Joint Committee on Financial Services and Markets First Report


  VII. MARKET ABUSE

Introduction

254. The draft Bill introduces a new regime for dealing with cases of market abuse, defined in broad terms in Clause 56. This regime is to apply to everyone, whether authorised or not. The market abuse regime is intended to supplement, but not replace, the existing criminal sanctions for insider dealing, misleading the market and market manipulation. It is designed to allow the FSA to deal with any conduct that is damaging to the markets and in particular it is intended to enable the FSA to deal with market-abusive behaviour by non-authorised persons which is not caught by the existing criminal offences. If the FSA is satisfied that a person has engaged in market abuse or has induced another person to do so, it can impose an unlimited fine. As noted above, the FSA must publish a policy statement on fines for market abuse and must act in accordance with that policy in deciding whether to impose a fine and when determining the amount of a fine. A person on whom the FSA decides to impose a fine for market abuse has the right to a hearing before the Tribunal.

255. Some of the written submissions received by the Treasury questioned the entire approach adopted in relation to market abuse and suggested that, as an alternative, consideration should be given to amending existing criminal provisions relating to insider dealing and market manipulation so as to address perceived difficulties in the operation of those sections.[347] In written evidence the FSA explained that the existing criminal offences cover only "a limited range of serious misconduct" and that the Government has decided that "the FSA, in pursuit of its objective of maintaining confidence in the financial markets, ought to be able to take administrative action against any market participant who abuses the market". [348]

256. We accept in principle the need for a market abuse regime that complements the existing criminal offences.

257. Clause 56 having established the perimeters of market abuse, the draft Bill requires the FSA to draw up and publish a Code of Market Conduct. The Bill provides for compliance with the Code to be evidence that market abuse has not occurred and for infringement of the Code to be evidence that it has. The Code thus operates within the statutory perimeters set by the Bill but compliance with or, as the case may be, infringement of the Code is not conclusive that market abuse has, or has not, occurred.

258. The status of the statutory provision (Clause 56), the Code, and related FSA guidance, is set out in Table III.

Table III :Requirements Generally Applicable - Market Abuse and Criminal Offences


Nature of Requirement

Enforcement

Tribunal Hearing

Public Announcement of FSA Decision (after Tribunal Hearing (if any))

Evidential Status

Market Abuse (cl 56)

FSA can fine any person (cl 58) or can ask the court to fine (cl 64)

Yes, for FSA decision to fine

Not mandatory; no stated FSA policy

N/A


Authorised persons also subject to FSA enforcement action as for contravention of rules (above)

Yes

As for contravention of rules (above)

N/A


FSA can ask the court for injunction (cl 203) or restitution order (cl 205) against any person

N/A

N/A

N/A


No FSMB action by other persons

N/A

N/A

N/A


Imposition of fine does not affect transactions (cl 66)

N/A

N/A

N/A

Code of Market Conduct (cl 57)

Helps to determine whether behaviour amounts to market abuse (cl 57)

N/A

N/A

Code may be relied upon so far as it tends to establish whether or not conduct complies with statement of principle (cl 57); has evidential value but is not conclusive

FSA Guidance (cl 87)can relate to market abuse

No FSA power to modify or waive market abuse requirements


As for FSA Rules, above

N/A

N/A

As for FSA Rules, above

Criminal Offences

eg, misleading statements and practices offence (cl 212


FSA can prosecute through criminal courts

No

N/A

N/A

259. Many witnesses expressed concerns about the proposed market abuse regime. Specific concerns mainly centred on two issues. The first is a perceived lack of certainty, arising from the very general way in which Clause 56 is drafted, the absence of any intent requirement in Clause 56, and the lack of a safe harbour for conduct in compliance with the FSA Code. The second is fairness, and the compatibility of the proposed regime with the European Convention on Human Rights. In a joint written submission, the ABI and the BBA encapsulated the concerns of many on this issue when they said that whilst they agree with the policy objective of seeking to ensure the open, transparent and fair operation of the UK markets, the draft Bill needs to be amended to ensure the fairness and sufficient certainty that are essential if firms are to feel confident in operating in those markets.[349] Lord Hobhouse went so far as to suggest that the deficiencies were such that the relevant Clauses should be dropped altogether from the Bill and that a market abuse regime should be held over for subsequent legislation.[350]

