|
Recent market abuse cases brought against David Einhorn, Greenlight Capital Inc. (“Greenlight”) and corporate broker Andrew Osborne by the UK’s Financial Services Authority (“FSA”) have attracted a significant amount of press comment. The cases, which resulted in total fines of more than £7.5 million, raise concerns for issuers, investors and financial intermediaries. In particular the cases:
-
confirm that the test of what constitutes improper use and disclosure of inside information is an objective one. What the discloser and user genuinely believed at the time is largely irrelevant;
-
demonstrate the need to take great care to identify whether individual pieces of information could be aggregated so as to constitute inside information;
-
emphasize the need to obtain compliance and legal advice on robust wall-crossing procedures and on any issues that could arise from doubts on whether those procedures were followed properly; and
-
highlight difficult issues for the market to consider in light of the FSA’s comment on the approach that must be taken when discussions held with an issuer do not lead to a transaction.
Facts
The facts stated in the FSA’s Final Notices (the “Notices”) that were identified by the FSA’s Regulatory Decisions Committee are relatively straightforward.
Greenlight manages hedge funds, and Einhorn is Greenlight’s sole portfolio manager. Funds managed by Greenlight (the “Greenlight Funds”) owned approximately 13% of Punch Taverns (“Punch”), a London Stock Exchange-listed issuer, through a combination of direct shareholdings and contracts for differences (“CFDs”).
Punch was considering a capital raising and through Osborne, its corporate broker, approached a number of existing large shareholders. Osborne approached Einhorn and asked whether he would be prepared to “cross the wall” and sign a nondisclosure and standstill agreement in relation to Punch (commonly referred to as an “NDA”).
Wall-crossing typically occurs when a market participant receives inside information. This often is preceded by the recipient executing an NDA. The receipt of inside information prevents the recipient from dealing in the securities and related derivatives to which the information relates. NDAs frequently contain contractual restrictions on such dealings. Einhorn refused the invitation to cross the wall.
Osborne arranged a conference call between himself, Einhorn and Punch management. Einhorn agreed to take part in a call on a “non-wall crossed” basis only. The FSA appears to accept that much of the call involved a high-level discussion of the pros and cons of a share issue and did not find that these parts of the discussion constituted inside information. In the course of the call, however, Punch management and Osborne also disclosed the following information to Einhorn:
-
Punch intended to raise £350 million in new equity capital (a large amount in relation to Punch’s then-market value of approximately £400 million);
-
the new capital was needed to help Punch repay convertible bonds and comply with covenants given in respect of Punch’s securitisation vehicles;
-
most of the other shareholders who had been approached had signed NDAs and were supportive of the share issue proposal; and
-
the NDAs were intended to operate for less than a week, indicating that the share issue also was intended to be completed within that period and that the transaction was, therefore, at an advanced stage.
The FSA found that the four items of information described above, when taken together, were price sensitive, not generally available and satisfied the statutory test for inside information set out in the UK’s Financial Services and Markets Act 2000 (“FSMA”).
As soon as the call ended Einhorn directed the sale of all of the Greenlight Funds’ holdings in Punch. From Tuesday, June 9, 2009 (the day the call took place), to Friday, June 12, 2009 Greenlight reduced the Greenlight Funds’ stake in Punch from 13.3% to 8.98%.
The Punch share issue was announced on Monday, June 15, 2009, following which the value of its shares fell by almost 30%. The FSA calculated that the Greenlight Funds avoided a loss of £5.8 million through the previous week’s trading.
The FSA’s Findings
The FSA found that Einhorn and Greenlight dealt in Punch shares and related investments (the CFDs) on the basis of inside information and that Osborne had improperly disclosed inside information. Both were breaches of the UK’s civil market abuse regime. The FSA had to establish that the information passed to Einhorn on the call was inside information for the purposes of sections 118C(2) FSMA. In other words the information needed to have been:
-
of a precise nature;
-
not generally available;
-
related directly or indirectly to one or more issuers of qualifying investments (which includes shares admitted to trading on the London Stock Exchange’s main market) or to one or more qualifying investments; and
-
likely to have a significant effect on the price of the qualifying investments, if generally available.
It was clear that the information passed to Einhorn on the call was generally not available and related to the issuer of qualifying investments. The remaining issues were whether the information provided during the call was sufficiently precise and likely to have had a significant impact on the price of Punch’s shares, if generally available.
Precise Information
Information is sufficiently precise if it passes the two tests in section 118C(5) FSMA. The information must:
-
indicate circumstances that exist or may reasonably be expected to come into existence or an event that has occurred or may reasonably be expected to occur; and
-
be specific enough to enable a conclusion to be drawn as to the possible effect of those circumstances or that event on the price of qualifying investments or related investments.
The FSA accepted that the Punch share issue was not a certainty at the time of the June 9 call. However, FSMA did not require that Einhorn be told that the share issue was definitely going to occur before the information could be deemed to be sufficiently precise. The FSA’s view was that the call disclosed an event that was reasonably expected to occur. The likely amount of the share issue and its purpose was disclosed. The effective term of the NDA indicated that the share issue plans were at an advanced stage and likely to happen within a short period of time.
The FSA found that this information was specific enough to enable a conclusion that the share issue would result in a fall in the value of Punch shares. In particular, the share issue was significantly dilutive. This was a point recognized by Einhorn who was quoted in the June 9 call transcript released by the FSA as saying that the share issue would be “shockingly horrifying from [his] perspective.”
