Class 2

There are four key directives:1. Prospective Directive2. Market Abuse Directive3. Transparency Directive.4. MiFID

In the first lecture we talked about the importance of securities regulation. We talked about the systemic risk. We have two key terms: Securities and Regulation.

What is so about regulation and ordinary laws? We mentioned about the regulated industries. Think about consequences. If you breach a normal law, consequences are damages. If you breach a regulation, there is a potential criminal responsibility. You find in each member state you find regulators. That is regulation.

We talked about securities. There are two definitions for EU law on Securities. One is transferable securities and the other one is financial instruments. We talked about transferable securities. What is security? What is transferability?

It is not in the sense of precious metals or collateral but wertpapier. There is no security without paper in Germany. Why can you trade security on stock exchange? What is the difference b/w loan and bond? We illustrated this by using triangle. Transfer of securities from one holder to another holder doesn’t impact on issuer. Here the important word is abstractness. The debtor is always obliged to pay under the security be it to initial holder or someone else. This enables to trade on stock exchange.

This is the one of the two presentations.

The first session was really meant to introducing terms and definitions and give broader meaning.

The main regulatory instrument is the prospectus. We will do it in four parts.

When we talk about prospectus, we sometimes say OC (offering circular).

Prospectus for securities should contain all the information for potential investor needs to properly assess the risks and returns.

Prospectus needs to be file done, it is available website and issuer’s website and always be there. Especially, in case when people are unhappy of their investments. Time of issuance of securities, the prospectus is also used as marketing instrument. Because in a Pros. You can describe yourself and advertise yourself. But There is another side to the Prs, which is concrete to security. Prospectus is letter of reference. We want to blame sb else when we have bad luck. Then we look at the prospectus and find out something is wrong with the Issuer. Something which went wrong wasn’t there in Pros, e.g. .

That is a legal character of Pros. The best thing is you write every potential half realistic risk that is connected with issuer. Then when things go wrong, it will help you. But you can imagine that prospectus is marketing instrument on the other hand legal instrument may cause friction.

As a marketing tool, they say how wonderful the securities are, and here lawyer comes and says no no you shouldn’t overexaggerate.

Every prospectus must contain prescribed information. There is always some prescription what has to be disclosed in the pros. Pros must disclose when has material value for investor to make informed decision.

Normally pros has be approved by the regulator. Here one distinction has to be made. It doesn’t necessarily mean civil liability side is covered. Regulator more or less formal analyses, is the pros there, individual parts of the pros are there. But they are not able to assess the information as to its correctness. Two years later court may grant fee for damages to the investor.

Let’s move on to the EU law that regulates Securities Pros. That is Prospectus Directive (PD) that comes together with the pros. Regulation. The Directive is to be transferred into national law by July 2005. A lot of them didn’t manage to do it on time. Only one country could do it.

This text here shows importance, strictness of law and two fields. You need pros for public offer and for the admission for trading on regulated market. Quite often it goes together but not always so.

Public Offer means you offer potentially to everybody. Listing on stock exchange is additional step.

There are a lot of exemptions. You find those in regulation. But this particular part is very complex. He would have preferred one article rather. You find a lot of bits and pieces based on which you can judge whether you need a prospectus or not.

What is a private placement ? There are a lot of attempt to say public offer to private placement. For ex. in Germany these are predefined people, to all dentists in Germany. This turned out to be not so much fruitful discussion.

But if I say to you do you want to buy my securities? It will be a public offer. Second important criteria is it is not transferable security. Trnasferabilty is defined in old directive ISD and it is replaced by MiFid.

No scope of application of PD.

UCITS (units in collected investment …)

Investment fund is secured investment. That is achieved legally separating underlying assets from the assets of the manager. If manager goes bankrupt, nevertheless assets are not used to cover debts. They do not fall under this PD.

There is a fantastic definition for money market instruments. Usually short term instruments shorter than 12 months. Shorter the duration of an instrument, less risky it is.

An individual in Germany cannot be a qualified investor.

Offers to employees are also exempt from pros b/c employers offer employees shares as bonuses.

That was statutory PO exemption. There is also statutory listing exemption:

1. Capital increasy by less than 10 %2. same as under Art 4 (1)3. already listed on another EU regulated market.

There is a distinction b/w open ended funds and closed ended funds. UCITS are open ended funds. Closed ended funds are funds where limited number of people participate.

If you get used to some model of pros you need to be able to understand pros from other countries easily as well. Therefore there is a harmonization.

There are several schedules on pros content. One for banks, one for other types of companies. Banks are already regulated therefore certain things are not necessary to be published.

There is also difference in share issuing and bond issuing.

It is something called ABS (asset backed securities).

RD for Bank – Registration (D??) for Banks

If you issue securities on repeated description.

You can get away English pros but the summary should be translated into local language.

Class 3

One very difficult question was is the prospectus marketing document or legal document.

What is prospectus for? When typical two situations? IPO and listing.

Prospectus content has been very simplified in Europe. WE stopped at approval and publication procedure for prospectus b/c pros should be approved otherwise they are useless. Regulator do review securities pros for completeness, coherence, and … . Basically coherence means regulator reads the pros as a fairly intelligent person, it ticks the chapter, if there is a summary of 2500… nevertheless issuer gets letter back with a compliance list. In the beginning it was ok to have 40

pages of complains. But that is an important point no material approval of correctness. You can be successfully sued for wrong prospectus.

What do you need if you submit the pros to the regulator? It must be signed. Can you have base prospectus for shares? No only for debt products.

You need to cross-reference list. It refers to building list. They give you very precise list and order of information that you need to provide. The information is different from bond to shares. There is fair amount of detail in this regulation. In order to make it easier for the regulator they either insist on you produce in the exact order or if you change that order you have to provide cross-reference list where it shows the place in the regulation. It is basically a road map for the regulator. To my mind, there was no regulator to issue without cross reference list. What typical documents by reference B?

You need translations to certain extent. If you are a lawyer and submit the document on behalf of the issuer, you need poa (power of attorney).

