Most bond issues in the Euromarkets are subject to English law: the majority are written under English law or are underwritten and marketed in London; some may be listed on the London Stock Exchange; a smaller proportion are by UK issuers but listed elsewhere, such as Luxembourg. For these reasons and because of the sophistication of the Euromarkets, English law has so far led other European jurisdictions on this subject. By and large, any lead manager that complies with English law should be safe as far as any other European jurisdiction is concerned.
Section 47 of the Financial Services Act 1986 (FSA) is the starting point. It contains two prohibitions: (1) against making a statement, promise or forecast which is false, misleading or deceptive in order to induce someone to buy or sell a security or not to do so; and (2) against doing anything which creates a false or misleading impression about the state of the market in respect of a security in order to induce someone to buy or sell it or not to do so.
The first prohibition contains more of a subjective test: what was your intent in making the statement? (By the way, it also covers concealing material information.) In legal terms, you have to have mens rea. A criminal act, say murder, requires both the actus reus (sticking in the knife) and mens rea (wanting to kill the person). In the case of murder you can still be guilty if you were reckless as to whether you killed the victim, ie didn't really care what the effect of the stabbing would be. Under section 47, you can be guilty under (1) above if you are reckless.
The second prohibition contains more of an objective test. It isn't so much what you intended, but what effect your actions had on others. This could, in practice, be problematic. How do you know how others might interpret what you do? Because of this, there is a defence that you reasonably believed that your conduct would not create a false or misleading impression.
One question prompted by section 47 when first enacted was whether it created a substantive obligation to disclose information. Certainly, if you are obliged under the listing rules or the Takeover Code, or even as a matter of market practice, to make a disclosure, section 47 makes failure to do so a criminal offence. But for a while there was a view - the "strict" view - that it created an obligation in its own right to make announcements whenever there was a risk of misleading or creating a false market. This is not the view generally taken now. But at the time there was anxiety over its extent: if a broker put out a piece of research which was completely wrong, did the company or its advisers have to go around correcting it? And in a market like the bond market where many issues are not listed, what is the mechanism for publicizing information - is it enough to publish it through Reuters, for example, on the assumption that most people have access to a Reuters screen? The London Stock Exchange has helped by framing some of its rules to be consistent with the less onerous interpretation of section 47, but on occasion the shadow of section 47 does prompt disclosure. For instance, it is customary to announce the results of an issue after the rump has been placed in the market. But in some issues where the overhang of paper is large, the lead manager may make an announcement before the placing stage in order to protect himself from potential section 47 problems.
There is a different aspect of English law - contained in the Criminal Justice Act 1993 - which causes problems: insider dealing. The test is whether someone is dealing in the market with knowledge of matters which are not public. The problem here is how a lead manager can deal in the market while knowing how well an issue has gone. Fortunately, the insider dealing offences can only be committed by an individual, not a firm, so by separating - with an effective Chinese wall - those who are trading (dealing with clients) from those who are selling down the book (with knowledge of how well or badly the issue has gone) a house can be reasonably safe: the only information the latter have is with respect to the particular issue, in which case the defence of using that information to facilitate the transaction concerned (as the legislation puts it) can be invoked.
But if, following the closing, the lead manager is left with surplus paper and wants to sell it in normal trading when the price is abnormally high, it takes just one person to tell an institutional buyer "we've got the whole issue away successfully", to trigger section 47 - and possibly land the lead manager with a civil action. The answer, in this case, is: make sure all your traders say no more than "the issue has been completed". The test is: if the information were known, would the price be lower? If the answer is yes, be careful. Market-makers are virtually exempt from these strictures. Not all issues have markets made in them; although in London, it is a condition of listing.
Finally, stabilization is one aspect of market manipulation that is sanctioned by the law. Stabilization puts a floor under an issue's price and is more prevalent with equity issues than bond issues where there is less volatility in the initial price. Generally the lead manager will over-allot an issue (if he has 100, he will place 110). If the price goes down, he can buy back at the lower price in order to fulfil the allocations. If the price goes up, he is happy with the issue's success but short of paper, so under what is called the green shoe option, he can call for more paper from the issuer.
This would, in normal circumstances, be struck down by the FSA: you are arguably creating a misleading market. But because the authorities see the wisdom of a steady market, it is sanctioned both by the FSA and by the EC directive on insider dealing, provided you comply completely with the SIB's (Securities and Investments Board) rules on stabilization. Some of these rules are detailed, requiring, for instance, specific warning legends to be put on the documentation. There is often much debate over the extent to which, given market knowledge, such legends can be omitted. "These rules are fairly straightforward when it comes to bonds, more complicated with equities and harder still with hybrids," says Peter King, a partner at Linklaters & Paines and an expert in market regulatory issues. "The real problem for compliance officers is that their colleagues who do the issues often don't have time to read them." |