Combating Insider Trading in Securities Markets: A Review of Kenya’s Legal Framework By: Silvia Muhongo Makanga ADMISSION NO: 133848 Supervisor: Professor Winifred Tarinyeba Kiryabwire Submitted in partial fulfillment of the requirements for the Master of Laws (LL.M) Degree (International Financial Law and Regulation) at Strathmore University. Strathmore Law School Strathmore University Nairobi, Kenya December 2021. ii 14th November, 2021 DECLARATION This thesis is my original work except for relevant sources referred and appropriately acknowledged, and it has not been submitted to any University or institution for any award. Signature:........................................ Date:...................................... SILVIA MUHONGO MAKANGA APPROVAL The thesis of Makanga Silvia Muhongo was reviewed and approved by the following: Professor Winifred Tarinyeba Kiryabwire, Adjunct Lecturer, Strathmore Law School, Strathmore University. Dr. Peter Kwenjera Mwangi, Dean, Strathmore Law School, Strathmore University. Dr. Bernard Shibwabo Director of Graduate Studies, Strathmore University. iii DEDICATION This work is dedicated to my father, Mr. Patrick Muhati Makanga, for his love of education and the great lengths and sacrifice that he went to see me get a decent education. iv ACKNOWLEDGEMENT I pay my deep sense of gratitude to my supervisor Professor Winifred Tarinyeba Kiryabwire, who was more than generous with her time and expertise and whose valuable guidance and kind supervision given throughout the course shaped the present work as it shows. No words of thanks can sum up the gratitude that I owe to my parents for their love, prayers, unwavering support and sacrifices for educating and preparing me for my future. I am very thankful to my brother and sister for their support and valuable prayers. Special thanks to Anita and Greg for being so gracious to me. Finally, to the love of my life, Rawlings Musiega, your support and encouragement when times got rough are much appreciated. Only him can attest to the late nights, early mornings and weekend readings that had to be invested to complete this research. Above all, I am grateful to the LORD ALMIGHTY the enabler of everything, the author of knowledge and wisdom, for without his grace and blessings this study would not have been possible. v ABSTRACT The idea of a fair market is dependent on all parties to a transaction possessing similar information when executing a transaction or trade. However, because of unfair market practices such as insider trading, this is rarely the case. Insider trading is a form of market abuse where one party deals in the securities of a public company while in possession of material non-public information. Often, a person practicing insider trading gains an advantage because of the information they possess over the other party. Today, insider trading is one of the most condemned corporate vices. As a result of its adverse effects on the market, insider trading has been prohibited by many countries in the world. In Kenya, insider trading is contemplated as an offence that attracts criminal sanctions under the Capital Markets Act 2013. However, as jurisprudence witnesses, it is difficult to sustain a conviction on a charge of insider trading in Kenya. As a result, the practice of insider trading often goes unpunished. The purpose of this paper is to examine the effectiveness of criminal sanctions in prohibiting the practice of insider trading in Kenya. The researcher also assessed the feasibility of employing alternative sanctions, that is, administrative and civil sanctions, in place of criminal sanctions in an effort to curb the practice of insider trading in Kenya. This paper argues that non-criminal sanctions are a more effective deterrent to insider trading than criminal sanctions. The study, therefore, suggests that the Capital Markets Authority should put emphasis on the use of non- criminal sanctions in the prohibition of insider trading rather than criminal sanctions. vi LIST OF ACRONYMS CMA – Capital Markets Authority NSE – Nairobi Securities Exchange IPO – Initial Public Offering JSE – Johannesburg Stock Exchange RSA – Republic of South Africa FSB – Financial Services Board (South Africa) FSCA – Financial Sector Conduct Authority (South Africa) vii LIST OF CASES Republic versus Terrence Davidson, Nairobi CMCR 1338/2008 (Unreported). Republic versus Bernard Mwangi Kibaru, Nairobi CMCR 1337/2008 (Unreported). Republic V Christopher Joseph Kirubi and 13 Others Nairobi CMCR 908/2008(Unreported). United States v. O’Hagan, 521 U.S. 642, 652 (1997). Dirks v. SEC, 463 U.S. 646, 647 (1983). SEC v. Yun, 327 F.3d 1263, 1280 (11thCir. 2003). SEC v. Sargent, 229 F.3d 68, 77 (1st Cir. 2000). SEC v. Maio, 51 F.3d 623, 632 (7th Cir. 1995). Chiarela v United States 445 U.S. at 224. Attwood v Small (1838) 6 Cl & F 232. Redgrave v Hurd (1881) 20 Ch D 1. viii TABLE OF CONTENTS DECLARATION .............................................................................................................. ii DEDICATION ................................................................................................................ iii AKNOWLEDGEMENT .................................................... Error! Bookmark not defined. ABSTRACT....................................................................................................................... v LIST OF ACRONYMS ................................................................................................... vi LIST OF CASES ............................................................................................................. vii TABLE OF CONTENTS ............................................................................................. viii CHAPTER ONE ............................................................................................................... 1 GENERAL INTRODUCTION........................................................................................ 1 1.1 Background ............................................................................................................... 1 1.1. Statement of the problem ......................................................................................... 5 1.2 Purpose of the Study ................................................................................................. 6 1.4 Research Questions ................................................................................................... 6 1.5 Hypothesis ................................................................................................................. 7 1.6 Theoretical Framework ............................................................................................. 7 1.6.1 The Public Interest Theory ..................................................................................... 8 1.6.2 The Classical Theory ............................................................................................. 9 1.6.3 The Tipper Tippee Theory ................................................................................... 10 1.6.4 The Misappropriation Theory .............................................................................. 10 1.6.5 Application ........................................................................................................... 11 1.7 Literature Review .................................................................................................... 12 1.7.1 Defining Insider Trading ...................................................................................... 12 1.7.1 Regulating Insider Trading .................................................................................. 13 1.7.2 Enforcement of Insider Trading Laws ................................................................. 15 1.8 Justification of the Study......................................................................................... 17 1.9 Scope of the Study .................................................................................................. 17 1.10 Research Methodology ......................................................................................... 17 1.11 Chapter Breakdown............................................................................................... 18 CHAPTER TWO ............................................................................................................ 20 REGULATORY FRAMEWORK FORINSIDER TRADING IN KENYA .............. 20 2.1 Introduction ............................................................................................................. 20 2.2 The Regulatory Framework of Insider Trading in Kenya....................................... 21 ix 2.2.1 Legal Framework: An Overview of the Capital Markets Act, CAP 485 A Laws of Kenya ................................................................................................ 21 2.1.1.Institutional Framework: An Overview of the Capital Markets Act, CAP 485 A Laws of Kenya ............................................................................................ 30 2.2. The Quest for Self-regulation ................................................................................ 35 2.3 Conclusion .............................................................................................................. 36 CHAPTER THREE ........................................................................................................ 37 CRIMINAL SANCTIONS AGAINST INSIDER TRADING: THE PHILOSOPHY OF DETERRENCE ........................................................................................................ 37 3.0 Introduction ............................................................................................................. 37 3.1 Insider Trading as a Criminal Offence .................................................................... 37 3.1.1 Insider Trading as a Strict Liability Offence ....................................................... 37 3.1.1 The Philosophy of Deterrence of Insider Trading using Criminal Sanctions ...... 39 3.1.2 Questioning the Effectiveness of Criminal Sanctions in Regulating Insider Trading ............................................................................................................... 42 3.2 The Use of Alternative Sanctions in Regulating Insider Trading ........................... 45 3.2.1 Civil Sanctions ..................................................................................................... 46 3.2.2 Administrative Sanctions ..................................................................................... 47 3.3 The Effectiveness of Criminal Sanctions against Insider Trading in Kenya .......... 49 3.3.1 Criminal Jurisprudence ........................................................................................ 49 3.3.2 Jurisprudence on Administrative Sanctions ......................................................... 50 3.4 Conclusion .............................................................................................................. 51 CHAPTER FOUR .......................................................................................................... 52 COMPARATIVE ANALYSIS: REGULATION OF INSIDER TRADING IN SOUTH AFRICA ............................................................................................................ 52 4.1 Introduction ............................................................................................................. 52 4.2 Background ............................................................................................................. 52 4.2.1 Regulation of Insider Trading in South Africa .................................................... 56 4.2.2 Definition of Insider Trading ............................................................................... 