Market Abuse: The EU and US Approaches Compared

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Market Abuse The EU and US Approaches Compared

• Guido Ferrarini, Professor of Business Law,
  University of Genoa Vice-Chairman, European
  Corporate Governance Institute (ECGI)

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1. Insider Dealing Four Elements
2. The Insider Dealing Prohibition
3. Market Manipulation
4. Preventive Regulation
5. Conclusions

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Insider Dealing

• Inside Information
• General
• the use of non-public information is allowed
  provided it is not price-sensitive
• role of financial research
• 4 Elements
• precise information
• Rumours are not covered
• Definitions Directive Art 1(1)

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• Non-public information
• SEC v. Texas Gulf Sulphur Co. (2nd Cir. 1968)
• Corporate Information/Market Information
• coming from within the company (dividend
  increase) or from the market (takeover)

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• Price-sensitive information
• likely to have a significant effect on price
• reasonable investors test
• Basic Inc. V. Levinson (US Sup.Ct. 1988)

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• Insiders
• Primary v. Secondary Insiders
• Primary Insiders
• broad notion (Article 2(1))
• directors and managers
• employees and advisors
• shareholders
• focus on the status, profession or activity
  giving access to inside information
• new category criminal insiders

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• Secondary Insiders
• Art. 4 MAD any person ... who possesses inside
  information while that person knows, or ought to
  have known, that it is inside information
• Analogy with the tippee concept under US Law
  however
• a tip is not required
• a breach of fiduciary duty is not required

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• Comparison with US Law
• the EU definition reflects the US equal access
  theory
• Cady, Roberts and Co. (SEC 1961)
• the disclose or abstain duty applies to anyone
  who has access to information intended to be
  available only for a corporate purpose and not
  for the personal benefit of anyone

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• Comparison with US Law
• the EU definition does not require a breach of
  fiduciary duty
• United States v. Chiarella (US 1980)
• Chiarella was a printer by trade handling
  announcements of takeover bids
• He traded in the stock of target companies
  exploiting confidential information
• The Court held that Chiarella did not violate
  10 (b) as he was not under a duty to disclose
  before trading

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• Comparison with US Law
• United States v. Chiarella (US 1980)
• The Court refused to recognize a general duty
  between all participants in market transactions
  to forgo actions based on material, non-public
  information (equal access theory)
• The Court held that Chiarella was not liable as
  he was not a fiduciary of the shareholders who
  sold shares in the target companies to him
  (fiduciary duty theory)

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• Comparison with US Law
• Dirks v. SEC (US 1983)
• Dirks (broker-dealer) received material
  non-public information from insiders of a
  corporation with which he had no connection
• He disclosed this information to investors who
  relied on it in trading the corporations shares

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• Comparison with US Law
• Dirks v. SEC (US 1983)
• The SEC argued that a tippee inherits the duty
  to disclose or abstain
• In the Courts opinion
• a similar rule could have an inhibiting influence
  on the role of market analysts
• however, tippees are not always free to trade
• It is necessary to determine whether the tip
  constitutes a breach of the insiders fiduciary
  duty

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• Comparison with US Law
• the EU definition does not require corporate
  information to be misappropriated
• United States v. OHagan (US 1997)
• OHagan was a partner in a law firm representing
  the bidder in a tender offer
• He did not work on the bid, but traded on the
  relevant information

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• Comparison with US Law
• United States v. OHagan (US 1997)
• Opinion of the Court
• A person who trades in securities for personal
  profit, using confidential information
  misappropriated in breach of a fiduciary duty to
  the source of the information, is guilty of
  violating 10 (b) and Rule 10b-5

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• Comparison with US Law
• United States v. OHagan (US 1997)
• Opinion of the Court
• The misappropriation theory outlaws trading on
  the basis of non-public information by a
  corporate outsider in breach of a duty owed not
  to a trading party, but to the source fo the
  information (OHagan traded in breach of a duty
  of trust and confidence owed to his law firm and
  to its client)

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The Insider Dealing Prohibition

• Article 2(1)
• prohibition of trading
• intent is not required
• Article 3(a)
• prohibition of tipping
• also recommendations are forbidden

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The Insider Dealing Prohibition

• Article 4
• these prohibitions also apply to secondary
  insiders
• compare Dirks v. SEC
• impact on analysts inhibiting influence?

