SECURITIES ANDEXCHANGE COF~'~ISSION

Washington, D. C. 20549( 202 ) 2 7 2.- 2 6 5 0

INSIDER TRADING: AN INTERNAL PROBLEMWITH INTERNATIONAL IMPLICATIONS

.---/An Address

byBarbara S. Thomas

~ CommissionerU.S. Securities and Exchange Commission

International Management 'Symposium

St. Gallen Graduate SchoolSwitzerlandMay 17, 1983

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It is a great pleasure for me to be here today at thisgathering of such distinguished members of the internationalcommunity •. This afternoon, I will report to you on the initia-tives recently taken by the Securities and Exchange Commission("Commission" or "SEC") to thwart trading on "inside" infor-mation in the U.S. securities markets and to enlist yourcooperation in our global effort to fight against this difficultproblem.

I should make it clear from the outset, however, that Idid not, come to this European forum to attempt to export U.S.morality. I believe that each country may regulate, or notregulate, its own securities markets as it chooses; but we must

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acknowledge that the securities mar~ets of most industrializedcountries' a=e increasingly international markets. Therefore,if those markets are to remain open for international use, wemust recognize that legitimate regulation of internal marketshas iI'!ternational implications. Although I have no simple~~swer to the question of how far any country may reach toprotect its own i.nternal -- although international securitiesmarkets, I do believe that a world-wide discussion of thisquestion is an urgent necessity.

In the United States, a central premise of our auction-based securities market is that no buyer or seller should havea trading advantage over other users of the market by utilizingnon-public information about a company received from the companyitself, or frC'm certain other parties, such as prospectivebidders for the compar.y's securities. Such activity is called

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"trading on inside information" or "insider trading" and isprohibited by our securities laws. Insider trading is nottrading on a more intelligent analysis of pUblicly known infor-mation about the issuer or the field in which it operates. Itrelates only to significant non-public information about theissuer that is, in general terms, derived from persons in aconfidential relationship to the issuer or from a potentialacquirer of the issuer's securities.

In our view, trading on inside information violates thepUblic's legitimate expectation that honesty and fairnessprevail in our securities markets. Individuals who convertconfidential information into personal gain corrupt the coreof the auction market. Thus, insider trading makes investorsreluctant to invest in the stock market because it dest~oystheir belief that they' have an equal chance to profit. Wheninvestors are driven from the market, the market becomes lessliquid, and thus less able to fuel the expanding capital demandsof free enterpris~.

The steps recently taken here in Switzerland toward thepassage of legislation that would make insider trading a crime,as well as the statutory initiatives taken in this area bycountries such as France and the United Kingdom, prove that othernations share our concern for the maintenance of honesty andintegrity in the securities markets •. Unfortunately, in manyother countries, insider trading is not only legal, but is ausual form of conduct. Indeed, in some countries, it is often

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considered bad manners not to share non-public informationwith a friend so that he too can make a profit.

Of course, insider trading is not a new phenomenon. Today,however, we in America seem to be in the midst of an epidemicof such activity, in which the accounts that we read about inThe New York Times and The Wall Street Journal represent onlythe most blatant cases.

Why has the problem become so acute? Probably because thepotential rewards to these cheaters seem more alluring now thanever before. The current wave of mergers and tender offers inthe U.S. -- with the precipitous price increases they generate-- often provide irresistable incentive to wrongdoers who seekenormous profits, virtually overnight, with little acccmpanyingrisk. This has been facilitated, in large measure, by theadvent and development of [oL~alized ~arkets for options trading,both in the U.S. and here in Europe.

As most of you probably know, an option is the right topur~hase or sell shares of stock in a particular company at aspecified price.within a limited period of time~ What makesoptions, in particular, so attractive to insider traders is theirlow cost, typically a fraction of the price of the underlyingsecurity. If the price of the underlying security goes updramatically, a purchaser of the options is able to magnify bymany times the profit he would have made on the same investmentin the stock itself.

