An article by Rachel Cook of Peters & Peters and Christopher Coltart KC, Head of Business Crime at 2 Hare Court

 

 

Insider dealing is prosecuted in the UK by the Financial Conduct Authority (‘FCA’). Cases which result in a guilty plea or conviction are ordinarily followed by confiscation proceedings under the Proceeds of Crime Act 2002 (‘POCA’).  For the purposes of the POCA calculation, common sense dictates that the amount by which a defendant benefits from insider dealing is the difference between the price at which he/she bought the shares and their increase in value following public revelation of the inside information.  It is that gain which has been illicitly secured, based on an unfair advantage over the rest of the market place.

 

To take a simple example, therefore: a defendant buys £1000 of shares in X plc on the basis of inside information that the company is going to merge with Y plc.  Following announcement of the merger, the shares go up in value to £1,100, at which point the defendant sells.  His/her benefit, one might think, would be £100.

 

Not so says the FCA.  The benefit figure is not restricted to the increase in value of the shares after they were purchased.  Rather, it is represented by the full value of the shares when they are sold (ie the purchase price plus any gain in value – £1,100 in our example).  This article explores that startling proposition and explains why it must be wrong.

 

The FCA’s argument (referred to as ‘the full value approach’) is based on the wording of s.52(1) Criminal Justice Act 1993 and s.76(4) POCA. 

 

S.52(1) CJA 1993 reads as follows:

 

“An individual who has information as an insider is guilty of insider dealing if…..he deals in securities that are price-affected securities in relation to the information.”

 

Meanwhile, s.76(4) POCA is in the following terms:

 

“A person benefits from [criminal] conduct if he obtains property as a result of or in connection with the conduct.”

 

Taking these provisions together, the FCA argue that the shares bought by the defendant on the basis of inside information are the property ‘obtained’ by him or her ‘as a result of or in connection with the criminal conduct’.  As a result, the benefit figure is the purchase price of the shares plus any subsequent increase in value, not just that increase.

 

This cannot be right.  ‘Property obtained’ for the purposes of s.76(4) refers to the illicit fruits of criminal activity.  This does not mean net profit (the jurisprudence is clear on that) but equally it does not mean including the expenses of the criminal enterprise in the benefit figure.  To suggest otherwise is to conflate obtaining with the means of obtaining. 

 

The point can be simply illustrated.  Two men agree to rob a bank.  In furtherance of that conspiracy, they buy a second hand car for £1,000 to be used as the getaway vehicle.  They rob the bank, stealing £10,000 in the process.  On the FCA’s analysis, the benefit figure would be £11,000, on the basis that the car has been obtained ‘in connection with’ the criminal conduct (ie the conspiracy to rob the bank). 

 

This is obviously nonsense.  Whilst the cost of the car cannot be deducted from the benefit figure (which is £10,000), it equally cannot be added to it either.  This is because the car is not ‘property obtained’ as a result of or in connection with the offending per s.76 POCA.  Rather, the car has been purchased in order to obtain such property (in this case, the swag). 

 

Applying this to insider dealing cases, shares which are bought on the basis of inside information are merely the platform by which ‘property’ (ie the increase in share value) is illicitly ‘obtained’ for the purposes of POCA.  Any alternative interpretation leads to capricious outcomes, for example:

 

 

1. If inside information received by a defendant proves to be dud and the shares he/she purchases go down in value, the FCA’s analysis dictates that the defendant has still benefited from his offending, namely to the tune of the shares which were purchased for full value.  That is absurd.  He did not benefit from them, he bought them.  Those are two quite different things.
2. Assume that the pre-existing, legitimate owner of shares receives inside information that their value is going to fall, such that he/she sells and avoids a loss.  His/her benefit is the value of the loss avoided.  On the FCA’s analysis, therefore, the benefit figure is dictated by the timing of the inside information.  If it arrives prior to the purchase of shares, the benefit figure is the purchase price plus profit.  If it arrives after shares have been legitimately obtained, it is limited to the loss avoided.  That is irrational.
3. On the FCA’s analysis, the ‘full value approach’ only applies where shares are purchased in anticipation of a rise in value, rather than shorted in anticipation of a fall in price.  This is because, in the latter scenario, the shares are never ‘obtained’ by the defendant, they are only borrowed.  As a result, benefit is limited to the profit made.  In other words, say the FCA, the calculation of benefit depends on whether you are betting on the value of shares going up or down.  That also cannot be right. 

 

The short point therefore is this: shares purchased in anticipation of a rise in value are not ‘property obtained’ within the meaning of s.76 POCA.  Rather, it is the illicit increase in value which is obtained and it is that sum which should be confiscated.

 

To date, the FCA has enjoyed some success arguing to the contrary at Southwark Crown Court and has a number of first instance decisions in its favour (albeit perhaps grudgingly so, in at least one case the judge granted leave to appeal).  As matters stand, however, the point has not been considered by the higher courts.  Once it has been, it is inconceivable that the FCA position will be upheld.  Some things are just plain and obviously wrong; this is one of them.