Securities Law has been a subject which is below the radar of most bar reviewees. The reason probably is that it is given middling attention in law school. It is seldom a stand-alone subject and is more often folded into Corporation Law, where time constraints not infrequently lead to it being discussed in a less than thorough manner.
It should be noted, however, that there has been a recent trend in the bar of asking questions on Securities Law. One of the frequently asked questions on Securities Law is that dealing with insider trading. Insider trading may appear to the uninitiated as an arcane subject. This short note seeks to refresh the bar reviewee’s knowledge of the law regarding insider trading.
Insider Trading
Insider trading occurs when an insider trades (i.e., buys or sells) securities while in possession of material non-public information (MNI) regarding the security. From this definition, we can see the three important elements of insider trading. There must be an insider, the insider must trade securities, and the insider is in possession of MNI regarding the security. (Keyword: TIM)
Rationale
Insider trading is a criminal offense under the Securities Regulation Code (§27 in relation to §71). Normally, buying or selling on nonpublic information not available to the counterparty is not a criminal offense. Thus, a buyer may buy land at the current market price on information not available to the seller that a highway will be constructed adjacent to the land and which development will substantially increase the market price of the land. The buyer has no duty to disclose this information to the seller.
However, insofar as securities transactions are concerned, insiders are considered as fiduciaries of the MNI in their possession and have a fiduciary duty to disclose such information to the counterparty. The law penalizing insider trading seeks “to level the playing field” between insiders and other market participants and to discourage the perception that the securities markets are rigged in favor of the “big boys,” thereby encouraging greater public participation in the securities markets.
Thus, if a director of ACME Drug Inc. has inside information that a company’s COVID treatment drug will be approved by the FDA, he is liable for insider trading if he buys the company’s shares without disclosing this information to the seller. Or, if the director has inside information that the drug will not be approved by the FDA, he is similarly liable if he sells ACME shares without the requisite disclosure.
Material Non-Public Information
MNI is material information about the security or the issuer that is not generally available to the public. Information is material when it will affect the price of the security or would influence a person in deciding whether to buy, sell, or hold a security. The price of securities tends to increase on good news or decrease on bad news.
Insiders
A non-insider is not liable if he trades securities even while in possession of MNI. The rationale is that he has no fiduciary duty of disclosure to the counterparty. Hence, it is important for us to know who insiders are.
Under §3.8 of the SRC, the following are considered as insiders: (Keyword: TRIGOD)
- The issuer. [I]
- A director or officer of the issuer or a person controlling the issuer. [DO]
- A person whose relationship or former relationship to the issuer gives or gave him access to MNI. [R]
- A government employee, or director, or officer (G-O-D) of an exchange, clearing agency, and/or self-regulatory organization (S-E-C) who has access to MNI. [G]
- A person who learns such information by a communication from any of the foregoing insiders. [T] In securities parlance, this person is called a “tippee.” The tippee must know that the tipper is an insider. (§30[b] RSA).
An insider cannot buy or sell a security while in possession of material non-public information regarding the security unless:
- The insider proves that the information was not gained by virtue of being an insider or from an insider. For instance, the insider may prove that he obtained the information from a security analyst who follows the company’s stock and who has deduced the information from analyzing the company’s SEC filings; or
- The counterparty is identified, and the insider proves that he disclosed the information to the counterparty or that he has good reason to believe that the counterparty is in possession of the information. (§27, SRC). In shares of stock listed at the Philippine Stock Exchange, a person buying or selling shares usually does not know the counterparty since trading is done through brokers. In such a case, the insider must simply refrain from trading to avoid criminal liability.
Note that under the SRC, the standard is “knowing possession” of MNI, not the use thereof. For instance, if a corporate officer gets to possess MNI regarding his company’s shares, he cannot buy the shares even if he already had been following a predetermined plan of purchasing 100 shares of the company every month. What he should do is to refrain from trading or to disclose the MNI to the counterparty.