Statutory Definition of Market Abuse

260. The draft Bill defines the term "market abuse" as covering any behaviour which occurs in relation to qualifying investments traded on a market designated by the Treasury and which satisfies any one or more of the following conditions:

  • it is based on information which is unavailable to informed participants in the market but which, if available to them, would be likely to be regarded by them as relevant in deciding whether or not to enter into transactions involving investments of that kind;

  • it is likely to give such informed participants a mistaken impression as to the supply of, or demand for, or as to the price or value of, investments of that kind; or

  • it is likely to distort the market so far as it relates to investments of that kind.

261. Additionally the behaviour must be likely to damage the confidence of such informed participants that the market is true and fair. It is intended[351] that the market abuse regime will apply initially to all investments and commodities traded on UK-based recognised investment exchanges and to derivatives entered into by reference to such investments or commodities.

262. The Minister explained[352] to us that the high degree of generality in the wording of Clause 56 is deliberate and is designed to give the market abuse regime a very broad application. However, many witnesses told us that they felt that the present wording, and especially the reference to a "true and fair market" in Clause 56(1)(c), creates too much uncertainty. Mr Morton said that "the main point about market abuse is the need for greater certainty in the definition, which does seem to us not to give an adequately clear impression of what behaviour is regarded as objectionable".[353] He developed this point: "If you look at the definition of market abuse, Clause 56(1)(c) in particular, that is not, I submit, a prime example of something that gives people a very clear indication of what conduct is permissible".[354] Lord Hobhouse, in a letter of 19th April,[355] drew attention to the absence of any stipulation either that the person accused of market abuse should himself be a participant in the relevant market, or that the conduct in question should be conduct in or directed at that market. Other witnesses expressed similar views.[356] The potential for the regime to apply extra-territorially[357] and the inclusion of inaction[358] as a form of behaviour that could amount to market abuse were also identified as points of concern.

263. We acknowledge that achieving an appropriate balance between certainty and flexibility is not an easy task. For most purposes adequate certainty could in principle be provided by the Code. However, it will in some cases be necessary to fall back on the statutory definition; and in any case the statutory definition will set the perimeters of the Code. We are therefore persuaded that a clearer statutory definition of market abuse is required than the one in Clause 56 as drafted.

Intent

264. The Law Society Company Law Committee suggested to the Treasury that the general lack of a mental element is unduly severe and may give rise to great uncertainty and potential injustice. This concern about the absence of an intent requirement was echoed in much of the written evidence which we received[359] and also in oral evidence.[360] Mr David Mayhew, a partner in Clifford Chance, expressed a view that we heard from several witnesses when he said that "We do not believe that strict liability is an appropriate mechanism in this case".[361]

265. The explanation given by the Government for the absence of an intent requirement is that the market abuse regime is concerned with the efficient operation of the market, not the moral culpability of individual players in the market: confidence in the markets can be affected by the effects of a player's conduct even if this is not the player's intention.[362] Mr Davies told us the same; but he added reassuringly, "We do not propose to prosecute people for accidental offences".[363]

Safe Harbours

266. We acknowledge the force of the Government's argument against requiring proof of intent, and accept Mr Davies's assurance that in practice the FSA will not victimise those whose intentions are honest. However we consider that the broad wording in the draft Bill and the absence of a general intent requirement strengthen the case for the regime to be modified so as to include some form of "safe harbour" for honest and careful persons.

267. A "safe harbour" is a defined class of conduct which is guaranteed to be safe from regulatory challenge, perhaps with qualifications requiring good faith and due care. It is widely felt that some form of safe harbour should be incorporated into the market abuse regime so as to achieve fairness and greater certainty. From the evidence we have received three possibilities emerge:

  • The first is for compliance with the FSA Code of Market Conduct to be in some sense a safe harbour.

  • The second is for the FSA to be empowered or even obliged to give (or refuse) pre-clearance in respect of a particular transaction, which would then create a safe harbour for that transaction. This process is sometimes described, in language borrowed from US practice, as a "no action letter".

