The impact of South Africa’s insider trading regime A report for the Financial Services Board March 2004

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25/03/2004: VERSION 1.2 Authors: Andrew Myburgh and Ben Davis

G:enesis Analytics is an economics consulting firm working in Africa and in other developing countries (www.genesis-analytics.com). With headquarters in Johannesburg, G:enesis provides policy advice, strategic direction, institutional design and implementation support. Its clients include the South African government, multilateral institutions, private and public sector companies and regulators.

G:enesis Analytics (Pty) Ltd 2nd Floor, No 3 Melrose Square, Melrose Arch, Johannesburg South Africa, 2196. Post to: Suite 3, Private Bag X1, Melrose Arch, Johannesburg, South Africa, 2076. Tel: +27 11 214 4080, Fax: +27 11 214 4099 www.genesis-analytics.com

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TABLE OF CONTENTS

List of Figures iv

1. EXECUTIVE SUMMARY VI

2. THE IMPACT OF SOUTH AFRICA’S INSIDER TRADING REGIME ON MARKET BEHAVIOUR 8

2.1. Introduction 8

2.1.1. The approach used 8

2.2. What is Insider Trading and why is it illegal? 10

2.3. The Insider Trading Regime 11

2.4. How could the Insider Trading Regime have affected market behaviour? 13

2.5. The deterrent 15

2.5.1. Changing attitudes 17

2.5.2. Companies associated with insider trading 17

2.5.3. Changing attitudes in the market 18

2.6. Procedures at listed companies 19

2.6.1. Insider trading policies 19

2.6.2. Procedures aimed at stopping company insiders from insider trading 20

2.6.3. Procedures aimed at stopping inside information from leaving the firm 21

2.6.4. Procedures at listed companies 22

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2.7. Procedures at financial firms 23

2.7.1. Financial firms with trading and investment banking divisions 23

2.7.2. Retail brokerages 24

2.8. Education and awareness 25

2.9. The effect on insider trading 27

2.10. Conclusion 30

3. APPENDIX 31

3.1. Questions and answers not published in the main text 31

3.1.1. Listed companies 31

3.1.2. Stock broking firms 32

3.1.3. Traders and asset managers 33

3.1.4. All respondents 33

LIST OF FIGURES

Figure 1. Timeline of corporate governance and insider trading reforms in South Africa 11

Figure 2. Settlements published by the FSB media department, in terms of the Civil provisions of the Act 15

Figure 3. Settlements vs. Implementation of insider trading policies in listed firms 19

Figure 4: New investigations by the FSB versus new equity capital raised 29

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Figure 5: New investigations by the FSB versus average daily shares traded on the JSE Securities Exchange 29

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1. EXECUTIVE SUMMARY

In 1999 South Africa instituted a novel regime aimed at combating insider trading. G:enesis was commissioned to assess whether the new regime has had an impact on conduct in the market. As insider trading cannot be observed directly, the methodology chosen was a representative survey of market participants. The impact of the Insider Trading Directorate’s enforcement actions was also analysed.

The results of the survey, reported in this paper, are striking. The new regime has changed prevailing attitudes to insider trading, resulted in new policies and approaches among listed corporates and their advisors, and – according to most market participants – led to a sharp reduction in the perceived incidence of insider trading. Among the findings of the survey:

• Market participants have become more aware of insider trading rules and regulations (according to 93% of respondents).

• Insider trading has become markedly less acceptable (according to 80% of respondents).

• Education at listed companies has increased (according to 82% of listed companies).

• 77% of traders and asset managers viewed the insider trading regime as having been either very successful or successful in reducing insider trading.

• The JSE’s insider trading booklet has been widely read (54% of respondents had read it).

• The majority of listed companies have implemented insider trading policies (59% of listed companies).

The survey also revealed areas in which there is room for improvement. 60% of smaller brokerages, mainly serving retail clients, do not have compliance manuals dealing with insider trading and only 20% had procedures to deal with the situation where a trader receives inside information. 18% of listed companies interviewed have not implemented an insider trading policy. Furthermore, levels of awareness

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about insider trading rules and requirements are low in 29% of listed companies interviewed.

The survey sheds light on how the new legislation has made an impact. In short, public enforcement of the legislation has contributed to a change in attitudes about the acceptability of insider trading. This, in turn, has dramatically raised the costs of being associated with insider trading: companies suffer reputational loss, reflected in the buying decisions of institutions; and individuals find their career prospects diminished along with their reputations. This dynamic, driven mainly by visible enforcement, is at the root of the success of the new regime.

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2. THE IMPACT OF SOUTH AFRICA’S INSIDER TRADING REGIME ON MARKET BEHAVIOUR

“Lawgivers make the citizen good by inculcating habits in them, and this is the aim of every law-giver; if he does not succeed in doing that, his legislation is a failure. It is in this that a good constitution differs from a bad one” Aristotle.

2.1. INTRODUCTION

South Africa’s Insider Trading Act is now five years old, having replaced an unsuccessful section in the Companies Act. Financial markets in the apartheid era were known for high levels of insider trading. Insider trading regulations are commonly part of corporate governance regulations aimed at improving the efficiency of financial markets. The new legislation aimed at raising South Africa up to a level that would make it comparable to international best practice, by including stricter definitions of insider trading and allowing for civil prosecutions.

Internationally the prohibition of insider trading is a recent phenomenon. Although insider trading was considered as fraud against shareholders as far back as a 1909 ruling, the United States enacted insider trading laws in the 1930’s. But most countries have only begun to address the issue in the last 15 years: Germany, for example, instituted its first insider trading regulations in 1994 under pressure from the European Commission.