In Europe positive decision is required. In the US it is other way around, if they don’t complain in certain time, it is fine. In Europe you need to get the approval. However, there are fixed dates within which regulators must give you the approval or the reason for not giving the approval. It is 15 days or 30 days if you are issuing for the first time.

In the USA, they are still conservative, there is basic form is delivery by hand. However no public offer, all stock exchange listing until one day passed after the approval.

Whoever lists his securities on stock exchange, they need to public ad hoc publications.

Often public offer takes place in certain time one month, two months… This is enough to publish one pros. But if something important happens, supplement of the pros must be published. Otherwise, the pros must be valid one year.

This is all part of publication.

If you have an issuer, there is always something going on. The job is basically never finished. It is good for lawyers. ;-)

We now come to the second part. And that deals with the two important things: 1. EU passport. 2. Impact of US securities laws to the rest of the word.

One of the biggest achievements of EU Directive 2005 was single EU passport for Securities Offers. That new regime replaced the mutual recognition. Mutual recognition was quite an achievement already. It basically said if MS had approved pros, the other MS would to certain extent recognize that approval and accept securities for public offering in their countries. It was better than nothing. And still better than non-EU situation. If you have pros approved in US, this doesn’t help you much if you want to sell them in EU. Mutual recognition within the EU meant pros approved in one MS, still required formal approval of the other MS. The idea of Single EU passport one further step. If you get one MS offer, you can sell in other MS. Initial MS is the home MS, and other MS are host MS.

It is a very simple procedure, you get the approval in home MS, you applied to your MS for notification of approved … to other MS. The pros directive goes one further step. They offer to choose their MS. Where home MS can be? Registered office.

Banks for whatever reason like Luxembourg. Most of the banks are debt securities listed and publicly offered in EU are approved by Luxembourg. The main reason for Luxembourg preference is because of less consumer protection. Big MS are probably very strict. Luxembourg is famous for its flexibility.

There will be a notification procedure b/w MS about the approval. It is two different question you have to differentiate. 1. In which language you can submit to your home MS. 2. Host MS they cannot require full pros in their language but they can require the translation of summary provided pros is written generally accepted business language.

Table gives us infor about the requirements in each MS.

IN Germany there are two language you can submit for approval. That is so for every MS. And Finns accept Swedish prospectuses. In most flexible are Luxembourg. IF germany is the home MS, we require the German translation of Summary and the whole pros must be English. That is all a MS can expect. In the old days, MS required full pros in their state language. Now they can’t anymore. If the original pros is in English, then if the issuer produces French language summary…This was an important thing. Especially, smaller countries suffered from that. It is not only translation costs but also not proper translation. It is not possible to translate absolutely correctly.

We spoke about the third country pros. Practice is non-EU issuers don’t’ use their non-EU pros for approval purposes in EU but rather produce EU prospectus. In theory they could, some additional direction of a global capital market by EU directive so far. A lot of info required has been based on IOSCO standards (International organization of Securities…). The bigger market is, the more liquid is, the better the prices for securities get.

That is the EU passport regime. You should not underestimate as far as its importance concerned.

Let’s move on to the US.

The US Sec. laws is in many ways similar to EU or rather EU similar to US approach. Because US approach is older. The date of Sec law is 1933 which is direct consequences of stock exchange crash. It also tries to achieve single US capital markets. But there are still some difference b/w EU and the US. Imperialistic approach that the US have without any criticism. The US as the biggest economy can afford that. Fundamental law is easy: you must not sell without pros or without exemption to the pros being available. Pros is called Registration Statement and you register your sec at SEC. There is a lot of exemption available. But nevertheless if even exemption applies, people produce some sort of document for liability reaons. There is also heavy tax implications. Tax laws also play role as far as production of pros concerned. US approach collecting taxes is much stricter than EU. It is no surprise that the current gov is very hard on taxes. Tax rules create imperialistic approach.

Registration approach is divided into 3 periods: pre-filing period – period before any document filed with the SEC. During that time you can’t offer sec anywhere. Pre-effective – after filing within (?) 20 days before you get the approval. During 20 days you can already start marketing your documents. You can use the prospectus then. Where some of the economic data is missing. Some of you have heard, colorful fish, it is called fish. (red herring).

A red herring prospectus is a document submitted by a company (issuer) who intends on having a public offering of securities (either stocks or bonds) in the United States. Most frequently associated with an Initial Public Offering (IPO), this registration statement must be filed with the Securities and Exchange Commission(SEC).

There is sort of wide range of exemptions available. Most important exemptions are the same. However there is a new notion. Quality of exemptions. High quality – safe harbor.

There are certain categories of exemptions. You offer outside the US, you need to meet requireemtn. If you offer securities only, there is also safe harbors, one is the private placement.

In the US sophisticated investors are called Qualified institutional buyers (QIB).

Public bodies do not have to submit pros.

There is an exemption of commercial papers for 90 days. No real reasons. It is considered that issuers are well known and…

Secondary market trading is quite interesting. IN EU it is not problem, once you have pros published, every on sale or public offering of securities do not require pros. In the US that is not necessarily so. If you acquire certain shares and sell it further, you need second prospectus unless you are a broker and keep the securities for forty days. And then other small issuers.

What is safe harbor?

If you stick to the conditions of safe harbor, you are safe. And what are selling restrictions, you find several selling restrictions in pros. IN Germany, selling restrictions do not make sense. In the US they make. If you write into your pros language that restricts the sellers of securities certain activities, that is one way to make sure safe harbor that applies. If you don’t have selling restrictions, you may run into problems. The rule 144A exemption is probably exemptions are used mostly by issuers of the equity securities in EU. What they do is they mainly issue and sell securities to the public in EU. They also found attractive to the US.