  • The third is for compliance with the rules of an appropriate recognised investment exchange to be in some sense a safe harbour.[364]


Safe harbour for conduct compliant with the Code

268. With regard to the first proposed safe harbour, we have received much evidence to the effect that compliance with the Code should be made an absolute defence to a charge of market abuse. As described above, as the Bill is drafted, this would not be the case; but the FSA told us in its first memorandum,[365] "Generally, where a person has acted in compliance with the standards set out in the Code, [we] will not seek to impose a civil fine for market abuse". In its second memorandum,[366] the FSA indicates that it now favours a statutory provision in these terms.

269. We favour strengthening the status of the Code. However we have some concerns about making it an absolute safe harbour, because this could leave scope for sharp practice that, technically, complies with the Code but which was in reality conducted in order to abuse the market. It would also give protection to novel forms of abuse on which the Code was silent and therefore could not be contravened. In this context we note that Lord Hobhouse, who was generally supportive of the proposition that the Code should be a safe harbour, qualified his support by saying that the safe harbour should only protect those who act bona fide.[367]

270. In our view, persons who disregard the consequences of their actions should properly be regarded as being within the scope of a regime that is concerned with the effect that behaviour may have on the operation of the markets. However, where there is compliance with the Code, it is fair for the legislation to place the onus on the FSA to prove intent, recklessness or possibly negligence. This approach also provides more certainty than the present draft Bill in that it ensures that honest and careful persons who act in accordance with the FSA's Code cannot be penalised for the inadvertent or accidental consequences of their actions. We recommend that the draft Bill should provide a safe harbour for behaviour that complies with the FSA Code of Market Conduct except where the FSA proves that the person responsible for it intended to engage in market abuse or exhibited recklessness or possibly negligence about the abusive effect of the behaviour. This is consistent with our recommendation above to enhance the evidential status of non-actionable rules and codes of practice.

Conduct in breach of the Code

271. In its second memorandum[368] the FSA puts forward the suggestion that the Code should be made altogether definitive so that conduct that contravenes the Code is deemed, without proof of anything more, to be market abuse. This suggestion is the counterpart to their proposal discussed above for compliance with the Code to be an absolute safe harbour. It would relieve the FSA of the burden of proving anything other than a breach of the Code. The conditions specified in Clause 56 would become merely the outer limits of the FSA's rule-making power. It would make the FSA the law-maker in the area of market abuse, raising the question of parliamentary control, on which the House of Lords Delegated Powers Committee would undoubtedly comment. This would be especially significant, as the FSA concedes, because the market abuse regime applies to everyone, not just to authorised and approved persons.

272. Our recommendation above, for compliance with the Code to be a safe harbour except where there is intent to abuse the market, or recklessness or possibly negligence, is based on the view, embodied in the draft Bill, that the limits of market abuse should be set by the legislation rather than by the FSA. The alternative model now suggested by the FSA is less flexible than our preferred approach, in that it would not catch those who set out to exploit a loophole in the Code or who abuse the market through recklessness or negligence. Under its model the FSA would have to act quickly to close the loophole and would not be able to pursue those who have already slipped through. We therefore recommend the "safe harbour" approach described above, rather than making the Code altogether definitive.

Guidance and Pre-clearance

273. The question of guidance and pre-clearance is discussed generally above in the context of discipline and enforcement. We noted there that the Government intend the powers of waiver and guidance to achieve the same effect as no-action letters. However, as the Bill is drafted at present, FSA guidance does not have any formal evidential status and the FSA does not have express power to waive or modify its Code of Market Conduct.

274. With regard specifically to the operation of guidance in the area of market abuse Mr Whittaker told us:[369] "If you were to come to us for guidance on a particular transaction, and we were to say that we thought that transaction was consistent with the market abuse provisions, then, provided you had been open with us in what you said and the situation was as you described it, I think we would be extremely unlikely to take any action in relation to those provisions". Mr Davies told us that in relation to market abuse, "We are currently working on a policy statement ... about the circumstances in which we will be prepared to issue clarificatory guidance".[370] He sounded a note of caution: "You have to be very, very clear about the terms of the transaction you are approving, because you do not want to approve something and then discover that, when it is actually effected, the transaction is rather different in crucial ways from the one that was put to you".

