Market Abuse Market abuse insider trading market manipulation

Market Abuse

• Market abuse: • insider trading • market manipulation • Insider trading: trading (by insiders) (ab)using inside information • Should Insider Trading Be Banned?

Should Insider Trading Be Banned? • (Selected) theories against the ban Victimless crime Managers’ compensation scheme Market efficiency • (Selected) theories for the ban Misappropriation theory Market egalitarianism Market integrity

Victimless crime Disclosure

Victimless crime Insider buys Disclosure

Victimless crime Insider buys Disclosure

Victimless crime Seller Insider buys Disclosure

Victimless crime Seller’s profits Insider buys Disclosure

Victimless crime Who are the sellers? • Intermediaries market makers, arbitrageurs • Institutional investors funds, pension funds, hedge funds • Other investors liquidity investors

Managers’ compensation scheme Henry Manne, Insider Trading and Stock Market, 1966 • salaries do not incentivize • bonus are too expensive • stock option are not flexible • insider trading is optimal

Market efficiency Weak – Previous prices Semi-strong – Public information Strong – Private information (Ban does not allow to reach Strong market efficiency)

market efficiency Fundamentals Insider’s trades Disclosure

Market efficiency See also Jonathan Macey: Corporate Governance: Promises Kept, Promises Broken, 2012 • Allowing insider trading on negative news would provide incentives to speed-up identification of securities frauds

Misappropriation theory Information is a company’s asset Insider as thief PS Can the company be insider?

market egalitarianism Potentially all investors should benefits from the same set of information

Market integrity • Theory of asymmetric information: impact on Intermediaries and Institutional investors • intermediaries as market maker: bid-ask spreads of all the stocks increase

market integrity No insider trading ban Insider’s trades Disclosure

market integrity institutional investors buy short sell Insider’s trades Disclosure

market integrity Effects of institutional investors’ losses: research price liquidity market confidence allocative efficiency market failures

REGULATORY IMPLICATIONS market integrity vs market efficiency How to face the cost of introducing a ban? Disclosure

REGULATORY IMPLICATIONS B A C Insider’s trades Disclosure

REGULATORY IMPLICATIONS B A C Insider’s trades Disclosure

B B* A Insider’s trades C* Disclosure AB*C* < ABC C

Insider trading: empirical evidence price run-up before takeovers Italy 8% (1991) UK 15% (1985) Insider’s trades

U. Bhattacharya – H. Daouk The World Price of Insider Trading (1999) 103 equity markets Insider trading ban enforcement 1989 34 9 Companies’ cost of capital is not affected by the ban while it is reduced by 5% in case of enforcement 1999 87 34

Market Integrity – An integrated and efficient financial market requires market integrity. – The smooth functioning of securities markets and public confidence in markets are prerequisites for economic growth and wealth. – Market abuse harms the integrity of financial markets and public confidence in securities and derivatives 26

The MAD… framework: from 1989 to 2003 Council Directive 89/592/EEC of 13 November 1989 coordinating regulations on insider dealing Lamfalussy procedures Level 1 Directive 2003/6/EC Level 2 Directive 124/03 (inside info) Level 2 Directive 125/03 (investment recommendations) Level 2 Regulation 2273/03 (safe harbours) Level 2 Directive 72/04 (AMP, insiders list, …) Level 3 first set CESR guidance (AMP, …), Level 3 second set CESR guidance (inside info, delay, …), Level 3 third set CESR guidance

The MAD… framework: from 2003 to 2013 1. ESME paper (2007) 2. Consultation on MAD revision (April 2009) 3. Market Abuse Regulation (596/2014) replace all the above 4. NEW Market Abuse Directive 2014/57/EU

Motivation for 2003 modifications of the EU market abuse framework NO existing directive on mkt manipulation (only on insider) Great diversity at national level (rules and enforcement) New financial instruments and techniques increasing mkt manipulation Need to protect market integrity to ensure integration of financial markets (other directives: ISD, single prospectus, transparency, takeover) Motivation for 2013 modifications of the EU market abuse framework gaps in regulation of new markets, platforms and over-the-counter (OTC) trading in financial instruments gaps in regulation of commodities and commodity derivatives regulators cannot effectively enforce the MAD lack of legal certainty undermines the effectiveness of the MAD, and administrative burdens, especially for small and medium-sized companies (SMEs).

