18 October 2004
Shell might have been fined £17m by the UK’s Financial Services Authority (FSA), but that is just the beginning of a long-expected global crackdown.
The number of cross-border regulatory investigations is set to rise because, in the wake of Parmalat, new market abuse legislation should be in place across Europe by the end of October.
At the beginning of this year, and ahead of most jurisdictions, Guernsey followed the UK in legislating against all forms of market abuse. Guernsey has taken an even tougher stance than the UK and has made market abuse a criminal offence that can result in unlimited fines and up to seven years imprisonment.
The new offence will duplicate existing offences, including: insider dealing; fraud; false statements; misleading statements and practices; civil causes of action, such as misrepresentation; and regulatory rules for open-ended funds. It will also cover some virgin territory.
Closely modelled on Part VIII of the UK’s Financial Services and Markets Act 2000, this offence will cover all traded securities on the Channel Islands Stock Exchange (CISX), as well as related investments, including derivatives such as spread bets on exchange indices and swaps related to the value of listed equity.
The UK’s regime already applies to behaviour in the Bailiwick of Guernsey that is connected with investments on or related to UK Recognised Exchanges, thereby protecting investors on the UK’s stock, commodity and financial futures exchanges. Once the EU’s Market Abuse Directive has been implemented by EU member states the same will be true for other EU exchanges and their related investments.
Just as in the UK, market “abuse” consists of behaviour that a regular user of that market would regard as a failure to meet the standard reasonably expected of a person in that position in relation to the market, and is behaviour that is either a misuse of information, gives misleading impression or is likely to distort the market. Essentially, the test is whether the behaviour complies with prevailing formal and informal market practices.
Mirroring the UK position, there will be statutory defences if the defendant acted within a code of market conduct, or “took all reasonable precautions and exercised all due diligence to avoid the behaviour amounting to market abuse”.
Misleading statements and practices
For all securities, whether listed or not, Guernsey recently implemented an enhanced offence of misleading statements and practices, with the sanction of unlimited fines and seven years’ imprisonment.
In summary, this offence applies to statements, promises or forecasts that are misleading, false or deceptive in a material particular, whether they are dishonestly concealed, or recklessly made, to induce any other person to enter into a controlled investment agreement. Broadly speaking, this covers subscription agreements and marketing material in respect of shares, units in collective investment schemes, partnership interests, debentures, warrants and derivatives.
Balancing the needs of investors and issuers
The CISX has a reputation for flexibility and has developed user-friendly listing rules, particularly for investment funds, debt issues and special purpose vehicle securitisation issues.
In contrast to EU exchanges, which will be restricted by the “maximum harmonization” that EU directives will impose on them from 2005, the CISX will still be able to make appropriate changes to its listing rules. For example, many non-EU issuers would rather not be subject to the restrictions imposed on them by the EU Prospectus Directive, but still want a listing in a time zone that is accessible for London, New York and Tokyo – the CISX is ideally placed to accommodate them.
Issuers’ compliance costs are reduced because the CISX will not be obliged to implement the EU Transparency Obligations Directive. Trading costs are further minimised as there is no stamp duty in Guernsey.
Tax advantages of enhanced corporate governance
The Parmalat and Shell cases have demonstrated the importance of good corporate governance at board level in order to protect investors against market abuse.
In contrast to most offshore centres, Guernsey regulates professional non-executive directors, as a consequence of which there is a readily identifiable pool of individuals who are suitably qualified and regulated.
While many funds are established in Guernsey, the traditional structure for the underlying funds is to incorporate in the Cayman Islands with administration in Dublin and investment management in London. The Caribbean fund domicile was originally designed by US lawyers who had no concept of the UK Inland Revenue’s approach to the “central management and control” of an offshore company.
The logistical difficulties of operating such a structure across the Atlantic mean it would often be impossible to convince the Inland Revenue that, although the fund was incorporated offshore with a majority of offshore directors, its management and control were exercised in or from any particular jurisdiction other than the investment manager’s. Such funds also run the risk of being judged as domiciled in the administrator’s jurisdiction, especially where the administrator has provided the fund with directors and facilities for board meetings.
It is surprising that the danger of the fund’s profits being taxed by the UK or Ireland has been ignored for so long, but the Inland Revenue has not forgotten and the danger has focused the minds of the more discerning fund managers to such an extent that they are considering migrating their existing funds.
Moreover, in these times of demanding corporate governance requirements it is preferable for directors to actually attend some board meetings in person. At the same time the investment manager can also attend as well as visit the administrator and, by so doing, clearly demonstrate to the Inland Revenue that the fund is domiciled and ‘controlled’ in a particular place.
Guernsey’s market abuse legislation provides extra protection for all investors. This has already led the FSA to approve the CISX as a Designated Investment Exchange, which is recognition that the CISX meets stringent requirements in the operation of the exchange’s supervision, membership, price information, clearing and compliance arrangements.
With the added sanction of criminal penalties for market abuse and enhanced corporate governance driven by sound tax considerations, Guernsey is arguably ahead of the pack in protecting investors while retaining the flexibility to encourage new listings.
Benjamin Wrench is a corporate lawyer with Ozannes