Differences Between US and UK Market Abuse Regimes

The UK Financial Services Authority (“FSA”) imposed fines of £3.651 million ($5.77 million) on Greenlight Capital Inc., a US hedge fund manager (“Greenlight”), £3.638 million ($5.74 million) on David Einhorn, Greenlight’s owner, and £350,000 ($553,000) on Andrew Osborne, a former Bank of America Merrill Lynch banker. These fines were levied in connection with Greenlight’s trading in the shares of Punch Taverns Plc (“Punch”), a UK pubs business, ahead of a planned equity offering. The FSA imposed the fines on the grounds that Greenlight traded on inside information conveyed to David Einhorn during a conference call with Punch’s CEO and Andrew Osborne, its broker. Greenlight specifically declined to be made an insider for the purposes of the call and David Einhorn requested that he would not be “wall crossed.” Notwithstanding this, the FSA determined that the information conveyed amounted to inside information, that trading on this information was prohibited by the UK’s market abuse regime and that Greenlight, David Einhorn and Andrew Osborne should have been aware of this. It is unlikely that Greenlight’s trading would have triggered an enforcement action by the US Securities and Exchange Commission (“SEC”) if it had occurred in the context of a US exchange. However, US financial institutions and other market participants active in UK financial markets should take note of the FSA’s actions as this case illustrates key differences between the regulation of insider trading and market abuse in the US and the UK, and the FSA’s more aggressive policing of UK markets.

Background

On June 8, 2009, Andrew Osborne, in his role as Punch’s broker, asked Greenlight if it was willing to be “wall crossed”, enabling Greenlight to receive inside information which would have had the effect of preventing it from trading for a limited period. This question was routed to David Einhorn, the manager of all of the Greenlight funds, who declined to be “wall crossed.” On June 9, 2009, David Einhorn and a Greenlight analyst participated in a conference call with Punch’s CEO and Andrew Osborne on an open / non “wall crossed” basis (the “Punch Call”). During the Punch Call, Punch’s CEO and Andrew Osborne disclosed to Greenlight that (i) Punch was in the advanced stage of the process of a significant new equity raise, (ii) the new equity would be used to repay an outstanding convertible bond and create headroom under covenant tests in Punch’s securitisation vehicles, (iii) in order to achieve this purpose, the new equity raise would need to be in the neighbourhood of £350 million, and (iv) if Greenlight were to be “wall crossed,” an agreement not to disclose confidential information would be in effect for less than a week.

Immediately prior to the Punch Call, Greenlight (through various funds under its management) held approximately 13.3% of Punch’s shares. Shortly after the Punch Call, on David Einhorn’s instructions, Greenlight began a three-day sell-down of its Punch shares, reducing its holdings from 13.3% to 9%. On June 12, 2009, Punch announced a new equity raise of £375 million; directly after this announcement, Punch’s share price fell by 29.9%. The alleged effect of Greenlight’s trading was to avoid losses of approximately £5.8 million.

The US Approach to Insider Trading Regulation

In the US, insider trading is prohibited by US federal securities laws. Almost all prosecutions for violations of insider trading laws are based on either (i) the “classical theory” of insider trading (where a person purchases or sells securities with scienter (guilty knowledge) while in possession of material, nonpublic information in breach of a duty arising out of a fiduciary relationship to the issuer of the security), or (ii) the “misappropriation theory” of insider trading (where a person misappropriates and trades on the basis of confidential information in a breach of a duty of trust or confidence owed to the source of the information). Although the scope of the US insider trading laws has not changed significantly, the SEC and US Department of Justice have expanded the scope and intensity of their enforcement efforts and, in particular, have focused more attention on hedge funds and expert networks.