Act Delegated acts TFUE Lamfalussy Level Draft preparation Final adoption Art. 290 2 Commission Implementing acts Art. 291 2 Commission (Comitology Reg. 182/2011) Regulatory Technical Standards (RTS) Art. 290 2+ ESMA Commission Implementing Technical Standards (ITS) Art. 291 2+ ESMA Commission Guidelines and Recomm. [Art. 263] 3 ESMA

Act MAR (Selected) Delegated acts • • Integration of indicators for manipulative conducts (Annex I) Exceptions to trading prohibitions during “close periods” Implementing acts • Privacy measures in case of whistleblowing RTS • • Buy back and stabilization conditions Detection systems for market abuse Market sounding procedures Transparency of investment recommendations ITS • • Communications inside information (means of publication; delay procedures) Way of keeping insider register (Selected) Guidelines and Recommendations • • • Conditions for delay disclosure (interest and misleading) Conduct rules for entities sounded during market sounding Means for disclosure obligations for SMEs

Inside information (art. 7 MAR) (a) "Inside information" shall mean 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 32

Inside information (art. 7 MAR) (b) "Inside information" shall mean, in relation to derivatives on commodities, information of a precise nature, which has not been made public, relating, directly or indirectly to one or more such derivatives or relating directly to the related spot commodity contract, and which, if it were made public, would be likely to have a significant effect on the prices of such derivatives or related spot commodity contracts and where this is information which is reasonably expected to be disclosed or required to be disclosed in accordance with legal or regulatory provisions at the Union or national level, market rules, contracts, practices or customs, on the relevant commodity derivatives or spot markets. 33

Inside information (art. 7 MAR) (d) for persons charged with the execution of orders concerning financial instruments, it also means information conveyed by a client and related to the client's pending orders in financial instruments, which is of a precise nature, which relates, 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, the price of related spot commodity contracts, or on the price of related derivative financial instruments. 34

Inside information (art. 7 MAR) 2. For the purposes of applying paragraph 1, information shall be deemed to be of a precise nature if it indicates a set of circumstances which exists or may reasonably be expected to come into existence or an event which has occurred or may reasonably be expected to do so and if it is specific enough to enable a conclusion to be drawn as to the possible effect of that set of circumstances or event on the prices of the financial instruments, the related spot commodity contracts, or the auctioned products based on the emission allowances. In this respect in the case of a protracted process intended to bring about, or that results in, a particular circumstance or a particular event, not only may that future circumstance or future event be regarded as precise information, but also the intermediate steps of that process which are connected with bringing about or resulting in that future circumstance or event. 35

Inside information (art. 7 MAR) 3. An intermediate step in a protracted process can be inside information if, by itself, it satisfies the criteria of inside information as referred to in this article. 4. For the purposes of applying paragraph 1, information which, if it were made public, would be likely to have a significant effect on the prices of financial instruments, related spot commodity contracts, or auctioned products based on emission allowances shall mean information a reasonable investor would be likely to use as part of the basis of his investment decisions. 36

Prohibition of insider dealing and of improperly disclosing inside information (art. 14, MAR) A person shall not: (a) engage or attempt to engage in insider dealing (art. 8); (b) recommend that another person engages in insider dealing or induce another person to engage in insider dealing (art. 8); or (c) improperly disclose inside information. 37

(Selected) Exceptions MAR Article 9 Legitimate behaviour Chinese walls Meeting pre-existing obligations Due diligence in view of a takeover (if disclosed to addresses) Article 11 Market soundings Use of information by addressees is prevented 38

Issuers disclosure obligation of inside information: • WHAT • WHEN • WHERE to disclose 39

What to disclose pre-MAD • Inside information/vs material info: different definitions in different documents; possibility not to disclose. • 79/279 and 2001/34: companies with listed shares (on regulated markets) shall inform the public only of “any major new developments in its sphere of activity which are not public knowledge and which may, by virtue of their effect on its assets and liabilities or financial position or on the general course of its business, lead to substantial movements in the prices of its shares” (art. 68 of Directive 2001/34). 40

What to disclose MAD 2003 Level 1 -2 • Inside info: inside information defined in the directive is the basis for both the obligation to disclose and the identification of the cases of market abuse • Only difference: “…which directly concern the issuer” (i. e. its own sphere? ) • Article 6. 2 stipulates that an issuer may under his own responsibility delay the public disclosure of inside information such as not to prejudice its legitimate interests provided that such omission would not be likely to mislead the public and that the issuer is able to ensure the confidentiality of this information. • MS may require an issuer (on regulated markets) to inform competent authority of the decision to delay • MS shall ensure issuers are deemed to have complied with MAD where, upon the coming into existence of a set of circumstances or the occurrence of an event, albeit not yet formalized, the issuers have promptly informed the public thereof • FD rule: simultaneous or promptly public disclosure in case of intentional or unintentional disclosure • CESR list (Italian Guide) 41

