After a decade of wrangling and lobbying, Russia’s new law on insider trading and market manipulation finally came into force last January. Such a law was overdue and a necessary step in fulfilling Russia’s stated ambition to make Moscow an international financial centre. It was also timely, given the rising concern of regulators and market participants worldwide about market abuse in the fledgling democracy.
In a recent CFA Institute global survey on the market integrity outlook for 2011 , responding members ranked market fraud (such as insider trading) as one of the most serious ethical issues facing global markets. The respondents from Asia Pacific also ranked it as the most serious local issue for their markets. However, the most pronounced result was for Russia: almost half of survey respondents considered market abuse the single-most-important ethical issue facing their own market. The lawlessness of the old Wild West now seems a bigger present danger in the markets of the East.
Insider Trading Laws: a Fairly New Phenomenon
Surprisingly, despite a current broad consensus that market abuse is a financial crime, the legal prohibition against it is relatively recent. According to research by Bhattacharya and Daouk (2002, Journal of Finance) , the median year in which an insider trading law was introduced in over 100 markets, including developed and emerging, was 1991, only 20 years ago. By comparison, the median year for the establishment of an exchange was much earlier, in 1953. For 7 early movers, the lag between the creation of an exchange and the enactment of insider trading laws was more than 100 years. Implementing prohibitive laws is a start in tackling market abuse. But it is the first prosecution which has the most electric effect, according to the same study cited above. Here, the median year is 1994, implying the difficulty in securing successful prosecutions. The burden of proof in criminal cases, and the challenge of finding sufficient evidence even in civil cases, is much greater for insider trading when compared to many other crimes.
The new Russian law relies significantly on the lessons learned from earlier American and European experiences. Like its many predecessors elsewhere, it aims to build trust by increasing transparency and deterring misdemeanours through legal sanctions. For the first time, the law properly recognises “inside information” and “insider trading” as legal concepts, making such activity subject to civil and criminal liability.
To better understand the implications of the new law, the local CFA society, CFA Russia, sponsored a roundtable discussion last April, “Insider Trading and Market Manipulation,” at MICEX, Russia’s largest exchange. At the gathering, delegates learned about CFA Institute efforts at countering market abuse, including the promulgation of codes of conduct and engagement with policymakers to better inform related regulations. (Request a copy of CFA Institute’s presentation here.)
Successful Prosecutions Are the Real Test
Throughout the panel discussions at MICEX, there were repeated calls for thorough surveillance and credible enforcement. In anticipation, the Russian regulator had already begun implementing a market surveillance solution used by some of the top European and American institutions. Ultimately, though, the real test will be in applying the new powers of the law in bringing about successful prosecutions. In this regard, Russia would do well to learn from other regulators, such as the FSA in the UK, which has prepared for more aggressive enforcement with additional resources, extra powers, tougher sanctions, and higher targets for successful prosecutions. Signalling this new attitude, the FSA chief warned potential perpetrators last year to “be afraid.”
Elsewhere in Europe, other jurisdictions are also reviewing their laws. About 5 years ago, the European Union’s Market Abuse Directive set a legal framework to define, deter, and sanction insider dealing and market manipulation. Since its implementation, several gaps have been identified and a consultation process was recently started to understand how best to fill them. CFA Institute responded to the invitation last July with a list of suggestions, some in support of proposed changes and others arguing for alternatives.
Over a decade ago, then-U.S. SEC Chairman Arthur Levitt observed: “Our markets are a success precisely because they enjoy the world’s highest level of confidence. Investors put their capital to work — and put their fortunes at risk — because they trust that the marketplace is honest. They know that our securities laws require free, fair, and open transactions.”
Every regulator, including Russia’s, understands that a vigorous enforcement of insider trading law is an important ingredient for creating that trust.