Legal Aspects of Finance Slide Set 8a Legal Liabilities on Securities Markets Calculating Adequately Causal Losses Matti Rudanko

Prerequsites of a compensation claim: Market Fraud Theory (1) insufficient or false information was published by the defendant (2) the inadequacy of the information was material (3) the securities were quoted on an efficient market (4) the inadequacy makes an average investor to misjudge the price of the actual security, and (5) the plaintiff transacted during the period between the publishing of the inadequate information and its correction Prerequsites of a compensation claim: Legal Aspects of Finance 8a

Background: market efficiency Legal Aspects of Finance 8a

Efficient Capital Markets Hypothesis ECMH (Fama Journal of Finance 1970) Legal Aspects of Finance 8a

Market Model for Investment Behavior Price development gives all the information relevant to an investor appraisal of a share is not a matter of economic valuation of the enterprise or its assets Cf. Information Theory of investment behavior investors seek as much information as possible and analyze it as a basis for investment decisions - Legal Aspects of Finance 8a

Portfolio theory and damages Systematic risk (market risk) portfolio diversification entitles to no compensation non-systematic risk ß -coefficient: relation between the volatility of a share and that of the market helps to correct the price development of the share for assessing the loss due to info failures Legal Aspects of Finance 8a

CAPM, Black – Scholes (1973 Journal of Political Economy) Theoretical models with mathematical method based applications Capital-asset pricing model (CAPM): Required return of an asset: return of risk free asset + β1 x (expected market return – risk free return) Black – Scholes options pricing model Right price: not possible to get risk free profits (arbitrage) by creating investment portfolios from short / long positions of an option and corresponding asset (share) Legal Aspects of Finance 8a

Capital Asset Pricing Model (CAPM) https://en. wikipedia The CAPM is a model for pricing an individual security or portfolio. For individual securities, we make use of their relation to expected return and systematic risk (beta) to show how the market must price individual securities This enables us to calculate the reward-to-risk ratio for any security in relation to overall market reward-to-risk ratio (the market risk premium) Legal Aspects of Finance 8a

Capital Asset Pricing Model (CAPM) Legal Aspects of Finance 8a

Event Study Based Method of Calculating Damage Dannenberg – Turtiainen 2013 European Journal of Law and Economics Based on material from TJ Group Case (KKO 2009:1) Market correlations after the the event (rectificaton of the false information, e.g. profit warning) are used to calculate backwards from the event. Statistical confidence levels are assumed Question to solve: how markets would have behaved if the information had been published earlier More accurate mathematical tools available Legal Aspects of Finance 8a

More Accurate Mathematical Tools vs. Supreme Court Reasoning KKO 2009:1: Defining the utility pursued and produced by misuse of inside information often based on such estimations that the random factors affecting them cannot be known in advance and that their influence on the rate of securities cannot exactly be known afterwards. Dannenberg and Turtiainen (2013): wanton court practices while damages are estimated subjectively without mathematical tools resulting in too mild verdicts A question of legal safety and due process Legal Aspects of Finance 8a

Damage due to information failure Damage due to information failure should usually be compensated only to investors who have traded in securities affected by the information failure during the duration of the effect of the information failure. Decision not to invest should in general not be deemed to be a compensabe loss, nor the effect of the information failure on the price of other securities of the issuer unless the information failure is a case of market abuse. The duration of the effect of an information failure shall in general be deemed to end when the wrong informaton has been corrected. Legal Aspects of Finance 8a

Compensation of Price Difference According to international practice, compensation of price difference is the way of defining the loss due to information failures. Other methods of loss definition may be appropriate when price formation on the market has not been efficient. Price difference based compensation consists of the difference between the materialized purchase or selling price of the security and the price of the security at the trading moment under correct information It prevents compensation of market risk and uncontrollably large damages liabilities that would also be speculative with respect to their contents. The compensation shall be decreased by the amount of the profit that the information failure has yielded to the injured person in reverse trades Legal Aspects of Finance 8a

Assessing the amount of a loss The “maturity time” (becoming compensable) of loss e.g. breach of redemption duties (AML 6:2): the current price of redemption time subtracted with actual current price (possible later profits have no effect) Legal Aspects of Finance 8a

Trial on Securities Markets Loss Cases The Act on Class Actions (444/2007) Act does not apply to a civil case concerning the conduct of an issuer of securities or the offeror in a takeover bid or mandatory bid. In a criminal case, e.g. abuse of insider information, there is no injured party but the object of legal protection is confidence in securities markets. An investor has no plaintiff position in these cases. (the Finnish Supreme Court KKO 2000:82, so-called Kansallisanti [National Issue] case). Legal Aspects of Finance 8a