Although, in general, insider trading has been an importantfocns of the Commission's enforcement program since at least

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the 1960's, the SEC's prosecution of insider traders in our owncountry has run up against three major roadblocks that continueto threaten our enforcement efforts. First, there seems to bea belief held by those who are tempted to trade illegally oninside information that the Commission cannot or will notprosecute them successfully, either because detection and proofare difficult, or the law is unclear. ~he second roadblock isthe absence of meaningfUl sanctions to punish those who arefound to have violated the law and would deter others from suchconduct: The third roadbloack is the refuge insider tradersoften find behind bank secrecy and blocking laws of othercountries that can be used to shelter both the identities ofthe perpetrators and their ill-gotten gains.

To eliminate these roadblocks; we at the Commission haverecently undertaken three significant initiatives.

First, we are vigorously enforcing.our own existing lawsagainst insider traders. In this connection, the Commission,

-~ith my full support, has begun to bring insider trading casesat an unprecedented rate. Indeed, prior to 1978, the Commissionhad brought only 40 insider trading cases; since then, it hasalready brought more than 50 such cases, including 20 casesagainst 59 individuals in 1982 alone. In addition, I haverecommended that the SEC refer insider trading cases to ourDepartment of Justice for criminal prosecution on a much morefrequent basis than we have in the past.

Our second initiative in the battle against insider tradingin our secuLitie~ mark~ts i.s the Cc~~ission's recent submission

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to our Congress of the Insider Trading Sanctions Act ("SanctionsAct"). 1/ This proposed legislation is necessary to make ourincreased enforcement efforts more potent. It provides forgreatly enhanced civil and criminal penalties against those whoviolate our Federal securities laws by trading on inside infor-mation.

The need for greater sanctions against insider traders isobvious. The SEC's principal weapons against all fraud, includinginsider trading, are legal actions for an injunction that requiresa defendant to obey the law in the future, and actions for addi-tional relief in the form of disgorgement of profits.

At most, an injunction subjects a defendant to possiblecontempt proceedings if he violates the law again. It is, ineffect, merely a wrist slap -- a warning to behave in the future.Similarly, cisgorgement -- although a useful r~medy in generalbecause it deprives violators of the fruits of their violation-- does not penalize defendants for their past actions, and,therefore, does not provide adequate deterrence. Indeed,because-disgorgement does not SUbject a violator to any monetary

.net loss, it places an insider who is caught profiting from theillegal use of inside information in no worse a position thanan honest person who refuses to violate the law in the firstplace.

The proposed Sanctions Act is designed to raise the stakesof the game, and would make two alterations in the sanctionsto which illegal traders are exposed.

, .d M.R. 559, 98th Cong., 1st Sess. (1983).

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First, it would increase the criminal fines for mostviolations of the Securities Exchange Act of 1934 ("ExchangeAct"), including insider trading, from their present level of$10,000 to $100,000.

Second, and much more important, the Sanctions Act wouldauthorize the SEC to bring an action in court to seek a civilpenalty in an amount, to be determined by the court, that doesnot exceed three times the profit gained or loss avoided bythe insider trader. Significantly, this sanction differs fromthe $100,000 criminal fine in that treble damages can be assessed

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only with respect to insider trading violations.Although a breakthrough in U.S. securities regUlation, this

kind of multiple monetary penalty for insider trading is notnew. Indeed, here in Europe, French law has irr.poseda fine of upto 'four tithes the amount; of tohe in:;iccr trader's profit on his

illegal deal since 1970.I firmly believe that our proposed Sanctions Act, by

providing both the increased criminal fine and the potentially-very costly treble damages provision, will grea~ly alter the

risk analysis that an insider trader employs when determiningwhether to trade on inside information, and thus will offer ar~a1istic and effective deterrent to such illegal action.