G:enesis was asked by the Financial Services Board to assess the impact of South Africa’s new insider trading regime on market behaviour.

2.1.1. THE APPROACH USED

Insider trading is difficult to measure directly. The practice is illegal and victims seldom know when they have been defrauded. Therefore, the impact of the new regime was measured indirectly through a survey and by tracking investigative activity.

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G:enesis sampled South Africa’s financial markets using a statistically validated approach. The population size of the various types of companies involved in South Africa’s financial markets was ascertained and representative samples constructed for the following groups: (1) actively traded listed companies, (2) brokerage firms, (3) asset management firms, (4) corporate finance firms, (5) audit firms and (6) law firms.1 Individuals interviewed within these groups either had direct contact with the market or were responsible for the implementation of policies within their respective firms. The survey presents results for four groups. They are:

1. Traders and asset managers who make and execute investment decisions on a daily basis.

2. Market advisors: merger and acquisitions advisors, lawyers, corporate finance advisors and sponsors2 who provide advice to companies during mergers or acquisitions.

3. Company secretaries at listed firms: company secretaries and/or investment managers who were responsible for ensuring that the firm abides by the relevant insider trading regulations and listing requirements.

4. Financial market compliance officers: compliance officers at stock broking and asset management firms, responsible for ensuring that the financial services firm abides by the relevant insider trading regulations.

An evaluation of the Financial Services Board’s enforcement actions was also conducted. Information regarding investigations, settlements and prosecutions progress is released onto the FSB website and disseminated through news services.

1 Listed firms were obtained from the JSE Securities Exchange; a sample of stockbrokers was obtained from the JSE; a list of asset management firms was obtained from Alexander Forbes; finance firms and law firms are listed in the Ernst & Young 12th edition on “Mergers and Acquisitions: a review of activity for the year 2002”; Major audit firms were approached during the course of the survey, with little response. 2 Sponsors are inherently also corporate finance advisors.

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2.2. WHAT IS INSIDER TRADING AND WHY IS IT ILLEGAL?

Inside information is information regarding a company that, if it were to be made public, would change the company’s share price. An insider is someone who has access to inside information. Insiders fall into two groups: either they (1) work directly for, or provide services to the company; or (2) are a person who receives “inside information”, knowing it is sourced from an employee or service provider. The latter group is known as tippees.

South Africa introduced the new legislation for two main reasons. Firstly, it was an attempt to improve the attractiveness and efficiency of South Africa’s financial markets; secondly, it was an aspect of an overall push to improve corporate governance.

Insider trading, corporate governance and the attractiveness and efficiency of financial markets are interrelated:

•

•

Corporate governance. People in a fiduciary position are tasked with managing the company on behalf of the owners of the company or shareholders. By trading whilst in the possession of information that they have received in the performance of their duties such individuals benefit at the expense of shareholders.

Market efficiency. Insider trading decreases market efficiency. In a study of 54 securities markets, Julan & Shang-Jin3 found that insider trading dramatically increases volatility in stock markets (after accounting for the impact of liquidity, maturity and macroeconomic fundamentals). Securities that offer similar returns but with differing risk profiles – essentially share price volatility – are priced at different levels. Furthermore, insider trading decreases investors’ confidence in the market by creating an unfair playing field, making it harder for companies to attract funds. Fishe & Robe4, in a unique study of US companies’ shares in which insider trading had taken place, showed that they had less liquid shares than unaffected market equivalents, raising the cost of capital for the affected firm. This is also true for stock markets as a whole. Bhattacharya &

3 Julan & Shang-Jin, 2003 Does insider trading raise market volatility? on [http://www.nber.org/papers/9541] [last accessed 19 March 2004] 4 Fishe & Robe, 2002 The Impact of Illegal Insider Trading in Dealer and Specialist Markets: Evidence from a Natural Experiment on [http://som.yale.edu/jfm/ProgramPDFs/BWPaperv11b.pdf] [last accessed 19 March 2004]

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Daouk,5 in a ground-breaking paper studying 103 securities markets, showed that effective enforcement of insider trading legislation had a significant impact on the cost of raising capital, which on average, decreased by 5% in the event of effective enforcement. Effective enforcement was prosecution by authorities under the insider trading legislation.

2.3. THE INSIDER TRADING REGIME

Insider trading was first made illegal in South Africa by the Companies Act in 1973. The Companies Act failed in its attempt to rein in insider trading and by the mid-1990’s South Africa had a reputation for a high level of insider trading. In 1997, the King Task Group recommended the reform of the insider trading regime. In 1998, on King’s recommendations, the provisions in the Companies Act were replaced by the Insider Trading Act.

The timeline below shows the critical dates in South Africa’s Insider trading regime:

1973

Insider Trading is first made illegal

1999 (January) The Insider

Trading Act is brought into effect

1999

(June to December) first six settlements

reached

2000

(October) JSE listings requirements on directors dealing

2004

(January) New listings requirements are introduced which counter insider trading

2002

(June) JSE’sInsider Trading

Booklet is published

1973

Insider Trading is first made illegal

1999 (January) The Insider

Trading Act is brought into effect

1999

(June to December) first six settlements

reached

2000

(October) JSE listings requirements on directors dealing

2004

(January) New listings requirements are introduced which counter insider trading

2002

(June) JSE’sInsider Trading

Booklet is published

Figure 1. Timeline of corporate governance and insider trading reforms in South Africa Source: FSB and JSE

5 Bhattacharya, U, Daouk, H, 1999 The world price of insider trading on [http://faculty.fuqua.duke.edu/~charvey/Teaching/BA453_2004/BD_The_world.pdf] [last accessed 19 March 2004]

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The new legislation:

• Widened prohibitions of insider trading: It is illegal to deal whilst in the possession of inside information, or to tip.

