Slap on wrist for insider trading
Financial Services Board criticised for lack of convictions
A HANDS-ON CEO at a listed company creatively inflated the profitability of his company, and thought he had covered his tracks by keeping two sets of debtors records.
He was caught out by the financial director of a target company who inspected the books closely before signing the deal. This saw him walk away.
Despite this, the CEO released the cooked financials to the market, duping investors into buying shares in the “profitable” company.
This is not a movie about corporate intrigue, but a case involving JSE-listed food company AH-Vest, trading as All Joy, that played before the Financial Services Board’s (FSB’s) enforcement committee.
AH-Vest CEO Marci Pather was fined R1.5-million personally, the same amount levied on the company, for this fraud more than three years ago. He appealed, but this was dismissed, according to papers published on the FSB website.
“Members of the investing public were placed at risk of illinformed decisions in matters, to them, of considerable commercial moment,” the FSB’s appeal board said in its ruling.
“The conduct of the appellants was fraudulent towards potential shareholders and anyone concerned to know the profitability of the company.”
A statement released by the financial industry regulator’s directorate of market abuse in June showed there were 18 investigations of market manipulation, insider trading and cases of false or misleading reporting — all actions likely to undermine confidence in the investment market.
But there are concerns that the “administrative fines” often paid by offenders are not enough to deter rogue executives and traders.
Since 1998, the state has pursued only eight criminal prosecutions against those accused of insider trading. No one has been convicted.
Insider trading involves the buying and selling of shares by a person with access to non-public information.
Patrice Rassou, head of equities at Sanlam Investment Management, said trading on inside information conferred an unfair advantage and allowed for short-term profits.
“Unfortunately, it would have to be something material to be noticed, [such as] announcement of results which are out of line with expectations, or corporate action,” he said.
The FSB’s Logan Ramalu said criminal cases against insider traders had to be watertight to secure convictions.
This is why the regulator has had to settle for administrative penalties against most of those found guilty of insider trading.
According to the head of the FSB’s directorate of market abuse, Solly Keetse, the penalty for insider trading under the Financial Markets Act is up to R1-million plus profits made or losses avoided.
Though not up to date, the regulator’s enforcement committee page on the website lists only two fines for insider trading topping R1-million since 2006 — a 2008 ruling against mining holding company Assore and a 2010 ruling against Sentula’s Johan Pieterse and Nicolaas van der Merwe.
For market manipulation, the highest fine levied during that period was R2-million.
Assore was penalised R2.5million after an admission by CEO Chris Cory that the chairman, Desmond Sacco, bought shares on the open market after gleaning non-public information contained in the company’s management accounts.
Cory said that this was an oversight, and his company offered the R2.5-million to anyone prejudiced by the trades.
Pieterse, then managing director of JEF Drill and Blast, a subsidiary of listed miner Sentula, and Van der Merwe, also a director in another Sentula subsidiary, were fined R1-million and R2-million respectively for using non-public information — on Sentula’s plans to impair grossly overvalued assets — to sell their shares in the company and avoid a loss.
The share price fell 25% on news of the impairment.
This does not mean insider trading is rare, however.
Said Rassou: “I don’t think that one can say it is not taking place as there have been executives fined, for instance, for insider trading. [The] reality is that it is hard to prove.
“We have an extremely liquid market with many types of players — some are simply speculators. This makes it hard to unravel trades based on inside information.”
Simon Brown, another trader, said insider trading was a lot less frequent than it was a few years ago.
“In 1999, I was invited to join an investment club that was only trading on insider knowledge,” he said. “They were chartered accountant candidates, and [their] parents were CFOs and auditors. That would never happen today — JSE surveillance [is] very much stronger.”
Peter Redman, a technical adviser at the JSE’s surveillance department, said all members of the exchange used the broker dealer accounting system to track details of trades closely, including personal details of those conducting the trades.
“Most other exchanges in the world are only able to see the identity of the broker. If they want more information, they must get it from the broker. This takes up valuable time,” said Redman.
Redman said the JSE ran computer scans that identified possible manipulative practices.
“The JSE rules require a trader to give consideration to orders placed by clients before entering them into the trading system. This is so that orders at prices far away from the last traded price can be identified and rejected.”
But being fined by the
The problem is the authorities’ lack of capacity to deal with the issues
enforcement committee has apparently not hurt careers. In the case of Assore and Sentula, most of the executives are still with their companies.
Why not both a fine and jail time?
“Insider trading is a criminal offence in South Africa,” said Ramalu. “We therefore have the option of sending the offender to jail if found guilty. The problem with criminal sanctions is that the Directorate of Public Prosecutions has to prove its case beyond reasonable doubt. Thus the burden of proof is very high, and the [directorate] is not always equipped to deal with insider-trading cases.”
Brown said such cases were very hard to prove. “[It is] easy to prove shares were bought ahead of a move. Making the link [between having inside information and buying shares] is very hard. Ideally it needs one to confess and turn on everybody else.”
But an asset manager, who did not want to be named for fear of reprisal, said the FSB was primarily to blame for the lack of convictions, which contrasted starkly with impressive rates of criminal convictions and huge fines in the US.
The asset manager said the FSB was incapable of catching anyone until it was “far too late”, using its handling of the Sharemax and Fidentia saga as examples.
“Then the prosecuting authority is incapable of successfully prosecuting as well, [as with] Fidentia,” he said.
“So I think the major problem is the authorities’ lack of capacity to deal with the issues. The crooks are still out there.”