Opinion of the Economic and Social Committee on "Insider dealing and market manipulation (market abuse)"
Date: 2002-01-17
Institutions: European Economic and Social Committee
Subjects: approximation of laws, insider trading, official market, securities

3.4.2002

EN

Official Journal of the European Communities

C 80/61

Opinion of the Economic and Social Committee on ‘Insider dealing and market manipulation
(market abuse)’

(2002/C 80/14)

On 2 July 2001 the Council decided to consult the Economic and Social Committee, under Article 262
of the Treaty establishing the European Community, on the above-mentioned proposal.

The Section for Economic and Monetary Union and Economic and Social Cohesion, which was
responsible for preparing the Committee’s work on the subject, adopted its opinion on 5 December
2001. The rapporteur was Mr Levitt.

At its 387th plenary session (meeting of 17 January 2002), the Economic and Social Committee adopted
the following opinion by 51 votes to two with six abstentions.

1.

Introduction

exchange of

1.1.
The European Commission has published a proposal
for a Directive on Insider Dealing and Market Manipulation
intended to increase standards for market
(Market Abuse)
integrity in the securities field throughout the EU based on
the principles of transparency and equal treatment of market
participants. It will require closer co-operation and a greater
degree of
information between national
competent authorities than exists at present. The proposal is
intended to reduce potential inconsistencies, confusion and
loopholes by establishing a basic
the
allocation of responsibilities, enforcement and co-operation
within the EU. The initiative is an important element of the
Financial Services Action Plan and the drive to create an
integrated financial services market by 2003. The Com-
mission stresses that it is one of the first two proposals for
Directives under the new "Lamfalussy" format distinguishing
framework principles from implementing technical details,
an approach which was endorsed at
the March 2001
Stockholm European Council.

framework for

1.2.
The Commission says there are two main categories
of Market Abuse: insider dealing and market manipulation.
The existing Insider Dealing Directive (89/592/EEC) was
adopted over a decade ago since when financial markets
have developed and it is necessary to update the provisions
in the current Directive. The proposal covers both insider
dealing and market manipulation to ensure that the same
framework will be applied for both categories of market
abuse and it is intended to be administratively simpler and
reduce the number of different rules and standards across
the EU.

provides for a general definition of what constitutes market
abuse which is intended to be flexible enough to ensure that
new abusive practices which might emerge are adequately
covered while it is sufficiently clear to provide adequate
guidance for behaviour to market participants. Scope is related
to all financial instruments admitted to trading on at least one
regulated market in the EU including primary markets. It
applies to all transactions concerning those instruments wheth-
er undertaken in regulated markets or elsewhere to avoid
abusive practices in unregulated markets, Alternative Trading
Systems or elsewhere. However, the Directive recognises that
in certain circumstances and for perfectly legitimate reasons
exemptions (safe harbours) will be needed where certain
prohibitions need not apply.

1.4.
The proposal stresses that integrated financial markets
in the EU require convergence, rather than divergence, in the
methods of implementation and enforcement by Member
States whereas at present different sets of responsibilities and
powers of national authorities hinder the establishment of a
fully integrated market and add to market confusion. There-
fore, the proposal envisages that each Member State should
designate a single administrative regulatory and supervisory
authority with a common minimum set of responsibilities to
tackle insider trading and market manipulation. Moreover,
given the increasing number of cross-border activities, the
legislation needs to ensure that regulatory and supervisory
authorities work effectively together and can rely upon
assistance and relevant information from each other in good
time.

1.3.
In order for the market abuse regime to remain relevant
in future in rapidly changing financial markets the proposal

1.5.
The Commission stresses that it is unacceptable in an
integrated financial market for wrongful conduct to incur a
heavy penalty in one country, a light one in another and no
penalty at all in a third. But the Commission acknowledges
there is no Treaty basis for harmonising sanctions
that

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although it is both desirable and consistent with Community
Law for the proposal to set a general obligation for Member
States to impose and determine the administrative and criminal
sanctions to be imposed.