• Civil and criminal provisions: In a path-breaking step the Act explicitly allows for both civil and criminal proceedings to be brought against offenders.

• Civil provisions: Under the civil provisions of the Act, fines of up to four times the gains made from a trade may be levied, as well as the legal costs.6

• Criminal provisions: Under the criminal provisions, the Act provides for a R2 million fine or imprisonment of up to 10 years, or both.

• FSB is empowered to act in civil cases: The Act enables the FSB to pursue civil claims against transgressors of the Act. The FSB is also empowered to compensate individuals who could have been prejudiced by the offending transactions.7

• Criminal prosecution: Investigations are handed to the National Director of Public Prosecutions for criminal prosecution.

The legislation has been reinforced by corporate governance reforms, which have improved controls on information dissemination within companies and financial markets. This has occurred in response to the two King Reports and has been incorporated into the JSE’s listing requirements. These requirements became compulsory for listed entities this year.

It is difficult to convict inside traders on a criminal charge, as it is onerous on the prosecuting authority to demonstrate beyond reasonable doubt that the defendant traded because of the inside information and not for some other reason. Civil actions, on the other hand, allow for a decision on the basis of a balance of probabilities. The FSB houses the Insider Trading Directorate, which investigates cases of insider trading and prosecutes offenders under the civil provisions of the Act. The JSE Securities Exchange (JSE) provides support in the form of market

6 Gains include losses avoided as well as profits made. 7 All settlements have resulted in a fine with a non-admission of guilt to insider trading on the part of the defendant.

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surveillance. All JSE transactions take place on a standardised trading platform. The JSE’s Surveillance Department monitors trading behaviour on the JSE, with information regarding trades known down to client level. Using the most sophisticated surveillance technology of any financial market in the world, the Surveillance Department is able to track actions on the exchange on a real time, trade-by-trade basis.8

Other institutions involved in the surveillance and prosecution of insider trading are the Bond Exchange of South Africa (BESA) and the National Directorate of Public Prosecutions.9

Since 1999 the FSB and the JSE have played an important role in educating the market about insider trading. This began with the Act itself, which clarified what types of behaviour constituted insider trading. The settlements and investigations have educated the market and raised awareness. The FSB and the JSE make numerous presentations to market participants and in 2002 the JSE produced a guide to issues surrounding insider trading, the Insider Trading Booklet.

2.4. HOW COULD THE INSIDER TRADING REGIME HAVE AFFECTED MARKET BEHAVIOUR?

The insider trading regime is a concerted attempt to change the behaviour of participants in South Africa’s financial markets. Behaviour changes for two interconnected reasons: (1) because incentives change; and (2) because norms of behaviour change.10

• Incentive changes. The incentive to engage in insider trading is determined by the costs and benefits of doing so. These are affected by market conditions as well as by the legal framework. The costs of engaging in insider trading include the possibility of being caught and punished. Some market conditions are more conducive to insider trading than others. During periods when there are many price sensitive announcements, such as mergers, listings and de-listings the opportunities for insider trading increase. Insider trading is thus cyclical, increasing during active corporate activity. Furthermore, the insider trading regime has required companies to

8 This excludes Over The Counter (OTC) trades which are a small proportion of shares traded on the market. 9 BESA has not played an active role in the Insider Trading Regime. 10 The sources used for this framework were: J. Elster 1989 Social norms and economic theory Journal of Economic Perspectives, Vol. 3 No. 4 S Bowles, 1998 Endogenous preferences: the cultural consequences of markets and other economic institutions Journal of Economic Literature, Vol. 36 No. 1

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communicate more quickly with the market, thus narrowing the window of opportunity to engage in insider trading and reducing potential benefits. Weighing up the relative benefits and costs, with the increased probability of being caught and the reduced window of opportunity, should lead to a reduction of insider trading in the market. Separating the effect of reduced corporate activity over the last three years from the increased costs of insider trading is difficult, as incentives to inside-trade are determined by both factors.

• Changing norms of behaviour. Attitudes and norms are the foundations on which a stable and successful society is built.11 The regulator, or in this case the law, can change market participants’ norms towards the sprit of the legislation. Whilst it is not well understood how norms change, it is likely that they adjust out of a combination of (1) the legitimacy of the regime and rules underlying it; (2) awareness and understanding of the legislation and regulations; (3) how the regime changes incentives; and (4) feed-back effects as adoption of the norm leads to further adoption. It is safe to say that the insider trading regime is the most important reason that norms against insider trading would have changed during the last five years.12

In South Africa’s financial markets, norms and incentives would affect behaviour in tandem. The increasing probability of being caught and increased costs of being caught deters market participants from engaging in insider trading. Importantly, changing norms also impact on incentives: the damage to one’s reputation of breaching a solidly established norm (not stealing) is greater than that of contravening a less established one (not jay-walking). As the norm against insider trading strengthens, the damage to reputation of being caught increases.

Education both teaches people how to stay within the legislation and motivates them to do so. It shows those that want to, how to act within the law and regulations. By communicating what behaviour is appropriate and what is not education also changes norms. Therefore, education facilitates behaviour change as well as inducing it.

