As described in our introductory article on Market Abuse (“What is Market Abuse?”) and the regulatory framework in the UK, the behaviour that constitutes Market Abuse can be classified in two categories, abuse of information or market manipulation. These in turn have three respectively four sub-categories of behaviour, making it 7 categories, or better, the 7 deadly sins of Market Abuse. This and the following articles of this series will look at each of the 7 forms of punishable behaviour under the Market Abuse Regime in more detail and provide practical examples and cases. Part I will start with Insider Dealing.
Insider dealing is dealing or attempting to deal on the basis of inside information. This definition is in line with the first Market Abuse Directive and the FSA, the then regulatory authority in the UK, adaption of it in the Code of Market Conduct as for example in the FSA’s factsheet.
The first question that springs to mind is what is inside information? The EU in its Market Abuse Directive of 2003 had defined it as “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.”
Based on this, one can determine whether information would be considered inside information by asking the following questions:
- Is it precise information that is not generally available?
- Is it related to one or more issuers or investment?
- Would a reasonable investor use it to help them make a investment decisions in that issuer or security?
- And, if it were generally available, would it be likely to significantly affect the price of an investment?
All answers YES? Inside information!
So far so good and if that sounded simple, the FCA has provided further detail in MAR 1.3 of the FCA Handbook on what behaviours consider to be insider dealing:
- dealing on the basis of inside information which is not trading information;
- front running/pre-positioning – that is, a transaction for a person’s own benefit, on the basis of and ahead of an order (including an order relating to a bid) which he is to carry out with or for another (in respect of which information concerning the order is inside information), which takes advantage of the anticipated impact of the order on the market or auction clearing price;
- in the context of a takeover, an offeror or potential offeror entering into a transaction in a qualifying investment, on the basis of inside information concerning the proposed bid, that provides merely an economic exposure to movements in the price of the target company’s shares (for example, a spread bet on the target company’s share price); and
- in the context of a takeover, a person who acts for the offeror or potential offeror dealing for his own benefit in a qualifying investment or related investments on the basis of information concerning the proposed bid which is inside information.
The FCA Handbook carries on to explain in further detail more factors that can help to determine whether a behaviour constitutes market abuse in the form of insider dealing, for example in particular situations like the making a market or executing client orders, takeover and merger activity. Thus, it is very useful and at times necessary to go through the single sections, but for the sake of this article and in order to not overcomplicate things, we will focus on the general aspects.
One such aspect is to keep in mind that the offence of insider dealing isn’t limited to dealing or attempting to deal on inside information; it also includes encouraging others to deal based on the inside information for example selective briefing at ours by directors or managers of issuers.
The FCA Handbook provides two examples (and several more all related to commodity derivatives though) for insider dealing:
- X, a director at B PLC has lunch with a friend, Y. X tells Y that his company has received a takeover offer that is at a premium to the current share price at which it is trading. Y enters into a spread bet priced or valued by reference to the share price of B PLC based on his expectation that the price in B PLC will increase once the take over offer is announced.
- An employee at B PLC obtains the information that B PLC has just lost a significant contract with its main customer. Before the information is announced over the regulatory information service the employee, whilst being under no obligation to do so, sells his shares in B PLC based on the information about the loss of the contract.
However, to put it into practical terms and real life cases, which might be more memorable and give an idea of the stakes, i.e. the fees and consequences of dealing on inside information and getting caught are, have a look the following cases:
- The Financial Conduct Authority (FCA) fine of Kenneth Carver for £35k for insider dealing. Carver, a retired accountant, purchased 62,000 shares in Logica Plc (Logica) on the basis of information Ryan Willmott, a family friend, provided to him. Mr Willmott held inside information relating to a potential takeover of Logica through his employment at the group. See the FCA’s press release here: http://www.fca.org.uk/news/kenneth-carver-fined-for-insider-dealing
- The sentencing of Ryan Willmott to 10 months imprisonment for insider dealing. Willmott admitted dealing on the basis of inside information he obtained during the course of his employment relating to the takeover of Logica PLC by CGI Group, as publicly announced on 31 May 2012. Willmott set up a trading account in the name of a former girlfriend, without her knowledge, to carry out the trading. He also admitted disclosing inside information to a family friend, who then went on to deal on behalf of Willmott and himself. See the FCA’s press release here: http://www.fca.org.uk/news/ryan-willmott-sentenced-to-imprisonment-for-insider-dealing
- The final case of the FCA’s Operation Tabernula that led to the sentencing of Julian Rifat – a former senior execution trader and portfolio strategist at Moore Europe Capital Management LLC – by the Southwark Crown Court to 19 months imprisonment and a fine of £100k plus costs of £159k. Rifat had passed inside information, obtained during the course of his employment, to an associate, Graeme Shelley, who then traded for their joint benefit. Graeme Shelley, previously a broker at Novum Securities, pleaded guilty to insider dealing with Rifat and with another associate, Paul Milsom, in March 2014; Paul Milsom, an execution trader at Legal and General Insurance Management Ltd, pleaded guilty to insider dealing in March 2013. See this and the related cases here: http://www.fca.org.uk/news/former-senior-trader-sentenced-for-insider-dealing
- With regard to offence in encouraging others, see the FCA’s Final Notice in relation to Mr Rahul Shah. Shah had encouraged another person to engage in behaviour that would have amounted to market abuse, if it had been engaged in by Mr Shah. But for Mr Shah’s financial position he would have been fined £125,000. Mr Shah was prohibited from performing regulated activities: http://www.fca.org.uk/your-fca/documents/final-notices/2013/mr-rahul-shah
- Rajat Gupta, who had been managing partner of McKinsey & Co. and a director at Goldman Sachs Group Inc. and Procter & Gamble Co., was convicted by a federal jury in 2012 of leaking inside information to hedge fund manager Raj Rajaratnam, the founder-owner of Galleon. To see the full ruling of the United States District Court, see here (http://www.nysd.uscourts.gov/cases/show.php?db=special&id=234 )
- The FSA fine for Greenlight Capital and its owner David Einhorn for £7.2 million for engaging in market abuse in relation to an anticipated significant equity fundraising by Punch Taverns Plc (Punch). See the FSA statement for more information on the case: http://www.fsa.gov.uk/library/communication/pr/2012/005.shtml
For further examples, have a look at the FCA’s Market Abuse Outcome page, where the FCA continues to publish information about action it has taken against market abuse and other related conduct: http://www.fca.org.uk/firms/markets/market-abuse/outcomes
Follow our series on the 7 deadly sins of Market Abuse in the next article on “Improper Disclosure” here.