THE MARKET ABUSE DIRECTIVE

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THE MARKET ABUSE DIRECTIVE
Public Lectures in Law and Economics Bologna, May
9, 2003 Carmine Di Noia
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Index of Presentation

• SECTION 1 Introduction
• SECTION 2 Insider Trading
• SECTION 3 Manipulation
• SECTION 4 Manipulation VS BBP Stabilisation
• SECTION 5 Preventive Measures
• SECTION 6 Competent Authority

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SECTION 1INTRODUCTION
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Introduction 1

• Market Abuse Directive timetable
• 1989 Directive on insider trading (89/592)
• 1999 Financial Services Action Plan
• 2000 Lisbon Council, implementation of FSAP by
• 2005 Wise Men Committee
• 2001 Lamfalussy Report, 4 level approach
• 2001 Commission proposal
• 2002 Common position Cesr
• 2003 Final Directive
• 2004, October 12 deadline for implementation
  (include laws, regulations and administrative
  provisions)

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Introduction 2

• LAMFALUSSY FOUR-LEVEL APPROACH LEVEL 1
  Framework Directive (Commission
  proposal/Council-Parliament codecision) and
  definition of implementing powers for the
  CommissionLEVEL 2 Implementing Measures (CESR
  technical advice after consultation/Commission/Eur
  opean Securities Committee (majority vote)
  European Parliament kept fully informed, may
  adopt resolutions a) within 3 months on draft
  implementing measures b) within 1 month after
  vote of ESC if level 2 measures exceed
  implementing powers)LEVEL 3 Joint
  interpretation/Common (non binding) standards
  (CESR)LEVEL 4 Compliance/enforcement (Commission
  against Member States)

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Introduction 3

• CESR/Commission level 2 timetable
• 2002, March. Commission 1st request to CESR for
  advice on implementing measures
• 2002, April on. Expert-Consultative Working Group
  meetings
• 2002, July. CESR 1st Consultation paper
• 2002, December. CESR final advice to the
  Commission
• 2003, January. Commission 2nd request to CESR for
  advice on implementing measures
• 2003, March. Commission publishes draft
  directives (2) and regulation (1) on implementing
  measures
• 2003, April CESR 2nd Consultation paper
  (Additional level 2 implementing measures)
• 2003, May. Inter-Institutional Monitoring Group,
  First Report

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Introduction 4

• Reason for a new directive on market
  abuse(insider trading market manipulation)
• NO existing directive on mkt manipulation (only
  on insider)
• Great diversity at national level (rules and
  enforcement)
• New financial instruments and techniques
  increasing mkt manipulation
• Need to protect market integrity to ensure
  integration of financial markets (other
  directives ISD, single prospectus, transparency,
  takeover)

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Introduction 5
Measures to Promote Market Integrity
intermediaries
exchanges
issuers
Price Discovery Process
regulators
Institutional investors
Analysts
Mass - Media Financial journalists
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Introduction 6
Market Integrity (2003/6/EC Directive)

• An integrated and efficient financial market
  requires market integrity.
• The smooth functioning of securities markets and
  public confidence in markets are prerequisites
  for economic growth and wealth.
• Market abuse harms the integrity of financial
  markets and public confidence in securities and
  derivatives

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Insider trading - Example
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Manipulation Example
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SECTION 2The 2003/6/EC DirectiveInsider
Trading
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Insider trading 1.1
Definition of inside information Art. 1

• "Inside information" shall mean information of a
  precise nature which has not been made public,
  relating, directly or indirectly, to one or more
  issuers of financial instruments or to one or
  more financial instruments and which, if it were
  made public, would be likely to have a
  significant effect on the prices of those
  financial instruments or on the price of related
  derivative financial instruments

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Insider trading 1.2
Definition of inside information (more)

• Member States should tackle the practice known as
  "front running", including "front running" in
  commodity derivatives, where it constitutes
  market abuse under the definitions contained in
  this Directive (whereas n. 19)
• For persons charged with the execution of orders
  concerning financial instruments, "inside
  information" shall also mean information conveyed
  by a client and related to the client's pending
  orders. (Art.1, 1 3rd para.)