What to disclose MAR 2014 (art. 17. 1) • An issuer of a financial instrument (regulated markets but also MTF and OTF) shall inform the public as soon as possible of inside information, which directly concerns said issuer. • The issuer shall ensure that the inside information is made public in a manner which enables fast access and complete, correct and timely assessment of the information by the public and, where applicable, in the Officially Appointed Mechanism referred to in the Transparency Directive. • The issuer must not combine the disclosure of inside information to the public with the marketing of its activities. The issuer shall post and maintain on its official website for a period of at least five years, all inside information it is required to disclose publicly. 42

What to disclose MAR 2013 (art. 17. 4) An issuer may under his own responsibility delay the disclosure of inside information, provided that all of the following conditions are met: the immediate disclosure would likely prejudice his legitimate interests; the omission would not be likely to mislead the public; the issuer of a financial instrument or emission allowance market participant is able to ensure the confidentiality of that information. Subject to the conditions referred to above, in the case of a protracted process, which occurs in stages, intended to bring about or which results in a particular circumstance or a particular event, an issuer may under his own responsibility delay the public disclosure of inside information relating to this process. Where an issuer has delayed the disclosure of inside information, it shall inform the competent authority that disclosure of the information was delayed and provide in writing an explanation on how the conditions were met, immediately after the information is disclosed to the public. National law may alternatively provide that a record of such explanation may be submitted only upon request of the competent authority. 43

What to disclose MAR 2013 (art. 17. 5) • In order to preserve the stability of the financial system, an issuer which is a credit institution or a financial institution, may under its own responsibility delay the public disclosure of inside information, including information which is related to a temporary liquidity problem, and in particular the need to receive temporary liquidity assistance from a central bank or lender of last resort, provided that all the following conditions are satisfied : (a) the disclosure of the information entails a risk of undermining the financial stability of the issuer and of the financial system; (b) it is in the public interest to delay the disclosure; (c) the confidentiality of that information can be ensured; and (d) the competent authority has consented to the delay on the basis that the conditions in points (a) to (c) are met. • The competent authority shall ensure that the delay is only for such period as is necessary in the public interest. The competent authority shall evaluate at least on a weekly basis if the conditions set out in points (a) to (c) are met. • If the competent authority does not consent to the delay, the issuer shall disclose the information immediately. • This paragraph shall apply to cases where the issuer decides not to delay the disclosure of inside information according to paragraph 4. 44

When to disclose • As soon as possible (Without delay, when issuer knows it if indirect, preparing press release before, procedures in place, …) • Open vs closed market/after hour trading • Listed vs going to be listed issuers • Rumours (17. 7): If the confidentiality of inside information not disclosed under the conditions of paragraphs 4 or 5, is no longer ensured, the issuer has to inform the public of this information as soon as possible. This includes situations where a rumour explicitly relates to a piece of inside information which has not been disclosed under paragraphs 4 or 5 when that rumour is sufficiently accurate to indicate that the confidentiality of that information is no longer ensured. 45

Where to disclose PRE MAD: • Electronic form • Newswire • Press agencies • Newspapers • Web sites POST: officially appointed mechanism (plus? ) 46

Preven(ta)tive measures Suspicious transactions Disclosure obligations Register of insiders Managers’ transactions Investment Recommendations And statistics … whistleblowers 47

MAD and MAR: a fatal flaw? Insider trading vs price sensitive info (ESME report) – Companies may delay the decision-making body approval – Companies may wait until the information is (almost) certain before disclosing (higher level of precision required) – Companies may make extensive use of delay (in certain MS, delay is (was) simplified, in others still authorized) – Some companies disclose too early (on purpose? ) – Risk of more insider trading or more market manipulation 48

Insider trading - Example 49

Manipulation – Example 50

Manipulation 1. 1 Types of manipulation: Trade based manipulation Information based manipulation (sometimes considered as including action based manipulation) 51

