The Continuing Obligations Regime - current issues and challenges
Speech by Mike Knight, Manager, Company Monitoring, the FSA
Institute of Directors
9th October 2009
Good afternoon and my thanks to the Institute of Directors for the invitation to speak to you today. We welcome the opportunity to discuss, with a variety of market participants, issues relating to the Continuing Obligations regime.
Directors of listed companies are key players in the disclosure process. They are in the front line when determining whether a particular piece of information should be made public. They are required to make judgements, on an ex ante basis, on the likely market impact of particular information. In addition, off-the-cuff comments by a company’s key executives can move the market and, separately, directors’ and their associates’ personal share dealings can also be of interest to market watchers.
I will therefore set out some thoughts, across a number of distinct themes we feel may be of interest to directors. I’ll talk about our experiences of the ongoing impact of market conditions, some technical aspects of disclosures, key issues that arise from our routine case enquiries or public disciplinary actions and, finally, our approach to oversight of directors’ dealings in listed securities.
But first, some background on the UK Listing Authority’s (UKLA, an operating division of the FSA) role as a frontline capital markets regulator. We undertake a number of activities. We monitor intraday share price movements and media stories to identify possible leaks of inside information and follow up with the relevant company and others as to whether an announcement is required. We also work with colleagues in the FSA’s Enforcement area to consider which of our routine post event enquiries warrant formal investigation with a view to public disciplinary action. Additionally, the UKLA provides a helpdesk function. The helpdesk is there to assist market participants’ compliance with their listing and disclosure regime obligations.
Ongoing impact of market conditions
As the UK listed community continues to operate in challenging, or at least uncertain, market conditions, so some stresses come to bear on the Continuing Obligations. Economic and market uncertainty can feed into both ongoing issuer trading performance, as well as acting as an important factor in determining the price sensitivity of certain undisclosed information. It can therefore produce a greater number of ad hoc announcements as companies update the market on a variety of issues.
The arrival of reporting seasons may produce a burst of price movement in the market. Issuers may be announcing both performance to date and guidance as to future performance. As we’ve previously commented publicly, the disclosure of inside information in a scheduled market announcement may raise questions as to the timeliness of disclosure. We’ll look at some technical issues around this shortly.
Another ever-present characteristic of market trading is rumour and speculation. Some of you might feel that this is an entirely undesirable characteristic. The FSA certainly takes a dim view of any market participant who spreads false and misleading information into the market – the Code of Market Conduct has provisions around that. But it is not for us to suppress speculation, (unless, of course, such speculation may be, for example, manipulative).
Applying the Continuing Obligations to live market situations
You may ask about the expectations on issuers as to the handling of leaks or rumour. Key to the framework set out in the Market Abuse Directive (and embedded in the Disclosure and Transparency Rules) is the notion of inside information.
Subject to the limited ability to delay release of any inside information to the public, an issuer is required to notify an RIS as soon as possible of all inside information in its possession. Issuers and their advisers should, when delaying disclosure of inside information, continue to monitor various media (and when appropriate, market prices) for signs of possible leaks and/or related price movements. Whilst an issuer may not be required to respond to a rumour that is false, when speculation or market rumour is largely accurate, it is likely that an issuer can no longer delay announcement of inside information.
In such circumstances, the UKLA may make contact with an issuer or its adviser, though consideration of announcement obligations should not wait for our contact. If required, we may seek to establish the truth or otherwise of a story and the presence (or likelihood) of related significant price movement. We may seek opinion from an issuer or advisers and challenge opinions received. We recognise that judgement and discretion is required and each case will be treated on its merits. Nonetheless, inaccuracies of some aspects of a story may not in themselves be justification for non-disclosure. An example may be inaccuracies in a rumour as to the size or pricing of a capital raising, which may not of themselves negate the obligation to announce the existence of a (planned) capital raising.
Should a leak occur and a full announcement not be possible, any holding announcement should be meaningful and, at minimum, reflect the extent to which a leak or rumour is truthful. We do recognise in time critical situations, there can be a tension between timeliness and completeness, and in working with issuers and advisers in managing a particular market situation, we may seek commitments as to planned timetables for announcements and the contents of these.
