Wednesday, 7 June 2017

Lexology/Hogan Lovells: Wall crossings and insider dealing – Financial Services Authority levies the second highest ever fine against Greenlight Capital hedge fund trader David Einhorn

Hogan Lovells

United Kingdom February 1 2012

On 12 January 2012, the Financial Services Authority ("FSA") levied its second highest ever fine of £3,638,000 against US hedge fund trader David Einhorn and a fine of £3,650,795 against Greenlight Capital Inc for market abuse.

David Einhorn is the owner of Greenlight Capital Inc ("Greenlight"), an investment management firm based in the US, which manages several Greenlight funds. The Greenlight funds held shares in Punch Taverns plc ("Punch"), which, prior to 15 June 2009, amounted to 13.3% of Punch's issued share capital. On 15 June 2009, Punch announced a new equity fundraising of £375 million, which would be used to pay off its convertible debt and create headroom in relation to Punch's securitisations vehicles in order to avoid a breach of covenants. The market was not expecting the fundraising and its anticipated size was substantial in relation to Punch's market capital at the time of the fundraising.

On 8 June 2009, Punch's brokers raised with Mr Einhorn the subject of a possible equity issue by Punch and invited him to be wall crossed in relation to Punch. Wall crossing, a well-established practice in large public companies and investment banks, allows a company to provide inside information legitimately to a third party (eg the company's investors) in order to discuss the third party's views in relation to a proposed transaction, but, once such third party has received that inside information, it is restricted from dealing or acting on it. Although Punch's other US shareholders had agreed to be wall crossed by signing non-disclosure agreements, Mr Einhorn refused this request and a call was arranged for the following day between Punch's management, the brokers and Mr Einhorn on a non-wall crossed basis.

During the 9 June 2009 call, Punch's management disclosed to Mr Einhorn that Punch was at an advanced stage of the process in relation to the issue of a significant amount of equity, probably within a one week timescale. Immediately following the call and over a period of four days, Mr Einhorn directed Greenlight's traders to sell a substantial number of shares, which reduced Greenlight's stake in Punch from 13.3% to 8.98%. When the equity fundraising was announced on 15 June 2009, Punch's share price fell by 29.9% and Greenlight avoided a loss of £5.8 million.

Even though the market abuse was not deliberate or reckless, the FSA considered that this was a serious case of market abuse under section 118(1)(a) of the Financial Services and Markets Act 2000. Whilst the FSA acknowledged that no single piece of information given to Mr Einhorn during the 9 June telephone call was inside information, the call had to be considered as a whole, such that the particular pieces of information together amounted to inside information. The FSA rejected a number of Mr Einhorn's arguments that he did not receive inside information, namely that the discussions during the call were high-level and conceptual, Punch's management made it clear they were considering different alternatives, no decisions had been made regarding an equity issue or other course of action, Mr Einhorn had refused to be wall crossed, none of the parties on the call considered that inside information had been disclosed and Mr Einhorn was told at the end of the call that he was not wall crossed. These were all irrelevant in the FSA's view, and they concluded that it was sufficiently clear from the phone call that the equity issue was imminent, the information was specific enough to enable Mr Einhorn to draw a conclusion as to the possible effect of the issue on the price of Punch's shares, the information was not generally available and it was likely to have a significant effect on price, as it was information which a reasonable investor would be likely to use as part of the basis of his investment decisions.

The FSA's finding that Mr Einhorn committed insider dealing was also made easier by the fact that he occupied a prominent position as President of a high profile hedge fund and was an experienced trader and portfolio manager and that, given his experience, it should have been apparent to him that the information he received on the Punch call was confidential and price sensitive and he used that information without first seeking any compliance or legal advice within Greenlight. It was also significant that Greenlight's trading took place over a four day period and represented a large part of the daily volume traded in Punch shares over that period. As a result, Mr Einhorn's error of judgment was a serious failure to act in accordance with the standards reasonably expect of market participants and warranted a substantial penalty.

Following this case, investors need to be mindful that, even if a UK listed company undertakes not to provide investors with inside information or the investors agree that they do not wish to receive inside information about the company, they have little protection where the company does in fact give them inside information, which they subsequently deal on. Investors will, therefore, need to be diligent in determining whether they can or cannot trade after receiving corporate information and, if they are in doubt as to whether they have been made an insider, they should take appropriate legal advice before dealing on that information.

Whilst the FSA are prepared to impose significant fines where the offender is an experienced market professional, brokers and other persons in positions where they are expected to be vigilant for signs that transactions may be improper will not escape either. The trading desk director who was instructed to sell the Punch shares received a £65,000 fine for failing to identify and act on a suspicious order to sell from Greenlight that allowed the firm to be used to facilitate market abuse and Greenlight's compliance officer was fined £130,000 for failing to question and make reasonable enquiries before the sudden move to sell the Punch shares. If traders and compliance officers are not satisfied that proposed transactions are proper, they must either prevent the trade or submit a Suspicious Transaction Report to the FSA.

The case further highlights that the offender's jurisdiction is not a hindrance to the FSA in its tackling of market abuse and insider dealing in relation to companies whose shares are listed in the UK. In November 2011, the FSA imposed its highest civil penalty against a Dubai-based private investor, Rameshkumar Goenka, who was fined US$9,621,240 (approximately £6 million) for manipulating the price of Reliance Industries plc's securities on the London Stock Exchange to avoid a loss on a related structural product.

A copy of the FSA's decision notice can be found here.

Hogan Lovells - Richard Ufland, Tom Brassington and Zoey Handforth  

Filed under

    United Kingdom Capital Markets White Collar Crime Hogan Lovells

Tagged with

    Insider trading FSA Greenlight Capital Punch Taverns

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