57 4.2.3 Scope of Application ............................................................................................ 60 4.2.4 Penalties for Insider Trading ................................................................................ 61 4.2.5 Regulatory Institutions ......................................................................................... 62 4.2.5.1 The Johannesburg Stock Exchange ................................................................... 62 4.2.5.2 The Financial Services Board ........................................................................... 62 x 4.2.5.3 Discussions from South Africa ......................................................................... 63 4.3 Conclusion .............................................................................................................. 65 CHAPTER FIVE ............................................................................................................ 66 SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATIONS ....... 66 5.1 Introduction ............................................................................................................. 66 5.2 Summary of Findings .............................................................................................. 66 5.3 Conclusion .............................................................................................................. 67 5.5 Recommendations ................................................................................................... 69 5.5.1 The Shift to Administrative and Civil Sanctions ................................................. 69 5.5.2 Training of Prosecutors on Insider Trading and Other Market Abuses ........... 69 BIBLIOGRAPHY ........................................................................................................... 71 APPENDICES ................................................................................................................. 74 Appendix 1: Ethical Clearance Report ......................................................................... 74 Appendix II: Plagiarism Report .................................................................................... 75 1 CHAPTER ONE GENERAL INTRODUCTION 1.1 Background The world was in shock when celebrated American television personality Martha Stewart was sentenced to prison. Martha Stewart was accused of insider trading after she sold four thousand Im Clone shares one day before that firm's securities’ price plummeted. But this has not been an isolated case. In the recent past, cases of insider trading have been rampant worldwide. Insider trading has become a sickening corporate vice that diminishes investor confidence and preys on unsuspecting traders. In the economy, information is power.1 Whoever has more information in a transaction possesses the bargaining power and can tilt the balance of trade in his favour.2Fair trade thus demands there should be information symmetry between parties in a transaction.3 Nevertheless, this has never been the case. In most instances, the vendor always has more information than the buyer. Thus, the vendor can manipulate price to his advantage and to the detriment of the buyer.4 No more is this clear than in the corporate world.5 Investors in the corporate world depend on information in the public domain to make decisions on which transactions to proceed with and which to forego.6 They do this with the faith that the information in the public domain is a true representation of the situation in terram.7Even where it is not, there is the confidence that other people willing to stake their funds on the same transaction possess the same information. This phenomenon has been dubbed as information asymmetry.8 In this vein, under common law, directors or company executives owe a fiduciary duty to the company. This duty imposes an obligation on the directors or executives to disclose 1 Zhang Ye-Cheng, The Information Economy, J. Johnson et al. (eds.), Non-Equilibrium Social Science and Policy, Understanding Complex Systems, (2017) DOI 10.1007/978-3-319-42424-8_10. 2 Zhang Ye-Cheng, The Information Economy, J. Johnson et al. (eds.). 3Alao, Adeniyi A, Issues in Information Asymmetries and Financial Markets: A Review of Literature, Journal of Accounting and Financial Management, Vol. 4 No. 2 (2018) 59 -71. 4Alao, Adeniyi A, Issues in Information Asymmetries and Financial Markets:59-71. 5Zainabu Tumwebaze et al., Information Asymmetry and Stock Market Participation: Evidence from the Uganda Stock Exchange, Operations Research Society of Eastern Africa (ORSEA) Journal (2014) 21- 42Vol. 4 Issue No. 2 at 21. 6Zainabu Tumwebaze et al., Information Asymmetry and Stock Market Participation,21. 7Zainabu Tumwebaze et al., Information Asymmetry and Stock Market Participation,21. 8Zainabu Tumwebaze et al., Information Asymmetry and Stock Market Participation,21. 2 such information that is material to the securities of the company. Consequently, a breach of this duty by any such director or executive could be remedied by an action of fraudulent misrepresentation under common law. Moreover, when such an action was initiated, principles of company law would apply. While these are the realities of modern-day trade, the law has attempted to control information asymmetry in economic transactions by imposing regulations such as financial reporting, prohibition of insider trading and enforcing the principle ofuberrimaefidei during disclosure. Such laws are aimed at eliminating several forms of market abuse that ultimately diminish the integrity of securities markets. Of particular interest to this discourse is insider trading. The classic definition of insider trading is the use of non-public information in trading shares of a company by someone who owes a fiduciary duty to the company.9 It is an economic vice that preys on the aforementioned information asymmetry for unfair gains. Many countries have prohibited insider trading through legislation. Most of these countries have empowered an authority to oversee securities markets and prevent forms of market abuse such as insider trading. There have been debates as to whether or not laws prohibiting insider trading are merited. The main argument justifying regulation is that insider trading is inherently unfair. Another school of thought argues that the regulation of market securities and thus prohibition of insider trading is a justifiable exercise. This argument is premised on investor protection in the sense that “effective investor protection mechanisms play an indispensable role in bolstering investor confidence and retention.”10Thus, regulation of market securities is essential in protecting the interests of investors who place reliance on information in the public domain. The latter argument professes aspersions of the public interest theory. A small minority resists government regulation of market securities and in particular insider trading. These isolated groups posit that practices such as insider trading are of immense benefit to corporations as they spur innovation and constitute an efficient 9 Brian A. Garner, editor in chief. Black's Law Dictionary. St. Paul, MN: Thomson Reuters, (2014). 10Gakeri K Jacob, Calibrating Regulatory Disclosure in Kenya’s Securities Markets: Challenges and Opportunities for Investors, International Journal of Humanities and Social Science (2014) 133-145 Vol. 4 No. 5 at 133. 3 means of compensating executives.11 They further argue that the profits realized by insider traders are rarely significant enough to cause a massive exodus of investors.12 Despite these arguments, the vast majority of jurisdictions have elected to regulate insider trading. Regulation varies in forum and approach. Countries that prohibit insider trading may choose to enforce those regulations through criminal sanctions or civil liability.13Japan for instance, purely enforces these regulations by the force of criminal law.14Jurisdictions like Australia and the USA use both criminal and civil sanctions to deter and punish insider trading.15 As regards approach, some jurisdictions such as United States of America regulate insider trading on account of the fiduciary relationship an insider owes to their company. Such regulation may be termed as relationship-based. In other jurisdictions such as the United Kingdom, regulation is market-based in that the rationale for regulating insider trading is to facilitate the smooth functioning of securities markets. It is important to note however, that in most jurisdictions, institutions marketing securities are regulated by independent bodies, to wit, a separate entity is usually given supervisory jurisdiction over all institutions trading securities. In the United States of America, this function is exercised by the Securities Exchange Commission while Japan has the Securities Exchange Council. Here in Kenya, the Capital Markets Authority is the statutory body mandated to oversee and regulate the trading of securities among other functions. The Capital Markets Authority has enacted several regulations and continuously amended the Capital Markets Act to adequately regulate securities market trading.16The earliest codified regulations were the Rules and Regulations of the Nairobi Stock 11Dent, George W., "Why Legalized Insider Trading Would Be a Disaster" (2013). Faculty Publications. 27. 12Dennis W. Carlton & Daniel R. Fischel, The Regulation of Insider Trading, 35 Stanford Law Review 857, 860 (1983). 13 Joshua Mitts & Eric Talley, Informed Trading and Cybersecurity Breaches, 9 Harvard Business Law Review 1 (2019). 14 Michael Whitener, "Japan Tackles Insider Trading," International Financial Law Review 7, no. 6 (June, 1998): 15-17. 15 Victor Lei and Ian Ramsay, 'Insider Trading Enforcement in Australia' (2014) 8 Law & Finance Market Review 214. 16Mwaniki Gillian, Effect of Insider Trading Prohibitions: Regulation on Security Market Returns in Kenya, The University Journal Volume 1 Issue 2 (2018) 77-96. 4 Exchange which were published in 195417 while the most recent among these regulations is the Capital Markets Act.18 One of the core objectives of this Act is to protect investor interests. In lieu of this, the law criminalizes insider trading.19 Thus, the sanctions emanating from the offence of insider trading are criminal in nature. Many authors have noted that insider trading is difficult to detect and even harder to prove.20 Moreover, and in most cases, the capabilities of enforcement agencies are often insufficient to match those of the perpetrators.21In light of this therefore, it becomes increasingly difficult to prosecute cases of insider trading under criminal law. It is trite that the burden of proof in criminal cases is “beyond reasonable doubt”. By any standard, this burden is difficult to discharge. It is for this reason that Capital Markets Authority of Kenya has on many occasions failed to secure a conviction on a charge of insider trading. A prosecutor in insider trading offences before a Kenyan court has to construct a coherent narrative that subscribes and manifests all the facets of interconnecting facts in order to prove his case beyond reasonable doubt. In apt illustration, the prosecution in the case of Republic v Terrence Davidson22failed to secure a conviction because they could not prove that information had not been made public. In rendering its decision, the court held that “the fact that Uchumi’s poor performance and the pulling out of its major shareholders was a matter that had been publicized in the newspapers. “Similarly, in the case of Republic v Bernard Kibaru23in acquitting the accused person, the court stated that “…the prosecution had not proved beyond reasonable doubt that the accused exploited information not generally available to the public that Uchumi was performing poorly, when he sold his shares.” This predicament is not unique to Kenya. As of 2019, the Security Exchange Commission of Zimbabwe had yet to successfully prosecute a single case of insider 17 These rules preceded the establishment of the Capital Markets Authority but were amended to what now is known as the Capital Markets Act. 18 Capital Markets Act Chapter 485A Laws of Kenya. 