11 An example of a norm would be “murder is unacceptable, irrespective of the consequences”. Nevertheless clearly not all norms are beneficial for society for instance norms requiring revenge are clearly anti-social. The norms discussed here are social norms, which are subtly different to moral norms which may exist and yet have a muted impact on behaviour, for instance various norms on sexual behaviour often have little impact on people’s actions. Whereas norms with little moral content such as those to do with appropriate types of clothing are strongly adhered to. 12 A contributing factor would have been the improving “culture of compliance” in corporate South Africa.

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All these characteristics highlighted above are illustrated clearly in the survey results listed below.

2.5. THE DETERRENT

The civil provisions of the Act have been the main tool utilised by the FSB, resulting in 17 settlements over the last five years. These settlements involved eight corporate insiders (including CEOs and directors) and 16 listed entities. The balance involved tippees. Total penalties levied have exceeded R23.7 million, excluding legal costs. Figure 2 provides an outline of when settlements under the civil provisions were made. The graph shows the highest number of settlements was in 1999 and that there has been a downward trend to one settlement in 2003.

0

1

2

3

4

5

6

1999H2 2000H1 2000H2 2001H1 2001H2 2002H1 2002H2 2003H1 2003H2

Settlements

Settlements

Figure 2. Settlements published by the FSB media department, in terms of the Civil provisions of the Act Source: FSB

Whilst settlements often include non-acceptance of liability an impression of guilt is often created in the minds of the public. Some 80% of respondents believed that individuals who settled with the FSB were either guilty or probably guilty. Settlements normally involve a fine, which is a multiple of up to four times the gains made from the offending transactions. The survey showed that the fine would be the most important consideration when considering settling for only 4% of

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respondents. Respondents were far more concerned about how settling would be perceived within the marketplace. When asked what their most important consideration would be when settling:

• 75% said damage to their career; • 12% said the shame of being caught; and • 4% said getting their name in the paper.

90% of respondents reported that if a colleague settled, their most pressing concern would be the damage to the firm’s reputation. A secondary concern, for 36% of respondents, was their colleague’s employment future.13

Question 79: Speaking hypothetically, if you were to settle with the Financial Services Board over a insider trading investigation, what would be your two most pressing concerns?

The damage to your career

Getting your name in the paper

The shame

of being

caught

The cost of the

settlement

I would not be

concerned OtherMost pressing concern 75% 4% 12% 4% 2% 4% 2nd most pressing concern 16% 32% 16% 30% 0% 6%

Question 78: If someone in your division settled with the Financial Services Board over an insider trading investigation what would be your two most pressing concerns?

Damage to your firm’s

reputation

The cost of

settlement

If foreign owned, reaction

the parent company

Damage to your

personal reputation

Concern for the

person’s employment

future OtherMost pressing concern 90% 2% 0% 0% 4% 4% 2nd most pressing concern 7% 4% 0% 11% 36% 31%

There are indications that the stigma associated with settling with the FSB is a new phenomenon. In preliminary interviews, market participants reported that insider trading was socially acceptable in the late 1990s and before. Furthermore, the FSB and lawyers advising defendants report that defendants have become far less willing to settle with the FSB. The reason that this stigma has developed is probably two-fold. Across the market, attitudes have changed and insider trading is

13 It was clear that many respondents considered it fitting that a colleague who engaged in insider trading lost their job. This explains the relatively low proportion of respondents registering concern about their colleague’s employment future.

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far less acceptable than it used to be. Additionally, listed companies linked to insider trading settlements have often tended to be unsuccessful or failing. Changing attitudes

Market participants report that there has been a notable change in attitudes towards insider trading since 1998. Some 90% of respondents reported that insider trading has become less or much less acceptable.

Question 83: Over the last five years, or for the years in which you have been working in South Africa, has insider trading become?

More acceptable

Less acceptable

Much less acceptable

No answer

Company secretary 0% 50% 43% 7% Compliance officer 5% 19% 71% 5% Traders and asset managers 0% 43% 50% 7% Market advisors 0% 10% 70% 20% Average % 2% 30% 59% 9%

Insider trading is reported to be unacceptable in South Africa’s financial markets by 71% of respondents. A significant minority of 22% report that it is still somewhat acceptable.

Question 82: Would you say that in the South African financial markets insider trading is perceived to be?

Highly unacceptable

Somewhat unacceptable

Somewhat acceptable

Highly acceptable

No Answer

Company secretary 29% 50% 14% 0% 7% Compliance officer 38% 29% 19% 14% 0% Asset managers and traders 29% 43% 21% 0% 7% Market advisors 10% 60% 0% 10% 20% Total 29% 42% 15% 7% 7%

The insider trading regime has had a significant impact on attitudes in South Africa’s financial markets. These changing attitudes have increased the stigma of visible involvement in an insider trading case.

2.5.1. COMPANIES ASSOCIATED WITH INSIDER TRADING

The reputation effects of insider trading on firms are significant. When officers of companies are involved in insider trading it is a clear signal to the market that they lack integrity. Furthermore firms involved in insider trading are associated with

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under-performance. Of the 16 shares involved in a settlement, eight firms had suspended trade by the time the settlement was announced. Of the eight remaining shares, only one firm had registered a share price gain between the announcement of investigation and settlement. The average share price at settlement was approximately 27% of the value at the beginning of the investigation. The stigma of being associated with insider trading is reflected in market behaviour. 79% of traders and asset managers reported that they would be less or much less likely to buy a share if the companies CEO settled with the FSB over an insider trading investigation.

