Market Abuse and Takeover Law – A New Start under Swiss Law

Market Abuse and Takeover Law – A New Start under Swiss Law

On 28 September 2012, the Swiss parliament passed a bill amending the Stock Exchange Act (SESTA). The amendment, which is due to enter in force on 1 April 2013, introduces fundamental changes to market abuse and takeover law, as well as other minor revisions of Swiss securities laws: it overhauls the market abuse regulations by introducing a new administrative enforcement regime and introducing heavier criminal sanctions for insider dealing and market manipulation. Second, it extends the scope of application of Swiss takeover law and disclosure rules, while introducing a strict regime of equal treatment of investors in connection with mandatory bids.

By Rashid Bahar (Reference: CapLaw-2013-2)

On 28 September 2012, the Swiss parliament passed a bill amending the Stock Exchange Act (SESTA). The amendment, which is due to enter in force on 1 April 2013 will change fundamentally Swiss financial markets regulations, market abuse, takeover law and rules on the disclosure of substantial shareholdings.

1) Market Abuse

The revision of Swiss market abuse law seeks to reinforce significantly measures against market abuse. To do so, the new law introduces an administrative law regime against market abuse granting explicit enforcement authority to the Swiss Financial Market Supervisory Authority (FINMA) and expands the scope of the criminal offense of insider dealing while introducing more severe sanctions for characterized forms of insider dealing and market manipulation and subjecting all offenses to federal jurisdiction.

a) Administrative Regime

Following the European example of the Market Abuse Directive (Directive 2003/6/EC), the revised SESTA introduces into Swiss law an administrative law regime against market abuse which will operate independently from the existing criminal law regime. Admittedly, since the late 1990s, the Swiss Federal Banking Commission, the predecessor of FINMA, held that a regulated entity as well as its directors and officers were not allowed to trade the basis of material non-public information and, after a heated debate, had issued in 2008 a circular on the market conduct rules with a list of actions securities dealers were expected to do to avoid market abuse (FINMA Circular 08/38). These efforts rested, however, on fragile foundations, since the regulator could not point out to a specific provision enabling it to address these issues and, more importantly, was powerless against actions committed by non-regulated entities which were beyond its reach. This gap has now been filled by the amended SESTA which includes two regulatory provisions on the use of insider information (article 33e SESTA) and market manipulation (article 33e and article 33f SESTA) and confers on FINMA the authority to enforce these provisions, as well as disclosure rules, against any investor, regardless whether it is regulated or not (article 34 SESTA).

i) Insider Dealing

Article 33e SESTA introduces an administrative regime against certain abusive practices in connection with “insider information” which is broadly defined as any confidential information whose disclosure is likely to significantly influence the price of securities admitted to trading on a Swiss exchange or a platform that is similar to an exchange within the meaning of article 3 (4) SESTA. In other words, this definition mirrors the definition of insider information as (a) material (b) non-public (c) information which is used in most jurisdictions, but limits scope to securities admitted to trading on a Swiss exchange.

More specifically, pursuant to article 33e SESTA, it is unlawful:

(a) to use insider information to trade in securities admitted to trading on a Swiss exchange or a similar institution (Swiss Securities) or on financial instruments based on such securities;

(b) to communicate insider information to another person; or

(c) to use insider information to provide a recommendation to acquire or dispose of Swiss Securities or derivatives based on them.

The statute distinguishes two types of insider dealing: on the one hand, insider dealing, strictly speaking, i.e. when an investor uses inside information to trade on the market, and, on the other, tipping, which can be committed either by tipping off other investors either by communicating insider information or by recommending other investors to acquire or dispose of Swiss Securities or derivatives, without actually disclosing the insider information itself.

Unlike its criminal law counterpart, this provision does not distinguish how the author got access to the insider information, whether the author sought to obtain a financial advantage or whether he acted intentionally (article 40 SESTA). As long as the author knew or should have known that he was using insider information, he is deemed to have committed a violation of administrative law. Thus, in line with the EU-Market Abuse Directive, administrative law enforces a strict application of the equal access doctrine which aspires to ensure that all market participants get equal access to all material information, and applies to any person having access to insider information. This provision applies, therefore, not only to insider dealing by “primary insiders” who are in a position giving them direct access to insider information, but also to other market participants who know by chance or through other dealings unrelated to the issuer, thus capturing the actions of analysts and financial journalists as well, regardless of how they access the information.