Because briefly discussed, that is the sale through sophisticated investors that do not require proper registration with the SEC and target the small but relatively liquid market segment in the US. And advantage of that is target publicly. It must only …

The other important safe harbor are … equivalent of European private placement. You don’t conduct marketing of your products. This is a safe harbor but it is not very popular one because risk …

Starting point for US securities is wherever securities issued may require SEC registration in the US. Especially in the times of internet. When certain criteria are fulfilled, US securities are not bothered with that. - It should be offshore transaction- No directed selling offers in USA- No substantial US Market Interest. (SUSMI). There are different categories of SUSMI. There are questions of whether issuer has subsidiaries in the US. That are questions need to be checked under this rule.

Tax side of the things. Most common debt securities are holder securities. That is impersonalized securities where holder of that securities has the right. It has to do with the old concept about the transferability. US call it registered, in Germany we call named security. That system had great advantage from taxmans point of view. Because then you know the person who gets the return on that amount. US is suspicious about bearer securities. However in Germany there are registered shares as well. Anyway, the US have certain rules that are called TEFRA C/D rules. (Tax Equity and Fiscal Responsibility Act of 1982)

The reason for TEFRA C and D is to limit Tax evasion that acquire non-US securities. There are two ways for an issuer to comply with the rules of the US tax authorities, one is called TEFRA C and the other is called TEFRA D. Although we don’t deal with regulatory rules but tax rules, it explains nicely safe harbor. TEFRA C which is easier to fulfill is not safe harbour, basically C applies to an issuance of securities takes place outside the US, therefore we have elements we have before, no directed selling in the US applies here too. If you make hard for the US citizens to buy them, however you can not make sure that. You don’t take proper precautious against this, you may be in trouble.

If you want to make really sure that you won’t have trouble, you can go for TEFRA D exemption. Mostly used in EU issuance. There is 40 day lock up period. … there was something else as well.

Next time we look closer to stock exchange. We will hear about how stock exchange trade is regulated and effected, and we will hear about clearing and settlement, which is very important part of stock exchange trading. That is it today.

Class 4

5.5.09

Stock Exchanges.

This is most interesting topic for our Professor.

Two things we talked about last time: European passport and US. Do you remember what was the difference b/w mutual recognition and EU passport regime? Mutual recognition was still a formal recognition and it needs to be translated. There was a risk of misinterpretation.

Prospectus liability is different each EU country. This is a big problem. Gross negligence and simple negligence. Gross negligence is the negiligence is an obvious mistake and simple negligence is not obvious negligence. Prospectus liability not been harmonized, it was on purpose excluded.

How does the EU pasporting function? It may take one day if you do it quick. Stock exchanges are a lot about speed. If there is no speed, arbitrage becomes very important. You use lack of speed to make a benefit.

Why US securities system is imperialistic? Because issuers in foreign countries should make sure that they are not violating US securities laws. There is extraterritorial effect. The US is saying independently where the securities are issued, the US laws are concerned. The US laws apply where securities are issued. Than SEC don’t want to bother with everything. There are exemptions, safe harbors. That brings us to the end of public offerings session and lead us to the straight to stock exchanges. What is the connection b/w stock exchange and pros?

What is an exchange? It is a place where you can match buyers and sellers. Frankfurt has a big stock exchange. Modern part is in Rodelheim and it is going to be moved Eschenheim. It was for tax reasons. Roemer is the place where the first fair took place. People come to sell and buy goods, where they exchanged goods. It is no surprise that stock exchanges developed where biggest fairs developed. In Germany it is more diverse, it is not so much centralized. Frankfurt has always been place for fairs. Therefore it is not accident that Frankfurt has the biggest stock exchange.

Why do you think people come to exchanges? One thing, selling and buying goods. The other reason is the price. Otherwise you can’t know the price for your good. What are the reasons that you go to stock exchange? Quality of products, diversity of products. There is a quality check. Prospectus are to be admitted. There are thorough checks for traders. In Stock exchanges you have extra layers of regulations that comes from the state and stock exchanges. Stock exchanges make their own rules, whenever you advise on stock exchange, there are laws of stock exchange rules and state rules.

Let’s summarize why stock exchanges are important. Of course, you need other people, that is liquidity element, and there is transparency elements, you get information about the prices. It is also quality element, checks are always done for the products. Custody or settlement element provides mechanism how to settle the transactions and trades.

1. Organization of stock exchanges2. admission of securities3. trading and settlement element.

If you go to stock exchange as market participant, what happens is basically three things. 1. Trading element, clearing element and there is settlement element. Sometimes in the middle of it you find central counterparty. Sometimes you don’t. Let’s first go through three elements or four elements that every transaction goes through.

1. trading is of course match of offer and acceptance.

2. clearing is the process transmitting… . It basically means, I offer 100 and accepting 100 it is quite simple.

3. settlement is when they really have documents and keep them in safes. Custody is therefore called safekeeping. Terms are not always clearly used. You will find here “deposit”, “custody”, “safekeeping” but it only means the same. Custodian is the really person who physically keeps, and Depositer is who manages the ….

EUrex is the derivative exchange.

Cash market exchange v. derivative exchange. Cash exchange means you do it now. Derivative exchanges are in future.

There are two basic forms of derivatives: 1. two sided derivative (Swap, or interest swap, you and I agree on 100 $ swap interest. One of us pays floating and the other pays fixed rate. And depending on how interest rate develops, somebody gains). 2. Option. Either call or put option for prearranged price. It is not two sided transaction. It has specific form and can be called security and can be called warrant. It is type of put/call option. If I put this in paper as a security that can be traded on stock exchange, you can have all of a sudden you can have a derivative and security. Then the question whether it is security and derivative bothered a lot of people until highest court decided upon it. Now it is called security.

Exchange:

Primary Market – before it comes to admission. Quite often admission goes on the same date. For lawyer it is difficult to determine IPO can be with or without stock exchange (OTC or private placement)

Secondary market…

Organization of stock exchanges is regulated by MiFID. Definition of regulated market. (N 14). It basically tells you what a stock exchange is.

When you read title 3, you will find out some missing elements, some settlement elements. It is important definition b/c a lot of rules for securities are based. Read some articles 36 and on.

There is one thing next to the regulated market. That is the open market.

