In this issue for Summer 2016 we cover recent developments in legislation and the approach of regulators to the enforcement of market abuse in Asia, Europe and the US.

Asia: Hong Kong

Hong Kong court interprets territorial scope broadly

In January 2016, the Court of First Instance handed down a landmark ruling that extends the territorial reach of Hong Kong securities law beyond insider dealing of Hong Kong listed securities (SFC v Young Bik Fung and others, HCMP 2575/2010). Insider dealing of overseas listed securities in Hong Kong may now be pursued through section 300 of the Securities and Futures Ordinance (SFO) so long as the fraudulent or deceptive conduct took place in Hong Kong.

The court found that two solicitors and the sisters of one of them contravened the SFO by insider dealing in the shares of a Hong Kong listed company and a Taiwan listed company. In both cases, the solicitors received material non-public information through their work and traded and/or tipped off other people, who traded in related shares and profited from those trades.

The Securities and Futures Commission (SFC) based its case for insider trading on shares in the Hong Kong-listed company on the insider dealing provisions of the SFO. Those provisions are only applicable to securities that are listed in Hong Kong or dual listed in Hong Kong and an overseas market.

In contrast, for the insider trading in the shares of the Taiwan-listed company, The SFC used section 300 SFO, which is drafted broadly to prohibit the use of fraudulent or deceptive schemes in transactions involving any securities (rather than insider dealing specifically). The court confirmed that section 300 can apply to dealings in overseas listed securities so long as the fraudulent conduct in question took place in Hong Kong.

SFC takes action using 2013 disclosure regime

In July 2015, the Hong Kong SFC commenced proceedings in the Market Misconduct Tribunal (MMT) against AcrossAsia Limited (AcrossAsia), a company listed on the Growth Enterprise Market for growth companies, its Chairman and CEO for late disclosure of highly sensitive inside information. The company failed to disclose insolvency-related proceedings in Indonesia against Across Asia for failure to pay money to its subsidiary. This is the first case taken by the SFC against a listed company and its directors for breach of the statutory disclosure regime introduced on 1 January 2013.

The SFC has indicated a focus on listed company disclosure and this could mark a new trend in cases. In March and April 2016, the SFC commenced two further actions against Hong Kong listed companies and directors under the statutory disclosure regime. The substantive hearings in the first two cases are scheduled towards the end of 2016.

Asia: Japan

  • trading based on an agreement or plan made before receiving the non public material information; and 
  • a counter bid made in response to a request by a target company’s board.

The new rules clarify what is understood to be legal under the existing rules rather than creating new exemptions. The new rules came into force in September 2015.

Asia: People’s Republic of China

China’s top fund manager arrested in insider probe

Xu Xiang, a prominent investor and the general manager of China’s biggest stock brokerage was detained on suspicion of insider trading and market manipulation in November 2015, and then formally arrested in April 2016.[1].

Xu ran Zexi Investment from Shanghai and was known as China’s Warren Buffett. He served an elite clientele and made more than a 300 per cent gain despite China’s stock market turmoil in 2015.

  • A number of Xu-related listed companies released announcements about receiving freezing orders from the Police[2], reflecting the ongoing in-depth investigation about Xu.

This is part of a broader campaign to crack down on stock-market manipulation and insider trading. According to the CSRC’s annual report released on 15 January 2016, the CSRC investigated 334 cases in 2015, which is a 54 per cent increase on the previous year.[3]

Europe: EU development

Market Abuse Regulation takes effect

A development affecting all of the EU jurisdictions is the coming into effect of the EU Regulation 596/2014 on insider dealing and market manipulation (the Market Abuse Regulation or MAR) on 3 July. MAR broadens the scope of the European civil market abuse regime to cover a wider range of financial instruments and trading venues, introduces procedures for market soundings and introduces a minimum set Of investigatory and sanctioning powers for national regulators.

