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Article: Regulatory Litigation Update

Business Litigation Reports

Insider Trading in the E.U. and U.S. Markets—An Ocean Apart? With increasing momentum towards global regulatory convergence—driven predominantly by G20 commitments—it is noteworthy that some important (and practically significant) distinctions remain between the market conduct regimes in the U.S. and the E.U.

This article should be of particular interest to those institutions and individuals transacting on U.S. and E.U. listed securities markets—regardless of their physical trading location.

Einhorn/Greenlight. Much has already been written on the Einhorn/Greenlight case, which served to highlight certain key differences between the U.S. and E.U. regimes; not to mention the extra-territorial reach of the U.K. regulatory authorities. To briefly re-cap, U.S.-based David Einhorn and his fund, Greenlight, were each convicted of (civil) insider dealing in the shares of Punch Taverns Plc (a UK-listed stock), notwithstanding that all trading was directed from the U.S.. In summary, Einhorn had failed to appreciate that information he had received during a call with Punch and its advisors, in the lead up to an imminent share issuance by the company, amounted to ‘inside information.’ Greenlight began to dispose of its entire Punch stake only a few minutes following this call. The equity issuance was announced to the market around a week later, whereupon the price of Punch shares fell by almost 30%. Perhaps unsurprisingly, this particular sequence of events prompted a formal regulatory investigation, which culminated in fines exceeding £3.5m for each of Einhorn and Greenlight.

Among other things, Einhorn argued in his defence that the call had been conducted on the express basis and understanding by all concerned that no inside information was to be divulged—a point repeatedly affirmed before and during the call. However, the U.K regulator—adopting a “substance over form”approach—contended that the totality of information provided to Einhorn, when taken in context, in fact amounted to inside information—in particular, the purpose, anticipated size and timing of the proposed issuance; and the fact that other shareholders were broadly supportive, on which Greenlight subsequently traded.

Significantly, despite the Regulator’s acceptance that Einhorn did not act deliberately or recklessly, he was nevertheless held to be an “insider” (and therefore culpable) because he ought to have recognized his receipt of inside information (even if, in actuality, he did not believe it to be).

Level Informational Playing-Field? The U.S. courts have repeatedly rejected the ‘parity of information’ doctrine, maintaining that there is no “general duty between all participants in market transactions to forego actions based on material, non-public information” (Chiarella v. United States, 445 U.S. 222, 233 (1980)). Instead, the scope of the U.S. insider trading offence is limited to situations where the insider had “a duty to disclose arising from a relationship of trust and confidence between the parties to a transaction … A relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation. This relationship gives rise to a duty to disclose because of the necessity of preventing a corporate insider from…taking unfair advantage of the uninformed minority of stockholders.” {our emphasis}

Similarly, a corporate “outsider” can only be liable for insider dealing where (s)he trades in breach of a fiduciary duty—but, importantly, only where such duty is owed to the source of the information. By necessary implication, no duty is considered to be owed to those persons with whom (s)he transacts.

In stark contrast, the E.U. Market Abuse Regulation is fundamentally underpinned by a notion of information parity and fairness across all market participants.

In essence, this approach is akin to a general duty between all market participants—of the type expressly rejected by the U.S. courts. Put another way, in the E.U., there is no restrictive pre-condition for the existence and breach of a specific duty—whether owed by the insider to: (i) the issuer or its shareholders; or (ii) the tipper/source of the inside information. This distinction is significant as the U.S. authorities are often faced with an insurmountable hurdle when pursuing alleged market miscreants.

“Personal Benefit” Requirement. The U.S. specific duty requirement has been the subject of numerous tipper/tippee cases, in which the issue of personal benefit to the tipper was a central consideration in the breach determination. In the seminal Dirks v. SEC case, the court held that the “test” for determining whether a breach of duty has occurred is “whether the insider personally will benefit, directly or indirectly, from his disclosure.” “Absent some personal gain” by the insider, there has been no breach and thus no duty to refrain from trading.

Exactly what will qualify as a “personal benefit” remains somewhat unclear. Most recently, in December 2016, the Supreme Court (in Salman v. United Sates) clarified that a gift to a trading relative or friend may satisfy the “personal benefit” requirement, even if the tipper had no expectation of personal pecuniary benefit. Interestingly, however, the Court limited its finding to disclosures to trading friends and relatives, and expressly refused to adopt the Government’s contention that a gift to “anyone” should suffice to meet the test—a stance which, had it been upheld, would have served to bring the U.S. regime into closer alignment with that of the E.U..

Other Key Differentials Between the U.S. and U.K. Regimes. There are some other important (and practically significant) distinctions between the U.S. and E.U. insider trading regimes. In summary:

  • Tippee Knowledge.
    • In the U.S., it is necessary for the authorities to establish that a tippee knew of the tipper’s breach: that is, the tippee knew that the information was obtained (by the tipper) in confidence and divulged for personal benefit. In practice, this can prove to be a challenging, if not prohibitive, obstacle for the authorities
    • There is no such positive knowledge requirement in the E.U.. Simply, a tippee who knew or ought to have known that s(he) possessed inside information, and who goes on to use that information, will have committed a prima facie offence. The relative ease with which a regulator can assert that a defendant ought to have recognized their receipt of inside information was clearly illustrated in Einhorn/Greenlight—highlighting the need for investors to remain constantly vigilant when, for example, interacting directly with listed issuers or receiving market soundings.
  • Insider—Circumstances.
    • As discussed above, an insider in the U.S. must have acquired the inside information in particular circumstances for liability to attach.
    • There is no equivalent requirement in the E.U.—it is irrelevant how the insider came into possession of the inside information.
  • Insider Knowledge More Generally.
    • Under the U.S. regime, a defendant can only be liable for insider trading if (s)he acted with a culpable state of mind, commonly referred to as “scienter.” The level of scienter required is the only legal difference between a civil and criminal insider trading violation. Broadly, the civil liability standard is a “reckless disregard” / “highly unreasonable” conduct; while under the criminal regime, the defendant must act willfully.
    • There is no equivalent “intent” requirement under the civil regime in the E.U.. Therefore, a genuinely ignorant defendant or one who failed to apply his mind can still have committed an offence in the E.U..
  • Liability for Improper Disclosure of Inside Information.
    • In the E.U., it is an offence to unlawfully disclose inside information other than in the normal course of the exercise of a person’s employment, profession or duties. In contrast to the U.S. position, there is no need for the recipient to have traded following receipt of the inside information. Nor is there a requirement for the insider to have received a personal benefit in order to be liable for unlawful disclosure.
  • Encouraging Offence.
    • The recommendation or inducement of another to engage in insider dealing will, in and of itself, constitute market abuse in the E.U.—irrespective of whether the other person follows through. There is no direct U.S. equivalent.

Conclusion. As illustrated, the E.U. market conduct regime is, in various respects, markedly broader in scope and application (and commensurately easier to violate) than the U.S. equivalent. US-based investment professionals and other market participants transacting on E.U. securities markets must remain continually alert to these differences. Ignorance will not afford a defense under the E.U. regime—as David Einhorn famously discovered to his considerable cost.