European Court Tightens Disclosure Rules

Posted by John F. Olson, Gibson, Dunn & Crutcher LLP and Georgetown Law Center, on Wednesday August 1, 2012 at 9:24 am
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Editor’s Note: John Olson is a founding partner of Gibson, Dunn & Crutcher’s Washington, D.C. office and a visiting professor at the Georgetown Law Center. This post is based on a Gibson Dunn alert by Philip Martinius.

On June 28, 2012, the European Court of Justice (“ECJ”) issued an important judgment that will have a significant impact on the disclosure of non-public, price-sensitive information (so-called “inside information”) by public companies listed on stock exchanges in the European Union (“EU”). The decision clarifies the definition of inside information in cases where the circumstances relevant to the disclosure develop over time, potentially involving several intermediate steps. The ruling is the latest in a string of court decisions concerning the spectacular departure of Daimler’s CEO in summer 2005 and the company’s allegedly late disclosure of this event.

The issue before the ECJ was whether Daimler had met its obligation to timely disclose inside information. Under EU and German law, each issuer of securities is obliged to disclose inside information if (i) the information is sufficiently precise, (ii) relates to circumstances which are not publicly known, (iii) relates to one or more issuers of securities (or the securities themselves) and (iv) the information would likely have a significant effect on the price of the securities if it became publicly known. Future circumstances may also constitute inside information if they are sufficiently likely to occur. Issuers can temporarily delay disclosure if certain conditions are met.

The ECJ reached two findings. First, in situations where the relevant facts (here: the departure of the CEO and his replacement by a successor) develop over time (here: over several months) the final decision on the replacement of the CEO may not be the only information that could trigger disclosure. Intermediate steps leading to such an event may be sufficiently concrete to themselves represent inside information. Second, future circumstances may also qualify as inside information, provided they can be reasonably expected to occur, taking into account all circumstances. If, however, a future event is not likely to occur, this cannot be outweighed by a potentially strong impact on the market price.

The Daimler Case

In early April 2005, Jürgen Schrempp, the then CEO of Daimler, began to consider his resignation before the end of his term in 2008. Over the next two months, he gradually informed his wife (also an employee) and three supervisory board members of his plans and the necessity to determine a successor. Around mid-June, Mr. Schrempp informed his designated successor (the current CEO Dieter Zetsche). In early July, a small team of employees prepared a press release and a draft letter to all employees. Around the same time, the news also may have been shared with another supervisory board member (an employee representative).

On July 13, a supervisory board meeting was called for July 28 (without mentioning the topic in the agenda) and the competent sub-committee meeting was called for July 27. On July 18, the CEO and the chairman of the supervisory board agreed to propose to the supervisory board a resolution on the replacement of the CEO (with effect as of the end of 2005). The sub-committee then approved the matter in the early evening of July 27 and the full supervisory board approved it on July 28. Immediately after the second resolution, Daimler disclosed that the supervisory board had approved the replacement of the CEO. The share price increased significantly after the information became public.

Several investors who had sold stock in the time before the disclosure subsequently sued Daimler for damages resulting from a late disclosure arguing that the departure of the CEO had already been sufficiently likely to occur before the decision was approved by the full supervisory board. As the relevant German provisions that require ad-hoc disclosure of inside information are based on EU directives, the German Federal Supreme Court (“BGH”) referred the matter to the ECJ to obtain clarification on the interpretation of the relevant EU directives. The questions raised by the BGH were twofold:

  • First, if certain potentially price-sensitive events come about through a series of intermediate steps, shall only the final event be analyzed as to whether it can represent inside information and is reasonably expected to occur? Or shall also intermediate steps leading to that event (e.g. the informal consent of the chairman or of the successor) be considered as to whether they can by themselves represent inside information that must be disclosed?
  • Second, does the term “sufficient likelihood” that is used in the German version of the EU directive imply that, in order to represent inside information, an event must be highly likely or at least more likely than not to occur or can the standard of likelihood also be lower, especially if, following its occurrence, the impact on the stock price would be very significant?

Answer to the First Question

The ECJ answered the first question by confirming that the information on intermediate steps can indeed represent inside information. This would apply both in cases where the intermediate steps have occurred or where they are reasonably expected to occur in the future.

In other words, if the CEO, the chairman of the supervisory board, the successor CEO and several members of the supervisory board agree that the CEO will step down with the consent of the supervisory board and be replaced by the successor, this could technically represent inside information, even though such a decision under German law only can be made by the supervisory board as the competent body (and it could well decide otherwise).

When looking at intermediate steps, the question then is whether such information is sufficiently concrete to enable a conclusion that it may significantly impact the stock price. For example, the CEO’s mere thought that he plans to step down would not be sufficiently concrete. But a decision by a subcommittee that is usually followed by the supervisory board could indeed be sufficient.

Answer to the Second Question

The second question relates to the necessary degree of likelihood of future events and turns also on a linguistic difference among the German version (“sufficient likelihood of future occurrence”) of the EU directive and the French, English and other versions of the same directive that require that the a future event “can be reasonably expected / thought to occur”.

The European judges held that no language version prevails but that they all must be interpreted in the same fashion. Therefore, a high likelihood cannot be required because this would give insiders an undue advantage. Rather, a sufficient likelihood of future events means that based on a full analysis of all relevant facts such events can be reasonably expected to occur. Contrary to the proposal of the advocate-general, the ECJ did not adopt a concept similar to the “probability/magnitude-test” used in U.S. securities law whereby the lack of likelihood of a future event can be outweighed by a potentially strong impact on the stock price. Rather, the ECJ decided to keep these two aspects separate.

The matter will now be referred back to the German BGH which will need to consider the answers by the ECJ. Thereafter, the competent lower court may be forced to further assess the facts and analyze the intermediate steps leading to the decision on the CEO’s replacement. It is thus not yet clear whether Daimler will have to pay the damage claims raised.

Practical Evaluation

This decision is relevant beyond the facts of the case because price-sensitive events that develop over time can frequently occur, for example, when an important contact is negotiated or a public takeover is planned.

The first answer of the ECJ confirming the relevance of intermediate steps comes as no surprise. The ECJ has always focused on securing equal levels of information for all market participants and tries to avoid that a relatively “technical” distinction allows circumvention by artificially focusing on the final step in a series of events. On the other hand, the judges have stressed that intermediate steps must be sufficiently concrete in order to represent inside information. The challenge for issuers will now be to handle this guidance in practice. Although the German securities regulator BaFin in the past has already required disclosure of intermediate steps, companies will be required to monitor such processes even more carefully. As a result, issuers are expected to disclose earlier (or ensure that the legal prerequisites for delaying disclosure are all met).

The second answer is equally important as the ECJ has confirmed that in order to qualify as inside information, a future event must be reasonably expected to occur, i.e. its occurrence cannot be open, but must be more likely than not. Several scholars as well as the advocate-general had argued that even a likelihood of occurrence below 50% could suffice, especially if such occurrence had a strong potential to impact market prices. This concept – which would have been a “legal transplant” from U.S. securities law – finds no basis in European law. It would not only have considerably extended the scope of the European disclosure rules, but also made it more difficult for issuers to comply with this standard. The ECJ decided wisely to exercise judicial self-restraint so that issuers can apply the rules in practice with sufficient legal certainty.

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