and uses that information in a securities and uses that information in a securities transaction transaction

regardless of whether he owed any duty to the regardless of whether he owed any duty to the shareholders of the traded stockshareholders of the traded stock

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Misappropriation Theory of Insider Misappropriation Theory of Insider TradingTrading

Misappropriating information is : Misappropriating information is : obtaining by improper means or obtaining by improper means or converting it to his/her own benefit even if properly converting it to his/her own benefit even if properly

obtained obtained According to Rule 10b5-2 a duty of trust or confidence According to Rule 10b5-2 a duty of trust or confidence

exists when:exists when: a person expressly agrees to maintain information in confidence; a person expressly agrees to maintain information in confidence; the facts and circumstances of the relationship as a whole show a the facts and circumstances of the relationship as a whole show a

history, pattern or practice of mutual sharing of confidences; or history, pattern or practice of mutual sharing of confidences; or a person receives information from a spouse, parent, child or a person receives information from a spouse, parent, child or

sibling, unless the person receiving the information can show that, sibling, unless the person receiving the information can show that, under the facts and circumstances of the family relationship, no under the facts and circumstances of the family relationship, no reasonable expectation of confidence existed. reasonable expectation of confidence existed.

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Scope of Rule 10b-5Scope of Rule 10b-5

Applies to any purchase or sale by any person of Applies to any purchase or sale by any person of anyany security security Fall within the jurisdictional reachFall within the jurisdictional reach ““In connection with the purchase or sale of a security” In connection with the purchase or sale of a security” To recover damages reliance (transaction causation) must be To recover damages reliance (transaction causation) must be

established (not for SEC)established (not for SEC) The plaintiff must also be able to prove “loss causation” The plaintiff must also be able to prove “loss causation” Rule 10b5-1 presumes that someone who trades while in Rule 10b5-1 presumes that someone who trades while in

possession of material non public information has in fact used possession of material non public information has in fact used the information in making the trade. the information in making the trade.

Statute of limitations is one year after discovery and three Statute of limitations is one year after discovery and three years after violation. years after violation.

Tipper &Tippee liability applies to both theories. Contact Tipper &Tippee liability applies to both theories. Contact between them should be established. between them should be established.

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Rule 14e-3Rule 14e-3

Prohibits insider trading during a tender offer and thus Prohibits insider trading during a tender offer and thus

supplements Rule 10b-5.supplements Rule 10b-5. Rule 14e-3(a) prohibits anyone, except the bidder, who Rule 14e-3(a) prohibits anyone, except the bidder, who

possesses material, nonpublic information of a tender possesses material, nonpublic information of a tender offer, from trading the target’s securitiesoffer, from trading the target’s securities

Rule 14e-3(d) is a preventive provision complementing Rule 14e-3(d) is a preventive provision complementing

Rule 14e-3(aRule 14e-3(a). ). Prohibits anyone with any form or Prohibits anyone with any form or connection to a tender offer from tipping material, connection to a tender offer from tipping material,

nonpublic information.nonpublic information. Is not premised on breach of a fiduciary dutyIs not premised on breach of a fiduciary duty

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SEC Enforcement of the Rule SEC Enforcement of the Rule 10b-5 and Rule 14e-310b-5 and Rule 14e-3

Permanent or a temporary injunctionPermanent or a temporary injunction Disgorgement of profits (most commonly used)Disgorgement of profits (most commonly used) Correction of misleading statementsCorrection of misleading statements

Disclosure of material informationDisclosure of material information Cease and desist ordersCease and desist orders Disciplinary sanctions and civil penalties for securities market Disciplinary sanctions and civil penalties for securities market

professionalsprofessionals Bounty provisions by the §20A of ITSFEA Bounty provisions by the §20A of ITSFEA §21A -> civil monetary penalty of up to three times the profit §21A -> civil monetary penalty of up to three times the profit

gained or loss avoided by a person who violates Rules 10b-5 gained or loss avoided by a person who violates Rules 10b-5 and 14e-3 and 14e-3

2020

Private Enforcement of the Rule Private Enforcement of the Rule 10b-5 and Rule 14e-310b-5 and Rule 14e-3

Under §20A’s express remedy, contemporaneous Under §20A’s express remedy, contemporaneous

traders are permitted to sue for a disgorgement of the traders are permitted to sue for a disgorgement of the

improper profits (or loss avoided).improper profits (or loss avoided). SEC’s power increased with private actions. SEC’s power increased with private actions. A plaintiff in a private damage action must have been A plaintiff in a private damage action must have been

purchaser or seller of the security forming the basis of purchaser or seller of the security forming the basis of the complaint and transaction causation usually the complaint and transaction causation usually

presumed but loss causation is required.presumed but loss causation is required.

