Inside information: predicting the direction of

Transcription

Author Oliver Pegden
Inside information: predicting the
direction of price movement and
insider dealing
In Jean-Bernard Lafonta v Autorité des marchés financiers (case C-628/13), 11 March
2015, the CJEU determined that information may be “inside information” for the
purposes of the market abuse regime even though it is not possible to predict in
which direction the price of the relevant security would move if that information
were to be released.
As has been widely noted, that is contrary to the position taken by the UK Upper
Tribunal in Ian Charles Hannam v Financial Conduct Authority [2014] UKUT 0233 (TCC).
This article discusses the potential relevance of the Lafonta decision to cases of
insider dealing.
has occurred or may reasonably be
expected to occur, and
(b)is specific enough to enable a
conclusion to be drawn as to the
possible effect of those circumstances
or that event on the price of
qualifying investments or related
investments.”
THE FACTS OF LAFONTA V AMF
(CASE C-628/13) IN SUMMARY
INTRODUCTION
n
The EU market abuse regime
regulates the misuse of non-public
price-sensitive information that is of a
“precise nature”.
Article 1 of Directive 2003/6/EC (the
Market Abuse Directive (MAD)) provides:
“’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.”
Article 1 of Directive 2003/124/EC (the
Implementing Directive) provides:
“… 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 financial instruments or
related derivative financial instruments.”
Article 1 of the Implementing Directive
is implemented in the UK by s 118C(5)
Financial Services and Markets Act 2000
(FSMA) which provides:
“(5) Information is precise if it—
(a)indicates circumstances that exist
or may reasonably be expected to
come into existence or an event that
Butterworths Journal of International Banking and Financial Law
Mr Lafonta was chairman of the Board of
Directors of Wendel. Between December
2006 and June 2007 Wendel entered into
swap agreements whose underlying assets
were shares in Saint-Gobain. Later in 2007
the swap agreements were unwound and
Wendel acquired shares in Saint-Gobain
directly, declaring its acquisition to the AMF.
The AMF investigated these
arrangements and found that Wendel
had intended to acquire a significant
shareholding in Saint-Gobain from the
time when it had initially entered into the
swap agreements, and had failed to make
public that inside information. It sought to
impose a penalty on Mr Lafonta.
Mr Lafonta argued that it had not
been possible to know what impact the
arrangements would have on Wendel’s
share price, and that therefore the
information relating to the arrangements
was not inside information.
May 2015
INSIDE INFORMATION: PREDICTING THE DIRECTION OF PRICE MOVEMENT AND INSIDER DEALING
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KEY POINTS
In Lafonta v AMF (Case C-628/13) the CJEU determined that information may be

“inside information” even though one cannot use that information to predict the direction
in which the price of the relevant security would move if the information were to be
released.
The case concerned an issuer’s obligation to disclose information to the market. Its

significance for the insider dealing regime, which has traditionally been used to target
investors who use inside information to predict price movements, is less clear.
In his opinion Advocate General Wathelet mentioned that there was evidence before the

Court relating to volatility trading. Although this evidence was not mentioned by the Court
in its judgment, it seems likely that the Court had such trading in mind in considering the
definition of “inside information” for the purposes of the disclosure obligation.
The decision in Lafonta may make it easier for regulators or prosecutors to take action

