FSA warns on how shareholder activism can amount to market abuse
In May, the UK's Financial Services Authority (FSA) issued advice in its 'Market Watch' newsletter about shareholder activism, warning investors not to cross the line into market abuse. It was the first time the regulator had issued information publicly on the subject of activists and the boundaries between legitimate trading and market manipulation.
The newsletter included warnings about potential insider trading arising from funds working together to build a stake in a company with the aim of forcing a change in the corporate structure. 'We don't think [it is market abuse] where market professionals are looking to take advantage of their own expert analysis of otherwise publicly available information,' states the FSA. 'However, we might reach different conclusions if other participants also come to trade on the basis of another participant's strategy.'
When asked whether the FSA had information about how common it was for activist investors to work together in secret, Mike Duignan, manager of market conduct in the market division at the FSA comments, 'There are suspicions that this happens. However, we referred to the idea that funds work together in secret as this is directly relevant to the topic of market abuse, but that doesn't necessarily mean it's happening.'
The newsletter also warned of potential market abuse on the basis of information 'however obtained', which brings attention to the fact that both active seeking and passive reception of information can lead to insider trading.
Being on the receiving end of information, however, leads to some gray areas, as Duignan points out: 'If that information is precise, and you go on to trade on the basis of that disclosure, that may well be market abuse. However, if someone said Company x is interesting, isn't it?, it would be pretty hard to say that was an improper disclosure. But if someone laid out their entire strategy to you, and you can tell once the market knows there will be a significant effect on the share price, then that is a different story.'
What does the FSA expect activists to do if they find themselves in the position of inadvertently finding out about another participant's investing strategy? Duignan explains that there are two options: 'One is that you don't trade and you ask the person not to tell you any more information. The second is that you contact us. We have various mechanisms, including a market abuse inbox where people can email us.'
The main way the FSA uncovers market abuse is through its Suspicious Transaction Reporting Regime. 'Suspicious transaction reports arise from the obligation on firms to be aware of deals and to notify us if they come across anything suspicious,' notes Duignan.
In a speech in May, Sally Dewar, director of the market division at the FSA, highlighted the FSA's expectations in this area, commenting: 'We would like to encourage firms to report to us matters of suspicion in relation to peers. Some firms have noted that they don't think that it is appropriate for firms to be 'whistle-blowers on their peers … I understand that some firms are concerned that the FSA is suggesting that there is a formal reporting obligation. I would like to confirm that this is not the case. What we want is for you to be good corporate citizens and to work with us to help identify instances of potential market abuse in the interest of a cleaner market.'
Activism on the rise
The information issued by the FSA reflects the growing concerns that many shareholder activists have about gray areas between legitimate trading and market manipulation. 'The information we issued was in response to changing market conditions,' comments Duignan. 'We found we kept being asked the same questions regarding market abuse.'
There are some commentators, however, who feel the information issued by the FSA does not go far enough. Andrew Shrimpton, senior consultant in the regulatory compliance practice at Kinetic Partners and former head of alternative investments supervision at the FSA, feels more clarification is needed.
'[If] an activist hedge fund increased its stake substantially in a single transaction by acquiring the position of another investor, [and] then released a public letter calling for a strategic overhaul, or requisitioned an extraordinary general meeting, it might enjoy a sudden share price rise. The FSA's note does not say whether such a strategy would be considered market abuse,' he comments.
When asked about this, Duignan responds, 'The reaction to the information in 'Market Watch' was generally very positive, but there will always be people who think we could go further with all information we issue.' He adds that the FSA has no plans to issue further comment on the subject of shareholder activism.
The fact that the FSA is addressing this topic is indicative of the recent rise in importance of shareholder activism across the Atlantic. Although the European activist market is still far behind the US, activist investors have never been more prominent in the European market. There are increasing numbers of activist investors entering the scene, with more funds under management. In addition, they seem to wield more and more power, sometimes with surprisingly small ownership stakes.
'Shareholder activism is more common now, and activists go beyond what they used to,' notes Duignan. 'In the past, people would build up a stake and then later on make a representation to management with proposals for change. It's more prevalent now that people will buy shares with the objective of changing something about the company.'
Rory Sullivan, head of investor responsibility at UK asset manager Insight Investment, points out that some activist investors are relatively small, with a modest amount of capital. 'Yet they often seem more powerful as they amplify their voice using the media, generating attention with the intention of influencing other investors,' he notes. 'They can try to exert influence above their weight and stature.'
Despite the increased number and influence of investor activists, the FSA is keen to point out that it does not mean to impose unnecessary rules on investors, and that the information issued is not a set of guidelines but principles for investors to abide by.
'Strict rules would not work as the activists could easily find ways of gaming them,' says Shrimpton. 'That kind of arbitrage is exactly what activists are good at. The only effective way to ensure activists don't undermine confidence is to use principles-based and outcomes-focused regulation and encourage activists to come up with an industry-led code of conduct.'
This is something Duignan agrees with: 'We are not an enforcement-led regulator, we seek to work in partnership with the industry,' he notes. 'Our fight against market abuse relies on the industry itself to act and to work with us to help identify and seek out the ne'er-do-wells that operate.'
In addition, despite the bad reputation they sometimes carry, most would agree shareholder activists can bring positive changes to companies and the market in general. The FSA seems to be of the opinion that giving them room to operate, rather than stifling them with over-regulation, is the way to maximize the benefits activists can bring.