Moreover, this broad definition of insider dealing will go over and above the narrow definition of insider dealing to include other practices, such as front running client orders or scalping clients, to the extent this information provides the financial intermediary with an undue advantage over other market participants. In other words, the market abuse will also bar securities dealers and asset managers from using their privileged position due to their access to information on their client orders or the status of its own inventories.

Considering the broad scope of the regulatory definition of insider dealing, the statute provides for an explicit regulatory authority for the Federal Council to issue an ordinance defining what types of actions are admissible in connection with the preparation of a public takeover bid and setting forth additional duties for insiders (article 33e (2) SESTA). A draft of these rules has recently been published for comments and, based on the draft, they are likely to permit a potential bidder to continue acquiring securities on the market in view of publishing a tender offer, as long as the decision to present – or the intention to present – a bid was not based on inside information (article 55e (b) P-SESTO). This rule will be extended to decisions based on an intention to trade in securities (article 55e(a) P-SESTO) and provide a general exemption for the Federal Government, the Cantons and Communes as well as the Swiss National Bank to the extent they discharge their public duties and are not trading for investment purposes article 55e(c) P-SESTO. Similarly, the draft ordinance contemplates to provide explicitly that forwarding inside information to a person needing such information to discharge legal or contractual duties does not constitute insider trading. However, the rules stop short from obliging issuers, financial intermediaries, or other parties from preparing insider lists or taking other specific measures to prevent insider trading, although many institutions will introduce such measures as a precautionary measure (article 55f P-SESTO).

ii) Market Manipulation

In addition to insider trading, the amendment also introduces an administrative law regime against market manipulation. Under this regime, market manipulation will cover two types of behaviors: on the one hand, it will apply to the public dissemination of false or misleading information, i.e. information which provides an incorrect or misleading signal with respect to the offer, the demand or the price of a Swiss Security. On the other hand, it will also apply to transactions and orders, by persons who know at least constructively, that such transactions or orders provide a false or misleading signal for the offer, demand or price of Swiss securities. Thus, unlike the criminal offense of market manipulation (article 40a SESTA) which only applies to simulated transactions, the administrative law regime will extend to real transactions carried out to manipulate the market for a Swiss security. This expands significantly the scope of the provision to cover various manipulative practices such as squeezes, pump and dump schemes, as well as naked short selling.

To offer a certain degree of legal certainty, the statute expressly mandates the Federal Council to define the limits of market abuse in an implementing ordinance which will provide for safe harbor rules and accepted market practices.

With respect to market manipulation, the SESTA specifically requires the ordinance to tackle price stabilization plans and share buybacks. While the rules were not yet adopted, it seems that the rules on share buybacks reflect the existing rules issued by the Takeover Board and will not entail significant changes to the substantive rules governing buybacks (article 55a to article 55c P-SESTO). However, the authority of the Takeover Board to regulate these capital market transactions will be significantly limited.

With respect to price stabilization, however, the ordinance will provide for a regulatory framework to carry out trades for stabilization purposes (article 55d P-SESTO) which mirrors to a certain extent the European law regime applicable to such transactions. It provides that price stabilization efforts may be carried out for 30 days after a public offering of Swiss securities provided that the price paid for stabilization purposes does not exceed the offering price or in connection with rights offerings the market price (article 55d(a) and (b) P-SESTO). Moreover, to ensure transparency, the duration of the stabilization plan and the securities dealer instructed to implement the plan need to be published in advance (article 55d(c) P-SESTO) and the actual volumes traded under the plan need to be published at the latest seven days after the initiation and upon completing the stabilization measures (article 55d(d) P-SESTO).

iii) Enforcement by FINMA

The main advantage of an administrative regime lies with the enforcement capabilities of a regulator which is bound by less procedural hurdles than a criminal prosecutor. Therefore, under the new administrative law regime, FINMA will be specifically empowered to investigate and take enforcement action against any persons who are suspected of having breached the regulatory provisions using all the tools of administrative law.

Moreover, FINMA will be able, under the new regime, to act against all market participants regardless whether they are regulated financial intermediaries or not. Therefore, FINMA will be entitled to request all market participants to provide information and documents under article 29(1) of the Financial Market Supervisory Authority Act (FINMASA), over and above their ordinary obligations to cooperate with an authority under the common rules of administrative procedure. Since FINMA acts exclusively as an administrative agency, these broad investigative powers are unfettered by any privilege against self-incrimination and, thus, will enable FINMA to compel individuals and agency to produce documents and testify against themselves. These powers will be only contained by the requirements of administrative procedure and most importantly formal due process rights.