Many items in the Europe section below relate to MAR or implementation of the related EU Directive no. 2014/57 on criminal sanctions (CSMAD). We have described the key features of MAR and CSMAD in more detail in previous issues of this newsletter (See Autumn 2013 and Winter 2013), so will not repeat that in this issue.

Europe: France

Reform of French sanctioning regime continues

In addition to the changes introduced by the Market Abuse Regulation (MAR), the French Constitutional Court decision No. 2015-462 of 18 March 2015 has prompted other changes to the administrative and criminal sanctioning regime in France for market abuse.

In its decision of 18 March 2015, the French Constitutional Court held that the sanctions regime providing for both administrative and criminal prosecution for the same insider dealing infringement by the same person was not compliant with French constitutional principles – in particular the non bis in idem principle. And the court decided that the legislative provisions that allow both administrative and criminal proceedings will be revoked by September 2016.

The French Senate approved new legislative provisions on 8 June 2016, which will enter into force in coming weeks. The new provisions govern the dialogue between the Public Prosecutor and the French Financial Markets Authority, the Autorité des Marchés Financiers (AMF), to avoid these authorities initiating both administrative and criminal prosecutions. If these two authorities disagree, the final decision to refer the case to the Public Prosecutor or to the AMF will be taken by the General Public Prosecutor at the Paris Court of Appeal (Procureur général près la Cour d’appel de Paris).

The reform also aims to transpose the EU Directive No. 2014/57/EU on criminal sanctions (CSMAD) by including provisions that increase maximum criminal sanctions imposed on individuals to five years’ imprisonment (from two years) and €100 million or ten times the profits made.

The reform also allows those accused of market abuse to enter into an administrative settlement with the AMF.

Another proposed reform is under discussion, which is expected to reinforce the powers of the AMF and, in particular, increase administrative sanctions that can be imposed on corporates to 15 per cent of total annual turnover.

Europe: Germany

Implementation of MAR and CSMAD in Germany

The Market Abuse Regulation (MAR) is directly applicable to all Eu member states. However, some rules concerning the supervisory and sanctioning powers of the Federal Financial Supervisory Authority (BaFin) and all provisions for criminal offences (based on Directive 2014/57/EU on criminal sanctions regarding market abuse (CSMAD)) were transposed into national law. This transition has been facilitated by amendments to the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG). The amended WpHG rules also apply from 3 July 2016.

There are two other changes to German law:

  • the new European market abuse laws apply to the Open Market segment of the Frankfurt Stock Exchange (Freiverkehr) and
  • the amended WpHG significantly increases administrative fines and criminal penalties for market abuse.

German market abuse law is extended to the Open Market

Until 3 July 2016, the Open Market segment of the Frankfurt Stock Exchange (Freiverkehr) was only partially governed by German market abuse laws, prohibiting insider trading and market manipulation.

This changed on 3 July 2016 in relation to reporting and transmission requirements, for example for inside information, insider lists and transactions by persons discharging managerial responsibility. From 3 July these requirements apply to issuers whose financial instruments are traded in the Open Market segment of the Frankfurt Stock Exchange (Freiverkehr) alone, if the financial instruments are admitted to trading on or included in the Open Market or an application has been made.

Criminal and administrative penalties increase under German law

Administrative fines imposed under the WpHG will significantly increase from 3 July 2016, when the WpHG is amended to transpose CSMAD into German law.

Not only primary insiders but also secondary insiders will now be subject to criminal penalties for all forms of insider trading, and attempted (as well as actual) market manipulation will also be a criminal offence.

This table provides an overview of the changes.