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The Insider Dealing Prohibition

• US Law Intent is required
• Ernst Ernst v. Hochfelder (US 1976)
• The 1934 Act was intended to protect investors
  against manipulation of stock prices
• The words manipulative or deceptive used in
  conjunction with device or contrivance strongly
  suggest that 10 (b) was intended to proscribe
  knowing or intentional misconduct

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Market Manipulation

• Types
• Transaction based manipulation
• (i) Transactions giving false or misleading
  signals as to the supply of, demand for or price
  of financial instruments (fictitious
  transactions)
• wash sales (no change in ownership of financial
  instruments)
• improper matched orders (entered into by
  colluding parties)

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• (ii) Transaction securing the price of one or
  several financial instruments at an abnormal or
  artificial level (market power manipulation)
• corner or squeeze (dominant position over the
  supply of or demand for a financial instrument)

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• Comparison with US Law
• US cases require to demonstrate
• an artificial price
• causality
• intent
• CFTC intent is the essence of manipulation
• Reference to intent distinguishes manipulation
  from legitimate market activity

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• the MAD does not require intent for market power
  manipulation
• could the mere accumulation of a large position
  be held as manipulative?
• could the accepted market practices defense be
  used?
• (iii) transactions which employ fictitious
  devices or any other form of deception or
  contrivance
• example trading at the end of the day (to affect
  the closing price)

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• Information-based manipulation
• Dissemination of information ... giving false or
  misleading signals as to financial instruments
• scalping (recommending a financial instrument
  after buying it)
• Special regime for journalists

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• Comparison with US Law
• the equivalent provision is section 10(b) of the
  1934 Act (see also SEC Rule 10b-5) making
  unlawful the use of any manipulative or
  deceptive device in contravention of Commission
  rules
• Ernst Ernst v. Hochfelder (US 1976)
• the SEC argued that the effect on investors is
  the same regardless of whether the conduct is
  negligent or intentional
• the Court argued that the words manipulative etc.
  make unmistakable a congressional intent to
  proscribe intentional or wilful conduct

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Preventive regulation

• Timely disclosure of inside information
• Art. 6(1) MAD
• corporate information
• Art. 2 Definitions Directive
• upon the coming into existence of a set of
  circumstances or the occurrence of an event,
  albeit not yet formalised

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• When is an event ripe for publication?
• Basic v. Levinson (US 1988)
• preliminary merger discussions can be material
• it is not necessary that an agreement-in
  principle has been reached
• Judge Friendlys approach adopted balancing the
  indicated probability of an event and the
  anticipated magnitude of the same

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Conclusions

• Insider Dealing
• US approach (R. Kraakman)
• Extended discussion of the concept of fraud
• Displacement of the equal access theory by the
  other two theories
• Assertions about the fairness or efficiency of
  informational disparities in the market

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Conclusions

• Insider Dealing
• US approach (R. Kraakman)
• Together, the fiduciary duty theory and the
  misappropriation theory reach most conduct that
  would be condemned under the equal access theory

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Conclusions

• Insider Dealing
• EU approach
• It is based on the equal access theory
• The scope of the insider dealing prohibition is
  potentially broader than in the US approach
• Financial analysts find a potentially narrower
  field of action in the EU approach

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Conclusions

• Market Manipulation
• US approach
• Reference to intent distinguishes market power
  manipulation from legitimate market activity
• Fictitious transactions are a form of fraud

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Conclusions

• Market Manipulation
• EU approach
• No reference to intent
• Unclear connection with fraud

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Conclusions

• Market Manipulation
• EU approach
• Questionable under the principle nullum crimen
  sine lege (Article 7 Human Rights Convention)
• Does the Directives definition lack specificity
  given that intent is the essence of market
  manipulation (CFTC approach in the US)?