Small Mistake, Big Consequences: Elliott’s Sanction by the Paris Court of Appeal for Declaring CFDs Instead of Equity Swaps
European law subjects investors to a number of disclosure obligations purporting to enhance the transparency of financial markets. The Transparency Directive of 2004, in particular, requires Member States to provide in their national legislations that investors shall disclose the proportion of capital and voting rights held in listed companies, or even declare their intentions toward such companies, whenever they cross specific detention thresholds. European regulations, however, only provide limited guidance as to the amount of applicable sanctions in case these rules are violated, giving substantial leeway to national legislators to determine the applicable maxima. In France, these sanctions can go up to 100 million euros or ten times the profit made or loss avoided, with limited guidance as to what criteria should be observed by the French Market Authority (AMF) when determining the application sanction in a specific case. This repressive framework comes at a risk of a substantial decorrelation between the seriousness of the offence and the magnitude of the pecuniary sanction.
Several funds managed by Elliott Management (Elliott) recently had the misfortune to experience this risk. On 24 March 2022, the Paris Court of Appeal handed down a judgment (N° RG 20/08390, available upon request) confirming most provisions of the French Market Authority (AMF)’s unprecedented sanction decision against Elliott, which was sentenced on appeal to a fine of €14 million for violating applicable disclosure rules (in addition to a €4.5 million fine for obstructing the AMF’s investigations).
In 2015, Elliott acquired shares and derivatives relating to financial instruments issued by French listed company Norbert Dentressangle (NDSA), which at the time was targeted by a takeover bid from US company XPO Logistics Inc. These acquisitions gave rise to several declarations of thresholds crossings and intention to the AMF. Elliott notably declared the crossing of the 5% capital and voting rights threshold of NDSA as a result of its acquisition of ‘contracts for difference’ on NDSA shares and that it wasn’t sure yet whether it would participate in XPO’s offer. Two weeks later, Elliott made a new declaration stating that it (i) intended to pursue its acquisitions of NDSA shares and related derivative instruments and (ii) didn’t intend to contribute to XPO’s offer. XPO eventually acquired 86.25% of NDSA’s capital and Elliott a bit more than 9%. This allowed Elliott to block the squeeze-out of NDSA’s minority shareholders by XPO, as French law provided at the time for a squeeze-out threshold of 95% (lowered to 90% since then).
The AMF decided to impose on Elliott a fine of €20 million for (i) declaring the crossing of the 5% threshold of NDSA’s capital through the acquisition of CFDs rather than equity swaps and being tardy in declaring its intent to pursue acquisitions of NDSA shares and not to contribute to XPO’s takeover bid. Both counts were confirmed by the Court of Appeal, which simply lowered Elliott’s fine from €15 to €14 million.
The Court of Appeal’s decision calls for many comments. We specifically focus in this post on the declaration by Elliott of CFDs instead of equity swaps.
Both CFDs and equity swaps are financial contracts allowing one party to perceive a remuneration corresponding to the performance of an underlying security at regular intervals. Assume for instance that Elliott holds a CFD or equity swap with €1 million worth of NDSA shares as underlying securities. An increase in 10% of NDSA’s share price at the end of a given intermediary period would have required Elliott’s counterparty, usually a banking institution, to pay Elliott €100 000, and vice-versa in case of a decrease in NDSA’s share price. Whether Elliott’s contract with its counterparty is a CFD or an equity swap, the counterparty will acquire as many NDSA shares as is needed to hedge itself against the risk associated with this contract (ie €1 million worth of NDSA shares in our example).
As acknowledged by the Court of Appeal, French law doesn’t define or distinguish CFDs and equity swaps [Court of Appeal Decision at 151]. A few factual criteria can at most be used for this purpose, the most important of which being the fact that CFDs usually give rise to a fixed remuneration of the counterparty, whereas equity swaps often involve payments indexed to a floating rate such as the Libor or Euribor. A number of other accessory features distinguish CFDs and equity swaps, such as the periodicity of payment dates  and the contractual documentation developed by the International Swaps and Derivatives Association (ISDA) .
In France, the obligation to declare the holding of derivative instruments whose underlying securities represent a given fraction of the issuer’s capital (5%, 10%, 15%, etc) and to disclose the nature of the instruments arose from the enactment of an Act reacting to the use, by French companies LVMH and Wendel, of the technique of equity swaps to acquire an economic exposure to their respective targets, Hermès and Saint-Gobain, superior to 5% of these companies’ capital without having to disclose it (as only shares and a few other financial instruments gave rise to disclosure obligations at the time). There are mainly two rationales that can justify this rule. First, an investor’s economic exposure can, in itself, be useful information for other investors on the market, whether this exposure results from a direct detention of shares or derivative instruments. Second, derivative instruments can facilitate the acquisition by their holder of the underlying shares. Assume for instance that an investor holds equity swaps representing 8% of an issuer’s capital with two counterparties, each holding shares representing 4% of its capital (thereby preventing them from declaring the crossing of the 5% threshold). The investor could quickly acquire all shares held by its counterparties at the market price (or a slightly higher price) rather than signalling its intention to the market to buy a large block of shares (either by crossing the 5% threshold or by carrying out market-moving block trades) and thereby having to pay a higher price for its block.
Whether the investor holds and/or declares CFDs or equity swaps, and assuming that there exists an objective way of distinguishing both instruments, the message to the market is exactly the same: the investor holds a derivative instrument giving it economic exposure to the issuer’s shares and potentially allowing it to acquire shares at better conditions than other market participants (ie quicker and/or at a better price). The fact that this economic exposure gives rise to a fixed or variable remuneration of the investor’s counterparty, or that it ticks the boxes of a given definition arising from the ISDA’s documentation, hardly makes any difference from this perspective.
The AMF, however, chose to disregard the absence of economic impact of Elliott’s mistake (declaring CFDs instead of equity swaps) by holding, in the Court of Appeal’s words, that ‘the objective is not to determine whether the market may have been misled by Elliott's statements, but only to determine whether Elliott complied with its disclosure obligations, which are particularly precise in a takeover period’ [135; see also AMF’s decision, 45]. Thus, according to the AMF, there is no point in questioning the purpose of applicable rules to determine Elliott’s liability: all that matters is that Elliott’s declarative mistake (however innocuous) led to a violation of their black letter. The Court of Appeal, on its end, opposed to Elliott the fact that the potential effect of its declarative mistake should be accounted for, rather than its actual effect —which was precisely the point made by Elliott in its defence . The Court’s own conclusion should thus have led it to invalidate the AMF’s decision.
This decision is all the more puzzling that very few explanations were given by either the AMF or the Court of Appeal as to the very high amount on the sanction imposed on Elliott. While the French Monetary and Financial Code provides for a list of detailed criteria to be taken into account when determining this amount, the Court of Appeal expeditiously concluded that Elliott’s mistake was ‘particularly serious’ without clearly explaining why and without relying on the specific criteria enumerated by the Monetary and Financial Code to determine the sanction’s amount [282-288]. The Court of Appeal’s position thereby exposes market participants to considerable uncertainty as to the potential sanctions to which violations of European financial regulation exposes them, even in the presence of very mild offences. This comes at the risk of unduly discouraging them from investing in European listed companies. Greater harmonisation of the sanction regimes of disclosure obligations at the European level, and finer tayloring of applicable sanctions to the nature and severity of the offences, would significantly help reduce this uncertainty and make European financial markets more attractive.
Paul Oudin is a DPhil in Law Student at the University of Oxford, an Associate at Vermeille & Co and a Member of the Rules for Growth Institute.