ECJ Ruling In Spector Photo Group Case Clarifies No Mental Element Required For Insider Dealing Under E.U. Market Abuse Directive

The European Court of Justice, in Spector Photo Group & Van Raemdonck v Commissie voor het Bank, Financie- en Assurantiewezen, clarified that where all of the constituent elements of Article 2 of the E.U. Market Abuse Directive are satisfied, a rebuttable presumption that an insider “used” inside information contrary to the prohibition on insider dealing will arise (see WSLR, January 2010, page 15).

It is therefore not necessary for the national authority also to prove that the person had used the inside information “with full knowledge” or to prove any other subjective mental element.

Background

Spector Photo Group NV (SPG), a publicly quoted company governed by Belgian law, operated a profit sharing policy with its employees by way of stock options. SPG would, to the extent that it held sufficient shares, satisfy options that were exercised by using shares in its possession. Where necessary, it would purchase additional SPG shares from the market. In 2002 SPG purchased over 45,000 SPG shares from the market.

Between May 28, 2003, and August 13, 2003, SPG (acting through Mr. Van Raemdonck, a director of SPG) purchased 27,773 SPG shares. Four lots of 2,000 SPG shares were initially purchased, before Mr. Van Raemdonck purchased the remaining 19,773 shares for SPG. This later tranche was purchased at an average price per share of €9.97.

On August 21, 2003, SPG announced that one of its subsidiaries had signed a letter of intent to acquire the business of a competitor. On September 11, 2003, SPG announced its first half year results for that financial year. These announcements increased SPG’s price per share to €12.50 (as at December 31, 2003).

On November 28, 2006, the Belgian Banking, Finance and Insurance Commission held that the share purchases by SPG and Mr. Van Raemdonck constituted insider dealing contrary to Belgian law. SPG and Mr. Van Raemdonck appealed the decision to the Appeal Court in Belgium. Pursuant to Article 234 of the Treaty establishing the European Community, the Appeal Court referred several questions to the European Court of Justice (ECJ) for clarification.

The Meaning of ‘Making Use’ of Inside Information and Whether it Requires Proof of Some Form of Mental Element

Article 2(1) of the Market Abuse Directive 2003/6 requires E.U. Member States to prohibit certain persons who possess inside information from “using that information by acquiring or disposing of, or by trying to acquire or dispose of, for [their] own account or for the account of a third party, either directly or indirectly, financial instruments to which that information relates”.

The principal issue the referring court asked the ECJ to consider related to the interpretation of the expression “use of inside information” in Article 2(1) of the Market Abuse Directive. In particular, the Belgian court asked whether prohibited insider dealing arises where a primary insider with inside information trades on the market to which that inside information relates (and without more), or whether the phrase “use of inside information” means that the insider must use the information “with full knowledge”.

The ECJ noted that Article 2(1) defines the constituent elements of prohibited transactions by reference to two criteria: 1) the persons that are likely to fall within the scope of the prohibition; and 2) material actions which constitute a prohibited transaction. However, Article 2(1) does not expressly set out what, if any, subjective mental element is required in respect of those material actions.

The ECJ explained that the Market Abuse Directive replaced Directive 89/592 and made two deliberate drafting changes in respect of the Article 2 prohibition on insider dealing. First, because of differing interpretations between Member States over the expression “with full knowledge of the facts”, the Market Abuse Directive jettisoned such wording. The basis for this was that a primary insider is likely to have access to inside information on a daily basis and will equally likely be aware that it is confidential. Secondly, the phrase “to take advantage of” inside information was replaced with “to use”. This was intended to remove the subjective requirement of purpose or intention from the definition of insider dealing and move towards a more objective definition that would aid the uniform harmonisation of the laws of the Member States.

The ECJ further explained that the fact that Article 2(1) does not expressly provide for a mental element can be explained on two grounds. First, the very specific nature of insider dealing enables the relevant mental element to be presumed in circumstances where the constituent parts of the definition have been satisfied. Secondly, recitals 2 and 12 of the preamble to the Market Abuse Directive explain that the purpose of that directive is to ensure that the integrity of Community financial markets is upheld and that investor confidence is enhanced. Administrative sanctions aimed at deterring insider dealing would be less effective where “a systematic analysis of the existence of a mental element” is required. As a result of this, in circumstances where the constituent elements of Article 2(1) are satisfied, the relevant intention on the part of the insider can be presumed.

The ECJ also noted that the presumption under Article 2(1) does not infringe fundamental freedoms and, in particular, the presumption of innocence under Article 6(2) of the European Convention on Human Rights and Fundamental Freedoms. A key reason for this was that the presumption can be rebutted and the rights of the defence are therefore guaranteed.