MTF –multi trading …

Regulated markets are normally understand stock exchanges. IN order to able to stock exchanges, you need a pros. And then it is up to the stock exchange itself to make further differentaiton in the segments. IN Frnakfurt stock exchange, quality segments, (prime standard and …) . Other stock exchange may have that as well.

Open markets/ third markets. Entry standard is the part of … Trading in securities organized stock exchange with far less rules and quality checks. For MTFs you don’t need prospectus. Another term is OTC. Basically entry standard doesn’t have any quality checks. The amount of

transparency. Securiites listed on prime standard will require the issuer to publsh more information than in general standard. In particular, sophisticated investors will probably deal with prime standard. Because they have the possibility to analyze the securities better because of the additional information. Of course, it is about normal people,…

One approach of the EU legislator to ensure quality is through provision of information. It is one important tool of information. The idea is that we must give the public to make their own decision.

Question: how things happen on the ground? You have two people, whom I call A and B. They want to buy and sell securities. You give an order to broker to sell or buy certain securities. They push this information into stock exchange through electronic systems. Xetra is the way more than ninety percent trade is carried out.

What is important here is price fixing on stock exchanges. And there will be always matching. If you say, I am only prepared to 10 but if there is not offer for 10, orders can not be executed.

Let’s talk in legal terms. We have realized we have four parties. Investor and bank, they can do two sorts of things: 1. financial commission business. 2. Sales contract. What are they?

1. Under german law there are two types of agencies: open and hidden agency. Can you imagine what they mean? When banks acts on behalf of the client openly or hiddenly. Legal consequence comes when the bank gets bankrupt. In open agency, you say, I am doing this deal on behalf of customer X, my counterparty knows that. If X wants to sell, I give the security to the client and get the money. If I become insolvent, then my client can ask the money back. However in hidden agency, this is not so. Although I act not on my own interest, it is still so, counterparty doesn’t know this, contractual parties are the bank and the seller. On insolvency it is not easy to get the money back.

2. Financial commission business. It is hidden agency.

Let’s consider the relationship b/w two banks. That is the definitely securities sales contract. But they do it on the basis of the conditions for transaction of that stock exchange. What that can mean or it means something special if we have central counterparty. CCP. IF stock exchange has CCP, you will have two contracts, that is seller bank and central counterparty sells it to the buying bank.

There is a margin requirement in derivative transaction which lasts six months. Because there is a risk that CCP may have to bear the risk. Let’s say LIBOR is four and fixed rate is 5 and there is 1 percent from one hundred should be put aside. All of a sudden if the margin gets bigger because of fluctuations of LIBOR, …

This brings us to the end. We will touch upon on settlement next session.

Missed the previous classClass 6

Last time we talked about insider dealing dealing. What do you need in order to have insider dealing? What is the legal test? Can anybody be insider dealer?

There are two types of people who have access to privileged information. Anybody can be insider dealer but there are qualified dealer. What else do we need? A) Specific person B) Listed security on whose price the privileged information can have affect.

Relationship b/w Ad hoc disclosure and insider dealing? If you publish information, there is no insider dealing. We are talking about listed companies.

Scalping?Cornering?Churning ? Excessive trading.

Directors’ dealing is a regulated practice. Directors must record their dealings, dealings of securities that are issued by their dealings. Why? The rational is that there is certain likelihood directors know more and general should know the same amount of information but they may know better in practice.

Thus leads to transparency directive.

Financial analysis. That is another big for capital markets regulation. It is specific aspect of a wider area of concern that is conflict of interest. Conflict of interest deal with securities. But in particular in the situation where one of the same companies publishes financial information on the particular issuer and at the same interested in promoting securities of this issuer.Take a bank. IF a company wants to issue securities they are advised by banks. Of course, at the same time this bank publishes scientific financial analyses, there is an incentive to say that it is a wonderful stock. At the same if they earn higher profits, you have classical conflict of interest. There is quite a lot of legislation how this conflict of interest should be dealt.

First, what is the financial analyses. It is not marketing. When you read marketing material, it is not objective. You have sometimes forget this, if he is particularly good seller.

IF somebody says there this is financial analysis, uses the word research, it is more than marketing material.

Consequences if you are confronted with financial analyses. There are a few. One is the most important is that existing conflict of interest do not materialize. In particular, issue of financial analyses should ont directly linked to sale of securities except two circumstances: market making and personal transaction contrary to current reomenndation is a approved by legal or compliance department.

For all investment banks they have both financial analysists and range of securities. In particular, int the US, several people went to prison for mixing up with conflict of interest. What you find today this is either very strict Chinese walls within an organization and investment bank or commerckal bank or even more regulary where finacial advisory outsourced to a subsidiary. Good example is big French bank Callilo (????)

They have a analyst bank called Shevro (?) they are independent from the mother house.

For them very important to keep it independent.

Most investment banks keep special subsidiaries keep apart.

Is it always possible to manage conflict of interest? No it is not easy.

That leads us to the third area of regulation, securites trading so called conduct of business rules.

There is a set of rules that every security firm must follow. Basic concept is that securities trade3r4 operating like … he gets money from his client whether he dos that as agent or principal economically doesn’t make difference although r it does matter.

You have triangle. I sell it to you and then you sell it to somebody else as agent. In the other case, there is only one contract b/w Principal and Buyer.

On top of that you dispose information that other people do not have.

There are certain rules conduct of business rules which are embodied in EU legislation. They require players in the market in the certain way. You see first conduct of investment business, terms of business and customer agreement.

I am as the investor must get the information that charge me but also about the venues where you execute the contracts infroamtion about the financial information. Legal sources for conduct of business is wide in EU is MiFID. (Markets in Financial Instruments Directive)

What are the duties of skills, care and diliegence? As a securities dealer act promptly and try to obtain the best bargain you must warn the client about the risk. And as a broker you have to familiarize yourself about the market conditions. All that covered by best execution. That was one of the highest debated of MiFID. He thought best execution was easy to understand. IT should go without a problem. But that wasn’t always so it turns out.

