The economic background: the link between fairness and economic growth

The financial crisis that started in the USA in 2007-2008 warned policy makers about the importance of trustworthiness and fairness in the field of banking and financial law. These elements are essential for the development of a market in which all the subjects, especially retail investors, can operate safely, being aware of the risks they might face and the benefits they might gain.

Notions as transparency and fairness are imprinted on the mind of regulators, in Europe as well as in the other parts of the world. They lead to an increase in investments and, broadly speaking, to a better functioning of the market. Investors need to reacquire trust in the market in order to establish a new situation of stability and economic growth.

The efforts made to favour the wished improvement in terms of integrity and transparency of financial market are evident. The analysis of the latest legislation allows to better understand this tendency. In particular, good examples of the abovementioned policy are the recent rules concerning the banking union (Reg. 1024/2013 UE, Reg. 806/2014 UE, and the single rulebook), the patrimonial requirements for banks (the so-called CRD IV), the development of ADR systems (Dir. 2013/11 UE). In the American system, the major reform regarding banks, financial market and consumer protection is the Frank-Dodd Act, dated 2010.

Market abuse: the legal sources in EU law. From harmonization to uniformity

However, the field of most concern for our purposes is financial market legislation and how legislators intend to achieve the aim of stability, transparency, fairness of markets, in the interests of all the operating subjects. In this perspective, an analysis of market abuse regulation, its evolution and its objectives is necessary.

Firstly, it is crucial to underline the economic idea on which this specific regulatory framework is based. In the last decade, an ultra-liberal point of view was abandoned in favour of a more realistic approach. It is evident that investors cannot simply rely on good faith and cooperation from issuers and their management. Therefore, a strict and severe regulation is necessary if the regulator wants to pursue a smooth and fair functioning of markets^[1].

Integrity and transparency are the main ideas conveyed by the market abuse regulation implemented by the EU legislator. The European institutions’ first intervention in the field of market abuse can be traced back to 2003, with the Directive 2003/6 CE on insider dealing and market manipulation (“MA Directive”).

Nevertheless, it was immediately clear that, to function properly, this regulatory framework needed a higher level of implementation and enforcement. This aspect was also emphasized in the “de Larosière Report”, drafted in 2009^[2]. This paper underlined that, in order to have a more efficient regulation, it is necessary to acquire more uniformity, to remove the distortion of competition between one member State and another. Furthermore, it must be noticed that using the legislative instrument of the Directive might leave too much space to a wide variety of enforcement and, moreover, to delays in effective implementation of legislation.

For these reasons, EU regulators decided to change the legislative technique and the 2003 Directive was overtaken by Regulation 596/2014 EU (“MAR”) and Directive 2014/57 EU (“New MA Directive”). Thanks to this integrated approach, a greater level of harmonization should be achieved. Consequently, it is possible to say that the aim of the European legislator in this field is to obtain uniformity through the use of the Regulation, which directly applies to all the member States. Certainly, this is not unusual in EU law, since this kind of approach is the most common in the last years, especially when the protection of a weaker part is needed, as in the case of retail investors. In addition, the Regulation has recently been supplemented by the Commission Delegated Regulation 2016/522 EU.

The illustrated regulatory framework is not only made of legislative acts, but it also consists of the technical standards issued by ESMA in July 2016, which implement the MAR as regards administrative and criminal sanctions adopted by national competent authorities (NCAs) and the submission of information from the NCAs to ESMA, according to articles 30,31,32 of MAR^[3].

Moving to a deeper analysis of the scope and the text of the abovementioned legislative body, it has to be noticed that the main objectives pursued by the legislator with the MAR are not different from those of the MA Directive. This clearly emerges from the words used in the Recital 2 of MAR, which state the following: «an integrated, efficient and transparent 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».

Even though the keywords used are the same when stressing out the relationship between market integrity, its smooth functioning and economic growth, MA Regulation represents a significant step forward of the EU financial regulation. Not only does MAR reflect the changes in the structure of financial markets realized between 2003 and 2014^[4], but it also tries to solve some of the already mentioned difficulties, which made it difficult to reach all the purposes pursued by the legislator^[5]. In particular, it aims to reduce differences in punitive systems among the States, through the cooperation between ESMA and National Authorities, and to simplify rules for small and medium businesses^[6].

The three typical conducts of market abuse

There are three kinds of conduct that typically fall within the MAR regime: “insider dealing” (art. 8 MAR), “unlawful disclosure of inside information” (art. 10 MAR), and “market manipulation” (art. 12 MAR).

