E LAW - MURDOCH UNIVERSITY ELECTRONIC JOURNAL OF LAW ISSN 1321-9447 Volume 10 Number 2 (June 2003) Copyright E Law and author ftp://law.murdoch.edu.au/pub/elaw-issues/v10n2/bollen102.txt http://www.murdoch.edu.au/elaw/issues/v10n2/bollen102.html ________________________________________________________________________ Research Analysts and the Australian Market Misconduct Regime Rhys Bollen Contents: * Introduction * Research analysts o Introduction o Recent allegations and regulatory responses * False, misleading and deceptive conduct o Overview o Research inconsistent with own views o Reasonable basis * Insider trading o Rationale o Overview of the Australian provision o Research and analysis o Analysts using inside information o Analysts and front running * Other implications and law reform o Chinese walls o Limited distribution research * Conclusion * References * Notes Introduction 1. Australia has had a market misconduct regime for several decades. It includes specific provisions dealing with insider and manipulative trading, as well as broader provisions dealing with misleading and deceptive conduct. The insider trading provisions, in particular, have been the subject of considerable commentary and analysis.[1] 2. Research analysts have been the subjects of negative media attention in recent years. Allegations have been made both here and overseas that their research has been significantly compromised by conflicts of interest. Substantial out-of-court settlements in the US have only reinforced public suspicions, and political pressure to be seen to respond has resulted in local and overseas governments taking a close interest in this part of the industry. 3. As a contribution to the Australian debate, this paper will consider to what extent the Australian market misconduct regime already addresses the key issues highlighted overseas. It will also look at some key US cases and examine how they would have been treated in Australia. Research analysts Introduction 4. For the purposes of this paper, research analysts may be described as market professionals that specialise in analysing public and non-public information about securities, and forming and communicating their views to the market in the form of research reports. Generally, these reports reflect a suggested trading response for the reader[2] based on detailed analysis. While independent firms carry out some research, the majority is conducted by groups of people employed by investment banks[3] or large asset managers.[4] 5. Analysts are subject to considerable conflicts of interest in their day-to-day operations.[5] While some research and analysis is performed on a fee-for-service basis, the majority is cross-subsidised by other departments of the relevant organisation. This places analysts in a difficult position where their employer's interests have the potential to conflict with their own or where the interests of one branch of their organisation conflicts with those of another.[6] In a typical 'sell-side' structure, the costs of providing research are typically subsidised by the equities dealing, asset management or corporate finance business areas. These business areas have a natural interest in ensuring that the research they fund encourages greater trading volumes, maximises portfolio values or encourages greater corporate finance business (and fees) respectively.[7] 6. Analysts themselves are also exposed to significant personal conflicts of interest. Their research, assuming it is of reasonable quality, tends to have an impact on the prices of the securities they cover. The market for each security tends to respond to the reports published by well-regarded analysts[8] This places the analyst in a position of considerable influence. There is the temptation to either take advantage of this to profit the analyst's own interests, or to use inappropriate means to maintain their research reputation. Recent allegations and regulatory responses 7. Research analysts have been the subjects of a number of serious allegations, particularly in the United States. These include allegations of: o using inside information in their research reports,[9] o publishing research reports that were favourably biased towards valued clients of their employer,[10] o publishing research reports that were favourably biased towards securities they or their employer held, or had underwritten and was trying to sell,[11] o publishing research reports that were disproportionately advising clients to buy or sell stock (churning) to maximise trading volumes, and[12] o taking advantage of the reliance placed on their research reports by trading ahead of upcoming reports.[13] 8. The New York Attorney General (Elliot Spitzer) and a number of state and federal agencies in the US have settled claims concerning the above allegations against Bear Stearns & Co LLC, Credit Suisse First Boston Corp, Deutsche Bank, Goldman Sachs, J.P. Morgan Chase & Co, Lehman Brothers Inc, Merrill Lynch & Co Inc, Morgan Stanley, Salomon Smith Barney Inc and UBS Warburg LLC.[14] As part of the in-principle settlement in the litigation run by the New York Attorney General and others, the firms involved committed to: o insulate research analysts from investment banking pressure, o ban spinning[15] of initial public offerings (IPOs), o require provision of independent research, o ensure disclosure of analyst recommendations, and o pay significant monetary sanctions. 9. Responding to the above cases and to concerns about other possible misconduct, the New York Stock Exchange (NYSE) and the National Association of Securities Dealers (NASD) have introduced detailed and prescriptive rules regulating analyst behaviour. The rules cover trading restrictions,[16] operational practices and procedures,[17] remuneration[18] and disclosure obligations[19] Whilst these rules are detailed, their coverage is limited to members of the NYSE and NASD. 10. The main Australian regulator in this area, the Australian Securities and Investments Commission, is also reported to be taking some interest in research analysts. O'Loughlin reported in June 2002, "... ASIC will investigate stockbroking firms and look into analysts' shareholdings to ensure they are giving independent advice".[20] Later Eakin and Marriner said, "... partly a result of the collapses of HIH, Ansett and One.Tel, the Federal Government has called upon ASIC to look at Australia's own analyst independence, whether the rules need to be changed and ultimately if there have been any breaches."[21] 11. The Financial Services Authority (FSA) in the United Kingdom has also taken considerable interest in research analysts recently. This has included surveillance and site visits, as well as policy development. In Consultation Paper 171 Conflicts of Interest: Investment Research and Issues of Securities (CP 171), the FSA proposed imposing further detailed rules regulating analyst conduct, including trading restrictions, quiet periods around securities issues, controls on dissemination of research, restrictions on ownership of securities covered and conflicts disclosure.[22] They are also consulting upon a possible restriction on analysts covering securities in which they hold an interest.[23] 12. In the Federal Government's latest Corporate Law Economic Reform Proposal (CLERP) paper,[24] it has raised some issues for discussion and put forward some limited proposals about analysts. The proposals include that the law remain unchanged and that ASIC be asked to develop specific policy in relation to research analysts.[25] The paper also raises a number of broad analyst issues, including operational structures, trading restrictions, quality of advice and conflicts of interest disclosures.[26] However, in a speech on 14 March 2003, the Parliamentary Secretary to the Treasurer stated, in relation to analysts, "I have had another very close look at the issues and how you can improve the law in the regulatory environment around us and we will be proposing some further measures within the law which will give ASIC, I think, a far clearer piece of legislation to hang any policy guidance off. ... the law and the ASIC guidance that flows from that law will be improved, will be made more onerous and made far more clear."[27] The Australian Stock Exchange has also published in October 2002 a draft guidance note on research analysts.[28] The draft contained detailed requirements on structural, trading, operational and disclosure issues. 13. The Australian market misconduct regime deals to some extent with the types of misconduct by research analysts discussed in this part of the paper. The key Australian provisions[29] cover insider trading, market manipulation, and false, misleading and deceptive conduct. A more detailed consideration of the insider trading, and the false, misleading and deceptive conduct provisions and their application to research analysts is in parts 3 and 4 of the paper. False, misleading and deceptive conduct Overview 14. There are four interconnected provisions dealing with false, misleading and deceptive conduct in Part 10.2, Division 2 of the Corporations Act 2001 (Corporations Act). They are: o the prohibition on materially false or misleading statements,[30] o the prohibition on false, misleading or deceptive inducements to trade,[31] o the prohibition on dishonest conduct,[32] and o the (civil) prohibition on misleading or deceptive conduct.