CP 118 Responsible Handling of Rumours

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1 9 November 2009 Mr Jonathan Coultas Senior Manager Market Participants and Stockbrokers Australian Securities and Investments Commission GPO Box 9827 SYDNEY NSW 2001 By Dear Mr Coultas CP 118 Responsible Handling of Rumours The Australian Financial Markets Association (AFMA) welcomes the opportunity to provide comments to the Commission on its consultation paper 118 entitled the Responsible Handling of Rumours. 1. General s Overall, AFMA considers the proposals put forward are not consistent with the Corporations Act 2001 (Corporations Act) and the Australian Securities and Investments Commission Act 2001 (ASIC Act) and would, if implemented by AFS licensees, create a high level of compliance risk for them. Regulatory guidance should provide practical understanding of and assistance in complying with current law. AFMA is concerned that complex administrative procedures are being proposed which would impose burdensome and inefficient practices on AFS licensees without any regulatory benefit. AFS licensees are in general well aware of their statutory obligations and the need to effectively manage compliance risk with regard to market information. AFMA considers that it would be more beneficial for the promotion of the responsible handling of rumours to direct more regulatory resources and attention to persons not associated with AFS licensees, such as those working in the media. Australian law already deals strictly and appropriately with false or materially misleading statements or information. Rumours which are false or materially misleading statements or information cannot be made or disseminated. Regulatory guidance and AFS licensee policies and procedures must focus the minds of people on the nature of false or materially misleading statements or information and not confuse the issue by suggesting that there are legal definitions for amorphous terms like rumour, speculation and opinion. The Australian Financial Markets Association ABN Level 3, Plaza Building, 95 Pitt Street GPO Box 3655 Sydney NSW 2001 Tel: Fax: info@afma.com.au Web:

2 question which must be front and centre is whether a rumour, speculation or opinion is false in a material particular or materially misleading. There is no ambiguity in the current law in that a materially misleading rumour cannot be made or disseminated. AFMA considers that AFS licensees should have in place written policies and procedures that accurately reflect and assist in compliance with the Corporations Act and ASIC Act, which includes dealing with false or misleading statements or information. False or misleading information may be spread by people outside the market who are not constrained by compliance with AFS licensing obligations. AFS licensees have policies and procedures in place in order to comply with the Corporations Act and ASIC Act and there is high compliance awareness in this group. By virtue of s911a(2), persons giving financial services general advice through print and electronic media are exempt from licensing and are not subject to the rigorous standards required of licensees. Mainstream and alternative media, such as blogs and web-based chat services, can be a rich source of statements not well founded on fact and which may lead to false or misleading information being disseminated. While professional journalists do their best to check the accuracy of their information and the objectivity of their opinion, nonetheless the media in its various forms publishes stories and commentary which may reflect assumptions, supposition, incomplete information, misunderstanding, time pressures or may be just plain wrong. The media has an important role to play in providing information to investors based, to the greatest extent possible, on verified information, competent opinion and well drawn conclusions. To be clear, we do not suggest the media should be subject to regulation about what can be reported and commented upon. However, there may be value in the Commission from time to time reminding the media, in all its forms, of its responsibility to guard against facilitating the spreading of rumours containing false or misleading statements or information. False rumour mongering is most effectively combated by enforcement of current law and by a continuous disclosure regime that recognises the need for the market and all investors to have fair access to price-sensitive information (positive and negative) on an equal footing. It requires listed companies to disclose, in a timely manner, to all market participants all relevant information which may affect security values or influence investment decisions. The timely release of material price-sensitive information is necessary to ensure that the same information (in both content and detail) is available to all investors, and to act as a deterrent to selective disclosure and insider trading, to counter market distortion through rumours and speculation and above all, to enable investors to make informed investment decisions. The basic premise of corporate disclosure is that the greater the quality, detail and timeliness of material disclosure made by a company in relation to its Page 2 of 13

