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E-MailMarco Ventoruzzo is a comparative business law scholar with a joint appointment with the Pennsylvania State University, Dickinson School of Law, and Bocconi University.
The European Market Abuse Regulation (No. 596/2014), which rewrites many rules governing insider trading and market manipulation, will come into full force in June 2016 in the Member States of the Union. With respect to insider trading, the underlying approach remains based on the equal access to information theory and the idea that—absent specific exemptions—everyone in possession of a price-sensitive, inside information, cannot trade without running afoul of the law, unless the information is properly disclosed when this is allowed. In this perspective, Europe can be contrasted with the U.S., where the fiduciary duty theory of insider trading has created a complex web of doctrines and rules, and caused significant uncertainty (just consider the recent certiorari granted by the Supreme Court in light of a split among Circuit Courts on the scope of tippee liability (discussed on the Forum here)). For an overview of the different approaches on the two sides of the Atlantic, also in an historical perspective, see here.
The new European rules are however also very complex, and they will impose significant compliance costs to issuers and market operators, and risks of sanctions. Among many relevant developments, one that deserves scrutiny concerns “market sounding” governed by Article 11 of the Regulation. The topic was extensively discussed by Italian and German scholars and practitioners at a recent workshop at Bocconi Law School in Milan. Market sounding rules aim at avoiding that inside information selectively shared with only some investors and market participants in order to inquire about their interest in a proposed transaction, might lead to an illegal exploitation of information asymmetries. The regulation hides a small but fundamental conundrum.
In short, the new rules require that whoever approaches, for example, banks that might participate in a public offer of securities, should evaluate if inside information should be revealed in the course of the market sounding. If this is the case, before sharing any relevant information, the disclosing party must warn the person potentially receiving it and obtain her consent to the disclosure. The solicited person is in a sort of Catch-22: without the information, it is hardly possible to decide whether to participate in a transaction, but accepting the inside information determines compliance costs and potential liabilities. In fact, both parties need to keep a written record of their determinations, take steps to evaluate the inside nature of information exchanges (on which they might disagree), prepare a register of people having access to the information, and so on. Of course, these duties, limitations, and potential liabilities are particularly problematic if the person receiving the information decides not to participate in the transaction.
The conundrum I mentioned is, however, even more tricky, and lies in the fact that even just the “warning” concerning the possibility, by continuing the discussion, to obtain inside information, could in some cases be an inside information.
Some readers will remember the scene of the motion picture “The Matrix” in which the head of the rebels Morpheus/Fishburne offers to Neo/Reeves the choice between the blue pill, which will make him forget their conversation and go back to his “normal life;” and the red pill, which will allow him to know the entire truth, but forever change his life and enlist him in the fight against the machines (for those who don’t, here’s a clip). A person approached under the “rules of engagement” of market sounding is in a somehow similar, if less dramatic, situation, with one profound difference: there is no blue pill granting the bliss of oblivion, and even simply being aware of the possibility of a transaction and obtain privileged information might lead to delicate legal consequences. The reason is that, even just to inquire about the availability to receive inside information, you need to disclose “something.” Simply knowing that X Inc., e.g. a bank with non-performing loans that might need an injection of capital, is seeking sponsors for issuing new shares, could be sufficient to infer what is going on.
This might seem the concern of a hyper-scrupulous lawyer, but market participants must consider this issue seriously. When does the mere request concerning the availability to receive inside information amount to inside information?
The solution should be found in the fact that this “pre-information” and warnings, this “testing the water,” by definition vague and generic, should not be precise and price-sensitive enough to be considered inside information. However, life, in this area, is rarely so simple.
There is a tendency at the European level and in single Member States, of both courts and regulatory authorities, to interpret broadly the notion of inside information. Just to offer a couple of examples, in the 2013 controversial (and not entirely clear) Lafonta case, the European Court of Justice determined that inside information does not require the person receiving the information to understand in which direction the market price might be affected—if it would go up or down. The rationale was that it is possible, especially through derivative instruments, also to speculate knowing that prices will vary in the future. In a somehow similar vein, in an insider trading case in 2014, the Italian Securities Supervisor, Consob, concluded that a market participant had shared sufficiently precise information with a tipee mentioning—in quite suggesting terms—a famous actress and showgirl, who at the time was dating the CEO of the corporation involved (the decision, only in Italian, is available here). It is common knowledge that insider trading accusations—as it is partially inevitable—are often based, and not only in Europe, on subtle hints, allusions, half-words, a cryptic phone call, a coffee with the wrong person, the mere circumstance that an insider shares a desk with an alleged tippee. This might all have rhyme and reason, but the broader the boundaries of inside information, the easier it is to be captured by the rules we are discussing also at a very preliminary stage of market soundings.
One might observe that the rules established by Article 11 of the Market Abuse Regulation simply formalize procedures that it would have been desirable to adopt also before the new regime, in order to protect inside information, the integrity of the market, and correct market activity. Possibly true, but this conclusion is of little avail for the conundrum illustrated. To go back to the “Matrix” metaphor, these rules, like the movie, blur the boundaries between reality and imagination. We can only hope that the “Agent Smith” responsible for policing the market, and humans operating in the “Matrix” of the European legal systems, will find a common ground to enhance legal certainty.