Question 80: If the CEO of a firm whose company’s shares are traded on the JSE settled with the FSB over an insider trading investigation. How would your likelihood of you buying the firm’s shares change?

Much less likely to buy firms shares

Less likely to buy firms

shares No

change No

AnswerTraders and asset managers 50% 29% 7% 14%

The perceived link between insider trading and a lack of integrity and quality in management gives firms a powerful incentive to ensure that they implement procedures to minimize the likelihood of insider trading. .

2.5.2. CHANGING ATTITUDES IN THE MARKET

The most costly aspect of settling with the FSB is the damage to the firm’s reputation and the person’s career. There are indications that this stigma developed after the introduction of the Insider trading regime. This stigma increased the impact of the FSB’s enforcement actions by increasing the deterrent value of settling.

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2.6. PROCEDURES AT LISTED COMPANIES

In the survey we asked listed companies, represented by company secretaries and investment relations personnel, about company procedures with respect to insider trading. For some companies the investment relations officer was better placed to answer some questions. This section reports these results in three sections. First the introduction of formal insider trading policies is analyzed. The second section considers procedures aimed at stopping company insiders from trading. The third looks at procedures aimed at stemming the flow of inside information. Figure 3.

Settlements vs. Implementation of insider trading policies in listed firms

0

1

2

3

4

5

6

1998 &Before

1999H2 2000H1 2000H2 2001H1 2001H2 2002H1 2002H2 2003H1 2003H20%

5%

10%

15%

20%

25%

30%

35%

Listed firms implementing insider trading controls for the first time

Settlements (Biannual)

% of listed firms implementing insider trading controls (Annual)

Settlements (Biannual)

Source: FSB and Survey

2.6.1. INSIDER TRADING POLICIES

72% of companies have a formal policy on insider trading matters. Figure 3 show that many companies only implemented a policy after a large number of settlements had been reached:

Figure 3 shows that companies did not implement policies after the Act was promulgated, but rather after a significant number of settlements were reached.

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This suggests that the settlements gave listed companies an incentive to improve their management of inside information. A significant minority of companies do not fit this pattern. 18% of companies had implemented an insider trading policy before the promulgation of the Act.

23% still do not have a formal policy. It is suggestive that companies without insider trading policies have fewer than 5 000 staff.

2.6.2. PROCEDURES AIMED AT STOPPING COMPANY INSIDERS FROM INSIDER TRADING

Most companies have implemented procedures aimed at stopping company insiders from trading on the basis of inside information. 58% of firms had a policy in which they required senior, and in a minority of cases, relevant employees, to get permission to trade in the firms shares. The balance of the sample, 41%, required all employees to seek permission to trade in the firms’ shares. 94% of firms required their employees to get written permission to trade in their shares. 35% of companies went beyond the JSE’s Listing Requirements by obliging senior staff and/or all their employees to get written permission to trade. Furthermore 58% of companies prohibited all their employees from trading in the company’s shares when a cautionary was in place.

Only executive and non-executive directors

Only Senior staff, including directors (both executive and non-executive)

Only Staff from certain divisions, senior staff

and directors (both executive and non-

executive) All

employees NoneQuestion 12: Which of your employees need permission before they are allowed to trade in your organizations shares? 0% 41% 17% 41% 0% Question 13: For which employees is this permission to trade granted in writing? 29% 24% 6% 35% 6%

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DirectorsDirectors and staff who have

information relevant to cautionary All

employeesQuestion 20: Once your firm has published a cautionary who do you prohibit from trading in your companies shares? 12% 30% 58%

2.6.3. PROCEDURES AIMED AT STOPPING INSIDE INFORMATION FROM LEAVING

THE FIRM

Insider trading cannot occur without inside information. Therefore procedures to control the flow of inside information are important. 96% of companies have imposed restrictions on who is allowed to speak to financial analysts.

Question 27: In your company which of the following types of employees is allowed to speak to financial analysts? Chairman

The CEO CFO

Media relations

Senior staff

% of respondents 27% 87% 47% 20% 4% 50% of companies did not take a record of what was said when representatives of the company met with financial analysts. In only 13% of cases were detailed notes recorded. Some companies do require two representatives of the company at all meetings with financial analysts. Nevertheless the small proportion of companies that take notes suggests the type of information disclosed in these meetings is not tightly controlled.

Question 29: Is a record taken when a representative of your company meets with a financial analyst? No record Brief notes Detailed notes Not sure 50% 25% 13% 13%

The survey showed that financial analysts have attempted to obtain inside information from 27% of firms. It was clear that financial analysts in many cases were contacting senior staff and others who were not designated contact persons at the company. The undercover nature of such contacts suggests that 27% is an underestimate.

In terms of the JSE’s rules, sponsors are required to ensure that any leaks of inside information during the annual general meeting are quickly communicated to the market through SENS. In 75% of the sample sponsors take an active role in monitoring the meeting and preparing the CEO. Smaller firms were once again the main culprits for non-compliance.

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Question 26: Is your company’s sponsor actively involved in ensuring, (i.e. by prepping the CEO, monitoring SENS announcements, monitoring the meeting etc.) that your CEO, abides by insider trading rules at the firm’s annual general meeting? Yes No

Not sure

75% 19% 6% Historically, service providers such as printers may have been an important conduit of inside information. Therefore the JSE listing requirements require companies to enter into confidentiality agreements with such service providers. Although some companies do not use the service providers mentioned, it is clear that compliance with these requirements is not widespread. Some respondents were unclear whether confidentiality agreements were required with professional organizations such as lawyers and auditors.