3 business operations and performance, the greater the market confidence and the lower the risk for investors in evaluating the company s investment potential, thereby promoting market efficiency. Disseminating material information as and when it occurs is the most effective way to mitigate the potential for negative surprises and to advance the interests of investors and cut off the opportunity for rumours to have effect. 2. s on Questions B1 We propose to define the term rumour as a statement containing 'unverified information, purporting to be fact, that a reasonable person would expect to have a material effect on the price of a security if it were widely circulated'. For this purpose 'a security' includes securities, derivatives, interests in a managed investment scheme, debentures, stocks or bonds issued or proposed to be issued by a government, certain superannuation products, and any other financial products that can be traded on a financial market. B1Q1 Do you agree with this definition in the context of its proposed application in our guidance? If not, why not? No Conform guidance to Corporations Act The Corporations Act is fulsome around the regulation of rumours. What is required is a proper understanding of current Australian law. This is an educative exercise for which regulatory guidance can provide a useful ready source of accurate information. Therefore, care needs to be taken in providing guidance which introduces new terms and concepts which may mislead the reader s understanding of the law. The danger is that guidance which does not accurately reflect the Corporations Act could promote the adoption of practices which are not good practice under the law. The development of ASIC guidance should closely relate back to provisions in the Corporations Act. The key provision is section 1041E. s1041e deals with the making of a statement or dissemination of information if the statement or information is false in a material particular or is materially misleading. The making or dissemination of such a statement or information is prohibited in the following circumstances Page 3 of 13

4 1. where the statement or information is likely to induce persons to apply for financial products s1041e(b)(i); or 2. where the statement or information is likely to induce persons to dispose of or acquire financial products s1041e(b)(ii); or 3. where the statement or information is likely to have the effect of increasing, reducing, maintaining or stabilising the price for trading in financial products on a financial market operated in this jurisdiction s1041e(b)(iii). For a statement to be likely to induce a purchase of a financial product in breach of s1040e it must have had the probable effect of inducing a purchase in accordance with the test laid down by the High Court in R v Boughey 1, which required that this probable effect had to be proved beyond reasonable doubt 2. Strict liability impact The prohibition will operate against a person if the statement or information was false in a material particular or was materially misleading. In relation to section 1041E(1), it is crucially important for the guidance to indicate that this is a strict liability offence and should impart an understanding of section 6.1 Criminal Code. This is because of the high compliance risk this places on persons where there is not a fault element. As the prosecution merely has to prove the physical elements of s1041e the thinking in the persons is not required for proving the offence. The Criminal Code provides that an offence consists of physical elements and fault elements. Physical elements relate to external events such as conduct or the result of conduct. Fault elements relate to a person's state of mind eg intention, knowledge, recklessness and negligence. The Criminal Code defines the physical elements of an offence to be conduct, the circumstances in which it occurs and the results of conduct. An omission to act can be a physical element if there is appropriate statutory provision or if it is the result of a breach of duty to act. Each offence must contain at least one of these physical elements, but any combination of physical elements may be present in an offence provision. In general, for every physical element of an offence, the prosecution must also prove a corresponding fault element. The Code establishes four fault elements - intention, knowledge, recklessness and negligence - in descending order of culpability. Where the physical element of an offence consists of conduct, intention is the default fault element. However, if the physical element is a circumstance or a result of conduct the default fault element is recklessness. The Code does not prevent an offence from specifying an alternative fault element, but indicates that the default fault element will apply in the absence of a specified fault element. 1 (1986) 161 CLR 10 2 Macleod v ASC (1999) 32 ASCR 172 at 187 Page 4 of 13