Our enforcement initiative was a logical and necessary"

first step, and the proposal for increased sanctions is anessential s~pplement to it. Without one further initiative,however, meaningful control of the p~oblem of insider tradingin our capital markets cannot be achieved. Our war against

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insider traders has been m~;e increasingly difficult by foreignbank secrecy laws that prc~~it the disclosure of customers'identities and blocking sta~~tes that are designed to limitthe effect of U.S. foreign =.iscovery procedures. Indeed, theuse of such statutes to prc~ct these wrongdoers was stronglycriticized by the Federal ~~strict Court in New York in therecent Banca Della Svizzera case. In this landmark decisionordering the Swiss bank to ~~veal the identity of its customer,the Judge noted that n [ilt ~uld be a travesty of justice to

,permit a foreign company to invade American markets, violateAmerican laws if they were ~~5eed violated, withdraw profitsand resist accountability f=r itself and its principals forillegality by claiming thei~ anonymity under foreign law."Accordingly, Q~r third init~ativc i5 to engage in international

.negotiation a~~ discussion i~ an effort to persuade othercountries. to per:'!anentlyde-;:;=iveinsider traders of the foreignhiding places ttey traditic~ally have used when seeking to

-avoid enforc~~~~ of U.S. la~s with respect to trading in the

U.S. securities narkets.I emphasize !!erethat -.If: are not attempting to deal wi th

regulation, c: ~~-regulation, of the securities markets outsidethe Uniteo S~~es. only with the r~gulation of our own securitiesmark~ts as ~:T Ere used by non-U.S. traders.

Our f i.rs; ::.L::or accomrlishment in this area was the historicaccord reac:.~:: ::5:' summer rAtween the Uni ted States and Swi tzer-Land , 0:-. ;~:.=;~ 31. 1982, c,".Jr. two govt:rnments -- after only

exe~uted a Memo~anaum of

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understanding that represents an important achievement in inter-national cooperation and is certain to improve our ability todiscover and thwart insider trading through Swiss bank accounts.

The Memorandum of Understanding is not a binding inter-national agreement. Rather, it is a declaration of each nation'scommitment to battle insider trading and to rely wheneverpossible upon the 1977 u.S. - Swiss Treaty of Mutual Assistancein Criminal Matters ("Treaty"). That Treaty provides for theexchange of law enforcement information on matters that are

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criminal in both nations. Unfortunately, insider trading,although a crime in the U.S., is not a crime as such in Switzer-land. Consequently, unless the conduct falls within moregeneral Swiss proscriptions against fraud or unfaithful manage-ment, the mutual criminality standard is not satisfied, andthe Treaty cannot be invoked. As the Swiss Federal Tribunalindicated in its recent decision in the Sante Fe case, itappears that these provisions cannot be'used against certaininsider trading activity.

---'.--:.In view of the existence of these shortcomings in theTreaty, the Swiss Bankers' Association has submitted to itsmembers a "private convention" that permits a signatory bank,without violating Swiss secrecy laws, to furnish informationto the SEC in connection with customers suspected of tradingon inside information. We may now request through our JusticeDepartment and the Swiss Police Department that a three membercommission appointed by the Swiss Bankers' Association investi-gate and report to us the identity of traders involved in

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questionable transactions (which must relate to either a businesscombination or the acquisition of at least 10 percent of acompany's shares). The bank will also freeze the suspects'assets up to the amount of the illegal gains in the transactionunder investigation. As of this date, I am happy to report,the private convention is operational.

The private convention, however, is only a provisional measure.Once legislation is enacted that makes insider trading a crime inSwitzerland, the convention, by its terms, will be terminated.As I understand it, such legislation has already been drafted bythe Swiss Federal Government and will shortly be circulated tovarious interested parties in Switzerland for their comments.

While the execution of the Memorandum, as well asSwitzerland's own efforts toward limiting the damaging impactof its bank secrecy laws on international law enfo~cemcnt areto be applauded, they will, by no means, solve the problem ofinsider traders in the u.S. market using the shield of foreign

-laws to hide their identities. Rather, with one of theirtraditional hiding places exposed, it is likely that these

.illegal traders will merely shift their base of operations toother jurisdictions fortified with secrecy laws and blockingstatutes: and unfortunately such jurisdi~tions abound.

