With as many as one-third of public takeovers raising suspicion of insider dealing, Kate Hanley asks whether law firms are doing enough to safeguard information


Michael Douglas’s portrayal of insider trader Gordon Gekko in the film ‘Wall Street’ may be 20 years old, but the image of the character’s naked greed and brazen flouting of rules still haunts lower Manhattan and the City of London in equal measure.



Indeed, recent surges of share prices around companies involved in UK deals have triggered action by both the Financial Services Authority and the Takeover Panel. A report on market cleanliness published by the former in March last year concluded that some 29% of takeover announcements and 22% of company trading statements between 2000 and 2004 were preceded by suspicious price movements.



Moreover, the Financial Services and Markets Act 2001, which gave new powers of civil sanctions to the FSA to ease prosecutions and increase penalties, appears to be failing as a deterrent: insider trading has increased since 2001, according to the report.



Such is the FSA’s concern that it has launched a review into the management of inside information by all parties advising on merger and acquisition (M&A) transactions, including lawyers.



‘The FSA is currently under a lot of pressure from the government in two areas: market abuse and money laundering,’ explains Julian Connerty, dispute resolution and regulatory partner at City firm Clyde & Co. ‘The number of cases of insider dealing are simply not falling. The FSA accepts that to make a difference it must prosecute more, and fines need to be larger. I think it will really begin to get tough with people and you’ll see a lot more prosecutions’.



As part of its review, the FSA is scrutinising four deals from last year, three of which were forced to announce early by the Takeover Panel following abnormal price fluctuation. It is interviewing the law firms, financial advisers, issuers and PR firms – among others – that acted on each deal and will be crawling over their IT systems, document management and personnel policies (see [2007] Gazette 4 January, 2).



‘As you can appreciate, this is a real concern for law firms because a key part of their reputation lies in keeping these things quiet,’ says Tony Williams, consultant at Jomati. The former managing partner of Clifford Chance and Andersen Legal adds: ‘Large firms are working on price-sensitive information all the time. You do need to be careful as you widen the number of specialists involved, but even seeing two parties together in the firm’s reception area can give the game away.’



At this stage, the FSA is not revealing the actual deals being analysed, nor the law firms involved. However, a spokesman confirms that the review is ‘not just confined to the firms involved in the particular deals. We are also talking to those firms which are heavily involved in the whole mergers and acquisitions field.’



The prospect of vastly experienced lawyers, used to the protective shroud of client confidentiality, being held to account by the FSA is an intriguing one. ‘It may be that firms will claim client confidentiality,’ continues the FSA spokesman, ‘but from our perspective this is a fact-gathering exercise and falls within the disclosure rules.’



Whether or not information is actually escaping from law firms is another matter. Mr Connerty says: ‘Lawyers know very, very well how serious this subject is and how zealous the FSA will be in prosecuting such cases. I would be extremely surprised if lawyers let this sort of information leak out.’



Among the measures implemented by City firms to safeguard M&A information are the use of codenames for all relevant parties; a series of rooms with restricted access; a separate IT server for use by the transaction team; stringent training on confidentiality for support staff joining the firm; limiting the number of people on a deal where possible; and drumming home

the message to avoid careless mobile telephone conversations or worse still, leaving papers in the back of taxis, if indeed they are allowed to be taken off the premises.



‘Before the announcement, you have to work on a need-to-know basis. Sometimes you have to go to extraordinary lengths to achieve that,’ says Mr Williams.



Andrew Beedham, committee member of the Law Society’s law management section (LMS), is not aware of any prescribed guidance on this issue ‘other than the general duty of client confidentiality’. He says: ‘To a large extent it is self-regulatory. All firms that do corporate transactions will do whatever is needed to avoid the risk of insider dealing.’



The problem, of course, is that the larger the deal, such as public takeovers, the bigger the law firm acting and the greater the risk of leaked information.



Remote access computer systems, allowing staff to work from home, are becoming increasingly common practices and could pose a threat. Mr Beedham’s firm, south-west solicitors Clarke Willmott, uses a system called ‘Community Internet’s 0800 charge-back service’. He admits: ‘Anything that has an electronic link is more susceptible to risk. In the old days, confidential documentation was locked away in the filing cabinet. The wider you give access to data, the greater the risk, but I would hope most of these products are sufficiently secure and access is sufficiently restricted.’



The use of Chinese walls, widespread in the City where there is a conflict scenario, also poses potential problems, because they are merely metaphorical barriers that restrict access to information by other members of the firm. It is a policy that the FSA is keen to learn more about.



Despite all the safety measures employed in large deals, information is leaking out somewhere along the mammoth deal chain, which runs from the investment banks down to the prospectus publishers. In 2004, a proof-reader at a financial printing company, who passed on information of imminent takeover and merger transactions, was convicted of insider dealing alongside three other individuals who acted on that information. All received prison sentences.



The FSA estimates that as many as 1,000 people are involved in the largest deals, and when multiple private equity houses are involved, the scale of the problem is exacerbated. This all makes tracking down the source of any leak a monumental task.



‘It is very difficult because the whole market works on the basis of rumour,’ says Mr Williams. ‘Quite rightly, the market is looking at spikes and trying to identify the causes behind them. But even with tight controls, people can put two and two together.’



He recounts the tale of a man who bought a substantial number of shares in a company some weeks before a significant hike in its share price. Investigated for insider dealing, the man revealed that he knew something was going on when his boss came to work one day wearing a new suit.



In most cases, watchdogs rely on tip-offs from members of the public, such as disgruntled shareholders who note a sudden price shift just prior to announcement, or from market analysts made aware of abnormal jumps in stock value.



In a large number of cases, the leak is the result of a passing comment to a friend or family member. ‘I acted for a director of a company who was at risk of prosecution from the FSA,’ reveals Mr Connerty. ‘He told me he was absolutely certain he hadn’t talked to anyone, but when interviewed by the FSA, he revealed that the only person he told was his wife, as if that didn’t count.’



There are those who argue that tip-offs are the essence of financial markets and that without them the stock exchange would remain stagnant. But financial gain through unfair advantage is hardly free enterprise. And as the FSA points out in its report, ‘We note only that financial markets are built on trust and that insider trading erodes that trust and can increase costs for all market participants.’



Kate Hanley is a freelance journalist