The Financial Markets Act No. 19 of 2012 (“Financial Markets Act”) sets out, as its purpose, to ensure that South African financial markets are efficient, fair and transparent. Furthermore, to increase the confidence in the South African financial markets and to reduce systematic risk. The Financial Markets Act’s function is therefore to promote the protection of regulated persons, investors and clients. The Financial Markets Act achieves this by addressing various market abuse practices and classifying them as offences, including that of insider trading. The Financial Markets Act replaces the pervious Securities Services Act 36 of 2004 (“Securities Services Act”).
This article shall briefly focus on the offence of insider trading and the possible defences thereto, with specific reference to a Chinese wall (“Chinese Wall”).
The Financial Markets Act defines insider trading as an insider who knows that they have inside information and who deals directly or indirectly, or through an agent, for their own account in the securities listed on a regulated market or in derivative instruments related to such securities, to which the inside information relates or which is likely to be affected by it. Such a person will be regarded as committing an offence in terms of the Financial Markets Act.
Persons who will be considered as ‘insiders’ through having access to inside information of the organisation by virtue of their respective employment or profession will include bankers, lawyers, auditors and various other professional individuals interacting with the organisation. It can therefore be held that the relevant person does not necessarily, when coming across the inside information, need to have a relationship or connection with the organisation.
One of the possible defences for insider trading that has been statutorily recognised in other jurisdictions, such as Australia and the United States of America, is that of a Chinese Wall. A Chinese Wall is the creation of either an operational or physical barrier between different segments/departments of a multi-functional organisation. It is thus a technique used to prevent insider trading and to control various conflicts of interest which will arise when various financial business operations are performed by a multi-functional organisation.
The barrier is set up in order to prevent information flowing from one group of a department to another group of a department within the same organisation. It thus serves as an information barrier. A Chinese Wall is there to protect a juristic person from incurring liability or being found guilty of insider trading resulting from the information from its employees being attributed to it in law. It should further be noted that certain policies and procedures pertaining to a Chinese Wall will be determined by each organisation taking into account the nature of its own financial business operations.
The implementation of a Chinese Wall will involve, inter alia, the following organisational arrangements:
- the physical separation of numerous departments within an organisation to cover them from one another;
- an ongoing educational learning programme within the organisation setting out the importance of preserving confidential information and continuous monitoring by compliance individuals; and
- the appropriate disciplinary action to be taken should an organisation’s Chinese Wall be breached.
There is no statutory provision made in the Financial Markets Act for the inclusion of a Chinese Wall as a defence for insider trading. An analysis has been drawn from English and Australian law jurisdictions where it was evident that the possibility exists to create a perfect Chinese Wall, but the application thereof in practice seems to be very difficult. It has further been held by some that due to the disadvantages associated with Chinese Walls substantially outweighing the advantages, no statutory provision should be made for a Chinese Wall as a defence to insider trading within the Financial Markets Act.
An alternative view is that the South African legislature failed to recognise the possibility of Chinese Wall defences and can be regarded as a substantial drawback in the current statutory provisions. In the absence of these provisions, the effectiveness of financial institutions like stock-broking firms and merchant banks can be severely affected.
Current Statutory Defences:
Section 78 of the Financial Markets Act sets out the statutory defences currently afforded to any person that may be consider as being guilty of insider trading. The Financial Markets Act differentiates between an insider who knows that they have inside information and who deals directly or indirectly or through an agent for their own account or for any other person. The Financial Markets Act sets out the following defences for both scenarios when it is proved on a balance of probabilities that such person:
- only became an insider after they have given the instruction to deal to an authorised user and the instruction was not changed in any manner after he or she became an insider; and
- was acting in pursuit of a transaction in respect of which:
- all the parties to the transaction had possession of the same inside information;
- trading was limited to the parties referred to above; and
- the transaction was not aimed at securing a benefit from exposure to movement in the price of the security, or a related security, resulting from the inside information.
In addition to the above defences, section 78 of the Financial Markets Act sets out an additional defence for an insider who deals directly or indirectly or through an agent for any other person, and such defence being that they are an authorised used and were acting on specific instructions from a client, and did not know that the clients was an insider at the time.
In conclusion, other jurisdictions, such as Australia and the United States of America, have provided for stronger statutory defences to market manipulation than that of South Africa, with specific reference to a Chinese Wall defence being statutorily omitted in the Financial Markets Act. Whether such a defence should be included in the Financial Markets Act is still uncertain, as on the one hand it has been highlighted on numerous occasion that the practical application of such a defence is very difficult to establish, whilst on the other hand the omittance of such a defence can negatively impact the effectiveness of financial institutions in their financial business operations.
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Published 7 September 2023