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Insider Trading Laws In Pakistan – A Crit ique| HaidermotaBNR

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INSIDER TRADING LAWS IN

PAKISTAN: A CRITIQUE

1993

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Insider Trading Laws In Pakistan – A Crit ique| HaidermotaBNR

PTCL, 1993 Jour. 42

INSIDER TRADING LAWS IN PAKISTAN

A CRITIQUE Prepared by:

Khozem A. Haidermota

Insider Trading Laws In Pakistan: A Critique

I. Introduction:-

Average investors act invariably on incomplete or inaccurate information, consequently there

are winners and losers; but for the development of and confidence in capital markets, it is

imperative that such losers do not perceive to have been defrauded. It is a well-established

principle in developed capital markets of the world that when “insiders” of a public company trade

in their own company stock with the knowledge of material non-public information, a fraud on

the market has been committed. This is based on the hypothesis that the price is an open and

developed securities market is determined by the available material information regarding the

company and its business. Misleading statements or material commissions distort the true value

of the securities and, therefore, defraud the market and consequently the shareholders at large.

The contention that insider trading must be curbed has, however, been controverted by

several scholars, through the views of such scholars have not been adopted by most capital market

regulators of developed and developing economics. To analyse the merits of such dissent is not

the purpose of this paper. The object is to examine the existing laws on insider trading and to

suggest amendments and clarification where appropriate.

In any event, very briefly, the two main arguments made by those who view insider trading as

acceptable practice are thus: -- First. It is argued that prohibition on insider trading cannot be

enforced under any reasonable commitment of administrative and judicial resources. This

argument has particular relevance in Pakistan because hard-to-detect evasion devices are

available to insiders, such as the use of factitious names or nominees, benamis etc. This problem

is compounded by our protracted and inefficient legal system. Second, unhampered insider

trading can be viewed as a necessary form of compensation for entrepreneurial activity. As

Professor Henry Manne contends, “insider trading is the means by which the incentives for

entrepreneurial activity in large corporations is effectively preserved: the individuals in the

corporation who are responsible for its successes must be able to appropriate the gains.” Manne,

Insider Trading and Law Professors, 23 Vanderbilt L. Rev. 547 (1970).

II. Overview of Legal Framework:-

The legal framework of insider trading laws in Pakistan are found in Sections, 223 and 224 of

the Companies Ordinance, 1984 (hereinafter, the “Companies, Ordinance”) and Section 17(e)(vi)

of the Securities and Exchange Ordinance, 1969 (hereinafter, the “Securities Ordinance”).

Sections 220 to 222 of the Companies Ordinance mandates inter alia that specified disclosures

made by insiders with respect to the beneficial ownership of their listed company’s securities. The

adequacy and timing of such disclosures, through intertwined with subject of insider trading laws,

will however be dealt with in a separate paper.

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Insider Trading Laws In Pakistan – A Crit ique| HaidermotaBNR

Section 223 of the Companies Ordinance prohibits short selling by certain insiders. Section 224

of the Companies Ordinance requires that insiders report to the Corporate Law Authority

purchases and sales of their own company’s securities within a period of less than six months. Any

gains by such insiders within six months are made recoverable by the company. Section 17(e)(vi)

of the Securities Ordinance prohibits an insider from buying or selling its own securities when such

insider is in possession of material facts and omits to disclose such facts while buying or selling

securities. Section 23(3) of the Securities Ordinance allows a shareholder to bring an action for

damages against an insider for violation of insider trading laws under the Ordinance. This Section

clarifies that such an action for damages may be brought without having to establish a contractual

relationship between the shareholder and the insider. Finally, Section 24 of the Securities

Ordinance permits criminal sanctions against the offending insider.

Research revealed that there has been no prosecution in Pakistan under any of the foregoing

statutes. Therefore, to analyse the implications of these statutes similar laws as existing in the

United States will be examined. Admittedly the capital markets of Pakistan and the United States

cannot be compared. Nonetheless reference to U.S. laws is appropriate for the following two

reasons: (1) insider trading laws have been on the books in the U.S. since 1933 and their courts

and legislators alike have made several mistakes. We could avoid such mistakes by learning from

their experiences; and (ii) for better or for worse, Pakistani statutes in substantial part are

modelled after the U.S. statutes.

III. Prohibition on Buying or Selling Securities with Insider Information under the Securities and

Exchange Ordinance: -

The statute that directly prohibits trading of securities predicated on inside information is

found in Section 17 of the Securities and Exchange Ordinance, 1969 which is relevant part states:

No person shall, for the purpose of inducing, dissuading, effecting or preventing in any

manner influencing or turning to his advantage, the sale or purchase of any security, directly or

indirectly—

(a) to (d) omitted.

(e) do any act or practice or engage in a course of business, or omit to do any act which

operates or would operate as a fraud, deceit or manipulation upon any person, in

particular—

(i) To (v) omitted.

(vi) being a director or an officer of the issuer of a listed equity security or a

beneficial owner of not less than ten percent of such security who is in

possession of material facts omit to disclose any such facts while buying

or selling such security.

Unfortunately, the above statute has not been interpreted by the Courts in Pakistan. If,

however, the regulators are keen to combat insider trading activities, it is likely that they will rely

on the above statute, since it is the only statute found in either the Securities Ordinance or in the

Companies Ordinance where an insider is prohibited from using material non-public information

while buying or selling listed securities.

There are three fundamental concerns with the above statute. First, definition of

insider is a narrow one and under certain circumstances would not cover persons with important

policy making functions at a listed company. Second, if an insider tips off a friend with non-public

material inside information and the friend trades on such information, is the insider (the tipper)

and/or the friend (tippee) accountable? Third, absent guidelines, it would be very difficult to

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Insider Trading Laws In Pakistan – A Crit ique| HaidermotaBNR

ascertain exactly what constitutes material non-public facts which must be disclosed prior to an

insider trading in the issuer’s securities.

III(a) Definition of insider under Securities and Exchange Ordinance:--

Presently, under the Securities Ordinance, insider trading is forbidden for a director or any officer

of the issuer of a listed equity security or a beneficial owner of not less than ten percent of such

security. The identification of a director is generally self-evident, but that of an officer is more

problematic. The definition of an officer found in Securities Ordinance states that “officer … in

relation to an issuer includes managing agents, manager, secretary, accountant or auditor of the

issue.” This definition is unsatisfactory since it makes no attempt to cover people likely to have

inside information, since a person’s title alone should not determine whether such person is an

insider. The proper focus should be on whether a person is “a corporate employee performing

important executive duties of such character that he would be likely, in discharging these duties,

to obtain confidential information about company’s affairs that would aid him if he engaged in

personal market transactions.” U.S. Securities Exchange Act Release No. 288