Insider trading: Is it rampant, cause for market’s ill or mere paranoia?
By Cassandra Mascarenhas
The latter part of the forum on insider trading titled ‘Insider Trading – Good, Bad or Ugly’ organised by the Institute of Chartered Corporate Secretaries of Sri Lanka and the Securities and Exchange Commission of Sri Lanka in partnership with the Daily FT held earlier this week consisted of an interactive Q&A discussion moderated by Daily FT Editor Nisthar Cassim. This is the second part of the panel discussion carried in the Wednesday 28 March issue of the paper.
Many interesting opinions and suggestions were aired by the expert panel consisting of SEC Chairman Thilak Karunaratne, University of Cambridge Prof. Gishan Dissanaike, Laugfs Holdings Chairman W.K.H. Wegapitiya, Heraymila Securities Limited Director/CEO Ravi Abeysuriya and Nithya Partners Partner Attorney-at-Law Arittha Wikramanayake, along with some insights from the members of the audience including CSE CEO Surekha Sellahewa and Ceybank Unit Trust CEO Chitra Sathkumara.
Moderator: If the prevalence of insider trading is so widespread, why haven’t we succeeded in detecting it and taking action? If the market has corrected itself, is this talk of too much insider trading actually preventing the market from development?
Wikramanayake: Insider trading is actually killing the market. In our discussion with the SEC, we were talking about giving credit. I don’t think it’s an issue of giving more credit, I think the whole issue is the lack of credibility because the whole market is pumped up by genuine long term investors and I think a handful of people can’t keep the market down. They can boost turnover up to a certain point but at some point you need to depend on the larger investor base and I know several people who will not come back into the market because they feel that they will not get a fair deal. When we tell people to complain to the SEC, they feel that nothing will come out of it.
Wegapitiya: My comment is based on what I experienced over the last nine months. There is a thing called favour trading. A friend of mine asked me to buy some stock on his behalf, from a company that I was not familiar with. After some time, I asked him what to do with the stock and he asked me why I still had it – by that time, the value of the stock was half the amount I had spent buying them. Even if the stock market picks up its momentum, there are people waiting for the first chance to dispose of their stock and get out.
Moderator: You are saying that no one is coming into the market because there is a perception that there is rampant insider trading activity taking place even now.
Wikramanayake: Markets work on perceptions, and the general feeling of the majority of investors is that they cannot get a fair deal. The perception is that unless you have access to inside information, favour trade or otherwise, you can’t make money in this market and when there is such manipulation in the market, people don’t come back.
There is a rule at the CSE that says that when a share goes up without any reason, the company has a responsibility to make a statement. If the company does not make that statement, there is an offense committed by the officers of the company so why has no action been taken?
Karunaratne: Actually when brokers asked for credit, it had been denied several times by the SEC but finally we thought that as the market is not going to go up with credit and these guys are so noisy we might as well silence them by giving them credit and we were proved right. In our 25 years of existence, we have inquired into about 69 cases of insider trading and 22 have been taken to task.
Yes, we have not sent anyone to jail but that does not mean that we have not taken any action. In Sri Lanka, under criminal action it is very difficult to prove, which is why we want to bring in civil procedures as well. We are investigating cases at the moment; it is not that the SEC is not doing its job but perhaps we are doing it too slow so it’s a question of accelerating the process. I guarantee that I will do my utmost to correct all these shortcomings.
Moderator: I think that 69 cases in a 25 year history is a drop in the ocean. Do you think it’s overplayed or that continuous emphasis on insider trading is good in the long term interests of the market?
Dissanaike: I think it’s difficult to take a number like 70 and say that it’s too high or low; it all depends on the scale of the insider trading that is taking place. However, presumably of the 70, at least some must have been found guilty. Does the public know who they are? I think that’s important as an example could be made of those who are guilty and I do believe that the companies they work for should be asked to take some responsibility as well. Various financial organisations in Singapore and other countries have lots of steps that they take to ensure that their employees act ethically and I do believe that in addition to the central regulatory structure, there is a lot that the major corporates can do to set an example. The day you get a really high profile person, that’s the day everyone will take it extremely seriously.
Wikramanayake: When you say that 22 people have been found guilty, it’s really compounded. Being compounded is an admission of guilt but unfortunately there has been a perception created that compounding does not mean very much. There were people whose offenses were compounded and remained on boards on the stock exchange. Compounding must carry consequences but the perception is that compounding is like making a confession.