Manipulation 1. 2 Trade based manipulation - In this case the manipulator tries to cause a price change in the price of a security by trading in the market. - E. g. the manipulator through a series of purchases in the market tries to induce others to think that he is an insider and thus to follow him in buying the security in order to create a “speculative bubble” 52

Manipulation 1. 3 Action based manipulation - In this case the manipulator tries to cause a change in the price of a security through actions that give the appearance of an active market in such security Examples: • wash sales (transactions involving no change in the beneficial ownership of the security); • matched trades (the buyer and seller have previously agreed to cancel the effects of the trade); • In both the examples the manipulator is bearing no risk. 53

Manipulation 1. 4 Information based manipulation - In this case the manipulator tries to cause a change in the price of a security by spreading false, exaggerated or misleading information. - Internet is the ideal way to implement such strategy 54

Manipulation 1 Definition (Art. 12) (a) entering into a transaction, placing an order to trade or any other behaviour which: - gives, or is likely to give, false or misleading signals as to the supply of, demand for, or price of, a financial instrument, a related spot commodity contract or an auctioned product based on emission allowances; or - secures, or is likely to secure, the price of one or several financial instruments, a related spot commodity contract or an auctioned product based on emission allowances at an abnormal or artificial level; unless the person entering into a transaction, placing an order to trade or engaging in any other behaviour establishes that such transaction, order or behaviour have been carried out for legitimate reasons, and conform with an accepted market practice as established in accordance with Article 13; 55

Manipulation 2 Definition (Art. 12) (b) entering into a transaction, placing an order to trade or any other activity or behaviour which affects or is likely to affect the price of one or several financial instruments, a related spot commodity contract or an auctioned product based on emission allowances, which employs a fictitious device or any other form of deception or contrivance; 56

Manipulation 3 Definition (Art. 12) c) disseminating information through the media, including the internet, or by any other means, which gives, or is likely to give, false or misleading signals as to the supply of, demand for, or price of, a financial instrument, a related spot commodity contract or an auctioned product based on emission allowances or secures, or is likely to secure, the price of one or several financial instruments, a related spot commodity contract or an auctioned product based on emission allowances at an abnormal or artificial level, including the dissemination of rumours, where the person who made the dissemination knew, or ought to have known, that the information was false or misleading; (d) transmitting false or misleading information or providing false or misleading inputs in relation to a benchmark where the person who made the transmission or provided the input knew or ought to have known that it was false or misleading, or any other behaviour which manipulates the calculation of a benchmark. 57

Manipulation 4 Definition (Art. 12) 2. The following behaviour shall, inter alia, be considered as market manipulation: (a) the conduct by a person, or persons acting in collaboration, to secure a dominant position over the supply of or demand for a financial instrument, related spot commodity contracts or auctioned products based on emission allowances which has, or is likely to have, the effect of fixing, directly or indirectly, purchase or sale prices or creates, or is likely to create, other unfair trading conditions; (b) the buying or selling of financial instruments, at the opening or closing of the market, which has or is likely to have the effect of misleading investors acting on the basis of the prices displayed, including the opening or closing prices; 58

Manipulation 5 Definition (Art. 12) (c) the placing of orders to a trading venue, including any cancellation or modification thereof, by any available means of trading, including by electronic means, such as algorithmic and high-frequency trading strategies, and which has one of the effects referred to in paragraph 1(a) or (b), by: (i) disrupting or delaying the functioning of the trading system of the trading venue or being likely to do so; (ii) making it more difficult for other persons to identify genuine orders on the trading system of the trading venue or being likely to do so, including by entering orders which result in the overloading or destabilisation of the order book; or (iii) creating or being likely to create a false or misleading signal about the supply of, or demand for, or price of, a financial instrument, in particular by entering orders to initiate or exacerbate a trend; 59

Manipulation 6 Definition (Art. 12) (d) the taking advantage of occasional or regular access to the traditional or electronic media by voicing an opinion about a financial instrument, related spot commodity contract or an auctioned product based on emission allowances (or indirectly about its issuer) while having previously taken positions on that financial instrument, a related spot commodity contract or an auctioned product based on emission allowances and profiting subsequently from the impact of the opinions voiced on the price of that instrument, related spot commodity contract or an auctioned product based on emission allowances, without having simultaneously disclosed that conflict of interest to the public in a proper and effective way; 60