The other suitability and appropriateness test. When somebody comes to you and says he wants to A, B, and C, you can’t do immediately. You have to find out if these securities are suitable for him. It looks patronalistic approach. But now there is now no doubt it should be so.

You have to check based on the specific questions. What sort of experience, education the customer has. As a consequence of this test, certain products can not be sold or should not be sold. Obvious example is, old person comes to you, I need something extra to my pension on monthly basis, and you sell with maturity of ten years. That is for sure not suitable for him.

These sorts of things should be taken into account. They are in trouble when the client sues them otherwise.

Front-running, customer order. You have a big customer, he wants to sell big chunks of X. If you are a clever trader, you will have short position. That will be front running. You are not allowed to that.

Somebody comes in. If a customer order comes in, you have to execute it immediately.

Inducements. It is another big item. The whole world of securities is financial inducements. If you want to buy insurance policy, you know the person who is selling the instruments, has inducement, or is getting commission.

There are thousands of inducements in the long chain. There are lot of people who want to benefit. The customer doesn’t know. And again rule is transparency is important. There must be inducement for the benefit of investor. Which is again difficult test that is something to be done. IF there is no justification, somebody in the long chain of selling investment products, there should not be….

Advertising, promoting and record keeping. Most of the record keeping must be dealt with sales prospectus. There are other cold calling rules. Telephone rings. It is illegal in Germany for securities.

Three important rules is identify the conflict, disclose the conflict, manage the conflict.

Front running is the perfect example. Either interest trader and customer.

How to manage such a process

…..

Securities Trading – Overview Part 2

Disclosure of voting rights. There are rules now that are based on the idea that general public should know who influences on the companies and the rational really is that you can really understand if you know the forces driving the certain situation. Therefore price of securities can be only real if everybody knows what is happening. There are specific take over rules. They usually start with 30 %. We are dealing here with levels below.

If you as an investor cross one of those thresholds, you are required to notify to the issuer of the shares and both of them publish. There are European countries which put stricter rules. In the UK, they have three percent disclosure rules. And that is within threshold. TO be precise that, there are two regimes. IT is not the right to receive dividends but voting rights.

The other one is securities. That is very interesting and highly debated. All this notification is highly controversial. A lot of legal work in this sphere because people do not want to publish. People are particularly secretive about money. And there are situations where you want to be secretive. Financial instruments, SWAPS, options.

Physical settlement option requires notification but cash settlement doesn’t require notification.

Margerate Shaeffler used to be one of the richest women in Germany. She made her money through a company that was run by her husband who died some years ago. Her inherited the wealth. Shaeffler was producing car parts. Conti was ten times than Shaeffler. Shaeffler started take over of Conti. And they wanted to avoid public takeover rules. Everybody can see by acquiring 5 %, 10 %, 15 % etc. But sometime Summer last year they only published information that they were about to take over Conti. They have the right to acquire 75 %. Vast majority of shares that they didn’t own yet, cash settled swaps, derivatives. Of course, there was an outcry. The price would have gone if it had been announced properly. It wasn’t illegeal in Germany. This is difficult to understand how you can have a situation, you will have cash settled derivatives and still Shaeffler can be confident that banks will deliver the shares instead of delivering difference. On the one hand, they are sure they have 75 % and the other hand it is cash settled. Contracts drafted in a way that would make not profitable just to pay the difference for the banks than deliver the shares. If there is result will be clear, than of course, contract says it cash settles. … Argument was which convinced BaFIN. Yes it is not only theoretical possibility that contract can be cash settled but contract settled.

UK says cash settled contracts to be published also.

Attribution scenarios – not only the voting rights holders should be disclosed but a number of people as well. You can hardly find simple corporate structure. Every block in the group should notify about the acquiring shares that reach certain threshold. Legal ownership and economic ownership do not go together always.

If I am an investor manager and my specific job is to hold securities for my customers but only do with shares what my customers tell me, yes I am the legal owner but it is considered as giving wrong information to the market. IT is reasonable to say that only the person who stands behind should notify. (portofolio managers, e.g.)

The same from different angle holds for UCITS and investment funds. But here we have typical have management company which belongs to larger company. Every bank has nowadays investment managing company. They hold billions of shares in many companies. Management company usually must notify. But the question is the holder should also notify? No, it should not because it would be misleading. Because Deutsche Bank doesn’t have influence here management company itself decides whose shares to buy.

We have specific rule in Germany for change triggered by EU rules that is ten percent rule where you as an investor you have to publish your strategic ….

Quite often if they do acquire more than 10 % (the idea is that people should say openly they want to do public takeover or not. Many people say no we don’t want yet, simply by saying now we are making decision). …

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Class 7

MiFid is taking different approach. Market participants have recently changed their deals, they said that it is really cost inefficient, what they are going to do is if they receive an order, why you have to forward to stock exchange, if you already know somebody who is going to buy it. It is cheaper to execute the order. Liquidity is drawn from stock exchanges. Trading bid and ask prices do not represent the true price.

If you look at the beginning of every EU directive, why certain topic has been subject to EU regulation.

Transparency for all venues, says directive. MiFid has found two more venues: Multilateral trading facility (MTF), Systematic internaliser.

The borderline b/w MTF and Systemic internaliser is not easy.

Implementing directive says you need to do this… Directive says you need to put price tags on products.

Post-Trade transparency requires the price and product that is bought.

Hottest topic under this field, this is very technical. We have had more discussion on IT.

MiFID wants to publish quotes. Quotes must be published without timely delay.

Real time disclosure is only for equities.

Covered bonds are debt securities backed by cash flows from mortgages or public sector loans. They are similar in many ways to asset-backed securities created in securitization, but covered bond assets remain on the issuer’s consolidated balance sheet.

REITS real estate investment trust. IT has some tax benefits. It is sort of an investment fund. It really comingles any type of capital market issue in legal field. You will find concepts in every major capital markets jurisdiction.

Pfandbrief is only one of the types of covered bonds. Pfandbrief has been established for many many years. It served as role model for every other jurisdiction that invented the covered bond.