[33] 15. The false, misleading and deceptive conduct provisions overlap. Conduct that breaches one of the four is likely to breach one or more of the other provisions. This is especially so with the civil action for misleading or deceptive conduct (section 1041H), which is modelled on section 12DA of the Australian Securities and Investments Commission Act 2001 (ASIC Act) and section 52 of the Trade Practices Act 1974 (TPA). 16. A substantial body of jurisprudence has developed around the analogous ASIC Act and TPA sections. With appropriate modifications, we are able to apply them to the false, misleading and deceptive conduct provisions in the Corporations Act. This allows some conclusions to be drawn about sections that have not themselves been subject to judicial interpretation.[34] 17. While each case will of course depend on its facts,[35] research reports generally contain both statements of fact and statements of opinion. For example, they tend to include statements about a company's financial position, key personnel, recent activities and upcoming projects. These are often gleaned from the issuer's financial reports, annual reports, and other public statements by the issuer and interviews with key officers. Reports also tend to include various statements of opinion about the issuer, in particular statements about financial forecasts, income and revenue prospects, and the issuer's plans and upcoming initiatives. Reports often (but not always) contain a summary including either an express trading recommendation[36] or an overall opinion[37] 18. Should any of these statements be untrue or misleading, at least an action under section 1041H should be available. It would appear to be more difficult to run such a case under sections 1041E, 1041F or 1041G. This is because these are criminal provisions and require additional elements to be proven, such as recklessness or an intention to induce a person to deal in the relevant securities. 19. The overall recommendation or opinion in a research report is clearly "likely to induce persons in this jurisdiction to dispose of or acquire financial products".[38] Research reports are, by design, intended to be used by readers in making investment decisions. It is axiomatic that this is the intention of such research, and it would be difficult to argue that a research report does not have such an intention. While it will, of course, depend on the facts of any particular case whether a recommendation or overall opinion is likely to induce other persons to trade, it is the author's view that at least in most cases of reputable and widely read reports, a court would accept that reports are likely to induce such actions in a reader. Research inconsistent with own views 20. In the US, research analysts have been criticised for publishing research reports with which they didn't subjectively agree. There have been allegations that their public recommendations about particular securities were inconsistent with their views (expressed privately) about the same stocks.[39] An interesting question to ask is to what extent such conduct, had it occurred in Australia, would be prohibited under our false, misleading and deceptive conduct provisions. 21. As a general rule, courts have treated statements of opinion and statements of fact differently under the analogous ASIC Act and TPA provisions.[40] Generally, while a statement would be misleading if it were later shown not to be consistent with objective facts, the same is not true for a statement of opinion.[41] Courts have held that a statement of opinion is likely to be misleading or deceptive if the person expressing it does not in fact subjectively hold it. A statement of opinion "conveys the meaning that the maker of the statement had a particular state of mind when the statement was made and that there was a basis for that state of mind".[42] If the person did not in fact hold such an opinion, the statement of opinion, at least without further clarification, would generally be misleading or deceptive. 22. Where a research report states an opinion or a recommendation about a security which the author of the research report or its publisher does not agree with, consistent with the case law discussed above, the statement is likely to be misleading within the meaning of the false, misleading and deceptive conduct provisions. It is difficult to state categorically whether the statement would be "materially misleading" (section 1041E), but there is a good argument that it would be a case where the author or publisher "knows, or is reckless as to whether, the statement is misleading, false or deceptive" (section 1041F). 23. At the least, it is likely that the civil action for misleading or deceptive conduct would be available in relation to the overall recommendation or opinion in a research report. Being a civil provision, the standard of proof is lower and the additional requirements of inducement, recklessness, materiality or dishonesty need not be proven. It is likely that the publication of a summary recommendation or opinion in a research report which did not reflect the subjective views of the author or publisher would be misleading or deceptive conduct within the meaning of section 1041H. The remedy for breach of section 1041H is an action for damages (section 1041I). One may argue that this is an inadequate remedy, requiring as it does an aggrieved person to take civil action. This is one argument in favour of legislative reform in this area, as contemplated in CLERP 9.[43] 24. The structure of firms publishing research causes some complexity in the application of the false, misleading and deceptive conduct provisions. In many cases, the research analyst will not have final authority to determine the content of a research report. For example, the contents may be finalised by their supervisor, or by a research committee. To the extent that the analyst is not in a position to control the final content of the report, a court will presumably look to the firm's senior management to consider whether the report, published in the name of the firm, reflects the "firm's" views about the relevant security[44] It will be the views of the officer or group of officers with the delegated authority to approve the report for publication against which the content of the report would be compared when questions of inconsistency are being considered. While this adds a level of complexity, the fundamental issue of inconsistency and the potential misleading nature of such inconsistency remain within the scope of the false, misleading and deceptive conduct provisions. Reasonable basis 25. In the context of expert or professional opinions, cases decided under the analogous ASIC Act and TPA provisions have held that a statement of opinion by a person in their professional capacity involves an implied assertion that the opinion has a reasonable basis, is the result of the exercise of due care and skill, and is able to be relied upon.[45] An opinion given in circumstances that suggest that the opinion was based on "the exercise of certain expertise ... carries with it the implication that it is based on rational grounds and accordingly will breach the prohibition if it has no reasonable basis".[46] This is especially true where the person giving the opinion holds themselves out as "having special skill in relation to the ... subject" of the opinion.[47] 26. This line of cases gives rise to a limited statutory expectation that advice will have a reasonable basis. Professionals or experts, when giving advice in their professional capacity, need to ensure that their advice has a reasonable basis, is based on the exercise of due care and skill and is fit to be relied upon.[48] Failure to ensure this will expose the professional to the risk that their advice is misleading or deceptive. This is a negative obligation; the direct obligation is to avoid misleading or deceptive conduct and it is for the complainant to show that the advice was misleading or deceptive due to its lack of reasonable basis. Presumably, clear and prominent disclosure of a lack of reasonable grounds may ensure that the advice is not misleading or deceptive.[49] Clearly, a positive obligation to have a reasonable basis would be preferable. However, this is a matter for law reform.[50] 27. Research analysts, as market professionals, hold themselves out as possessing and using expertise in the preparation of their research reports. Their reports may be misleading or deceptive if not based on reasonable grounds. There have been allegations that the recommendations or opinions contained in many research reports have been largely motivated by inappropriate matters like the desire to keep corporate clients, increase trading volume or cause the value of particular securities to increase. While such a motivation will not necessarily mean that a research report is not based on reasonable grounds, it would at least cast doubt over the reasonableness of the basis of the report. Of course, the onus would be on the complainant to demonstrate a lack of reasonable grounds and there may in fact be good reasons for the opinions in the report.