Australia’s insider trading laws play a critical role in maintaining market integrity. And yet it hasn’t always been clear exactly which financial products are subject to the insider trading provisions in the Corporations Act. The New South Wales Court of Criminal Appeal has now gone a long way to resolving the uncertainty in its decision in Joffe v R; Stromer v R [2012].

The insider trading restrictions in the Corporations Act (IT Restrictions) provide that a person who possesses inside information must not acquire or dispose of, or procure that another person acquires or disposes of, certain financial products, called Division 3 Financial Products or D3FPs. D3FPs include securities, derivatives and any other financial products that are able to be traded on a financial market.

The Joffe case involved an appeal from the New South Wales Supreme Court of two related findings of insider trading. The appellants, Mr Joffe (charged with the offence of procuring) and Mr Stromer (charged with the offence of acquiring), claimed that they could not be guilty of insider trading on the basis that the particular products in question, various contracts for difference (CFDs), were not D3FPs. 

In contemplating the appellants’ claim, the Court addressed the general issue of whether or not a product has to be a “financial product” within the general definition in the Corporations Act to be capable of being a D3FP; that is, whether or not D3FPs constitute a sub-category within the parent category of “financial products”.

The Court’s decision – D3FPs are a defined sub-set of “financial products”

The Court unanimously concluded that for a product to be a D3FP, it must first be a financial product. Accordingly, any specific exclusions that apply to financial products will also apply to D3FPs.

In reaching this conclusion, the Court focussed on the definition of “Division 3 Financial Product”, finding that the catch-all “any other financial products that are able to be traded on a financial market” at the end of the definition effectively frames the boundaries of the definition and must guide interpretation of its scope.

Consequences of the decision

Joffe has two important consequences for participants in the Australian financial system.

Firstly, the Court confirmed that the specific exclusions that prevent a product from being a financial product are equally applicable to D3FPs.

This should end the debate around whether or not the IT Restrictions apply to loans or other financial accommodation provided by banks or financial institutions. Prior to Joffe, it could not be said with certainty that because a loan is a credit facility (credit facilities are expressly excluded from the IT Restrictions under the Corporations Act), it is outside the ambit of the IT Restrictions.

In relation to loan trading, participants in the secondary debt market had to rely on detailed legal analysis as to a loan not being a “debenture” and thus not a “security” to conclude that the IT Restrictions would in general not apply to a loan trading transaction. Whilst this result tallied with market convention, the analysis could be open to question in relation to a loan where the borrower’s business involved acting as the financing company within its broader corporate group.  

Following Joffe, participants in the secondary debt market can now be confident that if the loan subject to their transaction falls within the broad definition of “credit facility” under the Corporations Regulations (and this will usually be the case), it will not be a D3FP and will not be subject to the IT Restrictions.

Secondly, the Court acknowledged that the subject of the phrase “Division 3 financial products” is financial products that can be traded on a financial market. Whilst not all members of the Court expressly made this point, each Justice’s reasoning leads to the conclusion that a financial product must be able to be traded on a financial market to be subject to the IT Restrictions.  This conclusion reflects the intention of the legislature as set out in the relevant explanatory memoranda.

This significant development clarifies which categories of product are subject to the IT Restrictions. For example, prior to Joffe it could have been argued that, contrary to accepted market practice, the IT Restrictions applied to sub-participations in respect of loans (Sub-participations). Not only are Sub-participations a tool for managing financial risk (thereby meeting a requirement of the general definition of “financial product”), their value varies by reference to the value or amount of something else (e.g. the value of the underlying loan). Therefore, Sub-participations could potentially be “derivatives” as defined in the Corporations Act for the purposes of the IT Restrictions.

Accordingly, finding solid legal support for the generally accepted market position that insider trading is not a relevant concern in relation to entering into Sub-participations was not without some difficulty. However, as Sub-participations are individually negotiated OTC products that are not able to be traded on a financial market, applying the reasoning in Joffe,the IT Restrictions should not be relevant to them.

Conclusion

Joffe provides significant comfort for market participants as to the scope of the IT Restrictions.  It should provide confidence that the law is now consistent with long accepted market practices and conventions – i.e. individually negotiated financial products that are not able to be traded on a financial market are not subject to the IT Restrictions.