Evgeny Zelensky and Natalya Dulichenko of Herbert Smith examine Russia’s new insider trading law and its implications for the country’s financial services industry.
One of the most long-awaited and controversial laws of the last decade, the Federal Law On Counteracting the Abuse of Inside Information and Market Manipulation and on the Amendment of Certain Legislative Acts of the Russian Federation No 224-FZ (the Insider Trading Law) was published on July 30 2010. The provisions relating to the development of internal procedures by insiders became effective on January 27 2011, but the bulk of the provisions will only become effective on July 30. Provisions relating to criminal liability for the illegal use of inside information will become effective on July 30 2013.
Because of significant resistance, nearly 10 years passed between the first introduction of a Bill on insider trading and the enactment of the Insider Trading Law. President Medvedev’s direct intervention in 2008 in support of a government plan to turn Moscow into an international financial centre was instrumental to the final passage of the Law in 2010. The adoption of the Insider Trading Law is another step in bringing Russian financial services legislation in line with that of the world’s main financial centres. It increases transparency in the Russian financial markets and aims to level the playing field for all market participants.
The Insider Trading Law creates a legal mechanism to combat abuse in the form of insider trading and market manipulation, and outlaws certain uses of inside information when trading in financial instruments, currencies and commodities that are admitted to trading on regulated markets in the Russian Federation or in respect of which an application for admission to trading on such markets has been made. The Insider Trading Law does not apply to operations of the Central Bank of Russia (CBR) relating to state monetary and credit policy or in support of the rouble exchange rate, or to the public debt management operations of state and municipal authorities.
It is not entirely clear how certain provisions of the Insider Trading Law will apply as they require the Federal Service for the Financial Markets (FSFM) and certain other regulatory bodies to issue a number of regulations that they have yet to develop. In addition, a number of provisions of the Insider Trading Law are vague and might be subject to varying interpretations by courts and state authorities.
The Insider Trading Law sets out an exhaustive list of persons considered to be insiders. Such persons can be divided into two categories: primary insiders - those in respect of which certain inside information exists (information about such persons, their activities and decisions is considered to be inside information); and secondary insiders - persons with access to inside information in relation to primary insiders. Primary insiders include:
- issuers of securities and investment managers of unit investment funds;
- persons occupying a dominant position in the market;
- stock exchanges, clearing organisations, depositaries and credit organisations that conduct settlement of transactions on stock exchanges; and
- professional participants in the securities markets (including brokers and asset managers that perform operations with securities admitted to trading on the organised securities market or in respect of which an application for admission to trading in such market has been submitted, or effect transactions in derivative financial instruments on behalf of clients on a stock exchange) and other persons.
Secondary insiders include:
- third persons that by way of a contractual agreement with a primary insider, have access to inside information in relation to the relevant primary insider; such persons include auditors, credit and insurance organisations, insurers and appraisers;
- shareholders that control 25% or more of the governingbody, such as the general shareholders’ meeting or a management company performing functions of the sole executive body, of any primary insider;
- shareholders with access to inside information about any primary insider pursuant to the constitutional documents or federal laws;
- persons with access to information about voluntary, mandatory or competing tender offers, including persons making such tender offers, credit organisations providing bank guarantees in connection with such tender offers and appraisers;
- press agencies that assist with disclosure in respect of any primary insider;
- rating agencies that issue ratings to any primary insider;
- members of the boards of directors, executive bodies, CEOs (including management companies performing functions of the sole executive body, managers and temporary CEOs) and internal audit committees of any secondary insider listed above or any primary insider;
- individuals with access to inside information belonging to any secondary insider listed above or any primary insider on the basis of employment or a contract;
- certain federal, regional and municipal agencies and authorities, which have the right under Russian law to make certain temporary financial investments (Governmental Investment Authorities) and the CBR; and
- heads and other employees of the Governmental Investment Authorities and employees of the CBR and the National Bank Council with access to insideinformation.
The Insider Trading Law does not specifically address circumstances where persons become insiders by inadvertently coming into possession of inside information. At the same time, the Insider Trading Law makes clear that any person in possession of inside information must keep it confidential unless it makes disclosure in compliance with the requirements of the Insider Trading Law.
Before enactment of the Insider Trading Law, Russian law did not recognise “inside information” and “insider trading” as legal concepts. Use of non-public information in securities transactions was prohibited only in respect of “work-related information” (sluzhebnaya informatsia) under the Federal Law On the Securities Market No 39- FZ dated April 22 1996 (the Securities Law).
Pursuant to the Insider Trading Law, inside information is defined as precise, concrete non-public information which, if publicly disclosed, may substantially influence the price of financial instruments, foreign currencies or commodities and which is of a type specified as such by the FSFM, the CBR and other public authorities. The Insider Trading Law requires the FSFM to enact regulations setting out an exhaustive list of items constituting inside information with respect to primary insiders, as well as rating and press agencies. Primary insiders, and rating and press agencies must approve and disclose on official websites their own lists of inside information, the scope of which may be broader than the categories of inside information that the FSFM is yet to approve.
