Stock markets play a central role in modern economies by efficiently allocating surplus savings from investors to businesses in need of capital for growth and innovation. A key policy objective of governments worldwide therefore has been to broaden investor participation in the market.
Insider trading undermines investor confidence and deters participation. When certain investors exploit access to non-public, price-sensitive information to profit from their investments, it creates the perception that the market is not a level playing field. Retail or smaller investors may therefore feel that they are disadvantaged and believe that only the well-connected can succeed in the market.
Insider trading laws have therefore emerged as a critical tool to curb unfair advantages and attract broad-based participation, thereby increasing market liquidity, reducing the cost of capital for businesses, and ultimately supporting economic growth.
Insider trading is regulated around the world using two broad approaches: the person-connected approach and the information-connected approach.
The person-connected approach is the older and more widely adopted model. Countries such as the United Kingdom, China and Japan follow this approach, which focuses on establishing a connection between the accused and the company since the law presumes that a person with such a connection is likely to have access to inside information when trading in that company’s securities.
In contrast, the information-connected approach focuses on whether the accused was in possession of inside information and traded based on it, irrespective of any formal relationship with the company. Singapore, Australia and Malaysia have moved towards this approach.
The now-repealed Securities and Exchange Commission of Sri Lanka Act, No. 36 of 1987 (hereinafter, the “Repealed Act”) adopted a person-connected approach to regulation.
However, the prevailing Securities and Exchange Commission of Sri Lanka Act, No. 19 of 2021 (hereinafter, the “Prevailing Act”) which is operative from 21st September 2021 has shifted towards an information-connected approach.
Section 137 of the Act prohibits insiders, whether or not they are connected to the company, from trading on, or communicating (tipping) information that is not generally available, which on becoming generally available a reasonable person would expect it to have a material effect on the price or value of the company’s securities. Such person must also know, or be reasonably expected to know, that the information is not generally available.
As a result, the offence of insider trading is no longer limited to the traditional “insiders” such as directors, employees or substantial shareholders. It also extends to any person who trades based on inside information, even if they have no formal relationship with the listed company.
The definition of “information” under section 133 is also particularly significant. The term includes:
In this context, it is relevant to note that the Repealed Act confined the term “inside information” to specific matters relating to, or of concern (directly or indirectly) to that company.
The new definition under the Prevailing Act is a significant expansion from the previous regime, since it covers information that may not even relate directly to the listed company, thereby broadening the scope of what may constitute insider information.
The offence of insider trading could previously be compounded (i.e., settled outside court) under the Repealed Act. However, the Prevailing Act has classified it as a non-compoundable offence, reflecting its broader societal impact and need for prosecution.
Insider trading was also a criminal offense under the Repealed Act. The prosecution was therefore tasked with proving the offence “beyond a reasonable doubt”, which is a demanding standard given the nature of the offence.
The Prevailing Act, in addition to imposing criminal penalties for insider trading, has also made provision for civil consequences.
Section 151 enables an aggrieved party to institute civil action against an insider to recover the loss suffered. Civil liability is determined on a “balance of probabilities,” requiring only a slight tipping of the scales in favour of the aggrieved party.
Section 152 further empowers the Securities and Exchange Commission of Sri Lanka to institute civil proceedings against an insider. If the Court is satisfied on a “balance of probabilities” that an offence has been committed by the insider, it may order that person to pay the Commission an amount equal to three times the gross pecuniary gain made, or loss avoided. Additionally, the Court may impose a civil penalty ranging from Rs. 10 million to Rs. 100 million.
Our current law has been modelled on the insider trading provisions of Singapore and Australia which have been recognised as one of the broadest prohibitions against insider trading in the world (see Keith Kendall and Gordon Walker, “Insider Trading in Australia and New Zealand: Information that is Generally Available” (2006) 24 Company and Securities Law Journal 343; and Lew Chee Fai Kevin v Monetary Authority of Singapore [2012] SGCA 12).
By adopting a similar approach, the Sri Lankan framework overcomes the limitations of the Repealed Act and introduces a more effective and practical mechanism for enforcing insider trading laws.
It is therefore essential for market participants and other stakeholders to understand the full scope and implications of these provisions to ensure compliance and safeguard the integrity of Sri Lanka’s capital markets.
