Problematic Effectiveness of Insider Dealing Sanctions - Essay Example

?Problematic effectiveness of insider dealing sanctions and harmonization according to latest EU developments Introduction Insider trading is a controversial aspect of securities regulation among the economic and law fraternity in the European Union. Insider trading is the trade in stock or other market securities by individuals with access to material non-public information of the security thus leading to market inefficiency in price determination. One category of the scholars assert that corporations should be allowed to implement their own insider trading policies while the other suggests that property rights to inside information should be granted and not subjected to contractual reassignment1. The deregulatory claims are premised on the view that inside information fosters market efficiency and that granting the property rights to security managers is an efficient compensation scheme. Prohibition of insider trading in European Union is justified on the basis of equity and fairness to all market participants. Generally, both firms, shareholders and the society benefit from the accurate pricing of the securities since it leads to efficient allocation of capital and decreases the volatility of the prices in the market thus attracting the risk-averse investors. The firm will also benefit from the accurate pricing through increase investor confidence in the security and reduction in monitoring costs. According to the proponents of deregulation, insider trading will benefit the society since it moves the price to a level which it would be if the inside information was available to the public. Henry Manne, asserts that insider trading leads to price accuracy thus it is an efficient mechanism for compensating the security managers for the release of stock information2. The aim of the new EU rules was address the divergence of the member states in their approach to market abuse3. Variations in the national laws have allowed many security managers to escape prosecution for insider dealing. Some countries even lack the sanction powers while other countries do not have sanctions for certain market manipulation offences. For instance, Bulgaria does not have any criminal laws to govern insider trading while other countries impose only up to five years maximum imprisonment for inside trading related offences. Another problem to the effectiveness of the sanctions is the Bank secrecy laws in some countries. For instance, French authorities have faced challenges in tracing the persons who executed order in Paris Stock Exchange via the Swiss banks. Some of the problematic effectiveness of sanctions includes the gaps in regulation of commodity derivatives, lack of legal certainty of the market abuse directive, the gaps in regulating new markets, platforms and over the counter instruments in the emerging markets. EU Directive 2003/6/EC24 adopted in 2003 updated the legal framework on insider dealing and market manipulation behavior. However, several market, technological and legislative changes have led to changes in the financial landscape thus creating loopholes for insider dealing. The Market Abuse Directive (MAD) faced numerous challenges in curbing insider trading. For instance, Section 3.1.1 of the MAD covered limited financial instruments in the regulated markets, but use of modern technology such as broker electronic systems and swap execution facilities have created new market instruments that are not covered by MAD. For instance, only three member states have extended the MAD to all MTFs. It was important to ensure that market integrity is extended to the new trading channels like credit default swaps and inter-dealer broker systems4. Another problematic effectiveness of the sanctions is market fragmentation since single security instrument could be traded in different markets by the same party thus marking it difficulty to detect market abuse. In addition, market players had resulted to use of related financial instruments such as OTC derivatives to manipulate the market since they were not explicitly covered by the MAD. The gaps in regulating the commodity and commodity derivative markets allowed individuals to extend their manipulative strategies across markets since one could benefit from inside information in one market through using it to trade in another market5. Another problem was the market manipulation that could occur across the financial commodity market and physical commodity markets since the commodity markets were unregulated. For instance, traders could hike the prices of commodities through hoarding thus leading to increase in the price of the derivatives. The derivatives could also be used to manipulate the prices of the physical commodities like in the energy markets whereby traders take large positions, stockpile the commodity and require the counterparties to settle the position through physical delivery of a commodity that has already been stockpiled6. Another main problem was enforceability of the sanctions since the authorities lacked the data on OTC derivatives and access to telephone traffic thus failing in detecting market abuse. Some regulatory authorities had no power to seek a court order that could grant access to private premises. Additionally, the whistle blowers were not protected while several members lacked administrative measures for market manipulation. Some member states lacked criminal sanctions for insider trading. For instance, 8 members had not criminal sanctions for improper disclosure while 6 members did not have criminal sanctions for ‘tipping’ by secondary insiders7. The European Court of Human Rights ruled that France was right in fining Soros 940,000 euros in 2007 for insider trading on the shares of Societe Generale since he had information on proposed take over in 1988. In the case of Spector Photo GroupNV, Chris Van Raemdonck v. Commissie voor het Bank, Financie-en-Assurantiewezen (CBFA), case C-45/08, the main question on the interpretation of inside information and whether companies that buy their own stocks can be regarded to be engaging in insider trading. Spector Company of Belgian bought its stock on Brussels stock exchange in implementing a stock option program for employees and later published market information thus forcing the price of the shares to rise. After some time, the national authority