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Insider Trading

From CEO to Convict


In Taiwan, the maximum penalty for insider trading is similar to that for rape or kidnapping, but the law is rife with gray areas that have CEOs terrified. What exactly is "reasonable" social justice?



From CEO to Convict

By Sara Wu
From CommonWealth Magazine (vol. 385 )

He is the CEO of a corporation with sales in the hundreds of billions of Taiwan dollars, a prominent businessman who maps out his company’s strategy on an international stage. Known for his upstanding reputation and kindness to others, he never suspected he could fall this far.

Suspected of insider trading, he has been detained in a jail cell 2.2 meters by 1.8 meters, about two-thirds the size of a parking spot. Because the jail is filled beyond capacity, he shares his cell with five other detainees suspected of a variety of crimes. The six sleep bunched together, crowded to the point where they can’t turn over.

The cell’s traditional squat toilet and faucet are exposed, so he cannot relieve himself or wash up without an audience.

Whenever the CEO leaves his cell to meet with his lawyer or attend a hearing, he is inevitably required to strip and subjected to a security search that includes a check of his anus.

He never suspected that the movie scenes of gangsters going into lockup could become his own reality. His world turned upside down, terrified by his sudden predicament and uncertain future, the CEO’s first question to his lawyer was, “When can I get out?”

The CEO’s son, studying abroad, was unaware of his father’s fate until he saw the shocking news on the Internet. The CEO’s father in southern Taiwan learned of his son’s detainment from television news. When he called his son’s family, the first question he asked was, “Was he just really greedy?” The executive answered through his family: “I was not money-hungry. It was company procedure.” Accompanied by the company’s high-ranking executives, the CEO’s wife visits the district prosecutor’s office every day for a glimpse of her husband, handcuffed and gaunt.

Although his guilt has yet to be proven, the executive has already been tarnished, his reputation destroyed in a flash.

The business acumen of Taiwan ’s top executives compares favorably with that of other executives around the world. According to Lausanne-based IMD (International Institute of Management Development), the entrepreneurial spirit of Taiwanese businessmen ranks 10th in the world out of 55 countries, and their ability to handle contingencies ranks 11th. The entrepreneurial spirit of Taiwan’s small and medium-sized enterprises and the competitiveness of its venture capital sector both rank 14th, while overall corporate productivity ranks 15th in the world. What is holding Taiwan back in the world rankings is primarily government efficiency, but now the judiciary has decided to get tough on the business community.

Insider trading regulations have never preoccupied CEOs or corporate managers in the past, and they failed to realize that Taiwan ’s prosecutorial and financial regulatory systems have undergone massive shifts in emphasis in ways that are impacting their lives profoundly.

Prosecuting insider trading is done in the pursuit of social justice. But what is reasonable social justice? How have standard investigative practices affected Taiwan ’s competitiveness?

One out of Every 15 Investigated

The Taiwan Stock Exchange occupies five floors of the world’s tallest building, Taipei 101, but it is one mysterious office on the 12th floor that has executives trembling. That’s where the bourse’s Market Surveillance Department operates, monitoring trades in shares of the market’s 1,100 listed companies. If it detects irregularities, it alerts Taiwan ’s key securities markets – the Taiwan Stock Exchange, the Gretai Securities Market – which handles over-the-counter trading and Taiwan ’s emerging market – and the Taiwan Futures Exchange.

The department’s surveillance methods range from daily “online surveillance” of the market when it opens, to “offline surveillance” of the market after hours, analyzing huge amounts of transaction data. The moment it spots an irregularity, it turns the information over to a special task force under the Financial Supervisory Commission’s Securities and Futures Bureau. The unit, set up by the FSC’s Financial Examination Bureau, the Taiwan Stock Exchange and the Gretai Securities Market, then studies the information with a prosecutor assigned to the FSC by the Ministry of Justice. They decide which cases to refer to prosecutors for further investigation.

According to FSC data, 75 cases of insider trading have either been referred to judicial authorities by the FSC or pursued independently by prosecutors since the financial regulatory body was established in July 2004. That means one out of every 15 listed companies is under investigation or prosecution for insider trading and more than 20 cases have led to indictments during that period.

“In Taiwan , every transaction made by every individual is clearly recorded. There is a trace left behind of anything that happens,” says Futures and Securities Bureau director-general Wu Tang-chieh. Even though he comes under intense pressure, his responsibility is to defend the market’s red line and maintain financial order, Wu says.