Insider dealing

According to art. 8, par. 1, MAR, insider dealing arises when «a person possesses inside information and uses that information by acquiring or disposing of, for its own account or for the account of a third party, directly or indirectly, financial instruments to which that information relates». The Regulation also considers the conduct consisting in delating or modifying an order related to the relevant financial instrument as insider dealing. Finally, the European law does not allow to convince or recommend another person to engage in insider dealing.

Therefore, it can be noticed that the aim of the article in question is wide enough to include a large number of conducts. In particular, the legislator focuses on all the possible manifestations of insider dealing, even when it happens indirectly or through the influence exercised over another individual. The main concepts that must be clarified to understand if an action falls within MAR regime are, from an objective point of view, “inside information” (art. 7 MAR) and, from a subjective point of view, “person who possesses inside information” or, in other words, “the insider” (art. 8, par. 4, MAR). Those are the elements which define the space where the Regulation can be applied.

On the one hand, inside information is «information of a precise nature, which has not been made public, relating, directly or indirectly, to one or more issuers 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»^[7]. The choice of the legislator is to exclude generic information from the scope of the considered provisions.

Furthermore, to decide whether a conduct is illegal, it is decisive to establish if the information might reasonably affect the price of the related financial instruments. This issue probably constitutes the most problematic aspect related to the effective application of the regulation concerning insider dealing, especially in the case of judicial controversy. The most appropriate method of evaluation that could be adopted is the “reasonable investor” test. Accordingly, the information is price-sensitive if a reasonable investor could use it as the basis of his decision, also taking into account the ex ante situation, the reliability of the source, and all the market variables^[8].

On the other hand, art. 8, par. 4, MAR, clarifies that the provision applies to every person who has a qualified relationship with the issuer of the involved instruments, the so-called “primary insiders”^[9]. In addition, the legislator also takes into consideration the situation of the “secondary insider”, a person who «possesses inside information under circumstances other than those referred to in the first subparagraph where that person knows or ought to know that it is inside information»^[10].

In order to make the Regulation applicable to the conduct, it is also necessary that the inside information is actually used by the insider and that, thanks to this, he takes an unlawful advantage. As regards the issue of the proof of the nexus of causality between the possession of the information and its use, art. 9 MAR establishes a presumption, with some relevant exceptions^[11].

As for causality, it could be useful to consider the decision of EUCJ in the Spector photo case^[12]. Here, the Court’s statement clarifies that «the fact that a person possesses inside information which he knows, or ought to have known, constitutes inside information and acquires or disposes of financial instruments to which that inside information relates as a rule signifies in itself that he “makes use” of the information. In situations where it is clear a priori that inside information does not influence the action of a person, mere knowledge of inside information does not in itself imply use of that information»^[13]. The principle ruled by EUCJ responds to the need to find an equilibrium between an efficient application of the legislation on market abuse, which has the main aim to defend integrity of the market, and the right to defence, according to which a person should have the actual possibility to reverse a presumption. Therefore, there must be proven consequentiality between the possession of the information and the insider’s action, which shall consist in the use of this information.

Unlawful disclosure of inside information

The second category of conduct which constitutes market abuse under MAR’s regime is “unlawful disclosure of inside information”. According to art. 10 MAR, it arises where «a person possesses inside information and discloses that information to any other person», except where the disclosure constitutes a normal exercise of an employment, profession or duty.

The most interesting and innovative aspect of the Regulation, with regards to this type of conduct, is the introduction of market sounding (art. 11 MAR) within the case of «normal exercise». This is an effort made by the legislator, based upon the consideration that this specific conduct can be useful, when not essential, to collect investments, especially in a time characterised by lack of confidence towards the market^[14]. Nevertheless, art. 11, par. 3, MAR, in order to warn about the importance of such a disclosure, stipulates that «a disclosing market participant shall, prior to conducting a market sounding, specifically consider whether the market sounding will involve the disclosure of inside information». In this case, a record shall be written and it could be transmitted, upon request, to the competent authority. It can be noticed, again, how the legislator tries to properly balance the investors’ protection, the integrity of market and its efficiency.

Market manipulation

To conclude with the description of the three kinds of market abuse, art. 12 MAR, regarding “market manipulation”, has to be examined. In this case, the legislator opts for a quadripartite definition of this specific conduct, also introducing a new concept, not previously contemplated by MA Directive dated 2003.

The first category of market manipulation is defined by art. 12, par.1, (a), MAR and comprises two kinds of activities in a particular context. The provision stipulates that «market manipulation shall comprise the following activities: (a) entering into a transaction, placing an order to trade or any other behaviour which: (i) 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; (ii) 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». Therefore, the article applies to a transaction or an order to trade, and aims to avoid that the market could receive misleading information and consequently the price of the instrument might be changed. An exemption is provided if the activity could be defined as an “accepted market practice”, under art. 13 MAR^[15].

