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TORONTO: MAY 17, 2012 - Al Rosen, principal of Rosen & Associates Limited, a firm of litigation and investigation accountants, poses for a photograph at his company offices in Toronto on Thursday, May 17, 2012. Rosen jokes that he "finds the skeletons" in people's closets for a living.

matthew sherwood The Globe and Mail

One of the most recent high-profile scandals to hit headlines is the insider trading trial of Rajat Gupta, a former director of Goldman Sachs Group Inc., and Procter & Gamble Co., which is built on accusations Mr. Gupta leaked confidential business information to hedge fund company Galleon Group.

For companies, the Gupta case is yet another reminder of the importance of ensuring that insiders with privileged access to non-public information play by the rules laid down by lawmakers and securities regulators.

"Insider trading is bad for everyone – investors, businesses, the country," says Al Rosen, a chartered accountant with Rosen & Associates Ltd., a Toronto firm that specializes in investigative accounting. "From a company's perspective, the business suffers in the sense that people lose respect for their management team, and the company starts losing its investors."

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While the country's securities regulators and courts see only a few cases of insider trading cases each year – the Canadian Securities Administrators, which represents the 10 provincial and three territorial securities in Canada, reports 40 cases concluded in the last three years – a number of market observers have pointed to consistent patterns of trading spikes in the days before an announcement of earnings or a significant business development, such as a merger.

"Insiders can't trade during certain periods, such as before a quarterly earnings release or before a company releases material information," says Brian Smith, a professor of finance at Wilfrid Laurier University in Waterloo, Ont., who has been studying insider trading for years. "But our evidence indicates that insiders aren't restricting themselves during these blackout periods."

The Ontario Securities Commission, the country's largest securities regulator, has recently vowed to crack down on insider trading. To protect their reputation and shareholders, companies need to wield their own whip on insider trading, says Mr. Smith. For starters, they can't just rely on the country's laws; they need to have their own insider trading policy – something that most large companies have but is still missing in many publicly traded companies.

An insider trading policy needs to clearly spell out the definition of an "insider" and "insider information," says Dr. Smith. It should also specify blackout periods when insiders are not allowed to buy or sell stock.

Benjamin Silver, a Montreal-based lawyer with McCarthy Tétrault LLP, notes that most large companies today require their top officers to notify the company's chief financial officer or legal department before making a trade.

More companies are also moving toward automatic share plans for their senior officers, says Mr. Silver. These plans allow top leaders such as CEOs to sell their shares according to a pre-arranged schedule.

"The concept is that you take away the discretion to trade from the insider, and the trading decision has nothing to do with the insider and is not necessarily dependent on any event," says Mr. Silver.

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Automatic share plans also make it easier for senior officers to exercise their stock options. Without such a plan, CEOs and other top officers typically have very limited periods during the year when they can trade; in addition to the usual blackout periods, they're also prohibited from trading during times when they possess non-public material information which, in the case of a CEO, is quite often.

"There are so few times during the year when CEOs can trade," says Mr. Silver. "Automatic share plans address this challenge and help companies avoid the perception of questionable trades."

To minimize their risk for insider trading, companies need to keep a close eye on external parties such as advisers and consultants, says Mr. Rosen. In a case that led to Canada's first criminal conviction for insider trading, a former Toronto lawyer named Gil Cornblum – who later committed suicide – secretly obtained confidential client information and passed them on to his accomplice Stanko Grmovsek, who made trades based on these insider tips.

Having an internal watchdog is a good idea, says Mr. Rosen. He recommends assigning at least one employee to monitor the company's stock trades.

"It doesn't take much skill to notice that something is unusual," he says. "And if you don't have someone to do this internally, then farm it out."

Companies should also take the time to carefully review analysts' reports for possible information leaks, says Mr. Rosen.

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"Be careful that they're not putting out 'buy, buy, buy' recommendations to help underwriters sell your company's stock," he says.

While internal monitoring is critical, it's also important to have third-party verification, says Mr. Smith. An accountant or auditor should check insiders' holdings at the end of the year and compare these to transactions they reported throughout the year, he says.

The idea that illegal insider trading can be eliminated is "a bit out there in dreamland," says Mr. Rosen. Nevertheless, he agrees with other experts' belief that companies need to do their bit.

Anita Anand, an associate professor at University of Toronto Faculty of Law, says it makes good business for companies to take their own steps to restrict illegal insider trading. It doesn't cost much to have an insider trading policy in place – although monitoring compliance to the policy can get expensive – and the benefits are likely to outweigh the costs.

"A company that voluntarily restricts insider trading would be less likely to come under regulatory oversight and would not suffer the impact that a public enforcement would have," she says. "You may call this 'reputational effects' of private regulation, but regardless of the characterization chosen, private regulation of insider trading certainly seems to make good business sense."


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Create an insider trading policy. Translate the country's criminal and securities laws on insider trading into clearly defined rules your officers and employees must follow. Be sure to specify blackout dates and spell out the meaning of insider and insider information.

Take extra precautions. For instance, go above and beyond what the law requires by asking senior officers to notify your CFO or legal department before they exercise their stock options.

Put top officers on automatic. To address the tight trading restrictions put on CEOs and other top officers, companies should consider automatic share plans that allow trades on a pre-arranged schedule.

Have an internal watchdog. Assign someone to monitor trades of the company's stock. It's also a good idea to form an investigations group that can look into suspicious trading activities.

But get outside help, too. Have a third party, such as an accounting firm, come in at the end of the year to verify insiders' holdings against their reported trades throughout the year.

Special to The Globe and Mail

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