Under current US insider trading law and practice, in order to impose insider trading liability there must be a fiduciary or fiduciary-like relationship (or, in the case of a claim under the misappropriation theory, a “duty of trust or confidence”). For example, in SEC v. Cuban, 620 F.3d 551 (5th Cir. 2010), the SEC relied on Rule 10b5-2(b)(1), and argued that an oral confidentiality agreement or understanding alone creates a duty to disclose or abstain from trading. In this case, Mark Cuban, then the largest stockholder of Mamma.com, allegedly sold off his entire stake after purportedly agreeing to keep confidential certain information regarding the company’s planned PIPE offering. On appeal (where the facts of the complaint were presumed to be true for purposes of the appeal), the US Court of Appeals for the Fifth Circuit held that the SEC had sufficiently alleged a duty of confidence and not to trade such that further proceedings were warranted. The SEC’s expansive position in the case leaves open the possibility that the SEC may pursue similar actions in the future.

It is doubtful that the behavior which underlies the FSA’s decisions in respect of Greenlight and David Einhorn would have constituted a violation of the US federal securities laws if it had occurred in the context of a US issuer. Greenlight, as a Punch shareholder, did not have a fiduciary or fiduciary-like relationship with Punch. Greenlight and, by extension, David Einhorn, were not insiders with a fiduciary relationship to Punch based on their shareholdings as Greenlight was a noncontrolling shareholder of Punch (a fiduciary duty can be found to exist based on controlling shareholder status). Neither David Einhorn nor Greenlight had taken on any additional role that would imply a fiduciary duty to Punch. In contrast to the SEC’s allegations in SEC v. Cuban, the FSA acknowledged that neither David Einhorn nor Greenlight agreed to keep confidential the information disclosed by Punch or Andrew Osborne, or refrain from trading.

The UK Approach to Market Abuse Regulation

In the UK, market abuse is regulated under the UK Financial Services and Markets Act (2000) (“FSMA”), which prohibits persons from engaging in market abuse. Under Section 118(2) of FSMA, behaviour which amounts to market abuse includes where “an insider deals or attempts to deal, in a qualifying investment or related investment on the basis of inside information relating to the investment in question.” An “insider” is any person who has inside information, among other things, as a result of having access to the information through the exercise of his professional duties. [1] “Inside information” is defined as information of a precise nature which (a) is not generally available, (b) relates, directly or indirectly, to one or more issuers of the qualifying investments or to one or more of the qualifying investments, and (c) would, if generally available, be likely to have a significant effect on the price of the qualifying investments. [2] Under FSMA, information is “precise” if, among other things, it indicates circumstances that may reasonably be expected to come into existence or that may reasonably be expected to occur, and is specific enough to enable a conclusion to be drawn as to the possible effect of those circumstances. [3] Market abuse enforcement actions under FSMA attract civil penalties and, unlike criminal insider dealing, do not require that a person must have acted deliberately or recklessly.

The FSA came to the conclusion that David Einhorn and his actions satisfied the criteria for engaging in market abuse in violation of Section 118(2) of FSMA. In its decision, the FSA stated that David Einhorn had access to inside information relating to Punch’s new equity raise by virtue of his employment by Greenlight and as a result of his position as the manager of Greenlight’s portfolios. The FSA also found that the sale of Punch shares by Greenlight constituted dealing in a qualifying investment (namely, Punch’s shares and contracts for difference (swaps) relating to Punch’s shares). The FSA determined that the information provided on the Punch Call amounted to inside information because the information (i) was not generally available (it was conveyed to Einhorn during the course of the Punch Call and could not have been deduced by market participants), (ii) related to Punch and the Punch shares, (iii) was precise as it indicated that an equity raise could reasonably be expected to occur in the near future and was specific enough to enable a conclusion to be drawn as to the effect on Punch’s share price, and (iv) would have had a significant impact on the price of the Punch shares had the information been generally available (as knowledge of a sizeable equity raise would likely depress the price of the Punch shares).

