In this issue for Summer 2017 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 Market Misconduct Tribunal ruling provides guidance on section 277
On 10 April 2017, the Hong Kong Market Misconduct Tribunal (MMT) handed down its decision on section 277 of the Securities and Futures Ordinance (SFO) in the context of a listed company announcement. Section 277 prohibits the disclosure of false or misleading information which induces securities or futures transactions. This is also the first case decided by the MMT on the meaning of the term “no material adverse change”, which Chapter 14A of the Listing Rules usually requires in circulars about connected transactions.
On 12 September 2008, CITIC Limited (CITIC, formerly, CITIC Pacific) published a circular relating to a disclosable and connected transaction. The circular included a “no material adverse change” statement, as follows: “Save as disclosed in this Circular, the directors are not aware of any material adverse change in the financial or trading position of the Group since 31 December 2007…”. Before the publication of this circular, it appeared that CITIC had become aware of a significant mark-to-market loss arising from various derivatives contracts into which CITIC had entered (that loss was approximately HK$14.7 billion as at October 2008). On 20 October 2008, CITIC published a Profit Warning Announcement. The announcement suggested that CITIC was aware of the exposure on 7 September 2008.
In other words, it appeared that CITIC was aware of the significant mark-to-market loss when it published the “no material adverse change” statement on 12 September 2008. The Securities and Futures Commission (SFC) referred the matter to the MMT, to determine whether there had been market misconduct under section 277 of the SFO. The implicated parties were CITIC and five of its former directors.
The MMT found that there had not been market misconduct under section 277 of the SFO. It analysed the facts of the case and section 277 as follows:
- Disclosure - There was no dispute that CITIC Limited had disclosed information through its circular and subsequent announcement.
- Market effect - Was the relevant information likely to induce dealing in securities or to maintain, increase, reduce or stabilize the price of securities in Hong Kong? The MMT held that this test is predictive; the question was whether it was probable that the information would have caused the necessary effect on CITIC’s share price. On the facts, the MMT concluded that there was no evidence that the “no material adverse change” statement caused the necessary effect on CITIC Limited’s share price.
- Was the information false or misleading? - For a material adverse change to be demonstrated, the change must be of deep significance to the company’s existing financial position, which undermines its financial integrity, and which is enduring. Material adverse change was to be determined objectively looking at financial and other information. The MMT emphasised that material adverse change, as a concept, is different from that of “price sensitive information” (which is to be determined from the perspective of the reasonable investor). On the facts, the MMT found that there was insufficient evidence of an actual material adverse change in CITIC’s financial position (the mark-to-market losses had not been realised yet).
- Knowledge and fault - Did CITIC and its five directors know, or were they reckless or negligent as to whether, the relevant information was false or misleading? Having found that the second and third elements had not been proved, the MMT did not make a ruling on this point.
Asia: People's Republic of China
China’s securities regulator has yet again broken records for fines for securities violations. This demonstrates ongoing, strict enforcement efforts against insider trading, information misreporting and other irregularities.
In the first five months of this year, the China Securities Regulatory Commission (CSRC) has levied RMB6.14 billion (US$901 million) of fines on rule violators. The fines up to May 2017 are already about 1.5 times those levied during 2016.
These included a RMB3.5 billion (US$500 million) fine on Xian Yan, the chairman of P2P Financial Information Service Co, in February 2017 for market manipulation. This fine is reportedly the largest administrative fine ever levied in China. In addition, Mr Xian will also be banned for life from trading on the Chinese securities market.
Austrian regulator's annual report shows active investigation of market abuse cases
In Austria, there are civil and criminal sanctions for market abuse. The Financial Market Authority (Finanzmarktaufsicht, FMA) investigates suspected market abuse and can impose a civil/administrative sanction. The FMA is obliged to report a suspected market abuse case to the Central Public Prosecutor for Economic Crime and Corruption (Wirtschafts- und Korruptionsstaatsanwaltschaft) if the FMA believes that the conduct constitutes a criminal offence. In the context of market abuse, the trading rules of the Vienna Stock Exchange also play a critical role to prevent market abuse and to identify breaches.
