Insider trading tightened up

With the decision no. 15224 rendered on 3 July 2014 (the “Decision”), the Italian Supreme Court has extended the boundaries of the prohibition on insider trading, i.e. the ban (on the basis of the legislation wording in force at the time of the relevant facts, namely Section 2 of Law 157/1991) on “purchasing or selling, or completing other transactions, including via a third party, in relation to securities, including related option rights, when in possession of confidential information obtained by virtue of a shareholding in a company or as a result of holding office, including public office, or of the exercise of a profession or role”.

The case brought to the attention of the Court concerned conduct by a pool of well-known Italian banks facing significant exposure towards a company operating in the real estate sector that was declared bankrupt. Relying on confidential information provided by an advisor – according to which, in the absence of recapitalisation or acquisition by another company, the debtor company would most likely be declared bankrupt – the banks in the pool had converted their receivables into shares of the debtor company and then sold them on the market to third-party investors, who suffered significant losses as a result of the decreased value of the shares.

The Court ‘s view is that the pool of banks was liable not only for having decided – on the basis of the privileged information – to sell the shares, but also because the information supplied by the advisor, which was relevant in terms of the shares’ performance on the stock market, should have been communicated to Consob (the Italian securities market regulator). Indeed, in this respect, Consob prompted to launch an investigation in connection with a breach of Section 2 of Law No. 157 of 1991.

Eventually, Italian Judges found that the pool of banks had taken advantage of privileged information to the detriment of investors, who could not acknowledge that the debtor company was in serious financial distress and who had no way out available.

The content of the advisor’s report. According to the Decision:

(i) the banks were perfectly aware that the debtor “was, to all intents and purposes, on its way down the path of liquidation, even though this had not been officially declared” and that bankruptcy was more of a certainty than a mere probability;

(ii) the information provided by the advisor was to be treated as confidential, of a definite and specific nature (the shareholding had in fact fallen from 78% to 14%) and able to provide clear signs (which were not lost in the pool of banks) that the company was, undoubtedly, insolvent. It is not a mere coincidence, the Court pointed out, that right after this information has been received, the pool of banks carried out a large-scale disposal of the shares (which is one of the requirements for the information to be treated as a possible tool for insider trading according to Section 181 of Legislative Decree 58/1998.

The nature of the privileged information. The Decision makes it clear that not only information relating to steps and decisions taken by others should be treated as privileged (and, therefore, subject to the legislation on insider trading): information concerning decisions made by the company itself and which are capable of prejudicing the investors as a group also falls under the same umbrella.

As the information in this particular case prompted steps to be taken and decisions to be made within the pool (i.e. the decision not to go ahead with recapitalisation and to reject a bid tabled by another company), the principles of propriety that underpin the rules of conduct governing financial operators meant that the banks, as parties with an “information advantage”, were bound to refrain from completing the transaction.

The Court argued that this duty of propriety and transparency does not take a back seat when the transaction is of a speculative nature, which is in fact the case with the majority of stock market transactions; in addition, the transformation of the receivables into shareholdings must not become a tool that is used to wrongfully shift, onto third parties, the loss in value corresponding to the original receivable.

The right to claim damages. Another key point of the Decision is that it recognises a right to claim damages in favour of all of the investors who, despite the absence of any direct contractual relationship with the party that placed the securities on the market, suffered losses that could be linked to the exploitation, by the financial operators, of the privileged information.

The Court in fact recognised that the legislation governing insider trading and the duties of propriety and transparency, which financial operators are bound to, has a broader scope of application when compared to the codified provisions: these duties are imposed in order to provide a guarantee of proper price formation in relation to financial instruments on the market, thereby providing a safeguard for anyone who happens to trade on the basis of those prices at any given time.

Against this backdrop, the Court went on to recognise: (i) the right to start an action in favour of all those who, despite not being clients of the banks that made up the pool, suffered losses at the hands of those banks as a result of the decreased value of the securities purchased on the stock market; (ii) a causal link between the unlawful conduct and the losses complained of.

On this last aspect, it was noted that the failure to notify Consob (and, therefore, the fact that the public was kept in the dark) the information which, despite being the information that drives the steps taken by the relevant owner, could lead to the group of investors to incur losses, is to be deemed unlawful in light of the principle that “whoever invites investment by the public by offering equity securities shall act in such a way that, in the context, the other party to the contract is in a position to carry out a proper analysis of the offer and of the merits of the transaction”.

In conclusion, with this Decision the Supreme Court grants an extremely broad scope of application to the provisions governing insider trading on the basis of the view that they “are capable of extending further than simply providing a safeguard for the other specific individual party to the contract, and can extend beyond the scope of the individual contract itself and beyond liability towards the individual client and contracting party, in order to ensure, in broad and general terms, propriety on the part of those operating on the market.