Faced with the FSC’s efforts to rectify Taiwan ’s financial order through an intolerance for misbehavior and tighter management of the markets, entrepreneurs are extremely nervous.

With the high rate of cases under investigation, many executives are wondering if they are on prosecutors’ lists.

Sensing Danger, CEOs Grow Vigilant

On October 23, the father of venture capital in Taiwan, WK Technology Fund chairman Wen Ko, was named a suspect in an insider trading case and was detained, along with WK Technology Fund president Ho Cheng-ching and vice president Lee Rung-hsun. No hearing had been held on their case three weeks after they were taken custody.

The arrest of Ko, who has been involved in the venture capital sector for nearly 20 years, sent shockwaves through the business community. Reputed for his integrity, Ko has poured seed capital into more than 200 small and medium-sized enterprises, including a young Hon Hai Precision Industry, enabling them to internationalize and adopt advanced technologies. Of those, 107 have gone public. The depth and breadth of his network of contacts only helped amplify the impact of his arrest, creating a critical mass of concern that raised alarms and doubts among Taiwanese executives.

Sensing danger everywhere, acutely attentive CEOs have become all the more cautious.

Asustek Computer Company president T.H. Tung Tsu-hsien reported to chairman Johnny Shih that he had asked the company’s financial, auditing, and share administration supervisors to go over the share transaction details of all high-ranking Asustek executives. He wanted to see if any trades had been made just before or after the company’s EeePC hit the market and the company’s strong third quarter results were released.

“Asustek is a company that’s very careful about maintaining self-discipline. Nobody is regulating us per se, but in an environment of vague regulations and political uncertainty, you have to be even more careful to avoid falling into traps,” Asustek’s president says.

Tung, who has been busy recently spinning off Asustek’s contract manufacturing business from its own-brand business, added that in a society in the process of learning and progressing, both sides can find plenty of flaws in each other.

“The business community should take the lesson to heart. But we also hope that legal circles will have the will to avoid political interference and that prosecutors will avoid trying to be heroes and selectively prosecuting cases,” Tung said.

Many managers acknowledge that they had not paid attention to the major changes made to insider trading laws in recent years.

Taiwan ’s insider trading laws were passed in 1988. At the time, the maximum sentence for the crime was two years, but most of those found guilty were sentenced to six months or less in jail and could have their jail terms commuted to a fine instead. As a result, businesses, prosecutors and society as a whole did not consider insider trading to be serious illegal behavior. Conviction rates were also low.

A Serious Criminal Offense

After being amended three times, the law on insider trading now mandates prison sentences of between three and ten years for those convicted of insider trading, and if their illicit gains exceed NT$100 million, the sentence increases to between seven and fifteen years.

The punishment can be stiffened another 50 percent if the insider trading destabilizes the market. In other words, the maximum penalty is 20 years in jail and a fine of NT$750 million, the most severe punishment under Taiwan law short of a life sentence or death.

While the penalties for insider trading are as stiff as any in the Taiwanese judicial system, the law is full of gray areas, leaving Taiwanese executives terrified.

The crime of insider trading occurs when information asymmetry enables company insiders or those obtaining information from insiders to make big gains at the expense of other, small shareholders.

In that case, when companies intervene in the market to defend their stock price, could that be considered insider trading?

Polytronics Technology Corporation chairman Ben B.C. Chang offers an example pointing to companies’ dilemmas on supporting their stock price. What if the share price falls by the maximum 7 percent and small shareholders call in to complain? Can the company move in and defend the share price? Chang wonders. If the stock price goes up as a result of the move, would that be insider trading?

“In the past, when the stock market nose-dived, the government and the president both called on business leaders to inject funds into the market to prop it up. How are we supposed to do this?” he asks.

Jason Chen, an attorney at international law firm Jones Day, suggests, however, that defending share prices is unrelated to insider trading and would more likely violate Securities and Exchange Act rules against manipulation of share prices.

But if before a company props up its shares, some material information develops, then it might still run the risk of insider trading. If, for example, a company bought back its shares before publicly disclosing important information, would that constitute insider trading? Taiwanese law provides no answer, because the buyer in the example is a company, and a company cannot be an “insider” under Taiwanese statutes. But United States legal precedents indicate companies in that country can be prosecuted for insider trading.

Controversial Legal Issues

Having access to “material information” about a listed company before it is released publicly is a key prerequisite for insider trading. But a big doubt in the mind of one CEO is at what point in time information actually becomes “material.”

