EFTA Court rules on market manipulation after MAD – emphasis on effect-doctrine

The Court of Justice of the European Free Trade Association States (the ‘EFTA Court’), the Court of Justice of the European Union’s distant cousin for the European Economic Area, delivered its advisory opinion to a referring Norwegian court in case E-5/19, criminal proceedings against F and G, on 4 February 2020. The preliminary ruling concerned a Norwegian criminal case to be decided under the older EU Directive on insider dealing and market manipulation (’MAD’), as the new EU market abuse regulation (‘MAR’) was not applicable according to the EEA-agreement at the time of the events. However, the relevant provisions of MAD have been carried over into MAR and the ruling is relevant for EU Member States as well. This is a very brief discussion of some of the questions raised in a decision that merits much more detailed contemplation.

The case concerned F, who was acting on behalf of a bond fund. The main strategy of the fund was to buy bonds at a discount and hold them to maturity. F had formed the opinion that a corporate bond would justify one buy price if certain conditions were met, notably that the issuer would maintain a profitable contract, and another lower price if the contract was not renewed. F recommended the fund to acquire further bonds to the stake already held and F was authorised to pursue the recommendation.

On 8 August 2016, the issuer of the bonds announced that the major contract was not renewed. This meant that F was authorised to acquire the bonds at the lower price indicated in his recommendation. Consequently, F took up contact with G, who was working with a brokerage firm. The market for bonds at the Oslo Exchange is illiquid, not transparent and mainly relies on brokers’ personal contacts as there is no automated auctioning and therefore no continuous and open price formation.

In their conversations, G explained to F the various orders known to him in the form of non-binding price indications. F asked G to both sell and buy the bonds. To sum up, on the Friday the fund sold 10m (Norwegian Kroner) NOK at 77.25, and on the following Monday the fund bought 50m NOK at 79.625 without indicating that the fund was the seller of bonds. In September, charges were brought against F and G on the basis that they had engaged in a form of manipulation, colloquially known as ‘trash and cash’, whereby an interested buyer lowers the sale price in the market by himself selling at a lower price than the prices established in the market and thus indicating that a lower sale price is necessary and warranted. F, as a defendant, argued that as an interested buyer he wanted to test the market and uncover whether buyers of the bonds in fact existed at the indicated prices. It was undisputed that the selling trade constituted a ‘real transaction’ executed on market terms.

Before addressing the questions presented by the referring court, the EFTA Court made two preliminary observations: first, that manipulation ‘does not cover situations that involve insignificant effects upon the market’, but only transactions that ‘actually have the effect of endangering the integrity of financial markets, and investor confidence’ (para 40). Second, the Court pointed out the need to apply EEA law in the light of fundamental rights, including the presumption of innocence and legal certainty (para. 41). This emphasis on avoiding a too extensive application of the ban on manipulation in MAD was made again later in the decision with a specific reference to the CJEU’s opinion in case C-45/08, Spector (para. 54).

The first question from the referring court was whether a ‘real’ transaction could constitute manipulation and the second question basically concerned whether the ‘real interest’ of the person conducting the transaction, if such an interest could be deduced from the circumstances, would be relevant in determining whether the transaction(s) undertaken constituted manipulation. The EFTA Court provided a joint answer and mostly rejected the relevance of subjective intent, instead placing emphasis on the so-called effect-doctrine. This doctrine describes the legislative choice of describing as far as possible the offence of manipulation by objective criteria and not relying on subjective motives of the person(s) acting. Thus, the Court directed the referring court to focus on whether the transaction has an effect on the market, which has to be determined by taking into consideration the conditions of that market, such as its liquidity (para. 53), and it was in this context that the Court made a reference to Spector and warned against extending the scope of the prohibition beyond what is appropriate and necessary (para. 54). Although emphasis was on the ‘results of a transaction and its effects’, the Court accepted that intent could play a part as an indication of manipulation (para. 60). However, whether the effect was ‘false or misleading’, as required by MAD Art 1(2)(a) (now MAR Art 12(a)(1)), must be determined from ‘subsequent conduct on the market’ (para. 60), ie objective observations.

The effect-doctrine was envisioned as helping prosecutors’ case, because it removed the need to prove a subjective intent (mens rea) to manipulate. Yet, that doctrine may actually make it more difficult to obtain convictions, because the prosecution must now, according to the EFTA Court, prove a significant and detrimental effect on the market while disregarding any indications of malicious intent as such intent is not enough in itself (para. 58) and can only play a part once the effect has been established.

The reference from the Norwegian court also raised other interesting questions. The third question from the referring court concerned the notions of ‘abnormal’ and ‘artificial’, used in MAD (and in MAR). Again, the EFTA Court made several references to Spector, partly to warn against introducing a subjective standard in lieu of the objective criteria applied by MAD (para. 67) and partly in recognition of the need to construe the provisions of MAD in light of its regulatory purpose of ensuring market integrity and enhancing investor confidence to avoid an excessively stringent application of the prohibitions (para. 69). In this context, the Court cited the CJEU’s decision in case C-445/09, IMC Securities, according to which a single transaction may secure the price at an abnormal or artificial level (para. 69), provided it has ’a determining influence on the price agreed in subsequent transactions’ (para. 70). It further ruled out that actual market power was necessary to secure prices in this way (para. 73).

Again, it should again be noted that the Court’s emphasis on effect may hinder the prosecution’s case, because the market effect must be demonstrated, for example by analysing prices ‘before a transaction took place’ (para. 74).      

The fifth question concerned the notion of dissemination, which is a constituent element in the definition of information-based manipulation is, cf MAD Art 1(2)(c) (now MAR Art 12(1)(c)). The EFTA Court limited the notion to dissemination by media (para. 95) and found that it implied a distribution of the information ‘in a wider sense than in the normal exchange of information in relation to a potential transaction in which information on buying or selling interests or orders to trade are passed through a broker’ (para. 95). The Court recognised that it was a narrow understanding, but noted that a contrary interpretation ‘would be liable to prevent brokers from passing on information to investors in the ordinary course of business, with the effect that market participants refrain from providing and gathering information as to supply and demand of financial instruments, to the eventual detriment of market liquidity and the efficient functioning of markets’ (para. 95). Consequently, only dissemination that reaches ‘an extended audience’ can produce the ‘effect’ that is deemed manipulative according to MAD (and MAR, since the wording is the same).

The EFTA Court’s pro-business, pro-fundamental rights approach is to be welcomed. It is useful to remind national courts that the regime on market abuse is there to further market efficiency, not hinder it. There must be a significant detrimental effect on the market by a person’s transaction for that person to be subjected to the harsh realities of prosecution. But once that significant detrimental effect has been established by relying on the objectively observable facts, taking into account the peculiarities of the trading venue, the subjective intent or motive of that person is irrelevant, except insofar as national criminal law requires a subjective intent or recklessness to undertake the relevant actions.

The EFTA Court is the designated court according to the EEA agreement and covers the Member States of the EEA that are not within the EU. It remains to be seen how relevant the CJEU will judge this decision to be in its own rulings.

Jesper Lau Hansen is a Professor at the Centre for Market and Economic Law at the University of Copenhagen.