Articles

The Dark Side of The Market: an exploration of the market abuse

April 7, 2023April 7, 2023
The Dark Side of The Market: an exploration of the market abuse

Author: Shahlar Ibadzade, LLM in Saarland University: Europa-Institut – European and International law, 2019-2022

Editor: Bobbie Smith, MA Geography University of Aberdeen 2016-2020 / Graduate Diploma in Law University of Exeter 2020-2022

Abstract

This article explores the unspoken truths of the market[1]: abuse, manipulation, insider dealing, and unlawful disclosures. To demonstrate the pitfalls of the umbrella term, in accordance with Market Abuse Regulation and Directive, a definition will be outlined. Secondly, a scope of conflicting forms and practices of market abuse and how these practices can harm investors will be presented. Lastly, considerations will be given to the legal framework to combat market abuse and the challenges associated with detecting and prosecuting such crimes worldwide. Overall, the aim of the article is to raise awareness of market abuse and root out the importance of robust safeguards to protect against it.

Introduction

Throughout the 20th century, the internal market of the European Union (the “EU”) – prior to the European Economic Area – suffered a multifaceted range of market abuse. By the end of the 20th century, the EU procured action to end the directive against market abuse. Subsequently, EU Insider Dealing Directive was approved in 1989 which standardised the prohibition on insider trading among the EU member countries. In addition, the European Union passed the EU Market Abuse Directive which was the aid of improving and discouraging market abuse in the EU’s securities and financial markets – however, had evident shortcomings. As a result, the EU Market Abuse Directive was repealed in 2014 and replaced with the Market Abuse Regulation (the “Regulation“) and the Criminal Sanctions for Market Abuse Directive.[2]

PART I

Market Abuse

Considering definition(s) of market abuse are subject to the jurisdiction, this article explores the European and Azerbaijani legislation as case studies. Under para. 7 of the Regulation, market abuse should be understood to consist of the following:

  • insider trading;
  • the unauthorized disclosure of inside information, and
  • market manipulation for the purpose of this Regulation.[3]

1. How Do We Define Market Abuse in Azerbaijan?

Foremost, for comparison between European and Azerbaijani legislation, there are two laws regulating market abuse in Azerbaijan: the Law on Market of Securities; and the Rules on Market Abuse Prevention in the Securities Market. According to the Law on Market of Securities (the “Market Law”), there are different approaches to market abuse and insider dealing which are separated in the Law, and market abuse is defined as market manipulation.

With respect to insider trading, there are two requirements which must be met for the act to be considered a criminal offence. First, confidential information must be identified. According to the Market Law’s definition of the term insider information, this regards knowledge that has not been made public and pertains directly or indirectly to one or more issuers, securities, or derivative financial instruments. Second, such information must be disclosed in a setting that is not open to the public. Suppose the information that was provided was found to have a material impact on the prices of securities or derivative financial instruments. In that case, the action taken must be recorded, and additional procedures must be followed.[4]

According to the Administrative Offences Code of the Republic of Azerbaijan, some offences can be considered as administrative offences if the amount of damage is less than EUR100,000. Under these circumstances, the administrative fine would be equal to two to four times the amount of damage that was incurred.[5]

In case the amount of the damages produced is greater than the threshold of EUR100,000, then the act in question will qualify as a criminal offence under the Criminal Code of the Republic of Azerbaijan. The maximum possible sentence for a criminal offence is imprisonment for up to six years or a payment of a fine equal to two times the amount of the damage caused (money earned from the offence).[6]

In accordance with the Market Law, the abuse of the market might feature any one of the following factors listed below:

  1. Completing transactions or issuing orders that provide, or may provide, inaccurate or misleading information concerning securities and derivative financial instruments or their demand and supply (including the potential to provide such information);
  2. Holding and modifying the price of securities or derivative financial instruments at the artificial level by multiple people acting alone or collectively by creating agreements or providing instruction to create agreements;
  3. Procuring the deals with the help of illegal instruments, in addition to trading with the securities or derivative financial instruments, or engaging in suspicious transactions; and
  4. The broadcast of news, rumours, and other information about securities or derivative financial instruments by media or any other means, with the intention of producing or forming notions that are deceptive or irrational in nature.[7]

As an alternative to criminal proceedings, there is a possibility that an application can be submitted to claim damages. According to the Civil Code, victims of insider trading and other forms of market abuse can bring legal proceedings on their behalf, in order to seek compensation.[8]

At face value, there are rules and laws in place to regulate market abuse and other offences against the market: however, there are just as many loopholes. There is scope for both criminal and civil proceedings to evaluate case by case, yet there are not enough safeguard mechanisms in place to prevent market abuse and insider dealings – whether first or seventh offence.