Points to Consider
The Einhorn case raised four main points to consider.
1. Wall-Crossing Where a Transaction Does Not Take Place
The FSA described the wall-crossing process and the position of a wall-crossed potential investor who has received inside information. The FSA stated that the wall-crossed potential investor can only trade in the relevant issuer’s securities once the inside information has been made public, and that, in the context of a transaction, the information will be made public:
-
if the transaction proceeds, when a “cleansing” market statement is issued announcing the transaction; or
-
if the transaction does not proceed, when a cleansing market statement is issued announcing that a transaction was contemplated but did not proceed.
The second point is potentially problematic for issuers and potential investors. The FSA suggests that if a wall-crossed potential investor receives inside information regarding a contemplated transaction (such as a share issue), the potential investor will be unable to trade, even if the transaction does not proceed, until a market announcement has been made clarifying that a transaction was contemplated but did not proceed. However, the decision overlooks the fact that the question of whether or not information is made public or remains price sensitive are matters of objective fact. It is possible to envisage a situation where, even absent a “cleansing” market announcement, the information in question is no longer inside information because it is either not price sensitive or has become generally available in any event.
The FSA’s decisions will, therefore, result in potential wall-crossed investors seeking greater certainty that they can continue to trade in the issuer’s securities if discussions end without a transaction taking place. Investors may therefore require an issuer to undertake to make an announcement stating that a transaction had been considered, but did not proceed. For an issuer that had not previously announced an intention to raise further capital, such an announcement could surprise the market with a resulting adverse impact on the price of the issuer’s securities. Whilst there are situations in which the failure to proceed with a fundraising transaction should in itself be considered inside information, that will not be true in all cases. The FSA’s decisions are likely to result in issuers feeling obliged to make a large volume of statements to the market, many of which may be vague and potentially misleading.
The Notices also refer to M&A transactions, in addition to capital raisings. The suggestion that an announcement that a transaction will not proceed is required to cleanse any inside information is contrary to market practice and the approach of the UK Takeover Panel. If secrecy has been maintained and discussions kept private, the UK Takeover Code normally does not require a bidder or a target to make an announcement once a decision has been taken not to proceed with an offer. Indeed, the making of such an announcement by a potential bidder would create consequences for it under the Takeover Code, because it would preclude it from bidding for the issuer for six months (subject to limited exceptions).
It is not clear whether the FSA intended such a broad brush approach. Also it is not clear why the FSA needed to deal with these types of issues in view of the specific and peculiar facts of the case. In particular, the FSA’s view was that Einhorn actually did receive inside information in the form of Punch’s advanced share issue plans. On the FSA’s analysis, Greenlight could not trade in Punch shares and CFDs until Punch made its share issue announcement on June 15, 2009. The FSA accepted that most of the points discussed on the June 9 call were not inside information. Each case will turn on its facts and simply talking to an issuer about possible plans may not be inside information. However, the FSA’s decisions will reinforce to issuers, investors and intermediaries the need to be extremely careful to ensure that a private discussion covering a possible capital raising or M&A transaction does not in fact convey inside information.
2. The Investor’s State of Mind
The FSA accepted that Einhorn did not deliberately or recklessly deal on the basis of inside information and in fact genuinely believed that the information was not inside information. Therefore, from a legal perspective Einhorn had no subjective intent. This lack of subjective intent, however, is not relevant to the civil market abuse offences in FSMA, which are predicated solely upon whether dealing actually occurred in qualifying investments on the basis of inside information.
The Einhorn case sets down another clear marker that objective intent is enough. An individual can commit market abuse if he ought to have known that the behaviour in question breached FSMA’s market abuse provisions.
3. Identifying Inside Information
The FSA acknowledged that there was no single statement of inside information provided to Einhorn and that some interpretation on his part of the information he did receive was required. However, in holding that the four items of information disclosed on the call were inside information, the FSA said that reasonable investors are expected to interpret comments in light of their context, which may mean understanding more than the precise words spoken.
The industry will need to take great care in identifying points made during a conversation to ensure that participants have not received inside information. Although the FSA found that Osborne did not “deliberately” or “recklessly” disclose inside information, he was nevertheless held liable for doing so. Regulators tend to use hindsight (viewing pre-transactional discussions through the perspective of subsequent movements in the share price), and the Einhorn and Osborne decisions show a willingness to give spoken words a meaning that may not have been apparent to the participants during a call.
4. The Importance of Getting a Second View
Einhorn was unable to convince the FSA that he took all reasonable precautions and exercised all due diligence to avoid committing market abuse and therefore show that he had a defence under section 123(2) FSMA. He also was unable to show that he reasonably believed that he had not committed market abuse. If Einhorn had asked Greenlight’s compliance or legal departments for a view on whether there were any issues in selling Punch shares after the June 9 call, he may have been able to show that he had taken all reasonable precautions and exercised all due diligence.
Osborne was criticized by the FSA for not referring the content of the call to his own senior management, compliance or legal personnel. The fact that Einhorn had refused to be wall-crossed meant that Osborne should have taken great care regarding information he disclosed. Once Osborne was put on notice that Greenlight was selling Punch shares, he should have raised concerns regarding the content of the call. However, the FSA found that Osborne did nothing to address the possibility that market abuse was taking place. Had he raised issues internally it is possible that this would have reduced the severity of the FSA’s action and could possibly have resulted in no action being taken against him.
|
