Inside information: the disclosure of intermediate steps
Market reCap September 2012 edition
- Primary Market Bulletin No.2: consolidation of UKLA guidance
- Primary Market Bulletin No.3 confirms the end of no names calls to the UKLA
- Inside information: the disclosure of intermediate steps
- Allocating your purchase price on a business transfer
- The Kay report: tackling short-termism in the UK equity markets
The European Court of Justice ("ECJ") has provided useful clarification in a recent case, Geltl v Daimler AG (C-19/11), as to whether information regarding the intermediate steps leading to a future uncertain event may potentially amount to inside information which is required to be disclosed immediately to the market.
In brief terms, the case (arising in Germany) related to the resignation of the chairman of Daimler's Board of Management, Mr Schrempp, in 2005. The company announced to the market, following a meeting of the Supervisory Board on 28 July 2005, that he intended to step down at the end of that year before the expiry of his term. Consequently, the company's share price rose sharply and a number of investors - who had sold Daimler shares prior to the announcement at a lower price - sued the company, arguing that the information should have been disclosed earlier as the event was sufficiently likely to occur.
The steps leading up to the announcement were as follows. Mr Schrempp first considered his resignation in early April 2005, following which he informed his wife (an employee of the company), then discussed his intentions with the Chairman of the company's Supervisory Board on 17 May 2005 and subsequently informed other members of the Supervisory Board. On 10 July 2005, the head of communications, with Mrs Schrempp and the head of the secretariat, began to prepare a press release, a public statement and a letter to the company's employees. On 18 July 2005, the Chairman of the Supervisory Board agreed to propose Mr Schrempp’s early retirement and the appointment of his successor at the meeting of the Supervisory Board on 28 July 2005.
Under the Market Abuse Directive (2003/6/EC) ("MAD"), member states are required to "ensure that issuers of financial instruments inform the public as soon as possible of inside information which directly concerns the said issuers". This requirement is implemented in the UK under chapter 2 of the Disclosure Rules and Transparency Rules, with the primary disclosure obligation being set out in DTR 2.2.1R (subject to DTR 2.5.1R which allows for the disclosure of inside information to be delayed in certain circumstances).
The first question to be determined in any situation involving a potential disclosure obligation is whether the issuer has inside information. The definition of "Inside information" in MAD requires the information to be "of a precise nature". Under Directive 2003/124, "information shall be deemed to be of a precise nature if it indicates a set of circumstances which exists or may reasonably be expected to come into existence or an event which has occurred or may reasonably be expected to do so and if it is specific enough to enable a conclusion to be drawn as to the possible effect of that set of circumstances or event on the prices of financial instruments or related derivative financial instruments."
The case was ultimately referred to the ECJ to determine:
(1) whether the taking of intermediate steps connected with a future set of circumstances or future event may constitute information of a precise nature; and
(2) does the expression "may reasonably be expected" in Directive 2003/124 require that the probability be assessed as predominant or high, or does it imply that the requisite degree of probability depends on the extent of the effects on the issuer and that, where prices are highly likely to be affected, it is sufficient if the occurrence of the future circumstance or event is uncertain but not improbable?
(1) Intermediate steps
On question (1), the ECJ confirmed that information on intermediate steps in a protracted process could constitute information of a precise nature.
The terms "set of circumstances" and "event" (which are not defined in the directives) should be given the meaning normally attributed to them, which could include intermediate steps, and not having regard to such intermediate steps risked undermining the objectives of protecting the integrity of the markets and enhancing investor confidence.
This conclusion was supported by another provision of Directive 2003/124 which gives examples of inside information where disclosure may legitimately be delayed. The examples include intermediate steps in a protracted process, such as negotiations in course, and decisions taken or contracts made by the management body of an issuer which need the approval of another body of the issuer in order to become effective.
(2) Degree of probability
Question (2) was somewhat complicated by the fact that the German text refers to "sufficient probability" rather than a “reasonable expectation” in the English version. However, the court considered the necessary level of probability to refer to "future circumstances or events from which it appears, on the basis of an overall assessment of the factors existing at the relevant time, that there is a realistic prospect that they will come into existence or occur." Accordingly, this did not require proof to a high level of probability, but excluded matters which were implausible.
The court went on to hold that the level of probability and the effect on the price of the issuer's financial instruments were not co-dependent. It was not the case that the greater the possible effect on the share price, the lower the probability required for the information to be held to be precise.
The court's decision means that information about intermediate steps may have to be disclosed, including steps which may be reasonably expected to come into existence or occur, even if they have not already.
The outcome of the case is not unexpected and is consistent with the Disclosure Rules and Transparency Rules, which anticipate that information relating to a protracted process can be inside information.
As the ECJ was only ruling on points of interpretation, the German court will now have to address the more difficult question as to which specific step triggered the disclosure requirement.