Insider Trading Regulations in M&A

Overview of Insider Trading Regulations

Insider trading is when a company insider with knowledge of an undisclosed material fact buys or sells company stock before the material fact is made public. Since a company insider with knowledge of an undisclosed material fact can predict to some extent whether the stock price will rise or fall when the material fact is made public, the insider can certainly make a profit if he or she buys or sells the company’s stock before the general public becomes aware of the material fact. Since such transactions give insiders a special advantage over ordinary investors, they cause inequality among investors and harm confidence in the securities market. Therefore, the Financial Instruments and Exchange Law prohibits insiders from trading in stocks before material facts are made public.

Persons subject to insider trading regulations

Company-related persons

Persons subject to insider trading regulations are referred to as company-related persons. The definition of company-related persons is set forth in the Financial Instruments and Exchange Law (Article 166, Paragraph 1 of the Financial Instruments and Exchange Law). Specifically, the following persons fall under the category of Company Affiliated Persons

① Officers, agents, employees, or other persons engaged by a listed company

Officers, agents, employees, and other workers of a listed company” include directors, auditors, employees, contract employees, temporary employees, part-time workers, and part-time workers of a listed company. In addition, officers, agents, employees, and other workers of a parent company or subsidiary of a listed company are also considered to be company-related persons.

② Shareholders holding 3% or more of the voting rights of a listed company

Under the Financial Instruments and Exchange Law, a person who has the right to request inspection and copying of accounting books is considered a related party of the company in accordance with Article 433 of the Companies Act. A person who has the right to request inspection and copying of accounting books means a shareholder who holds 3% or more of the voting rights of the company. Such a shareholder’s purchase or sale of shares based on information obtained in connection with the exercise of the right to request inspection and copying of the accounting books constitutes insider trading.

③ Persons with legal authority over the listed company

This includes public officials who have the authority to grant licenses and approvals. In order to obtain a license or approval under laws and regulations, it is necessary to disclose inside information of the company to public officials or other persons with licensing authority. Public officials and other persons with licensing authority are prohibited from trading in shares based on information obtained in connection with their duties.

④Persons who have entered into a contract with a listed company or are negotiating the conclusion of a contract

This includes business partners, certified public accountants who audit the company, and legal advisors. Business partners may include financial institutions, counterparties with whom the company buys and sells products, counterparties with whom the company conducts joint research and development, counterparties with whom the company has license agreements, counterparties with whom the company negotiates M&A agreements, etc. The counterparties to these contracts, certified public accountants, lawyers, etc. are not employees or officers of the company, but rather external corporations or individuals. However, they are in a position to potentially receive material information from the company under the contract. Therefore, it would be unfair for a person in such a position to buy or sell stock based on information obtained in connection with the contract. Therefore, these persons (those who have concluded a contract with a listed company or those who are in the process of negotiating the conclusion of a contract) are also prohibited from buying and selling shares, as they are considered to be company-related persons.

⑤ If ② and ④ above are corporations, officers of such corporations

If a person who exercises the right to request a listed company to inspect the books of a listed company and inspects the books of the listed company is a corporation, the officers, etc. of that corporation also fall under the category of persons related to the company and are therefore prohibited from trading in the shares of that listed company. Similarly, if a person who has entered into a contract with a listed company or is negotiating to enter into a contract with a listed company is a corporation, the insider regulations will also apply to the officers of the corporation, and they will be prohibited from buying or selling shares of the listed company.

Former company-related persons of a listed company (proviso in the main clause of Article 166(1) of the Financial Instruments and Exchange Law)

It would still be unfair for a company-related person of a listed company to trade stocks by using material information that he/she learned while he/she was a company-related person after he/she ceased to be a company-related person. Therefore, the Insider Regulation is applied to persons who have been no longer related to the company for less than one year, and prohibits them from buying and selling shares of the listed company.

Related Persons of a Takeover Bidder, etc. (Article 167 of the Financial Instruments and Exchange Law)

In addition to Article 166 of the Financial Instruments and Exchange Law, the purchase or sale of shares by a takeover bidder, etc., is prohibited under Article 167 of the Financial Instruments and Exchange Law.

