Toward More Robust Russian Capital Markets: The Importance of Being Earnest ' ' ' About Insider Trad

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Toward More Robust Russian Capital Markets The
Importance of Being Earnest . . . About Insider
Trading
Seventh Annual Russian Securities Convention
12 October 2005
Mark M. Banovich, Esq.Partner, Moscow Office
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Overview

• The Importance of Being Earnest about Insider
  Trading
• Being Earnest about Insider Trading
• Some Further Thoughts . . .
• Conclusion

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• The Importance of Being Earnest about Insider
  Trading
• Regulatory Objective Improve the international
  competitiveness of Russian capital markets
• Key obstacle identified by regulators
  Illiquidity, with the following results
• Unreliable pricing mechanism (inefficient market)
• Systematic discounting of prices
• High price volatility

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• Illiquidity in the Russian market
• Supply-side Russian issuers appear to prefer
  the international capital markets over the
  domestic market
• Statistical evidence Trading in Russian issuer
  shares in the form of ADRs and GDRs in NY and
  London
• Anecdotal evidence Many Russian issuers view a
  Russian listing as a perfunctory regulatory
  requirement, which must be fulfilled before they
  can get permission to list shares abroad in the
  form of DRs

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• Demand-side Russian investors have little
  confidence in the Russian capital markets due to
  pervasive market abuse (i.e., insider trading and
  market manipulation)
• Statistical evidence Very little is available
  principally because there is no effective market
  monitoring capability by the regulator or the
  stock exchanges. This itself is problematic for
  investor confidence.
• Anecdotal evidence
• Insider trading Widespread press reports of
  otherwise inexplicable rises in securities prices
  in advance of major news events
• Market manipulation Widespread perception of
  wash sales, matched orders, and deliberate
  dissemination of misleading information

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• Proposed Solutions
• Supply-side Solution Amend Article 16 of the
  Securities Law to require issuers to list in
  Russia first
• Problem Is this confusing cause and effect?
• Problem Isn't the problem of illiquidity a
  demand-side problem? If so, unless the
  demand-side is fixed, this "solution" may only
  make matters worse it may not improve
  liquidity, and may well inhibit capital formation
  by Russian issuers
• Demand-side Solution Enact a law that will
  facilitate the prevention, detection,
  investigation and punishment of market abuse
• Old problems
• Definition of the offense and the offenders
• Detection, investigation and enforcement
• Penalties
• New opportunities Draft Concept of a Federal
  Law "On Insider Information and Manipulation in
  Financial Markets" (the "Concept Release")

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• Being Earnest about Insider Trading
• Market Abuse it's all about information
• Insider Trading and Market Manipulation Two
  sides of the same coin
• Insider trading Make money by trading on the
  basis of new information, when the market thinks
  there isn't any
• Market manipulation Make money by giving the
  market the impression there is new information,
  when in fact there isn't any
• Each of kind of deceptive practice undermines
  investor confidence, leading to illiquidity and
  the parade of horribles noted above

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• The Concept Release
• It addresses both aspects of market abuse,
  applying international experience to the Russian
  market
• EU Market Abuse Directive ("MAD")
• US insider trading law
• As it pertains to insider trading, the Concept
  Release is asking all the right questions
• What is inside information?
• Materiality Impact on price, or on price
  formation?
• Precision Only facts, or also rumors and other
  "soft" information.
• Enumeration Query the wisdom of enumerating the
  kinds of information that constitute inside
  information

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• Who is an insider?
• Insiders Enumerated list, or any person with
  access to nonpublic information generated by an
  issuer?
• Tippees Any person possessing inside
  information? Who knew or should have known it was
  inside information? Who received it in trust or
  confidence?
• Others who may be liable Control persons?
  Listed companies (and their compliance officers?)
  who fail to enforce the insider trading policies
  required by the FSFM's listing regulations?
• Ban on insider trading and tipping
• Use Is this to be presumed by virtue of
  possession? Awareness? Knowing possession?
• - If so, consider an exclusion for performance
  of agreements concluded before coming into
  possession of inside information, like MAD
  Article 2(3), or an affirmative defense for such
  situations or for program trading, like Rule
  10b5-1
• Tipping Proposed ban on communications to third
  parties should be clarified.
• - Consider permitting insiders to communicate
  inside information to third persons who owe them
  enumerated "duties of trust or confidence", as in
  Rule 10b5-2, or a "duty of confidentiality" as in
  MAD Article 6(3)

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• Detection and Prevention
• Self-policing Insider lists, other
  record-keeping requirements, insider trading
  policies and compliance officers, reporting of
  insider transactions, Chinese walls?
• - How effective will insider transaction
  reporting obligations be in the absence of a
  short-swing profits disgorgement rule, as in
  Section 16 of the US Securities Exchange Act of
  1934 (the "'34 Act"), and the rules thereunder?
• - How effective will insider trading policies be
  unless companies are delisted and/or they and
  their compliance officers are subject to
  substantial administrative penalties for failure
  to enforce them?
• Market policing Squeal rule for securities
  market professionals (as in MAD Article 6(9)) and
  bounty payments (as in '34 Act Section 21A)?
• Regulatory and stock exchange monitoring
  Automated trade tracking and analysis systems,
  and databases

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• Investigation and Enforcement
• The Regulator
• - Power to conduct regular on-site inspections,
  and special on-site inspections based on
  reasonable suspicion of violations
• - Power of subpoena and subpoena duces tecum
  with respect to all persons who may have relevant
  information
• - Power to hold hearings and adjudicate
  administrative actions
• - Power to bring civil actions in court and
• - Discretion to refer criminal cases to the
  procurator.
• Stock Exchanges Although they may not be vested
  with the coercive power of the state, they should
  have the same powers to request the information
  that the regulator has to require, and should
  have the right (obligation?) to refer cases to
  the regulator (i) where its requests are unheeded
  and (ii) where it has identified potential
  administrative or criminal violations.

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• Penalties
• Civil and Administrative
• - Civil Penalties and Damages Recissionary,
  benefit-of-the-bargain, or disgorgement? A
  multiple of damages?
• - Injunctive Order market participants to
  cease desist from prohibited activity
• - Professional Bar certain offenders from
  conducting professional activity related to their
  offense
• - Suspensions Power to de-list issuers or halt
  trading
• - Preliminary Powers to freeze or sequester
  assets pending outcome of proceedings
• Right to appeal administrative decisions to a
  court
• Criminal
• - Weigh deterrence against potential for abuse

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• Some Further Thoughts
• What's missing from the Concept Release?
• Private rights of action.
• Funding mechanism for FSFM and stock exchange
  detection, investigation and enforcement program
  
• Budgetary appropriations
• User fees?
• Retention of a portion of civil and
  administrative penalties?
• Conclusion

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QUESTIONS?
Towards More Robust Russian Capital Markets The
Importance of Being Earnest . . . About Insider
Trading
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