19 Section 11 (1) (a) and Preamble of the Capital Markets Act. 20 Ryan, Deirdre. "Dealing with the Market Abuse Regulation: A Case for Modernisation." King's Inns Law Review, 8, (2019), p. 60-87; See also Howard Chitimira & Pontsho Mokone, "An Analysis of the Role-Players in the Enforcement of the Zimbabwean Insider Trading Laws" (2019) 9: Special Issue Juridical Tribune 134. 21 Ryan, Deirdre. "Dealing with the Market Abuse Regulation:134. 22Republic versus Terrence Davidson, Nairobi CMCR 1338/2008 (Unreported). 23Republic versus Bernard Mwangi Kibaru, Nairobi CMCR 1337/2008 (Unreported). 5 trading.24In the same vein Japan has also been struggling to prosecute insider trading without accomplishment.25In fact, this failure is widespread and has been noted in several literature canvassing the subject of insider trading.26 1.2 Statement of the problem Since its inception, the Capital Markets Authority has found it difficult to sustain a conviction when prosecuting an offence categorized as insider trading under the Capital Markets Act.27Legal commentators have argued that this difficulty arises due to the nebulous nature of the provisions creating the offence of insider trading.28 Thus, it is herculean a task to dispense the burden of proof imposed on the prosecution in the event of a criminal trial.29 While it is laudable that such provisions exist within the legal framework, it is irking to prove the existence of certain facts based on the criteria set out in the Act. For instance, it is nearly impossible for the Capital Markets Authority to objectively prove, in a court of law, that a complaining company was in possession of certain sensitive information or whether such information was sensitive in the first place. When and how is information considered to be in the public domain? How does one prove that the accused had knowledge of such information which eventually informed his decision to trade? These challenges have and continue to plague the Capital Markets Authority in the pursuit of bringing unscrupulous traders to book. If this situation is left unchecked, insider traders will continue to exploit the lacuna in the legal framework to get away with crime. The ripple effect will erode investor confidence in the capital markets and ultimately wreak havoc on financial markets in Kenya. 24 Howard Chitimira & Pontsho Mokone, "An Analysis of the Role-Players in the Enforcement of the Zimbabwean Insider Trading Laws" (2019) 9: Special Issue Juridical Tribune 134. 25 Michael Whitener, "Japan Tackles Insider Trading," International Financial Law Review 7, no. 6 (June, 1998): 15-17. 26Uptal Bhattacharya and Hazem Daouk, 'The World Price of Insider Trading' (2002) 57(1)The Journal of Finance75, 104. 27 The CMA has had little success in prosecuting insider trading offences. Since it was founded a successful prosecution was witnessed in 2019 when Andre DeSimone, Aly Khan Satchu and Kunal Bid were found guilty of insider trading of Kenol Kobil Shares. Save for this instance, many attempts to prosecute have been unsuccessful. 28Muindi Brian and Mbabu Oscar, Insider Trading and the Restoration of Investor Confidence, The Above Standard: Climate Change Compliance and Private Entities Volume 004 [May 2019], The authors liken the prosecution of insider trading to a Gordian knot which the Capital Markets Authority is yet to unravel. 29Republic V Christopher Joseph Kirubi and 13 Others Nairobi CMCR 908/2008(Unreported). While acquitting the accused persons, the Chief Magistrate noted that that the Authority had failed to establish his culpability beyond reasonable belief and had not dispensed with their burden of proof. As such, the Court saw it unfit to convict them of insider trading. 6 Although contemplated as a criminal offence, the Capital Markets Act empowers the Authority to take other punitive measures against offenders. These measures range from administrative sanctions, admonishment and the suspension of licenses. The literature reviewed suggests that criminal sanctions on insider trading have been less than fruitful in prohibiting insider trading. On the other hand, civil and administrative sanctions have been seen, in the reviewed literature, to better deter insider trading. Where the latter measures exist in law, it flies in the face of logic why the Authority would still insist to take a criminal approach that has not yielded the deterrent function it was meant to achieve. There is an urgent need for a change in tact when dealing with cases of insider trading. The Authority should consider the feasibility of enforcing non- criminal sanctions and possibly emphasize their use. 1.3 Purpose of the Study The main objective of this research is to critically assesses the adequacy of the current legal framework regulating insider trading in Kenya. The researcher will be guided by the following specific objectives; i. To appraise the effectiveness of the obtaining legal and institutional framework regulating insider trading in Kenya. ii. To interrogate and compare the efficacy of criminal and non-criminal sanctions in prohibiting insider trading in Kenya. iii. To compare the legal and institutional framework in Kenya with that of South Africa iv. To identify areas of reform in the legal and institutional framework and suggest recommendations where necessary. 1.4 Research Questions Throughout the course of this study, the researcher will be guided by the following research questions; i. How effective is the obtaining legal and institutional framework in regulating insider trading in Kenya? ii. How efficient are non-criminal sanctions imposed by the Capital Markets Authority in deterring insider trading in Kenya? iii. How has South Africa addressed issues of insider trading? 7 iv. Is there need for reform in the legal and institutional framework governing insider trading in Kenya? 1.5 Hypothesis To give credit where its due, the Capital Markets Authority, in 2019 sanctioned Aly Khan Satchu, Andre DeSimone and Kunal Bid after finding the three individuals guilty of insider trading of KenolKobil shares.It is important to note, however, that the aforementioned sanctions emanated from the determination of an ad-hoc committee appointed by the Capital Markets Authority. So far, no individual or corporate entity has been found guilty in a court of law on a charge of insider trading. For this reason, the researcher will proceed on the assumption that the Capital Markets Authority has been unsuccessful in prosecuting cases of insider trading in Kenya. Moreover, Kenyan courts in making determinations on insider trading charges have noted with concern that the prosecution had failed to discharge the burden of proof. The researcher further hypothesizes that the non-criminal sanctions are a more effective way of deterring insider trading in Kenya. This sentiment follows the premise that a criminal approach on deterring insider trading has failed. Thus, the Capital Markets Authority should place an emphasis on non-criminal sanctions especially since they are empowered by the Act to do so. 1.6 1.6 Theoretical Framework Over the years, many legal theories have been propounded by scholars and other legal commentators to justify the imposition of liability on an insider. These theories are informed by the arguments against insider trading. The bulk of these arguments are either moral or economic.30Moral arguments suggest that insider trading is unfair in the sense that it does not allow every person to profit equally.31 Economic arguments are premised on pricing efficiency and desertion of investors. Various jurisdictions have formulated their own theories on insider trading based on their peculiar prevailing circumstances. The public interest theory borrows from the argument that insider trading is inherently unfair and thus justifies government regulation. Other theories focus on their relationship between the issuer and the insider. In the United 30 Cox Charles &Forgaty Steven, Bases of Insider Trading Law, Ohio State Law Journal (1977) Vol. 4 343-363. 31 Cox Charles et al, Bases of Insider Trading Law,343-363. 8 States of America for instance, three theories have emerged in an effort to standardize how to impose liability on perpetrators of insider trading. These are the classical, tipper/tippee and misappropriation theories.32In this section of the thesis, the researcher will highlight these theories in an attempt to justify regulation and prosecution of insiders for the offence of insider trading. 1.6.1 The Public Interest Theory In general terms, the Public Interest theory postulates that government regulation seeks to protect and benefit the public.33According to this theory, government regulation is instrumental in overcoming the disadvantages of imperfect competition, unbalanced market operation and undesirable market results. Thus, the theory assumes that markets are extremely fragile and likely to operate very inequitably if left alone, resulting in market failures.34 Insider trading when defined under this theory would have a focus on the effect of market failures on the public. Thus, priority would be given first to the interests of investors who are more likely to suffer as a result of such market failures and second to the market generally. Ultimately, this theory can be termed as a market-based theory. The Public Interest theory is criticized for its ambiguity. Critics suggest that it is difficult to determine when the interests of the public have been served when many other governmental interests are being served as well.35 Another criticism is that it is also difficult to tell how much regulation is optimal for the best performance of markets. 36 This theory is of particular importance since it provides a point of reference when justifying the prosecution of insider trading offences in Kenya. That the law prohibiting insider trading was enacted as a result of market failures which were not in the best 32 Cox Charles et al, Bases of Insider Trading Law,343-363. 33Hantke–Domas, Michael, The Public Interest Theory of Regulation: Non-Existence or Misinterpretation”, European Journal of Law and Economics (2003)15 (2): 165-194. 34E.O George, R.O Akingunola and J.E Oseni, ‘The Influence of Information Asymmetry on Initial Public Offers in the Nigerian Stock Market’ [2012] (92) International Research Journal of Finance and Economics 32-42, 33, 34. < http//www.internationalresearchjournaloffinanceandeconomics.com> on 20 June 2020. 35 Smyth Russell, Soderberg Magnus, Public Interest versus Regulatory Capture in the Swedish Electricity Market, journal of Regulatory Economics (2010) 38 (3): 292-312. 36 Smyth Russell et al, Public Interest versus Regulatory Capture in the Swedish Electricity Market,292- 312. 9 interests of the public. The theory also reflects the objects of the legislation in Kenya which is to protect investors. 