The second category, defined by art. 12, par.1, (b), MAR, applies to the conduct consisting in entering into a transaction, which affects the price of one or several financial instruments that employs a fictitious device or any other form of deception or contrivance.

In addition, the third concept of market manipulation is the information dissemination through media, which can determine false or misleading information to the supply or the price of a financial instrument to an abnormal level^[16].

Finally, as already mentioned, the Regulation has introduced a new hypothesis of market manipulation. The provision of art. 12, par.1, (c), MAR, refers to disseminating false or misleading information related to benchmark, so that the calculation on the benchmark can be manipulated. It must be noticed that this provision refers to the benchmark, contrary to the other hypothesis which generally refers to the supply or price of a specific financial instrument. The reason for this new category of market manipulation is probably to prevent false information about the capability of some Eurozone States to repay their sovereign debt, a very common phenomenon during the last years of crisis^[17].

Prohibitions and exemptions

In conclusion, in order to have a complete overview about the concept of market abuse, the system of prohibitions and exemptions provided by MAR has to be examined. Provisions of articles 14 and 15 MAR firmly forbid to engage, or even attempt to engage, in insider dealing, unlawful disclosure or market manipulation.

However, the legislator leaves a certain margin of flexibility. Firstly, the prohibition of insider trading and market manipulation does not apply in case of trading in own shares, buy-back programs, and trading in securities for the stabilization of securities, if conditions indicated in MAR recur. Moreover, the Regulation does not apply to public authorities in pursuit of monetary, exchange rate or public debt management policy^[18]. It is undoubted that economic and political reasons must justify exemption to a regime that otherwise would become too rigid and not suitable for the purposes pursued by policy makers.

In addition, to favour the smooth functioning of the market, art. 13 MAR provides exemption for the so-called «accepted market practice», so that operators could finalize the transactions which fit this definition. When a conduct is not likely to alter the market’s equilibrium, but might rather have a positive impact on it in terms of efficiency or liquidity, then it should be permitted. In this case, the role of NCAs is very important, because it must declare whether the exemption applies or not, after consultations with ESMA and the representatives of issuers, financial service providers and consumers^[19].

The importance of prevention

Nevertheless, the European regulator was conscious that a set of prohibition and exemptions is not enough to assure the proper effectiveness of MAR. As for the banking crisis sector, the role of prevention is crucial to stop illegal conducts happening before they can actually produce their effects, which must be irreversible with an ex post intervention.

On the one hand, market operators and investment firms must have an efficient system of internal auditing to prevent and detect market abuse. If a person is aware of a transaction which might be prohibited under MAR regime, that must be reported «without delay» to the competent authority^[20].

Public disclosure of inside information

On the other hand, the most important aspect of the Regulation is probably the one referring to disclosure of inside information. Not only are companies and firms subject to prohibitions and negative obligations, but they are also placed in a situation of transparency towards public authorities and, broadly speaking, the market itself. This means that they must make some key information public, in order to avoid market abuse.

The challenge for policy makers is to determine when information must be disclosed and what must be disclosed. From one point of view, disclosure is a high cost for companies that go public, probably the most relevant to take into account. From another point of view, transparency in a transaction means that parties can better evaluate it. Moreover, information are essential for investors, as they could be convinced to invest and bring money to the market^[21].

The aim of art. 17 MAR, which regulates disclosure, is to preserve market integrity, therefore «an issuer shall inform the public as soon as possible of inside information that directly concerns the issuer». It is clear that, to decide if something must be revealed to the public, the notion of “inside information” is again crucial,  also in the light of the most recent statements by the EUCJ. It is useful to underline that not all the inside information are relevant to the end of the disclosure but only those which directly concern the issuer. The provision also establishes how the information must be disclosed, in a way that permits «fast access and complete, correct and timely assessment of the information by the public»^[22].

Therefore, European companies are subject to a continuous, constant flux of information that must be kept public. In this respect, the Regulation differs from the USA, where the duty to disclose arises only in particular circumstances, and companies are generally allowed to stay silent. Nevertheless, US firms must update, correct and guarantee that the information given are true, which makes the two regimes quite similar indeed.

The most problematic aspect that MAR must solve about the specific issue of disclosure is timing. Deciding when the information must be made public is essential, in order to avoid that the announcement made by the companies could rely on misleading or false information, which could lead to an even worse effect for the market, in terms of pricing and, consequently, the investors’ protection.