The Commission proposal stresses that at present the
1.6.
existing EU legal framework to protect market integrity is
incomplete because there are no common provisions against
market manipulation and there is a great variety of rules
dealing with market abuse among the Member States. These
differences lead to competitive distortions in markets and leave
investment firms and other economic actors often uncertain
about concepts, definitions and enforcement in each European
market. Market abuse can increase the cost of capital for
companies, harm the integrity of financial markets and public
confidence, and dissuade new investors. The result could be to
weaken the EU’s economic growth.

The Proposal

follows the recommendation of

1.7.
the
Lamfalussy Committee of Wise Men, as endorsed by the
Stockholm March European Council, in distinguishing between
framework principles incorporated in the Directive while ‘non
essential’ technical implementing measures will be adopted
under the comitology procedures. In this instance, the adap-
tation and clarification of the definitions and exemptions
needed to ensure uniform application and compatibility with
technical developments in financial markets will be subject to
comitology.

1.8.
The explanatory memorandum to the Proposal says,
‘In view of the urgency of action in the area of market abuse,
and in view of the extensive consultations on the issue already
carried out with Member State governments, regulators and
supervisors, financial industry (...) and other interested parties,
the Commission has decided to come forward with a Proposal
now rather than to delay it through recourse to a more formal
consultative process. In line with the Report of the Wise Men,
the Commission will engage in consultations (...) when it
prepares the implementing measures in accordance with the
relevant provisions of the proposed Directive’.

2. Main features of the Proposal

2.1.

Insider information is defined as follows:

Article 1(1) defines insider information as ‘infor-
2.1.1.
mation which has not been made public of a precise nature
relating to one or more issuers of financial instruments or to
one or more financial instruments, which, if it were made
public, would be likely to have a significant effect on the price
of those financial
instruments or on the price of related
derivative financial instruments’.

2.2. Market manipulation is defined in two ways:

2.2.1.
Article 1(2)(a): ‘Transactions or orders to trade, which
give, or are likely to give, false or misleading signals as to the
supply, demand or price of financial instruments, or which
secure, by one or more persons acting in collaboration, the
price of one or several financial instruments at an abnormal or
artificial level, or which employ fictitious devices or any other
form of deception or contrivance.’

Article 1(2)(b):

‘Dissemination of

2.2.2.
information
through the media, including the Internet, or by any other
means, which gives, or is likely to give, false or misleading
signals as to the supply, demand or price of financial instru-
ments, including the dissemination of rumours and false or
misleading news.’

2.2.3.
Article 1(5) says that clarification of these definitions
will be handled by a comitology process described in article 17
(2).

2.3.
Articles 2, 3 and 4 are those which specify the
prohibition of the misuse of inside information and it should
be noted that Article 2.1 specifies that these prohibitions shall
apply to ‘any natural or legal person who possesses inside
information from taking advantage of that information’.

2.4.

Article 5 stipulates that:

‘Member States shall prohibit any natural or legal person
from engaging in market manipulation. A non-exhaustive
list of typical methods used for market manipulation is
laid down in Section B of the Annex. (...) Member States
may decide to introduce specific provisions to cover
persons acting for journalistic purposes in the normal
course of the exercise of their profession.’

2.5.
Article 6 sets out the requirements for the disclosure
of information, for example Article 6.1 states ‘Member States
shall ensure that issuers of financial instruments inform the
public as soon as possible of inside information’. However
Article 6.3 says, ‘An issuer may at its own risk delay the public
disclosure of particular information such as not to prejudice
his legitimate interest provided that such omission would not
be likely to mislead the public (...)’.

2.6.
Articles 7 and 8 specifies certain exemptions from the
general rules otherwise set out in the Directive; for example
they do not apply to certain operations by Member States,
central banks or share ‘buy backs’.

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2.7.
Article 9 says the provisions of the Directive ‘(...) shall
apply to any financial instrument (...) trading on a regulated
market and at least one Member State, irrespective of whether
the transaction itself actually takes place on that market or
not.’ Article 10 says,
‘Every Member State shall apply the
prohibitions and requirements provided for in this Directive at
least to actions undertaken within its territory whenever the
financial instruments concerned are admitted, or are going to
be admitted to trading in a Member State.’

Article 11 specifies that ‘Every Member State shall
2.8.
designate a single administrative authority competent to ensure
that the provisions of this Directive are applied.’

2.9.
Article 12 says, ‘The competent authority shall be given
all supervisory and investigatory powers that are necessary for
the exercise of its functions.’

