The following provides an outline of some of the key issues arising out the Financial Services Authority's draft Code on Market Abuse (FSA Consultation Paper 10). The draft Code has important implications for the existing UK criminal and civil regime in relation to market abuse and insider dealing. Responses to the consultation paper should be sent to the FSA by 6 November 1998.
Although the draft Code is likely to go through a number of further drafts, it will be important to stay abreast of the proposed changes, not least so as to provide input into the consultation process. The draft Financial Services and Markets Bill which sets out the new UK statutory framework for the regulation of investment, banking and insurance business has also now been published for consultation. Norton Rose will be providing an outline of, and comments on, the Bill in the near future.
There are three principal aspects to the proposed new markets abuse regime. Firstly, there will be a dramatic extension to the existing (largely criminal) law in relation to market abuse and insider dealing through the introduction of new civil powers (including the power to impose unlimited fines on regulated and unregulated persons). Secondly, the new civil regime as currently drafted does not follow the scope and definitions of the existing criminal law. This could give rise to significant complications, particularly in respect of insider dealing and the operation of Chinese Walls. Thirdly, in terms of market abuse more generally, there are also significant concerns as to the scope of the Code.
THE FSA'S NEW POWERS
The Code will operate within the context of the FSA's new civil powers, and will include:
- the power to impose unlimited fines on any person, regulated or not, who engages in market abuse;
- the power to require persons to answer questions and produce documents; and
- powers to order disgorgement of profits, compensation to identifiable victims and payment of the FSA's investigation costs.
A new financial services appeals tribunal will consider appeals against the FSA's exercise of these powers. The tribunal will be managed as part of the Court service and it is hoped that it will include a significant number of market practitioners (appointments are to be made by the Lord Chancellor). The FSA will also have powers to bring criminal prosecutions in respect of insider dealing (under Part V of the Criminal Justice Act 1993), market manipulation (currently under section 47 of the Financial Services Act 1986) and money laundering.
Many of the procedural and individual protections under the new system remain unclear (even following publication of the draft Bill). The FSA will, however, need to comply with natural justice principles and the European Convention on Human Rights. Outstanding issues include whether there will be a right to silence (probably not) or a right to a hearing before a determination has been made. The draft bill appears to envisage that the right to make representations will not include a right to a hearing, except where an appeal is made to the FSA tribunal.
It is likely that the new FSA will bear more than a passing resemblance to the US Securities and Exchange Commission, although no suggestions have (yet?) been made for a move to formalised plea bargaining.
DRAFT CODE OF MARKET CONDUCT
The Code will provide evidential weight of a breach of the new statutory provisions. It is likely to cover abuse, on or off-market, which affects investments traded on Recognised Investment Exchanges (such as the LSE, the LME and LIFFE).
In relation to insider dealing, the draft Code differs significantly from the existing criminal law, and it may result in changes to existing Chinese Walls and personal dealings rules. The Code will also give new prominence to matters partly covered by existing law on market abuse, such as section 47 of the FSAct, where few actions have been brought to date.
There will still be overlap with other prosecuting authorities such as the DTI and the Serious Fraud Office. However, of more immediate concern is the continuing overlap between matters covered by the Code and the rules of the RIEs and the Takeover Panel. For example, it is not clear if there will be a specific 'safe haven' for all matters covered by the Takeover Code. It does appear that actions under existing stabilisation rules will not be affected.
The Code divides market abuse into market manipulation and the misuse of privileged information. The detail of these provisions can be found in the FSA's consultation paper, and the following provides an outline of some of the issues.
MARKET MANIPULATION
Market manipulation under the Code covers artificial transactions, price manipulation and dissemination of misleading information.
Artificial transactions are abusive where they mislead others, for example, in the case of wash trades (where genuine trading appears to be taking place but is not) or share support operations. The prohibition is on entering into transactions that would 'reasonably appear' to other market users to involve a genuine change in a party's interests or to have been effected under a market mechanism providing for price competition when that is not in fact the case. Our concerns in this area relate to how this provision will affect legitimate share support operations (such as fending off a hostile takeover, where target shareholders who support the existing management may buy shares in addition to their existing shareholdings). Nor does it appear that the person carrying out the operations should have intended to mislead other market users.