1.6.2 The Classical Theory The classical theory is an American theory of insider trading law that proceeds on the premise that corporate insiders, such as the directors, officers, agents and employees of a company, are prohibited from trading based on material non-public information that they have obtained in connection with their positions in the company. This theory applies where an insider is in breach of their fiduciary duty to their own company or another company to which they owe a fiduciary duty. The theory was restated in the case of United States v. O’Hagan37 where Justice Ruth Bader Ginsburg held that an individual maybe held responsible for misappropriation of confidential information even where there was no duty to disclose such information. This theory derives from the common law doctrine of fraudulent non-disclosure. Under common law, a representation or concealment of a fact is material if it operates as an inducement to the other party to enter into the contract, where, except for such inducement, it would not have done so.38Thus, where a party acted on confidential information to the detriment of another party who had placed reliance on disclosed information, the injured party could seek remedial action under common law. The classical theory has however fallen into disuse for its several shortcomings. The theory only applied to insiders who owed a fiduciary duty to the company. The absence of a fiduciary duty to any parties in a transaction therefore invalidated the application of this theory. Consequently, no liability could be impugned against a party that did not owe a fiduciary duty to the other party in the transaction. Further, it could not apply in cases where a company was repurchasing its own stock since a company does not owe a fiduciary duty to its shareholders. The theory does not apply to persons who are not insiders. It therefore does not apply in instances such as where an employee of a company would share the confidential information with another person and the third party acted on that information. 37United States v. O’Hagan, 521 U.S. 642, 652 (1997). 38Attwood v Small (1838) 6 Cl&F 232; See also Redgrave v Hurd (1881) 20 Ch D 1. 10 1.6.3 The Tipper Tippee Theory This theory was an extension of the application of the classical theory in response to the shortcomings imposed by a mandatory existence of a fiduciary duty. This theory would operate under certain circumstances only. Firstly, there had to be a tipper- an insider in the traditional sense who possess material non-public information and disseminated this information to another party, the tippee.39The theory still placed great significance on fiduciary duty. For liability to be imposed, the tipper, according to this theory, has to have breached their fiduciary duty to a company; the tippee knew or had to know that the breach had occurred; the tippee acted on the information from the tipper to trade in securities and; the tipper received some personal benefit in return.40The theory’s maiden articulation was in the case of Dirks v. Securities Exchange Commission41. One of the criticisms of this theory is that it was difficult to ascertain the legal standard of what constitutes “personal benefit” to the tipper.42Courts in the United States of America have therefore taken a broad view on what constitutes a personal benefit.43It is important to also note that this theory still faced the same shortcomings as the classical theory since it was bound by the requirement of a fiduciary relationship. 1.6.4 The Misappropriation Theory The misappropriation theory postulates that a person, who is not an insider and who comes and transacts on the basis of confidential information is liable for insider trading.44The misappropriation theory covers the lacuna left by classical theory. The theory was first articulated in Chiarela V United States45in Justice Burger’s dissenting opinion thus; “… when an informational advantage is obtained, not by superior experience, foresight, or industry, but by some unlawful means… then [that party] has an 39Cox Charles &Forgaty Steven, Bases of Insider Trading Law, Ohio State Law Journal (1977) Vol. 4 343- 363. 40 Cox Charles et al, Bases of Insider Trading Law,343-363. 41Dirks v. SEC, 463 U.S. 646, 647 (1983). 42 Drummonds Katherine, Resuscitating Dirks: How the Salman 'Gift Theory' of Tipper-Tippee Personal Benefit Would Improve Insider Trading Law, (2016) Available at https://www.law.ox.ac.uk/business-law- blog/blog/2016/07/resuscitating-dirks-how-salman-gift-theory-tipper-tippee-personal on 20 June 2020. 43SEC v. Yun, 327 F.3d 1263, 1280 (11thCir. 2003); See also SEC v. Sargent, 229 F.3d 68, 77 (1st Cir. 2000); SEC v. Maio, 51 F.3d 623, 632 (7th Cir. 1995). 44United States v. O’Hagan, 521 U.S. 642, 652 (1997). 45Chiarela v United States 445 U.S. at 224. https://www.law.ox.ac.uk/business-law-blog/blog/2016/07/resuscitating-dirks-how-salman-gift-theory-tipper-tippee-personal https://www.law.ox.ac.uk/business-law-blog/blog/2016/07/resuscitating-dirks-how-salman-gift-theory-tipper-tippee-personal 11 absolute duty to either disclose that information to the other party of the securities transaction or refrain from trading”46 This theory thus imposes a duty to any person who comes across confidential information to keep it confidential or abstain from transacting using that information. Thus, the liability is no longer restricted to the traditional insider but to every person who acts on material non-public information to obtain a personal benefit by trading on the basis of such information. 1.6.5 Application The classical, tipper/tippee and misappropriation theories are relationship based, in that, for insider trading to be proved against an individual, a fiduciary relationship has to subsist between the parties in the securities exchange transaction. Thus, for one to be liable for insider trading, there must be a breach of fiduciary duty. This requirement has been problematic since in the contemporary corporate world, inside trades could be perpetrated by parties who owe no fiduciary duty to the company. As Gakeri posits, the main objective of a securities’ regulatory framework should be to protect investors. The argument is echoed in the Capital Markets Act as one of the objectives of the Act. In this light, the researcher is moved to appreciate the philosophical underpinnings of the Public Interest Theory in the course of this study. First, the theory appreciates the importance of regulation. It suggests that government is involved in regulation to protect public interests. The practice of insider trading poses a threat to market integrity and holds a looming danger of investor losses. Ultimately, it causes the market to depreciate to the detriment of the public. Secondly, the criticism of the theory addresses the possible dangers that come with regulation. For instance, where the government is waist-deep in regulation, the line between government interests and public interests is blurred. Consequently, regulation loses its meaning. The classical, tipper/tippee and misappropriation theories show the evolution of jurisprudence on insider trading particularly with regarding to culpability. The three theories will be useful in the instant thesis as the researcher attempts to show the difficulty encountered in sustaining convictions on a charge of insider trading. The 46Chiarela v United States 445 U.S. at 239. 12 theories are also helpful in that they show the dynamic and broad interpretations that come with assigning insider trading liability. Thus the law may not be able to capture essence of the offence of insider trading while contemplating all the exactitudes. 1.7 Literature Review Many authors, local and foreign, have made contributions on the subject of insider trading. It is universally recognized as an economic vice that significantly affects the balance of power between shareholders of a company and investors. To this end, most of the literature reviewed herein will reiterate that insider trading needs to be stopped at all costs in order to promote investor confidence. However, more central to this discourse, authors will comment on how difficult it is to prosecute cases of insider trading. It will emerge, in this review of literature, that there are two major approaches to defining insider trading. These approaches largely determine the letter of the law and prosecution of the offence of insider trading. 1.7.1 Defining Insider Trading The definition of insider trading is relatively universal. Henning suggests that the term is now common parlance “to describe situations in which previously undisclosed information is used to gain an unfair transactional or tactical advantage.”47 Many definitions have fallen in the parameters laid out in Henning’s rudimentary definition. Doffou48 defines insider trading as the sale or purchase of securities by corporate insiders, using monopolistic information to their advantage to generate abnormal returns. The author continues to define monopolistic information as that which is privileged, price sensitive and material non-public. Doffou further identifies insiders as those persons who have easy access to the monopolistic information. The International Organization of Security Commissions concurs with Doffou’s definition of an insider.49 The organization suggests that before defining who an insider is, it is important to consider two issues namely confidentiality and materiality of the subject information.50 Wang deems insider trading to be “trading by anyone (inside or outside of the issuer) on 47 Henning, Between Chiarella and Congress: A Guide to the Private Cause of Action for Insider Trading Under the Federal Securities Laws, 39 University of Kansas Law Review. 1, 1 (1990). 48Doffou Ako, Insider Trading: A Review of Theory and Empirical Work, Journal of Accounting and Finance Research, Vol. 11, No 1, (2003). 49 The Organization of Securities Commissions, Insider Trading: How to Regulate It, A Report of the Emerging Markets Committee of the International Organization of Securities Commissions (2003). 50 The Organization of Securities Commissions, Insider Trading: How to Regulate It, A Report of the Emerging Markets Committee of the International Organization of Securities Commissions (2003). 13 any type of material non-public information about the issuer or about the market for the security.”51 Similarly, Ventoruzzo and Mock state that insider trading involves “the 'trading [of] securities while in possession of material nonpublic information' that is, information capable of affecting the price of a security if made available to other investors.” While the authors add a different paradigm to the definition, that is “price sensitive information”, the definition still exhibits the basic facets as in Henning’s generic description. Many authors have however abstained from defining insider trading. They instead opt to define the various terms that constitute insider trading. The reason for this is that, as Henning puts it, the term “insider trading” as commonly used is a misnomer since it also applies to persons who are not corporate insiders.52 Thus, in a bid to transcend this limitation, it is prudent to define the constituent terms of what is traditionally known as insider trading. 1.7.1 Regulating Insider Trading The subject of insider trading is highly controversial around the world. The term cohabits the echelons of newspaper headlines undetached from other vices such as financial greed and wheeler dealing. It is also a central focus in the spheres of academia and policy circles where debates revolve around the desirability of regulating insider trading.53 Those in favour of regulation of insider trading have always insisted that insider trading is inherently unfair and that legislation promotes market efficiency. Gakeri notes that it is unfair because it places investors at a disadvantaged position.54 He adds that investors need protection since such protection forms the baseline line of financial market security.55 He particularly notes that in Kenya, there are exceedingly low levels of financial literacy. Consequently, it is crucial to afford some protections to parties who wish to invest their money into different entities for the betterment of the economy. 51 Wang S. William, Introduction: Insider Trading, University of California, Hastings College of the Law (2010) Available https://www.researchgate.net/publication/228273857 on 20 June 2020. 