against those who use inside information to trade on volatility rather than movement in a
particular direction.
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THE LAFONTA DECISION
The French Court referred the following
question:
“Must point (1) of Article 1 of Directive
2003/6 and Article 1(1) of Directive
2003/124 be interpreted as meaning
that only information in respect of
which it may be determined, with a
sufficient degree of probability, that,
once it is made public, its potential
effect on the prices of the financial
instruments concerned will be in a
particular direction may constitute inside
information?” (emphasis added)
The CJEU answered that question
as follows:
“[36] The increased complexity of the
financial markets makes it particularly
difficult to evaluate accurately the
direction of a change in the prices
of those instruments…. In those
circumstances – which can lead to
widely differing assessments, depending
on the investor – if it were accepted
that information is to be regarded as
precise only if it makes it possible to
anticipate the direction of a change in
the prices of the instruments concerned,
it would follow that the holder of that
information could use an uncertainty in
that regard as a pretext for refraining
from making certain information public
and thus profit from that information to
the detriment of the other actors on
the market.”
“[37]….. the answer to the question
referred is that, on a proper construction
of point (1) of Article 1 of Directive
2003/6 and Article 1(1) of Directive
2003/124, in order for information to
be regarded as being of a precise nature
for the purposes of those provisions, it
need not be possible to infer from that
information, with a sufficient degree of
probability, that, once it is made public,
its potential effect on the prices of the
financial instruments concerned will be
in a particular direction.”
288
May 2015
As has been widely noted, that was
contrary to the position taken by the UK
Upper Tribunal in Hannam. It held as
follows (at 121(b)):
“As to the requirements for information
to be specific enough to enable a
conclusion to be drawn as to possible
effect on price, and in particular
what the word ‘possible’ means: the
information must indicate the direction
of movement in the price which would
or might occur if the information were
made public. The information does not
need to indicate the extent to which the
price would or might be affected. The
information does not need to be such
as to enable an investor to know with
confidence that the price will move if the
information were made public but only
that it might move and, if it does, the
movement will be in a known direction.”
PREDICTING THE DIRECTION OF
PRICE MOVEMENT
It is straightforward to envisage the
sorts of information that may satisfy
the other elements of the definition of
inside information, but from which it is
not possible to predict the direction of
movement in price that would or might
occur if the information were to be made
public (referred to hereinafter as “Lafonta
inside information”).
One example might be, as in the Lafonta
case, information about a future acquisition
the impact of which on the acquiring
company’s share price is difficult to predict.
Advocate General Wathelet gave
another example in his opinion dated
18 December 2014 in relation to the
Lafonta case as follows:
“[51]…….the fact that the CEO of an
undertaking in the construction industry
is retiring and might be replaced by an
executive with many years of experience
in the field of telecommunications may be
information of a precise nature likely to be
taken into account by reasonable investors,
some of whom will take the view that that
replacement will breathe new life into the
undertaking whereas others will consider
that the recruitment of an executive from
outside the industry can only weaken
the undertaking. In both cases, the
information will have to be made public
as soon as possible, in accordance with
Article 6 of Directive 2003/6.”
RELEVANCE TO INSIDER DEALING
Lafonta concerned Wendel’s obligation
to disclose inside information. It was not
a case of improper disclosure or insider
dealing. What is the relevance of the case
to insider dealing, which is traditionally
thought to involve an investor profiting by
using inside information to predict price
movement in a particular direction?
Paul Stanley QC has suggested that
since a rational actor may find it hard to
profit if he cannot predict the direction
of price movement, the Court in Lafonta
may have been concerned, not with the
risk of insider dealing, but with a “broader
conception of the fair and well-functioning
market” which it failed to articulate.1 That
suggests a broadening of the definition of
inside information to include information
from which an insider dealer could not
profit. For the UK that might be said to
signal a return to the pre-MAD position
when the thresholds for disclosure and
insider dealing were separate.
That view seems questionable for three
reasons. First, the CJEU has previously
emphasised the “close link” between the
prohibition on insider dealing and the
concept of inside information (see Case
C-45/08 Spector Photo Group NV and Chris
Van Raemdonck v Commissie voor het Bank-,
Financie- en Assurantiewezen (CBFA) at [50]).
Second, the Court in Lafonta expressly
based its decision on a desire to prevent
improper use of inside information (at
paras [21] and [35]).
Third, the Court appears to have had
before it examples of how such improper
use might occur in relation to Lafonta inside
information. Although this was not mentioned
by the Court in its judgment, in his opinion
Advocate General Wathelet specifically noted
that the Court had before it evidence of
“financial mechanisms which enable
an investor to profit from a significant
change in the price of a security,