Primary Information Recipients (Article 166, Paragraph 3 and Article 167, Paragraph 3 of the Financial Instruments and Exchange Law)

A person who receives information regarding a material fact from a person related to the company is considered a “primary recipient of information” and is prohibited from buying or selling shares before the material fact is publicly announced. If a relative or acquaintance of a person related to the company receives information from a person related to the company and trades in the stock, he or she will be able to gain an unfair advantage just as if the person related to the company himself or herself trades in the stock, and this will harm the confidence in the securities market. Therefore, it is prohibited for a person who receives first-hand information from a person related to the company to trade in shares of a listed company prior to the announcement of a material fact, just as a person related to the company is prohibited from trading in shares of a listed company prior to the announcement of a material fact. A person who receives information regarding a takeover bid from a person related to the takeover bid is also considered a primary recipient of information. Secondary information recipients who receive further information from a primary information recipient are not considered insiders, and are not prohibited from buying or selling shares of a listed company prior to the announcement of a material fact.

Types of Information Subject to Insider Trading Regulations

Information subject to insider trading regulations is information regarding “material facts” of a listed company. Information on material facts include information on decisions (Article 166, Paragraph 2, Item 1 of the Financial Instruments and Exchange Law), facts of occurrence (Article 166, Paragraph 2, Item 2 of the Financial Instruments and Exchange Law), financial information (Article 166, Paragraph 2, Item 3 of the Financial Instruments and Exchange Law), and other information that may significantly influence investors’ investment decisions (Article 166, Paragraph 2, Item 4 of the Financial Instruments and Exchange Law). In addition, under insider trading regulations concerning related parties such as the tender offeror, facts concerning the implementation of the tender offer or the cancellation of the tender offer constitute material facts (Article 167, Paragraph 2 of the Financial Instruments and Exchange Law).

Fact of Decision of Listed Company

Determined facts are facts that have been decided by the executive body of the listed company. Examples of decided facts include the following

• – Issuance of new shares
• – Reduction of capital stock
• – Acquisition of treasury stock
• – Reorganization such as merger, company split, share exchange, share transfer, etc.
• – Transfer of business
• – Business alliances

All of the above facts are considered to be material facts because they have a significant impact on investors’ investment decisions. However, even in the case of the above transactions, if the amount of the transaction is small, it may not be a material fact because it meets the criteria of minor importance. In addition, not only listed companies but also subsidiaries of listed companies are considered to have made the above decisions when their executive bodies make such decisions (Article 166, Paragraph 2, Item 5 of the Financial Instruments and Exchange Law). Therefore, if the executive body of the subsidiary decides to conduct a merger or other reorganization action, the corporate officials of the parent company (listed company) will not be able to buy or sell shares.

Facts of Occurrence of a Listed Company

A fact of occurrence refers to the fact that a material event that significantly affects investment decisions has occurred with respect to a company. Examples of material events that significantly affect investment decisions are as follows

• – Damage resulting from a disaster or damage incurred in the course of business operations
• – Changes in major shareholders
• – Judgment in a lawsuit, conclusion of a lawsuit without a trial
• – Change in parent company
• – Suspension of transactions with major business partners

The above facts have a significant impact on the company’s management and can be said to have a significant impact on the share price. Therefore, the occurrence of these facts is considered to be a material fact, and until they are publicly announced, persons related to the company are prohibited from trading in the shares of the listed company. In addition to the facts stipulated in Article 166, Paragraph 2, Item 2 of the Financial Instruments and Exchange Law, the Cabinet Order (Article 28-2 of the Financial Instruments and Exchange Law Enforcement Order) defines what kinds of facts constitute occurrence facts. In addition, the occurrence of such a fact at a subsidiary of a listed company is also considered as an occurrence fact (Article 166, Paragraph 2, Item 6 of the Financial Instruments and Exchange Law).

Financial Information of Listed Companies

Financial information means information that there is more than a certain degree of difference between the most recently announced forecast and the latest forecast or financial results with respect to sales, ordinary income, net income, etc. of a listed company (Article 166(2)(iii) of the Financial Instruments and Exchange Law). Information about the occurrence of such a difference in the subsidiaries of a listed company is also included in “financial information” (Article 166, Paragraph 2, Item 7 of the Financial Instruments and Exchange Law). The following criteria are used to determine whether information constitutes financial information.

1. ① When the new forecast or settlement figures for non-consolidated or consolidated net sales have increased or decreased by 10% or more from the most recently announced forecast.
2. ② If the new forecast or financial results for non-consolidated or consolidated ordinary income increase or decrease by 30% or more from the most recently announced forecast, and the increase or decrease is 5% or more of the smaller of net assets or capital stock at the end of the previous fiscal year.
3. ③ When the new forecast or settlement figure for non-consolidated or consolidated net income has increased or decreased by 30% or more from the most recently announced forecast, and such increase or decrease is 2.5% or more of the smaller of net assets or capital stock at the end of the previous fiscal year.
4. ④ If the new forecast or financial figures for dividends from surplus have increased or decreased by 20% or more from the most recently announced forecast.