WpHG (currently in force)

Administrative Fines

Criminal Sanctions

MAR / WpHG 3 July 2016

CRIM-MAD

Legal Person

Natural Person

WpHG 3 July 2016

Insiderdealing

Up to EUR 200.000 imprisonment of up to 5 years2

Up to the higher of EUR15million and 15per cent of the total turnover[4]

Up to EUR5million

Imprisonment of up to 4years or fine

Imprisonment up to 5years or fine[5]

Unlawful disclosure of Inside Information  

Up to EUR200.000 Imprisonment of up to 5years

Up to the higher of EUR15million and 15per cent of the total turnover1

Up to EUR5million

Imprisonment of up to 2years or fine

Imprisonment of up to 5years or fine2

Market Manipulation

Up to EUR1million Imprisonment of up to 5years

Up to the higher of EUR15million and 15per cent of the total annual turnover1

Up to EUR5million

Imprisonment of up to 4years or fine 2

Imprisonment of up to 5years or fine 2 In qualified cases imprisonment of not less than 1year and up to 10years

Failure to publicly disclose Inside Information

Up to EUR1million

Up to the higher of EUR2.5million and 2per cent of the total annual turnover1

Up to EUR1million

Breach of insider list requirements

Up to EUR50.000

Up to EUR1million

Up to EUR500.000

Breach of Directors’ Dealings requirements

Up to EUR100.000

Up to EUR1 million

Up to EUR500.000

In addition, those committing market abuse face administrative penalties of up to three times the economic benefit (an estimate of gains realised and losses avoided).

Europe: Italy

Italian court avoids decision on double jeopardy

At a hearing on 8 March 2016, the Italian Constitutional Court was asked to consider whether sanctioning a person twice under the civil and criminal market abuse regimes for the same conduct was unconstitutional in the light of double jeopardy principles. The court gave judgment on 16 May 2016 declaring the claims inadmissible without ruling on the double jeopardy issue (judgment No. 102).

Europe: Spain

Changes needed to Spanish Criminal Code to implement CSMAD

The use or supply of inside information by people who are in a position to access this information is penalized both by administrative proceedings and as a criminal offence under Article 285 of the Spanish Criminal Code. Although there is abundant academic literature on the offences, Spanish court rulings on these provisions are scarce and therefore, many questions of interpretation of the offences remain unresolved.

In a recent decision interpreting part of the Criminal Code, a Madrid Criminal Court has condemned a former director of a company for avoiding a loss of millions in the Spanish stock market due to insider information in a case where the judge equated “benefit” with “loss avoided”. The insider, due to his position as director of the company Cartera Hotelera, knew that this company was about to sell shares of Occidental Hoteles at half the price they were trading. To avoid losses from the drop in the share price, the insider resigned from his position as director of Cartera Hotelera and sold his stake in Occidental Hoteles immediately before the transaction was announced publicly.

The Spanish legislator has an opportunity to address uncertainties in the criminal offences for insider trading whilst implementing  Directive 2014/57/EU on criminal sanctions for market abuse (CSMAD). The current criminal offencemay be contrary to the wording and spirit of CSMAD. . For instance, Article 285 as it has been construed by the Spanish Supreme Court (in Case San Jose / Eurohypo, 23 July 2015) does not encompass an attempt to commit market abuse whereas CSMAD expressly provides for this. Also, Article 285 includes a minimum profit/loss threshold of EUR 600,000 for conduct to trigger prosecution for a criminal offence,  whereas CSMAD does not.

Although implementing CSMAD will be an opportunity to update the Spanish Criminal Code as regards insider trading offences, this may only occur after Autumn 2016, when a new Spanish Government is in place following an election.

Europe: United Kingdom

Changes to UK regulatory materials for MAR coming into effect

Sections 118-122 of the Financial Services and Markets Act 2000, which contained the UK’s civil market abuse offences, were repealed on 3 July 2016 when replaced by MAR. In addition, the FCA’s Code of Market Conduct, which contained guidance and examples of what might and might not be regarded as market abuse and a formal safe harbour, is removed for the most part. In place of this code, the FCA now has guidance referred to as “MAR1” in the FCA handbook, which signposts provisions in MAR and contains only limited guidance. The guidance issued by the European Securities and Markets Authority (ESMA) is also more limited than under the FCA’s old Code of Market Conduct. Therefore, unless ESMA issues more guidance to fill the void,  there will be more uncertainty about the interpretation of the civil market abuse offences than in the past.