52 Henning, Between Chiarella and Congress: A Guide to the Private Cause of Action for Insider Trading Under the Federal Securities Laws, 39 University of Kansas Law Review. 1, 1 (1990). 53 Benny N Laura, The Political Economy of Insider Trading Legislation and Enforcement: International Evidence, Discussion Paper No. 348, Harvard Law School, The Harvard John M. Olin Discussion Paper Series (2002). Available at http://www.law.harvard.edu/programs/olin_center/ on 20 June 2020. 54Gakeri J, Calibrating Regulatory Disclosure in Kenya’s Securities Markets,133-145. 55Gakeri J, Calibrating Regulatory Disclosure in Kenya’s Securities Markets:133-145. https://www.researchgate.net/publication/228273857 http://www.law.harvard.edu/programs/olin_center/ 14 Gakeri’s work, however, only covers disclosure of information as a means of investor protection. The author does not delve into the intricacies of insider trading. Manove advances the argument that insiders appropriate the advances of trade to the disadvantage of shareholders.56 In this sense, as Manove argues, investors are discouraged from putting in more investment and further that there is a manifest reduction in the economic efficiency. The author proceeds with an in-depth analysis of the impact of insider trading on the market as well as the issuing entity. He discusses the roles played by both insiders and outsiders. However, while some of Manove’s arguments still reverberate in the modern-day market outlook, most fail to appreciate the role technology has played in shaping up the dynamics of the contemporary financial market. The main argument against regulation of insider trading, as Benny suggests, is that such legislation favors special interests at the expense of efficiency.57 In this sense, Bainbridge argues, regulation and thus the prohibition of insider trading, lacks a rational economic basis.58 Manne advances the argument that insider trading has the ability to generate significant benefits without necessarily causing damage.59 The author adds that the benefits that may accrue may be the best ways to compensate company executives and to enhance innovation. Accordingly, insider trading spurs economic advancement and promotes efficiency in business. Manne stated thus; [An] entrepreneur's contribution to the firm consists of producing new valuable information. The entrepreneur's compensation must have a reasonable relation to the value of his contribution to give him incentives to produce more information. Because it is rarely possible to ascertain information's value to the firm in advance, predetermined compensation, such as salary, is inappropriate for entrepreneurs. Instead, claimed Manne, insider trading is an effective way to compensate entrepreneurs for innovations. The problem with this line of argument, as Dent puts it, is that in the contemporary corporate world, it is not the executives alone who create valuable information for them 56Manove Michael, The Harm from Insider Trading and Informed Speculation, Quarterly Journal of Economics, (1989) 823-845. 57Manove Michael, The Harm from Insider Trading and Informed Speculation,823-845. 58 Bainbridge Stephen, Insider Trading, UCLA School of Law (1999). 59 Henry Manne, Insider Trading and The Stock Market, 172-73, 178 (1966). 15 to be incentivized.60 More so, Dent adds, many cases of insider trading today are not perpetrated by executives who create and possess valuable information but rather by employees. Thus, the use of insider trading to reward innovation would occasion huge logistical problems since companies would be required to designate who would conduct such trades when they occur and also monitor compliance.61 Wang argues that insider trading positively affects the accuracy of prices in the financial markets.62 A similar argument is advanced by Leland who contends that the prohibition or regulation of insider trading may prevent effective price discovery and have undesirable effects on innovation.63 The premise of this argument is that insider trading quickly reveals information to the public thus improving on the in formativeness of prices.64 Levine et al., approach the subject of insider trading laws in an empirical study conducted in 103 market economies.65 The authors’ analysis is premised on a quantitative study previously conducted by Bhattacharya and Daouk. Levine et al, find that corporates begin experiencing a surge in IPOs and SEOs when their local jurisdictions begin to enforce insider trading regulations. The authors also note that legal systems that impede insider trading and thereby encourage investors to acquire information and value firms more accurately exert a material impact on innovation. The researcher however notes that these findings were biased to companies and corporates that utilized technology in one way or the other. 1.7.2 Enforcement of Insider Trading Laws Gakeri emphasizes the importance of regulating financial markets.66 He discusses different paradigms of regulation and enforcement to wit government regulation, government-led regulation, self-regulation or a hybrid of the foregoing. The author then 60 Dent, George W., "Why Legalized Insider Trading Would Be a Disaster" (2013). Faculty Publications. 27. 61 Dent, George W., "Why Legalized Insider Trading Would Be a Disaster",27. 62 Wang S. William, Introduction: Insider Trading, University of California, Hastings College of the Law (2010) Available at https://www.researchgate.net/publication/228273857 on 20 June 2020. 63 Leland, H.E., Insider Trading: Should It Be Prohibited? Journal of Political Economy, (1980) 859-887. 64 Grossman, S.J., Stiglitz, J.E., On the Impossibility of Informationally Efficient Markets. The American Economic Review 70, (1980) 393-408. 65 Levine et al, Insider Trading and Innovation, Working Paper 21634, National Bureau of Economic Research (2015) Available at http://www.nber.org/papers/w21634 on 20 June 2020. 66Gakeri Jacob, Regulating Kenya’s Securities Markets: An Assessment of the Capital Markets Authority’s Enforcement Jurisprudence, International Journal of Humanities and Social Science, Vol. 2 No. 20 (Special Issue – October 2012). https://www.researchgate.net/publication/228273857 http://www.nber.org/papers/w21634 16 discusses enforcement of insider trading laws and deems it to determine the efficaciousness of regulation. In doing so, he highlights the roles of the Capital Markets Authority of Kenya and comments that the CMA enjoys the full complement of powers needed to effectively carry out its enforcement mandate. He assesses the scope of the roles of the CMA and in particular the roles of inspection and investigation. In conclusion, Gakeri notes that the CMA lacks an elaborate enforcement philosophy which in turn has impacted negatively on securities markets confidence. He attributes these challenges to the absence of securities litigation citing the lack of jurisprudence from the Kenyan judiciary. While Gakeri delves into the institutional shortcomings in the enforcement of insider trading laws, he fails to identify any concerns with regard to prosecution and the provisions of law. The researcher intends to address these issues in the immediate study. Nyangau reiterates similar sentiments in his work.67 He suggests that the Kenyan judiciary has failed to convict persons accused of insider trading. However, Nyangau suggests that this trend is caused by the high standard of proof imposed on prosecutors by the provisions of the Capital Markets Act. He argues that it is difficult for the prosecution to produce evidence in court since the perpetrators of insider trading take serious precautions to cover their tracks. Thus, the author adds, the bulk of evidence produced in such cases is either superficial or circumstantial but ultimately not enough to sustain a conviction. Nyangau insists that it is difficult to find direct evidence in insider trading cases. In conclusion, Nyangau states that the employment of technology in insider trading has made it increasingly difficult to discover, investigate and prosecute. He recommends an amendment of the law in response to these advancements. Muindi and Mbabu poetically analogize the prosecution of insider trading to the proverbial Gordian knot.68 The authors convey the difficulty that the Capital Markets Authority has faced in prosecuting cases of insider trading. They, like Nyangau above, attribute such difficulty to an impossible standard of proof to be discharged by the prosecution. However, the authors also highlight significant steps that have been taken by the Capital Markets Authority in a bid to ease the yoke that is producing evidence. The authors prospect that the CMA will achieve success in near future. 67Nyangau Shem, A Peek into Insider Trading in India and Kenya; a Critique of the Legal Regime, Journal of Research in Business and Management, Volume 7, Issue 5 (2019) pp: 69-73. 68Muindi Brian and Mbabu Oscar, Insider Trading and the Restoration of Investor Confidence. 17 1.8 Justification of the Study This study intends to unravel the challenges that haunt the Capital Markets Authority when prosecuting cases of insider trading. The study will therefore identify various aspects of the law that have impeded successful prosecution of insider trading cases. The challenges will also be addressed in the study. In this light, the study will be a useful reference tool for legal reform. Data collected will be a useful foundation for future academic pursuits in insider trading. The findings of this thesis will benefit further research by academic. It will also be a basis and/or a reference point for policy making by the Capital Markets Authority, the Nairobi Securities Exchange and other stakeholder in the expansive field of financial markets. 1.9 Scope of the Study The study will be limited to the prosecution of insider trading cases in Kenya only. As such, the researcher will evaluate case law emanating from the auspices of the Capital Markets Authority and judicial decisions touching on the subject at hand. Accordingly, the researcher will place reliance on Kenyan law with comparative references being made to other jurisdictions. 1.10 Research Methodology The researcher will employ a doctrinal methodology. Reliance will be placed on secondary sources of data. The researcher will refer to books, journal articles and international reports containing literature on the immediate study. The study will focus on current literature. The study will draw inferences from literature emerging from the European Union and the United States of America which offer a much-needed perspective on how developed economies regulate insider trading. The study will also analyse literature from Kenya to gain an understanding on the prevailing situation with regard to insider trading. Document analysis will be made of various international instruments to better understand the contemplation of their provisions. The researcher will also conduct an evaluation of existing jurisprudence, local and foreign. This will be achieved by analyzing decided cases in Kenya since the enactment of the Capital Markets Act. The study will also analyze foreign case law with focus on particular legal principles to understand how these principles have been applied over time. 18 Reference will also be made to empirical studies conducted by other authors on the instant subject. The study will compare South Africa’s financial markets’ legal regime with that of Kenya. The South African securities market presents an ideal comparative study subject for various reasons. Firstly, the Johannesburg Stock Exchange (JSE), South Africa’s premier securities market, is the largest of its kind in Africa and the 14th largest in the world with a market capitalization of over US $900 billion.69 Secondly, with regard to their respective economies, South Africa ranks slightly above Kenya. South Africa has the 35th largest economy in the world with a gross domestic product of $368 billion while Kenya ranks 66th on the global scale with a gross domestic product of $87 billion. In this sense, Kenya has something to learn from South Africa. In contrast, however, Kenya is ranked 4th in Africa with regard to ease of doing business while South Africa 6th. 1.11 Chapter Breakdown This thesis is divided into five thematic chapters that relate to the regulating and prosecution of insider trading cases in Kenya as follows; Chapter one is a brief introduction into the subject of insider training. It contains the background against which this study was conducted, a statement of the problem being addressed and the objectives of the research. The chapter also contains a review of relevant literature on the instant research topic and the theories which inform the researcher’s school of thought. Chapter two entails an assessment of the efficacy of the legal and institutional framework regulating insider trading in Kenya. The chapter identifies how insider trading is contemplated under the law. It also assesses how the relevant institutions have implemented the provisions of the Act. Chapter three interrogates the efficiency of non-criminal sanctions in prohibiting insider trading. This is achieved by assessing jurisprudence emanating from Kenyan courts and other adjudicating tribunals. 