5 In this case Parliament has specified in s1041e(3) that s1041e(1) is a strict liability provision. At common law there is a presumption that every offence contains a mental element. However, an increasing number of statutory offences dispense with fault elements. Whether an offence is a strict liability offence depends on the interpretation of the offence provision. Working from common law principles, Chapter 2 of the Criminal Code requires offences of strict liability to be expressly identified as such. Failure to do so means that fault elements are applied to all the physical elements in the offence. As well as providing for the identification of strict liability offences, the Criminal Code allows a law which creates an offence to provide that strict liability applies to some physical elements of that offence. Although the prosecution does not need to prove fault in relation to strict liability, the Criminal Code supplies a defence of mistake of fact to strict liability offences and to other offences to where strict liability is applied to some of their physical elements. The Code does not prevent defences other than mistake of fact applying. Scope By merely referring to securities the guidance misleads with reference to the scope of the critical provision s1041e. While the definition securities is appropriate when referring to the insider trading prohibition in s1042a, false and misleading statements, information and conduct all relate to the relevant definitions of financial product. To illustrate the danger, the wording of the guidance, if it were to be relied upon by a lay market participant who has not received the benefit of RG 146 training or the AFS licensee policies and procedures proposed in CP 118 they might misleadingly be drawn to the conclusion that derivatives are outside this part of the law. Obviously this would be a very erroneous conclusion. B1Q2 Are there particular aspects of this definition that you feel require particular guidance? A false statement is judged by whether it relates to information which is known to be incorrect. This is a question of fact. Accordingly, to refer to a statement containing 'unverified information is problematic as there is no positive obligation in the Corporations Act to confirm the veracity of a statement under s1041e. However, as has already been noted because strict liability applies it is necessary for a person to make sure that the statement or information is not false or misleading in a way that would induce persons to deal in financial Page 5 of 13

6 products or affect the price of trading in financial products. In practice this means that caution needs to be exercised and only statements based on information that are known to be true and not misleading can be disseminated. Where a false or misleading statement or information is having an effect on trading or the price of a financial product an accurate account can be disseminated on the observable impact of such information. should be restricted to describing the market impact of the false or misleading statement or information and worded to avoid inducing persons to whom this information is being passed onto from applying for, acquiring or disposing financial products or affecting the price of financial products. B1Q3 Do you think there should be a specific carve-out for opinions? If so, how would you deal with an opinion where the speaker has no knowledge on which to base an opinion? Section 1041E(1)(c) already adequately deals with the distinction between prohibited false or misleading statements or information and permissible opinions that have been derived from actual information and may include matters of analytical supposition and are clearly stated as the opinion of the author. It is difficult to see how the author of an opinion derived from actual information and which may include matters of analytical supposition and which is clearly stated as an opinion could be taken to either (a) not care whether the statement or information is true or false (s1041e(1)(c)(i)), or (b) know or ought reasonably to have known, that the statement or information is false in a material particular or is materially misleading (s1041e(1)(c)(ii)). C1 We propose that the following high level principles should apply: (a) AFS licensees should have in place written policies and procedures which provide clear guidance to employees and representatives about how to deal with rumours. Those policies and procedures would stipulate that: (i) AFS licensees, their employees and representatives should not under any circumstances be involved in the origination of a rumour; and Page 6 of 13

7 (ii) a rumour may only be communicated if it is already widely circulated and it is reasonable to pass it on, given all the circumstances (see below). (b) AFS licensees should ensure employees and representatives receive formal training in the policies and procedures applicable to rumours. (c) AFS licensees should have arrangements to monitor compliance by employees and representatives with the policies and procedures. C1Q1 Do you agree with the proposed principles? If not, why not? AFS licensees should have in place written policies and procedures which provide clear guidance to employees and representatives about what the Corporations Act requires with regard to false and misleading statements and false and misleading information and other relevant prohibitions which could involve the making of a statement or the dissemination of information. This is good risk management process. C1Q2 Are there any other principles that should be included? AFMA considers that AFS licensees should have in place written policies and procedures that accurately reflect and assist in compliance with the Corporations Act and ASIC Act. The three key elements for such policies and procedures are: 1. The adoption of relevant formal written policies and procedures on handling statements and information. 2. The provision of training for staff in respect of the policies and procedures described in item Monitoring of the AFS licensee s communications and trading to ensure compliance with policies and procedures. Such policies and procedures provide a framework for complying with the law when dealing with financial products which are the subject of rumours in an appropriate and cautious way. These policies and procedures not only deal with false and misleading statements or information but also the possibility that a rumour may contain inside information. Where a rumour may contain inside information it cannot be disseminated. The proposed guidance suggests that there may be circumstances where a rumour could be circulated Page 7 of 13