[51] However, where the reasons (other than the conflicts noted above) for the report are few or not particularly compelling, a court may be convinced that the report was not based on reasonable grounds and is therefore misleading or deceptive. 28. Research analysts generally document the grounds for any opinion they publish in a research report. Indeed, these reasons are usually included in the research report. Where there are conflicts of interest relating to the research, it would be prudent to ensure that there are compelling objective reasons for any recommendation or opinion. Otherwise, a sceptical court or regulator may surmise that the primary grounds for the research were the conflicts of interest, that the report was not based on reasonable grounds and was therefore misleading or deceptive within the meaning of the market misconduct provisions. Insider trading Rationale 29. There has been a large amount of academic commentary discussing the rationale of the Australian insider trading regime. Whilst it is not beyond all doubt, the generally accepted view is that the Australian regime is based on market fairness and access to information theses.[52] It was not always so. Indeed, as recently as the 1970s the Australian regime was based more closely on fiduciary and misappropriation theses.[53] 30. Internationally, there are three main views as to the appropriate theoretical basis for an insider trading regime. Leaving aside the sporadic arguments against any form of insider trading prohibition,[54] most international regimes follow one of the following: market efficiency or fairness, fiduciary duty and misappropriation.[55] Overview of the Australian provision 31. The current Australian insider trading prohibition has two main limbs. It prohibits trading or procuring trading while in possession of inside information[56] as well as the communication of inside information to others[57] A detailed analysis of the Australian prohibition and its history is beyond the scope of this paper. However, a brief analysis of some key elements of the offences will assist the discussion below. 32. The Australian prohibition, consistent with its access to information rationale, adopts a broad definition of inside information. For the purposes of the above prohibition, inside information is: "information in relation to which the following paragraphs are satisfied: (a) the information is not generally available; (b) if the information were generally available, a reasonable person would expect it to have a material effect on the price or value of [the relevant] financial products." This definition encompasses information generated outside of the relevant product issuer. Information need not be "leaked" or obtained from within the issuer to be inside information. That means that any person or organisation capable of creating price-sensitive information about a financial product is potentially able to create (and possess) inside information. This has profound and far-reaching consequences, which is evidenced by the broad range of exemptions provided under the Act. There is the risk, as some commentators have pointed out, that "dogged pursuit of such a rule can significantly diminish the incentive to bring new information into the market".[58] 33. For example, the above definition of inside information would include a director knowing that their company intends shortly to purchase a large parcel of particular listed securities. Assuming that the parcel is large enough that it is likely to affect the market price for the securities, the director's knowledge would be inside information. As the company is considered to possess information held by its officers, in the above scenario the application of the insider trading prohibition would have an absurd result - the company would not be permitted to carry out its proposed transaction, simply because its officers knew in advance that it intended to carry out that same transaction. To prevent this clearly inappropriate result, the legislature included exemptions for "knowledge of one's own intentions" in sections 1043H-1043J.[59] 34. The Australian prohibition, consistent with its access to information rationale, also adopts a broad definition of an insider. An insider is essentially a person who is in possession of inside information and appreciates at least at a basic level the significance of the information. Provided that the person appreciates that the inside information is not generally available and is price-sensitive, they will themselves be an insider. The means by which the insider came into possession of the inside information is largely irrelevant for the purposes of the prohibition.[60] It has even been said that the provisions apply in an "unprincipled"[61] way and "indiscriminately to any market participant, whether diligent analyst or fraudulent director" [62] While of course the means by which the person acquired the information would be relevant to a jury in considering to what extent the person appreciated the significance of the information, it is at most a relevant background fact only. 35. This is in contrast to many otherwise comparable overseas regimes, where a person in possession of inside information is only caught by the insider trading prohibition if they have a material connection with the issuer.[63] Most overseas regimes, being founded on a premise of fiduciary duty or misappropriation of information, attach the insider trading prohibition only to those persons who are themselves closely connected to the relevant issuer[64] or who have received the inside information from such a person in circumstances involving confidence, breach of fiduciary duty or misappropriation of information. As we shall see from the discussion below, this is a key reason why the Australian regime's application to research analysts is quite different to and arguably more effective than comparable overseas regimes. 36. Another key aspect of the Australian prohibition is its concept of generally available information. Information that is generally available is, ipso facto, not inside information, and can therefore be traded on or communicated freely. The definition of generally available information is particularly important in the context of the application of the insider trading prohibition to analysts. In essence, information is generally available if it is readily observable, broadly disseminated (and a reasonable period of time has passed) or is deduced from either of these sources.[65] Research and analysis 37. A number of jurisdictions, including Australia, provide a limited exception for research and analysis.[66] In Germany, it is limited to research based on publicly available information.[67] The US exception applies to all research and analysis, regardless of whether it is based on non-public information.[68] 38. In Australia, the exception is limited to deductions, conclusions or inferences drawn from either readily observable matter[69] or information that has been broadly disseminated.[70] The rationale for this exception is that research analysts and other market professionals should not be prevented from using their expertise to analyse the market and trade accordingly.[71] "Competition among brokers, analysts and advisers manifests itself in what one could call the race for information: a race to obtain and disseminate to one's client information which is not generally available. ... [Limiting this competition may] impede the process by which information which is not generally available becomes generally available."[72] Strictly speaking, there is no time restriction or quiet period in the research and analysis exemption. By contrast to the broadly disseminated information limb (section 1042C(1)(b)), provided that a particular piece of information is drawn exclusively from other generally available information, it itself is generally available information at all times. This means a market professional may trade immediately on the basis of their research or analysis, provided it is based exclusively on deductions drawn from other generally available information. 39. The main limitation to the research and analysis exemption is its limitation to deductions etc drawn from generally available information. In many cases, research and analysis is drawn from a combination of generally available and non-public information. The product of such research or analysis is not, by definition, generally available information. It is, therefore, capable of being inside information (if it is also price-sensitive).