Other items that significantly affect investors’ investment decisions (Article 166, Paragraph 2, Item 4 of the Financial Instruments and Exchange Law)

This is stipulated as a basket clause. It is to be determined on an individual and specific basis whether there is an impact equivalent to or greater than the individual criteria above.

Facts concerning the Implementation or Suspension of the Tender Offer, etc.

This refers to a decision by the Offeror to make a tender offer or a decision by the Offeror not to make a tender offer (Article 167, Paragraph 2 of the Financial Instruments and Exchange Law).

Acts subject to insider trading regulations

Persons subject to insider trading regulations are prohibited from engaging in the following acts

1. 1. Buying or selling shares of the subject company, etc.
2. 2. acts of communicating undisclosed insider information

“Buying and selling” of shares, etc.

A corporate official of a listed company or a primary recipient of information who becomes aware of an undisclosed material fact may not buy or sell shares of the subject company before the material fact is made public (Article 166, Paragraphs 1 and 3 of the Financial Instruments and Exchange Law). The term “purchase, sale, etc.” includes the transfer or acquisition of shares, succession through merger or demerger, and derivatives transactions.

Prohibition of Communicating Undisclosed Material Facts

When a person associated with a company becomes aware of an undisclosed material fact concerning a listed company, he/she is prohibited from communicating the undisclosed material fact to others for the purpose of enabling others to profit or to avoid incurring losses. Recommending others to buy or sell is also prohibited (Article 167-2, Paragraph 1 of the Financial Instruments and Exchange Law).
In addition, upon learning that a tender offer is to be made or a tender offer is to be cancelled, a person related to the tender offeror, etc., is prohibited from communicating to others the fact that an undisclosed tender offer is to be made or a tender offer is to be cancelled for the purpose of enabling others to profit or to avoid losses (Article 167-2, Paragraph 1 of the Financial Instruments and Exchange Law). Article 167-2, Paragraph 2 of the Financial Instruments and Exchange Law).
While the communication of information is prohibited to persons related to the Company or persons related to the Offeror, etc., the communication of information is not prohibited to primary recipients of information. Therefore, although a primary recipient of information is prohibited from trading in shares based on undisclosed material facts, the act of communicating information to others is not itself subject to punishment.

What is “public disclosure”?

Insider trading prohibits a person with knowledge of an undisclosed material fact from buying or selling shares of a listed company before the information is made public, but does not restrict the buying or selling of shares after the material fact is made public. Therefore, when the “public announcement” is made is an important merkmal to determine whether or not it constitutes insider trading. Under the Financial Instruments and Exchange Law, “public announcement” means that one of the following measures has been taken (Article 166, Paragraph 4 of the Financial Instruments and Exchange Law)

1. 1. the fact has been disclosed by the listed company or its officers, etc. to two or more major media outlets and 12 hours have elapsed
2. 2. The fact in question has been made available for public inspection (i.e., it has become freely available to the general public) through timely disclosure by the listed company, etc. based on the listing rules of a financial instruments exchange.
3. 3. Material facts have been made available for public inspection in securities reports, securities registration statements, extraordinary reports, etc.
4. 4. the Tender Offer Registration Statement or the Tender Offer Withdrawal Statement has been made available for public inspection.

Penalties

Violation of the Insider Trading Regulations may result in a surcharge payment order or criminal penalties.

Surcharge Payment Order

If a person associated with the company or a primary recipient of information trades stocks in violation of the insider regulations, he/she will be ordered to pay a surcharge (Article 175 of the Financial Instruments and Exchange Law). The calculation of the surcharge is described in detail in Article 175 of the Financial Instruments and Exchange Law.

Criminal Penalties

If a company official or a primary recipient of information conducts insider trading in violation of the law, he/she will be punished by imprisonment for not more than five years or a fine of not more than 5 million yen (Article 197-2, Item 13 of the Financial Instruments and Exchange Law).
A person who communicates undisclosed material facts is liable to imprisonment for not more than five years or a fine of not more than 5 million yen for violating the prohibition against communication if the person to whom the information was communicated trades stocks, etc. (Article 197-2, Items 14 and 15 of the Financial Instruments and Exchange Law). Communicating undisclosed material facts is punishable by criminal penalty only when the communicating party trades stocks.
If a representative, agent, employee, or other person of a corporation commits insider trading with respect to the business of that corporation, not only is the offender punished for violating the insider trading provisions, but the corporation is also subject to a fine of up to 500 million yen (Article 207, Paragraph 1, Item 2 of the Financial Instruments and Exchange Law). The so-called “double punishment” provision applies.