Whilst the UKLA can require an issuer to publish such information in such form and within such time limits as it considers appropriate to protect investors or to ensure the smooth operation of the market, we do not see this power as reducing an issuer's obligations to announce inside information or to at least make meaningful holding statements. Where the UKLA is obliged by an issuer's non-disclosure to invoke our powers to require an announcement, we may make ex post enquiries as to whether all parties have been sufficiently open and cooperative in their dealings with us to that point and whether there have been any breaches of the FSA’s rules.
When an issuer is, or should be, in a position to make a meaningful announcement, we would not normally expect a suspension of listing to be sought or to be granted. Unless the smooth operation of the market is at risk, or investors require particular protection, market disciplines should remain unfettered. Further, the FSA will not suspend the listing of a security to fix its price at a particular level.
Further on the UKLA’s approach to interacting with issuers and advisers in live market situations
There has been a misconception in some areas of the market that the FSA requires issuers’ boards to seek legal or broking advice. That is not the case. But where an issuer does decide to seek advice as to its obligations – and compliance with those obligations - it is for the issuer to ensure that it uses an appropriately qualified advisor and that any adviser is fully briefed.
Whilst the disclosure regime bites on issuers in the first instance, directors – collectively and individually – steer the issuer’s course through these. I would repeat that we in the UKLA do not seek to replace a board’s thinking or responsibilities in live market situations, but this must be balanced against our powers and obligation to protect investors and overall market integrity. We may therefore challenge (quite robustly where appropriate) a board’s intended approach to (non)disclosure.
It is nonetheless important to recognise the actual or potential role of advisers in this context. Advisers can add valuable assistance to directors when considering disclosure obligations, though compliance responsibilities cannot be delegated. Taking advice, from even a suitably skilled and fully informed adviser, may be an appropriate step for an issuer to take, although doing so does not absolve the issuer (or its directors) from their obligations. We’ve previously stated this in a public disciplinary case (Wolfson).
Some further comment on our interaction with the advisory market. Whilst the UKLA’s formal relationship in our real-time monitoring of the Continuing Obligations is with the relevant issuer, our working practice is often to seek market insight on a particular stock from the issuer’s appointed broker(s). We are conscious that the advisory market is, or at least has been, tight. If there is fierce competition for a particular advisory mandate, the provision of advice on the listing regime and, perhaps more saliently, the management of relationships with regulators such as the UKLA may have been a key selling feature.
The UKLA thereby risks encountering an agent-principal conflict where the commercial imperative of the adviser can override the compliance risk to the principal. For instance, we are encountering increasing numbers of joint broking mandates. In this context, it is particularly irritating to be caught between brokers as to ownership of issues, or finding rival advisers seeking separately our endorsement of their views.
I will take the opportunity to say to directors and the advisory community at large, where we feel we are not getting satisfactory progress with an adviser (broker, sponsor, legal adviser etc) in our live market discussions, we may contact an issuer directly to advise of our sense that the issuer may be becoming exposed to risk of a breach of the Continuing Obligations.
Some further thoughts on ‘inside information’, issuer trading performance and announcement obligations
As mentioned earlier, subject to the limited ability to delay release, an issuer is required to notify to the public, via an RIS, all inside information in its possession. This obligation derives directly from the Market Abuse Directive. We are often asked about the application of this fundamental concept of the Continuing Obligations and the Disclosure Rules to a director’s or board’s monitoring of ongoing trading or financial performance.
Uncertainties can arise here as the key factor behind a possible announcement obligation is likely to be whether and when inside information may be present. This can be distinct from event-driven situations, (for instance a contract loss or win), where debate and analysis may be less driven by identification of the presence of inside information, but focuses on whether the provisions within the rules allowing for ‘legitimate’ reasons to delay disclosure apply.
I’ll set out some thoughts specific to ongoing trading or financial performance in a ‘Q&A’ format, noting that these are not intended to be FSA guidance and are not intended to be contrary to any previous statement or guidance on the issue from the FSA or the Committee of European Securities Regulators:
How far away from market consensus does trading have to be to warrant ad hoc announcement?
