February 2012 FSA penalties reinforce need for caution when wall-crossing A guide to best practice post-einhorn Overview The practice of pre-sounding investors is often a necessary precursor to a capital raising or refinancing. Pre-sounding is the term given to discussions with investors (which take place prior to announcement of an actual transaction) to gauge their interest in a potential structure or transaction and/or its potential pricing. One attendant risk of such discussions is that nonpublic, price-sensitive or inside information may be disclosed to the investor. The recent high-profile penalties imposed by the Financial Services Authority on David Einhorn, Greenlight Capital Inc. and others for market abuse serve as a timely reminder of the need for investors to take precautions to avoid violating rules on market abuse. In addition, there needs to be clarity on the sell-side as to whether or not an investor is being made an insider or is being wall-crossed and what should happen if the investor requests not to be wallcrossed. In the Einhorn decision, Mr Einhorn expressly requested not to be wall-crossed but the FSA found that nonetheless he had been given inside information during the course of a telephone call and that his subsequent dealing amounted to unlawful market abuse. A detailed analysis of the Einhorn decision is available here. This note summarises some of the legal concerns involved in the practice of pre-sounding investors. Contents Overview... 1 Legal context... 1 What is inside information?... 2 Precise?... 2 Significant effect on price?... 2 Examples of inside information... 2 Other offences... 3 When can inside information be disclosed?... 3 What if the investor refuses to be given inside information?... 3 When are you no longer an insider?... 4 Comment... 5 Legal context Market abuse is defined in Section 118 of the Financial Services and Markets Act 2000 as inappropriate behaviour relating to qualifying investments on a prescribed market. One category of inappropriate behaviour is where an insider discloses inside information to another person otherwise than in the proper course of the exercise of his employment, profession or duties (Improper disclosure - Section 118(3)). Another is dealing by an insider in qualifying investments, on the basis of inside information possessed by him relating to those investments (Insider dealing - Section 118(2)). FSA penalties reinforce need for caution when wall-crossing 1
Therefore it is essential to ascertain whether or not the information being divulged during pre-soundings constitutes inside information. What is inside information? Inside information is defined in Section 118C FSMA as information which: > is of a precise kind; > is not generally available; > relates, directly or indirectly, to a company with securities trading on a prescribed market ; and > would, if generally available, have a significant effect on the price of securities. Precise? Information is considered precise if it (i) indicates circumstances or events which exist or may reasonably be expected to come into existence and (ii) is specific enough to enable a conclusion to be drawn as to its possible effect on price (Section 118C(5) FSMA). The Einhorn decision serves as a reminder that the regulator always has the benefit of hindsight, which is likely to give rise to a presumption that what did actually occur could be reasonably expected to occur, whereas it is much more difficult for those looking forward to a possible transaction or event to judge whether it can reasonably be expected to occur. "the regulator always has the benefit of hindsight" Significant effect on price? The FSA s view is that information is likely to have a significant effect on price if it is information which a reasonable investor would be likely to use as part of the basis of his investment decisions (regardless of its likely impact on share price). Many commentators consider this to be too broad an interpretation of the legislation, but it is the approach that the FSA has taken in a number of enforcement actions. Examples of inside information Obvious examples of inside information include information that there is about to be a change in the issuer s credit rating or as to the content of an imminent results announcement or trading update, or information about a potential equity issue or M&A transaction by the issuer. However, more subtle examples of inside information include the fact that an issuer is contemplating issuing new debt securities or buying back a significant amount of existing securities. In the Einhorn decision, although there was no single statement of inside information, the FSA stated that the conversation in question had to be taken as a whole and in its context and on that basis the FSA s view was that there was inside information. In that case it did not matter that no information was given on the type of securities to be issued or how and with whom they were to be placed, or that the transaction was not a certainty at the time of the discussion. This emphasises that there can be no hard and fast rules on what type of information is or is not inside information it is always necessary to it is always necessary to use judgment to determine whether information disclosed, when taken in its context, is inside information FSA penalties reinforce need for caution when wall-crossing 2
use judgment to determine whether information disclosed, when taken in its context, is inside information. In some circumstances, for example if an investor has a very limited portfolio, advisers need to be especially careful as even the call by the bank, with the request to wall-cross, may be enough to give away the identity of the issuer. Other offences Another category of market abuse is behaviour based on information which is not inside information, but is information that is not generally available and which a reasonable investor would consider relevant in making investment decisions, known as RINGA (Section 118(4) FSMA). An offence can be committed if behaviour is based on RINGA and is likely to be regarded as a regular user of the market as a failure to observe the standard of behaviour reasonably expected of a person in the relevant person s position. Therefore, even where information disclosed is not technically inside information, it is still necessary to use caution to ensure there is no behaviour which falls short of market standards. There are also criminal offences under the Criminal Justice Act 1993 of insider dealing, encouraging another to deal in price-affected securities and improper disclosure of inside information. Although there are differences between the civil