The draft regulation on disclosure of inside information raises a number of practical issues. For example, it considers any information that the issuer files with a foreign stock exchange, as well as any information that may materially affect the value of securities, to be inside information. On this basis, the terms of placement, the price range, the issuer’s consolidated statements, appraisal reports, capex plans, development strategy and other nonpublic information routinely disclosed in analyst presentations, preliminary offering circulars and roadshow materials will qualify as inside information.
Since potential investors do not fall into any of the categories of persons to whom the Insider Trading Law permits disclosure of non-public price-sensitive information, disclosure of such information to potential investors would violate the Insider Trading Law and would disqualify them from purchasing the securities. The limitation on disclosure applies from the time of filing an application for admission of securities to trading (around two months before the offering) and until the time such information becomes public. It is not yet clear how this restriction will apply in practice as it may seriously jeopardise the preoffering marketing by Russian issuers.
The Insider Trading Law does not consider as inside information (i) information which has been disclosed to the public; (ii) research, forecasts, estimates and recommendations in respect of financial instruments, foreign currency and commodities; other types of recommendations prepared on the basis of publicly available information; and (iii) offers to enter into a transaction involving financial instruments, foreign currencies or commodities.
The FSFM will have to develop and approve the timetable and procedure for the disclosure of inside information by primary insiders and by rating and press agencies. The draft regulation on disclosure of inside information not only specifies the disclosure procedure but also contains a list of categories of inside information that legal entities in respect of which certain inside information exists do not need to disclose. In particular, the current draft exempts professional participants from an obligation to disclose inside information contained in client orders for the purchase and sale of securities.
The Insider Trading Law imposes obligations on legal entities in respect of which certain inside information exists, and persons with access to inside information of such entities. Legal entities (other than Governmental Investment Authorities and the CBR) must maintain a list of insiders. The content of this list depends on the category of an Insider. Secondary insiders’ lists should include members of their supervisory or management boards, CEOs, members of internal audit committees; and individuals that have access to inside information relating to such secondary insiders on the basis of labour contracts and other agreements. Primary insiders’ lists should in addition include information about rating and press agencies and any persons, legal entities and individuals that have access to inside information of such primary insiders on a contractual basis.
The FSFM has yet to clarify whether, in order to include a person in the insider list, such person should have actual access to inside information or a mere ability to obtain such information. If the FSFM takes the view that even the potential access to inside information will qualify employees as insiders, the company will have to include a number of employees in the list irrespective of whether they have actually received inside information and they will remain on the list permanently.
Persons on the insider lists of primary insiders (other than professional participants) and persons that have access to inside information relating to primary insiders on a contractual basis must notify the relevant primary insiders and the FSFM within 10 business days of certain transactions that they perform, depending on the nature of the transaction and the type of the entity in respect of which they are the insiders. The relevant FSFM regulation permits delivery of notification by e-mail in cases where electronic digital signature is available, as well as by other means so long as they allow for confirmation of delivery.
In addition to maintaining insider lists, the Insider Trading Law requires legal entities to notify their insiders of their inclusion in and removal from the insider lists within one business day. The FSFM has developed a standard form of notification that the legal entity must either deliver by hand or otherwise in a way that provides for confirmation of receipt. If a person on an insider list does not receive the notification, the legal entity must send the notification to the FSFM within five business days from the date it learned of the failure of the initial notification.
Legal entities compiling lists of inside information must submit their insider lists to any exchanges conducting operations with relevant financial instruments, foreign currency and commodities not later than on the trading day following the date of compiling the insider list.
Legal entities in respect of which certain inside information exists (other than Governmental Investment Authorities and the CBR) must attach to their insider lists written consents to the processing of personal data from the persons included in the list. If the filer fails to provide such consent in respect of any person, the exchange may refuse to accept the insider list altogether. This may lead to sanctions against the filer even if it made every effort to obtain the consent of a relevant person but that person refused to grant it. Legal entities (other than Governmental Investment Authorities and the CBR) must also submit their insider lists to the FSFM, but only upon its request.
Finally, legal entities in respect of which certain inside information exists (other than Governmental Investment Authorities and the CBR) must develop and approve procedures for granting access to inside information; for maintaining the confidentiality of inside information; and for monitoring compliance with the Insider Trading Law. For this purpose they need to set up a compliance department or appoint a compliance officer. There are no qualification requirements in respect of such officer.
To streamline reporting processes, investment banks and other financial institutions frequently centralise control room functions within one entity of the group, and that entity is responsible for the control of information exchange within the group. Although the Insider Trading Law imposes reporting and certain other obligations on the subject entities, it is believed that, in the absence of express prohibition, it should be possible to contract third parties to perform these functions on behalf of such entities. Primary responsibility for complying with these obligations will, however, remain with the subject entities.
Use of inside information
The Insider Trading Law prohibits: (i) the use of inside information for the purpose of carrying out transactions with financial instruments, currencies and/or commodities for one’s own or another person’s account, except when the party entered into the transaction before the receipt of the inside information; (ii) the use of inside information for the purpose of giving recommendations to third parties, obliging or inducing third parties to purchase or to sell financial instruments, foreign currencies and/or commodities; and (iii) disclosing inside information to third parties, other than to a person on the insider list, in connection with performing obligations under federal laws, or in connection with performing employment duties or contractual obligations.