Take the example of a company forecasting a loss. When does it become “material information”? Is it when the company begins to discuss it, or when it completes its financial statement, or when a certified public accountant signs off on the statement? Or is it after the board of directors passes the resolution formalizing the statement, or when shareholders acknowledge it?

According to Jason Chen of Jones Day, the most recent case that hinged on the timing of “material information” was that involving DBTEL Taiwan Limited. Prosecutors believed DBTEL engaged in insider trading when large volumes of its shares were unloaded on two occasions prior to the public release of downgraded earnings forecasts. But on October 31, the Taipei District Court ruled DBTEL not guilty on the grounds that the lowered forecasts became “material information” only when certified public accountants signed off on them. Prosecutors and the court clearly differ in their interpretation of when information becomes “material” in the context of insider trading.

Closed Investigations to Prevent Smearing the Target

Aside from the gray areas in insider trading-related law, executives are even more frustrated by the lack of professionalism among prosecutors and investigators.

Acer founder Stan Shih says he hopes prosecutors can uphold the principle of confidentiality in investigations. When prosecutors and investigators launch high-profile raids on companies, television news SNG trucks are there to cover them in detail, or prosecutors give the media their side of the story. For those companies and persons who have not been indicted or convicted, the raids in effect tarnish their reputation. Because the public immediately judges those under investigation to be guilty, the company’s share price falls, employee turnover increases, customers’ doubts grow, and the company may even be left without its leader, adversely affecting the company’s operations.

Enterprises even wonder, if in the end they are found not guilty, whether they are entitled to compensation from the state for the harm done to their reputations.

Prosecutors see their duty as upholding justice. But in their efforts to carve out more freedom to prosecute their case and avoid having superiors try to influence cases on behalf of their contacts, prosecutors can easily sacrifice their professionalism. One prosecutor has said: “Today it’s rare that supervisors dare discuss cases with prosecutors or judges. The moment they say anything, we will relay it to reporters. For us to battle with people who are so high up is definitely a losing proposition. Fortunately, there’s the fourth estate. Our biggest backer is the news media.”

When prosecutors demand the freedom to handle cases independently, they cooperate with the media to create pressure through public opinion and avoid having politicians interfere in the process. But at the same time, they sacrifice their professionalism by failing to uphold the principle of confidentiality.

Split Class Consciousness

Legislator Lai Shyh-bao says the Legislature quickly passed three amendments to the insider trading law because of society’s sense of injustice.

“Today, Taiwan is an ‘M’ society and there’s tension among the classes. The people despise those who have quickly amassed wealth through stock or capital transactions, so the spirit of the legislation was to take a strict approach. It’s the same abroad,” he explains.

But has the pendulum swung too far in the other direction? One owner of a medium-sized enterprise believes that under the current environment, “all businesses are evil and the rich are heartless,” and this makes it hard to do business.

Albert M.L. Hsueh, a territory senior partner at accounting firm PriceWaterhouseCoopers, contends that neither the economy nor society should be afraid of others making money, and that if the rules of the game are clear, a win-win scenario can be achieved for both enterprises and society as a whole. “We should not assume that the rich are criminals,” he says.

What is worrying is that the business community and the judicial system seem to exist in two different worlds, with each having different mindsets and values.

The role of the judiciary is to maintain social justice and strictly enforce the law, but there are times when, because it does not have sufficient financial expertise, it follows the letter of the law without considering the big picture. Jason Chen of Jones Day, who was a judge for 10 years before becoming an attorney, says the judiciary has yet to actively raise its level of financial expertise, especially in terms of its knowledge of how multinationals operate around the world.

Enterprises are the locomotives of society’s affluence, determined to maximize the value of shareholder wealth and make entrepreneurship their top priority. But in the past, their sense was that they could act at their own discretion, confident of surviving any crisis, while lacking a sense of the rule of law.

People from the business and judicial worlds rarely interact. It’s only when problems arise that they come into contact with each other for the first time. Business may not understand the legal transition that is underway, and legal circles investigating financial cases remain undermanned and still lack sufficient knowledge about the industry.

Over the past 10 years, contributions from private enterprise, rather than government investment or public infrastructure projects, have been the main engine of Taiwan ’s GDP growth. In its World Competitiveness Yearbook comparing 55 countries, IMD ranked Taiwan high in economic performance but in the bottom 10 in social cohesiveness, risk of political instability, and consistency of policy direction within the government. As one executive sincerely remarks, society needs people to learn from one another, and “value Taiwan ’s competitiveness under a system of justice.”

Translated from the Chinese by Luke Sabatier