It would be difficult for us to answer this directly as our rules are not drafted in this language. We would, though, expect that when assessing disclosure of trading or financial performance, directors will apply the various legs of the definition of inside information; in particular, the likelihood of a significant effect on price should disclosure be required.
We do recognise that in some sectors of the listed community, there are accepted market timings or cycles for the disclosure of trading performance. This should not, though, negate the importance of timeliness of disclosure where an issuer is in possession of inside information.
Inside information is defined as information being of a ‘precise nature’. How precise does trading performance need to be to meet this test?
As a starting point, the Financial Services and Markets Act defines ‘precise’ as meaning information that is either based on circumstances that exist (or may reasonably be expected to come into existence) or an event that has occurred (or may reasonably be expected to occur). In addition, information must be specific enough to enable conclusions to be drawn about its effect on the price of a company’s traded securities.
So, applying this definition to trading performance, it is likely that the areas to look at will be ‘circumstances that exist’ and whether there is the required amount of specificity such as to allow conclusions to be drawn as to price effect. Directors will have to take into account a variety of considerations to come to their conclusions on these points, which are likely to include the degree of certainty of the underlying management information (MI) they may have in their position and the tightness or narrowness of market expectations against which it may be being compared.
Regarding the first consideration, it is arguably reasonable for an issuer, on identification of period to date trading or financial performance MI that appears to have diverged from budgeted or expected performance, to pause and consider the circumstances of this. Data integrity should not be an issue here though – the Listing Rules and the Combined Code together create a framework that requires an issuer’s systems and controls, including arrangements for provision of information provided to a board, to allow timely and accurate consideration by the board. Directors may find themselves asking ‘does one set of out of line MI constitute a trend or requires announcement or can we await further data?’ Directors will need to make a judgement here, but if further data is sought, we would expect that the collation and analysis of this is accelerated.
We accept that seasonality may be relevant in some cases – perhaps there are key trading periods which are seen by the directors or the market as determining overall trading for a period. Regularity of MI may also be a relevant – do boards only see this monthly, whilst key executives, perhaps including the CEO and FD, access end of week or even end of day data? Should information held by the CEO or FD, but not disclosed to the board or a sub-committee, be considered of a type that could constitute inside information, these key directors risk being knowingly concerned in a breach of the issuer’s duty to publicly disclose such information in a timely fashion.
The second consideration, which relates to price effect, is also important in respect of a baseline for comparison. Directors might need to ask themselves ‘what does the market expect?’ ‘is there a range of expectations (of a particular metric)?’, ‘do we remain within expectations – are we at the upper or lower end?’
A narrow range of market expectations and performance that appears to be outside that range, may, in combination, suggest that the relevant MI is specific enough to enable conclusions about its price effect. Even trading at an upper or lower end of a range of expectations could still meet this condition. Of course, expectations can exist as a result of extant disclosures made by the company alone, as a combination of these disclosures and subsequent market or economic events, or purely from other market (mis)understandings.
Can intra-group positive and negative trading or financial performance be balanced against each other?
We are often asked about our attitude towards contrasting performance between different areas of a company (ie one area performing better than expected, another worse) that would seem to net out poor performance. We’ve said previously in public statements that netting of inside information should generally not occur. We remain to be convinced that balancing positive or negative intra-group trading performance can be achieved legitimately under our rules.
Directors will need to consider whether either leg in isolation or taken together constitutes inside information and, if so, that information must be disclosed (unless there are grounds for delay). Directors may need to consider how comparable the respective positive and negative performance is and whether any netting effect between these may change over time, perhaps across financial reporting periods. The better course of action, where there is doubt, is for the issuer to announce the information to the market so that the market can assess the information for itself.
Can we wait until a scheduled results announcement to disclose ongoing performance related inside information?
Generally, no. It is possible that board review of MI may only occur immediately before a scheduled announcement. But where this is the case, we would question whether in fact the board should have received the relevant MI earlier, or whether the board, in fact, having received the relevant MI, should have decided to disclose performance at an earlier date. Market moving scheduled announcements can often receive an ex post enquiry from us a result.
When can an issuer provide guidance or forward-looking statements?