The Insider Trading Law does not recognise the concept of information barriers, or Chinese walls, to limit information exchange within an organisation. This raises serious problems in respect of information exchange within legal entities, particularly, financial institutions that may provide financing, investment banking and other services to publiclytraded companies and, at the same time, engage in trading for their own account, whether for profit, hedging or as part of their treasury operations. Accordingly, if one department of a financial institution comes into possession of inside information about a publicly-traded company, and another department of the same institution independently enters into a trade in respect of the securities of such company, such institution will breach the Insider Trading Law.
The Insider Trading Law permits the transfer of inside information on the basis of contractual arrangements. It does not, however, specify what type of contract provides the basis for the disclosing party to transfer inside information, nor does it contain specific requirements regarding the form or terms of appropriate non-disclosure agreements. Common sense dictates that the contract should either have confidentiality provisions or be a non-disclosure agreement.
It is not clear whether the requirements of the Law apply to foreign companies that gain access to inside information directly from the primary insider. Informally, FSFM officials have confirmed that the Insider Trading Law applies to foreign companies to the extent that such foreign companies fall under the definition of Insider and engage into legal relations in the Russian Federation.
There is no clear guidance, for the purposes of the Insider Trading Law, as to what constitutes an engagement by a foreign company into legal relations in Russia. In the authors’ view, the FSFM will consider whether such foreign company carries out any activities which are restricted pursuant to the general prohibition under the Insider Trading Law on the use of inside information. The scope of the FSFM’s interpretation, however, remains vague and the interpretation itself is non-binding.
The Insider Trading Law replaces the concept of “price manipulation” previously found in the Securities Law with “market manipulation”, which it defines as actions resulting in the price, supply, demand or volume of trading in the relevant financial instruments deviating substantially from what it would have been had such actions not been taken. Among others, market manipulation activities include wilful distribution of information known to be false through publicly available sources; entering into a transaction involving financial instruments, currencies or commodities where the parties to the transaction have a pre-existing agreement to undertake such transaction and which results in a change in the market price in relation to such financial instruments, currencies or commodities which would not have occurred in the absence of such transaction; entering into transactions where the ultimate beneficiary on both sides of the transaction is the same person; and submitting buy and sell orders for or on behalf of the same person where the price of the buy order is equal to or greater than the price of the sell order.
The actions described above do not constitute market manipulation if their goal is to:
- support the price of securities in connection with a placement by a market maker acting pursuant to an agreement with the issuer;
- support the price of shares through a company buyback or the redemption of closed unit investment funds, where allowed under applicable Russian legislation; or
- support the price, supply, demand or volume of trading of financial instruments, currencies or commodities by a market maker acting pursuant to an agreement with the exchange.
Pursuant to the Insider Trading Law, any person who illegally uses inside information or manipulates the market may be subject to civil, administrative and/or criminal liability. However, persons are not liable for misuse of inside information or market manipulation if they do not know, or could not have known, that they are using inside information or disseminating misleading information.
The Insider Trading Law sets out special provisions regarding use of inside information by professional market participants and mass media. In particular, professional market participants and other entities are not liable for transactions that they execute upon instructions of third parties. However, third parties giving instructions to act in breach of the Insider Trading Law would incur liability. Mass media are not subject to liability for the dissemination of misleading information if such information is a literal reproduction of an interview or other comments of third parties or a literal reproduction of information published by other mass media.
Civil liability: All persons who suffer damage as a result of unlawful use of inside information or market manipulation may seek to recover damages from the person in breach. However, the fact that a transaction has involved the unlawful use of inside information or market manipulation does not constitute grounds for invalidating the relevant transaction.
Administrative liability: This is imposed only if no criminal liability arises. The primary means of determining whether administrative or criminal liability applies is the size of losses of the injured party resulting from the illegal use of inside information or market manipulation. If losses exceed RUR2.5 million (about $83,000), criminal liability will attach.
The Insider Trading Law amends the Administrative Code to create the three new administrative offences of unlawful use of inside information, market manipulation and breach of legislation on the use of inside information and market manipulation. These administrative offences may result in fines, the level of which depends on whether an individual, officer or legal entity has committed them. In addition, the court may require the disgorgement of profits received or levy the amount of losses avoided as a result of the unlawful use of inside information or the market manipulation.
Professional market participants, credit organisations and other regulated entities holding licences to carry out activities on the securities markets may face suspension or revocation of their licences if their employees participate in market manipulation or transactions using inside information. To avoid such sanctions relevant entities need to demonstrate that they have taken all necessary steps to prevent breaches of the Insider Trading Law.
Criminal liability: With effect from July 30 2013, the Insider Trading Law amends the Criminal Code to create two new criminal offences: market manipulation and unlawful use of inside information. In either case, criminal liability ensues only in cases of wilful and deliberate action.
Penalties vary depending on the magnitude of the crime and include fines, disgorgement of income, or imprisonment with or without loss of the right to hold certain offices or to conduct certain activities.