The efficacy of market abuse regulation in the UK

Publication Date11 Jul 2016
AuthorBrendan John Lambe
SubjectAccounting & Finance,Financial risk/company failure,Financial compliance/regulation
The efcacy of market abuse
regulation in the UK
Brendan John Lambe
Department of Management, University of Leicester, Leicester, UK
Purpose – The purpose of this paper is to ascertain the efcacy of Financial Services and Markets Act
(FMSA) (2000) in deterring illegal insider trading in target companies around the time of a merger and
aquisition announcement.
Design/methodology/approach The author uses an event study to measure the cumulative
average abnormal returns (CAARs) around both the announcement and rumour date for a sample of UK
takeovers between 2001 and 2010.
Findings – Statistically signicant CAARs prior to the event date are observed across the sample.
Research limitations/implications – It is not possible to link unknown instances of illegal insider
trading with pre takeover residuals, therefore explaining the residuals remains a deductive process.
Practical implications Pre-event abnormal returns may indicate that trading on material
nonpublic information is still a contributory factor in the run-up proportion of takeover premiums.
Social implications – This draws a question over the efcacy of the regulatory system.
Originality/value – This study provides evidence which points to insider trading activity ahead of
Mergers in a post FMSA 200 UK context.
Keywords Regulation, Insider trading
Paper type Research paper
Since assuming the guardianship of market integrity, surprisingly little research has
been carried out to gauge the success of the UK’s nancial regulatory body in meeting its
enforcement responsibilities. The role of protecting the markets from abuse of various
kinds was assumed by the Financial Services Authority (FSA) in 2000 following the
introduction of the Financial Services and Markets Act 2000. In 2013, the FSA split into
two bodies, the Prudential Regulatory Authority (PRA) and the Financial Conduct
Authority (FCA). While the PRA was created to promote nancial stability through
regulating the deposit taking institutions in addition to investment banks and insurance
rms, the FCA adopted the remaining regulatory responsibilities which include policing
the nancial markets, its support structure and any rms which fall outside of the remit
of the PRA. Market abuse can be classied into two distinct types: the rst is the
manipulation of a security’s price on the capital market and the second involves trading
on price sensitive non-public information. The former of these, the manipulator can
either conduct misleading transactions or manipulate information so that it causes the
security’s price to move in the desired direction. The latter, the insider trader, readjusts
her portfolio ahead of key price altering events which have as yet not been publicised.
There are some key differences between each type of transgressor. The manipulator
relies upon her activities being made public, thus leading the price to a desired point,
while the insider acts covertly taking the price ahead of the perceived change. A further
The current issue and full text archive of this journal is available on Emerald Insight at:
Journalof Financial Regulation
Vol.24 No. 3, 2016
©Emerald Group Publishing Limited
DOI 10.1108/JFRC-06-2015-0029
difference is that the insiders’ activities are reliant upon the presence of non-public price
sensitive information while the manipulator is not forced to wait for such an
opportunity. This study will focus on the activities of insiders with the objective being
to examine the efcacy of the regulatory regime in the UK as a deterrent in controlling
the misuse of insider information around mergers and acquisitions in the period since
the adoption of Financial Services and Markets Act (FMSA) (2000).
To date, empirical studies that examine instances of abuse focus upon known cases
of insider trading (Meulbroek, 1992;Jarrell and Poulsen, 1989). Research in this area
often investigates corporate restructuring events such as mergers, acquisitions and
tender offers which can be encompassed in the catch-all term, takeover. Announcements
relating to these have been shown in the literature to have a price altering effect when a
proportion of the anticipated premium is incorporated into the underlying asset price
ahead of the completion date following the announcement (Seyhun, 1992). The
anticipation is not limited to beginning just after the date when an acquiring rm
ofcially announces its intention to engage in a takeover. A reaction is discernible in the
target company’s stock price prior to the date when the knowledge of the event becomes
publicly available. A broad body of empirical literature has been published both in
Europe and the USA, which supports this position (Keown and Pinkerton, 1981;Jensen
and Ruback, 1983;Seyhun, 2000;Bris, 2005; amongst others). The question for
researchers and regulators is, what factors drive these anticipatory price movements?
Presumed in much of the previous work is that the pre-event price run up occurs as a
result of informed trading (Seyhun, 1992;Meulbroek and Hart, 1997;Meulbroek, 1992;
Korczak et al., 2010). If such abnormal returns are observable in the run-up to a takeover
announcement, then this could draw into question the effectiveness of legislation and
the regulator’s capacity to act as an enforcer and a sufcient deterrent to insiders. This
is often referred to in the literature as the “Informed trading hypotheses”. This paper’s
main contribution is to attempt to resolve this debate in the UK within a post FMSA
(2000) context.
Shortly after the passing of the FMSA into legislation, the FSA (which has now
become the FCA) adopted the role of “policeman of the markets” ensuring that those in
a position to engage in market abuse would be sufciently deterred from doing so.
Monitoring the activity of capital markets in an economy which is as developed as that
of the UK is not an easy undertaking. By its own admission, the FSA acknowledges that
a scarcity of resources prohibits it from following up on every suspicious transaction
that is made (Barnes, 1999). The level of success is difcult to gauge as gures drawn
from detection levels can only be understood as a proportion of all wrongdoing.
Instances of market abuse go largely unreported, and while the practice is not
victimless, it is often the case that the victims themselves are not aware of the
transgression. As such, to glimpse some evidence of market abuse, we are forced to rely
upon inferences from activity prior to events which are known to affect a company’s
value in a given way. Takeovers are an event type which offer to those in possession of
private information an opportunity to capitalise on their position. An individual in
possession of the knowledge that a takeover may occur can place themselves on the
winning end of a trade in a target rms shares. The investigative procedure for this
study seeks to establish whether there is a signicant ex ante reaction in stock price
prior to the news reaching the market of an impending takeover.
Market abuse

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