The FMA’s annual report for 2016/17 shows the FMA actively investigating potential market abuse cases. Specifically, the FMA:
- Carried out 1,192 routine analyses and reviews;
- initiated 92 investigations;
- completed or withdrew 86 investigations; and
- forwarded 4 reports to the Central Public Prosecutor for Economic Crime and Corruption.
Austria has introduced criminal sanctions for misuse of inside information and market manipulation
An insider who intentionally uses inside information is subject to imprisonment for a maximum of five years, if the transaction volume exceeds EUR 1 million. Recommendations involving inside information are also subject to imprisonment for up to five years. The unlawful disclosure of inside information is punishable by a maximum imprisonment of two years.
In 2016, 26 investigations involving inside information were initiated and 15 were completed. In four cases the FMA submitted a report to the Central Public Prosecutor for Economic Crime and Corruption concerning the alleged misuse of inside information (ie insider dealing and/or unlawful disclosure of inside information).
Market manipulation involving a transaction value exceeding EUR 1 million constitutes a criminal offence with a maximum sentence of five years in prison. In 2016, 66 investigations related to market manipulation were initiated and 71 were completed by FMA. An administrative penalty of EUR 5,000 was imposed in nine cases.
Footnotes:  The annual report 2016 is at https://www.fma.gv.at/en/publications/fma-annual-report/
Longer limitation period for Market Abuse Offenses
Act no. 2017-242 of 27 February 2017 (the Act) introduces longer limitation periods for criminal offenses, including criminal offences of insider trading, price manipulation and dissemination of misleading information. The limitation period for these offences has doubled from three to six years with immediate effect, including for offenses committed before the Act entered into force, provided that they are not yet time-barred. In contrast to the prosecution of criminal offences, this longer limitation period does not apply to regulatory misdemeanours enforced by the French Financial Market Authority (AMF), which are still subject to a three year limitation period.
In addition, the starting point of the limitation period remains either the date of the commission of the offense or the date of its discovery, for concealed offenses. Regarding the latter, the Act provides that the prosecution action cannot be commenced more than twelve years after the commission of the offense.
French market authority considers scope of inside information legislation
On 29 May 2017, the AMF issued a decision with regard to the scope of the use of inside information. The Enforcement Committee of the AMF sanctioned a financial analyst for a breach of professional duties but not for the misuse of inside information, though the analyst used financial analysis reports to trade on the market before the reports were public. The Enforcement Committee decided that the financial analysis reports did not meet the three conditions for inside information in Article 621-1 of the AMF General Regulation (ie (i) the information is precise; (ii) the information is non-public; and, (iii) the information might have a significant influence on the market) because it considered that a reasonable investor would not use the reports on which the recommendations were based in making his investment decision.
Subjects of AMF sanctions have the right to request anonymity
Legislation number 2016-1691 (the Sapin II Act), which came into force on 11 December 2016, amends article L. 621-15 of the French Monetary and Financial Code in relation to the disclosure of AMF sanctions. Accordingly, subjects of AMF sanctions can ask for sanction notices to be anonymised five years after the sanction is imposed, regardless of the nature of the misconduct.
Increase in number of BaFin investigations
The German Federal Financial Supervisory Authority (BaFin) is increasingly investigating cases of market manipulation and suspected insider trading. According to its annual report for 2016, BaFin analysed 706 cases in 2016, compared to 570 cases in 2015. There were 42 formal investigations of potential insider trading and 272 of market manipulation. BaFin filed 127 reports with the prosecuting authorities (21 on insider trading and 106 on market manipulation). Despite the increased investigations, so far there have only been a small number of court convictions in this area: one conviction for insider trading and 23 convictions for market manipulation in 2016.
The public prosecutors are currently investigating a couple of prominent cases. It remains to be seen what the outcome of these investigations will be and if investigations – and enforcement – will continue to increase.
