In July 2019, the German Federal Financial Supervisory Authority (BaFin) presented its long-awaited consultation draft on Module C of the new issuer guidelines, which set out its administrative practice on insider rules, ad hoc disclosure and managers’ transactions under the EU Market Abuse Regulation (MAR). The final version of Module C1 was published on 22 April 2020. The significant changes to insider rules and ad hoc disclosure are described below.
The reasonable investor
The likelihood of information to have a significant effect on prices – also known as price relevance – has always been determined from the ex ante perspective of a reasonable investor. BaFin interprets a reasonable investor to be “an investor with average knowledge of the stock market, who bases his/her decision on objectively verifiable information” (I.2.1.4.1). Although specialist knowledge is not required, a reasonable investor is familiar with the basics of securities trading and corporate law. This is in line with the image of a "layman with stock market experience" that is customary in practice. It is generally accepted that, when making a decision, a reasonable investor will take into consideration all publicly available information and use it as a basis for an overall assessment.
However, since BaFin’s previous statements in its FAQ on Article 17 MAR it has been unclear whether a reasonable investor always acts rationally and with the aim of making a profit or whether further speculative investment practices need to be considered. BaFin’s former FAQ could be interpreted to mean that in special cases a reasonable investor would have to take into account behaviour of other market participants that is (i) speculative and based on short-term price fluctuations or (ii) possibly even irrational. Following justified criticism from practitioners, BaFin has significantly watered down its statement: According to Module C, a reasonable investor also takes into consideration “how, in his/her experience, other market participants (i.e. the investing public) have responded to similar circumstances in the past.” This statement describes rational investment behaviour and is in line with the prevailing opinion.
While a fundamental value-based assessment of an information’s likelihood to significantly affect prices is on the rise in both practice and literature, BaFin has made a vague restriction to this approach: According to BaFin, a reasonable investor considers “not only the company’s future financial position and profitability”, but also “possibly other factors which, – regardless of any change in its enterprise value – may influence the price of the financial instrument.” It remains unclear which “other factors” BaFin is referring to. One can only assume that BaFin does not (yet) wish to fully commit to the relatively new fundamental value-based approach. However, it is hard to imagine that information can affect prices without affecting the fundamental value of the issuer.
Intermediate steps as inside information
In protracted processes, intermediate steps to a final event can also constitute inside information. BaFin distinguishes between two types of intermediate steps (I.2.1.4.3): those that are, by themselves and viewed separately, inside information (type 1), and those that derive their likelihood to significantly affect prices from the future final event (type 2):
- A type 1 intermediate step has its own relevance under insider rules, which is fully independent from the probability of occurrence of the final event.
- For type 2 intermediate steps, BaFin assumes that the more important and probable the final event is, the greater is an intermediate step’s likelihood to significantly affect prices. Where, however, the desired final event is still improbable, an intermediate step is generally not likely to have a significant effect on prices.
Type 1 intermediate steps rarely occur in practice. One relevant example is the Daimler/Geltl case, which essentially centred around the unpublished fact that the then DaimlerChrysler CEO was weary of office. According to case law a reasonable investor could have concluded from the CEO’s weariness that a substantial shift in strategy with a significant effect on prices was imminent.
BaFin appears to apply the so-called “probability/magnitude” formula to type 2 intermediate steps. In contrast to some opinions voiced in recent legal literature, this approach cannot be objected since it is in line with the principles of capital market economics. When assessing the likelihood of an intermediate step to significantly affect prices, a reasonable investor will naturally also consider its future implications, the occurrence of which, although not likely (but cannot be entirely ruled out either), would nonetheless have a significant impact on the fundamental value of the issuer.