Illustrative Bar Question
Q Grand Gas Corporation, a publicly listed company, discovered after extensive drilling a rich deposit of natural gas along the coast of Antique. For five months, the company did not disclose the discovery so that it could quietly and cheaply acquire neighboring land and secure mining rights to the land. Between the discovery and its disclosure of the information to the Securities and Exchange Commission, all the directors and key officers of the company bought shares in the company at very low prices. After the disclosure, the price of the shares went up. The directors and officers sold their shares at huge profits.
a) What provision of the Securities Regulation Code (SRC) did they violate, if any?
b) Assuming that the employees of the establishment handling the printing work of Grand Gas Corporation saw the exploration reports which were mistakenly sent to their establishment together with other materials to be printed. They too bought shares in the company at low prices and later sold them at huge profits. Will they be liable for the violation of the SRC? (2008 Mercantile Law Bar Question No. 13).
Suggested Answer:
a) The directors and officers violated the SRC provisions on insider trading.
Under the SRC, directors and officers who trade shares of their corporation while in possession of material non-public information are liable for insider trading.
Here, the directors and officers were in possession of non-public information that Grand Gas had discovered a rich natural gas deposit and such information was material since it would boost the share price of Grand Gas. Hence the directors and officers are liable for insider trading. (Sec. 27, SRC; SEC v. Texas Gas Sulphur Co., 401 F.2d. 833).
b) No, the printing establishment’s employees are not liable for insider trading.
Under the SRC, for one to be liable for insider trading, he must first be an insider.
The employees are not within the purview of §3.8(c) since their relationship as employees of the print shop handling the printing work of Grand Gas did not give them access to material non-public information. The employees were not fiduciaries. They were not intended to have access to MNI as shown by the fact that the exploration reports were mistakenly sent to them. It was not their relationship but the erroneous sending of the exploration reports which gave them access to MNI. Nor are they insiders under §3.8(e) as they did not learn of the MNI by a communication but through an error. Hence, the employees cannot be held liable for insider trading. (Chiarella v. United States, 445 U.S. 222 [1980]).
Illustrative Problem
Q Andy, a lawyer working with Bigfoot Mining Corporation, whose shares are listed in the Philippine Stock Exchange, is aware that the DENR will close down BMC’s Samar mine for violation of environmental laws. This information is not yet known to the public. He discloses the information to his friend Pedro, who knows that Andy is a lawyer working with BMC on sensitive matters. Pedro discloses the information to his mistress Jana who is aware of the nature of the information and how Pedro came across it.
a) Andy, Pedro, and Jana all sell shares of BMC prior to the announcement by the DENR that it will close the Samar mine. Are Andy, Pedro, and Jana liable for insider trading?
Andy is liable since his relationship as lawyer gave his access to MNI. Pedro is a tippee and thus is an insider who is liable for insider trading. Jana is not liable since she is not an insider. She did not learn her communication from the insiders mentioned in §3.8(1)(2) and (3) and (4) but from a tippee.
b) Would Andy be liable if he did not sell shares of BMC?
Yes, it is unlawful for an insider to disclose MNI to another person who by virtue of the communication becomes an insider if the insider knows that the other person will likely buy or sell a security of the issuer while in possession of such information. (§27.3). By virtue of Andy’s communication to Pedro, the latter became a tippee or an insider and likely to trade on such information. It is immaterial whether Pedro actually buys or sells BMC shares.
c) Would Pedro be liable for his disclosure even if he does not sell BMC shares?
No. While Pedro himself is an insider or tippee, Jana herself did not become an insider by virtue of Pedro’s communication. Hence, Pedro would not be liable for the violation of §27.3.
Presumption of possession of MNI
Except where the prosecution is in possession of a “smoking gun” evidence, such as a letter or tapped phone call, it would be extremely difficult for it to prove that a purchase or sale made by an insider was done while in possession of MNI. Hence, the law created a presumption of possession of MNI. A purchase or sale by an insider shall be presumed to have been effected while in possession of MNI if transacted after such information came into existence but before public dissemination and the lapse of a reasonable time for the market to absorb or digest such information. This presumption shall be rebutted upon a showing by the purchaser or seller that he was not aware of the MNI at the time of the purchase or sale. (§27).