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Insider trading 2 Level 2
European Commission asked advice on the meaning
of
1)
Precise nature
2)
Price sensitive
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Insider trading 2.1
1) precise information (art. 2 draft directive)
a)
Information of a precise nature shall mean any
information consisting of a matter or an event
which is true or could reasonably be expected to
become true in the future (remember relevant
definition also for issuers disclosure!)
True based on firm and objective evidence (as
opposed to Rumours) which are not are not inside
information
could become true uncertain but contingencies
dont mitigate precise of info (if expected
merger doesnt occur, this could be in any case
precise info).
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Insider trading 2.2
1) precise information (art. 2 draft directive)
b)
when this information is specific enough to
allow a conclusion to be drawn about its possible
impact on prices
The information should be price sensitive A piece
of info allow a conclusion Either when
enable a reasonable investor to take an
investment decision without (or at very low)
risk Or when it is likely to be exploited
immediately on the market
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Insider trading 2.3
2) price sensitivity of information (art. 3 draft
directive)
Information which would be likely to have a
significant effect mean ex-ante available
information an average person would be likely to
use as part of the basis of his investment
decisions in order to optimise his interests
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Insider trading 2.4
2) Price sensitivity
Market participants have to be able to assess
beforehand whether the information is price
sensitive, in order to be able to act
accordingly, regarding the duties of
confidentiality, prompt disclosure and
prohibition to enter into transactions. This
assessment has to take into consideration the
market impact, which would be foreseeable at the
moment when the information has not yet been
disclosed. Ex-ante factors have to be found in
order to guide market participants in their
decisions. Any (relevant) information available
at the time has to be taken into account. Other
variables would include prices, returns,
volatilities, liquidity, price relationships
among financial instruments, volume, supply,
demand, order book, timing of prices and news
disclosure, rules governing the exchange and
market microstructure, etc. A piece of
information could be considered as likely to have
a significant effect on prices of financial
instruments even though, when the piece of
information is published, this doesnt actually
produce any effect.
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Insider trading 2.5
2) price sensitivity
Useful indicators Type of info is the same as
info which had in the past a significant effect
on prices Pre-existing analysts reports and
opinions indicate the that type of info is price
sensitive Issuers itself has treated similar
events as inside info List of price sensitive
information point 35 (Level 3)
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Insider trading 3.1
Definition of insider trader (Primary insiders)
Art. 2

• Any person who possesses an inside information
•  (a) by virtue of his membership of the
  administrative, management or supervisory bodies
  of the issuer, or
•  (b) by virtue of his holding in the capital of
  the issuer, or
•  (c) by virtue of his having access to the
  information through the exercise of his
  employment, profession or duties, or
•  (d) by virtue of his criminal activities.

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Insider trading 3.2
Definition of insider trader (Secondary insiders
-Tippees)

• The prohibitions applicable to the Primary
  insiders should also apply to any person, who
  possesses inside information while that person
  knows, or ought to have known, that it is inside
  information (Art. 3).

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Insider trading 3.3
Prohibition

• Member States shall prohibit any person
  (primarysecondary insiders) . who possesses
  inside information from
• using that information by acquiring or disposing
  of, or by trying to acquire or dispose of, for
  his own account or for the account of a third
  party, either directly or indirectly, financial
  instruments to which that information relates
• disclosing inside information to any other person
  unless such disclosure is made in the normal
  course of the exercise of his employment,
  profession or duties (confidentiality duties)
• recommending or inducing another person, on the
  basis of inside information, to acquire or
  dispose of financial instruments to which that
  information relates.

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SECTION 3 The 2003/6/EC Directive MANIPULATION
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Manipulation 1 Definition (Art. 1.2)
1. Transactions or orders to trade which give,
or are likely to give, false or misleading
signals as to the supply of, demand for or price
of financial instruments, or which secure, by a
person, or persons acting in collaboration, the
price of one or several financial instruments at
an abnormal or artificial level 2. Transactions
or orders to trade which employ fictitious
devices or any other form of deception or
contrivance 3. Dissemination of information
through the media, including the Internet, or by
any other means, which gives, or is likely to
give, false or misleading signals as to financial
instruments, including the dissemination of
rumours and false or misleading news, where the
person who made the dissemination knew, or ought
to have known, that the information was false or
misleading.
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Manipulation 1.1
Types of manipulation

