The Market Abuse Directive has resulted in significant changes to the market abuse regime in the UK. We covered the new Disclosure Rules for listed companies, stemming from the UK’s implementation of the Market Abuse Directive, in our Law-Now of 6 June 2005 (click here to read it). This article outlines several other changes.
The Directive on Insider Dealing and Market Manipulation (2003/6/EC), known as the Market Abuse Directive, came into force on 1 July 2005. In the June 2005 issue of Clearly Corporate we covered the consequential changes to listed companies’ obligations to disseminate information and the new requirements on insider lists. The Directive has also had a wider impact on the UK’s market abuse regime under the Financial Services and Markets Act 2000 (FSMA) and the Financial Services Authority’s Code of Market Conduct, particularly as regards the new types of civil market abuse offences that may be committed. These new offences were also introduced by equivalent legislation in other EEA member states.
The existing UK criminal offences relating to market manipulation under FSMA and the insider dealing offences under the Criminal Justice Act 1993 remain in place and untouched. Somewhat surprisingly, when implementing the Directive the Treasury chose to maintain the existing UK civil market abuse offences under FSMA which had come into force on 1 December 2001 (although they are due to cease having effect on 30 June 2008). This leaves the UK with an unnecessarily convoluted market abuse regime, with multiple jeopardy in respect of the different types of offences.
The civil market abuse offences – in brief
The civil offences of market abuse are enshrined in the revised sections 118 and 118A of FSMA. They consist of three elements:
- in relation to “qualifying investments”,
- which is “insider dealing” or “market manipulation” behaviour, or encourages/requires such behaviour.~
Taking the various elements in turn:
This includes action or inaction, and may be carried out by one person acting alone, or two or more acting jointly or in concert.
There is a broad range of financial instruments which fall within the definition of a “qualifying investment”, including both equity and debt instruments. The investments must be admitted to trading, or a request for trading must have been made, on certain prescribed markets (including the London Stock Exchange, AIM and OFEX). Behaviour which occurs before a request for admission can also be relevant if it continues to have an effect once the application for admission has been made.
Unfortunately, one of the problems with the new regime is that the qualifying investments for the UK-specific market abuse offences differ from the qualifying investments for the purposes of the new market abuse offences introduced by the Directive. The new offences apply to investments admitted to trading (or in respect of which a request for trading has been made) on all EEA regulated markets, while the UK-specific offences only relate to certain domestic markets (although the criminal offence of insider dealing has covered EEA markets for many years). In addition, the new “insider dealing” market abuse offences extend to related investments whose price or value depends on the price or value of a qualifying investment (for example, derivatives such as contracts for differences, spread bets, options and futures). The UK-specific insider dealing market abuse offence also applies to anything that is the subject matter of a qualifying investment, anything whose price or value is expressed by reference to the price or value of a qualifying investment, and investments whose subject matter is the qualifying investment.
Insider dealing behaviour
The concepts of “inside information” and “insiders” underpin the new market abuse offences introduced by the Directive. These were discussed in the June issue of Clearly Corporate. Broadly, inside information is information directly or indirectly relating to a publicly-traded company or its securities that
- is precise, in the sense that it indicates actual or likely circumstances or events and is specific enough for a conclusion to be drawn on the possible effect on price,
- is not generally available, and
- would be likely to have a significant effect on the price of the company’s securities if it were generally available (judged by whether a reasonable investor would take account of it in making investment decisions).
The definition of “insider” is drawn widely, and captures almost anyone possessing inside information in most scenarios. The two new market abuse offences which turn on these concepts prohibit:
- an insider dealing or attempting to deal in a qualifying investment or related investment on the basis of inside information relating to a qualifying investment or a related investment (for example, a director aware of an impending takeover bid for his company, dealing in the relevant shares or placing a spread bet based on the relevant shares) (prohibited dealing); and/or
- an insider disclosing inside information to another person otherwise than in the proper course or exercise of his employment, profession or duties (for example, selective briefing of analysts by directors of issuers or others who are persons discharging managerial responsibilities, or simply disclosing such information in a social context) (prohibited disclosure).
In addition, there is the UK-specific market abuse offence based on the “misuse of information”, which is behaviour which does not fall within either of the two new insider dealing market abuse offences above and which:
- is based on information which is not generally available to those using the market which, if available to a regular user of the market, would be, or would be likely to be, regarded by him as relevant when deciding the terms on which transactions in qualifying investments should be effected; and
- amounts to a failure of the regular user test (i.e. it is behaviour which a regular user of the market would consider to be a failure to meet the standard of behaviour expected of a regular user of the market).
This UK-specific offence now covers behaviour not caught by the first two new offences introduced by the Directive – for example, when behaviour occurs in relation to information that cannot be regarded as inside information (in the way defined in the Directive) but is information that is not generally available to the regular user of the market (for example, information concerning negotiations over a company’s major trading contract, which might not be regarded as “precise” under the Directive).