Moderator: Do you think the reason people are not coming into the market is insider trading?
Abeysuriya: I think it’s not only insider trading, there are so many aspects. For people to come into the market, they need to have trust and confidence that the market will be fair and can make a fair return. A few people made a lot of money purely because they had access to certain information, it could be inside information or market manipulation, but by means that are not ethical and that is what makes people angry and not come back as soon as alternatives become available. So one reason why our market was attractive at that time was very low interest rates so people came in because it is tax free but that is no longer the case.
In Sri Lanka, we have a code of conduct but it is not implemented. I think the SEC has suggested that by June, for the local community to produce a mandatory code of conduct and I would really like to see that happen.
Moderator: Unpublished, price sensitive information is the criteria for insider trading but unfortunately Sri Lanka has a history where even dividend announcements, rights issues, bonus issues or strategic announcements does not push the share price up. We talk about unpublished information being the key cause for insider trading but how relevant is it in a Sri Lankan investor mindset? How critical is unpublished information?
Wikramanayake: At a seminar held recently, a very prominent investor stood up and said, “We don’t care about financial information.” What really matters is that by the time that information hits the market, there are others who actually use that information to trade beforehand. That’s probably why something like a dividend does not have an immediate impact on the market.
Abeysuriya: I have looked at some of the trading patterns and you can clearly see that before the stock exchange announcement, there are a certain amount of leakages happening. If you look at the trading volumes, that’s easily identifiable and I see that it is a fact that the insiders are directors of companies leaking out through the cocktail circuit.
Karunaratne: I don’t know how many are doing serious research in this country. You said that some of the IPOs were overvalued but did any broker or analyst say not to buy? They all said buy. That’s misleading the investors. Nobody had the guts to do a proper analysis and say don’t buy this, it is overvalued. So part of the blame should go to them as well.
Moderator: I think some brokers qualified some of the IPOs including Ravi.
Wikramanayake: It’s a chicken and egg situation. At the moment, most of the investors don’t depend on research reports.
Dissanaike: Actually even in developed markets, that is the case. It is very rare for you to see the market respond very dramatically to a routine dividend announcement and that is because the information has already been incorporated. One of the reasons for that is that it is well-known that dividend policy is sticky so there are rarely surprises to dividend announcements.
So it’s only when dividend policy changes dramatically, that you might expect to see more effect but even there, you see the price start to move before the actual announcement although the major price change is after the announcement.
I think it was back in 1968 when the first study of price sensitive information was done in relation to an annual report. They looked at the effect of annual reports on prices and what was very interesting was that most of the price adjustment had taken place before the actual announcement so it seems that analysts were quite able to look at periodic reports and predict what the outcome was.
When insider information is really successful, of course the returns are much larger but doing academic work to find out whether insider information is so successful is very difficult by the nature of the subject because to identify the private information and then do a study is very difficult. The general finding is that superior returns can be earned through insider information.
If you find that the market price is going up, why is it that market professionals do not advice others not to buy? Certainly if they knew and they are advisors they should especially if they know that the market prices are not going to be sustainable. On the other hand, we know that it is not necessarily rational for the individual investor to sell even if he knows that the market price is overvalued if he knows that the price is going to go up even further. The trick is to sell before the drop. Of course, market advisors should be driven by a higher standard of conduct.
Sellahewa: I would like to direct this comment to Mr. Wegapitiya. After this when a friend calls you and asks you to invest in stock, please don’t do it because you might get more calls when its close upon the end of the financial year and so I know from the goodness of heart you might decide to invest but just because a friend tells you, please don’t do it because you are unwittingly being made a victim of somebody’s mechanisation to do market manipulation.
Wegapitiya: There was a time when this bubble was growing, when it was a disgrace if my stock was not increasing every day. People look at you like a hero if you get a price ban. No matter how much value you create through your company, if your stock does not increase in price, they look at you as if you are incapable and these brokers call every morning and ask for announcements; like instant noodles they want announcements. We are all responsible for this particular situation and we all got stuck in this spiral.
It was a good opportunity. For a lot of start-up companies in Sri Lanka this situation created a rare opportunity to take a company to the next level which companies benefitted from immensely but unfortunately the same benefit was not made available for most Sri Lankan entrepreneurs like myself. They wanted a shortcut to reach success.