M&A transactions
In case of M&A transactions, each individual procedural or intermediate step has to be assessed as to whether or not it constitutes inside information. BaFin seems to consider the existence of inside information in particular in cases where the parties have reached an understanding about key points of a possible transaction or where both parties’ desire to reach an agreement has otherwise been demonstrated during the process. By contrast, only unilateral actions to prepare for a potential transaction do usually not constitute inside information. However, the fact that the parties have yet to engage in the actual contract negotiations, determine the purchase price or other essential provisions of the sale and purchase agreement does not, according to BaFin, mean the transaction does not constitute an inside information. Future transactions of significant importance must therefore be assessed at a very early stage regarding possible inside information in connection therewith.
Financial results
BaFin has also detailed its administrative practice on the conditions under which financial results are to be treated as inside information (I.2.1.5.2). If in the process of preparing financial statements, the range of the relevant financial results can be determined in form of a “corridor”, and it is already to be expected that even the results at the edge of such corridor significantly deviate from the relevant benchmark (see below), according to BaFin, this constitutes inside information.
BaFin still uses the established three-stage benchmark test of (i) an issuer’s own published forecast, (ii) market expectations (consensus) and (iii) prior-year figures with one important modification: Where the financial results deviate on the one hand from an issuer’s own forecast but are in line with the considerably more up-to-date market expectations on the other, according to BaFin, these financial results do not constitute inside information. BaFin uses the average (mean value) of the current consensus estimates to determine market expectations.
According to BaFin, in case an issuer’s own forecast is overly vague or broad it is not a suitable benchmark. Where the issuer has specified a corridor in its forecast, it must have been established on the basis of ascertainable facts. If the financial results are outside the corridor, they can be regarded as inside information. The following principle applies to financial results within the corridor: The narrower the corridor, the less it can be regarded as inside information. Conversely, this means that these financial results may constitute inside information if the forecast corridor is very broadly defined and the results are near its top or bottom end.
Forecasts
In addition to the initial publication of a forecast, adjustments to an already published forecast can also qualify as inside information (I.2.1.5.1). If the issuer has specified – both in its original and its updated forecast – a reasonable corridor of expected profit or loss, BaFin generally bases its assessment of the price relevance of the updated forecast on the deviation of the average (mean value) of the original forecast from that of the updated forecast. As with financial results, the updated forecast can only be assumed to have a significant effect on prices if the updated forecast additionally deviates from market expectations, i.e. current consensus estimates. In contrast to the consultation draft of Modul C, BaFin now no longer requires issuers to review forecasts if market expectations subsequently deviate from their originally published forecasts. Nor does it generally constitute inside information if an issuer keeps to its original forecast.
Responsibility of management board and supervisory board for delay of disclosure
In general, the entire management board is responsible for the decision to delay the public disclosure of inside information. In practice however, this task is usually delegated to one or two management board members. Under BaFin’s previous administrative practice, which had no base in stock corporation or capital markets law, the decision to delay disclosure always required the involvement of at least one management board member. In Module C, BaFin now only stipulates that at least one management board member “should” be involved in the decision (I.3.3.1.1). If BaFin is trying to say that the involvement of one management board member is desirable, but not mandatory, this is to be welcomed. However, it remains unclear from BaFin’s wording under which circumstances it considers a deviation from its “recommendation” to be acceptable and what the consequences of non-compliance would be.
Where the supervisory board is inherently responsible for the subject matter (e.g. the composition of the management board), BaFin now correctly recognises that the supervisory board is solely and exclusively responsible for the decision to delay disclosure of inside information (I.3.3.1.1). The decision must be made on the basis of a supervisory board resolution; according to BaFin it can, however, also be delegated to an ad hoc committee or even an individual supervisory board member. Even though such delegation would be desirable in practice, it is not permissible due to the mandatory restrictions as regards the delegation of authority under stock corporation law. However, since the decision to delay disclosure can be delegated to a supervisory board committee (e.g. the executive committee), the fact that this decision cannot be delegated to an individual supervisory board member should not be insurmountable.
The management board remains responsible for the later publication of inside information. Companies must therefore ensure that the inside information is passed on by the supervisory board to the management board without undue delay, once the prerequisites for a delay of the disclosure no longer apply.
1 In the following, section numbers refer to the relevant passage in Module C
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