May 2005BIICL - Market Abuse Program Market Abuse: A US Perspective Mark S. Bergman Partner and Head...

May 2005 BIICL - Market Abuse Program

Market Abuse: A US Perspective

Mark S. BergmanPartner and Head of Global Capital

Markets


Overview

• Corporate disclosure obligations• Insider trading• Selective disclosure• Market manipulation

US does not have concepts of "market abuse" per se or "close periods"

The US does have a broad range of rules and regulations that serve as a basis for addressing:


Disclosure Obligations in the US

• Disclosure duties generally

• Duty to correct • Duty to update• Duty to comment

on rumors• Protection for

forward-looking statements

• Selective disclosure • Rules on use of pro

formas• Filing obligations

for earnings releases • Insider trading

issues• Responsibility for

analyst reports• Rules for analysts

What do US companies worry about when they issue public statements?


When Must One Speak?• Silence absent a duty to disclose is not

misleading (includes “no comment”)• When a company does speak it must do so in

a truthful manner (anti-fraud rules)• Key is whether there is a duty to disclose:

– Voluntarily statement that is misleading– SEC filings – Trading in own stock– Live statement becomes misleading– Rumors from the company

• Stock exchange rules stricter, but not controlling


No Comment• “No comment” inappropriate if

company issues prior inaccurate statements (no merger talks at a time when there are)

• “No comment” may be inappropriate if company’s prior correct statements later become misleading at a later date (no merger talks followed by talks)


When One Does Speak• SEC filings must cover mandated

disclosure items, which include forward-looking statements

• Public statements will be subject to the anti-fraud rules as well – Press releases– Earnings calls– Conference participation

• RSA Security: “achieved analyst expectations in a difficult economic environment” -- misleading


Regulation FD

Selective Disclosure


Selective Disclosure• Intentional vs unintentional disclosure• Can cure unintentional disclosure

(SEC filing)• Applies to statements made by senior

officials and regular spokespersons• Applies to material information• Applies to statements made to broker-

dealers, other investment professionals, securityholders

• Exceptions: NDAs, insiders, rating agencies, registered public offerings

• Guidance is “material”


Enforcement Actions• SEC serious about monitoring compliance

and will enforce• Individuals risk liability if active role in

violation• Non-intentional disclosure must be

remedied right away and no further disclosure other than a press release

• Senior officers must be vigilant in monitoring disclosure and acting on violations

• Issues can arise from release of positive news as well as bad news


Enforcement Actions• Guidance remains a dangerous area• Selective after-the-fact communications

to clarify statements that were misunderstood is a problem

• Cannot use code words to convey guidance


Trading on Basis of Inside Information

Rule 10b-5 Violation


Insider Trading• No specific statutory prohibition; no statutory

definition – instead regulators rely on Rule 10b-5• 1980: Supreme Court holds that Rule 10b-5

imposes duty to disclose or refrain from trading on inside information only when trading is a breach of duty

• 1983: Supreme Court restated rejection of “possession” theory and extended fiduciary duty theory to tippee liability; tipper had to breach fiduciary duty unless could show “personal gain”

• SEC tries to advance position that CEO that disclosed information to analyst did so to enhance reputation, to establish “personal gain”


Insider Trading

• 1997: Supreme Court establishes misappropriation theory – need to find duty of trust and confidence

• SEC adopts Rule 10b5-2 to facilitate actions based on misappropriation:– Agree to keep information confidential– History, practice or pattern of sharing

confidences resulting in reasonable expectation of confidentiality

– Family relationship

• Resolution of “possession” vs “use” – evolution of 10b5-1 plans


Possession vs. Use – Rule 10b5-1

• SEC rejected a straightforward “use” test as well as more balanced “use” test with a strong inference of use from “possession.” Instead, adopted “knowing possession” standard, balanced with affirmative defenses

• As a general principle, insider trading liability will arise when a person trades while “aware” of material nonpublic information.

• Several exceptions from liability where person is not likely to have used the inside information: namely, where trade resulted from a pre-existing plan, contract or instruction that was made in good faith.

• Affirmative defenses intended to cover situations where defendant can show that information possessed was not a factor in a trading decision


Short Swing Profits Rules

• Officers, directors and 10% shareholders subject to reporting of ownership and trades and liability for profits made on "sales and purchasers" or "sales and purchases" within six months

• 5% shareholders subject to reporting obligations – intended to address tender offer abuses not insider trading


Other Aspects of Manipulation


Market Manipulation

• Section 9(a)(2) – creating appearance of a trading market

• Rule 10b-5: basis for insider trading actions; actions in respect of inadequate disclosure (including misleading the market)

• Regulation M – proscribes purchases at the time of a "distribution"

• Regulation SHO – regulates short sales• Rule 10b-18 – safe harbor for corporate

repurchases


Areas of Concern/Focus

• PIPES Market – trading ahead of deals– Criminal action against head trader at

investment bank (April 2005)– Civil action against manager of hedge fund

(May 2005)

• Toxic converts and "naked" shorts• Grant of options had of release of positive

earnings• Number of financial fraud actions have also

had an element of profiting through insider trading


Analyst Conflicts

• SRO rules (round I)• SRO rules (round II)• Global Settlement with 10 firms• Regulation AC• SRO rules on IPO allocation practices


Contact

Mark S. Bergman7367-1601

[email protected]

www.paulweiss.com

May 2005BIICL - Market Abuse Program Market Abuse: A US Perspective Mark S. Bergman Partner and Head...

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