Under European law, companies that issue securities that are listed on a regulated market in the EU, i.e., listed stock corporations in most cases, shall promptly and publicly disclose any instances of inside information directly affecting them. This so-called duty of “ad-hoc disclosure” evidently extends to present as well as future, uncertain events, including those that are reasonably expected to occur in the future. In doubt and controversial are the following issues:
- When does an event qualify as “reasonably to be expected to occur” such that it triggers an ad-hoc disclosure duty?
- Is there an ad-hoc disclosure duty for the intermediate stages that typically precede a future event (e.g., the signing of a letter of intent for a proposed acquisition) or is it instead the expectation of the final result alone that triggers this duty?
- As Germany’s national law has implemented European law, namely the Market Abuse Directive 2003/6/EC of 28 January 2003 and its implementing Directive 2003/124/EC of 22 December 2003, the Federal Court of Justice (BGH), by order of 22 November 2010 in case no. II ZB 7/09, has referred these two controversial issues to the European Court of Justice (ECJ). The BGH’s order for referral to the ECJ shows potential for a stricter interpretation of the ad-hoc disclosure duties of issuers.
The BGH has issued its order for referral in German model case proceedings brought by investors in the capital markets against an issuer for alleged delay in ad-hoc disclosure of the departure of the issuer’s then CEO. The departure had not been disclosed until right after the supervisory board meeting adopting the resolution. Several shareholders claimed delay in disclosure and asserted damages because, among other things, the CEO had announced his departure intention some two months earlier to the chairman of the supervisory board and, step by step, to other members of the supervisory board and the executive board as well as the chairman of the group and joint works council, and staff had been asked to prepare the communication of his departure. No resolution was actively adopted for the temporary delay of the ad-hoc notification, which § 15 (3) Securities Trading Act (WpHG), in implementation of a respective provision of the Market Abuse Directive, allows if legitimate interests of the issuer so require.
Indecision at the Federal Court of Justice
In the same proceedings, the BGH earlier addressed these issues in part only. Setting aside a first model case decision of the Stuttgart Court of Appeal that withheld damage claims and applied stricter standards to the expectation of occurrence of uncertain events, the BGH found that one could ignore the question whether the element of “reasonable expectation” requires a predominant or an even stronger expectation of occurrence in order for an ad-hoc disclosure duty to be triggered, reasoning that the CEO’s departure had not even been predominantly likely before the decisive supervisory board meeting. As has been expressly stated in the BGH’s order for referral (margin 20), the BGH now has second thoughts about its own findings on how to interpret the required element of “reasonable expectation.”
The Contrarian Positions of Germany’s Courts of Appeal
What has happened? The BGH refers to the ECJ’s recent decision in “Spector Photo Group” in which the ECJ emphasized the correlation between the term “inside information” and the prohibition on insider trading. Evidently, the reach of the prohibition on insider trading depends essentially on the definition of inside information, yet this has not been a primary statement of the ECJ. More elucidating will be an analysis both of the second model case decision of the Stuttgart Court of Appeal in the same lawsuit and of the parallel decision passed by the Court of Appeal in Frankfurt am Main in the lawsuit over the fine imposed by the Financial Supervisory Office (BaFin) for the very same issue:
First, the Court of Appeal in Frankfurt am Main had found that isolated intermediate steps of an ongoing event might be subject to ad-hoc disclosure as such and that this qualification does not necessarily depend on the expectation of occurrence of the final result. Consequently, an ad-hoc notification regarding the CEO’s departure ought to have been published as early as on the CEO’s announcement of his departure intention to the chairman of the supervisory board.
Soon after this finding, the Stuttgart Court of Appeal had issued a finding to the contrary, stating that the isolated consideration of intermediate steps of an ongoing event was impermissible because only the expectation of occurrence of the final result, i.e., the actual departure of the CEO, was relevant. After all, in accordance with the BGH’s previous interpretation, it was not until much later that that fact became at least predominantly likely and thus “reasonably expected to occur.”
The present order for referral demonstrates that the BGH disagrees with the legal view of the Stuttgart Court of Appeal and prefers the decision of the Court of Appeal in Frankfurt am Main.
