If you’re holding 13% of a £400 million cap company and you suspected it was going to issue £350 million in new equity – consequently tanking the price – what would you do?
Any portfolio manager would instruct his trading desk to sell or at least reduce his exposure. But problems can arise for PM and trader alike if the former’s suspicions arise while inadvertently or unknowingly ‘crossing the wall’.
Last month David Einhorn, owner of US-based hedge fund Greenlight Capital, was hit by a whopping £7.2 million (US$11.4 million) fine handed down by UK regulator the Financial Services Authority (FSA) for supposed insider trading. Einhorn has branded the penalty as unfair and “inconsistent with the law”. And he may have a point.
The whole affair started with a phone call in 2009 between Einhorn, the CEO and CFO of pub chain Punch Taverns, and Andrew Osborne, then Corporate Broking MD at Merrill Lynch.
During the call, Einhorn was repeatedly asked to cross the wall and he repeatedly refused, but nonetheless found himself in a conversation about a potential £350 million new equity fundraising by £400 million market cap Punch. Einhorn was under the impression that at no point had he been exposed to information that was subject to a non-disclosure agreement (NDA). He made his intention very clear that he did not want to cross the wall or sign any NDA to be exposed to inside information which would restrict his ability to trade. Continuously, Punch insisted no decision had been made on the possible dilution.
The FSA has accepted Einhorn’s sale of Punch stock was not deliberate market abuse, because he did not believe that it was inside information (he’d refused to cross the wall or sign any NDA). And the watchdog’s rules state that even if the FSA suspects insider trading, it won’t issue a penalty if there are reasonable grounds the person believed his behaviour wasn’t market abuse.
But the FSA insists Einhorn’s belief – the ‘honest belief’ that he had not crossed the wall and therefore was not in possession of privileged information unavailable to other investors – was not reasonable. Even though the watchdog agrees that at no point during the phone call did Punch confirm they would issue new equity, and in fact, made comments to the contrary.
Greenlight trader Alexander Ten-Holter was also hit with £130,000 for failing to question the request before selling Greenlight’s shareholding.
Ten-Holter’s penalty comes largely from his dual role as compliance officer at Greenlight, and he is now prohibited him from performing compliance oversight and money laundering reporting functions – a sanction which, frankly, most traders might welcome.
Ten-Holter had never talked to Einhorn directly about the Punch call, and was given his orders from another person in the firm. Is it really fair to assume he should have questioned the trade? Or should alert traders be aware of all the market intelligence impacting a stock, including corporate actions, whether alerted to them by their PMs or otherwise?
Two middlemen have also been caught in the crossfire. Caspar Agnew, a trading desk director at JP Morgan Cazenove, was slapped with a £65,000 fine for failing to identify and act on a suspicious order, while Merrill Lynch’s Andrew Osborne was slugged with a £350,000 sanction for improperly disclosing inside information.
The Einhorn case seems to show a willingness at the FSA set wide boundaries with its current definition of what it considers inside trading. And things look likely to become even more difficult for investors in Europe. Brussels’ revision of the 2003 Market Abuse Directive (MAD), proposed by the European Commission in October, will make any information made “available to a reasonable investor, who regularly deals on the market and in the financial instrument or a related spot commodity contract concerned” considered as inside information.
Buy-side trade body the Investment Management Association (IMA) has lobbied Brussels for rules which contain clarity and certainty. While more in favour of London’s approach, the IMA believes Europe’s the wording of what comprises inside information could “make it impossible for asset management companies to continue their active management practices, such as meeting with companies in which they invest, detailed interviews with senior management and with brokers who follow those companies”.
The IMA worries investors could never be sure information disclosed during the course of communicating with CEOs was not ‘relevant to an investor’, and if they traded following such meetings they could be insider trading.
MAD and an accompanying regulation (MAR) on “insider dealing and market manipulation” is currently in the hands of the European Parliament, which will then pass it on to the Council of the European Union for a subsequent reading before trialogue discussions with the European Commission.
Enforcement of the new European legislation is not expected for at least a couple of years. In the meantime, two things seem clear from the Einhorn case. The FSA is willing to go outside its own jurisdiction to hunt down those that transgress its rules. And honest belief does not seem to be enough to protect you from the FSA if it suspects you of insider trading or market abuse. So, trader beware – and keep a close eye on MAD’s progress into European law.