8 that may contain inside information. This would breach s1043a of the Corporations Act. C1Q3 What additional costs might be associated with implementing these principles? Can you quantify such costs? In general, AFS licensees should have in place written policies and procedures that accurately reflect and assist in compliance with the Corporations Act and ASIC Act. AFS licensees should also be required to consider what form of training would be appropriate in respect of such written policies and procedures and what level of monitoring of compliance with the law would be appropriate within the context of the likely risk of breach assessed by that AFS licensee given the nature and extent of its licensed activities. However, in respect of the comment in Consultation Paper 118, that AFS licensees need to comply with these guidelines to be sure that they are meeting their obligations to act efficiently, honestly and fairly we would consider it more appropriate for the Commission to view a failure to comply with the guidelines as a factor which may carry significant weight when the Commission is forming a conclusion as to whether an AFS licensee is meeting its obligation to act efficiently, honestly and fairly. This approach would provide the necessary flexibility for both the Commission and the particular AFS licensee to take into consideration all relevant circumstances in any given factual scenario. C2 Having regard to the principles above, we propose that AFS licensees should adopt policies and procedures for dealing with rumours. These policies and procedures should cover the items in Table 3. C2Q1 Do you agree with the proposed policies and procedures? If not, why not? No The Table 3 procedures are not practical and not consistent with the obligations of persons under the Corporations Act. In our view they will make compliance less certain and not address the regulatory concerns. Page 8 of 13

9 A process for recording, in writing, details of the rumour including: the content of the rumour; the disseminator (who and where did the rumour come from); the originator (if known); and the time and date of receipt. This process would in practice require the continuous manual logging of all statements received during the course of a working day. This would impose an immense and unnecessary burden which would seriously impede the efficient functioning of the market. If the threshold question has been answered that information is false or misleading in a way which is contrary to s1041e, it cannot be disseminated. Information should not be perpetuated by preserving it and possibly leading to its continuing existence. In fact the recording of such information might constitute dissemination. To the extent that the information recorded contains confidential client information, issues of client consent to disclose such information in the absence of a legal requirement may also arise. A process for attempting to verify the rumour with the company concerned (without further dissemination), together with evidence of those attempts. This idea is highly impractical. It would require the contacting of a responsible manager authorised to speak on behalf of the company. In practice, it would also require that responsible manager to take any number of calls as the guidance as currently proposed appears to require anyone who hears a possible rumour to contact the company about it. If the company is complying with its continuous disclosure obligations, it is difficult to see what is to be gained by requiring individuals to approach companies with enquiries about rumours. If the company is not complying with its continuous disclosure obligations, a policy on rumourtrage is not the appropriate place to attempt to indirectly regulate listed company disclosure and the proposed line of enquiry is unlikely to remedy such failure to comply in any event. Unless the company adopts a standard no comment response to such enquiries, the company is potentially exposed to abuse of the enquiry system by public nuisance callers. It is highly likely that in most cases a company would not wish to say anything about the information as this could create a conflict with its continuous disclosure obligations. Without significant training and monitoring, the company may position its employees to be in breach of tipping with respect to inside information, as this must be the first means by which a company must provide a comment on information circulating about it. A process for ensuring any dissemination of a widely circulated rumour Page 9 of 13

10 includes the following information: that the information is an unverified rumour; and how and where the rumour is in wide circulation. In the case where the rumour is having an observable impact on the market, and brokers need to be able to explain this to their clients. The question of whether the rumour is in wide circulation is not the relevant one, it is the observable impact that the rumour is having through the market movement itself which is of importance in explaining market conditions to the client. To do anything else would not be acting in the client s best interests. When it is necessary to comment on a false or misleading statement or information to accurately explain market conditions by describing the observable impact of such information, comment should be made in such a way as to avoid inducing persons to whom this information is being passed onto from applying for, acquiring or disposing financial products or affecting the price of financial products. A stipulation that suitably senior representatives of the licensee are required to make decisions in respect of communication of a rumour. This is not an appropriate use of senior management time and resources. Policies and procedures should provide sufficient guidance so that reference to senior representatives of the licensee is not required to make decisions about the rumour. The appropriate role of senior management in respect of this issue is to set in place effective risk management processes, which include necessary policies and procedures and related training and monitoring to ensure their effectiveness. A requirement that rumours that are passed on will not be altered or embellished, but may include bona fide opinion on the accuracy of the rumour. should be restricted to describing the market impact of the false or misleading statement or information and worded to avoid inducing persons to whom this information is being passed onto from applying for, acquiring or disposing financial products or affecting the price of financial products. If it is believed that the rumour is not accurate this is appropriate comment to provide and compatible with complying with s1041e. C2Q2 Are there any other policies or procedures that should be included apart from those listed in Table 3? Page 10 of 13