What is covered bond? If you want to build a house, you need money. Get the money from the bank and ask for money. Bank says ok, you get it. Will do they take a security? Yes, mortgage. Special security. It is not you who is generating income but you have got the house. Now bank loans out money but where do they get it from? Bonds will be issued. Investor will buy the bonds. It is a bond secured by the assets especially attributed to cover pool. The cover pool contains claims of the bank. This is specifically secured by mortgage securities. There are detailed provisions under German Pfandbrief act or under other jurisdiction to secure that these claims are worth.

This is pfandbrief is not harmonized under EU.

You can also take public loans. Because the government has to pay anyway. Mortgages, public loans and what else? Ships and aircrafts. Since March we can issue aircraft pfandbriefs. Engines are separately registered, fuselage registered.

In Germany you need to be specially qualified and licensed credit institutions. Up until 2005 it was even stricter in Germany. They have to have a license. There are certain minimum capital requirements and etc.

There are also cover audits such as checking into cover pools. They look at the valuation of assets and have special person sachwalter who will look into this and evaluate this.

Asset-liability –management is also important thing. NO matter if you are a bank or grocery store you need to have this.

Insolvency remoteness of cover pool. You have two insolvency scenarios when you evaluate, first of all, Bank may go bust. What happens? There is certain insolvency administrator to take care of cover pool, the assets and see when they will be mature and what circumstances, when you have to pay principle and asset. Investors will have priority access to asset pool.

UCITs are only open-ended funds in EU.

Parties involved – the “invfestment triangle”

Custodian controls the manager, also may sue the manager on behalf of the investors. It holds assets, and calculates net assets.

Collective investment scheme contracts:

- the investment management contract b/w investment manager and the fund. It is about which assets they may invest or not invest. 50 % eg can be invested in real estate.

- The custodian contract. - The investment policy.

June 9, 2009

Magic triangle: custodian, manager and the fund. What are the roles of them? The funds holds securities. What is a fund? It is a legal entity in some countries. In Germany it is not a legal entity. The fund itself cannot be a party to a contract in Germany. It is a special fund of assets. What is the legal role of manager? What happens to the fund if the manager faces liability? Nothing happens. Custodians and managers are like trustees. What is the relationship b/w custodians and managers? Custodians are like supervisors. There are certain transactions if manager wants to carry out, custodian may say no.

Registration of UCITs. Registration of UCITS is basically like notification of securities. Registration process provides for passport like system in EU. Although words and terms are

different. You have a MS, where you get registration and you go through some admin. process in other MS in EU and try to get registration in those jurisdiction, that allows you public distrubition. Once you get registration in one MS, it is easy to get registration in other MSs.

ETF – are listed funds. They are listed in Luxembourg and Dublin or Duesseldorf in Germany.

There is also a competition b/w stock exchanges. It is funny to see how economic environment can change the competition. Until the crisis, stock exchanges with lighter rules were preferred. Lesser rules are positive but on the other.

The biggest problem the fund has a planning problem. You don’t know if tomorrow investors will come and demand to redeem. Under circumstances, they are closed. That is not the normal case. (master feeda fund???)

Regulated v. unregulated Funds. German fund system, you have KAG. They call themselves investment funds and they are regulated funds. It is less clear in other jurisdictions. There are some funds that are unregulated. What is the perfect example for funds? Hedge funds. Why? The key issue of regulation is restrictions in investments and hedge funds by nature need liberty. Legislator takes very protective approach.

Hedge funds are most risky business. They look for returns of up to 40 %.

There are other items, where fund manager should comply with certain criteria. You must have clear criminal record, you need to have experience in investment business. You must demonstrate financial resources.

There must be certain structure within the fund. There must be check and balances. A regulated fund must publish a prospectus. You need a custodian and you have the investment policy.

But funds is a very generic term. Big difference can be made b/w investment funds, (open end funds and closed end funds). Main difference b/w the two the right to return on the daily basis. There are other differences as well but this is the most important one.

Let’s stop here for a moment as far as prospectus laws and securities are concerned. Approach of EU legislator is basically starting point is securities. IF an issuer wants to sell or list securities, they need prospectus acc. to Pros. Dir. Investment funds are securities but they are expressly exempted from the rules from Prosp. Dir. The reason, there are special rules. European securities rules are newer than rules on UCITS.

What applies to a financial instruments nor open ended funds? There doesn’t exist proper prospectus law for other funds. But in a number of individual MS you do find laws and a directive is trying to cover other financial instruments. But it looks as it takes some time. There is a lot of debate going on about this.

Majority of investment in this country goes into this type of investments, which is surprising to some extent since it is the least regulated stuff, the most dangerous but the most popular. IN Germany it is regulated. It is a verkaufspropectusgesetz. And we don’t go to that in detail.

Close ended funds are usually not listed on the stock exchange. SO you should be careful when you are buying them.

There is a lot of politics in this. Some years ago it was decided that German ship manufacturing should be protected. And there were tax cuts for the funds which are devoted to fund ship manufacturing.

One important thing is that there are of course there are advantages in closed ended funds but one big disadvantage is that we don’t have notification or passport. So they are usually very domestic. You don’t’ have EU harmonized market for them because of the lack of regulation.

Let’s go to real estate investment funds. This a special investment fund designed for real estate. He is not going to into much detail. Basically, REIT is an investment fund. By definition it only invests in real estate. IN the US it is very popular. And the US legislation was model for German legislation as well. The trick is the funds do not have to pay income taxes so it can accumulate a lot of value and it will be taxed at the level of fund holder at the time of distribution of profits but you can obtain this…

No. 8. Public takeovers

Public takeover of listed companiesSqueeze out of minority shareholdersDelisting of securities

What is the public takeover law for? 1. Fair competitive M&A. 2. Protect minority shareholders.

Why do minority shareholders to be protected? Can you think of a situation protected? To give a fair price to minority shareholders. Second protect minority shareholders from company policies which do not care for minority shareholder interests. One of the most important rights of majority shareholders is to decide to give dividends or not. And as a minority shareholder might be deprived of getting dividends for years.