market abuse offences under FSMA and the criminal offences under the CJA, generally speaking, behaviour which is acceptable under the civil regime is unlikely to constitute a criminal offence. When can inside information be disclosed? Financial advisers risk breaching market abuse rules if they disclose information without a legitimate reason for doing so. However, exploring a potential new transaction or refinancing would constitute a legitimate reason for disclosure of inside information in the proper course of employment/profession. MAR 1.4.5 in the FSA s Code of Market Conduct lists the factors which the FSA will take into account for this determination and requires that the disclosure is accompanied by the imposition of confidentiality requirements upon the person to whom the disclosure is made. Therefore, it is clear that (i) the recipient must be made aware that they may be given potentially inside information and (ii) reasonable steps must be taken to protect the on-going confidentiality of the information. "the recipient must be made aware that they may be given potentially inside information" What if the investor refuses to be given inside information? If an investor expressly requests not to be wall-crossed, as in the Einhorn case, or refuses to agree to confidentiality conditions (whether orally or in a more formal non-disclosure agreement) it is imperative that no inside information is given to that investor. Great care must be taken to ensure any discussions that do take place do not divulge information which, when assessed by the FSA with the benefit of hindsight, could be seen to be inside information. Compliance teams should consider policies on what can be discussed when someone has refused to be wall-crossed. FSA penalties reinforce need for caution when wall-crossing 3
Investors also need to exercise caution if taking part in open or non-wall crossed conversations, particularly if they have been asked to sign an NDA, as this may indicate that inside information exists. When are you no longer an insider? It is market abuse to deal on the basis of inside information. If a person deals while in possession of inside information it is presumed that he has dealt on the basis of that information and the onus is on him to rebut the presumption. The Einhorn decision confirmed that the presumption will not be rebutted just because the inside information was one of several motivations for dealing. Therefore anyone in possession of inside information should ideally not deal until the information is no longer inside information (known as cleansing ). Once the transaction is launched or another public announcement has been made in respect of it, that information will be generally available and will no longer constitute inside information. At that point the conditions and restrictions attached to the information will fall away. If an NDA is in place, the terms of this should specify that it terminates automatically in these circumstances. The position is more difficult where the transaction does not proceed and no public announcement cleansing the market is made. If the transaction is postponed and is likely to be resurrected in the near future, then in the absence of an issuer announcement, the confidentiality obligations and dealing restrictions are likely to continue to apply. The position is less clear if the transaction is cancelled and there is no intention to resurrect it in the future, or if the information becomes stale (e.g. if an investor is told that the transaction won't happen if it doesn't happen by a certain deadline and that deadline has passed). If an NDA is in place, the terms of it should be carefully considered. Financial advisers should carefully consider whether, when telling investors that a transaction will not proceed, they also give a reason for this, which may itself amount to further inside information. In such a case, the principles set out above should be followed. The FSA states in the Einhorn decision notice that an insider will be cleansed, in the context of a transaction, either when the transaction is announced or, if it does not proceed, when an announcement is made to the market stating that a transaction was contemplated, but did not proceed. This description of cleansing could be regarded as something of an over-simplification. It is possible to envisage circumstances in which a possible transaction does not proceed where there would be no reason to make an announcement to the market. However, it does indicate that the FSA will normally expect a cleansing announcement following the failure of a proposed deal. Consideration will need to be given in such a case to whether this is required and, if so, what it needs to include, or, if not, to the reasons why an announcement need not be made. "the FSA will normally expect a cleansing announcement following the failure of a proposed deal" FSA penalties reinforce need for caution when wall-crossing 4
Comment The Einhorn decision should prompt market participants and compliance teams to review their procedures for pre-soundings (whether on a wall-crossed or open basis). Procedures should cover issues such as the steps needed to preserve confidentiality, standard scripts, post-conversation actions and record-keeping. If you would like to discuss appropriate procedures for presoundings please speak to your usual Linklaters contact or one of the contacts named opposite. Contacts For further information please contact: Peter Bevan (+44) 207 456 3776 peter.bevan@linklaters.com Lucy Fergusson (+44) 207 456 3386 lucy.fergusson@linklaters.com John Lane (+44) 207 456 3542 john.lane@linklaters.com Mairead Ni Dhonncha Counsel (+44) 207 456 5356 mairead.ni_dhonncha@linklate rs.com Tom O'Neill Author: Lucy Reeve This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters LLP. All Rights reserved 2012. Linklaters LLP is a limited liability partnership registered in England and Wales with registered number OC326345. It is a law firm authorised and regulated by the Solicitors Regulation Authority. The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP together with a list of those non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ or on www.linklaters.com and such persons are either solicitors, registered foreign lawyers or European lawyers. Please refer to www.linklaters.com/regulation for important information on our regulatory position. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by emailing us at marketing.database@linklaters.com. (+44) 207 456 3237 tom.oneill@linklaters.com One Silk Street London EC2Y 8HQ Telephone (+44) 20 7456 2000 Facsimile (+44) 20 7456 2222 Linklaters.com 5 A14532874/0.10/06 Feb 2012