Abeysuriya: It occurred to me at the mention of brokers calling, in the US there is something called regulation fair disclosure. It states that you cannot, as a company, disclose to individual brokers. You have to have public announcements disseminated through any means. The fact of it is that the directors should not be talking to one broking company as that broker will benefit and that too is insider trading as far as I am concerned.
Moderator: It is suggested that minimising insider dealing is by increasing disclosure – has any progress been made on this front?
Sellahewa: I think what needs to be done is educating and building the awareness of listed companies because I was quite shocked to hear Mr. Wegapitiya say that brokers call him and ask him for announcements as that means that they do this with other listed companies as well. What we need to do apprise our boards of listed companies not to give information on a one-on-one basis to brokers because that is clearly not is what envisaged in the rules.
As far as information dissemination is concerned, we always have the good companies calling and checking on how information disclosures should be made and then you have the bad and the ugly making very skimpy announcements. We are trying to get companies to make announcements that are user-friendly. It is a lot learning; I think the most important is education and awareness and I think that our broker firms should also be advised of the dos and don’ts.
Dissanaike: One of the areas where I have often found can do with some development in Sri Lanka is financial journalism itself. If you compare the Sri Lankan journalistic efforts in this domain with some of the other countries of a comparable nature, you could say that there is a lack of sophistication in some of the articles so there is a lot that financial journalists can do.
In many countries, you have specialists in certain industries. Many of the articles that are placed in newspapers here have been placed by the companies themselves – it’s almost a regurgitation of what the company wants the public to hear. There is no independent analysis of whether the company’s prospects are good. Financial journalists I think are very important here because if there are people who understand a particular industry very well, by piecing together information from different institutions in the same industry, they can actually comment quite well on various activities so I think they have a role to play too.
Abeysuriya: I have asked some journalists to come to me and they respond saying that they would never say sell your shares in the newspaper as advertising will drop or a call will come from the chairman of that particular company either to me, my analysts or the newspaper. We have a huge problem in saying sell but I’m going to say sell.
Moderator: I was wondering how cautious should analysts be when companies during their research visits disclose their plans. Where do you know to draw the line?
Dissanaike: Let me talk about some instances where I don’t think there is any insider trading going on. Analysts play a very important role in the economy. Sophisticated analysts can make very good use of existing information. So by piecing together different bits of information, sophisticated analysts can get more from it than other investors. If they are not using insider information but are simply using the existing information better, that is not insider information and I think we must have incentives for people to do that because they are providing a social service there.
Let me give you an extreme example. Many investment banks hire mathematics PhDs from Stanford, Cambridge, MIT, etc. to devise trading algorithms. They are not dealing with insider information but are trying to find additional ways of adding value. The fact that these people are dealing with complicated models that ordinary investors can’t use doesn’t make that insider information.
Now if an analyst has used a piece of information given privately by a company and added that to other information they have then it becomes a little more complicated so one of the problems that has been highlighted in our country is that some analysts find it difficult to know when exactly they are crossing the line so education is key there in explaining the law but there is a grey area.
Wikramanayake: I think that is a hugely complex area and one that the SEC should be looking at. We have large institutional investors who come to buy large chunks of shares of listed companies. That fact is that the market is so far to give them access to due diligence – that’s clear insider dealing. When one shareholder is selling shares to a third party the company can’t give access to its books. This came up recently with a very conservative investor who came so we made very sure that the information he dropped was not published and price sensitive but until now the practice has been to open up all books to large investors – you can’t do that, that’s clear insider trading. This is where the SEC needs to come in; the time has now come to put all this right.
Sathkumara: I don’t think that the main reason for the market downfall was insider trading. I have been trading in this market for the past 18 years and I don’t think that insider trading is taking place in a big way in this market. I think that the downfall was mainly due to the manipulation and I don’t agree with Ravi on one thing. He said in 2010, the market was grossly overvalued. I don’t think it was overvalued but there were certain companies which were overvalued while at the same time there were companies trading at reasonable valuations.
Unfortunately what happens in the market is that most investors don’t distinguish between market manipulation and insider trading so they blame the whole thing on insider trading. Perceptions matter; if people think there is no level playing field, they will not come into this market.
