This article was first published in Solicitors Journal and is reproduced by kind permission.
Insider dealing is known as a difficult offence to prosecute but, with extensive investigation and the right evidence, the FSA is beginning to get results and is closing in on perpetrators in the City, says David McCluskey
THE RECENT NEWS that two senior lawyers, including a partner at a US law firm, are to be prosecuted for insider dealing, a statutory offence covered in Part V of the Criminal Justice Act 1993,has echoed through the corridors of legal London. Having got those 'difficult' first and second cases under its belt, the FSA enforcement division is apparently now looking to focus on insider dealing rings within the City.
This is a laudable objective, given the frequency with which insider dealing apparently occurs in the City and the perception that it is a 'difficult' offence to prosecute. The practicalities of investigating and prosecuting this offence certainly mark it out as slightly different to other 'fraud' cases but, as the FSA is beginning to show, applying the right resources can produce results.
Following The Evidence
While most frauds rely on some form of secrecy, the environment of enforced confidentiality in which insider dealing takes place means that it is all but impossible to catch insider dealers 'in the act'. Absent a tip off, an investigation usually begins with what the rest of the market can already see: an unusual trading pattern just prior to an announcement. The FSA obtains a list of those who traded in advance of publication and the lists of 'insiders' from the institutions involved in the transaction. Investigators will usually begin with basic cross-matching of data between insiders and traders, looking for some correlation between them.
In a case prosecuted by the Crown Prosecution Service in 2004, investigators were struggling to find a connection between a series of well-timed spread bets on financial stocks placed by four individuals who had no apparent connection to the City. It was discovered that one of the four had shared an address for a time with a fifth individual, who worked at an investment bank which had had a role in almost every transaction or announcement under scrutiny. It transpired that the five were good friends, who socialised regularly.
Once such a link is made, the investigation tends to grow organically in that investigators may look at a trader's entire trading history, comparing it to frequency of contact with the insider or other traders. Thus an investigation that begins by looking at one timely trade may end up as a prosecution for a whole series. In the same way, an investigation will gradually reveal links to other individuals who may or may not be part of the 'ring'. This is why, when investigators execute search warrants and conduct arrests, they often target computers and mobile phones for evidence of communication. From there, the resources that are required to be put into analysing and marshalling the mountains of data that are recovered are truly staggering. But this is the heart of a successful prosecution: putting together information from disparate sources in away that tells a compelling inferential story.
Prosecution By Inference
It is rare for an insider dealing case to come to court with direct evidence of inside information being passed to another person, or of it being in a person's possession. Prosecutors must often rely, for crucial elements of the offence, on persuading a jury to draw inferences from the circumstantial evidence. That is not to say, as the FSA and others before have shown, that it is an impossible task. If sufficient resources are put into the building of the case, the jury can be presented with a picture that shows an uncanny proximity of insider to information, some form of communication to or meeting with the trader (such as a phone call log or the fact that they are related) followed by a timely call to a broker or spread bet company to place a bet or trade in a relevant company.
In large-scale cases the prosecution can build up repeat examples of timely trades to an almost overwhelming extent, and challenge the defence to rebut the inference from the sheer number of successful trades that they were based on inside information. It is prosecution by statistics: a coincidence of inside information and a 'lucky' trade on one occasion could be just that; when it happens on 50 occasions over a period of a year a defendant may have much more explaining to do. And indeed he can: a number of defences, such as that the information was already public, or that the trader would have bought anyway are hard-wired into the Criminal Justice Act (s.53).
Of course the converse also holds true: someone who has never traded before (or never that stock, or that way) who makes a stupendously lucky winning bet will find his conduct under scrutiny if he also had access to an insider. James Melbourne had never traded in TTP before when he bought shares just before a merger announcement. He was convicted of insider dealing along with his son-in-law who, as General Counsel to TTP, had advance knowledge that TTP was about to be bought by Motorola.
Over Confident
Insider dealing rings are usually careful to conceal their connections and their communications, and the most successful focus on keeping their profile down. As with most frauds, it is often greed that leads to a downfall. In the 2004 case referred to above, the traders simply became too successful and perhaps too confident. One attempted to place a down bet of £1,000 per point (equivalent to a massive short position) against a stock just minutes before that company issued a profit warning. That, along with the fact that he was winning too much too often, led to his trading activity being reported to the FSA.
During the investigation, it was discovered that the four traders in question kept a detailed spreadsheet which they regularly emailed to each other, listing all of their trades and calculating their profits. What was most damning about the document, however, was that it showed how each trader invariably split his profit with a fifth person (the insider) who did not trade himself, yet received up to 80per cent of the profits of each trade. Melbourne gave his son-in-law the equivalent of half his profit from his TTP trade.
In neither case, was there direct evidence of information or encouragement flowing from insider to trader. But with the right evidence, the inferences to be drawn can be irresistible.
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