The market abuse regime in the U.K. is Part VIII of the Financial Services and Markets Act 2000, due to come into force on Dec. 1 and is a new concept for English financial regulatory law. The fundamental concept of the regime is that users of a U.K. regulated market have a positive duty to ensure that they do not, by their acts, statements, conduct or omissions, impede the efficient operation of that market. This duty extends to persons who, although they do not use the market themselves, benefit from it--thus derivatives traders should not act in such a way as to damage the markets in the underlying securities by reference to which they price their derivatives. This duty is loosely equivalent to a duty of care and a breach of the duty is punishable by a fine. Section 118 of the act sets out that behavior is to be treated as market abuse if it is behavior which is "likely to be regarded by a regular user of that market who is aware of the behavior as a failure on the part of the person or persons concerned to observe the standard of behavior reasonably expected of a person in his or their position in relation to the market". This is an "objective intent" test--that is, the question of culpability is determined not by reference to what the person doing the act intended, but by reference to what an experienced external observer would have concluded that that person's intentions were. This has the interesting side effect that market abuse can be perpetrated entirely inadvertently--even where a person can prove that they had no intention of abusing a market, if the FSA can show that a reasonable market user would have objected to the conduct, then the conduct is prima facie market abuse. Note also that where a transaction between two parties to an over-the-counter derivative has the effect of abusing a market in a reference obligation, the question of what the counterparts to the derivative should have known and thought and what they must have intended will be assessed by reference to a regular user of the underlying market, despite the fact that neither of the parties to the OTC derivative may be users of that market at all. The point here is that if you do things which may have the effect of abusing markets, the FSA takes the view that it is up to you to educate yourself as to the customs and practices of those markets.
For behavior to constitute market abuse it must also fall within one of the three defined categories of market abuse proscribed by the act (for more details, go to www.derivativesweek.com). But in summary they are:
* Misuse of information--behavior based on information
which is not generally available but which, if it were
available, would be relevant when deciding the terms on
which market transactions are done (s. 118(2)(a));
* False or misleading impressions--behavior likely to give a
regular user of the market a false or misleading impression
as to the supply of, or demand for, or as to the price or
value of, investments (s.118(2)(b));
* Distortion--behavior which a regular user of the market
would, or would be likely to, regard as likely to distort the
market in investments (s.118(2)(c)).
Qualifying Investments & Relevant Products
The market abuse regime is intended to protect the London markets and the duty which is owed is owed only in respect of behavior which could potentially affect investments traded on the London markets ("qualifying investments"). Where a qualifying investment is priced by reference to an underlying product (a "relevant product"), as for example a London listed warrant priced by reference to a non-London listed security or basket of securities, then manipulating the prices of the underlying non-London-listed securities may constitute market abuse if the effect of the manipulation constitutes abuse of the market in the listed warrant. Conversely dealing in non-London-listed products, which are priced by reference to London-listed products, can constitute market abuse if the effect of the dealings constitutes abuse of the market in the London-listed product.
The Code
Section 119 of the act states the Financial Services Authority must prepare and issue a code which will give appropriate guidance to those determining whether or not behavior amounts to markets abuse. The code sets out in greater detail both the FSA's views on acceptable and unacceptable conduct and its views on the regular user test.
Perhaps the most important aspect of the code is its observations on the regular user. A regular user is defined as in relation to a particular market, a reasonable person who regularly deals on that market in investments of the kind in question. Behavior will amount to market abuse only where it would be likely to be regarded by a regular user as a failure on the part of the person or persons concerned to observe the standard of behavior reasonably expected of a person in his or their position in relation to the market. Behavior that conforms to standards that are generally accepted by users of the market is relevant but not determinative. The importance of this provision is that it makes clear that when the FSA applies its "regular user" test, it will not be seeking to determine what market practice actually is, but rather to determine what, in its view, market practice ought to be. The importance of this is that even where a person is acting fully in accordance with standards in a particular market, it will still be open to the FSA to take the view that the standards in the market as a whole are below those which would reasonably be expected, and to make a finding of market abuse.
Third Party Liability
The FSA takes the view that a person who requires or encourages another to behave in a way which constitutes market abuse may be fined as if they were themselves guilty of the market abuse concerned. This regime can catch, for example, directors of companies who release relevant information to specific users and not to the market generally, to persons who recommend or advise others to engage in behavior which will amount to market abuse and where an employer becomes aware that one of its employees or any other person under its power or control is engaged in market abuse but permits that person to continue engaging in the relevant behavior. The FSA is particularly emphatic that "early or selective disclosure of information which a regular user would expect market users to have on an equal basis will generally be considered to constitute requiring or encouraging another to commit market abuse unless there is a legitimate purpose for making the disclosure..." (Code 1.8.5).
This week's Learning Curve was written by Simon Gleeson, partner at Allen & Overy in London.
