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U.S. insider trading vs. U.K. market abuse rules

by contributors Jeffery Roberts, John H. Sturc and Edward Tran, Gibson Dunn | Published May 9, 2012 at 1:52 PM

The U.K. Financial Services Authority imposed £7.2 ($11.2 million) of fines on Greenlight Capital Inc., a U.S. hedge fund, and David Einhorn, Greenlight's owner. The FSA levied these fines in late January in connection with trading in shares of Punch Taverns plc, a U.K. pubs business, ahead of a planned equity offering. The fines were imposed on the grounds that Greenlight traded on inside information conveyed to Einhorn during a June 2009 conference call with Punch's CEO Roger Whiteside and Andrew Osborne, a former Bank of America Merrill Lynch banker and Punch's corporate broker. Osborne asked Greenlight if it would be "wall crossed" (that is, allowing it to receive confidential information in return for being prohibited from trading). Greenlight declined, and the conference call was conducted on a nonwall-crossed basis. However, on the conference call, Einhorn learned that Punch was considering an equity offering of around £350 million ($563 million), the proceeds of which would retire outstanding debt, and, if Greenlight were wall crossed, the confidentiality period would be less than one week. Prior to the conference call, Greenlight held approximately 13.3% of Punch's shares. Following the conference call, it reduced its holdings to 9%, which allegedly allowed Greenlight to avoid losses of approximately £5.8 million. The FSA determined that inside information was conveyed on the conference call and Greenlight traded on this information in violation of U.K. market abuse rules. It's less likely that Greenlight's actions would have triggered an enforcement action by the U.S. Securities and Exchange Commission in the context of a U.S. exchange.

In the U.S., insider-trading prosecutions are almost all based on the "classical theory" of insider trading (purchase or sale of securities with scienter, or guilty knowledge, while in possession of material, nonpublic information in breach of a duty arising out of a fiduciary relationship to the issuer of the security) or the "misappropriation theory" of insider trading (misappropriation and trading on the basis of confidential information in a breach of a duty of trust or confidence owed to the source of the information). Under current law and practice, a fiduciary or fiduciary-like relationship (or, in the case of a claim under the misappropriation theory, a "duty of trust or confidence") is required to impose insider-trading liability.

Greenlight's actions are unlikely to have constituted a violation of the U.S. federal securities laws in the context of a U.S. exchange. Greenlight and, by extension, Einhorn were not insiders with a fiduciary relationship based on their shareholdings as Greenlight was a noncontrolling shareholder (a fiduciary duty can be found to exist based on controlling shareholder status). Also, Greenlight and Einhorn did not take on any role that would imply a fiduciary duty to Punch, and did not agree to keep confidential the information disclosed or refrain from trading.

In the U.K., market abuse is prohibited under the U.K. Financial Services and Markets Act 2000. Under Section 118(2) of FSMA, market abuse includes where "an insider deals or attempts to deal, in a qualifying investment or related investment on the basis of inside information relating to the investment in question." An "insider" is any person who has inside information, inter alia, as a result of having access to the information through the exercise of his professional duties. "Inside information" is information of a precise nature that (a) is not generally available, (b) relates, directly or indirectly, to one or more issuers of the qualifying investments and (c) would, if generally available, be likely to have a significant effect on the price of the qualifying investments. Information is "precise" if, inter alia, it indicates circumstances that may reasonably be expected to come into existence or occur, and is specific enough to enable a conclusion to be drawn as to the possible effect of those circumstances.

The FSA concluded Einhorn engaged in market abuse. Einhorn had access to information by virtue of being a Greenlight employee and a fund manager. Trading shares constituted dealing in a qualifying investment. Although Einhorn was not definitively informed of the offering terms, timing or that it would occur, the information was inside information because it:

was not generally available (being conveyed only during the conference call) and could not have been deduced by market participants;

related to Punch and its shares;

was precise (the offering was reasonably likely to occur in the near future) and specific enough to draw a conclusion as to the effect on the share price; and

would have had a significant impact on the share price had the information been generally available (a sizable equity offering would likely depress the share price).

There is no penalty for market abuse if a person takes all reasonable precautions and exercises all due diligence to avoid committing, and reasonably believed that he has not committed, market abuse. Although the FSA acknowledged Einhorn acted in good faith, it stated that he should have been more diligent (obtaining compliance/legal advice before trading). Also, the FSA fined Greenlight's U.K. compliance officer £130,000 for failure to question and make enquiries confirming the trades were not based on inside information.

U.S. financial institutions and other participants in U.K. financial markets should take note of the FSA's decisions as they illustrate key differences between the regulation of insider trading and market abuse in the U.S. and the U.K.

Under U.K. market abuse regulations, if a person is an insider and possesses inside information, however obtained, that person is prohibited from dealing in the relevant securities in U.K. markets.

Insiders under FSMA are more broadly defined as compared to under the U.S. securities laws, covering persons who have inside information through the exercise of professional duties.

The U.K. approach does not require a fiduciary or fiduciary-like relationship or a duty of trust or confidence between the source and recipient of the information. It is also likely that the FSA will take the following positions in future enforcement actions:

When determining if inside information has been conveyed, communications will be considered in context; couching discussions as hypotheticals will not prevent liability if the intention is to convey more than purely hypothetical information.

Position, knowledge and experience will be considered, with less leeway according to senior and experienced individuals. Note the FSA fined Osborne, an experienced banker, approximately $550,000 for his role in this matter.

Unintentional violations of market abuse rules and acting in good faith will not prevent imposition of liability. For example, in a recent case, which is being appealed, the FSA fined Ian Hannam, a J.P. Morgan Cazenove Ltd. banker, $720,000 for market abuse violations under Section 118(3) of FSMA (improper disclosure) even though he (i) did not intend to engage in market abuse or make disclosures with the intent that the information would be abused and (ii) no trading resulted from the disclosures. Compliance mechanisms designed to detect and prevent insider-trading abuses under U.S. securities laws may not be sufficient to ensure compliance with U.K. market abuse rules and, by extension, those of the European Union (as U.K. market abuse rules are based on the EU market abuse directive). Since the FSA has been vigorously pursuing claims against market participants in the area of insider trading and market abuse, compliance, training and receiving appropriate legal advice can be critical.

Jeffery Roberts is a corporate partner in the London office of Gibson, Dunn & Crutcher LLP. John H. Sturc is co-chair of Gibson Dunn's securities enforcement practice group and practices in the Washington office. Edward Tran is a corporate associate practicing in the firm's London office.

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