BaFin publishes revised sanctioning guidelines
Also, in February 2017, BaFin published its revised Sanctioning Guidelines for breaches of the German Securities Trading Act, deriving from the European Directive amending the Transparency Directive. BaFin’s new guidelines refer to a scale of severity dividing offences into five categories depending on the circumstances around the offence.
German Federal Court of Justice rules out criminal loophole for insider trading and market manipulation
In its decision of 10 January 2017, 5 StR 532/16, Germany’s highest court for civil matters, the Federal Court of Justice (Bundesgerichtshof: BGH) clarified the position on the question often cropping up in practice regarding a potential loophole in prosecuting insider trading and market manipulation. The question before the BGH was whether the new version of section 38(3)(1) and section 39(3d)(2) German Securities Trading Act (WpHG) of 2 July 2016 opened up a loophole in the law regarding the prosecution of insider trading and market manipulation. On the one hand, amendments to the German Securities Trading Act came into force on 2 July 2016 and make specific reference to the European Market Abuse Regulation (MAR) and, on the other hand, the relevant rules of the MAR relied upon and referred to became directly applicable in EU member states from 3 July 2016 (one day after the German legislation).
In this case the defendant had been sentenced to a substantial fine by a lower court for committing the administrative offence of market manipulation. In the BGH hearing, the defendant argued that there was no legal basis for his conviction because under German law, If the law in force at the time of the offence is amended prior to the decision, the more lenient law shall apply (section 2(3) German Criminal Code and section 4(3) German Administrative Offences Act). The defendant also argued that the references to EU rules in the German Securities Trading Act, which came into force on 2 July 2016 were null and void, because, at the time, the MAR had not yet entered into force.
The BGH did not accept this line of reasoning. Instead, the BGH held that the references to Art. 14 and 15 of the MAR in the German Securities Trading Act meant that the German legislator declared those provisions of the MAR as applicable in Germany from 2 July 2016 before becoming directly applicable to all member states. From a European perspective, there was nothing precluding the German legislator from declaring that articles 14 and 15 of the MAR were directly applicable before 3 July 2016, even though Art. 39(2) MAR stipulated that the Regulation was only directly applicable as of 3 July 2016.
Consob amends regulations to implement EU law
On 6 April 2017, the National Commission for Companies and the Stock Exchange (Consob) approved amendments to Consob Regulation no. 11971/199 (the Issuers Regulation), Consob Regulation no. 16191/2007 (the Markets Regulation) and Consob Regulation No. 17221/2010 (the Related-party Transaction Regulation) to implement the European market abuse regulation (MAR), which came into force on 3 July 2016. These amendments aim to align domestic and Community regulations. In particular, the threshold that triggers a disclosure obligation for transactions carried out by executives and relevant shareholders of issuers (so-called internal dealing) has been increased from Euro 5,000.00 to Euro 20,000.00.
Consob issues operational guidelines
In light of the significant number of requests for clarification on the application of MAR, Consob consulted on operational guides for listed companies and other stakeholders. The consultation closed on 6 June 2017 and CONSOB issued draft operational guides in the form of Notices (Comunicazioni Consob) to form a handbook. The first Operational Guide covers the management of privileged information and the drawing up of insider lists. The second Operational Guide deals with the fair presentation of investment recommendations, the disclosure of conflicts of interest, and the description of the cases under which Consob may ask for clarification of investment recommendations made to the public.
Europe: United Kingdom
FCA brings enforcement actions and first use of restitution powers for market abuse
The UK’s Financial Conduct Authority (FCA) published it’s business plan on 28 April 2017. It’s sector specific priorities for financial markets include implementing the Market Abuse Regulation, focusing on how firms manage conflicts of interest, systems and governance to prevent financial crime and continuing to bring enforcement action where market abuse is detected. So far this year, the FCA has brought very few enforcement actions but it continues to emphasise its desire to hold individuals to account. In this vein, the FCA has obtained criminal or administrative sanctions for market abuse against four individuals in the first half of the 2017 calendar year.