found Spector guilty of insider trading and imposed fines of 80 000 euros to the company and 20 000 to the manger, Mr Van Raemdonck. In its interpretation on the appeal by Spector, the European Court of Justice held that the goal of Market Abuse Directive 2003/6 was to protect the integrity of markets and enhance investor confidence by proving all investors with equal playing ground thus a mere proof that an insider has traded implied that inside information has been used, thus it is totally unnecessary to provide information that the insider had full knowledge of the inside information. The financial instruments that are covered by the market abuse directive include multilateral trading facility (MTF) and over the counter securities8. Market abuse occurs price sensitive information that is non available to the public is used or trading or when prices are distorted by a price-setting mechanism. Another instance of market abuse include dissemination of mislead or false information in the market. The new regulations comply with Article 114 TFEU that provides the legal basis for market abuse by aiming at reducing the legal technicalities across the Union and guaranteeing single market. According to Article 5.3 TFEU, aims of market abuse prohibition cannot be attained by member states alone thus Union wide approach is necessary in deterring insider trading9. The rules have been harmonized to ensure that insider trading perpetrators cannot exploit the differences across member states in committing market abuse10. In September, 2010, the European Commission outlined the European Market Infrastructure Regulation (EMIR) that would regulate the over the counter (OTC) derivatives by ensuring increased market oversight and reducing counter-party exposure in the market11. The financial counterparties within the EMIR will be required to clear the derivatives transactions through central clearing counterparty (CCP) based in the European Union. Additionally, all the cleared transactions must be reported including the details of the parties to the contract, the underlying derivatives and nominal value of the contract. The Revised Markets in Financial Instruments Directive (MiFID II) aims at protecting professional, retail and counterparty investors through establishing an integrated market whereby investors are guaranteed of integrity. The directive deals with disclosure of data and information, third parties and rules of clearing facilities. It mainly deals with commodity derivatives by making it a must for venues that trade liquid commodity derivatives to publish information of aggregated weekly breakdowns of the positions of numerous market participants12. The market authorities have been empowered to limit the capacity of parties in commodity derivative contract and also request for the reduction of their positions in the contract. For instance, companies dealing with emissions have to comply with MiFID II provisions13. The market abuse directive will apply to all instruments traded on multilateral trading facilities, financial instruments traded on the over the counter market and also commodity derivatives and markets. The directive has made it an offence ‘attempted’ manipulation of financial information such as placing of orders that cannot be executed or issuing misleading information. The directive has also strengthened the powers of the market authorities including the right to make a request for freezing of assets, seizing of important documentation and right to access private information and access data traffic records. The applicable fines can be double the profits made or losses avoided due to breach of the directive in case the gain or loss can be ascertained in monetary terms. For individuals, the fines can reach 5 million euros and for companies the fines can be 10 percent of total annual revenues from the previous year figures14. Although Article 6 (1) of the Market Abuse Directive requires the issuers of securities to inform the public ass soon as possible of any inside information, the new Regulation will make it mandatory for issuers to immediately inform the competent authorities of any decision to delay disclosure of inside information after the disclosure has been made public. The authorities can delay such disclosure in order to increase investor protection and maintain the market stability15. The Harmonization will require modified inside information to be disclosed in the SME growth markets while transactions made by persons on behalf of the managers when the manager pledges his shares must be notified to the competent authorities. A threshold of EUR 20 000 has been implemented across the Union. Conclusion The new directives by the EU will guarantee competitiveness, integrity and efficiency in the financial markets. The new Market Abuse Regulation will extend the scope to cover the derivatives and also introduce new offences of attempted market manipulation. The market authorities have been granted the powers to investigate insider dealings, seize documents and access telephone records. Member states are also required to lay down administrative sanctions defined in Article 25 for parties guilty of insider trading including persons who disclose insider information as outlined in Article 9. According to Article 26, competent authorities can apply sanctions such in case of failure to cooperate in an investigation, or request suspension of the securities or freezing of the assets. Bibliography: Aki, Paul. Insider trading: global developments and analysis. New York: CRC Press. 2009. Alexander, R.C.H. (2006). Insider dealing and money laundering in the EU: law and regulation. Aldershot: Burlington. Chiu, Iris. Regulatory convergence in EU securities regulation. Austion: Wolters Kluwer & Business. 2008. P.44. Ferran, Eilis. Building an EU securities market. Cambridge: Cambridge University Press. 2004. Kravitt, Jason. Securitization of financial assets. New York: Wolters Kluwer Law & Business. 2012. P 70. McGee, Robert. Corporate governance in transition economies. New York: Springer. 2008. Schoppmann, Ernoult. European banking and financial services law. Brussels: European Association of Public banks. 2008. P 60. Seredynska, Iwona. Insider dealing and criminal law: dangerous liaisons. Berlin: Springer. 2012. European Commission Directive 2010/78/EC. European Commission Market Abuse Directive (MAD) 2003/6/EC. Read More