Public takeover law is relatively young. There is EU council directive 2004. German takeover law is older dates back to 2002 or so. German takeover law was reaction to a particular case. Manisman was old steel producer which was taken over by Vodafone in a very very interesting exercise. This was considered as an attack by foreigners. In the end the takeover was successful and it led to a number of legal proceedings afterwards. Most famous being suing the Josef Ackermann. After taking over Mannisman, but the share price had gone up so high that in the end shareholders got very good deal and former CEO of Mannisman were very happy. Basically they decided to give him a big chunk of money. Afterwards, a lot of people got interested in this case. CEO itself got prosecuted. Again something widely covered was after the decision was by the court. There was a photo taken with him and it was considered notorious.

It is important to differentiate two situation: 1. Takeover bid 2. Mandatory offer.

A takeover bid exists when somebody who has no controlling stake plans to acquire control in a listed company. It is usually considered 30 %. Usually you have the majority with 30 % because of absentees in the voting.

What is a fair price? In Germany we have the fair price considered to be the average stock price for the last three months preceding publication offer.

Basic rule is average of three months. If it gets higher for particular shareholders, then they must…

Another important feature is board’s neutrality. Board is obliged to treat the offer. It cannot oppose the offer in Germany except the board has been given certain rights to oppose an offer beforehand. In the US it is different.

Poison pill? White knights?

Mandatory offers are different from takeover bids. Mandatory offer is the one you must make if you have controlling stake in a company.

The US system is much less straightforward. Rules existed for much longer time. But there is no unified state law. Main features are mandatory requirements are quite rare whereas in EU it is strict, the border doesn’t have to be. However there are strict rules on availability of offers what is usually to be 20 days. You have to keep an offer open for 60 days in EU(I think).

June 16, 2009

Last time we spoke a little bit about UCITS and public takeovers. One of you was very insistent on one topic and if the prof. was sure. Investment funds are not taxed, you were right. The prof. fesses up.

Why do we need public takeover law? Why public takeover law was introduced in Germany? What was the famous case? Mannisman was taken over by Vodafone. And there were no rules regarding takeover law. Afterwards Germany introduced takeover law.

One of the reasons is minority shareholder interests. Second reason is making fair M&A.

What are the two steps in takeover? 1. Voluntary bid. 2. Mandatory bid.

One different rule in the US and EU is that the board must should stay neutral. What is a white knight? If someone gives you better price. Poison pill is giving extra voting rights to existing shareholders.

Now we need to cover some bits under heading of public takeover laws. Page 9. Squeeze out is a wonderful word. There is even no German translation. In German this English term is used. It just such a good word to describe the situation.

This is something under normal circumstances should not happen. Successful majority bidder gets the right to squeeze out the minority. According to EU directive, majority should have 90 % voting rights and shares. But MS are not prevented from having higher threshold. HE thinks Germany has 95 % threshold. Appropriate compensation must be at least the same price which the bidder paid for majority shareholders. Once squeeze has been successful or was to be successful, delisting of publicly listed companies…

Usually it doesn’t make sense for the bidder to keep the listing since it wants to have full control and it costs money and there are disclosure rules, to cut short, lots of headache.

Usual distinction b/w mandatory and voluntary delisting is cold delisting and and …

Cold delisting is a corporate measure through which indirect delisting takes place. Eg, listed company merges with not listed company and gets delisted. Regulator delisting is when the company decides for any sorts of reasons to delist itself from the stock exchange.

What is the requirement to delist ? General meeting decision. 50 % of shareholders vote suffices to delist. The Highest Court in Karlsruhe had this opinion. There is a disadvantage for minority shareholders because they cannot trade their shares any more and also they lose a number of benefits. So majority shareholders should compensate that.

Can you think of other examples of cold delisting? If you think of corporate form of companies, for example, if you convert from AG to GmbH.

We move on quickly to session number 9.

Insolvency is interesting so far because it relates to other things we discussed so far.

What are the sanctions if people do not comply with requirements. You distinguish b/w civil and criminal liability and enforcement.

Criminal sanctions.

What has criminal to do with this? It is believed that there are certain actions and activities within securities industries that are considered so strict grave that criminal sanctions seem appropriate. What kind of criminal cases can you think of? Insider trading. In the US it often happens. In France Societi General.

Janet says in the US, they interpret fraud very strict in cases of securities and she asks the professor if it is the case in Germany. Prof. says he doesn’t want to take his fifty percent chance of being right or wrong, so he basically doesn’t know the answer.

The guy who came with the prof. says there is separate section in Criminal Law in Germany for securities fraud and “normal” fraud.

Civil Law on the other side is concerned with compensation. Here we have the same system for all claims, like, for negligence. Remedies include, injunctive relief and etc.

What do you think is the area brings about most litigation in the field of securities? The information that provided by the company which misled the investors or shareholders to buy or sell their securities and which led to financial losses.

Discoveries rules in EU are very weak, in Janet’s opinion and she wants to know if the prof. agrees. He sort of agrees. You must prove breach, damage, cause, defendant was responsible for this. OF course, to prove many of these elements require knowledge and discoveries all about this. You need to reverse the burden of proof. You cannot absolutely reverse the burden of proof. Very often problem in misselling is “you never told me, and the def. says yes you did”. What is the truth then? If there were only two people in the room, it is difficult to prove. Under normal rules, when A says “yes” and B says “No”, you can decide upon that.

Draw of minutes of the meeting or talks and get signed by the investor and minutes disclose what has been discussed and what hasn’t been.

Very often regulation has different purpose, for example, safeguarding the financial system not protecting individual interests.

You must notify if you exceed 5 %, if you don’t notify, will it necessary damage ? No, of course.

Is prospectus liability enforced in EU? No, it is not harmonized.

Page 9. - What about “forecasts”? Can it be a cause for action? Yes, companies can be liable. However, companies do not give such forecasts with absolute guarantee. Companies usually say they probably will earn some amount of money but not for sure.