The BGH’s New Position
The BGH’s order for referral initially states that its interpretation in fact would allow isolated intermediate steps of an ongoing event to be subject to ad-hoc disclosure and that the expectation of occurrence of the final result was not always relevant. The decisive factor should be that the intermediate step as such would be reasonably expected to have a significant effect on the stock price, i.e. that a reasonable investor would take it into account when making his or her investment decision. The BGH states this was definitely true for “decision-making processes with unsure conclusions” (order for referral, margin 16).
The BGH takes this one step further: In derogation from its view so far, it has now reduced the conditions for the elements of “reasonable expectation” to be met. Market participants that learn about future events before the general public does could have an advantage even if the occurrence of the event is uncertain (order for referral, margin 20). As this should apply even more so to uncertain facts with high potential to influence the stock price, the conditions for the elements of expectation of occurrence to be met might even be less stringent in this case. On the other hand, the BGH states that the occurrence of the future event must not be “unlikely” (order for referral, margin 22).
The Effects in Practice
The BGH’s decision blows up the truism “knowledge is better than ignorance” into a maxim for purposes of insider trading law. This maxim has too short a reach and leads to substantial ambiguities affecting the ad-hoc disclosure practice of issuers.
In practice, an issuer would already now analyze any isolated intermediate steps for ad-hoc disclosure requirements and not simply rely on the expectation of occurrence of the final result only. The expectation of occurrence – contrary to what has been suggested in the BGH’s decision – is not a precise measurement that is readily quantifiable as a percentage. Moreover, it is not always clear enough what fact qualifies as final result and what events are just intermediate steps towards a continuing development. It is especially problematic that the BGH appears to have a tendency of detaching the concept of stock-price relevance from the expectation of occurrence and thus of classifying totally uncertain facts as being inside information requiring ad-hoc disclosure. This tendency disregards that isolated intermediate steps of an ongoing event are commonly marked by their stock-price relevance depending on the occurrence of the final result.
Alarmingly, the BGH apparently wishes to take the interpretation of “reasonable expectation” one step further to incorporate facts that are less expected to occur than to not occur, at least if a fact would have a particularly significant effect on the stock price. In practice, this means that ad-hoc disclosure — a duty which is on penalty of fining and may involve substantial damage claims — is supposed to be evaluated by putting a barely measurable element — the element of “reasonable expectation” — into a reciprocal relation to another barely measurable element – the element of probability/expectation to substantially influence the stock price. It is plain that this involves considerable legal uncertainty.
If the ECJ decides the two issues in the way suggested in the BGH’s order for referral, ad-hoc disclosure (and consequently the insider trading prohibitions) will be shifted to an early stage of pure speculation and the duty of ad-hoc disclosure would arise much earlier, not only in Germany but possibly also in other EU member states where the interpretation so far has not been as strict as now suggested by the BGH. This would be in conflict with the protective purpose of ad-hoc disclosure of keeping insiders from having a lead over non-insiders regarding secured knowledge and thereby having a “free lunch”, yet not of preventing speculation on purely uncertain events. Also, this would hardly serve the interests of investor protection: Investors have to deal with an abundance of information already and the expected growth in the number of ad-hoc announcements would only aggravate this situation.
Recommended Corporate Practice
Companies should be ready to adapt their practice because the ECJ’s interpretation will be applied to former cases in general, including facts that precede the ECJ’s decision. So, if the duty of ad-hoc disclosure of uncertain and continuing facts arises earlier, issuers are well advised to work along the principle of in dubio pro publicatione and to publish their ad-hoc announcements early on when in doubt.
On the other hand, at least in Germany, beware of overdoing things as the BaFin has a strong dislike of excessive ad-hoc announcements. Specifically, issuers should use the instrument of self-exemption early on, if only as a matter of precaution. Contrary to the second model case decision of the Stuttgart Court of Appeal, they should not rely on an exemption being available whether with or without an active exemption resolution. This creates organizational challenges for companies: They must ensure that the relevant information be disclosed to those within their organization who can initiate such self-exemption in good time and possibly earlier than required before: i.e., for relevant intermediate steps and a lower level of expectation of occurrence.