These extensive investigative powers are however counterbalanced by the range of measures FINMA can order: while, FINMA has enforcement powers ranging from issuing a declaratory decision, including a “naming and shaming order” requiring the publication of the decision, to confiscating the proceeds of unlawful activities, its powers will stop short from collecting fines or other monetary punishment. Therefore, it remains to be seen what the practical impact of this regulation will be with regard to unregulated market participants who do not necessarily care for their standing with the regulator nor their reputation in the public eye. At the same time, it remains to be seen if courts will let FINMA act on these broad powers or whether they will try to constrain them through procedural safeguards based on the European Convention on Human Rights considering the repressive nature of these administrative measures.

b) Criminal Law

In addition to introducing an administrative regime, the amendment also revamps the criminal law provisions on insider trading and market manipulation. On a purely formal basis, these provisions will be moved from the Criminal Code into SESTA. However, the reach of the amendment goes over and above this presentational issue.

i) Insider Trading

The criminal provision on insider trading has been extended and refined (article 40 SESTA). First of all, the revised article 40 SESTA expands the definition of primary insiders, i.e. persons who are deemed to be an insider based on their position, to encompass all persons who due to their shareholding or their activity have access to insider information, thus including major shareholders to the list of insiders and opening up the characterization of primary insiders from an enumerative catalogue of positions (article 40(1) SESTA). Second, the statute also extends the definition of tippees to include not only persons who receive insider information, directly or indirectly, from a primary insider but also persons who acquire access to such information through a crime or a felony (article 40(3) SESTA).

The amended provision on insider trading also introduces heavier criminal sanctions ranging up to five year of prisons for insider trading carried out by a primary insider in view of achieving a financial advantage of more than CHF 1 million (article 40(2) SESTA). This change affects the characterization of the offense by making such characterized forms of insider trading a crime (as opposed to a mere misdemeanor). Consequently, this revision makes such forms of insider trading predicate offenses to money laundering. Thus, financial intermediaries will be expected to monitor their clients to detect characterized insider trading and, consequently, senior executives of listed companies, bankers, auditors, and corporate lawyers may, going forward, need to be treated as high risk clients subject to close scrutiny.

Finally, the amendment creates a new offense, which sanctions with a fine the use of insider information by persons who are neither primary insiders nor tippees in view of realizing a financial advantage through trading in Swiss Securities or any derivative financial instrument, thus, substantially expanding the scope of this offence.

ii) Market Manipulation

By contrast, the criminal provision on price manipulation has largely remained unchanged (article 40a SESTA) and the few changes are limited to drafting points: the statute aligns the terminology with the one used in connection with insider trading, thus ensuring that both provisions have the same scope. Furthermore, the statute no longer provides that the financial advantage sought to be gained through market manipulation needs to be unlawful. However, this amendment does not really change the situation, since it was widely accepted that any financial advantage gained through market manipulation was deemed to be unlawful.

The most notable change in connection with criminal market manipulation is the characterization of offenses carried out with a view of realizing a financial advantage of more than CHF 1 million as a crime. As mentioned above in connection with insider trading, this turns characterized market manipulation into a predicate offense to money laundering, with the same consequences for banks and financial institutions that were already mentioned above in connection with insider trading. Therefore, banks and financial intermediaries will be required to monitor trading patterns and intervene if they believe that they identified a case of market manipulation.

iii) Federal Jurisdiction

The revision subjects both offences to federal jurisdiction (article 44 SESTA) in order to centralize the prosecution of these offenses with the hope that this will lead to more effective enforcement of the criminal sanctions for market abuse.