Article 14 specifies that Member States are required
2.10.
to impose,
‘(...) administrative and criminal sanctions in
conformity with their national law’ where the provisions of
the Directive have not been complied with, and Member States
competent authorities are required to cooperate with one
another under Article 16.

3. General comments

3.1.
The intentions of the Directive — furtherance of the
objective of securing an integrated financial market through
reducing the myriad of national approaches to market manipu-
lation — is in itself entirely admirable. However, the approach
taken in the instance of this particular proposed Directive is
subject to a number of concerns.

important elements of

3.2.
Although the Press Release, the Explanatory Memor-
andum and the Directive itself make frequent reference to the
recommendations of the Lamfalussy Committee of Wise Men
and the endorsement of
that Report by the Stockholm
European Council, the Directive itself fails to meet one of the
most
the Lamfalussy Recommen-
dations. This is that consultation with market practitioners
and other interested parties should be open and continuous
throughout the legislative process. This was not done in the
case of this Directive, one of the first two to be issued
ostensibly according to Lamfalussy Recommendations, on the
grounds of the need to make rapid progress. However, it might
be the case that had consultation with market practitioners
been properly conducted prior to the Commission adoption
of the Directive the whole process might have been faster than
that which could ensue now. While it is true that market
practitioners provided comments and expressed concerns
the precise meaning and
— including questions about

interpretation of certain provisions which were contained
in the proposals of the Federation of European Securities
Commissioners (FESCO) — those comments did not receive
any reasoned response. So the Proposal does not in fact
conform to the Lamfalussy Recommendations. It is essential
that the Lamfalussy principles are adhered to henceforth.

3.3.
A principal objective of the Proposal is to reduce the
complexity and variety of different national approaches to
market manipulation but in a number of respects the text
needs to be clarified with regard to:

— the precise definition of insider dealing;

— the application of the proposed regime to market manipu-

lation;

— the precise requirements concerning disclosure;

— the potential for confusion as to which national authority

has responsibility;

— how common standards crucial

the
Directive will be achieved, this should be a major task for
the article 17 (2) regulatory process.

to the aims of

These remarks are explained in more detail in the following
section.

4. Specific comments

4.1.
Articles 1(1), 2, and 4 aim to define the offence of
misuse of inside information (see paragraphs 2.1, 2.2 and 2.3
above) but it is not absolutely clear from the text as drafted (in
particular Article 2) whether a person can be accused of inside
information if they are not in full possession of all the relevant
facts, i.e. do they know it is inside information? Do they know
it is market sensitive? And did they intend to take advantage
of inside information? The relationship between Articles 2 and
4 on the issue of the test of ‘full knowledge of the facts’ needs
to be clarified. Article 2 fails to refer to the test of ‘full
knowledge of the facts’. It is surprising that there is no test of
culpability on the basis of
therefore, no
possibility of defence by anyone accused of inside information
on the grounds that they had no intention to abuse that
information. As drafted, it leaves any employee of any firm
liable to accusation, although that is not the intention of the
Directive.

intent — nor,

4.1.1.

Proposed amendment: Article 1 (2)(a)

4.1.1.1.
rying out transactions which give, or are likely to give, ...’.

‘Market manipulation’ shall mean: ‘Knowingly car-

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4.1.1.2.

Reasons:

1)

2)

It is important to specify that the manipulation operations
in question have to be carried out with a full knowledge
of the facts, i.e. knowingly. This condition is generally
admitted in criminal law and forms part of the safeguards
to protect people.

The words ‘or orders to trade’ should be deleted because
the act of placing an order is simply the implementation
of the wishes of a third party. The person who actually
places an order does not know what the intentions of the
customer are, or what the effects of the transaction will
be.

4.1.1.3.
amended in a comparable manner:

For similar reasons, articles 2 and 3 should be

— Article 2: Member States shall prohibit any natural or
legal person who possesses and knows he/she possesses
inside information from taking advantage of that infor-
mation with full knowledge of the facts ...;

— Article 3: Member States shall prohibit any person subject
to the prohibition laid down in Article 2 who knowingly
possesses inside information ...

4.1.2.

Proposed amendment: Article 4

‘... any person other than those persons referred to
4.1.2.1.
in those Articles who knowingly uses or causes use to be made
of inside information.’