• trade based manipulation
• information based manipulation
• action based manipulation

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Manipulation 1.2
Trade based manipulation -

• In this case the manipulator tries to cause a
  price change in the price of a security by
  trading in themarket.
• E.g. the manipulator through a series of
  purchases in the market tries to induce others to
  think that he is an insider and thus to follow
  him in buying the security in order to create a
  speculative bubble

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Manipulation 1.3
Action based manipulation

• In this case the manipulator tries to cause a
• change in the price of a security through
  actions
• that give the appearance of an active market
  in
• such security
• Examples
• wash sales (transactions involving no change in
  the beneficial ownership of the security)
• matched trades (the buyer and seller have
  previously agreed to cancel the effects of the
  trade)
• In both the examples the manipulator is bearing
  no risk.

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Manipulation 1.4
Information based manipulation

• In this case the manipulator tries to cause a
• change in the price of a security by spreading
• false, exaggerated or misleading information.
• Internet is the ideal way to implement such
• strategy

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Manipulation 2
CESR approach
Signals to be taken into account for possibly
manipulative behaviours (art. 8 of draft
directive)
Level 2

• Rules related to
• market microstructure
• market liquidity
• diagnostic flags indications which should draw
  further scrutiny and are likely to be present
  individually or cumulatively as signals of
  manipulative behaviour

Level 3
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Manipulation 2.1

• Orders which produce false signals

2) Orders which secure the price at an abnormal
or artificial level

• Factors offering a strong indication
• The extent to which orders given or transactions
  undertaken represent a significant proportion of
  the daily volume of transactions in a financial
  instrument, in particular when these activities
  lead to a significant change in the price of the
  financial instrument.
• The extent to which orders given or transactions
  undertaken by persons with a significant position
  (long or short) in a financial instrument lead to
  significant changes in the price of the financial
  instrument or related derivative or underlying
  asset

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Manipulation 2.2

• Orders which produce false signals

2) Orders which secure the price at an abnormal
or artificial level

• Factors offering a strong indication
• Whether orders given or transactions undertaken
  lead to no change in beneficial ownership of the
  financial instrument or which reallocate holdings
  among associated companies within a corporate
  holding.
• The extent to which orders given or transactions
  undertaken include position reversals in a short
  period and represent a significant proportion of
  the daily volume, and/or are associated with
  significant changes in the price of a financial
  instrument.
• The extent to which orders given or transactions
  undertaken are concentrated within a short time
  span in the trading session and lead to a price
  change which is subsequently reversed.

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Manipulation 2.3

• Orders which produce false signals

2) Orders which secure the price at an abnormal
or artificial level

• Factors offering a strong indication
• The extent to which orders given change the
  representation of best bid or offer prices in a
  financial instrument, or more generally the
  representation of the order book available to
  market participants, and are removed before they
  are executed.
• Whether the systematic purchase or sale of a
  financial instrument affects its price, without
  symmetric price impact by simultaneous
  counteracting transactions on other markets.
• The extent to which transactions when undertaken
  at or around a specific time when reference
  prices, settlement prices and valuations are
  calculated lead to price changes which have an
  effect on such prices and valuations..

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Manipulation 2.4
3) Orders which employ fictitious devices or any
other form of deception or contrivance

• Factors offering a strong indication
• Whether orders to trade given or transactions
  undertaken are preceded or followed by
  dissemination of false or misleading disclosure
  by the same or or associated persons.
• Whether orders to trade might be given or
  transactions undertaken by persons, and
  associated persons, before or after they produce
  or disseminate research or investment
  recommendations which are erroneous or biased and
  demonstrably influenced by material interest

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Manipulation The Grey Area

• Journalists (art. 1.2.c)
• in respect of journalists when they act in their
  professional capacity such dissemination of
  information is to be assessed,.., taking into
  account the rules governing their profession,
  unless those persons derive, directly or
  indirectly, an advantage or profits from the
  dissemination of the information in question.
• Discretion to Member States for self-regulation