[73] It is a factual question in any particular case as to whether the product of particular research and analysis is merely "deductions, conclusions or inferences made or drawn from" generally available information, or is (or includes) "deductions, conclusions or inferences made or drawn from" other information. The "other" information need not be confidential or inside information itself to take the research outside the scope of the section 1042C(1)(c) exemption - it is enough that it is other than generally available information. Analysts using inside information 40. The first question that has to be asked is to what extent a research report or its contents might be inside information. Where some or all of the contents of a research report is (or is drawn from) inside information[74] the research analyst and any other person also in possession of the contents of the report would be unable to trade on it or communicate it to others. This is merely a restatement of the general proposition - analysts, like any other person, must not trade on or communicate inside information, regardless of the fact that the method by which they intend to communicate the information is the publication of a research report. The prohibition on communication of inside information is absolute and makes no exception for the publication of research reports.[75] To the extent that the publication of a research report involves the communication of inside information, it is prohibited. 41. A recipient of such a research report, assuming it was widely distributed, may be able to trade on the information or communicate it to others. The contents of the research report, once widely distributed, would be generally available information for the purposes of section 1042C(1)(b). The information will not be "generally available" for the purposes of section 1042C until "a reasonable period for it to be disseminated ... has elapsed". However, the recipient will effectively be able to trade on it and communicate it to others immediately, due to the operation of the defences in section 1043M(2) and (3). This assumes that the recipient acquired the information solely through the receipt of widely distributed information.[76] 42. In Dirks v SEC, a research analyst received information about serious financial and management problems at a listed insurance company (Equity Funding of America (EFA)).[77] Dirks received the information originally from Secrist, a former officer of EFA. Dirks confirmed what he was told by Secrist and also obtained further information about EFA from other sources. The court accepted that the information in Dirks' possession was not generally available. In the Companies and Securities Advisory Committee (CASAC) in its June 2001 Insider Trading Discussion Paper, the committee states: "In the leading US decision, Dirks v SEC, the Court held that an analyst who questioned corporate employees about rumours of possible fraudulent activities in the company, and then discussed his findings with some clients, who subsequently sold their securities in that company, did not breach the US insider trading rules. The Court ruled that the analyst had obtained material non-public information from diligent research. To prohibit this activity through the insider trading laws: 'could have an inhibiting influence on the role of market analysts, which ... is necessary to the preservation of a healthy market. It is commonplace for analysts to "ferret out and analyse information" and this is often done by meeting with and questioning corporate officers and others who are insiders'."[78] There was no suggestion in Dirks that the information was other than price-sensitive. Certainly the information was successfully used by Dirks' clients to trade in advance of public knowledge of the problems at EFA and, when the information became widely known, the price of EFA's securities fell dramatically.[79] 43. The Supreme Court held that Dirks did not breach the US insider trading prohibition.[80] Dirks was not an insider or otherwise sufficiently connected with EFA, nor was he subject to a duty to keep the information confidential.[81] Being based on fiduciary or misappropriation of information rationales, the US prohibition did not catch Dirks' conduct. "The policy rationale was that a wider prohibition could have an inhibiting influence on the investigative role of market analysts, which the SEC itself recognises is necessary to the preservation of a healthy market."[82] The case report and commentary that followed also hints that the court may have shown Dirks some sympathy, from a public policy perspective, for his attempts to expose the financial problems and alleged fraud at EFA. The public interest was served in Dirks' communication of information about EFA.[83] 44. The information in Dirks' possession about EFA would have been inside information for the purposes of the Australian provisions, had the scenario taken place here.[84] The information (as a whole) wasn't generally available, although it probably contained some information gleaned from research and analysis of the publicly available information about EFA. The information in Dirks' possession clearly was of a nature that was "likely to, influence persons who commonly acquire [EFA's securities] in deciding whether or not to acquire or dispose of" EFA's securities.[85] It in fact had this effect on a number of Dirks' clients.[86] 45. None of the relevant exemptions would have applied to Dirks' actions. CASAC considered whether an exemption for conduct of this nature was warranted and concluded that it probably was not.[87] Hence, prima facie, Dirks' conduct would have breached the Australian insider trading provisions.[88] This may raise the question of whether some form of public interest or whistle-blower defence is necessary.[89] However, the history of the enforcement of the insider trading provisions in Australia has been that only the most clear-cut and serious breaches have been prosecuted. Therefore, it may be sufficient to rely on the relevant federal agencies[90] to take a sensible and common sense approach to enforcing the insider trading provisions in circumstances involving some element of whistle-blowing. As one commentator states, "the difficulty with treating insider trading as currently defined in the Corporations Law as a criminal offence is that the sort of conduct caught will often fall well short of the standards of moral culpability we normally expect in the criminal law."[91] Analysts and front running 46. The second question to ask is whether knowledge about the contents of an upcoming research report is itself inside information. Knowledge that a research report from a particular firm or author with particular content is to be published shortly is itself a separate piece of information to the contents of the report. This is the distinction between information in a report and information about a report. For example, let us assume an upcoming research report is based purely on generally available information.[92] According to section 1042C(1)(c) the contents of such a report (information in the report) would not constitute inside information. However, information about the contents and timing of the report (information about the report) may itself be inside information. 47. Information about the contents and timing of an upcoming research report would be inside information if it is not generally available and is price-sensitive.[93] It would not be readily observable,[94] is unlikely to have been communicated to a wide audience and is probably not ascertainable by analysis of information that is readily observable or broadly disseminated.[95] 48. Empirical research about the predictive ability of research reports and their impact on the market price for the securities they analyse has provided mixed results[96] However, it is probably fair for the purposes of this discussion to suggest that the contents and timing of many research reports will be price-sensitive. Certainly it is clear that research reports are intended to influence decisions made by investors about whether to acquire, hold or dispose of securities. It would be reasonable to expect that reports by high profile, respected and influential analysts would be "likely to, influence persons who commonly acquire [securities] in deciding whether or not to acquire or dispose of" the securities. It is the raison d'etre of the provision of such research. One consequence of this is that there is likely to be some temptation for the analyst to "trade in those securities before publishing their research findings (and any recommendations), for instance, by buying [selling] securities in advance of releasing positive [negative] research results (and recommendations) concerning those securities."[97] 49. There have been at least two overseas prosecutions for insider trading based on pre-publication trading or dissemination of information about the contents and timing of upcoming research reports or similar material. In US v Carpenter, a columnist with the Wall Street Journal was convicted of insider trading in a scheme involving the communication of information about upcoming pieces in his influential market analysis column to associated persons who traded on the information.