Market Abuse

Introduction

This Assignment will look at the meaning of Market Abuse and the problems that are associated with it. This Assignment will look at all aspects of market Abuse and explain how the problems surrounding the subject may influence the term.

So what is Market Abuse?

Market Abuse can result to various amounts of behaviours.

Some of the main areas include the points below.

1. Insider dealing: One of the main abusive behaviours leading to market abuse. When an insider of a company or business tried to deal on basis of information. Misusing information is a classic example of this.

2. Improper disclosure – this is where an insider improperly discloses information to another party or person.

Market Abuse, defined in Section 118 of the Financial Services and Markets Act 2000[1] and in The Market Abuse Directive, consists primarily of Insider Information and Market Manipulation. The Market Abuse Directive provides an EU wide market abuse regime aimed at reducing the incidence of market abuse.[2]

The Market Abuse Directive adopted by the UK on 1st July 2005 expressly prohibits insider dealing, market manipulation and misleading behaviour. Making statements or spreading rumours through the mass media or otherwise (e.g. internet chat rooms) which give or are likely to give a regular user of the stock market false or misleading impressions as to the supply of or demand for a listed share, can be a criminal offence. [3]

Background

The Market Abuse regime was first introduced in 2001 to bring people in trade who may trade inside information to justice. Similar to the criminal regime of insider dealings however market abuse operates on a lower standard of proof required for civil proceedings and covering more transactions. Although Market Abuse cannot lead to imprisonment it however can lead to high amount fines.

The Financial Services Authority (FSA) has been keen to pursue cases of abuse in the markets and has brought a high amount of actions against the guilty parties or even individuals in the past up until the present. However the European Commission has improved compliance in and around Europe with the Market Abuse directive mentioned earlier. This provided an introduction to a new market abuse regime in the UK. Most of the features of the new regime correspond widely to what used to go on before the regime had been introduced. However what may have previously been allowed before the regime may not necessarily be allowed now. The new regime applies to the more financial instruments mentioned later on this assignment. This deals with the more criminal offences of insider dealings and market manipulation.

Market Abuse is not just associated with companies and individuals Regulated by the FSA. This can be done by anyone at any time. The liability aspect of Market Abuse can be associated with an indirect attempt or even unintentionally done by encouraging abusive behaviour by another person for example.

The Scope of Market Abuse:

The Regime as mentioned earlier in this assignment covers the area of financial instruments these include – Shares, warrants, futures, contracts for differences, options and debt instruments traded on every regulated market in Europe or for which an application for admission to trading has been made. In the UK, the relevant markets include the London Stock Exchange and commodity derivative markets.[4]

The regime also covers transactions relating to those instruments even if they may be carried out off- market. However if certain instruments trading on the market are not trading as themselves this sort of behaviour regarding these instruments may be caught and punished. Behaviour on the subject involving securities traded or trading on a foreign unregulated market may be caught if an option linked to them is trading n London.

Different Types of Behaviours and Problems Associated to Market Abuse

There are several types of behaviours and problems related to market abuse.

The first type is known as Insider Dealing – this is where an attempt or dealing is done on the basis of inside information. Insider dealing is one of the many illegal offences where employees of a company may have used confidential information for their own gain. However the insider does not have to work for the company. The second Improper Disclosure of inside information – this is where an insider discloses inside information to another person. (Outsider) An example may be where an employee at his company is sure of a takeover bid. Before a bid is put forward, the employee buys shares in the company. Then this information is disclosed to a close friend before being made publically addressed. This sort of behaviour creates an unfair market place. However if the person selling the shares had known about the takeover bid then it can be argued that the shares would have even be sold. Both the buyer and the friend may unlawfully profit from such a move. However both the friend and the insider are to be deemed guilty. An illustration of such behaviours can be seen in the case of Anil Kumar, a former director of global management consulting firm Mc Kinsey, Mr Kumar had pleaded guilty on supplying information to Mr Raj Rajaratnam who had discretely paid Mr Kumar 1.6 million for the inside market information[5].

The third type of behaviour is the Misuse of information – this is the behaviour that is based on information not generally available to those using the market but more likely to be seen by the regular users [6]as relevant when deciding the terms on which transactions in investments should be made and are likely to be seen by regular users as below reasonable or acceptable standards. If an employee sell’s the shares owned by gaining knowledge that the employer may lose a significant contract with its main customer then this can be seen as an unfair market place. The fact the buyer of the shares would not have known about the loss of contract it can be expressed that buyer may not have bought the shares in the first place. Jonathan Malins finance director of AIM Company Cambrian Mining had chaired a meeting to approve share pricing at a reasonable premium to the market. However Malins bought shares that afternoon for his own account at a cheaper rate. This had been done an hour before the share prices had been announced. Malins had repeated the same procedure one week later, making a profit of £6400. However in December 2005 Malins had been fined £25,000 by the FSA for the misuse of information[7].

