Market Abuse Regulations - Insights from EU Frameworks

Josef Bergt
2023

Introduction

Market abuse, a term that encapsulates insider trading and market manipulation, has been a subject of increasing scrutiny and regulation in the financial markets. The objective of this article is to delve into the complexities of market abuse, examining its legal framework, the implications for market participants, and the mechanisms for its prevention and prosecution. This article aims to provide a nuanced understanding of market abuse, drawing upon European Union regulations, while also offering insights into the role of regulatory bodies in maintaining market integrity.

Defining Market Abuse

The term "market abuse" is primarily defined under Regulation (EU) No. 596/2014 on Market Abuse (Market Abuse Regulation – MAR) and Directive 2014/57/EU on criminal sanctions for market manipulation (Market Abuse Directive – MAD). The overarching aim of combating market abuse is to ensure the integrity of financial markets and bolster investor confidence. Market abuse may occur when investors are directly or indirectly harmed through:

• The utilization of confidential information (Insider Trading)
• The distortion of financial instrument pricing or the dissemination of false or misleading information (Market Manipulation)

Such behaviors fundamentally undermine the principle that all investors should be treated equitably.

Legal Framework and Guidelines

The provisions of the Market Abuse Directive and the provisions Market Abuse Regulation requiring implementation, as well as the associated implementing acts have been implemented into national law of the EU and EEA member states unless they are directly applicable.

The key legal provisions include the prohibition of market manipulation under Articles 12 and 15 MAR, and the prohibition of insider trading under Articles 8 to 11 and 14 MAR.

Regulatory Oversight and Enforcement

Preventing market abuse and facilitating the detection of violations plays a pivotal role. Ensuring compliance with these provisions is indispensable for achieving the aforementioned objectives of market integrity and investor confidence. The introduction of criminal sanctions, especially in severe cases of market abuse, sends a clear signal to the public and potential perpetrators that violations of market abuse provisions are unacceptable behaviors.

Reporting and Whistleblowing

Complaints and tips from the market can make a significant contribution to the pursuit of market abuse. Professionals dealing with financial instruments are obliged to report suspicious transactions and orders. However, due to official secrecy, the national competent supervisory authority cannot provide information on the progress or outcome of investigations.

Insider Trading

The concept of insider trading is defined under the Market Abuse Regulation (MAR), effective since July 3, 2016. According to this regulation, information qualifies as insider information if it is non-public, precise, and directly or indirectly related to one or more issuers or financial instruments. Furthermore, the information must have the potential to significantly influence the price of a security if disclosed and would likely be used by a reasonable investor as part of their investment decision-making process.

The offense includes exploiting insider information for oneself or a third party through buying or selling, altering or cancelling trading orders, or recommending securities or disseminating the information to others. The competent national supervisory authority is obligated to report suspected violations to the public prosecutor's office, which can then commission further investigations.

In terms of criminal penalties, the misuse of insider information can result in imprisonment or monetary penalties. This generally applies to primary insiders who intentionally violate the prohibition against insider trading. Secondary insiders, such as spouses of board members or cleaning staff, are in general subject to this penalty only if they knowingly commit the offense. Legal entities can also be held accountable.

The misuse of insider information has far-reaching implications for capital markets. It erodes investor trust, leading to decreased investment and increased capital costs for companies. This can result in market failure and even the collapse of the capital market. Legal precedents from the European Court of Justice have further clarified the definitions and implications of insider information and insider trading, emphasizing the need to protect market integrity and investor trust.

• Judgment on June 28, 2012: The ECJ addressed the question of when information related to protracted processes can be considered "precise" and thus constitute insider information. The Court ruled that even intermediate steps linked to the realization of a circumstance or event can be considered insider information.
• Concept of 'Sufficient Likelihood': The judgment clarifies that "sufficient likelihood" refers to the assessment of future circumstances or events. If a comprehensive evaluation indicates that they can reasonably be expected to occur in the future, then there is sufficient likelihood. The judgment does not consider the extent of the impact on the financial instruments' prices.
• Judgment on March 11, 2015: The ECJ clarified the interpretation of the term "precise" information once again. The Court ruled that being classified as "precise" does not require predicting the direction of price movement. The key criterion for determining whether information can be insider information is the reasonable investor. The judgment concludes that predicting the exact direction of price movement is not necessary due to the complexity of financial markets.

In summary, the legal framework surrounding insider trading is intricate and carries severe penalties for violations. The misuse of insider information not only has legal repercussions but also undermines the integrity of financial markets, affecting both investors and companies.

