Inside look

In Case C-626/13 Lafonta v Authorité des marchés financiers (Second Chamber, 11 March 2015), the Court of Justice of the European Union (CJEU) reached a predictable conclusion concerning the definition of ‘inside information’ for the purposes of Directives 2003/6 and 2003/124. But, although predictable, the result is of some interest.

Between September 2007 and early 2008, the private equity group Wendel, a company of which Mr Lafonta was chairman, gradually acquired increasing numbers of shares in another company, Saint Gobain. The purchases were duly announced as market rules required.

However, it emerged that Wendel had entered into equity swap transactions in 2006 and 2007, which, the French regulator found, had been designed to pave the way for them. The regulator decided that by 21 June 2007 at the latest, Wendel had been engaged in a ‘financial operation’ to acquire a significant holding in Saint Gobain, and that this constituted ‘inside information’ which ought to have been reported to the market under Article 6(1) of Directive 2003/6 and the French law implementing it.

Specific information

To constitute ‘inside information’, information must be ‘of a precise nature’ and be ‘likely to have a significant effect on the prices’ of financial instruments or derivatives. Directive 2003/124 further explains that precise information must be ‘specific enough to enable a conclusion to be drawn as to the possible effect of [the event or circumstances to which it relates] on prices’. Mr Lafonta argued that the information concerning Wendel’s operation was not ‘specific enough’ in this sense, because it was not possible to say whether investors would regard it as positive (encouraging them to buy) or negative (encouraging them to sell).

The CJEU rejected this argument. Nothing in the EU legislation expressly required that it was necessary to be able to predict the direction of price movement that would result from general disclosure of the information. Indeed, a proposal to include such a requirement had been omitted. In complex financial markets, investors may react differently to particular information. It would not, the CJEU thought, be right to allow information holders to use ‘uncertainty… as a pretext for refraining from making certain information public and thus profit from such information to the detriment of other actors in the market’.

Significant effect

This is not at all a surprising result. But, although intuitively attractive, it is not beyond criticism – at least in terms of the reasoning. First, as a textual matter, why is ‘uncertainty’ irrelevant? The definition requires that the information be such as would enable a ‘conclusion to be drawn as to the possible effect’. If the ‘possible effect’ is so uncertain that no conclusion can be drawn, even as to the ‘direction’ of movement, why is that irrelevant?

The answer, which the court hinted at but did not make sufficiently explicit, lies in the terms of the legislation. The ‘possible effect’ in question must be related to the ‘significant effect’ referred to elsewhere, which is, in turn, stated to be satisfied if a ‘reasonable investor would be likely to use [the information] as part of his business decisions’.

In other words, ‘effect’ here does not require proof of how the information will affect market prices in the aggregate, but simply that it will be taken into account by individual investors in the decisions they take. It might be quite unclear whether, looked at in the aggregate, the overall effect of a particular piece of information will be positive or negative, and yet quite evident that it will have had some effect in the sense of forming a significant factor in investor thinking, which is the real question.

Second, one might quibble with the court’s reference to the information holder ‘profiting’ from the inside information. As Mr Lafonta pointed out, the rational actor may find it hard to profit if he cannot predict even the direction of price movement. But that is not really the point.

Although the prohibition on insider trading aims at such exploitative behaviour, it seems strongly arguable that the requirement to communicate price-sensitive inside information promptly serves broader objectives. For instance, it improves market efficiency.

It seems likely that the legislation embodies a broader conception of the fair and well-functioning market – a broader conception which amply justifies the court’s decision, but which the court did not explicitly articulate. SJ

Paul Stanley QC is a barrister practising from Essex Court Chambers