275. We recommend that the Treasury should consider the case for giving FSA guidance on the market abuse regime the same evidential status as the FSA Code of Market Conduct. This would further increase the certainty of the regime; on the other hand, it might make the FSA more cautious about giving guidance than they would be if it had no special status.

Rules of exchanges as safe harbour?

276. Mr Whiting considers that his exchange, the London Metal Exchange, has succeeded in defining market abuse clearly in its own rules, and that compliance with such rules should constitute a safe harbour.[371] Mr Whittaker explained to us in evidence[372] the difficulty that behaviour could affect more than one market. However he added, "We do think it is desirable that a Code should give weight to the rules of the exchange in the way in which it describes particular abuses". Also, "Where an abuse arises only within a particular exchange, we would expect it to be that exchange that would take enforcement action, we ourselves would not get involved".

277. We regard this as a sensible approach and do not consider that a case has been made for the enactment of this type of safe harbour.

Civil or criminal?

278. The impact of the ECHR on the proposed market abuse regime featured prominently in the representations made to us. We recognise, as noted above in the general context of discipline and enforcement, that this is an area of legal complexity and that there is scope for contrasting views on how the ECHR applies. Nevertheless, a strongly-supported view, based on the oral and written representations we received, is that although the draft Bill classifies the market abuse regime as civil, such classification under the domestic law is not conclusive for the ECHR and that, for that purpose, it is likely to be regarded as criminal. This conclusion is arrived at by considering the nature and scope of the regime and the nature and severity of the penalties.

279. The characterisation of the regime as criminal carries with it a variety of implications. It means that the legislation by which it is created must satisfy Article 7 of the ECHR, which has been interpreted as meaning that the nature of a criminal offence must be stated with sufficient certainty to enable a person to be able to foresee the legal consequences of his actions. It also means that the special safeguards provided by Article 6 of the ECHR for proceedings involving criminal charges apply.

280. Earlier, we said that the Government should publish their thinking as to whether the Bill's general disciplinary and enforcement processes are civil or criminal in ECHR terms, and in the light of that how the relevant Convention standards are to be met. In view of the weight of evidence that we have heard about this point in relation to the market abuse regime in particular, we consider that there is a compelling case for the Government to respond to the concern that the market abuse regime is criminal in substance in ECHR terms and that the necessary safeguards do not appear in the Bill as drafted.

281. There are three main options:

  • they could recognise on the face of the Bill that the regime is criminal and make the whole of market abuse a criminal offence, limiting the FSA's role to that of prosecutor through the criminal courts—this approach would run the risk of creating a regime so heavy-handed as to be of limited effectiveness;

  • they could incorporate criminal justice safeguards (in particular, privilege against self-incrimination and some form of legal aid) into the enforcement regimes established by the Bill, for cases sufficiently serious to count as criminal in ECHR terms; or

  • they could make the regime more clearly a civil regime, by restricting the remedies available (which might weaken the effectiveness of the regime) or by requiring the FSA to have greater recourse to the civil courts.

We look forward to seeing the Government's response on this issue. As noted above, we intend then to revisit the question with fresh evidence and a further report.


347  E.g. LIBA, Goldman Sachs Back

348  Appendix 4, para 33 Back

349  Appendix 13, para 32 Back

350  Q 433 Back

351  FSA Consultation Paper 10 Back

352  Q 117 Back

353  Q 200 Back

354  Q 223 Back

355  Appendix 60 Back

356  E.g. Farrow QQ 201, 221; Mayhew Q 202; Blunden Q 261; Buxton Q 276 Back

357  Mayhew Q 202. Also Bates Q 223 Back

358  Hobhouse Q 433 Back

359  E.g. APCIMS, Appendix 37, para 4.1 Back

360  E.g. Bates Q 245; Vipond Q 284; Sylvain Q 284 Back

361  Q 202 Back

362  QQ 117, 288 Back

363  Q 78; cp Whittaker Q 448 Back

364  E.g. Farrow Q 223 Back

365  Appendix 4, para 39 Back

366  Appendix 5, para 4 Back

367  Q 436 Back

368  Appendix 5 Back

369  Q 290 Back

370  Q 78 Back

371  Q 223 Back

372  QQ 224-5 Back


 
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