Market Manipulation

Market manipulation is a multifaceted concept that can manifest in various forms, including executing trades under specific conditions, issuing orders under false pretenses, or disseminating misleading information. According to Article 12 of the Market Abuse Regulation (MAR), market manipulation encompasses activities or orders that either send false or misleading signals about the supply, demand, or price of financial instruments, or artificially influence the price to an abnormal or artificial level. Exceptions are made if there are legitimate reasons for the activity and it does not violate acceptable market practices.

The scope of market manipulation also extends to activities conducted under false pretenses or other deceptive practices. Moreover, the dissemination of false or misleading information through media channels, as well as providing incorrect data for the calculation of a reference value, also fall under the umbrella of market manipulation.

Specific practices considered as market manipulation are outlined in Article 12 of MAR and its annexes. These include securing a dominant market position to unfairly influence prices, executing trades at market close to mislead investors, and leveraging media access to manipulate financial instrument prices.

In terms of legal repercussions, market manipulation may be subject to criminal penalties, depending on the specific criteria met. According to Article 30 of MAR, administrative penalties may also be imposed and can go up to €5 million or three times the benefit derived from the violation, including any avoided loss. Legal entities can also be held accountable, with penalties reaching up to €15 million or 15% of the annual net turnover.

The concept of "Crossings", also known as wash trades, involves transactions where the economic ownership does not change, essentially making them sham transactions. These can distort trading in the affected financial instrument and are considered market manipulation unless legitimate reasons exist, and acceptable market practices are not violated.

In summary, market manipulation is a complex and multifaceted violation that can manifest in various forms, from deceptive trading practices to the dissemination of misleading information. The legal framework provides for stringent penalties, both administrative and criminal, to deter such activities and maintain market integrity.

Reporting suspicious transactions and orders

Operators of trading venues are mandated to establish and maintain effective systems and procedures to prevent and detect insider trading and market abuse. Professionals dealing with financial instruments must report suspicious transactions or orders to the competent national supervisory authority immediately. Such reports can be submitted through specific platforms or via email. 

Conclusion & Outlook

Market abuse remains a complex and evolving area of law that necessitates a multi-faceted approach for effective regulation and enforcement. The legal frameworks at both the European Union and national levels provide a robust mechanism for combating market abuse, but their successful implementation hinges on vigilant regulatory oversight and active market participation. 

With regard to crypto assets, the Market in Crypto-Assets Regulation (MiCAR) also addresses the regulatory framework surrounding market abuse, encompassing both insider trading and market manipulation within the realm of crypto-assets. Articles 86-92 of the Markets in Crypto-Assets Regulation (MiCAR) establish a comprehensive legal framework aimed at preventing and prohibiting market abuse in the realm of crypto-assets. Article 86 delineates the scope, making the rules applicable to any person involved in crypto-asset trading activities, whether within the European Union or in third countries. Articles 87 and 88 define "inside information" and mandate its timely public disclosure, while Articles 89 and 90 explicitly prohibit insider dealing and unlawful disclosure of inside information. Article 91 focuses on the prohibition of market manipulation, defining it as any activity that gives false or misleading signals about crypto-asset prices. Lastly, Article 92 mandates that professionals in the crypto-asset trading sector have effective systems in place for the prevention and detection of market abuse, requiring immediate reporting of suspicious activities to competent authorities. Collectively, these articles aim to ensure market integrity, transparency, and accountability in the rapidly evolving crypto-asset landscape.

Source: Austrian FMA on Market Abuse, Insider Trading and Market Manipulation

Executive Summary:

• Market abuse encompasses insider trading and market manipulation, with legal definitions primarily rooted in EU regulations.
• National laws of EU and EEA member states have incorporated these EU directives and regulations, providing a comprehensive framework for combating market abuse.
• Competent national supervisory authorities play a crucial role in preventing market abuse and facilitating the detection of violations.
• Criminal sanctions serve as a deterrent, emphasizing the unacceptability of market abuse behaviors.
• Reporting mechanisms and whistleblowing systems are essential tools for regulatory bodies in their pursuit of market abuse violations.
• Insider Trading: Trading platform operators are required to have robust systems and procedures in place to prevent and identify insider trading. Suspicious activities must be reported to the financial market authority.
• Market Manipulation: Professionals involved in financial instruments are obligated to report any transactions or orders that they suspect could constitute market manipulation to the financial market authority.