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FRONT RUNNINGFRONT RUNNING

A broker trades on a security while in possession of A broker trades on a security while in possession of

material non-public information concerning the imminent material non-public information concerning the imminent block transaction of one of his customersblock transaction of one of his customers

The SEC has suggested that the exchanges designate The SEC has suggested that the exchanges designate front-running as a practice “inconsistent with just and front-running as a practice “inconsistent with just and equitable principles of trade” equitable principles of trade”

SEC’s current regulation is through its oversight authority SEC’s current regulation is through its oversight authority over the self-regulatory organizations (SROs); NYSE, over the self-regulatory organizations (SROs); NYSE, AMEX, NASDAQ.AMEX, NASDAQ.

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INVESTIGATION, REGULATION, INVESTIGATION, REGULATION, ENFORCEMENT COMPAREDENFORCEMENT COMPARED

Comprise at least about 10% of the enforcement actions Comprise at least about 10% of the enforcement actions

of SEC. of SEC. As of 24.02.2003 only 10 out 820 suits of Capital As of 24.02.2003 only 10 out 820 suits of Capital

Markets Board of Turkey were related to insider trading. Markets Board of Turkey were related to insider trading. Development of capital markets is usually matched with Development of capital markets is usually matched with

new insider trading schemesnew insider trading schemes

Transnational insider trading casesTransnational insider trading cases United States has the most extensive insider trading United States has the most extensive insider trading

regulationsregulations

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INVESTIGATIONS INVESTIGATIONS COMPAREDCOMPARED

The same for both companiesThe same for both companies Sources of casesSources of cases

InformantsInformants• Anonymous CallsAnonymous Calls• Market professionalsMarket professionals• Disgruntled employeesDisgruntled employees• CompetitorsCompetitors

Market SurveillanceMarket Surveillance Investigative StepsInvestigative Steps

Analyze market trading recordsAnalyze market trading records Obtain chronologiesObtain chronologies Conduct InterviewsConduct Interviews Analyze Monthly Account StatementsAnalyze Monthly Account Statements Analyze Telephone RecordsAnalyze Telephone Records Chart Out Connection b/w Insiders & TradersChart Out Connection b/w Insiders & Traders Take TestimonyTake Testimony Follow the MoneyFollow the Money Create and Update “Names” and Phones” DatabasesCreate and Update “Names” and Phones” Databases

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REGULATION AND REGULATION AND ENFORCEMENT IN TURKEYENFORCEMENT IN TURKEY

Only specific regulation against insider trading is Article 47/A-Only specific regulation against insider trading is Article 47/A-

1 of CML:1 of CML: ““To benefit to his/her self-owned property or to eliminate a loss so as to To benefit to his/her self-owned property or to eliminate a loss so as to damage equal opportunity among the participants in capital markets with damage equal opportunity among the participants in capital markets with the aim of gaining benefit for himself/herself or for third parties by making the aim of gaining benefit for himself/herself or for third parties by making use of non-public information which will be able to affect the values of use of non-public information which will be able to affect the values of capital market instruments in insider trading. The chairman and members capital market instruments in insider trading. The chairman and members of the Board of Directors, directors, internal auditors and other staff of the of the Board of Directors, directors, internal auditors and other staff of the issuers within the scope of Article 11, capital market institutions or of the issuers within the scope of Article 11, capital market institutions or of the subsidiary or dominant establishment, and apart from these the persons subsidiary or dominant establishment, and apart from these the persons who are in a position to be have information while carrying out their who are in a position to be have information while carrying out their professions or duties, and the persons who are in a position to have professions or duties, and the persons who are in a position to have information because of their direct and indirect relations with these.”information because of their direct and indirect relations with these.”

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REGULATION AND REGULATION AND ENFORCEMENT IN TURKEYENFORCEMENT IN TURKEY

In summary according to the CML;In summary according to the CML;

Scienter is required,Scienter is required, The scope of possible defendants is very broad,The scope of possible defendants is very broad, A gain of profit or avoidance of loss is required,A gain of profit or avoidance of loss is required, Materiality depends on the ability of the non-public information to affect the Materiality depends on the ability of the non-public information to affect the

valuevalue of the capital market instruments, of the capital market instruments, CMB may request a legal prosecution and/or may prohibit the violators CMB may request a legal prosecution and/or may prohibit the violators

temporarily or permanently from transactions on exchanges and other temporarily or permanently from transactions on exchanges and other organized markets (According to Article 46/i of the CML). organized markets (According to Article 46/i of the CML).