Question 31: Who have you signed a confidentiality agreement with? Printer Lawyers Auditors

Corporate finance

advisors Media

consultantsManagement consultants Other

73% 53% 40% 27% 47% 7% 13%

2.6.4. PROCEDURES AT LISTED COMPANIES

It is significant that the majority of companies implementing formal insider trading policies only did so after a significant number of settlements. This suggests that companies responded to the active enforcement of the Act rather than the promulgation of the Act itself.

The vast majority of listed companies have implemented policies to stop company insiders from trading on inside information. In this regard many companies have exceeded their obligations under the JSE’s Listing Requirements. In contrast the implementation of procedures to control the flow of inside information are patchier, in many cases falling short of the JSE’s Listing Requirements. While almost all companies restrict contact with financial analysts to the CEO, Chairman or CFO, few companies take detailed notes when the CEO meets with financial analysts, many companies have not entered into confidentiality agreements with their service providers, and for a significant majority their sponsor does not play an active role in the annual general meeting.

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2.7. PROCEDURES AT FINANCIAL FIRMS

Financial firms are discussed in two parts. The first looks at larger financial firms that trade on behalf of institutions as well as individuals. These companies typically have research divisions and provide advice to clients. The second looks at retail brokerages. These companies trade on behalf of individuals and do not have research or investment banking divisions.

2.7.1. FINANCIAL FIRMS WITH TRADING AND INVESTMENT BANKING DIVISIONS

Institutional financial firms include brokerages, asset managers, investment banking and corporate finance divisions. These companies have access to inside information both because they provide advice to listed companies (both through corporate finance and asset management) and because their financial analysts are sometimes privy to inside information. These companies may trade for their own account on the stock market and so could profit from the inside information some of their divisions have access to. Therefore institutional financial firms have to manage significant conflicts of interest as both holders of inside information and active traders in financial markets. These companies can also inadvertently receive inside information through their clients.

67% of these firms had a compliance manual and 80% of those required employees to sign off on it. 67% had a black list of shares that their employees were not allowed to trade in. Of these, 90% updates this list weekly or less. All had procedures in place if one of their traders inadvertently received inside information.

Stock Broking and Corporate Finance Compliance Officers for non retail traders Yes No Question 38: Does your organization have a compliance manual that discusses inside trading? 86% 14% Question 39: If 38 is Yes: Are your employees required to sign off on this compliance manual? 100% 0% Question 36: Does your organization have a list of shares in which your employees are not allowed to trade? 71% 29%

Weekly or less Longer than a

week Question 37: If Question 36 is Yes: How often is this listed updated? 100% 0%

A large majority of firms have procedures to control inside information. All firms have procedures to ensure that inside information itself is not passed on to those that do not need to see it. 80% of corporate finance firms stop their employees from entering the trading division. 90% of firms physically separate employees with

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inside information from those without. Therefore a large majority of firms have implemented Chinese walls to control the flow of inside information.

Stock Broking and Asset Management Compliance Officers. Firms that do research or investment banking. Yes No Question 34: Only for corporate finance, Are employees in your corporate finance department allowed to enter your trading division? 0% 100% Question 43: Do you physically separate employees with access to inside information from those who don’t? 80% 20% Question 44: Do you have procedures to ensure that inside information is not sent via email to employees with no need to see it? 100% 0% Question 45: Do you have procedures in place to restrict employees from accessing to files and data that contain inside information about other companies that they do not need to access? 90% 10% Question 46: Do you have procedures to ensure that employees, who do not need to, do not attend meetings where sensitive inside information will be discussed? 100% 0%

The vast majority of financial firms that have research or advisory divisions have procedures in place to control inside information. This is true of both local and foreign owned financial firms.

2.7.2. RETAIL BROKERAGES14

Retail brokerages, i.e., those trading on behalf of individuals, present a different picture. The firms themselves do not have access to confidential information in the same way that companies with corporate finance or research divisions do. For the most part retail brokerages come into contact with inside information through their clients. Therefore the survey evaluated whether retail brokerages have implemented procedures to deal with this possibility.

If traders know that a client is trading on the basis of inside information they themselves are guilty of insider trading. Only 20% of retail brokerages interviewed have procedures to deal with the situation where a client communicates to the trader that he/she has inside information. 60% did not have a list of shares in which employees are not allowed to trade. Furthermore, some 40% of retail brokerages did not record phone calls between brokers and their clients. 15 This absence makes it more difficult for compliance officers or the investigating authorities to evaluate whether inside information was communicated over the phone to the broker. Furthermore 60% did not have a compliance manual that discusses insider 14 Some brokerages trade on behalf of both individuals and institutions. These brokerages are not included in this discussion. Most brokerages focus on either individuals or institutions. 15 Traders record phone calls to protect their clients and themselves where there is a dispute about whether an order was implemented correctly by the trader.

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trading and only 50% of those with a compliance manual required their employees to sign off on it.

Retail brokerages have few of the procedures in place that are necessary to deal with issues arising out of insider trading.

2.8. EDUCATION AND AWARENESS

The JSE and FSB have conducted presentations and published a booklet on insider trading. These efforts combined with the enforcement actions seem to have raised awareness. Many respondents had received material on insider trading from numerous sources.

Respondents were asked how aware the people they meet in their working lives were of insider trading regulations, requirements and laws. 93% of respondents stated that associates in their working life were quite or very aware. Company secretaries reported that their associates were the least aware of all respondents. In contrast compliance officers reported that their colleagues were the most aware. 89% of respondents reported that there had been an increase in awareness over the past five years. Market advisors reported the largest increase, 88% stated that awareness had increased dramatically.