Turning first to bank secrecy, my research has shown thatat least 32 countries have bank secrecy laws that keep bank accountsand depositors shielded from foreign scrutiny. Moreover, thenumber is increasing, not decreasing_ H~re in Switzerland, thebank secrecy law, which is of lessened significance to theCommission in light of t.he Memoro.nd\l.11l of Underl:itcmding,

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nevertheless reflects a relationship between the government andits citizens that is deeply rooted in history, and is aimed atpreventing government intrusion into the private sector.

The secrecy laws of some smaller nations are less rootedin a historical fear of government intrusion, and may be theresult of cynical attempts to attract business of any sort tothose countries. These nations may become the next major refugefor insider traders in the U.S. markets. In the Bahamas, forexample, there are two statutes that offer substantial incentivesfor maintaining the confidentiality of customer information. 2/Like the Bahamas, the Cayman Islands also offer the allure -- toboth the honest and the dishonest -- of a disclosure-free bankingenvironment. l/

Of course, the Caribbean is not the only locale wherepromises of secrecy may attract illicit insid~r truders.

~/ One of these laws, the 1965 Act to Regulate Banking Businessand Trust Companies, as amended in 1980, provides for afine, imprisonment, or both, for disclosure to anyone ofinformation with respect to a bank or its customers, ifsuch information was acquired in the course of the violator's

_--relationship with the bank. There is an exception, however,for disclosure made pursuant to Q court order or in connectionwith the day-to-day responsibilities of bank employees.A second law, the 1974 Act to Provide for the Establishmentof a Central Bank, subjects anyone who divulges bankinginformation to a similar fine, and imprisonment. Thislatter statute differs from the first in that it appliesonly to the disclosure of information to a governmentalauthority without bank or court authorization, and doesnot apply to general business relationships.

~/ The Cayutan statute, the Confidential Relationships (Preser-vation) Law of 1976, provides criminal penalties of fineand imprisonment for dis~losu=e of ccnfidential informationwith respect to virtually all business activities, inclUdingbanking. Pursuant to 1979 amendments to that law, anyperson who requests disclosure of confiden~ial informationmust first make an application to the Grand Court of theCaymans (a trial-type court) for authorization aDd direction.

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Right here in Europe there are a number of laws that can beused to prevent disclosure of banking information to legitimateforeign investigative authorities.

In Austria, for example, the Banking Law of 1979 il imposesa duty of secrecy enforceable by criminal sanctions, and a similarduty is imposed in the Netherlands by its banking laws. 51

Although I firmly believe that these laws were enacted to furtherthe legitimate national interests of those nations, and not toharbor those who trade on inside information in the U.S markets,nevertheless, their effect is to make foreign investigationsof such violations more difficult.

Like secrecy laws, blocking statutes are prevalent, andcan impede the SEC's ability to discover insider traders. Asmost commonly enacted, these statutes prohibit the proouctionof information pursuant to foreign administrative or judicialrequests. In addition, certain blocking laws are designed tominimize the impact of foreign court judgments. These statutesreflect a determination that enforcement of a foreign order isinconsistent with iocal legal or financial principles, or is athreat to sovereignty or national interest.

One such statute is the blocking law enacted by France. ~I

The French statute is one of the most recent, and, in my view,one of the most stringent of these laws. Although technically

!I Austrian Banking Law of 1979, Sections 23 and 34.~I Section 46 of the Banking Act of 1978.21 Law No. 80-538 of July 16, 1980.

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an amendment to a statute regulating communications with respectto maritime commerce, it relates directly to the SEC's abilityto acquire information about activity that violates u.S. statutesbut that occurs in France.

The primary purpose of the French blocking law is to ensurethat foreign lawyers comply with the judicially supervisedFrench discovery procedures. To achieve this result, as Iunderstand it, the provision not only prohibits any disclosureof documents or information that would threaten the sovereignty,security or essential economic interests of France, or thepublic,order, but also makes the very act of requesting anydocuments or information without following jUdicial proceduresan offense. Specifically covered by the statute are mattersof an economic, commercial, industrial, or technical nature,

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intended for use as evidence in connection with pending orprosPective foreign jUdicial or administrative proceedings.