Hence, if ACME Petroleum had discovered a massive offshore oil field in its exploration sector, a purchase of ACME shares by its vice-president before such information is released to the public is presumed to have been made while in possession of MNI. The burden of evidence is on the accused to show that he was not aware of the MNI. My opinion is that a bare denial by the accused that he was aware of the MNI is enough to shift the burden of evidence back to the prosecution, pursuant to the “bursting bubble” theory on presumptions.
Interestingly, §27 also presumes that a similar purchase or sale by an insider’s spouse or relative by affinity or consanguinity within the second degree (whether legitimate or common-law) was effected while in possession of MNI. This provision is paradoxical. Does it mean that the insider’s spouse or relative is also presumed to be an insider? The text of the law does not bear this out. The provision is ambiguous and any doubt should be resolved in favor of the accused. The prosecution should still prove that the insider’s spouse or relative is an insider, for instance, a tippee. In such a case the presumption of possession of MNI would arise from the fact that the buyer or seller is an insider. Hence, the presumption of possession arising from relationship would be redundant. For purposes of the bar review, my suggestion is that a reviewee should simply disregard this portion of §27.
Special rule re tender offer
Tender offers or intended tender offers usually result in the price increase of the shares of the target corporation.
The SRC provides that it is unlawful for a person other than the tender offeror who has MNI relating to such tender offer to buy or sell securities of the target corporation if he knows or has reason to believe that the information is non-public and has been acquired directly or indirectly from the tender offeror, those acting on its behalf, the target corporation, or an insider of such target corporation. (§27.4[a][i]. Such buying or selling shall constitute insider trading under §27.4 (§19.10, 2015 SRC Rules). The person need not be an insider just so long has he knows or has reason to believe that the information is non-public and has been acquired from the tender offeror, etc. Hence if a tender offeror mistakenly sends the tender-offer documents to its printer, the printer will be liable for insider trading if he buys shares of the target corporation.
Likewise, the tender-offeror, the issuer, and an insider cannot communicate MNI to other persons if the communication is likely to result in such person buying or selling the securities of the target corporation.
Illustrative Bar Question
Q Ms. OB was employed in MAS Investment Bank. WIC, a medical drug company, retained the Bank to assess whether it is desirable to make a tender offer for DOP Company, a drug manufacturer. OB overheard in the course of her work the plans of WIC. By herself and thru associates, she purchased DOP stocks available at the stock exchange priced at P20 per share. When WIC’s tender offer was announced, DOP stocks jumped to P30 per share. Thus OB earned a sizable profit.
Is OB liable for breach and misuse of confidential or insider information gained from her employment? Is she also liable for damages to sellers with whom she traded? If so, what is the measure of such damages? Explain briefly. (2004 Mercantile Law Bar Question No. 2).
Suggested Answer:
A Yes, OB is liable for breach and misuse of confidential or insider information.
Under §27.4(a)(i) of the SRC, it shall be unlawful where a tender offer has commenced or is about to commence for any person (other than the tender offeror) who is in possession of MNI relating to such tender offer, to buy or sell securities of the target corporation if such person knows or has reason to believe that the information is nonpublic and has been acquired directly or indirectly from the tender offeror, those acting on its behalf, the issuer of the securities sought or to be sought, or any insider of such issuer.
Yes, OB is liable for damages to the sellers with whom she traded. Under §63 in relation to §61, the court is authorized to award damages in triple the amount of the transaction plus actual damages. The court may also award exemplary damages and attorney’s fees not exceeding 30% of the award.
(Note: The facts of the problem appear to indicate that OB is not an insider within the terms of §3.8 as she “overheard” the plans of WIC. Hence the nature of her work at MAS did not give her access to MNI. Nonetheless she is still liable under §27.4(a)(i) which applies to tender offers and which does not require that the person trading the securities of the target corporation be an insider as defined in §3.8).
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