69Segun Olarinmoye, Top 5 Stock Exchanges in Africa, Available at https://nairametrics.com/2017/07/23/the-top-5-stock-exchanges-in-africa/ on 5August 2021. https://nairametrics.com/2017/07/23/the-top-5-stock-exchanges-in-africa/ 19 Chapter four is a comparative study that aims at identifying the best practices in the regulation of insider trading. Chapter five concludes on various aspects of the study, reports findings and suggests recommendations on the various issues identified. 20 CHAPTER TWO REGULATORY FRAMEWORK FORINSIDER TRADING IN KENYA 2.1 Introduction The classic definition of insider trading is the use of non-public information in trading shares of a company by someone who owes a fiduciary duty to the company.70 The ethics of insider trading have long been the subject of considerable academic debate among business and legal scholars.71 Some commentators advocate for the practice to be unregulated since “the practice does not harm anyone in the strict sense.”72They argue that no one in particular suffers any “actual loss” as a result of insider trading and further question whether an insider owes any legal duty to any person who actually suffers loss.73 In the past two decades, discussions on the utility of insider trading have subsided with a general consensus that the practice should be banned.74 Those who favour the regulation of insider trading have often argued along two schools of thought; that the practice is unethical and that it hampers economic growth of a free market. However, both these schools of thought have had their criticisms over the years. Those who argue that the practice of insider trading is unethical, as Lawson points out, often have undeveloped premises to support their arguments. Ultimately, the argument on ethics is reduced to a mere exclamation with no empirical substance to support their premise. On the other hand, those who rely on an economic premise often lack empirical evidence to advance their argument. Despite the foregoing, today insider trading is an illegal business practice which is now widely considered to be unethical.75 This notion stems from the assertion that traditionally, insiders have had a fiduciary relationship with the complaining company.76 Insider trading breaches this relationship of trust and confidence in favour of profit. 70 Brian A. Garner, editor in chief. Black's Law Dictionary. St. Paul, MN: Thomson Reuters, (2014). 71 Klein, William A.; Ramseyer, J. Mark; Bainbridge and Stephen M, Business Associations: Cases and Materials on Agency, Partnerships, LLCs, and Corporations (2018) University Casebook Series (10th ed.) 72Klein et al, Business Associations. 73 Klein et al, Business Associations. 74Engelen, PJ., Van Liedekerke, L. The Ethics of Insider Trading Revisited. Journal of Business Ethics 74, 497–507 (2007). https://doi.org.ezproxy.library.strathmore.edu/10.1007/s10551-007-9532-z 75 Moore, J. What is really unethical about insider trading? Journal of Business Ethics (1990) 9, 171–182. https://doi.org/10.1007/BF00382642 76Mwaniki Gillian, Effect of Insider Trading Prohibitions: Regulation on Security Market Returns in Kenya. The University Journal, (2018) 1(2), 77-96. 21 However, as the researcher will note in the foregoing discussions, jurisprudence has since shifted away from this traditional view that an insider must have a fiduciary relationship for them to commit the offence of insider trading. It is against this background that the chapter will analyze the legal and institutional framework prohibiting insider trading in Kenya in this chapter. 2.2 The Regulatory Framework of Insider Trading in Kenya Gakeri argues that a strong securities market largely depends on a facilitative legal and regulatory framework. Such framework, as Gakeri states should stimulate and encourage private sector investment, protect minority shareholders and facilitate transparent and timely resolution of disputes. 77 The foregoing discussion reviews various provisions regulating insider trading under the Capital markets Act with a view to establish whether they meet Gakeri’s threshold of a good regulatory framework. 2.2.1 Legal Framework: An Overview of the Capital Markets Act, CAP 485 A Laws of Kenya The Capital Markets Act is the primary legislation regulating securities in Kenya.78 The Act came into force on 15th December 1989.79 In 2000, the name of the Act was changed to the Capital Markets Act from the Capital Markets Authorities Act. The objective of the Act as captured in its preamble is to establish a Capital Markets Authority for the purpose of promoting, regulating and facilitating the development of an orderly, fair and efficient capital market in Kenya and for connected purposes.80 In 2013, the Cabinet Secretary for National Treasury called for amendments to the Capital Markets Act while speaking to the Budget and Appropriations Committee of the National Assembly. Among his proposals was the broader definition of the term “insider trading”. These amendments acquired the force of law vide the Capital Markets (Amendments) Act81 which came into force in December 2013. The Act now broadly provides for insider trading and other market abuses under Part VI.82 77Gakeri Jacob, ‘Enhancing Securities Markets in Sub-Saharan Africa: An Overview of the legal and Institutional Arrangements in Kenya’ International Journal of Humanities and Social Science (2011) Vol. 1 No. 9,140. 78Gakeri J, Enhancing Securities Markets in Sub-Saharan Africa,140. 79 Preamble, Capital Markets Act, Cap 484A Laws of Kenya. 80 See Preamble, Capital Markets Act. 81Capital Markets (Amendment) Act, 2013. 82Capital Markets Act Section 32A-L and 33. 22 2.1.1.1. Definition of insider trading Conventionally, insider trading has been defined to mean the use of non-public information in trading shares of a company by someone who owes a fiduciary duty to the company. However, this definition has been problematic over the years, mainly because it assumes that an insider must have a fiduciary relationship with the company. As Henning aptly put it, the term “insider trading” is a misnomer because it is also applicable to persons who are not corporate insiders.83 The Capital Markets Act borrows a leaf from this sentiment. Although criminalized, the practice of insider trading is not expressly defined under the Capital Markets Act. Section 32B of the Act instead stipulates instances which would amount to the offence of insider trading. Under this section, a person commits the offence of insider trading if they “[encourage] another person to deal in securities or their derivatives which are price-affected securities in relation to the information in the possession of the insider, knowing or having reasonable cause to believe that the trading would take place” or “discloses the information, otherwise than in the proper performance of the functions of his employment, office or profession, to another person.”84 Before amendment, Section 32A prohibited the use of unpublished inside information in the following terms; No insider shall a. either on his own behalf or on behalf of any other person, deal in securities of a company listed on any stock exchange on the basis of any unpublished price sensitive information; or b. communicate any unpublished price sensitive information to any person, with or without his request for such information, except as required in the ordinary course of business or under any law; or c. Counsel or procure any other person to deal in securities of any company on the basis of unpublished price sensitive information. 83 Henning, Between Chiarella and Congress: A Guide to the Private Cause of Action for Insider Trading Under the Federal Securities Laws, 39 University of Kansas Law Review. 1, 1 (1990). 84Capital Markets Act Section 32B. 23 Notably, Section 32B excludes the use of the term “unpublished”. The Act, unlike its predecessor, has broadly and generously defined “inside information” and what constitutes “public information” under Section 32C and D. According to the Act, inside information is information “which relates to particular securities or issuer of securities; has not been made public and where if it were made public is likely to have a material effect on the price of the securities.”85 Information is deemed by the Act to be public if it can readily be acquired by those likely to deal in any securities or it is published in accordance with the rules of a securities exchange for the purpose of informing investors and their professional advisers.86 Perhaps this amendment was informed by the difficulty by the prosecution to prove that certain information was unpublished as was the case in R v Terrence Davidson.87In that case, the accused person was charged with insider trading particulars being that the accused person was privy to the financial status of Uchumi Supermarket being the CEO of the retailer’s bank. The prosecution maintained that the accused person acted on the information to instruct his stock broker to sell his shares a few days before the retailer collapsed. In acquitting the accused person, the court stated that the financial status of the retailer was something of public knowledge noting that the company’s information memorandum indicated that the company had been making severe losses and the fact that major shareholders were pulling out was information in the public domain. Another notable difference is the substitution of the words “on the basis of’” with the words “in relation to”. In the repealed Section 32A, a person would only be guilty of the offence if they acted “on the basis” of non-published information. The phrase “on the basis of” denotes that the insider placed reliance on such information to make a trade. This means that not only should the prosecution show that the accused person dealt in certain securities, they also have to prove that such a dealing was informed by inside information that was known by the insider. To this end, the prosecution had the extra burden of proving mens rea of an offence which ordinarily is a strict liability offence. The absence of this nexus would result in an acquittal. 85 Section 32C, Capital Markets Act, 2013. 86 Section 32D, Capital Markets Act, 2013. 87Republic vs. Terrence Davidson, Nairobi CMCC 1338 of 2008 (UR). 