Indicators of Manipulation MAR Annex 1 A. Indicators of manipulative behaviour relating to false or misleading signals and to price securing For the purposes of applying point (a) of Article 12(1) of this Regulation, and without prejudice to the forms of behaviour set out in paragraph 2 of that Article, the following non-exhaustive indicators, which shall not necessarily be deemed, in themselves, to constitute market manipulation, shall be taken into account when transactions or orders to trade are examined by market participants and competent authorities: (a) the extent to which orders to trade given or transactions undertaken represent a significant proportion of the daily volume of transactions in the relevant financial instrument, related spot commodity contract, or auctioned product based on emission allowances, in particular when those activities lead to a significant change in their prices; (b) the extent to which orders to trade given or transactions undertaken by persons with a significant buying or selling position in a financial instrument, a related spot commodity contract, or an auctioned product based on emission allowances, lead to significant changes in the price of that financial instrument, related spot commodity contract, or auctioned product based on emission allowances; 61

Indicators of Manipulation MAR Annex 1 A. Indicators of manipulative behaviour relating to false or misleading signals and to price securing (c) whether transactions undertaken lead to no change in beneficial ownership of a financial instrument, a related spot commodity contract, or an auctioned product based on emission allowances; (d) the extent to which orders to trade given or transactions undertaken or orders cancelled include position reversals in a short period and represent a significant proportion of the daily volume of transactions in the relevant financial instrument, a related spot commodity contract, or an auctioned product based on emission allowances, and might be associated with significant changes in the price of a financial instrument, a related spot commodity contract, or an auctioned product based on emission allowances; (e) the extent to which orders to trade given or transactions undertaken are concentrated within a short time span in the trading session and lead to a price change which is subsequently reversed; 62

Indicators of Manipulation MAR Annex 1 A. Indicators of manipulative behaviour relating to false or misleading signals and to price securing (f) the extent to which orders to trade given change the representation of the best bid or offer prices in a financial instrument, a related spot commodity contract, or an auctioned product based on emission allowances, or more generally the representation of the order book available to market participants, and are removed before they are executed; and (g) the extent to which orders to trade are given or transactions are undertaken at or around a specific time when reference prices, settlement prices and valuations are calculated and lead to price changes which have an effect on such prices and valuations. 63

Indicators of Manipulation MAR Annex 1 B. Indicators of manipulative behaviour relating to the employment of a fictitious device or any other form of deception or contrivance For the purposes of applying point (b) of Article 12(1) of this Regulation, and without prejudice to the forms of behaviour set out in paragraph 2 of that Article thereof, the following non-exhaustive indicators, which shall not necessarily be deemed, in themselves, to constitute market manipulation, shall be taken into account where transactions or orders to trade are examined by market participants and competent authorities: (a) whether orders to trade given or transactions undertaken by persons are preceded or followed by dissemination of false or misleading information by the same persons or by persons linked to them; and (b) whether orders to trade are given or transactions are undertaken by persons before or after the same persons or persons linked to them produce or disseminate investment recommendations which are erroneous, biased, or demonstrably influenced by material interest. EN 12. 6. 2014 Official Journal of the European Union L 173/55 64

Manipulation vs. Buy Back Program and Stabilization (Art. 5) “The prohibitions in Articles 14 and 15 of this Regulation shall not apply to trading in own shares in buy-back programmes. . or to trading in securities or associated instruments for the stabilisation of securities”. . . conditions Safe harbour Insider trading (i. e. Exemption) Market Manipulation 65

The Directive on criminal sanctions on market abuse (2014/57/EU) Member States required to provide at least for serious cases of insider dealing, market manipulation and unlawful disclosure of inside information to constitute criminal offences when committed with intent. For the purposes of the Directive, insider dealing and unlawful disclosure of inside information should be deemed to be serious in cases such as those where the impact on the integrity of the market, the actual or potential profit derived or loss avoided, the level of damage caused to the market, or the overall value of the financial instruments traded is high. Other circumstances that might be taken into account are, for instance, where an offence has been committed within the framework of a criminal organisation or where the person has committed such an offence before. 66

The Directive on criminal sanctions on market abuse (2014/57/EU) For the purposes of the Directive, market manipulation should be deemed to be serious in cases such as those where the impact on the integrity of the market, the actual or potential profit derived or loss avoided, the level of damage caused to the market, the level of alteration of the value of the financial instrument or spot commodity contract, or the amount of funds originally used is high or where the manipulation is committed by a person employed or working in the financial sector or in a supervisory or regulatory authority. Minimum harmonization directive NO opt in by UK and Denmark (opt in by Ireland) 67