Forward-looking statements are not an ad-hoc requirement of the Continuing Obligations, although the periodic reporting requirements of the Transparency Directive (and some elements of the Listing Rules and Prospectus Directive) do require some forward-looking statements. The important issue from the UKLA’s perspective is that where forward-looking statements are made, a baseline against which future actual performance may be measured, is of course created, and market expectations are, to some extent, directed. Our comments regarding the disciplines of inside information are then relevant.
Key issues arising from our routine enquiries and public disciplinary cases
We’ve previously publicly commented that the UKLA makes in the order of 200+ routine enquiries per year of issuers and their advisers. A majority of enquires will, not unexpectedly, end in no further action from us, though we will provide ‘good practice’ comments or propose private warnings where we feel appropriate. A small proportion of our enquiries are referred to our Enforcement colleagues for formal investigation into whether there has been a breach of the Continuing Obligations. In turn, some formal investigations result in public disciplinary action.
We think it may be useful to surface some of the key themes, issues that we see arising from these various activities:
- We are looking to promote compliance with our standards and expectations regarding the identification, handling and analysis of inside information, along with any related disclosure obligations.
- Issuers need to balance the requirement for timely disclosure with the need to ensure all reasonable steps have been taken to ensure an announcement includes key information and that the announcement is not false, misleading or deceptive.
- That there is an important distinction between regulatory disclosure as against wider investor relations strategies. These can of course overlap. It is neither acceptable, nor grounds for delaying disclosure, to find an issuer’s sole rationale for not wanting to disclose inside information is that it may lower a share price and the shareholders would not want that.
- We’ve confirmed recently via a List! article that we are prepared to consider taking action against breaches of Listing Principles alone. Issuers are reminded of the requirement to establish and maintain adequate systems and controls cases to enable them to meet their obligations and to communicate information in a way to avoid the creation or continuation of a false market in their listed securities. The requirement for adequate systems and controls means that, where there has been a failure to comply with the Continuing Obligations, it would not be a defence for the issuer to say that the right people did not have the right information at the right time. We would also comment that directors could be found knowingly concerned in breaches of this requirement.
- Acknowledgement of the circumstances under which professional advice is sought or received and the extent to which it is reasonable to rely, unchallenged, on that advice. To restate my earlier point, it is for issuers to assure themselves as to the appropriateness and expertise of those from whom they seek advice.
- With regards to the monitoring of major shareholdings – we have recently privately warned a major shareholder for non-timely disclosure of its holdings – there are also powers available to issuers to make enquiries of those suspected of having direct or indirect control over voting rights. Where we feel there may be concerns over non disclosure of holdings, we may also enquire as to steps taken by an issuer to resolve any uncertainties.
- Finally, I would remind issuers and their IR areas to remain vigilant when communicating with analysts or investors – our rules specify that selective disclosure of inside information can only occur under strict conditions. In particular, the process of guiding should not entail anything that transgresses this.
The UKLA’s role in the oversight of director’s dealings in the securities of their company
I would comment that our work in this area is twofold. We would see these activities as:
- Providing advice and guidance on the application of the Model Code and disclosure of so called ‘PDMR’ dealings. For example, over the last couple of years, we have published comment on how we believe capital gains tax-related ‘bed and breakfasting’ should be considered within this framework and, separately, clarified for directors and issuers our position on the disclosure of the granting of security over shares.
Additionally, we receive helpdesk queries on case-specific application of the Model Code. On this, I would comment that we do not look to waive the Model Code – if issuers, directors and advisers find compliance a problem, they may wish to consider how to restructure their proposals to enable them to comply with the Model Code. We also should not be used as a mechanism to legitimise particular dealings, proposed dealings or incentive plans; these are corporate governance matters for the board and investors to consider. - We also undertake periodic monitoring of dealings for compliance with the Model Code and may work with colleagues in our anti-market-abuse area to consider any issues arising from the Code of Market Conduct.
Concluding remarks
I hope you’ve found the thoughts I’ve set out useful. We’ve looked at a number of distinct themes affecting directors of listed companies. These have included our experiences of the ongoing impact of market conditions, some technical aspects of disclosures, key issues that arise from our routine case enquiries or public disciplinary actions and finally, our approach to oversight of directors’ dealings in listed securities. We look forward to working with you in our day-to-day work and promoting compliance with the Continuing Obligations.