The criminal penalty for the violation of this Article is a prison sentence from The criminal penalty for the violation of this Article is a prison sentence from two to five years and a heavy pecuniary fine from 10 billion TL up to 25 two to five years and a heavy pecuniary fine from 10 billion TL up to 25 billion; If 2 or more cases are combined then min 3 max 6 years of prison. billion; If 2 or more cases are combined then min 3 max 6 years of prison.

No upper limit for pecuniary punishment, but not less than threefold of the No upper limit for pecuniary punishment, but not less than threefold of the benefitsbenefits

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REGULATION AND REGULATION AND ENFORCEMENT COMPAREDENFORCEMENT COMPARED

DifferencesDifferences

Philosophy different; in U.S. definition deduced from court Philosophy different; in U.S. definition deduced from court interpretations; an emphasis on breach of fiduciary dutyinterpretations; an emphasis on breach of fiduciary duty

Bounty systemBounty system In U.S. insider trading seen as a private fraud <-> In Turkey In U.S. insider trading seen as a private fraud <-> In Turkey

public fraud harming markets; no civil actions only criminal public fraud harming markets; no civil actions only criminal Subpoena PowerSubpoena Power In Turkey; no regulations like 14e-3, Regulation FD and no In Turkey; no regulations like 14e-3, Regulation FD and no

specific front-running rules. specific front-running rules.

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REGULATION AND REGULATION AND ENFORCEMENT COMPAREDENFORCEMENT COMPARED

Similarities Similarities

In Turkey; there is a public disclosure requirement similar to In Turkey; there is a public disclosure requirement similar to §16(a)§16(a)

Securities do not have to be traded or listed on an exchange in Securities do not have to be traded or listed on an exchange in order to attach a liability to an insider trader, in contrast to the order to attach a liability to an insider trader, in contrast to the case in many European countriescase in many European countries

CMB’s power to temporarily (for 2 years) or permanently prohibit CMB’s power to temporarily (for 2 years) or permanently prohibit the violator from transacting on exchanges and other organized the violator from transacting on exchanges and other organized marketsmarkets

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WHAT IF FAMOUS CASES WHAT IF FAMOUS CASES HAPPENED IN TURKEY?HAPPENED IN TURKEY?

    Turkey Conviction

in

Case Subject Materiality Gain/Loss Turkey?

Cady Roberts Co.A registered broker-dealer directed his customers to liquidate their holdings in Curtis-Wright stock because he had advance knowledge of a dividend cut.

√ √ √

Texas Gulf Sulphur

Insiders of a mine company purchased company stock on the open market with knowledge of a valuable mineral find that had not been publicly announced and made a considerable profit after the announcement.

√√ √

Chiarella

A financial printer deduced the names of the target companies in takeover bids from the documents he printed. He purchased the target company’s securities before the announcement of bids and sold them after the bids, thus making a profit.

? √ ?

DirksA company’s former official’s selective disclosure of insider information to an analyst giving an unfair advantage to the analyst and the analyst’s clients over the public generally

√ √ √

CarpenterA columnist of the Wall Street Journal traded the securities he wrote about and in turn gained a profit.

In Turkey this case would be interpreted as manipulation.

√

O'HaganThe attorney, after having learned of the law firm’s client’s planned tender offer, purchased call options in the target company prior to the announcement of the tender offer.

? √ ?

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A PROPOSAL FOR TURKEYA PROPOSAL FOR TURKEY

The word “value” in Article 47/A-1 can be changed as “value The word “value” in Article 47/A-1 can be changed as “value

and/or price” and/or price” The requirement for a profit gain or avoidance of a loss can The requirement for a profit gain or avoidance of a loss can

be eliminatedbe eliminated An addition may be made to Article 47/A of the CML, in order An addition may be made to Article 47/A of the CML, in order

to provide CMB with pecuniary punishments for violations of to provide CMB with pecuniary punishments for violations of insider tradinginsider trading

Adding bounty provisionsAdding bounty provisions Under CMB’s oversight, Association of the Capital Market Under CMB’s oversight, Association of the Capital Market

Intermediary Institutions of Turkey may prohibit front-running Intermediary Institutions of Turkey may prohibit front-running by enacting a uniform rule to be applied in all exchanges and by enacting a uniform rule to be applied in all exchanges and organized markets.organized markets.

CMB may promulgate a regulation similar to Regulation FDCMB may promulgate a regulation similar to Regulation FD

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