- In January, two individuals were convicted in an FCA criminal prosecution for insider dealing in connection with the takeover of Logica Plc. Manjeet Mohal, a former employee of Logica, disclosed inside information relating to that takeover to his neighbour, Reshim Birk, who made over £100,000 in profits by trading Logica securities. Mr Mohal and Mr Birk received suspended sentences of 10 months and 16 months imprisonment, respectively, and were ordered to undertake a combined total of 380 hours of community work.
- In April, the FCA banned and fined two former employees of Worldspread Limited. Niall O’Kelly, the former Chief Finance Officer, was fined £11,900 (reduced on account of pleaded financial hardship) for his role in providing misleading information to the market and managing an undisclosed hedging strategy involving fake client accounts. Lukhvir Thind, was fined £105,000 for his role in helping O’Kelly falsify financial information provided to the company’s auditors.
In addition, the FCA has used its statutory power to impose a market wide compensation scheme for market abuse under s384 of the Financial Services and Markets Act 2000 for the first time. Tesco plc issued a trading statement on 29 August 2014 that contained misleading information , which the FCA viewed as having given a false or misleading impression to the market. Under the restitution order, Tesco Plc will pay compensation to investors who purchased shares following the August 2014 trading update and who retained some or all of those securities at the time of a corrective statement.
Further commentary on the interpretation of the Market Abuse Regulation
Uncertainty surrounding the operation of the Market Abuse Regulation (MAR) has prompted the Financial Markets Law Committee (FMLC) to produce a discussion paper and the City of London Law Society (CLLS) and the Law Society company law committees jointly to produce some guidance on the application of MAR.
The FMLC published a discussion paper in May 2017 that considered the continuing issues of legal uncertainty in the context of MAR, especially in the context of market soundings outside the EU of instruments with a remote nexus to the EU. In particular:
- which financial instruments are intended to be caught by MAR, for example when considering whether there is a causal link to the price of another instrument traded on a platform within the EU; and
- the scope of the terms “transaction” and “announcement” within the market soundings regime, which could be interpreted very broadly.
The FMLC concludes that the European Securities and Markets Authority could clarify these issues by supplementing existing guidance or allow national regulators to do so.
On 30 June 2017, a Law Society joint working party published an updated Q&A document to provide some suggested guidance on the application of MAR. Although primarily aimed at listed corporates, there are points of particular interest to financial institutions acting in an advisory or other capacity in transactions. Amongst other points, these Q&As cover persons with managerial responsibility dealing during closed periods, stake-building, market soundings and insider lists.
Americas: United States
US Supreme Court limits disgorgements in SEC actions to five years
The US Supreme Court unanimously held that the US Securities and Exchange Commission’s (SEC) practice of ordering disgorgement is a “penalty” and is thus subject to the same five-year limitation period that the SEC faces in seeking to impose other penalties. The SEC used this power to compel wrongdoers to pay an amount equal to the gains made from misconduct, irrespective of when the misconduct occurred. The Court’s decision greatly limits one of the SEC’s main tools in market abuse and other cases.
In Kokesh v SEC, decided in June, the Supreme Court held that any claim for disgorgement in an SEC enforcement action must be brought within five years of the date that the claim accrued. In the case, Charles Kokesh was initially ordered to disgorge $35 million for taking money from companies he controlled. Of the $35 million, $30 million arose from violations outside a five-year limitation window, so the SEC could only obtain $5 million in disgorgement following the ruling of the Supreme Court.
The SEC has used its wide authority to disgorge billions in market abuse cases. For example, the SEC extracted $3 billion in disgorgement, and only $1.2 billion in other penalties, from securities violators in 2015 alone; ten percent of those actions related to market manipulation and insider trading. As to insider trading, disgorgement need not be tied to a defendant’s actual gain - tippers have been ordered to disgorge profits gained not by themselves, but, instead, by tippees who traded on the insider information. The decision is already having an impact. The SEC quickly announced that it would not seek disgorgement in one case and a federal court vacated an SEC order for disgorgement in another.