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FSA warns activist funds on insider trading abuses

The Financial Services Authority has issued a warning to activist hedge funds about potential insider trading abuses that may arise where funds build stakes in target companies with a view to enhancing their value by forcing a change in strategy or a corporate restructuring.

The UK financial industry regulator says its comments in a newsletter are intended to offer high-level principles to guide funds whose strategies involve buying shares in quoted companies with a view to a subsequent exercise of shareholder rights and/or a corporate re-structuring of the target.

Developing a strategy involving acquiring or building upon a stake in a target company does not in itself constitute abuse of inside information on the part of the fund, the FSA says, even if that stake-building prompts movement in the share price as other market participants anticipate corporate changes.

'In general our approach would be not to view conduct as abusive of the market if the participant will merely carry out acquisitions of the target's securities on the basis of its intentions and knowledge of its strategy,' the regulator says. 'We don't think our market abuse powers should be relevant where market professionals are looking to take advantage of their own expert analysis of otherwise publicly available information.'

However, the situation may change if two or more funds are secretly acting in concert. 'We might reach different conclusions if other participants also come to trade on the basis of another participant's strategy,' the FSA says.

'We do not, for example, think the interests of market integrity would be upheld if this were to result in several parties acquiring shares independently and thereby seeking to avoid any market disclosures which would otherwise be necessary were the shares acquired by a single entity. Such behaviour might be market manipulation under our rules.

'We would also need to examine whether the behaviour of such other parties amounted to market abuse if they deal for their own account (or for the account of others) on the basis of their knowledge of another participant's intentions and strategy, however obtained. Any person who discloses such information to those parties may also have engaged in behaviour amounting to market abuse.'

The line must be drawn, the regulator believes, between other market participants driving up the share price of a target company because of public knowledge of a fund's activist strategy, and the fund or others seeking to boost the target's share price by deceptively creating the expectation of a change in corporate strategy or structure.

'There is also obvious potential for abuse were a participant deliberately to set out to generate a false expectation of some future corporate action knowing that it, or others associated with it, may be able to take advantage of a short term movement in the price of the target's securities,' the FSA says.

'Generally we expect participants to take reasonable care to ensure that any announcement or informal comment does not rise to false or in the circumstances deceptive signals about their intentions. In deciding whether such conduct amounts to market abuse, we will take into account whether a reasonable person would know or should have known that information was false or misleading.'

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