Question 72: Of the people you meet and associate with in your working life. How aware would say they are about insider trading regulations, requirements and laws:

Somewhat unaware

Quite aware

Very aware

Company Secretary 29% 36% 36% Compliance officer 0% 33% 67% Asset managers and traders 0% 50% 50% Market advisors 0% 75% 25% Total 7% 44% 49%

Question 73: Has awareness of insider trading regulations, requirements and laws over the last five years?

Remained the same

Somewhat increase

Increased dramatically

Company secretary 7% 29% 64% Compliance officer 10% 33% 57% Traders and asset managers 23% 15% 62% Market advisors 0% 13% 88% Total 11% 25% 64%

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The JSE and the FSB have played an important role educating the market. The JSE Insider Trading Booklet had been read by 54% of respondents and 42% had been to a presentation by the JSE and FSB. Respondents had accessed various other sources of information, including conferences and internal documents, both of which had been used by 49% of respondents. On average respondents had accessed three sources of information. It is notable how well educated asset managers and traders are relative to compliance officers.

Question 81: Types of education have you received on insider trading?

Company secretary

Compliance officer

Asset managers and traders

Market advisors

Proportion of sample

The JSE's "Insider Trading Booklet" 57% 62% 57% 30% 54% Presentation at Conference 57% 76% 29% 10% 49% Document written by your organisation 29% 57% 71% 30% 49% Presentation by the JSE and the FSB 36% 62% 36% 20% 42% Other, including professional qualifications 36% 10% 50% 50% 32% Email 21% 24% 57% 10% 29% Discussion with Lawyer 21% 29% 21% 30% 25% The internet 7% 48% 7% 10% 22% Discussion with Sponsor 29% 10% 7% 10% 14% Presentation by a Sponsor 36% 0% 7% 0% 10% Presentation by a company secretary n/a n/a 7% 20% 5% None 7% 0% 7% 0% 3%

82% of listed companies have increased the amount of education aimed at insider trading over the last five years. The JSE Insider Trading Booklet was used by 27% of listed companies to educate their staff and directors. The Insider Trading Booklet was the source material for many company documents, which 53% of companies provided. This booklet was only published in 2002 which suggests that much education followed the enforcement actions by the FSB between 1999 and 2001.Only 40% of listed companies gave a compliance manual to their staff and/or directors.

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The Insider trading regime has had a dramatic impact on levels of awareness in the marketplace. Most respondents reported that awareness is high and had increased since the regime was implemented. The JSE and FSB have played an important role educating market participants.

2.9. THE EFFECT ON INSIDER TRADING

In paragraph 2.4 it was argued that the Insider trading regime would decrease the levels of insider trading if it changed incentives and norms. The results from the survey show that there have been wide ranging changes in both:

• Changing incentives. The regime has reached a number of settlements. Almost all respondents reported that damage to their careers would be the most significant cost of settling. This suggests that settlements provide a significant deterrent. Settlements seem to have lead to the implementation of procedures at listed companies. These should have made it more difficult for company insiders to engage in insider trading, and should have decreased the flow of inside information to the market, thus diminishing opportunities to engage in insider trading. Therefore, the survey suggests that the incentive to engage in insider trading has fallen over the last five years as a consequence of the insider trading regime.

• Changing norms. During the period in which the regime has been operative insider trading has become unacceptable within the market. Respondents concerns about the effect on reputation and career of settling an insider trading investigation reflect these changing attitudes.

Along with changing norms and incentives market participants have received extensive education about the legislation and regulation of insider trading in South Africa. As a consequence of these changes, one would expect a substantial decrease in insider trading over the period. Measuring this impact is complicated by two interrelated issues. Firstly directly measuring the incidence of insider trading directly is enormously difficult which means that various indirect measures have to be relied upon. Secondly it is difficult to separate the impact of the insider trading regime on levels of insider trading from changes in market conditions.

Levels of insider trading are measured using two approaches: (1) respondents’ perceptions about changes in the levels of insider trading; and (2) changes in the number of investigations over time

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Respondents were asked to rate, on a scale of one to seven, the pervasiveness of insider trading in South African markets for 1998 and 2004. Respondents who are more involved with the JSE on a day to day basis, reported higher falls in insider trading. Market advisors reported a 47% fall. Traders and asset managers recorded a 45% fall. Company secretaries who are the least involved with the JSE reported the lowest decrease at 18%.

Question 84: Please rate the pervasiveness of insider trading in South Africa where 1=extremely uncommon and 7 = pervasive or extremely common. 1998 2004

Percentage change between 1998 and 2004

Company secretary 4.8 3.9 -18% Compliance officer 4.6 3 -35% Market participant 4.9 2.7 -45%

Market advisors 5.9 3.1 -47% Total 4.9 3.2 -35%

Asset managers and traders have observed an improvement in the efficiency of South Africa’s financial markets. 92% reported that the market impact of inside information has diminished.

The number of investigations opened by the FSB is a valuable indicator of insider trading.16 Most investigations are opened on the advice of the JSE. The JSE has access to significant amounts of information through their sophisticated monitoring technology. They use this technology along with preliminary investigations to isolate incidents that may be insider trading. Only when they have a concern that insider trading may have occurred do they recommend an investigation. Figure 4 and Figure 5 illustrate that the number of insider trading investigations has fallen dramatically since the late 1990s: They also show measures of market activity, listings and daily share trades.

