Capital markets regulator now ought to bite harder

The good news for investors at Nairobi Securities Exchange (NSE) is that insider trading is now being punished.

The Capital Markets Authority (CMA) in a statement on March 12 said they seized cash linked to 14 accounts that were frozen in October last year when the buyout of Kenolkobil by French firm Rubis Energy was announced.

Some Sh458 million was seized from insider trading suspects who sought to gain from the oil marketer’s takeover.

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Insider trading is when an employee trades in the securities of the firm on the basis of asymmetrical information.

Illegal insider trading is the practice of trading on the securities at stock exchange to one’s own advantage because of having access to confidential information. However, the regulators globally find proving insider trading difficult.

It is hard linking an insider transaction to the traders involved. The prevalence of insider trading distorts asset prices and results in misallocation of resources and CMA must put in an effort to stop it.

The explanation as to why taming insider trading is a challenge is found in our understanding of what is legal and illegal insider trading. Legal insider trading is when the employees of the firm trade share of the company but within the security regulator’s laws.

The debate on illegal or legal insider trading is a question that CMA and all stakeholders should address to a point where the rules of engagement are acceptable to all players.

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While we argue about winning stock techniques, there is one thing that nearly everyone can agree on - that market players with the best information ordinarily win. In the case of securities traded at NSE, those privileged are the corporate insiders who are obviously privy to information that the rest of us will never have.

This gives them an unfair advantage over an average investor when insiders are buying and selling their own company shares.

It is not surprising then that the CMA requires corporate insiders to report all their trades.

The regulator clarifies that insider trading violations may also include “tipping” such information, securities trading by the person “tipped” and trading by those who misappropriate such information.

The CMA defines illegal insider trading as “buying or selling a security in breach of a fiduciary duty or other relationship of trust and confidence while in possession of material, nonpublic information about the security.”

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Material information may be defined as any information specific to a company that would be considered important enough by an investor who is thinking of buying or selling shares.

This could include a lot of items, including financial results that differ from current expectations, security-related items such as an increase or decrease in dividend, developments, share split, acquisition or divestiture, winning or losing a major contract or customer. It is illegal to trade on nonpublic information in the country. Nonpublic information” refers to information that has not yet been released to the investing public.

Corporate insiders

Through the years, the regulators have brought insider-trading cases against hundreds of parties, including corporate insiders who traded the company’s shares, after learning of significant confidential developments.

Others are insiders’ family and friends as well as other recipients of tips who traded securities after receiving such information.

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Employees of service firms such as law, banking, brokerage, and printing companies who came across material nonpublic information on firms and traded on it are subject of insider trading.

Government staff who obtained inside information because of their jobs and trade on the same are not spared.

Since direct evidence of insider trading is usually rare, the evidence acquired is almost completely circumstantial.

CMA tracks insider trading in a number of ways, one being through market surveillance activities. This is one of the most important ways of identifying insider trading.  

The regulator uses sophisticated tools to detect illegal insider trading, especially around the time of key events such as earnings reports and key corporate developments.

Such surveillance activity is helped by the fact that most insider trades are conducted with the intention of “hitting it out of the ballpark”. This means that an insider who is indulging in illegal trading typically wants to rake in as much as they are able to rather than settling for a small or minimal score.

Such large, anomalous trades are usually flagged as suspicious and may trigger a CMA investigation. Insider trading is also revealed through tips and complaints from sources such as unhappy investors or traders on the wrong side of a trade.

Tips about insider trading may also come from whistle blowers who are able to collect between 10 per cent and 30 per cent of the money collected from those who break CMA securities laws.

However, whistleblowers seem to be more successful in unearthing widespread fraud rather than isolated illegal insider trading. Although Kenyan penalties for insider trading are among the stiffest globally, the number of cases filed by the CMA shows the practice may be impossible to completely stamp it out.

Therefore, there is a debate as to whether the issue of managing insider trading should be left to the individual companies or be a purview of CMA.

Insider trading borders on fraud and investors are likely to punish firms associated with the vice by denying them capital.

-The writer teaches at the University of Nairobi

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Nairobi Securities ExchangeCapital Markets AuthorityRubis Energy