Currently, it is unclear what impact there will be on the UK market abuse regime if and when the UK leaves the EU. 

UK market abuse enforcement

The FCA continues to use the civil and criminal market abuse regimes to bring enforcement action for market abuse. Although many enforcement actions, particularly under the criminal regime, concern straightforward trading on inside information, the FCA stated that it wants to focus its efforts on market professionals and more sophisticated conspiracies. A recent success for the FCA is the conviction of five individuals for an insider dealing conspiracy[6]. The conspirators traded on inside information on a number of corporate acquisitions over a period of about four years. They used encrypted means of communications, cash payments and safety deposit boxes to conceal their activity. Evidence was obtained using covert surveillance techniques in the course of the joint investigation by the FCA and the UK’s National Crime Agency. Martin Dodgson, a senior trader at three investment banks during the period and the source of the inside information, received a sentence of four years and six months, which is the highest sentence to date in an FCA insider dealing prosecution.

Following the introduction of the Senior Managers and certification regime in March 2016, enforcement action against senior individuals is anticipated to remain a priority for the FCA.  MiFiD II (which is due to come into force in January 2017) may also lead to a rise in enforcement action for misconduct in the context of high frequency trading and dark pools, which will be the subject of new rules. In contrast to other jurisdictions (most notably France and the US) ,we have to date seen little FCA action in these areas since they were raised as an FCA focus in 2015.

Also, MAR extends the market abuse regime to a wider range of trading venues, which may lead to more enforcement activity relating to conduct on those trading venues where more work may be needed to raise standards of conduct.

Americas:  United States

US  Supreme Court to review potential landmark insider trading case

In January 2016, the US Supreme Court agreed to hear a case that may have a long-reaching impact on insider trading prosecutions and how market participants are able to share and discuss material nonpublic information about companies.

The case arises from a July 2015 lower appellate court decision, Salman v. United States, that affirmed the conviction of an insider trader defendant who had traded based on stock tips that he had received[7].  The court held that these tips, intended, in the first instance, “as a gift of market-sensitive information” from one brother to another, was sufficient to establish the “personal benefit” required by law to prove insider trading, even in the abscence of an actual pecuniary gain.

Back in December 2014, a separate appellate court, in United States v. Newman, established a much higher threshold for the government[8].  That court held that prosecutors need to prove that a “tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit.”  The court further ruled that, “[t]o the extent . . . that a personal benefit may be inferred from a personal relationship between the tipper and tippee . . . such an inference is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”

Since Newman, lower courts have vacated several convictions, following a long string of government successes; the US Department of Justice has also withdrawn from certain prosecutions as a result of Newman.  For traders and market analysts who receive company information from indirect sources, the conflicting approaches taken by the lower appellate courts has created uncertainty regarding the diligence firms must undertake when learning nonpublic news about a company .  This uncertainty is likely to continue for some time:  Salman will not be argued until the Supreme Court’s next term, which begins in October 2016.

Market abuse continues to be  a US enforcement focus

Insider trading and market manipulation remain a focus of US regulators.  The Financial Industry Regulatory Authority, for example, started to issue traders and brokers with report cards in April 2016 to help them identify manipulative practices.  Multiple US regulators continue to investigate potential US Treasury market manipulation, with multiple private lawsuits consolidated in the Southern District of New York.  And, finally, in early 2016, two major financial institutions agreed to settle separate actions, brought in parallel by the United States Securities and Exchange Commission and the New York State Office of the Attorney General, regarding alleged misrepresentations and violations made in connection with the banks’ respective alternative trading systems, including dark pools .  In respect of these cases, New York Attorney General Eric Schneiderman stated that “[t]hese cases mark the first major victory in the fight to combat fraud in dark pool trading and bring meaningful reforms to protect investors from predatory, high-frequency traders.”[9]