Therefore, the choice made by the legislator after a long debate in the European Institutions is to adopt the so-called “tie-in approach”, according to which the disclosure must start when the information is qualified as inside, but there is a right to delay disclosure in certain circumstances, which is broader in case of a protracted process^[23]. This approach is reflected by art. 17, par. 4, MAR. The provision allows issuers, under their own responsibility, to delay disclosure where: «(a) immediate disclosure might prejudice the legitimate interest of the market participant, (b) delay of disclosure is not likely to mislead the public, (c) the issuer is able to ensure the confidentiality of information». The rationale behind this allowance is to avoid a serious danger to the viability of the issuer and not giving misleading information to the public.

In addition, and this represents the element that the Regulation adds to the classical “tie-in approach”, 2^nd subparagraph of art. 17 MAR rules the case of protracted process, which occurs in stage. Here the EU legislator accepts the idea that delay should be allowed in case of multi-stage ongoing process, because immediate disclosure might jeopardise the prospect of actually concluding the transaction^[24]. Furthermore, an information provided where a complicated process is not concluded yet, could mislead the public. Nevertheless, art. 17, par. 3, requires that market participant that has used the right to delay informs the competent authority about the reasons who justified the delay, explaining which of the conditions set by MAR were fulfilled.

Furthermore, art. 17 MAR allows delay also where financial stability is at risk (art. 17, par. 5 MAR), with the same obligation of notification to the national competent authority described above. 

As regards “selective disclosure”, art. 17, par. 8, MAR states that if the information is disclosed to a third party «in the normal course of exercise of an employment, profession or duty, they must make complete and effective public disclosure of that information». Consequently, the obligation that arises from art. 17 MAR still preempts any significant use of selective disclosure. As a result, only information that cannot be defined “inside” can be disclosed selectively.

In conclusion, art. 18 MAR, with the same purpose to prevent and detect market abuse conduct, thanks to mandatory provisions that force market participants to be in a condition of transparency, makes issuers draw up an «insider list». This list should contain the names of all the people who might have access to inside information and must be promptly updated and transmitted to competent authority^[25]. This is an important instrument of prevention, which makes the authority aware of the individuals who are more likely to manage inside information in a company, so that control and detection should be easier. For this reason, art. 18, par. 2 MAR states that «issuers or any person acting on their behalf, shall take reasonable steps to ensure that any person on the insider list is aware of sanctions applicable to insider dealing and unlawful disclosure of inside information».

Conclusion: the importance of enforcement

This brief analysis of the main provisions of the new MAR shows how complex the market abuse regime is. Regulating such an issue requires choices that have a great impact on the financial system and, indirectly, on real economy. The legislator should respond to different needs and balance contrasting interests.

From this point of view, the Regulation that has just come into force represents an important effort made by the EU regulator, which takes place in a wider context of economic reforms tending to economic stability and growth.

Nevertheless, it must be underlined that the real effectiveness of a set of rules can be measured through its enforcement, both public and private.

As far as public enforcement is concerned, the MAR aims to a strict cooperation between NCAs and ESMA^[26]. National authorities shall ensure the application of the Regulation within their territory, working together with ESMA, and issue the administrative sanctions set by national laws, in accordance with the maximum established by the European legislator^[27]. Criminal sanctions are provided by the New MAD, which must be implemented by the member States in their Codes.

ESMA’s task is to develop draft regulatory technical standards (RTS) and implement technical standards (ITS) regarding the main points of the Regulation. In addition, ESMA received two mandates from the European Commission to provide technical advice to assist the Commission in drafting the delegated regulation. This shall help a coherent and effective application of market abuse legislation throughout all the EU.

As for private enforcement, MAR represents a guarantee for all the protagonists of financial market, but especially for investors. The importance of both national and EUCJ jurisprudence is relevant in defining the aim of the Regulation.

However, real confidence in the effectiveness of MAR relies on the possibility to obtain actual remedies by national Courts. For this purpose, it essential to allow fast and cheap access to justice, otherwise the Regulation risks to be substantially neutralized. Therefore, it is really important to favour the development of alternative dispute resolutions (ADR), which allows quick and not expansive resolution of disputes. In this respect, the efforts made by EU Institution for the implementation of ADR in all the member States must be underlined, lastly with the Directive 11/13 EU. In addition, the development of ADR is also mentioned by art. 81, par.2, (g), TFUE. In Italy, both the Arbitro Bancario Finanziario (ABF), in the banking sector, and the recently introduced Arbitro per le controversie finanziarie (ACF), in the financial sector, are two examples of this legislative tendency.

In conclusion, it can be said that the improvement of private enforcement and the clarification of competences among the public national authorities are the two keys to ensure the good functioning of financial legislation, in order to reach financial stability and economic growth^[28].