irrespective of the direction of that
change, if certain market conditions are
met” (at [49])
The Advocate General did not give any
examples of these mechanisms but he may
have had volatility trading in mind, for
example where an investor purchases both
an out-of-the-money call option
and an out-of-the-money put option in
relation to the relevant security, enabling
him to profit whether the price of the
security increases or decreases, losing the
cost of the options if the price does not
change. This is sometimes referred to as
“buying volatility”.
In the UK such trades would fall within
the scope of the insider-dealing regime by
virtue of s 118(2) FSMA which provides
that insider dealing includes circumstances
where an insider deals, or attempts to
deal, in qualifying investments or related
investments. Pursuant to s 130A(3), s 22
and Sch 2 Part II para 17 FSMA “related
investments” includes options to acquire or
dispose of shares.
It seems likely therefore that the Court
was equally concerned with insider dealing
as it was with disclosure, albeit that it
failed to articulate the potential relevance
of its decision to insider dealing.
The most obvious impact on
insider dealing cases, is likely to be
that defendants are precluded from
arguing that, because they did not have
information which enabled them to predict
price movement, they did not have inside
information.
Nevertheless, it might be thought that
in an insider dealing case involving Lafonta
inside information, a defendant might
be able to rebut the “presumption of use”
established by the Spector Photo case, on
the basis that he should not be presumed to
have used information from which he could
not predict future price movement.
Of course the courts may not be
sympathetic to such an argument raised by
an investor who has specifically traded so as
to profit from volatility as described above.
But it is questionable whether such an
argument would carry weight even in a
case involving an investor who has taken a
straightforward long or short position.
First, insider dealing cases are, in
practice, likely to involve an investor
having made a profit through his trading.
It may be difficult to disabuse the
regulator or the court of the hindsight bias
arising from that profit in arguing that
the direction of price movement could
not have been known at the time of the
trade. So it may be difficult to establish
that the information was Lafonta inside
information in the first place.
Second, the key point made by the
CJEU in Lafonta is that investors may take
different views as to whether a security
is more or less valuable in the light of a
particular piece of information such that
it may be difficult to predict the aggregate
impact of the information’s release on
price. It does not follow from this that the
Court considered individual investors any
less likely to use the information.
It can be readily seen how at an
individual level investors might use the
information differently, each having their
own view as to its significance. The Court
in Lafonta appears specifically to have
contemplated this with its reference to
“widely differing assessments, depending on
the investor” at para [36] of its judgment.
The examples given above –
management change, and proposed
acquisition – will, in most cases, be
important pieces of information in relation
to an issuer likely to be used by most
investors, albeit that views will differ as to
how the information should be interpreted.
Thus any defendant seeking to rebut the
presumption of use on the basis that the
inside information in question was Lafonta
inside information may find the regulator
arguing that he should be presumed to
have taken a view on the significance of the
information, as contemplated by the Court
in Lafonta. A defendant may well find it
easier to rebut the presumption of use by
focusing on the nature of the information
in question.
CONCLUSION
In most insider dealing cases it will not be
in dispute that the information in question
would have enabled a trader to predict price
movement in a particular direction. The
Lafonta decision will be of little relevance, if
any, to those cases.
However, the decision may well make it
easier for the regulator to take action against
those who use inside information to profit
from volatility.
Such a case may become more likely when
the scope of the insider dealing regime is
widened with the introduction of the Market
Abuse Regulation having regard to the fact
that a wider class of financial instruments
will be caught within the scope of the market
abuse regime.
n
1 Paul Stanley QC, Inside Look, Solicitors
Journal 24 March 2015 http://www.
solicitorsjournal.com/22269/inside-look
“As Mr Lafonta pointed out, the rational
actor may find it hard to profit if he
cannot predict even the direction of price
movement. But that is not really the point.
Although the prohibition on
insider trading aims at such exploitative
behaviour, it seems strongly arguable that
the requirement to communicate pricesensitive inside information promptly
serves broader objectives. For instance, it
improves market efficiency.
It seems likely that the legislation
embodies a broader conception of the fair
and well-functioning market – a broader
conception which amply justifies the
court’s decision, but which the court did
not explicitly articulate.”
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Biog box
Oliver Pegden is a senior associate in the regulatory investigations and financial crime team
at Clifford Chance. Email: [email protected]
Further Reading:
Acceptable delay in disclosure of inside

information [2014] 9 JIBFL 567.
Company disclosure and selective

briefing of investment analysts [2013]
11 JIBFL 699.
LexisPSL: Financial Services: Market

Abuse – insider dealing and improper
disclosure.
May 2015
289