PART II

Forms of Market Abuse

According to the Regulation, there are different kinds of market abuse threats. Briefly, the revised Market Abuse Directive (the “MAD”) and the Regulation came into force on July 3rd, 2016 and have been implemented at the national level as of the end of 2016. The Regulation and Directive seek to protect investors by regulating insider dealing, unlawful disclosure of inside information and market manipulation, which have since been defined as prohibited behaviours.

In regard to the prohibition of insider dealing, unlawful disclosure of inside information, a person shall not:

  1. Engage or attempt to engage in insider dealing;
  2. Recommend that another person engage or induce to engage in insider dealing, or;
  3. Unlawfully disclose inside information.[9]

Additionally, subject to the prohibition of market manipulation, a person shall not engage in or attempt to engage in market manipulation.

Parallel to the prohibitions, the EU coined the scope of the Regulation to be all financial instruments; transferable securities, money-market instruments, units in collective investment undertakings, and financial derivatives.  Benchmarks, spot (or physical) commodity contracts and emission allowances were admitted to trading on a regulated market – as well as Multilateral Trading Facilities (the “MLTFs”) and Organized Trading Facilities (the “OTFs”). In the meantime, the transactions, orders, and/or behaviours were sought to happen within the European Economic Area (the “EEA”) and the issuer or financial instrument which are located outside the EEA.

Furthermore, the Regulation also provides that there is an:

  1. Obligation for the issuer and adviser to keep records of market soundings;[10]
  2. Obligation for the issuer to keep an up-to-date insider list at all times and provide them to the local regulatory upon request; and
  3. Obligation to make a suspicious order report in addition to making suspicious transaction reports.

In accordance with Article 2 of the Regulation, inside information refers to specific information that has not been made public and that relates directly or indirectly to one or more issues or to one or more financial instruments, and that would likely have a significant impact on the prices of such investment products or on the price of relative derivative financial instruments if it were made public. As an example, inside information can be scaled to:

  1. Information relating to corporate governance such as changes in control and control agreements, in management and supervisory boards, changes in auditors or any other information related to auditor’s activity;
  2. Information related to a financial institution, results or forecasts;
  3. Information relating to the strategy of the company as capital operations or issue of debts and etc;
  4. Information related to the business such as the development of a new product and even a new material contract; and
  5. Information relating to the legal situation as license granting, litigation, trust clearance and etc.[11]

The value of the financial instruments issuers might be affected when confidential information becomes public knowledge. When it comes to information that directly affects the issuer, such disclosure of that information is mandatory. The goal is for all potential investors to be as well informed as possible so that they all stand a fair opportunity of making a good profit on their investment.[12]

An insider is regarded as a person who is aware of inside information as a result of:

  1. Being a member of the administrative management or supervisory body of the issuer or emission allowance market participant;
  2. Having a holding in the capital of the issuer or emission allowance market participant;
  3. Having access to information through the exercise of an employment, professional or duties at an issuer such as director; and/or
  4. Being involved in criminal activities.[13]

Successively, a person can possess inside information as a result of other circumstances where that person knows or ought to know that it’s inside information such as through a family member or friend.

How Do We Detect Market Abuse and Protect Ourselves?

According to Market Abuse Regulation, companies must establish and maintain effective arrangements, systems and procedures to detect any suspicious transactions, in addition to monitoring suspicious transactions to the local authority without delay and adhering to reporting obligations.

Effective protection is to put in place key controls during the onboarding of investors. Briefly, any insider dealing risk needs to be screened at the onboarding stage, whereby the teams performing the first line of defence are in charge of identifying possible insiders. When an insider is detected, the specific data capturing team must focus on that insider’s transactions to ensure there is no suspicion of insider dealing. If there is a suspicion, the insider and transaction will be reported to the local authority.[14]

On the other hand, the second protection method has an up-to-date list log that includes all customers identified as insiders. Two different types of insiders are logged as:

  1. Active Insiders – individuals who have an active role in the quoted company; and
  2. Passive Insiders – individuals who have an indirect link with the quoted company such as former board member or director, business partner or family member or friend etc.

What Threats are Associated with Different Forms of Market Abuse?

A possible risk is undermining the investor’s confidence. Since an insider is a person who is aware of the situation and the other members – investors in the market do not have any propositions relating to such inside information. In turn, the insider’s actions harm the financial market’s integrity, which decreases the level of investors’ confidence.[15]

As it’s highlighted above, the second kind of market abuse threat is predominantly the result of any manipulation and/or attempts to manipulate the market. Subsequently, another risk is notoriously called pump and dump. This entails the action of an individual, or corporate body, creating hysteria and encouraging investors to purchase shares in a company which artificially rockets the price. Then the individual sells his own or third party’s shares while the price is high. Similarly, another risk called ramping is where an individual creates a rumour and/or fake activity in order to get the attention of investors in the market. In turn, the stock price increases.