Price manipulation is divided into abusive squeezes and demand side manipulation. Abusive squeezes occur where a person has significant influence over supply and uses this in conjunction with an on-exchange position to force other market users to settle at 'arbitrary and abnormal prices'. The prohibition is intended to cover both the commodities and securities markets, but the Code only provides examples in the commodities area. It does not explain its effect in the securities markets, and this clearly needs to be remedied.
Demand side manipulation occurs when a person enters into a transaction or series of transactions the principal purpose of which would reasonably be regarded as positioning market price at an 'arbitrary or abnormal' level. The provision is intended to prohibit the 'stage management' of prices. It acknowledges that many market users will price products or funds from an exchange's closing price, and will try to move the price accordingly, but it does not clarify when such actions will be legitimate. If dealing for the purposes of moving prices (other than under the stabilisation rules) will be in breach, then this could have a significant impact on market practice.
The Code also introduces new requirements in relation to the dissemination of information. It requires that a person responsible for the submission or dissemination of 'relevant information' (any information which market users would reasonably regard as significant when determining whether to deal) should take reasonable care to ensure the accuracy of the material, if that person has a 'material interest' in the investment. The obligation is likely to cover journalists and other PR individuals, but only where they have a material interest.
MISUSE OF PRIVILEGED INFORMATION
The other key aspect of the Code is in relation to the misuse of privileged information, which broadly covers the same area as the existing criminal law on insider dealing, with some significant extensions. The current draft follows different definitions to the existing criminal law. This is likely to give rise to compliance problems in relation to Chinese Walls and generally in terms of setting up appropriate internal compliance mechanisms.
The Code states that a person with 'privileged possession' of 'relevant information' that is 'disclosable information' should not deal in any investment to which the information is relevant or do any act or engage in conduct likely to encourage any other person to deal.
The prohibition extends beyond information which is price-sensitive (as under the existing criminal law) to other information which may affect a decision to deal. Although the consultation paper states that it is not intended to extend existing disclosure obligations, this remains unclear as the definition of disclosable information also covers impending developments and negotiations which, if they came to fruition, would be required to be disseminated. Given that companies and their advisors are often (in some cases, almost continuously) involved in discussions the majority of which may come to nothing, we are concerned that the current wording could seriously inhibit the carrying on of dealings.
The following defences are provided under the Code. These relate to:
- Takeovers - where an offeror buys an equity stake in a company which is the subject of a takeover bid. What is not clear, however, is the extent to which compliance with the Takeover Code will provide a safe haven from allegations of breaches of the Code on Market Abuse. Takeover bids could also be seriously impeded if allegations of a breach of the Code on Market Abuse are used to obstruct the outcome of a takeover bid.
- Where the person can demonstrate that the information did not in any way influence him in determining whether to deal. The Code, in our view needlessly, follows more restrictive wording than under the existing provisions of Part V of the Criminal Justice Act 1993.
- Order flow information, namely information concerning an intention to deal or details of trades that have taken place. The paper identifies three possible treatments for the use of such information, all of which differ from the current market information defence under the CJA 1993. Aside from the complications of the overlap with the existing criminal defence, two of the possible models (models B and C) would have significant implications for Chinese Walls and in our view could prove unworkable.
CHINESE WALLS
The Code provides that where Chinese Walls are in place the firm will be presumed not to be in possession of relevant information if it can demonstrate that the information was not in the possession of relevant personnel, and that at all material time effective Chinese Walls arrangements were in place. This could give rise to serious difficulties for firms - as currently drafted, the firm will be required to prove a negative (namely that the information was not in the possession of relevant personnel), otherwise they will be presumed to have been in possession of relevant information.
This note is intended to provide general information about some recent and anticipated developments which may be of interest. It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.
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