4.1.2.2.
importance
Reasons: This article is of special
because it is particularly aimed at company employees. The
expression ‘with full knowledge of the facts’ is less clear than
‘knowingly’, which implies an intention to act. Replacing
‘possesses’ by ‘uses or causes use to be made of’ is also clearer.

Because Article 2 refers to both legal and natural
4.2.
persons, the affect could mean that European investment
banks one department of which provides corporate finance
advice (e.g. on new issues, mergers and acquisitions) and a
separate department of which takes market positions or
provides advice to investors on the very companies about
which their colleagues in the former department is advising,
could stand accused of insider dealing. Again, this is not the
intention of the Directive but the draft as it stands does not
make this crystal clear. In particular, it could mean that the
traders taking market positions or senior management of the
bank which is aware of the activities of both departments but

does not prohibit
their trading arm from taking market
positions could stand accused of insider dealing although
‘Chinese walls’ within the institution prevent inside infor-
mation possessed by the corporate finance department being
used by the traders.

4.2.1.

Proposed amendments: Article 6(4) and (6)

4.2.1.1.

Delete the following text:

— in §4 ‘and disclose their interests or indicate conflicts
of interest in the financial instruments to which that
information relates.’

— in §6, last indent — ‘and the disclosure of particular
interests or conflicts of interest as referred to in para-
graph 4.’

4.2.1.2.
Reasons: These provisions are against the practice
and the internal ethics of service providers. The rule that is
rigorously applied is to establish a ‘Chinese wall’ between the
persons responsible for managing orders and those responsible
for managing customers’ accounts. Any breach of this confi-
dentiality rule would be prejudicial to the very foundations of
the directive.

4.3.
The provisions concerning insider dealing (Articles 2
and 6) have a clear rationale when applied to securities, where
inside information about the issuing company is material to
the question of market manipulation. But the proposed regime
extends to such things as interest rate, exchange rate and
commodity derivatives where no issuer is involved, e.g. an oil
company may be concerned about production prospects over
the coming year and seeks to hedge its position against the
risk of an adverse price movement by the use of an appropriate
derivative instrument. Under the proposed regime as drafted,
it could be required to disclose all its information to counter-
parties and competitors and this cannot be right. Clarification
is needed. Although Article 9 seems to exclude over-the-
counter derivatives traded by restricting the application of the
Directive to regulated markets, the definition of ‘regulated
is currently under discussion in the review of the
market’
Investment Services Directive and the matter remains of
concern to market operators.

4.4.
Article 1(2)(b) defines the dissemination of rumours as
market manipulation without any test as to whether or not
the principal objective or a significant objective of spreading
the rumours is to manipulate the market nor is there any test
of whether or not
the rumour is correct. Again, some
clarification of the intention of the Directive is required.

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4.5.
The disclosure requirements in Article 6 are ambigu-
ous. Whereas 6.1 requires disclosure as soon as possible,
Article 6.3 permits delay by an issuer ‘at its own risk’. This
could give rise to differences in interpretation among the
competent authorities of the different Member States. Also,
Article 6.4 requires those responsible for the production/disse-
mination of information to the public to take ‘reasonable care’
but the standard as to what represents reasonable care is not
stated; likewise Article 6.5 prohibits anyone from entering
into a transaction if it ‘reasonably suspects’ that the transaction
would be based on inside information, without defining what
‘reasonably suspects’ means. In both cases the standard of
reasonableness needs to be specified (e.g. reasonableness as
understood in criminal courts? Civil courts?)

financial instrument is traded to impose its own rules on the
market participant wherever that participant may be based.
An alternative would be to specify that the principal competent
authority should be that where the market participant is
based (country of origin basis) and that authority could be
required/empowered to require that all market participants
abide by its rules. It might be, however, that the intention is to
protect the integrity of markets where securities are first issued
to prevent market manipulation by traders based in another
Member State — but that is far from clear from the text of
Article 10 (see paragraph 2.7 above) which appears to enable
the authority of any Member State to take action against
any market participant trading in any financial instruments
admitted in any Member States.

4.5.1.

Proposed amendments: Article 6(5)

4.5.1.1.
possession objective elements allowing it to suspect’.