[98] The CASAC report also referred to "a recent successful prosecution under the German insider trading law of a business journalist who purchased securities in advance of publishing his price-sensitive recommendations concerning those securities."[99] 50. In US v Carpenter the columnist, Winans, gave pre-publication information about the content and timing of upcoming articles in his column "Heard it on the Street" to a selected group of stockbrokers.[100] Those stockbrokers traded on this information and the group shared profits. Winans distributed information about 27 upcoming columns to the stockbrokers and together they made around US$690,000 profit.[101] 51. Interestingly in this case, the court accepted the appellants' argument that the information communicated in the columns themselves was based on generally available information.[102] Hence, the publication of the columns in the usual course of the Wall Street Journal's business was not prohibited. However, the insider-trading prohibition caught the pre-publication information about the content and timing of upcoming column articles. Although Winans was not closely connected with the companies whose securities he was writing about, the court held that Winans' conduct involved misappropriation of information that was rightly the property of the Wall Street Journal. It was Winans' misuse of this information for his private profits that triggered the US insider trading prohibition. This was consistent with the misappropriation of property approach to the insider trading prohibition, which was influential in US jurisprudence at the time.[103] The Supreme Court was evenly split in the appeal, so the lower court decision (being a conviction) was upheld.[104] 52. There was no doubt in Carpenter that the information selectively distributed to the group of stockbrokers by Winans was not generally available. Further, the court readily held that the information was price-sensitive. The headnote to the US Supreme Court report states that the "investment advice column ... because of its perceived quality and integrity, had an impact on the market prices of the stocks it discussed".[105] 53. The information about upcoming columns would have been inside information under the Australian provisions, had the case been decided here. The difficulty the US Supreme Court has with whether the necessary connection, duty or misappropriation was present to attract the US insider trading prohibition is not a significant issue in the application of the Australian provisions. The Australian definition of inside information looks only to the nature of the information, not to the holder's connection with the relevant company or their conduct (or misconduct) in acquiring the information.[106] The information, on its face, was both price-sensitive and not generally available. As such, it would be inside information for the purposes of the Australian regime. 54. Winans' communication of the inside information would have been contrary to section 1043A(2).[107] Trading on the information by the stockbrokers would have been contrary to section 1043A(1).[108] In both cases, the relevant actors were in possession of inside information about listed securities in circumstances where they knew or ought to know that the information was inside information. In the circumstances, fundamental to the illegal scheme was an understanding by the parties that the information they received from Winans was both price-sensitive and not generally available. 55. As a general rule, based on the analysis about Carpenter's case and the Australian provisions, trading in advance of the publication of a research report by a person who possess information about the content and timing of the report would prima facie be a breach of the insider trading provisions. Likewise, communication of such information to third parties in circumstances where the recipients know or ought to know that it is inside information would also be a breach. The CASAC appeared to come to a similar conclusion in their July 2001 report, where they stated, "Trading in affected securities by an entity prior to publication of its price-sensitive recommendations appears to constitute insider trading, except where there is an effective Chinese Wall between the research and trading personnel of the entity. The inside information in this case is the research findings (and any recommendations), notwithstanding that they may be based on deductions, conclusions and inferences drawn from publicly available information. Also, the statutory exceptions for persons having knowledge of their own intentions or activities only apply to their own transactions in securities, not to the content of any report that may influence trading by others."[109] Other implications and law reform[110] Chinese walls 56. Traditionally, the law has treated information in the possession of an officer of a company as being held by the company as a whole, as with information held by one partner of a partnership.[111] In the context of insider trading, this would mean that a company is unable to trade in any securities where any one of its officers possesses inside information about the securities. A "Chinese walls" defence applies for body corporates and partnerships.[112] Essentially it enables such entities to structure and manage themselves so that particular staff do not hold inside information and are therefore able to trade or communicate with others without breaching the insider trading provisions.[113] The July 2001 CASAC report states the "Australian legislation seeks to permit organizations to both research and trade, while protecting themselves from the insider trading provisions for any dealing done on their behalf, through the use of Chinese Walls between their research and trading divisions."[114] However, the exemption applies to conduct prohibited by section 1043A(1) only (trading). It does not apply to communicating inside information to others (section 1043A(2)).[115] 57. In the context of analysts, this means that an officer in the dealing unit of an investment bank may trade in securities covered by upcoming research reports provided that the officer is not aware of inside information about the upcoming report (eg its timing or content), arrangements were in place to restrict the communication of such inside information and in fact no such communication took place. As there is no analogous exemption for communication of inside information, technically if any one officer in the company is in possession of inside information about a security, the company as a whole is treated as holding inside information about the issuer and is prohibited from communicating it to third parties. This would mean that if (for example) officers in the corporate finance unit of an investment bank are aware of inside information about one of their corporate clients, the whole company is taken to be in possession of that information. 58. Whether a research analyst employed by the bank could publish research about the corporate client, even if in fact they were unaware of the inside information held by the corporate finance staff, would depend on whether the publication of the research was, of itself, "directly or indirectly, communicat[ing] the [inside] information, or caus[ing] the [inside] information to be communicated" for the purposes of section 1043A(2).[116] This section has an implied quasi-Chinese walls defence, in that while the whole bank may be taken to be in possession of the inside information, communications about the relevant security are only prohibited if they will, directly or indirectly, result in the communication of the relevant inside information. 59. Full service firms[117] need to take particular care to ensure that any staff permitted to communicate with members of the public about securities are not in possession, at any time, of inside information about those securities. Further, it would be prudent for external communications to be screened by compliance or similar staff aware of the inside information that the organisation holds to ensure that communications (eg research reports) do not inadvertently or indirectly communicate any inside information, even if the information was not subjectively known by the report's author.[118] 60. CASAC[119] recommended that the Chinese walls defence in the former section (section 1002M) be extended to procuring.[120] It did not comment on the absence of a Chinese walls defence to the communicating offence.[121] This may have been due to a view that the implied quasi-Chinese walls defence is sufficient. However, this author suggests that the insertion of an appropriate defence would be preferable to reliance on an arguably implied defence. Limited distribution research 61. As discussed above, there is a defence for trading by recipients of research reports containing inside information.