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SECTION 4Manipulation vs. Buy Back Program
Price Stabilisation
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Manipulation vs. Buy Back Program
(Art. 8) The prohibitions provided for in this
Directive shall not apply to trading in own
shares in buy-back programmes or to the
stabilisation of financial instrument provided
such trading is carried out in accordance with
implementing measures adopted pursuant to the
procedure referred to in Article 17(2)
Insider trading
Safe harbour (i.e. Exemption)
Market Manipulation
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Manipulation vs. Buy Back Program
CESR/Commission Approach
Allow BBP without jeopardise market integrity
Aims
BBP identification
BBP disclosure
Main issues
Potential for Market Abuse
Fair treatment of shareholders
Allow flexibilities
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Manipulation vs. Buy Back Program
BBP identificaton

• The safe harbour covers
• (1) the buying back of shares for the purposes of
  reducing the capital of an issuer
• (2) the buying back of shares to meet obligations
  arising from debt financial instruments
  exchangeable into equity instruments
• (3) fulfilling obligations arising from employee
  share option programmes and other allocations of
  shares to employees.

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Manipulation vs. Buy Back Program
BBP ex-ante disclosure

• Prior to the start of trading, full details of
  the programme must be published through an
  officially appointed mechanism in the
  jurisdictions in which an issuer has requested
  that its shares be admitted to trading on a
  regulated market. () All subsequent changes to
  the programme must be published through the same
  officially appointed mechanism(s).
• The issuer must have in place the mechanisms
  necessary to ensure that it is able to fulfil
  trade reporting obligations to the relevant
  competent authority and/or market.

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Manipulation vs. Buy Back Program
Conditions for trading (art. 3 draft regulation)

• When executing trades under the programme, an
  issuer
• shall not purchase shares at a price higher than
  either the price of the last independent trade or
  the current independent bid
• may not purchase more than 25 of the average
  daily volume of the shares in any one day on the
  regulated market.
• however, in case of extreme low liquidity, the
  issuer may deviate from the above mentioned 25
  limit provided that the issuer a) informs in
  advance the Competent Authority b) disclose
  adequately its intention c) does not exceed 50
  of the average daily volume.

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Manipulation VS. Stabilisation 1

• Stabilisation mean to any purchase or offer to
  purchase Relevant Securities, or any transaction
  in Associated Securities equivalent thereto, by
  investment firms or credit institutions, which is
  undertaken in the context of a Significant
  Distribution of Relevant Securities (IPO or
  secondary public offering) for exclusively
  securing a market price for such Securities that
  would not otherwise prevail.
• Activity that is not directly linked to this
  purpose will not benefit from the safe harbour.

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Manipulation vs Stabilisation - Conditions 1

• Stabilisation Period
• Stabilisation shall be undertaken only during a
  defined period that has been disclosed to the
  market in advance.        
• Stabilisation Price
• Stabilisation may only be undertaken to support
  the market price of the Relevant Securities
  having due regard to prevailing market conditions
  and in any event may not be executed above the
  offering price.

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Manipulation vs Stabilisation Conditions 2

• Ex ante disclosure
• The possibility of Stabilisation, together with
  adequate disclosure of the risks and other
  aspects of Stabilisation which could be material
  to an investors decision to subscribe for or
  purchase the Relevant Securities, must be
  disclosed.
• The existence and maximum size of any
  Overallotment Facility or Greenshoe, the exercise
  period of the Greenshoe and any conditions for
  the use of the Overallotment Facility or exercise
  of the Greenshoe must also be disclosed, as well

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Manipulation vs. Stabilisation Conditions 3

• Post Stabilisation Disclosure
• Within one week after the end of the
  Stabilisation Period, the Stabilisation
  transactions undertaken must be adequately
  disclosed to the public. This disclosure has to
  contain the following information
• the date at which the Stabilisation period
  ended
• whether or not Stabilisation was undertaken
• the price range between which Stabilisation was
  undertaken
•  the date at which Stabilisation last occurred.

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Manipulation vs Stabilisation Conditions 4

• 1. Record keeping
• Systems must be in place to record Stabilisation
  orders and transactions.
• 2. The stabilisation manager
• One Investment Firm shall act as central point of
  inquiry for any regulatory intervention.

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SEZIONE 5Preventive Measure
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Preventive Measures
Prevention of insider trading

• The protection of investors requires that

they will be protected against the improper use
of inside information they are supplied with
appropriate, regular information form the issuers
of listed securities to ensure that they are
placed on equal footing and remove information
asymmetry.
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Preventive Measures Issuers Disclosure NEW!