Another big behaviour is Manipulating Transaction – this is where employees participate in transactions or orders to the trade and give false or misleading impressions either about the supply price or to secure an investment that is deemed as a fake or non natural level. The fifth type of behaviour is Manipulating devices – participating in transactions or orders to trade that employ fictitious devices or any other form of deception or contrivance[8]. This is where an employee is buying shares and then spreading misleading information with a view to increasing the price. This could give investors a false impression of the price of a share and lead them to make the wrong investment decisions[9]. One of the largest cases in history involving manipulating transactions was Shell who had been fined 17 million by the FSA.[10]

The sixth type of behaviour involves the Disseminating information likely to give a false or misleading impression – meaning an act done where false information may be spread in order to mislead others. An employee posting false information about take an imminent takeover bid on the internet on personal social websites for example. Although the person knows the information is fake and not true, this may result in people making incorrect investment decisions.

The Last behaviour leading to market abuse is Market distortion – behaviour that gives a false or misleading impression of either the supply of or demand for an investment or behaviour that otherwise distorts the market in an investment[11].The movement of an empty cargo ship that is used to transport a particular commodity. This could create a false impression of changes in the supply of, or demand for, that commodity or the related futures contract. It could also artificially change the price of that commodity or the futures contract, and lead to people making the wrong investment decisions.[12] The case that illustrates this best is the case of Vijay Kumar Sharma sole director of mortgage broker Exetra UK Limited. Mr Sharma had made false and misleading statements to the FSA. Mr Sharma had later pleaded guilty too in court and was fined for £3000 for acquiring a controlling interest in a regulated firm and not giving the notice to FSA as explained above. This is the first criminal prosecution brought by the FSA for failing to notify the regulator about changes in control of such a regulated firm[13].

The Financial Services Authority will take actions and enforcements on market abuse and areas relating to it. However before any of the actions or enforcements are looked upon the FSA will include certain factors into consideration before taking any of the above decisions.

The FSA will take into consideration the nature and seriousness of the suspected behaviour, the conduct of the person concerned after the results of the behaviour have been identified.

Other factors include the degree of sophistication of users in the market that may be in question. This will also depend on the size liquidity of the market and the vulnerability of market to abuse.

The FSA will also look at factors of similar cases and the action taken within them. Other regulated authorities will also be reviewed upon what action had been taken by them and whether it was sufficient enough. The FSA will also take into consideration of any impact (regarding the behaviour) of any financial penalty or public statement may have on the financial market or interest of consumers. As well as any likelihood that the same type of behaviour may be repeated by either a person or a company and see to the fact if no action is taken. Other factors include looking at the disciplinary record and general history of any person or company who has committed market abuse.

If the factors are looked upon and a penalty or action is required the FSA will tend to impose fines and on individuals and companies who have committed market abuse. The FSA may impose other penalties such as a public statement to explain that a person has engaged in such market abuse. Other penalties include court injunctions to prevent such abuse happening again, paying back any profit made or to pay compensation during the abuse to the victims who may have suffered from the abuse. The FSA has a point to prove to companies and individuals that this sort of behaviour is unacceptable. However the FSA will also not only attract a certain amount of publicity to this company breaching its brand value but also threaten its reputation and the history of a company. The Main general restraint is to the market as a whole.

Conclusion

Why do we have market abuse?

Market Abuse has been an area of regulation of rapid growth over recent years. Todays market both market abuse and insider dealings are the subject of criminal regulatory rules. The real reason behind why we have market abuse is mostly due to the fact that we have a lot of share holders and investors in the market. This results in more growth over the years in national and international business. However it can be argued that the law itself may not be as effective in practice as it could be, The FSA Suggests that the high amount of abnormal price movements ahead of take over announcements is the main reason for companies and individuals to take advantage off and make profit by committing market abuse.

[1] Section 118 Financial Services and Markets Act 2000

[2] http://www.fsa.gov.uk/pages/About/What/financial_crime/market_abuse/index.shtml

[3] http://www.bankofscotlandhalifax.co.uk/sharedealing/Education_Centre/glossary.asp

[4] http://www.out-law.com/page-8304

[5] http://news.bbc.co.uk/1/hi/business/8447348.stm

[6] Regular User – The Code of Market Conduct states that, in some cases, behaviour will be market abuse where it falls below the standards expected by the ‘regular user’. A regular user is effectively a reasonable person who deals regularly and understands the workings of the market concerned. In some places, the Code employs

A ‘reasonable person’ test similar to the one that has often been used in the English courts.

[7] http://www.out-law.com/page-8305

[8] http://www.out-law.com/page-8304

[9] http://www.fsa.gov.uk/pubs/public/market_abuse.pdf

[10] http://www.out-law.com/page-8305

[11] http://www.fsa.gov.uk/pubs/public/market_abuse.pdf

[12] http://www.fsa.gov.uk/pubs/public/market_abuse.pdf

[13] http://www.fsa.gov.uk/pages/Library/Communication/PR/2009/120.shtml