[122] Where the research has been broadly disseminated, recipients will be able to trade on it. For immediate trading, while the information will not be "generally available" for the purposes of section 1042C until "a reasonable period for it to be disseminated ... has elapsed", there is a defence available under section 1043M. For non-immediate trading, the information contained in the research report would be generally available for the purposes of section 1042C.[123] 62. These defences are only available where the information has been "made known in a manner that would, or would be likely to, bring it to the attention of persons who commonly invest in ... financial products of a kind whose price might be affected by the information".[124] Broadly distributed research reports would fall within this concept. However, it is less clear for limited distribution, subscription only research reports. Can it be said that the information in such reports is made available in manner that is likely to bring it to the attention of persons who commonly invest in the securities that are the subject of the report? If not, the recipients of the research report will be unable to trade on the basis of the report. As the information would not satisfy section 1042C(1)(b)(i), neither the section 1043M defence nor the exclusion for generally available information would apply. Narrowly distributed research reports containing inside information would themselves be inside information and recipients would be unable to trade on them or communicate them to others. 63. This is consistent to the "access to information" rationale underlying the Australian regime. If the research report contains or is based on inside information the firm producing the report should not be able to trade on it or communicate it, and the same should apply to other recipients of the information. This may in effect discourage limited distribution of research reports containing inside information. Once recipients realise they are unable to rely on the research, they are unlikely to pay for it and producers will be forced to withhold the research until its contents are no longer inside information.[125] In either case, the "access to information" rationale of the provisions appears to have been served. However, one commentator has suggested that: "Assuming [the analyst] used no unlawful means to obtain the information and did not receive any confidential information, this conclusion is arguably somewhat unfair. To require [the analyst] to disseminate it before being allowed to trade or tip ... again provides no reward or incentive for diligence. ... the definition of when information is generally available is narrower than justified by the unfair advantage theory. Specifically, that definition should include cases where the information could lawfully be obtained by a member of the public without a third party disclosing confidential information."[126] Conclusion 64. Australia's market misconduct regime has been in force for several decades. It includes specific provisions dealing with insider and manipulative trading, as well as broader provisions dealing with misleading or deceptive conduct. 65. The Australian market misconduct regime provides a partial response to the risks and alleged misconduct of research analysts. Front running of a research report and distribution of inside information through the publication of research reports are both prohibited by the insider trading regime. Publication of research reports that do not reflect the views of the firm that published them would at least prima facie be misleading or deceptive within the meaning of section 1041H. Further, a negative reasonable basis obligation can also be drawn from the case law on misleading and deceptive conduct. 66. There are some implications for future Australian law reform identified in the paper. In particular, they are in the area of Chinese walls and a positive reasonable basis obligation. Potential law reform in the area of limited circulation research reports is also identified but not recommended. 67. Australia is in some ways a number of years ahead of comparable overseas regimes in its regulation of research analysts. The access to information rationale for our insider trading provisions has meant that their drafting addresses misconduct by research analysts in ways that few other countries do. Further, our broad misleading or deceptive conduct regime[127] is sufficiently flexible to address at least some cases where research reports are published with a manifest lack of reasonable basis. References Aitken, "The Impact of Brokers' Recommendations: Australian Evidence" Pacific Basin Muthuswamy Journal of Finance (pending publication). Draft available at and Wong http://finance.ecom.unimelb.edu.au/TestingArea/Research/pacap_papers/23.pdf Shaun "The Regulation of Insider Trading in Derivatives" (1995) 13 CSLJ 476 Ansell Ashley "The Reform of Insider Trading law in Australia" (1992) 15 UNSWLJ 214 Black Australian Media Release 02/170 "Christopher Savage banned for 3 months", 15 May 2002 Securities (http://www.asic.gov.au, accessed 20 March 2003) and Investments Commission Australian "Draft Business Rule Guidance Note", Australian Stock Exchange, 11 October Stock 2002 (http://www.aimr.com/pdf/standards/comments/SIA_attachment2.pdf, Exchange accessed 10 March 2003) TE Bostock "Australia’s new insider trading laws" (1992) CSLJ 165 Senator Ian "Address to ASIC Summer School – Sydney", 14 March 2003, Campbell (http://parlsec.treasurer.gov.au/parlsec/content/speeches/2003/001.asp, accessed 20 March 2003) Jason "The Future of Frontrunning" (1995) 13 CSLJ 434 Carley Companies Insider Trading Proposals Paper, CAMAC, September 2002 and Markets Advisory Committee (CAMAC) Companies Insider Trading Discussion Paper, CASAC, June 2001 and Securities Advisory Committee (CASAC) Julian "Insider trading and OTC derivatives under the Financial Services Reform Donnan Act" (2003) 14 JBFLP 32 Jan Eakin "ASX gets tough on brokers", The Age, October 14 2002 (http://www.theage.com.au/articles/2002/10/13/1034222680514.html, accessed 20 March 2003) Jan Eakin "Long arm of coincidence", Sydney Morning Herald, 30 November 2002 and Cosima (http://www.smh.com.au/articles/2002/11/29/1038386314281.html, accessed 1 Marriner March 2003) Barbara "No quick fix: As the bear market illuminates analysts’ conflicts, Wall Etzel Street looks for a cure" Investment Dealers Digest, 7 May 2001 Freeman and "Australian Insider’s Views on Insider Trading" (1999) 10 Australian Adams Journal of Contract Law 148 Financial Discussion Paper 15 Investment research: Conflicts & other issues (DP15) Services Authority (UK) Financial Consultation Paper 171 Conflicts of Interest: Investment Research and Services Issues of Securities (CP171) Authority (UK) Ford, Ford’s Principles of Corporations Law, 11th edition, Butterworths, Austin and Melbourne Ramsay Michael "Insider Trading Enforcement: Where Are We Now and Where Do We Go From Gething Here?" (1998) 16 CSLJ 607 Mathew "Power and conflicts of interest in professional firms: evidence from Hayward investment banking" Administrative Science Quarterly (March 1998) Colin The Law of Misleading or Deceptive Conduct, Butterworths, Perth, 1998 Lockhart H Manne "In Defence of Insider Trading" (1966) 43 Harvard Business Review 113 Justin "Insider trading – The Need for Conceptual Clarity" (1996) 14 CSLJ 151 Mannolini Russell Miller’s Annotated Trade Practices Act 1974, 24th edition, Lawbook Company, Miller Sydney 2003 New York "Affidavit of Eric R. Dinallo in New York Attorney General’s investigation Attorney of Merrill Lynch & Co Inc" (April 2002) General’s (http://www.oag.state.ny.us/press/2002/apr/MerrillL.pdf, accessed 20 March office 2003) New York "Exhibit B, Agreement between the Attorney General of the State of New York Attorney and Merrill Lynch, Pierce, Fenner and Smith Inc", 21 May 2002 General’s (http://www.oag.state.ny.us, accessed 20 March 2003) office New York Press release "Merrill Lynch stock rating system found biased by Attorney undisclosed conflicts of interest", 8 April 2002, General’s (http://www.oag.state.ny.us/press/2002/apr/apr08b_02.html, accessed 10 office March 2003) New York Press release "SEC, NY Attorney General, NASD, NASAA, BYSE and state Attorney regulators announce historic agreement to reform investment practices - General’s $1.4 Billion Global Settlement Includes Penalties and Funds for Investors", office 20 December 2002, (http://www.oag.state.ny.us/press/2002/dec/dec20b_02.html, accessed 10 March 2003) Toni "Review to protect man and dad investors", Sydney Morning Herald, 22 June O’Loughlin 2002 (http://www.smh.com.au/articles/2002/06/21/10238644503534.htm, accessed 20 March 2003) Simon "The Regulation and Prosecution of Insider Trading in Australia: Towards Rubenstein Civil Penalty Sanctions for Insider Trading" (2002) 20 CSLJ 89 Semaan, "Is Insider Trading a Necessary Evil for Efficient Markets?: An Freeman and International Comparative Analysis" (1999) 17 CSLJ 220 Adams Kathryn "The Fiduciary Basis of Insider Trading Liability: Dirks Down Under" (1984) Skoyles CSLJ 13 R Tomasic Casino Capitalism? Insider Trading in Australia, Australian Institute of Criminology, 1991 (http://www.aic.gov.au/publications/lcj/casino/, accessed 4 March 2003) Dr Gordon "Insider Trading in Australia: When is Information Generally Available?" Walker (2000) 18 CSLJ 213 Victor Yeo A comparative Analysis of Insider Trading Regulation – Who is liable and what are the sanctions?, (Nanyang Business School, Nanyang Technological University, Singapore, 13 January 2001) Notes [1] See for example Black, "The Reform of Insider Trading law in Australia", 1992, at 222 [2] Eg 'buy', 'hold' or 'sell' [3] Known as 'sell-side' analysts [4] Known as 'buy-side' analysts [5] Etzel, "No quick fix: As the bear market illuminates analysts' conflicts, Wall Street looks for a cure", 7 May 2001 [6] Hayward, "Power and conflicts of interest in professional firms: evidence from investment banking", March 1998 [7] Etzel [8] Aitken, Muthuswamy and Wong, "The Impact of Brokers' Recommendations: Australian Evidence" [9] New York Attorney General's office, "Affidavit of Eric R. Dinallo in New York Attorney General's investigation of Merrill Lynch & Co Inc" April 2002; Dirks v US (1983) 463 US 646 [10] New York Attorney General's Press Release, 20 December 2002; New York Attorney General's office, "Affidavit of Eric R. Dinallo in New York Attorney General's investigation of Merrill Lynch & Co Inc" (April 2002); New York Attorney General's Press Release, 8 April 2002 [11] New York Attorney General's Press Release, 20 December 2002; New York Attorney General's office, "Affidavit of Eric R. Dinallo in New York Attorney General's investigation of Merrill Lynch & Co Inc" (April 2002); New York Attorney General's Press Release, 8 April 2002 [12] New York Attorney General's Press Release, 20 December 2002; New York Attorney General's office, "Affidavit of Eric R. Dinallo in New York Attorney General's investigation of Merrill Lynch & Co Inc" (April 2002); New York Attorney General's Press Release, 8 April 2002 [13] United States v Carpenter 791 F.2d 1024 (1986) [14] New York Attorney General's Press Release, 20 December 2002. A settlement 'in principle' was announced on 20 December 2002. As at 20 March 2003, a formal and final settlement had not yet been reached. Separate litigation was resolved with Merril Lynch in May 2002 - see New York Attorney General's Press Release, 8 April 2002. [15] allocating lucrative IPO shares to corporate executives and directors who are in the position to greatly influence investment banking decisions [16] to address concerns about inappropriate trading activity close to the publication of research [17] covering matters such as reporting lines to address concerns about inappropriate influence on research analysts by other business units [18] to address concerns about improper incentives [19] covering both conflicts and performance issues [20] "Review to protect man and dad investors", 22 June 2002 [21] "Long arm of coincidence", 30 November 2002 [22] Chapter 4 [23] paragraph 4.20-4.22 [24] CLERP 9 - Corporate Disclosure: Strengthening the financial reporting framework [25] proposal 17, page 121 [26] p121-128 [27] Address to ASIC Summer School, 14 March 2003 [28] "Draft Business Rule Guidance Note", 11 October 2002 [29] Primarily sections 1041E, 1041F, 1041G(1), 1041H and 1043A [30] Section 1041E(1) "A person must not (whether in this jurisdiction or elsewhere) make a statement, or disseminate information, if: (a) the statement or information is false in a material particular or is materially misleading; and (b) the statement or information is likely: (i) to induce persons in this jurisdiction to apply for financial products; or (ii) to induce persons in this jurisdiction to dispose of or acquire financial products; or (iii) to have the effect of increasing, reducing, maintaining or stabilising the price for trading in financial products on a financial market operated in this jurisdiction; and (c) when the person makes the statement, or disseminates the information: (i) the person does not care whether the statement or information is true or false; or (ii) the person knows, or ought reasonably to have known, that the statement or information is false in a material particular or is materially misleading." [31] Section 1041F "(1)A person must not, in this jurisdiction, induce another person to deal in financial products: (a) by making or publishing a statement, promise or forecast if the person knows, or is reckless as to whether, the statement is misleading, false or deceptive; or (b) by a dishonest concealment of material facts; or (c) by recording or storing information that the person knows to be false or misleading in a material particular or materially misleading if: (i) the information is recorded or stored in, or by means of, a mechanical, electronic or other device; and (ii) when the information was so recorded or stored, the person had reasonable grounds for expecting that it would be available to the other person, or a class of persons that includes the other person." [32] Section 1041G(1) "A person must not, in the course of carrying on a financial services business in this jurisdiction, engage in dishonest conduct in relation to a financial product or financial service." [33] Section 1041H(1) "A person must not, in this jurisdiction, engage in conduct, in relation to a financial product or a financial service, that is misleading or deceptive or is likely to mislead or deceive." [34] The false, misleading and deceptive provisions have been in force since 11 March 2002, the commencement date for the Financial Services Reform Act 2001. [35] Miller, Miller's Annotated Trade Practices Act 1974, at paragraph 1.52.25 [36] Eg. 'buy', 'hold' or 'sell' [37] Eg. 'outperform the market', 'in line with the market', 'underperform the market' [38] Section 1041E(1)(b)(ii) [39] Exhibit B, Agreement between the Attorney General of the State of New York and Merrill Lynch, Pierce, Fenner and Smith In, 21 May 2002 (http://www.oag.state.ny.us, accessed 20 March 2003) [40] Lockhart, The Law of Misleading or Deceptive Conduct, 1998 at paragraph 4.32-35, Miller at paragraph 1.52.55 [41] Lockhart at paragraph 4.30, Global Sportsman Pty Ltd v Mirror Newspapers Pty Ltd (1984) 2 FCR 82 [42] Miller at paragraph 1.52.55; James v ANZ Banking Group Ltd (1986) 64 ALR 347; Lockhart at paragraph 4.30; Tobacco Institute of Australia Ltd v Australian Federation of Consumer Organisations Inc (1992) 38 FCR 1; Global Sportsman Pty Ltd v Mirror Newspapers Pty Ltd [43] the same is true to a misleading or deceptive conduct action in relation to a research report without reasonable basis - see discussion below [44] Criminal Code (Cth), Part 2.5 [45] Miller at paragraph 1.52.55; MGIGA (1992) Ltd v Kenny & Good Pty Ltd (1996) 70 FCR 236 [46] Lockhart at paragraph 4.36; RAIA Insurance Brokers Ltd v FAI General Insurance Co Ltd (1993) 41 FCR 164; Chiarabaglio v Westpac Banking Corporation (1989) ATPR 40-971 [47] Lockhart at paragraph 4.36 [48] The second and third elements are reflected in the warranties implied under the ASIC Act (section 12ED). [49] However, it would have to be clear and prominent, and this is unlikely to be commercially appealing to many professional advisers. See Miller at paragraph 1.52.95; Sweetman v Bradfield Management Services Pty Ltd (1994) ATPR 41-290; MGM Bailing Enterprises v Austin Australia Pty Ltd [2002] NSWSC 259 [50] See the CLERP 9 paper at p126; cf section 945A [51] That is, the presence of conflicts of interest would not reverse the onus of proof. The complainant would still have to show that the report was not based on reasonable grounds. However, evidence of conflicts would be of some weight in showing a lack of reasonable grounds. [52] Carley, "The Future of Frontrunning", 1995 at 437; Mannolini "Insider trading - The Need for Conceptual Clarity", 1996 at 152-156; Griffith Committee report 1989 (House of Representatives Standing Committee on Legal and Constitutional Affair, Fair shares for all); Ansell, "The Regulation of Insider Trading in Derivatives", 1995 at 477; Bostock, "Australia's new insider trading laws", 1992 at 170; Gething, "Insider Trading Enforcement: Where Are We Now and Where Do We Go From Here?", 1998 at 608; Semaan, Freeman and Adams "Is Insider Trading a Necessary Evil for Efficient Markets?: An International Comparative Analysis", 1999, at 223; Yeo A comparative Analysis of Insider Trading Regulation - Who is liable and what are the sanctions?, 13 January 2001, at 5; Black, "The Reform of Insider Trading law in Australia", 1992, at 222 [53] Gething at 609 [54] Manne, "In Defence of Insider Trading", 1966; Carley at 438; Black at 236 [55] Skoyles, "The Fiduciary Basis of Insider Trading Liability: Dirks Down Under", 1984, at 23; Semaan, Freeman and Adams at 221 [56] Section 1043A(1) "Subject to this Subdivision, if: (a) a person (the insider) possesses inside information; and (b) the insider knows, or ought reasonably to know, that the matters specified in paragraphs (a) and (b) of the definition of inside information in section 1042A are satisfied in relation to the information; the insider must not (whether as principal or agent): (c) apply