Replace ‘if it reasonably suspects’ by ‘if it has in its

Reasons: The expression ‘reasonably suspects’ is far
4.5.1.2.
too vague. It is not clear how an intermediary could refuse
orders simply on the basis of an impression. It imposes
on service providers (agents instructed by customers), a
responsibility which exceeds what may reasonably be expected
from them. In addition, the text is not clear about where the
burden of proof lies. It would be very difficult to prove that
the service provider could ‘reasonably suspect’ that an offence
was being committed.

The principle of the Directive is to promote a simpler
4.6.
and more coherent regime but differences in interpretation of
the precise wording of the Proposal by the competent authority
in each of the 15 EU Member States will not secure this
desirable objective. As a general principle, the broader the
range of interpretations of any of the Articles of the Directive,
the greater that risk whereas the narrower the specification of
what is required in the Directive then the lower is that risk.
Consequently it is important that the draft should be tightened
up and more narrowly focused in several places, as outlined
above.

4.8.
Article 12, supplemented by Article 14, set the frame-
work for effective enforcement by the Member States and the
requirement that a single competent authority should be
established in each Member State is desirable. Article 12, last
paragraph should be deleted, since it will entail an unequal
treatment of the companies and natural persons in the Member
States depending on whether or not there are any national
legal provisions on professional secrecy. Indeed, chances are
that in those countries where there are no exceptions to the
rule of professional secrecy, it will be far more difficult to
investigate cases of market abuse and hence the enforcement
of the regulations will be far more restricted. However, it is
also likely to be the case that the relative dearth of successful
prosecutions of insider dealing/market manipulation in the EU
reveals deficiencies in the resources devoted to enforcement
— in terms of both the quantity of such resources and quality
(e.g. in terms of skills and supporting information/intelligence
gathering/monitoring systems). More proactive enforcement
without enhancement of skills and systems could damage
the operation of legitimate market participants while doing
nothing to impede the activities of the truly guilty. In any
event, all Member States should ensure that have and enforce
effective proportionate administrative sanctions.

4.8.1.
be added to Article 14(1):

The Committee proposes that the following sentence

4.8.1.1.
basis of solid evidence of market manipulation’.

‘Criminal sanctions should only be invoked on the

4.7.
An important aspect of market integration is that
market participants should know what regime they face, with
which rules they must comply and which competent authority
has responsibility for enforcing the rules and any possible
sanctions. However, Articles 10-15 appear to enable the
authority of any Member State where a given security or

4.8.1.2.
Reasons: The proposed accumulation of adminis-
trative and criminal sanctions is an extremely serious matter.
Concerns which the Committee expresses in paragraphs 4.1,
4.2, 4.3, 4.5 and 4.9 above need to be taken into account.

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4.8.2. A r t i c l e 1 6 ( 2 ) , 3 r d s u b - p a r a g r a p h

Delete the last sentence of

this sub-paragraph
4.8.2.1.
‘However, where the competent authority communicating
information consents thereto,
the authority receiving the
information may use it for other purposes or forward it to
other States’ competent authorities.’

Reasons: Since the aim of the directive is to stamp
4.8.2.2.
out market abuse,
it is inappropriate to provide for the
possibility of such information being used for other purposes.
EU competition law lays down the principle that communi-
cated information should only be used for the purposes of
applying competition law.

4.9.
Article 5 says that Member States may ‘introduce
specific provisions to cover persons acting for journalistic
purposes in the normal course of their profession’ It is unclear,
however, whether a journalist in Country A, where the State

introduces provisions to protect journalists, may be at risk
from the authorities in Country B where such protection is
not available, if he/she comments on a company based in
Country B.

5. Conclusion

5.1.
The objectives of the Directive in terms of furthering
the integration of European financial markets and reducing the
complexity and confusion surrounding the rules concerning
market manipulation are entirely worthwhile. But in a number
of respects it would be helpful for the draft to be refined so as
to reduce ambiguity about interpretation and the consequent
risk of differences in implementation and enforcement across
the EU. Moreover, more serious consideration needs to be
given to the question of how a test of ‘intent’ — and a defence
of lack of intent to manipulate the market — can be introduced
into the Directive.

Brussels, 17 January 2002.

The President

of the Economic and Social Committee

Göke FRERICHS