24 In contrast, the drafters of section 32B elected to use the words “in relation to”. This phrase connotes some relativity and not compulsion.88 It should be sufficient for the prosecution to demonstrate the mere possession or knowledge of non-public information by an insider at the time of the offending transaction in order to ground liability.89 A reading of section 32B reveals that the offence of insider trading is designated as a strict liability offence. This means that when prosecuting a charge under this section, the state does not have to show mens rea on the part of the accused.90 The strict liability approach therefore means that once it is established that insider trading has occurred, the burden of proof lies with the offender to prove that the motive of carrying out the subject trade does not touch on inside trading.91 It is also important to note that the stipulations under section 32B do not make it mandatory for an insider to have a fiduciary relationship with the complaining company. The approach taken by the Act has some benefits. Most importantly, it eradicates the deficiencies of the classical definition of insider trading. Secondly, it is immaterial whether or not the insider benefits from information. An offence is committed on the premise that the insider used non-public price-sensitive information to make a trade or shared the information with a third party who made a trade on the basis of that information. Another important addition under section 32B is its application to derivative securities. Conversely, the approach also limits its scope of application. Under section 32B, only two precise instances amount to insider trading. Anything falling outside these two instances would strictly not qualify as insider trading under the Act. Moreover, the instances provided under the section have a great many qualifications which make it exceedingly difficult to prove in a court of law. The latter will be illustrated in the next section. 88Kotonya Anne, Combating Insider Trading in Kenya’s Capital Markets: Challenges and Opportunities for Reform, (2012) Unpublished Thesis. Available at http://erepository.uonbi.ac.ke/handle/11295/9404on 25 February 2021. Kotonya argues that the phrase “on the basis of” underscores the mental disposal of an insider which is very difficult to show. 89Kotonya A, Combating Insider Trading in Kenya’s Capital Markets. 90 Wasserstrom Richard A, “Strict Liability in the Criminal Law.” Stanford Law Review (1960)12 No. 4 at 73 91Ondari Ian, How Effective is the Legal Framework on Insider Trading? Nairobi Business Monthly (November 2016) Available at https://www.nairobibusinessmonthly.com/how-effective-is-the-legal- framework-on-insider-trading/on 25 February 2021. http://erepository.uonbi.ac.ke/handle/11295/9404 https://www.nairobibusinessmonthly.com/how-effective-is-the-legal-framework-on-insider-trading/ https://www.nairobibusinessmonthly.com/how-effective-is-the-legal-framework-on-insider-trading/ 25 2.1.1.2. Scope of Application The operation of section 32B of the Capital Markets Act extends to listed securities or their derivatives and any derivatives traded on any market regulated by the Authority. As of 2021, the Nairobi Securities Exchange (NSE) is the sole securities market licensed to operate in Kenya. All listed securities are traded on the NSE. The Act in general, and thus section 32B, applies to all securities that are traded on the NSE. The derivative market in Nairobi began trading in 2019, a few years after the amendments were included in the Act.92 The broad definition of an “insider” and “inside information” extends the application of the Act to many individuals other than those directly linked with a company. Under section 32A, an insider is a person in possession of inside information.93 Inside information is defined under section 32C as information which (a) relates to particular securities or to a particular issuer of securities; (b) has not been made public; and (c) if it were made public is likely to have a material effect on the price of the securities. Pursuant to this description, any person may be liable for insider trading as long as they could reasonably access information that had not been made public. This deduction is in consonance with the description of an “insider” under section 2 which deems an insider to be any person who is or was connected with a company, or is deemed to have been connected with a company and who is reasonably expected to have access, by virtue of such connection, to unpublished information which, if made generally available, would be likely to materially affect the price or value of the securities of the company, or who has received or has had access to such unpublished information. In strict conscription, the term would apply to members of the issuing entity, professionals who ordinarily carry out business with the issuing company such as lawyers and bankers, friends and family of corporate employees, government officials who may come across confidential information in the course of their duties and hackers.94 These individuals, by dint of the Act, are presumed to have reasonable access to confidential information. However, when prosecuting the offence, the state still has to 92Cytonn Investments, Understanding the Derivatives Markets, (July 2019) Available at https://cytonn.com/topicals/understanding -the-derivatives-1on 25February 2021. 93 Section 32A 2(h). 94 James Wairoto and Bernard Musyoka, Insider Trading in Kenya, MWC Newsletter (2019) Available at https://mwc.legal/insider-trading-in-kenya/on 25 February 2021 https://cytonn.com/topicals/understanding%20-the-derivatives-1 https://mwc.legal/insider-trading-in-kenya/ 26 discharge the burden that the individuals had access to that information, the information was not made public, it was price-sensitive and the persons acted on the basis of that information. To give credence where it is due, the Act has made forward steps in providing a guide to what inside information is. Before the 2013 amendments, it was difficult to know what information would amount to inside information. This was problematic because proof of possession/knowledge of information was central to prosecuting a charge of insider trading. This requirement was reflected in section 32A of the Act which made reference to insider trading as trading “on the basis” of unpublished insider information. With the introduction of section 32C, it is now possible to succinctly describe inside information. Concerns however emanate from the requirement that for such information to qualify as inside information, it should not have been made public. Thus, information in the public domain cannot, under any circumstances, be inside information.95 This begs the question, when is information deemed to be in the public domain? Section 32D outlines various instances when information may be deemed to be public. These are: if it is published in accordance with the rules of a securities exchange; for the purpose of informing investors and their professional advisers; it is contained in records which by virtue of any law are open to inspection by the public; it can readily be acquired by those likely to deal in any securities to which the information relates or of an issuer to which the information relates; or is derived from information which has been made public. The researcher takes great exception to the notion that information is deemed public merely by the fact that it can readily be acquired by those likely to deal in securities or that information has been made public.96 This objection is premised on the fact that not all information in the public domain is there legally. For instance, confidential company information may be leaked to the public by an insider for the sole purpose of conducting a certain trade. This situation is further convoluted by the provision that information is still deemed to be in the public domain even where it is released to only a segment of the public.97 Furthermore, a newspaper or tabloid article may speculate, without cause, 95 Section 32C, Capital Markets Act, 2013. 96 Section 32D (1) (c), Capital Markets Act, 2013. 97 Section 32D (2), Capital Markets Act, 2013. 27 information which turns out to be true. Such speculations, although baseless, are protected by Section 32D (a) and (c). The Act fails to take into account the reliability of the source of information and thus gives a lot of leeway for culprits to claim that the subject information was in the public domain. Like in the case of Terrence Davidson above, the court in the case of Republic v Bernard Kibaru98noted that the prosecution had failed to prove beyond reasonable doubt that the accused person had exploited information not generally accessible to the public when disposing of his shares in the company. In the case, the accused person was an employee of the issuing entity and regularly attended board meetings regarding the financial prospects of the company. The Capital Markets Act extends the culpability of insider trading to persons connected to a body corporate. Under the Act, a person who is connected with a body corporate shall not deal in any securities of that body corporate if by reason of his being, or having been, connected with that body corporate he is in possession of information that is not generally available but, if it were, would be likely to materially affect the price of those securities.99 Such a person is also barred from communicating such material non-public information with any other person if trading in those securities is permitted on any securities exchange; and he knows, or has reason to believe, that the other person will make use of the information for the purpose of dealing or causing or procuring another person to deal in those securities.100 The Capital Markets Act defines a person connected with a body corporate as a natural person who is an officer of that body corporate or of a related body corporate; or is a substantial shareholder in that body corporate or in a related body corporate; or occupies a position that may reasonably be expected to give him access to information by virtue of his professional or business relationship; or being an officer of a substantial shareholder in that body corporate or in a related body corporate.101 98Republic versus Bernard Mwangi Kibaru, Nairobi CMCR 1337/2008 (Unreported). 99 Section 33 (1) Capital Markets Act, 2013. Section 33 (2) describes “information” as information not generally available to the public and if it were it would materially affect the price of the subject securities. Information falling under this description is also information that relates to any transaction (actual or expected) involving both bodies corporate or involving one of them and securities of the other. 100 Section 33 (5) Capital Markets Act, 2013. 101 Section 33 (9) Capital Markets Act, 2013. 28 Generally, a body corporate is prohibited from dealing in securities where any officer in the body corporate has in his possession information which is not in the public domain and would affect the price of those securities if it were public.102 However, there are some exceptions to this rule. A company is not barred from trading by reason only of information in the possession of an officer of that body corporate if the decision to enter into the transaction was taken on its behalf by a person other than the officer.103 2.1.1.3. Penalty for Insider Trading under the Capital Markets Act Insider trading under the Capital Markets Act is contemplated as a criminal offence of strict liability. Under various provisions, the Capital Markets Act prefers a custodial sentence or a fine upon conviction on charges of insider trading. Among these provisions is Section 32E which stipulates that first offenders convicted of insider trading are liable to a fine not exceeding two million five hundred thousand Kenya Shillings or a custodial term of two years for natural persons. In addition, the convicted person will also pay the amount of the gain made or loss avoided through the act of insider trading.104 Bodies corporate will, upon conviction, be liable to a fine of up to five million shillings and payment of the amount of the gain made or loss avoided.105 Natural persons found guilty of a subsequent offence are liable to a fine not exceeding five million shillings or to an imprisonment for seven years and payment of twice the amount of the gain made or loss avoided. Companies found guilty of insider trading after the first offence are liable to a fine not exceeding ten million shillings and payment of twice the amount of the gain made or loss avoided.106 There seems to be some contradiction in terms of the sentence imposed to a natural person where they are convicted on insider trading charges. As above, section 32E (a) (i) of the Act provides for a punitive fine not exceeding two million five hundred thousand shillings. This sanction is replicated in Section 33 (12). However, under section 32L, the Act provides that any person who contravenes the provisions of Part VI is liable to a fine not exceeding five million shillings. 