Market manipulation behaviour
The following types of behaviour constitute the new “market manipulation” offences and are prohibited:
- behaviour consisting of effecting transactions or orders to trade (otherwise than for legitimate reasons in conformity with accepted market practices on the relevant market) which give, or are likely to give, a false or misleading impression as to the supply or demand for, or as to the price or value of, one or more qualifying investments (such as wash trades, where the underlying beneficial owner of the investments remains the same, but the impression is created that there is increased demand for the investment) (false or misleading transactions); or which secures the price of one or more such investments at an abnormal or artificial level (for example, collusion in the after-market of an initial public offering, where those who have received an allocation in the primary offering collude in placing orders in the secondary market for shares with the sole intention of keeping the price up before selling) (artificial pricing);
- behaviour consisting of effecting transactions or orders to trade which employ fictitious devices or any other form of deception or contrivance (fictitious devices); and
- behaviour consisting of disseminating, or causing the dissemination of, information by any means which gives or is likely to give a false or misleading impression about a qualifying investment by a person who knew or could reasonably be expected to know that the information was false or misleading. This covers, for example, releasing information through the media – including the internet or by other means – with the intention of moving the price of a security in a direction that is favourable to the position held by the person releasing the information (dissemination of false or misleading information).
In addition, there are the UK-specific market abuse offences based on market manipulation, which covers behaviour which does not fall within either of the above new market manipulation offences above and which:
- gives, or is likely to give, a regular user (see below) of the market a false or misleading impression as to the supply of, or demand for, or as to the price or value of, qualifying investments, or
- would be, or would be likely to be, regarded by a regular user of the market as behaviour that would distort or would be likely to distort the market in such an investment and fails the regular user test (see above).
The FSA gives a number of detailed practical examples of the various types of market abuse offences in its Code of Market Conduct.
Requiring or encouraging
This covers taking, or refraining from taking, action so as to require or encourage another person to engage in behaviour which would amount to market abuse if the encourager had carried out the behaviour. The person required or encouraged does not need to have actually engaged in the market abuse, and there is no requirement that he should actually have benefited from it; nor does he need to have been aware that the encouragement related to inside information. For example, a director possessing inside information (for example, the loss of an important sales contract by the company) may commit the offence by encouraging his brother to sell the affected shares even though he may not pass on the relevant inside information to his brother.
Reporting suspicious transactions
In addition to the changes to the civil offence of market abuse under FSMA, the implementation of the Directive has brought in a new requirement to report suspicious transactions. The requirement applies only to firms that arrange or execute a transaction with or for a client – i.e. generally, FSA-regulated firms. Where such firms have reasonable grounds to suspect market abuse they are required to notify the FSA without delay.
Both individuals and companies can commit the civil market abuse offences. Penalties may include unlimited fines, public censure and orders to compensate or release profits to affected persons. Injunctions to prevent or remedy market abuse (and to freeze assets) may also be available.
The defences available in respect of the market abuse offences include:
- Buyback programmes: this is a new defence, introduced by the Directive, which protects those who go through the various procedural requirements for a buyback programme carried out for the sole purpose of reducing the issuer’s capital (in value or number of shares) or to meet obligations from debt financial instruments exchangeable into equity instruments or under employee share schemes.
- Price stabilisation: the existing defence has been altered post-Directive, and the stabilisation can now only be carried out for a limited period (the price stabilisation rules determine how long – generally 30 days, but it varies for different instruments). There are also additional procedural requirements that must be met.
- Conformity with designated rules: this protects those using proper and effective Chinese Walls and those relying on the parts of the Listing Rules and Disclosure Rules that relate to the timing, dissemination or availability of, and the content and standard of care applicable to, a disclosure, announcement, communication or release of information.
- Takeovers/mergers: in general terms, this defence allows a bidder who has inside information on a company (beyond his own intention to bid) to make a bid and take preliminary and ancillary steps in the context of a public takeover bid or merger with the company.
- Trading defences of “legitimate business”: a person can give effect to his own trading intentions (for example, he can sell a stake that is large enough to make information about the proposed sale inside information) without having to pre-announce his intention to do so.
By far the most important defence generally is that the FSA cannot impose penalties on a person who reasonably believed that he was not committing market abuse or requiring or encouraging another to do so. Nor can it exercise these powers against a person who took all reasonable precautions and exercised all due diligence to avoid committing market abuse or requiring or encouraging another to so. Companies therefore need to document, implement and monitor appropriate procedures to deal with the new requirements (for example, on handling inside information, maintaining insider lists, approving personal account dealing, training relevant staff on the new requirements and so on).
We can provide clients with a detailed brochure on market abuse (free of charge), in-house training, systems review/design, and/or advice on specific transactions under the Code of Market Conduct.