2) Takeover Law

The amended SESTA will introduce three series of changes to existing takeover law by expanding the scope of Swiss regulations, prohibiting the payment of control premiums prior to the publication of a mandatory bid, and adjusting the procedure rules applicable to takeovers.

a) Scope

First, the revised SESTA extends the scope of the Swiss disclosure rules and Swiss takeover law to include public tender offers for shares of foreign issuers that are listed primarily in Switzerland (article 20(1) SESTA; article 22(1) SESTA). Swiss law will therefore apply to all Swiss issuers provided their equity securities are listed in Switzerland and to foreign issuers whose securities are listed primarily in Switzerland. The term “primary listing” is, however, not explicitly defined by the act and the Listing Rules of SIX Swiss Exchange do not use it either. Based on the draft ordinance, this term will cover all foreign issuers that are subject to at least the same rules than Swiss ones (article 53b(1) P-SESTO-FINMA). To avoid any misunderstanding, the exchanges are expected to publicize which firms are primarily listed in Switzerland (article 53b(1) P-SESTO-FINMA).

To avoid contradictions among regulatory regimes, the act provides that the Takeover Board may grant an exemption from Swiss takeover regulations in situations where the latter is in conflict with a foreign law that ensures an equivalent level of investor protection (article 22(1bis) SESTA). It remains, however, to be seen how this provision will be applied in practice and, in particular, in which situations the Takeover Board will consider that foreign law is equivalent to Swiss law, even if it leads to an outcome that is not compatible with the one provided for by Swiss law.

b) No Control Premiums prior to Mandatory Bids

More importantly, the amendment bars acquirers from paying a control premium prior to a mandatory bid (article 32(4) SESTA). Whereas currently bidders are allowed to pay a premium of up to 25% of the bid price when acquiring shares before publishing a tender offer, the revised rules provide with respect to mandatory bids an absolute equal treatment of investors with respect to transactions carried out both during and prior to the publication of the tender offer. This change is, thus, the epilogue to a series of cases where the takeover board sought to expand the scope of the best price rule, which provides that a bidder is, during a tender offer, required during a bid to offer to shareholders tendering the shares at least the same price as what it paid in off-exchange transaction, as well as efforts of independent directors to ensure that all shareholders receive the same price for their shares.

This does not mean that control premiums will disappear altogether under Swiss law. Indeed, even after the entry in force of this amendment, it will remain possible for issuers to opt out from the mandatory bid regime altogether and, consequently, to pay control premiums in connection with takeovers of such issuers. Although this option was not open in most transactions until recently, a recent decision of the Takeover Board may turn the situation upside down. Indeed, the Takeover Board overruled its existing precedents banning all opting-out decision which profit a specific investor and held instead that it would not challenge opting-out decisions provided that they were approved by a majority-of-the-minority vote (see Decision 518/01 of 11 October 2012 of the Takeover Board in the matter of Advanced Digital Broadcast Holdings AG, N 16). Based on this precedent, bidders who would like to pay a control premium, will be allowed to do so, if they can convince the minority shareholders to opt out of the mandatory bid regime. It therefore remains to be seen if this new decision does not undo in fact the newly adopted prohibition of control premiums.

c) Enforcement of Mandatory Bids

To improve the enforcement of the mandatory bid regime, the amendment includes two types of measures: First, it confers to the Takeover Board, instead of civil courts, the power to suspend voting rights and prohibit any further acquisition of shares if it has founded suspicions of a breach of the duty to present a mandatory bid (article 32(7) SESTA). These measures can be ordered as long as needed to determine the existence of an obligation to present a mandatory bid and after that, if required, until the bid is published.

This change is more than a formal change. Indeed, by granting the Takeover Board the authority to issue such orders, the regulation of takeover bids is likely to become more effective. As an administrative authority, the Takeover Board will be entitled to act of its own initiative without waiting for a plaintiff to file a civil complaint and civil judge to act. As the authority in charge of deciding on the merits of an obligation to publish a takeover bid, the Takeover Board will also be in a position to act quickly by issuing, if necessary, a preliminary order. Moreover, from an institutional perspective, the Takeover Board has proven that it is capable and committed to act quickly and decisively in situations where time is of the essence.

Second, the revised SESTA makes it an administrative criminal offence to intentionally fail to present a mandatory bid notwithstanding a final decision finding that such a duty exists sanctioned with a fine of up to CHF 10 million. Considering that the time that may lapse from the moment that a mandatory bid is triggered to the final decision on the merits declaring that a bidder is obligated to present a bid, this offense is, practically speaking, not likely to apply very often. To the contrary, it is more likely to as a deterrent. Nevertheless, it may contribute to ensure compliance with the mandatory bid rules.

d) Other Procedural Changes

Incidentally, the amendment provides for several other procedural changes. Most importantly, the threshold for minority shareholders to have standing as a party in takeover proceeding was raised from 2% to 3% of the voting rights (article 33b(3) SESTA). While reducing access to justice for minority shareholders, this will offer greater certainty to bidders: by matching the threshold for having standing to sue with the first threshold for the disclosure of substantial shareholdings, bidders will be able to map prior to launching their bid where opposition is likely to come from and address this issue proactively. Additionally, the amended rules clarify that minority shareholders can participate in appellate proceedings in front of FINMA only if they were a party to the proceedings of the Takeover Board or if they did not have the possibility to participate in such proceedings at the level of the Takeover Board.