• Member States shall ensure that issuers of
  financial instruments inform the public as soon
  as possible of inside information which directly
  concerns the said issuers (art. 6) MISTAKE?
  INSIDE INFO VS RELEVANT EVENTS!
• Only for admission on request (art. 9)
• An issuer may under his own responsibility delay
  the public disclosure of inside information, such
  as not to prejudice his legitimate interests
  provided that such omission would not be likely
  to mislead the public and provided that the
  issuer is able to ensure the confidentiality of
  that information. (Additional requirement inform
  competent authority without delay).

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Preventive Measures Issuers Disclosure

• Possible legitimate interests for issuers to
  delay public disclosure (art. 6 draft directive)
  (but dont avoid risks!)
• (1) Matters in course of negotiation, when public
  disclosure would be likely to affect the
  conclusion of a deal or the normal course of
  negotiations
• (2) Decisions taken or contracts made by the
  management board of an issuer which need the
  approval of the supervisory board in order to
  become effective, where the organisation of such
  an issuer requires the separation between these
  boards, provided that such a public disclosure
  before the approval would jeopardise the correct
  assessment of the information by the public.

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Preventive Measures Research (art. 6.5)

• Member States shall ensure that there is
  appropriate regulation in place to ensure that
  persons who produce or disseminate research
  concerning financial instruments or issuers of
  financial instruments (including recommending or
  suggesting investment strategy), intended for
  distribution channels or for the public, take
  reasonable care to ensure that
• such information is fairly presented, and
• disclose their interests or indicate conflicts of
  interest concerning the financial instruments to
  which that information relates.
• (Lack of) Coordination with ISD ancillary
  service)

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Preventive Measures Research Level 2

• Research and other information recommending or
  suggesting investment strategy shall mean
• information produced by an independent analyst,
  an investment firm, a credit institution, a
  rating agency or an individual employed by them
  that, directly or indirectly, expresses an
  investment recommendation on a financial
  instrument or an issuer of financial instruments,
  as well as
• information produced by others than the persons
  referred to above which directly recommends an
  investment decision on a financial instrument.

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Preventive Measures Research Level 2

• Standard for presentation of the recommendations
• All Relevant Persons - other than those financial
  journalists who are subject to an appropriate and
  equivalent self regulatory regime - should take
  reasonable care to ensure that
• facts are clearly distinguished from
  interpretations, estimates, opinions and other
  types of non-factual information
• all sources are reliable or that, where a source
  is not considered reliable, this is clearly
  indicated
• all projections, forecasts and price targets are
  clearly labeled as such and the material
  assumptions made in using them are indicated.

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Preventive Measures Research Level 2

• Specific Rules
• Investment firms, credit institutions and credit
  rating agencies should take reasonable care to
  ensure that
• all substantially material sources are indicated
• any basis of valuation or methodology used to
  evaluate an issuer or financial instrument is
  adequately summarised
• the meaning of any rating category assigned
  (e.g.buy, sell etc) or recommendation (e.g.
  buy/hold/sell) made, is adequately explained and
  any appropriate risk warning indicated
• reference is made to the planned frequency, if
  any, of updates of the Relevant Information and
  to any major changes in the coverage policy
  previously announced (e.g. a decision to stop
  coverage)
• the date at which the Relevant Information was
  first released for distribution is indicated
  clearly and prominently, as well as the relevant
  date and time for any financial instrument price
  mentioned
• the most recent change in recommendation or
  rating issued, if such change occurred over the
  previous twelve months, is indicated clearly and
  prominently

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Preventive Measures

• Other preventive measures

• the creation of insiders lists",
• the application of "window trading" to sensitive
  categories of personnel,
• the application of internal codes of conduct and
• the establishment of "Chinese walls".