Inside information can be disclosed based on the substance and totality of a conversation

Significantly, the FSA decided that David Einhorn traded Punch shares on the basis of inside information even though he was not definitively informed that the equity raise would occur, nor was he told the terms or precise timing of the proposed equity raise. In its decisions, the FSA concluded that the substance and totality of the Punch Call were sufficient, when viewed as a whole, to allow the FSA to conclude that inside information was conveyed. In particular, the FSA stated that the information conveyed was (i) precise because it indicated that a new equity issue of some significance (in the neighbourhood of £350 million was referred to), (ii) likely to occur within the one-week confidentiality period mentioned on the Punch Call, and (iii) specific enough to enable a conclusion to be drawn as to the possible negative effect of the share issuance on the price of Punch shares (i.e., given Punch’s existing market capitalisation of £400 million, the issue of an additional £350 million of shares would likely cause the share price to fall).

Inside information was disclosed notwithstanding statements to the contrary

David Einhorn argued that the discussion during the Punch Call did not disclose that an equity issue was imminent and the conversation was presented as a back and forth series of hypotheticals. Nevertheless, the FSA took the position that the Punch Call should be viewed as a whole and in context, and, as a consequence, it was clear that an equity issuance was reasonably to be expected to occur imminently, notwithstanding the comments by Punch management to the contrary. Moreover, the FSA stated that although “there was no single statement of inside information, and some interpretation was required, the clear interpretation of the comments made on the Punch Call disclosed inside information.” Punch management’s and Andrew Osborne’s confirmation that no inside information had been disclosed did not prevent the FSA from reaching the conclusion that David Einhorn received inside information during the Punch Call. The FSA stated in its decision that reasonable investors are required to interpret comments and actions in their appropriate manner and if it is sufficiently clear that a conversation is not purely hypothetical, then disclaimers and other words to the effect that a conversation is purely hypothetical will not prevent inside information from being given and liability from being imposed.

Declining to cross the wall and acting in good faith alone do not satisfy the criteria for the reasonable care and all due diligence safe harbour

Under FSMA, no penalty will be applied for market abuse if a person can be said to have taken all reasonable precautions and exercised all due diligence to avoid committing, and reasonably believed that he had not committed, market abuse. In his defence, David Einhorn argued that he had refused to be “wall crossed”, engaged in the Punch Call on an open and nonconfidential basis, told Punch management and Andrew Osborne that he may trade in Punch’s shares, was told by Punch management at the conclusion of the call that no formal decision regarding the equity issue had been taken and that he had not been “wall crossed.” David Einhorn noted that he acted in good faith, the trading order was relayed to the trader who served as Greenlight’s UK compliance officer, and the sales were vetted by Greenlight’s in-house counsel to make sure that the necessary regulatory filings were made. However, the FSA took the view that David Einhorn should have been more diligent than usual regarding the possibility that he may have received confidential information given that he took the Punch Call after declining to be “wall crossed” and, in furtherance of this diligence, should have obtained compliance or legal advice before trading. Having failed to take these steps, the FSA decided that David Einhorn did not in fact exercise all due diligence to avoid committing market abuse and that his belief that he had not committed market abuse was not reasonable. Not only did the FSA find David Einhorn’s defence unpersuasive, the FSA also fined Greenlight’s UK compliance officer £130,000 on the basis that before selling Greenlight’s shareholding in Punch he failed to question and make reasonable enquiries to satisfy himself that the trade order was not based on inside information, despite the risk that it was.

Rebuttable presumption of dealing on the basis of inside information

Once it had been established that David Einhorn was in possession of inside information, the FSA took the view that there was a rebuttable presumption that he had traded on the basis of that information. This presumption is consistent with the European Court of Justice’s judgment in Spector Photo Group and Van Raemdonck v Commissie voor het Bank-, Financie-en Assurantiewezen. In this case, the ECJ found that the presumption was permissible under the EU Market Abuse Directive, [4] which is implemented in the UK by FSMA. In his defence, David Einhorn argued that he had reasons for trading other than the information conveyed during the Punch Call. Although the FSA acknowledged that this may have been the case, the FSA did not believe that David Einhorn had rebutted the presumption that he dealt on the basis of that information by showing that Punch’s proposed equity issuance did not play a material part in his decision. In addition, the FSA was not persuaded by the argument that Greenlight’s selling was not as aggressive as it could have been (Greenlight reduced its holdings from 13.3% to 9%) as Greenlight’s trading allowed it to avoid losses of approximately £5.8 million.