Finally, the revised SESTA disapplies the rules on the standstill of deadlines during court holidays in connection with proceedings relating to takeovers, thus correcting what was probably a legislative oversight (article 33d (3) SESTA). Furthermore, the statute grants the Takeover Board the authority to collect fees from parties to cover the costs of proceedings, thus providing a formal statutory basis for the existing practice of the Takeover Board under its Takeover Ordinance (article 23 (5) SESTA).

3) Disclosure of Substantial Shareholdings

The revised SESTA finally introduces changes to the rules on the disclosure of substantial shareholdings. These amendments expand the scope of the rules and the enforcement authority of FINMA, while cutting back the maximum fine for violations of the disclosure rules.

a) Expanded Scope and Enforcement Authority

The first change to the Swiss disclosure rules mirrors the ones introduced for takeovers. It expands the application of this area of Swiss securities laws to shareholdings in foreign issuers that are primarily listed in Switzerland (article 20(1) SESTA). However, unlike takeover law, the revision does not contemplate the possibility of an exemption if other applicable rules offer a similar level of protection as Swiss law. Thus, investors holding positions in dual listed foreign issuers may need to monitor positions and disclose shareholding under several regulations, as they already have to do for positions in dual listed Swiss issuers.

The broader enforcement authority conferred onto FINMA marks, however, a more significant change. Following the same model as with mandatory bids, FINMA will acquire the power to suspend the voting rights and to prohibit investors from acquiring additional shares or options on shares if it has sufficient evidence of a potential breach of disclosure duties (article 34b SESTA). This measure can remain in force until FINMA determines wheter the investor complied with its disclosure obligations (either because the latter filed a notice or because FINMA recognizes that no disclosure duty applies). As explained above in connection with mandatory bids, this shift away from civil courts to an administrative authority should also improve the effectiveness of enforcement measures and overcome certain shortcomings of the existing regime in connection with secret stake building.

Finally, the revised SESTA formally empowers FINMA to take administrative enforcement action in connection with breaches of disclosure duties pursuant to articles 20 and 21 SESTA as outlined above regarding breaches of the regulatory provisions on insider trading and market manipulation (article 34 SESTA). FINMA will be entitled to take all the administrative measure described in connection with the market manipulation regime to tackle breaches of disclosure duties.

b) Milder Criminal Sanctions

Whereas overall the revision moves generally towards harsher rules and more powers to regulators and prosecutors, it introduces milder criminal sanctions for violations of disclosure duties by setting the maximum fine for intentional breaches at CHF 10 million (article 41(1) SESTA). Admittedly, by doing so it brings this regime in line with other sanctions for breaches of financial market regulations by repealing the harsh sanctions that were introduced in 2008 after a wave of secret stake building outraged the public opinion and lawmakers.

4) Conclusion

Overall, this revision of the SESTA, which went virtually unchallenged through Parliament, will introduce several important changes to Swiss financial markets laws. It will expand the reach of FINMA in areas such as market abuse and takeover law and establish the federal prosecutors as the sole authority in charge of bringing criminal charges in this area. Over and above these changes, the harsher sanctions for characterized insider trading and market manipulation make these offenses predicate offenses to money laundering, thus enlisting financial institutions to monitor their clients and report any suspicious activity in connection with these offenses.

In addition to an expanded scope of Swiss takeover law and added powers to the Takeover Board, the amendment also bars bidders from paying a higher price when buyer shares, thus introducing an absolute regime of equal treatment of shareholders. The only way to avoid this principle will be to have the issuer resolve to opt out of the mandatory bid regime altogether. It remains, however, to be seen whether this new rule abolishing payments of control premiums will lead to more cases of opting-out, thus leading to a counterproductive result for minority shareholders. Thus, in both cases, the jury is out to determine how the new law in the books will play out in action.

Rashid Bahar (