16 The “Report on the observance of standards and codes (ROSC), Corporate governance country assessment, Republic of South Africa” (World Bank, July 2003) highlights the importance of investigations in measuring the effectiveness of the Insider Trading Regime.

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R 0

R 20

R 40

R 60

R 80

R 100

1999H2 2000H1 2000H2 2001H1 2001H2 2002H1 2002H2 2003H1 2003H2

New Investigations

0

5

10

15

20

25

30

New Equity Capital Raised (Billions)

New Investigations (Biannual)

New Equity Capital Raised (Annual)

Figure 4: New investigations by the FSB versus new equity capital raised Source: FSB & JSE

0

5

10

15

20

25

30

1999H1 1999H2 2000H1 2000H2 2001H1 2001H2 2002H1 2002H2 2003H1 2003H2150

170

190

210

230

250

270New Investigations

Average Daily Shares Traded, Millions

Average Daily Shares Traded, Millions

New Investigations

Figure 5: New investigations by the FSB versus average daily shares traded on the JSE Securities Exchange Source: FSB & JSE

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The fall in measured insider trading incidents shown in Figure 4 and Figure 5 may not be fully correlated with actual incidents of insider trading. Since 1999 the JSE has implemented a more sophisticated sifting process for recommending an investigation. This has decreased the number of investigations opened. Taking this into account, the fall in insider trading investigations is clearly greater than the decrease in market activity. This suggests that the insider trading regime has successfully decreased the levels of insider trading.

2.10. CONCLUSION

68% of respondents in general and 80% of traders and asset managers reported that the Insider trading regime has been a success. This success is reflected in the wide-ranging changes in attitudes, procedures, awareness and education that the Insider trading regime has precipitated. Furthermore indications are that the regime has successfully decreased the level of insider trading.

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3. APPENDIX

3.1. QUESTIONS AND ANSWERS NOT PUBLISHED IN THE MAIN TEXT

3.1.1. LISTED COMPANIES

Yes No Not Sure Question 14: Does your organization have a compliance manual that employees are required to sign off? 41% 53% 6% Question 15: Does your organization have an induction program where employees are educated about insider trading? 31% 69%

Question 16: If answers Yes to 14: Which employees are given this compliance manual?

Senior staff including directors

All employees Other

% of respondents saying yes to question 14 29% 57% 14%

Question 7: Does your company have a policy on insider trading?

We have a written document outlining all

procedures

We have a written policy which states that as a firm we

follow JSE regulations

No formal policy

present 77% 6% 17%

Yes No Question 21: Are directors in your firm required to prohibit their associates from dealing in the firms securities during a closed period? 94% 6% Question 22: Are directors in your firm required to ensure that their investment managers only trade on their express permission? 88% 12%

Question 23:Which of the following types of employees has your organisation educated about insider trading over the last six months?

Non-executive directors

Executive directors

Senior staff including directors

All employees None

% of respondents 20% 20% 60% 7% 13%

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Question 24: If yes to above: what types of education have your employees received on inside trading?

Presentation by company

secretary

Presentation by your

sponsor to the directors

An email

Provision of

company provided

document with sign

off

Provision of a

company document

without sign off

Provision of JSE’s “Insider trading

booklet” Other % of respondents 47% 33% 33% 20% 33% 27% 7%

Question 25: Has the amount of education directed at insider trading changed in your firm since 1998?

Increased dramatically Increased

Stayed the same

47% 35% 18%

Question 28: How often in the last six months have you felt that financial analysts have attempted to obtain inside information from your firm?

No Attempts

No Answer

Many times

67% 7% 27%

Question 30: Do you monitor news services for indications that inside information about your company has been released to the media before it has been released through SENS? Yes No

88% 12%

3.1.2. STOCK BROKING FIRMS

Question 33: For stock broking firms, Does your organization record phone calls between your brokers and their clients? Yes No 82% 18%

Note: the figure for question 33 is the global figure for both retail and institutional brokers.

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3.1.3. TRADERS AND ASSET MANAGERS

Question 69: I would now like you to score sectors on the level of inside trading that has occurred over the last year. A seven would imply that the sector has rampant, or widely spread, insider trading, A one would imply that the sector never experiences insider trading.

Gold

Platinum

Minerals &

Mining Finance

Oil &

Gas

Forestry & Paper

Steel & M

etals

Construction

Small &

Medium

Market C

ap

Banks

Other Finance

IT

Average 2.9 1.9 1.6 2.0 2.1 3.0 3.4 4.3 3.1 2.9 4.1Std Dev 1.3 1.1 1.2 1.3 1.4 1.7 2.0 1.7 1.8 1.5 1.3

3.1.4. ALL RESPONDENTS

Question 77: How many settlements would you estimate the Financial Services Board has reached over the last five years? The correct answer: 17. Average Std. Dev. Min Max Company secretary 35.9 39.5 1 100 Compliance officer 51.8 92.1 4 350 Asset managers and traders 19.5 20.2 5 80 Market advisors 36.9 29.5 12 100 Total: (Correct Answer = 17) 37.4 60.6 1 350

Question 76: How successful would you say the Insider Trading regime has been at decreasing insider trading since 1998:

Very successful Successful

Not sure Unsuccessful

Very unsuccessful

Company secretary 0% 62% 23% 15% 0% Compliance officer 15% 45% 25% 15% 0% Asset managers and traders 23% 54% 15% 0% 8% Market advisors 13% 75% 13% 0% 0% Total 13% 56% 20% 9% 2%