There is not a public list of all market abuse threats; however, the main takeaway of this article is that effective safeguard mechanisms, reporting, and uniform monitoring for further investigation by local regulations are paramount.[16]

Forecast

As the EU tries to bring financial regulation into a new technological era of investment, trading, and market structure implementations, the MAR/MAD package was a crucial step in the process. The goal of making European financial markets more appealing to issuers, investors, and traders who operate across national borders can be advanced by ensuring that there is uniformity across all financial instruments, execution venues, and national jurisdictions and implementing a sanctioning regime that serves as a deterrent. The advantages that are anticipated to result from the package in its current form are far more than the costs that are associated with it.

Even without a surveillance component, the lengthy delays that are outlined are the most significant danger posed by the MAR. Some acts will be delegated, as well as the drafting of some technical standards. Recent occurrences serve to remind us that crises that may directly be linked to market structure and practice have the potential to significantly undermine investor confidence.

One of the possible solutions is expanding the definition of market abuse on the business level to include computerized trading conduct, which past market manipulation regulations have not dealt with satisfactorily. This solution contributes well to achieving MAR’s objectives since it enhances market integrity and investor protection while maintaining a unified set of rules and maintaining a level playing field for investors. As a result, this recommendation aims to identify inappropriate actions, draft legislation to cover such behaviours and ensure compliance with the Regulation.

The second solution is driven by the need to conduct enforcement. Surveillance is not a choice but a legal requirement. A unified audit trail housed in a central repository managed by registered entities is something that has been proposed. Orders must be tracked from the point of origin through receipt, routing, modification, and cancellation. In order to accomplish this goal, material terms of an order are isolated, which provides sufficient information to reconstruct trading activity in securities. I believe this is the only alternative that is even somewhat possible for the effective implementation of MAR/MAD.

Surveillance, and the human capital skills required to identify manipulative behaviour, will demand continuous revision during the next ten years. Such a surveillance system would be revolutionary and would demand a huge technical improvement mainly in information technologies and human resources. Therefore, revolutions often come at a high financial cost. Despite this, regulators and authorities can take advantage of the innovative technology used in trading to keep a credible enforcement strategy in place.

 

Citation:

[1] The market in Business law means a venue that is conducive to the meeting of buyers and sellers for the purpose of easing the process of exchanging or transacting products and services

[2] Howard Chitimira „A Historical Overview of Market Abuse Prohibition in the United Kingdom“ <https://www.researchgate.net/publication/274582607_A_Historical_Overview_of_Market_Abuse_Prohibition_in_the_United_Kingdom> accessed on 31 December 2022

[3] EU Commission, Market Abuse Regulation <https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32014R0596> accessed on 31 December 2022,

[4] CIS Legislation, The Law of the Republic of Azerbaijan about Securities Market <https://cis-legislation.com/document.fwx?rgn=78575> accessed on 31 December 2022,

[5] CIS Legislation, The Code of Republic of Azerbaijan about Administrative Offences <https://cis-legislation.com/document.fwx?rgn=85141> accessed on 31 December 2022.

[6] CIS Legislation, The Code of Republic of Azerbaijan about Administrative Offences <https://cis-legislation.com/document.fwx?rgn=85141> accessed on 31 December 2022

[7] CIS Legislation, The Law of the Republic of Azerbaijan about Securities Market <https://cis-legislation.com/document.fwx?rgn=78575> accessed on 31 December 2022,

[8] ADS Database, The Criminal Code of the Republic of Azerbaijan <  https://adsdatabase.ohchr.org/IssueLibrary/AZERBAIJAN_Criminal%20Code.pdf >  accessed on 31 December 2022

[9] EU Commission, Market Abuse Regulation para 56. < https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32014R0596 > accessed on 31 December 2022,

[10] Ibid. para 84

[11] EU Commission, Market Abuse Regulation Article 7. <https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32014R0596> accessed on 31 December 2022

[12] Celyad Oncology, Internal Rules for Prevention of Market Abuse, <https://celyad.com/wp-content/uploads/2020/06/Celyad-Oncology_Dealing_Code-20200608-1.pdf> accessed on 31 December 2022

[13] EU Commission, Market Abuse Regulation Article 8. <https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32014R0596> accessed on 31 December 2022

[14] EU Commission, Market Abuse Regulation Article 16. <https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32014R0596> accessed on 31 December 2022

[15] Allenovery, Market Abuse Regulation: The First Five Years <https://www.allenovery.com/en-gb/global/news-and-insights/publications/the-market-abuse-regulation-the-first-five-years> accessed on 31 December 2022,

[16] Deloitte, Market Abuse Outlook: Overview of Global Regulatory Priorities and Focus Areas <https://www2.deloitte.com/content/dam/Deloitte/global/Documents/Financial-Services/gx-market-abuse-outlook-v3.pdf> accessed on 31 December 2022

 

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