As to the specific nature of the offence, the ECJ noted that not all “uses” of inside information would constitute insider dealing. The ECJ recognised that if any primary insider who has inside information at the time of trading on the relevant market is automatically within the prohibition on insider dealing, this would go beyond what is necessary to achieve the objectives of the Market Abuse Directive. As such, the ECJ said that it is necessary to distinguish between uses of inside information that infringe those objectives and uses that don’t.

The ECJ said that the purpose of Article 2(1) is to ensure equality between parties in the financial markets by protecting parties from improper use of inside information, and to enhance investor confidence. The ECJ noted the close relationship between the prohibition on insider dealing and the concept of inside information, which, as defined under Article 1 of the Market Abuse Directive, is non-public, precise information in respect of financial instruments or issuers of financial instruments that is “likely to have a significant effect” on the price of such financial instruments. This relationship puts those in possession of inside information at a significant advantage. In order to ensure that the scope of Article 2(1) is not extended beyond what is intended or what is necessary to achieve its goals, each situation may require a thorough examination of the factual circumstances to ensure that the use of the inside information is actually unfair and thus contrary to the prohibition on insider dealing. The ECJ said that the recitals in the preamble and the objectives of the Market Abuse Directive will provide guidance on when the use of such information may be unfair.

The ECJ did not make a ruling on whether complete harmonisation of the Market Abuse Directive was required such that Member States could not impose a prohibition which was stricter than that required by Article 2, as it said that this was unnecessary in light of its decision on the principal issue.

The Relevance of Gains Made and Potential Criminal Liability to the Sanction

The ECJ was also asked whether, when imposing sanctions in respect of insider dealing and in order to respect the principle of proportionality, it is necessary to consider any gains realised by the defendant and, if so, at what date and on what basis should such gains be calculated.

The ECJ noted that Article 14(1) of the Market Abuse Directive requires Member States to impose sanctions in respect of insider dealing in breach of Article 2 that are “effective, proportionate and dissuasive”. However, Article 14 is silent as to the criteria to decide on whether a proposed sanction is sufficiently effective, proportionate and dissuasive. Recital 38 in the preamble provides that any sanction should be sufficiently dissuasive and proportionate to the gravity of the infringement and the gains realised.

The ECJ therefore concluded that gains realised from insider dealing may be relevant in determining whether a proposed sanction is “effective, proportionate and dissuasive”. However, the method of calculating such gains and the relevant date for such calculation are matters for national law to determine.

Finally the ECJ was asked whether the fact that a criminal sanction can be imposed and/or the level of such sanction must be considered when imposing an administrative sanction.

The ECJ noted that the Article 14(1) requirement to impose sanctions in administrative proceedings that are “effective, proportionate and dissuasive” is explicitly without prejudice to the right to impose criminal sanctions. It therefore clarified that it is not necessary to consider the level of criminal sanctions, or possible criminal sanctions, for the purposes of assessing whether an administrative sanction is “effective, proportionate and dissuasive”.

The ECJ did, however, highlight that recital 38 in the preamble to the Market Abuse Directive imposes an obligation on Member States to ensure that sanctions in respect of insider dealing are consistently applied. In the United Kingdom, Paragraph 2.7 of the U.K. Financial Services Authority’s (FSA’s) consultation paper “Enforcement Financial Penalties” in July 2009 specifically recognises this need, and states that the “more structured and transparent approach to setting penalties” they are proposing to pursue “will aid consistency”. Paragraph 2.9 also states that it is the FSA’s intention to increase the deterrent effect of such penalties by increasing the overall level of such penalties that they impose, something the ECJ makes clear is a matter for each Member State.

Comment

This decision clarifies that the insider dealing provisions of the Market Abuse Directive do not require regulators to prove, in circumstances where the other constituent elements of the offence have been established, that, subjectively, the insider intended to carry out insider dealing or used the inside information “with full knowledge”. Rather, where the constituent elements are proven (and the use of the inside information is unfair or contrary to the objectives of the Market Abuse Directive), a relevant mental element (and, unhelpfully, the ECJ did not expand on what this mental element is) can be inferred. It will then be for the accused to rebut this.

U.K. law did not directly transpose the wording of Article 2. Rather, insider dealing (under Section118(2) of the Financial Services and Markets Act 2000 (FSMA)) precludes trading “on the basis of” inside information as opposed to precluding the “use” of inside information. The FSA considers that a person’s behaviour is likely to be “on the basis of” inside information where that information is the reason for, or a material influence on, the insider’s decision to deal. This has required an assessment of the person’s subjective motivation for the trading, albeit that in some cases the motivation may be inferred from the circumstances.

Following Spector, it is arguable that FSMA needs to be amended in order to ensure that the prohibition under Section 118(2) is consistent with that required by the Market Abuse Directive. It will certainly be interesting to see whether the FSA will adopt a slightly different (and tougher) approach to cases under the insider dealing limb of market abuse, both in terms of the cases they are willing to pursue and the level of any sanction that they go on to impose.