Markets in Financial Instruments Directive – MiFID

“Seventy years ago the Securities and Exchange Commission (SEC) was created to serve investors.” (Roberta S. Karmel, Mutual Funds, Pension Funds, Hedge Funds and Stock Market Volatility – What Regulation by the Securities and Exchange Commission is Appropriate, 80 Notre Dame L. Rev. 909 (2005) – see reference list).

The Securities Act of 1933 and the Securities Exchange Act of 1934 were New Deal statutes that addressed the perceived causes of the 1929 Stock Market crash. These causes were stock market manipulation, insider trading, and breaches of fiduciary duties by public corporations and their intermediaries (Ibid. at 910).

The development of investor protection for retail customers addressed foremost the different level of information between corporate insiders, investment professionals, and the retail customer based on classical economic theory and contract law.

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One of the theoretical presuppositions of market economies is relatively perfect competition in the market, including perfect dissemination of knowledge. Consumer protection legislation arose to correct inherent imperfections in the market caused by, for instance, consumers’ inability to wield perfect knowledge or equal bargaining power in standardised commercial transactions. While consumer protection legislation cuts against classical contract theory by limiting the parties’ freedom of contract, governmental regulation of the market is in fact rather modest because most consumer protection statutes merely regulate extreme forms of commercial misconduct and provide the consumer with information that theoretically restores the market to its ideal state (John J.A. Burke and John M. Cannel, Leases of Personal Property: A Project for Consumer Protection, 28 Harv. J. on Legis 115, 137 n.32 (1991)).

Analogical argument leads to the same conclusions for disclosure of market information to retail investors.

The European Union has followed a similar, if not identical approach. Directive 2001/34/EC of the European Parliament and of the Council of 28 May 2001 on the admission of securities to official stock exchange listing and on the information to be published on those securities, as amended by Directive 2004/109/EC using the term “regulated market”, requires issuers to disclose specifically identified information to investors prior to making a public offer, and subsequently to produce a continuous stream of information deemed material to investment decision.

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Disclosures of information about securities and about the corporations or entities that issue them fail to protect the investor. With certain exceptions, information, in and of itself, is meaningless. The overwhelming majority of retail investors lack the skills necessary to interpret the information, compare that interpretation to alternative investments, to make informed decisions about purchasing securities. This point has been made dead certain by the prior two illustrations involving the “fundamental analysis” techniques to IBM equity and involving simplistic bond mathematics to determine annual yield. In addition, if a retail investor were to build a small portfolio of securities, say ten different instruments, the amount of information the law would require to be disclosed would overwhelm the retail investor. Finally, if one endorses the Efficient Capital Market Hypothesis, reading through the data is a waste of time, since prices already reflect all material information available to the entire market.

Further support for the ineffectiveness of this method of investor protection is the time delay between the emergence of the “evil” in the market and the enactment of the law to correct the “evil”. Regulation FD (Fair Disclosure) is an apt example. That regulation requires issuers to disclose to the public information they give to professional analysts during periodic interviews. The practice of analysts holding conferences with corporate representatives, often the CEO, to acquire information about the issuer was a standard practice of the industry. The SEC did not issue Regulation FD until year 2000. This delayed reaction is like “closing the barn door after the horse has bolted”. Elìs Ferran makes a related observation about the development of EU law in the financial services area:

The Lamfalussy process was applied to many of the new EU laws that are considered in this book. However, those laws were first formally proposed in the FSAP, an initiative which preceded the adoption of the new legislative process. This sequence of events deserves emphasis. Whilst it is legitimate to ask whether the adoption of the Lamfalussy process has helped produce better-quality laws governing securities market activity within the EU, it is also important to bear in mind that the Lamfalussy process came late, after certain important strategic policy decisions had been made and, crucially, after the timetable for the adoption of the FSAP had been set. These considerations must qualify whatever blame for the substantive quality of the recent laws is laid at the feet of the legislative process (Elís Ferran, supra at 6 – see reference list).

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Although it is difficult to compare the US and EU legislation, given the differences in historical development and the relatively recent action of the Community in the forum of financial markets, nevertheless the two different jurisdictions have adopted an approach to investor protection that does not accord with the reality of the retail investor. Admittedly, corporations that list and sell stock to the public must be subject to penalties for legal violations. However, it is difficult to assess how well disclosure laws defeat the conduct it is designed to prohibit (E.g., Pikoulas v. Kefalaiagoras, Case C-430/05 (2007) where the First Chamber upheld penalties imposed by the Greek Capital Market Commission because the company Donik AE whose shares were already trading on the stock exchange filed a listings particulars requesting an increase in authorised stock that had serious discrepancies in its profit and loss statements).

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