11 AFMA considers that policies and procedures should be based on the requirements of the Corporations Act and ASIC Act. This means that the requirements of the law need to be accurately reflected so that staff are able to confidently comply with the law. Introducing additional requirements, particularly those that would appear to be inconsistent with the requirements of the current law, will constrain the formulation, discussion and dissemination of bona fide views and opinions to the detriment of efficient functioning exchange markets. C2Q3 To what extent do AFS licensees current practices reflect these procedures? AFS licensee practices are focused on compliance with the Corporations Act and ASIC Act. Current practices reflect policies and procedures which support compliance with current law. C2Q4 What additional costs might be associated with this proposal? Can you quantify such costs? We expect the additional costs associated with the proposal to be significant. It is difficult to quantify such costs. However, it can be seen from the following time and costs examples that, in addition to being a constraint on AFS licensees time which could be devoted to other monitoring and assessment tasks and client-facing activity, AFS licensees with more employees will potentially be impacted to the greatest extent. Such an unbalanced impact does not meet a cost benefit analysis justification in the light of the results of Project Mint which did not demonstrate a systemic market integrity risk in respect of rumourtrage in the Australian market. The consultation paper is far-reaching in its proposals. Systems would need to be put in place, additional policies and procedures developed and supervision of those new systems, policies and procedures would need to occur. By way of example, consider a sales trader who takes on average 3 to 5 calls per day from 10 clients (each sales trader receives an average maximum of 50 calls). It would not be uncommon on a typical day for a larger AFS licensee s sales trading desk for 5 of those 50 calls to involve a client Page 11 of 13

12 asking for market colour behind a particular security price. Providing the response sought by the client could involve providing information which may or may not fall within the Commission s proposed definition of a rumour. The proposals could result in the following per sales trader in this example: 5 calls x 5 mins locating and discussing with rumourtrage adviser whether the Commission s definition applies x 3 minutes recording rumour details in log/contacting listed company = 40 minutes per sales trader. For a desk which has 5 sales traders this simple example shows an additional time cost of 5 x 40 minutes per day per desk, ie more than 3 hours per day. C2Q5 Do you agree that a process for recording rumours is an important part of the compliance process? Is it an undue cost burden? As noted in response to C2Q1 the process for recording rumours is unrealistic and impractical. It would result in a significant portion of AFS licensee employee and representative time devoted to detailed record keeping. The undesirable result would be to divert attention away from close monitoring of market conditions and assessment to administrative paperwork. An AFS licensee would need to establish a reliable system for recording rumours one which could be interfaced without undue difficulty by different staff of the AFS licensee and could be stored and retrieved at the appropriate times (subject to issues of client confidentiality and privacy). There would also be a cost for developing or modifying the appropriate system. In addition, current staff and each new staff member would need to receive training on using the recording system which would further divert attention away from client-servicing and monitoring of market conditions. As noted in our responses above, the proposed definition is not consistent with current law and may, in a variety of circumstances, require the recipient to seek advice on the application of the proposed definition in order to determine whether there is a need to record the rumour or contact the company the subject of the rumour, even though the recipient may have otherwise decided not to pass it on. This could likely have an adverse effect on competition, with a particular impact on the larger AFS licensees which we do not consider is justified based on the published results of Project Mint, or demonstrated systemic risk to market integrity or investor protection. Those AFS licensees with more employees who are particularly good at monitoring movements in certain company stock (by way of a skilled research analyst or sales trader for example) are likely to be contacted by their clients for their view as to what may be behind moves in a company s stock price, and are likely to be most hindered by those aspects of the proposals which require logging of rumours and contacting listed companies in respect of rumours. Page 12 of 13

13 3. Concluding s AFMA appreciates the opportunity to comment on the consultation paper. Please do not hesitate to contact me at dlove@afma.com.au or (02) if further clarification or elaboration is desired. Yours sincerely David Love Director, Policy Page 13 of 13