Key Lessons

From a US perspective, in light of the recent trend in SEC enforcement actions, any party who receives information of a sensitive nature similar to the information received by David Einhorn during the Punch Call should be cautious about trading on that information, particularly if a confidentiality agreement is in place or there is an expectation that the information will be kept confidential. This is particularly relevant in light of the SEC’s recent aggressive prosecution of insider trading offenses and the criminal convictions in cases involving tips from corporate insiders, including expert networks. The law in this area continues to develop.

From a UK perspective, the FSA decisions in the Greenlight matter are illustrative of positions which the FSA may take in respect of future investigations. For example, when considering whether inside information has been conveyed, the FSA will likely consider communications, taken as a whole, in their context and disclaimers and couching discussions in terms of hypotheticals will not be sufficient if in fact the intent is to convey more than purely hypothetical information. Also, unintentional violations of market abuse rules will not prevent the FSA from imposing significant fines, and good faith alone is not a defence to liability. Position, knowledge and experience will be weighed by the FSA, with less leeway being according to more senior and experienced individuals.

From a cross-border perspective, financial institutions and investment professionals active in UK financial markets (including those based in the US) should be mindful of the significant differences between US and UK market abuse regulation, including the following:

• Under UK market abuse regulations, if a person is an insider and possesses inside information, however obtained, that person is prohibited from dealing in the relevant securities.
• The definition of insider for the purposes of FSMA is broader than under the US securities laws, covering a person who has inside information, among other things, as a result of having access to the information through the exercise of his professional duties.
• In contrast to the US, the UK approach does not require that there be a fiduciary or fiduciary-like relationship or a duty of trust or confidence between the source of the information and the recipient of it.

David Einhorn’s defences did not prevent him from being fined by the FSA even though these defences would typically be relevant under US federal securities laws. Significantly, the various compliance mechanisms designed to detect and prevent insider trading abuses maintained by US asset managers, investment banks and expert networks may not be sufficient to prevent liability for violations of the UK market abuse rules. Since the FSA has been vigorously pursuing claims against market participants in the area of insider trading and market abuse generally, compliance, training and receiving appropriate legal advice can be critical.

The UK market abuse rules are based on the EU Market Abuse Directive and as a result the position regarding market abuse rules in the UK is similar throughout the EU. The European Commission is in the process of reviewing the EU Market Abuse Directive with a view towards enacting a new Directive which will replace existing EU and UK law. One of the proposed changes is to broaden the definition of inside information and thereby lower the bar for actions which could violate market abuse rules. Financial firms and investment professionals should be mindful of the forthcoming changes.

Endnotes

[1] Under Section 118B of FSMA, an insider is any person who has inside information–

(a) as a result of his membership of an administrative, management or supervisory body of an issuer of qualifying investments,

(b) as a result of his holding in the capital of an issuer of qualifying investments,

(c) as a result of having access to the information through the exercise of his employment, profession or duties,

(d) as a result of his criminal activities, or

(e) which he has obtained by other means and which he knows, or could reasonably be expected to know, is inside information.
(go back)

[2] Section 118C of FSMA.
(go back)

[3] Section 118C(5) states that information is precise if it:

(a) indicates circumstances that exist or may reasonably be expected to come into existence or an event that has occurred or may reasonably be expected to occur, and

(b) is specific enough to enable a conclusion to be drawn as to the possible effect of those circumstances.
(go back)

[4] Directive 2003/6/ED, of the European Parliament and Counsel of 28 January 2003 on insider dealing and market manipulation (Market Abuse Directive) and the corresponding regulations issued by the European Commission in relation to exemptions for buy-back programmes and stabilisation of financial instruments, Commission Regulations (EC) No. 2273/2003 of December 2003.
(go back)