As orginially enacted, the French blocking law appearedto c~eate serious obstacles to our ability to investigate

-insider trading in the U.S. markets that involved activity inFrance. In this connection, it also threatened to underminethe traditional cooperation between the SEC and the CommissionDes 'Operations de Bourse ("COB"), a prospect which, I am

Isure, troubled that distinguished agency as much as it troubledus. HappilYf however, I understand that pursuant to recentamendments to the blocking law, the COB will once again beable to assist the SEC in investigations involving activitiesoccurring in France.

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In direct contrast to the strictness of the French statute,the British blocking law 1/ confers wide discretionary authorityon the Secretary of State to allow or prohibit foreign discoveryrequests. Under that law, if a person carrying on business inGreat Britain is requested to produce information concerningconduct occurring outside the requesting country's jurisdiction,whether or not such activity took place in Britain, he may berequired to give notice to the Secretary of State. If theSecretary determines that the request threatens Great Britain'stradiryg interests, infringes on its jurisdiction, or prejudicesits sovereignty or security, he may prohibit compliance withthe foreign order.

It should be noted that although the Act was motivated bywhat the British perceive as unreasonable and chauvinisticextraterritorial applications of the United States antitrustlaws, the actual scope of the Act is not so limited. By itsterms the Act may apply to any foreign measure affecting thetrading interests of Great Britain. It is clear, therefore,that t~~ Act ~an be used to block enforcement of foreign lawsthat, according to the tenor of the times, may be consideredunfair or unpopular by the British government.

In the face of all of these obstacles to enforcement ofour securities laws with respect to trading in our markets,we in the U.s. are keenly aware that international solutionsare needed. Toward this end, I believe that significant

7/ The Protection of Trading Interests Act of 1980 (Eliz II).

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progress has been made. One important initiative has been thenegotiations that our Department of Justice has conducted andis currently conducting with many nations aimed at procuringtreaties of mutual assistance in criminal matters thdt do notcontain the kind of dual criminality requirement that has provedso troubling in our treaty with the Swiss. Such negotiationshave recently been concluded successfully between our countryand the Netherlands, Colombia, and Turkey, respectively, andsimilar accords are expected in the near future.

/ ~ven more significant, I believe from a global perspective,was the gathering together in Amsterdam in March of an informalgroup of international securities regulators. This almostentirely European gathering discussed various regulatory issuesof common interest to all of the participants. The establishmentof this group as a continuing entity, without U.S. leadershipor domination, has been one of my personal projects since I

,have been at the Commission. I was inspired in this regard byDean Robert H. Mundheim of the University of Pennsylvania LawSchool, and other members of the International Faculty forCorporate and Capital Market Law, a standing group of academicsconcerned with the health of the world's capital markets. Iwas also encouraged by the outstanding results achieved by theBasle Committee, an international working group of bank super-visory authorities originally led by W. Peter Cooke, with whomI consulted at the outset of my ef£orts. It is my strongbelieve that the face-to-face contact fostered by such a groupwill operate to facilitate personal solutions to international

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problems. I am €xtremcly optimistic about the role of informaldiscussions in bridging the transnational gaps in cooperationin all matters relating to the world's capital markets, and inparticular, to the problem of insider trading.Conclusion

I have attempted to outline briefly the measures we at theUnited States Securities and Exchange Con~ission have taken,as well as the obstacles we still face, in our ongoing battleagainst insider trading in the U.S. securities markets. Itis clear to us, however, that our efforts to date are onlysmall attacks in what must be a global battle.

Although my mission today is to outline our own strugglesin keeping the U.s. securities markets free from insider tradersf~om all countries, the problem ofnational one. Isolated unilateral or bilateral efforts aresalutary and may relieve temporary discomforts, but they cannotbring about long-term recovery. A lasting cure can only be

___developed through cooperation by all nations engaged in multi-national commerce.

It is therefore of the utmost importance that groups suchas this one, and the informal group of international securitiesregulators that I discussed briefly, pledge themselves toestablishing a continuing dialogue on this issue. It is onlyby continuation of such a dialogue thc3.t meiab ers of the inter-national community, through both formal and intormal mc.c3ns,can accommodate their own national interests ~hi]e promotingour common international ob;ectives.

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