Implementing Measures
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Preventive Measures
Insiders lists The directive requires all
issuers and third parties acting on their behalf
or for their account with access to inside
information to draw up lists of insiders. CESR
proposes that those concerned should maintain
lists of persons with access to inside
information together with permanent lists of
those who have regular access to inside
information. These lists should be updated on a
continuous basis to ensure that they are always
current Disclosure of (all) transactions The
directive requires those in managerial positions
within an issuer to disclose dealings in the
shares of the issuer. CESR proposes that this
obligation should cover members of the
administrative, management or supervisory boards
of the issuer together with senior managers
having similar decision making capacity within
the issuers.
57
Preventive Measures
Notification of suspicious transactions The
directive requires intermediaries to notify the
competent authority of transactions that they
suspect of being abusive. CESR proposes that
notification should occur once suspicions are
aroused. These persons need not have any
evidence. The notification obligation has to be
fulfilled if the person professionally arranging
transactions has sufficient indications that the
transaction might be abusive.
58
Preventive Measures

• Other measures

• A primary role in the prevention of insider
  trading is played by the existence of rules
  imposing a clear segregation of functions within
  investment firms (i.e. Chinese walls)
• Chinese walls within firms helps
• to ensure that privileged information will not
  flow or be disseminated to other departments or
  divisions engaging in other activities of
  projects, and
• To avoid that people working for the other parts
  of the firm be considered as holding privileged
  information and, as such, be hampered or crippled
  in their activities.

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SECTION 6 The Competent Authority
60
The Competent Authority 1 (art. 11)

• Without prejudice to the competences of the
  judicial authorities, each Member State shall
  designate a single administrative authority
  competent to ensure that the provisions adopted
  pursuant to this Directive are applied.
• Member States shall establish effective
  consultative arrangements and procedures with
  market participants concerning possible changes
  in national legislation. These arrangements may
  include consultative committees within each
  competent authority, the membership of which
  should reflect as far as possible the diversity
  of market participants, be they issuers,
  providers of financial services or consumers.

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The Competent Authority 2

• Appropriate administrative measures (without
  prejudice to criminal sanctions) effective,
  proportionate and dissuasive (art. 14).
• The competent authority shall be given all
  supervisory and investigatory powers that are
  necessary for the exercise of its functions. It
  shall exercise such powers
•  (a) directly or
•  (b) in collaboration with other authorities or
  with the market undertakings, or
•  (c) under its responsibility by delegation to
  such authorities or to the market undertakings,
  or
•  (d) by application to the competent judicial
  authorities (art. 12).

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The Competent Authority 3

• The powers of the Competent Authority should
  include at least the right to
• have access to any document in any form
  whatsoever, and to receive a copy of it
• demand information from any person, including
  those who are successively involved in the
  transmission of orders or conduct of the
  operations concerned, as well as their
  principals, and if necessary, to summon and hear
  any such person
• carry out on-site inspections
• require existing telephone and existing data
  traffic records
• require the cessation of any practice that is
  contrary to the provisions adopted in the
  implementation of this Directive
• suspend trading of the financial instruments
  concerned
• request the freezing and/or sequestration of
  assets
• request temporary prohibition of professional
  activity.

63
The Competent Authority 4

• Competent authorities shall cooperate with each
  other whenever necessary for the purpose of
  carrying out their duties, making use of their
  powers whether set out in this Directive or in
  national law.
• Competent authorities shall render assistance to
  competent authorities of other Member States. In
  particular, they shall exchange information and
  cooperate in investigation activities.

64
The Competent Authority 5

• Competent authorities shall, on request,
  immediately supply any information required for
  the purpose referred to in paragraph 1. Where
  necessary, the competent authorities receiving
  any such request shall immediately take the
  necessary measures in order to gather the
  required information.
• If the requested competent authority is not able
  to supply the required information immediately,
  it shall notify the requesting competent
  authority of the reasons.
• Information thus supplied shall be covered by the
  obligation of professional secrecy to which the
  persons employed or formerly employed by the
  competent authorities receiving the information
  are subject.

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The Competent Authority 6

• The competent authorities may refuse to act on a
  request for information where
• communication might adversely affect the
  sovereignty, security or public policy of the
  Member State addressed
• judicial proceedings have already been initiated
  in respect of the same actions and against the
  same persons before the authorities of the
  Member State addressed or
• where a final judgement has already been
  delivered in relation to such persons for the
  same actions in the Member State addressed.
• In any such case, they shall notify the
  requesting competent authority accordingly,
  providing as detailed information as possible on
  those proceedings or the judgement.