for, acquire, or dispose of, relevant Division 3 financial products, or enter into an agreement to apply for, acquire, or dispose of, relevant Division 3 financial products; or (d) procure another person to apply for, acquire, or dispose of, relevant Division 3 financial products, or enter into an agreement to apply for, acquire, or dispose of, relevant Division 3 financial products. [57] Section 1043A(2) "Subject to this Subdivision, if: (a) a person (the insider) possesses inside information; and (b) the insider knows, or ought reasonably to know, that the matters specified in paragraphs (a) and (b) of the definition of inside information in section 1042A are satisfied in relation to the information; and (c) relevant Division 3 financial products are able to be traded on a financial market operated in this jurisdiction; the insider must not, directly or indirectly, communicate the information, or cause the information to be communicated, to another person if the insider knows, or ought reasonably to know, that the other person would or would be likely to: (d) apply for, acquire, or dispose of, relevant Division 3 financial products, or enter into an agreement to apply for, acquire, or dispose of, relevant Division 3 financial products; or (e) procure another person to apply for, acquire, or dispose of, relevant Division 3 financial products, or enter into an agreement to apply for, acquire, or dispose of, relevant Division 3 financial products." [58] Semaan, Freeman and Adams at 232 [59] However, it would not apply to director's trading on his or her own account prior to publication of a research report. [60] Ansell at 478-9; Semaan, Freeman and Adams at 220; Yeo at 13; CASAC Insider Trading Discussion Paper, June 2001at paragraph 0.22; Black at 226; Rubenstein, "The Regulation and Prosecution of Insider Trading in Australia: Towards Civil Penalty Sanctions for Insider Trading", 2002, at 95 [61] Bostock at 181 [62] Mannolini at 155 [63] eg, the US prohibition. [64] eg, an officer, agent or professional adviser [65] Section 1042C(1) "... information is generally available if: (a) it consists of readily observable matter; or (b) both of the following subparagraphs apply: (i) it has been made known in a manner that would, or would be likely to, bring it to the attention of persons who commonly invest in [the relevant] financial products of a kind whose price might be affected by the information; and (ii) since it was made known, a reasonable period for it to be disseminated among such persons has elapsed; or (c) it consists of deductions, conclusions or inferences made or drawn from either or both of the following: (i) information referred to in paragraph (a); (ii) information made known as mentioned in subparagraph (b)(i)." [66] CASAC, July 2001 [67] above at Appendix 4 (Germany), p121 [68] above at Appendix 6 (US), p136 [69] R v Firns [2001] NSWCCA 191 [70] section 1042C(1)(c) [71] Walker, "Insider Trading in Australia: When is Information Generally Available?", 2000 at 217-8; Black at 236 [72] Bostock at 174 [73] CASAC, July 2001, paragraph 2.69 [74] this would include deductions drawn from inside information [75] Mannolini at 155 [76] There may be an argument that recipients of selectively and narrowly distributed research reports would be unable to rely on this defence - see part 5 'other implications and law reform' below. See also Black at 238 (although discussing a previous provision, the same conclusion would presumably be drawn). [77] Dirks v US (1983) 463 US 646 [78] Appendix 6 (US), p136 [79] Skoyles at 21; Dirks at 649 (the shares fell from $26 to $15 in the space of about 2 weeks) [80] Dirks at 658-9 [81] He was not, for example, a fiduciary. See Skoyles at 21. [82] Semaan, Freeman and Adams at 234 [83] Black at 236-7 [84] cf Skoyles at 25. For an analogous Australian case, see also ASIC Media Release 02/170 "Christopher Savage banned for 3 months", 15 May 2002 [85] section 1041D [86] Dirks at 649 [87] CASAC, July 2001, at paragraph 2.75 [88] Black at 243 (although discussing a previous provision, the same conclusion would presumably be drawn) [89] akin to section 1043E; see also sections 49B-49C of the Insurance Act 1973 (Cth) [90] ASIC or the Commonwealth Director of Public Prosecutions [91] Mannolini at 156. Of course, an affected client may utilise the civil liability provisions regardless of the fact that the regulator may in its discretion decline to pursue matters involving some element of whistle-blowing. To this extent, law reform may still be desirable. [92] although it would contain deductions, opinions and recommendations based on that information [93] Section 1042A [94] R v Firns [95] There may be some unusual cases where, based on the pattern of an analyst's previous reports and on the recent information available about the issuer, one may be able to surmise the likely contents of an upcoming research report. If the analyst is known to publish reports on a regular basis, it may be that the timing of the report can be guessed with reasonable accuracy. However, for the purposes of the following discussion, it is assumed that in at least most cases information about the timing and content of upcoming research reports will not itself be generally available information. [96] Aitken, Muthuswamy and Wong, "The Impact of Brokers' Recommendations: Australian Evidence" [97] CASAC, July 2001, at paragraph 2.76. This type of conduct is generally known as front running: see Carley at 434. [98] Mannolini at 153; United States v Carpenter 791 F.2d 1024 (1986) [99] CASAC, July 2001, at paragraph 2.80 [100] CASAC, July 2001, at paragraph 2.79 [101] Above at paragraph 22 [102] Above at paragraph 21 [103] See, for example, Chiarella v US (1980) 445 US 222; Skoyles at 19 [104] 484 US 19 at 20, 24 [105] 484 US 19 at 19 [106] Black at 227 [107] Black at 227 and 244 (although discussing a previous provision, the same conclusion would presumably be drawn) [108] Black at 227 and 244 (although discussing a previous provision, the same conclusion would presumably be drawn) [109] at paragraph 2.78. CASAC considered whether there should be an exception for frontrunning a research report, and concluded that "There should be no statutory exemption to permit persons to trade before publishing their own price-sensitive reports or recommendations." at paragraph 0.25. Firms in such a position need to choose between using their research for internal trading purposes only (eg decline to publish the research) or decline to trade until the research has been published (paragraph 2.84) [110] Note also the reference to potential law reform to introduce a positive reasonable basis obligation in part 3 [111] sections 1042G, 1042H; Ford, Austin and Ramsay, Ford's Principles of Corporations Law at paragraph 16.210 [112] sections 1043F, 1043G' [113] Black at 246 [114] paragraph 2.190. The report does discuss the argument that Chinese walls are of limited effectiveness in our modern environment, but makes no conclusion on this (paragraph 2.193). See also Black at 247. [115] Julian Donnan, "Insider trading and OTC derivatives under the Financial Services Reform Act" at 34 [116] Section 1043A(2) [117] for example, those providing both research and corporate finance services [118] For example, a report about a security may be capable of indirectly communicating inside information if a reasonable reader is able to deduce inside information from its contents, even if the author was not subjectively aware of the inside information. For example, if when reading the report together with other generally available information, a reasonable reader is able to deduce inside information in the possession of the investment bank, then the bank may be taken to have communicated that information, regardless of the fact that the author of the report was not subjectively aware of the inside information. This particularly so whether the author of the report suspects (but doesn't know with certainty) inside information that is in the possession of other parts of the organization. [119] and more recently in the form of the Companies and Markets Advisory Committee (CAMAC) [120] September 2002 report at paragraph 3.61, July 2001 report at 2.195. This appears to be an issue in the current version of the defence as well (section 1043F). [121] section 1043A(2) [122] Strictly speaking, information that is inside information as at the time of the publication of the research report [123] and therefore its use would not breach section 1043A. See Black at 238 (although discussing a previous provision, the same conclusion would presumably be drawn). [124] Section 1042C [125] Another option, at least from the client's perspective, is for the provider of the research report to ensure that the report is widely distributed and therefore is able to traded on by the client. However, as the report contains inside information, the publisher would still be in breach of section 1043A in communicating it to the public - see the discussion in part 4. [126] Gething at 614 [127] based as they substantially are on the broad US anti-fraud provisions