MAD regulation in the UK The impact of EU law on the regulation of market abuse in the UK Martyn Hopper 23 May 2005

2 Contents Background The pre-2001 regime – fiduciaries and intent The market abuse regime – the elusive “effects-based” regime The market abuse regime post-MAD – in search of a coherent rationale Problem areas The death of the “reasonable regular user” Materiality -vs- price sensitivity Trading information Prevention and detection Consistency of interpretation and enforcement across the EU

3 Background The pre-2001 regime – fiduciaries and intent Insider dealing –“insiders” who have information through their office, employment or profession –specifc/precise price sensitive information –knowledge –intention to profit Market manipulation –Proof of purpose to mislead –Proof of purpose to induce others to buy/sell

4 Background The market abuse regime – the elusive “effects based” regime “misuse of information” –Any behaviour by any person “based on” relevant information –Source of the information is irrelevant –FSA Code provisions make “disclosability” key –No need to prove »Specific /precise / price sensitivity »knowledge of significance of information »intention to profit –But “based on” and “disclosability” bring some of these concepts back “misleading impressions” and “distortion” –The move towards a negligence standard for misleading/distorting the market –FSA Code provisions reintroduce purpose tests for many types of manipulation

5 Background The market abuse regime post-MAD – in search of a coherent rationale Insider dealing –Follows the disclosability rationale – information which must be disclosed cannot be dealt upon –“Insiders” are anyone who has inside information »true insiders, or »those who “could reasonably be expected to know” that it is inside information –Specific /precise / price sensitivity –No need to prove »knowledge of significance of information – but dealing must be “on the basis of” the information »intention to profit Market manipulation –No purpose test for false or misleading transactions, disseminating misleading information or abnormal prices –Wide prohibition of “fictitious devices or any other form of deception or contrivance”

6 Problem areas The death of the “reasonable regular user” A long-stop on the regime to protect legitimate trading practices Post-MAD “accepted market practices” defence –Only available in relation to false or misleading transactions and abnormal/artificial prices –Requires acceptance by the regulator Where does this leave the role of purpose in assessing allegations of market abuse? To what extent is market practice relevant in assessing whether information is likely to mislead?

7 Problem areas Materiality vs price sensitivity Two competing definitions –Likely to have a significant effect on price –Likely to be regarded as significant by reasonable investors Tension between test for continuing disclosure by issuers and test for insider dealing prohibitions – caused by abandoning the fiduciary model for insider dealing regulation?

8 Problem areas Trading information regime: general safe harbour for dealing on the basis of trading information Post-MAD – inside information includes information about pending client orders “Front-running” – an abuse on the customer or an abuse on the market? Information of potential large order Details of unexecuted client order Unreported information on executed trade Information on reported trade Firm order acceptedTrade executedTrade reported

9 Problem areas Prevention and detection Controls over access to inside information – “need to know” policies –What standard of protection is required? Requirements to record who has access – insider lists –Who has “access”? Expanded directors/senior executive dealing disclosures –Who is a senior manager? –Who is a connected person? Extension of Model Code requirements to all who have access Suspicious trade reporting obligations –What is the extent of intermediaries monitoring obligation? Research recommendations and conflicts of interest –What does this have to do with market abuse?

10 Problem areas Consistency of interpretation and enforcement across the EU Will we see real harmonisation of standards? Do we want real harmonisation of standards? How will overlapping enforcement jurisdiction be managed? What are the implications of extending administrative fining powers across the EU?

11 Herbert Smith LLP, Gleiss Lutz and Stibbe are three independent firms which have a formal alliance