102 Section 33 (6) Capital Markets Act, 2013. 103 Section 33 (7) Capital Markets Act, 2013. 104 Section 32E (a) (i) Capital Markets Act, 2013. 105 Section 32E (a) (ii) Capital Markets Act, 2013. 106 Section 32E (b) Capital Markets Act, 2013. 29 A reading of section 33 (13) reveals that the drafters of the Act contemplated civil action by a complaining company for the recovery of loss. In addition, subsection 14 stipulates that conviction under the Act does not absolve the offender of liability accruing from any other written law. The Capital Markets Authority, exercising its mandate of enforcement, is also empowered to impose addition penalties other than those highlighted above.107 The Authority may reprimand, suspend, revoke a license, remove one from directorship, levy a financial penalty or recover twice the amount of money lost or gained from a person found in contravention of the provisions of the Capital Markets Act. In addition, the Authority also has the power to make orders of restitution or require a certain company to take action against one of its employees. The Act requires the Authority to publish the names of offenders and the actions taken against such offenders in the Authority’s annual report.108 To some extent, insider trading is considered a white-collar crime. Sutherland defined white-collar crime as “crime committed by a person of respectability and high social status in the course of his occupation".109Many perpetrators of insider trading are usually corporate executives high up the social and corporate ladder who get access to inside information by virtue of their positions. As in many white-collar crimes, the offence of insider trading is difficult to prosecute because perpetrators are sophisticated criminals who have attempted to conceal their activities through a series of complex transactions.110 2.1.1.4. Enforcement The Capital Markets Act and its licensing regulations advocate for self-regulation of securities exchanges in Kenya.111However, this is hardly the situation on the ground. The NSE operates under heavy oversight of the Capital Markets Authority which is an authority established under the Capital Markets Act.112One of the core objectives of the Capital Markets Authority is to implement a system of self-regulation “to the maximum 107 Section 25A Capital Markets Act, 2013. 108 Section 25A (4) Capital Markets Act, 2013. 109 Sutherland, Edwin H. The White-collar criminal. American Sociological Review (1940) 5:1–12 110White Collar Crime/Fraud Statistics Available at http://www.diogenes llc.com/ whit ecollarfraudstats.htmlon 25 February 2021. 111 Section 11A (1) (b) Capital Markets Act, 2013. 112 Section 5 Capital Markets Act, 2013. 30 practicable extent.”113 In this regard Gakeri argues that the regulation of securities markets in Kenya is government led.114 Being a statutory authority, the CMA is imbued with executive powers delegated by the Ministry of Finance (Treasury). It is thus responsible for the implementation and enforcement of the regulations under the Capital Markets Act. To discharge its mandate, the Authority is empowered to prevent, license, authorize, investigate, inspect and sanction all players in the securities market. Exercising its full complement of powers, the Authority is the primary institution responsible for regulating securities markets and thus prohibiting insider trading in Kenya. 2.1.1. Institutional Framework: An Overview of the Capital Markets Act, CAP 485 A Laws of Kenya Fishman argues that the effectiveness of the regulatory scheme rests upon the nature and scope of enforcement tools.115 In the same vein, Gakeri suggests that the interface between regulation and enforcement manifests itself through supervision which broadly encompasses: licensing or authorization, inspection, investigation and sanctioning.116 From the foregoing, it is then trite to conclude that the enforcement of legislation is heavily dependent on the effectiveness of the institutional framework. In Kenya, the Capital Markets Authority personifies this institutional framework. In this section, the researcher will assess the effectiveness of the Authority in discharging its statutory mandate. In this pursuit, the researcher will look at the extent of the powers devolved to the Authority through the Capital Markets Act and how the Authority has exercised those powers in the prohibition of insider trading. 2.1.2.1. Capital Markets Authority In the 1980 of Kenya, the government of Kenya embarked on a quest to enhance the role of the private sector in the economy, reduce the demands of public enterprises on the exchequer, rationalize the operations of the public enterprise sector to broaden the base of ownership and enhance capital market development. To help further along this objective, the government set up the Capital Markets Development Advisory Council in 113 Section 11 (1) (c) Capital Markets Act, 2013. 114Gakeri J, Regulating Kenya’s Securities Markets,270 and 271. 115 James J. Fishman, Enforcement of Securities laws Violations in the United Kingdom, 9 International Tax and Business Law 131 (1991). 116Gakeri J, Regulating Kenya’s Securities Markets, 270 and 271. 31 1988 which was charged with the responsibility of creating a regulatory body for the capital markets in Kenya. The Council drafted the first Capital Markets Bill which was passed by Parliament in 1989.117 The Capital Markets Authority was established in 1989 by this Act of Parliament in a bid to enhance the development of capital markets. It began its operations in 1990 as a statutory agency charged with the “primary responsibility of regulating the development of orderly, fair and efficient capital markets in Kenya.”118 This maiden Act was merely a framework and was not intended to interfere with the operations of markets significantly.119 Over the years, the Act has seen several amendments that have widened the powers of the Authority and fortified its position from a development facilitator to a market regulator. 2.1.2.2. Composition of the Authority Section 5 of the Capital Markets Act, 2013 establishes the Authority as a body corporate with perpetual succession. The Authority is composed of a chairman appointed by the President of Kenya; six members appointed by the minister; the Permanent Secretary of the ministry or his delegate appointed in writing; the Governor of the Central Bank of Kenya; the Attorney General and a Chief Executive Officer.120 The Act requires that the chairman and all six members appointed by the minister to have experience and expertise in legal, financial, banking, accounting, economics or insurance matters.121 The Act also prescribes that the Chief Executive Officer of the Authority must be a person with at least ten years’ experience at a senior management level in matters relating to law, finance, accounting, economics, banking or insurance and has expertise in matters relating to money or capital markets or finance.122 The chairman and members have a renewable three-year tenure of office. It is a requirement that the appointment of 117 Capital Markets Authority Handbook, Available at https://www.cma.o .ke/index.php?opti on=com_phocadownload&view=category&download=140:cma-handbook-complete&id=45:information- for-investors&Itemid=222on 25 February 2021. 118Rothwell Kevin, Regulations and Market Practice, Chartered Institute for Securities and Investments (2016) 119Gakeri Jacob, Enhancing Securities Markets in Sub-Saharan Africa: An Overview of the Legal and Institutional Arrangements in Kenya, International Journal of humanities and Social Science, Vol 1 No. 9 (2011). 120 Section 5 (3) Capital Markets Act, 2013. 121 Section 4 Capital Markets Act, 2013. 122 Section 8(2) Capital Markets Act, 2013. 32 members of the Authority takes place at different times so as to foster continuity of operations of the Authority.123 The composition of the Authority has often been criticized for being inordinately large.124 This criticism best manifests in the quorum of six required for any decision to be taken by the Authority. Furthermore, it has been argued that the financial implications of a large membership defeat the objects of efficiency where such monies used to pay allowances may be used for civic education. Heavy board memberships in government agencies are often seen as pervasive and to entrench political patronage.125 This concern is further compounded by the fact the appointments to membership are not subjected to any form of vetting by statute. The composition of the Authority draws members from the industry. In this light, it is inevitable that some of these members, at one point or the other, have a conflict of interest. The Act fails to expressly provide for such a situation. The Authority and its members are shielded from liability arising out of any act which is done in good faith or purported to be done by such person, on the direction of the Authority or in the performance or intended performance of any statutory duty.126 2.1.2.3. Powers of the Authority One of the objectives of the CMA is to formulate rules and guidelines on various aspects of the securities markets, license, approve and supervise all market intermediaries. This full complement of powers is characteristic of any regulator of securities markets. The Authority’s powers fall into three distinct categories. These are prevention, monitoring and information gathering and power of intervention, sanctions, penalties and judicial proceedings. Prevention The Authority is the gate-keeper of securities markets. It is empowered by statute to restrict entry into the industry to only persons with unquestionable business history and conduct. This is achieved through the Authority’s powers of registration, authorization, approval and licensing. In furtherance of this mandate, the Authority is also empowered 123 Section 4A Capital Markets Act, 2013. 124Gakeri J, Enhancing Securities Markets in Sub-Saharan Africa,134-169. 125Kiarie Mwaura, Regulation of Directors in Kenya: An Empirical Study, 13 (12) ICCR, 465, 479 (2002). 126 Section 10 Capital Markets Act, 2013. 33 to set industry standards and maintain such standards in a bid to protect the unsuspecting public. In relation to insider trading, the Authority has the power to approve certain transactions.127 If a certain transaction is suspect, the Authority may refuse to authorize dealing in those securities pending further investigation. Along with the registration and licensing functions, the Authority has the power to deregister as well as revoke licenses of offenders. These powers were exercised in the case of Aly Khan Satchu and Andre De Simone. In that case, the Authority, in addition to cash penalties banned the offenders from dealing in securities for three and one year respectively. Mo