-statements of risk. It is the important part of every prospectus. Why can’t we say there is a chance to win a lot of money when we are talking about the risks? Because it may trigger liability.

Page 10.9.4. Insolvency.

Every creditor of the company can file for insolvency but with banks it is not so. Only regulator can require filing for insolvency.

Under the heading of good and bad banks, power of regulators split banks into two: good assets go to one way and bad assets go to the other way.

Some basics of insolvency proceedings. Those principles of universality and territoriality play great role with banks. These issues concern all companies. Should I see all banks assets as one insolvency state or should it be possible to form several insolvency proceedings? Within EU, EU Directive 2001 which lays down good rules. There is the principle of universality, which says

there will be main proceedings and it can affect the assets in all EU MS and there are secondary proceedings which only covers the local assets.

Depository schemes. Within US and EU there are uniform which currently under heavy review. General rule that applies both to the US and EU is that depositors are always protected by compensation and investors are to a lesser extent protected. Those people who had deposits in Germany are protected but who are acquired bonds are not protected.

June 23, 2009

Reform of Securities Regulation – Overview

We talked about briefly insolvency and enforcement which are last time’s topics. We will also talk about what securities regulation has to do with crisis.

Enforcement and insolvency. What are the three areas of law in enforcement? Where is liability can be enforced? Civil, Criminal and Administrative Law.

You see most often administrative sanctions. This is where the regulator directly operates. These are the weapons of the regulator. Administrative fines and other restrictions that regulators can impose. Civil Law is not necessarily next step in the escalator. It often goes in parallel with administrative law. Criminal law is reserve for the most serious stuff. Police work hand to hand together with regulators. Regulators cannot put nobody to prison.When we talk about civil law liability, does every breach of securities regulation lead to private action of individuals? No, there should be an interest. What are the four criteria?

1. Breach of rule (cause). 2. Damage 3. Link b/w cause and damage. 4. Interest.

Let’s talk about the breach of regulation. Suppose the other three elements are there, does always lead to claim of an individual or do we need extra something? Yes, we do need. Purpose of the regulation which is breached must be the protection of individual rights. There might be purposes of general nature, like functioning of stock exchanges. GERman courts would always start their reasoning from if the purpose of regulation is breached. If not individuals cannot claim.

You can argue both ways for the regulation which oblige shareholders to disclose shareholders when they exceed certain thresholds. Now if you don’t do it and therefore people say you are a big shareholder and you start selling and it doesn’t get public. But some people know about that. And somebody says “had I known this, I would have sold earlier”. Is there breach? Yes. IS there damage? Yes. Is there cause? Yes. Still the purpose of this regulation not protection of individual shareholders. The purpose is to have level playing field for the market.

Insolvency. What are the differences? Who can initiate the proceedings. They can intervene earlier. Pre-insolvency rights of the regulator.

Now we will discuss the shortcomings of securities regulation and reforms.

Page 3 presents the perceived defects.

Moral hazard. In securitization, banks didn’t keep the risk but transferred to SPVs. Very often bank was supposed to bail out the SPV although it wasn’t obliged to do so. Taking this idea forward here, basically banks say we will do whatever we want, the state will bail us out. That is an argument.

Redistribution. There is regulator which puts strict on financial institutions, there is additional costs and quite often put on top of financial products. Basically, is that really what we want? That basically all the investors have to pay for the regulation although some doesn’t have to do who are sophisticated. Wouldn’t be better if we offer only to sophisticated investors? That is the argument.

Excessive consumerism. State behaves like parents. They tell exactly what to do. Children being passive consumers, regulators make sure of the quality of products.

Costs. Those who are supervised they pay for supervision.

International collisions. If you like, b/w regulatory systems. The idea is to have harmonized systems, even within EU. Very important area which is not harmonized. People in Brussels talked about it. Prospectus liability.

Over-criminalization. Isn’t it bit harsh?

Protectionism. Aren’t regulations sometimes used to keep out foreigners? Yes. If you remember the times prior to the prospectus in 2005, officially passporting system existed. However there was translation problems. There was strong suspicision. They wanted to reserve for local markets. Officially it was consumer protection.

Reduction of competition. Of course, if you leave for market forces, you have harder more competition.

Reputational risks. Do you remember an accounting firm called Arthur Andersen? They advised Enron and made out financial statements. What really killed them they helped Enron to destroy documents. Name and Shame policy in the US. You disclose companies which are shameful.

Herd bahaviour. One cow is going to one direction, other cows follow it.

Unrealistic expectations. Prospectus say a lot about risks but you should do your own calculations. No regulator in the world can make that judgment for you.

Impracticality. There are certain things you cannot regulate properly.

Page 4.

What now led to dramatic current crisis?

….

KII – key investor information. You have 100 pages prospectus that nobody reads. How to fill the gap b/w boring documents that needs to be extensive and efficient document? How can you manage to say everything concisely and precisely like in summary?

PRIPS. That is ABS that come along in innocent disguise, like a bond. I am a bond, I am heavily regulated by prospectus. What I am not saying is what is behind me, four times repackaged…

It is about necessity to disclose it. There are excellent brains. You seem to circumvent regulations. Repackaging is the way of going around.

AIFM goes in the same direction, it covers everything concerning investment fund. We had that in Germany. Under German law, there is sort of test you have to do. When you see financial products, you need to identify if it is security or investment fund or something else. Then you apply the respective law. EU is trying to create similar laws for all forms of investments.

In the US, regulatory system is more diverse and less centralized. US has become famous and most EU MS followed this short selling. It was blamed for aggravating the crisis.

THRIFTS are sparkasse in Germany.

EXAMsWritten, closed book questions.Short questions. What you can expect is type of questions that we had in the begininig of each session. It will be relatively short questions that you can answer if you attentively followed the courses. There will not be philosophical questions. 90 minutes. About 10 questions.

Introduction 1, 2, 3,

2-3 (17+19) Public offeringsStock ex (19)5-6 Securities Trading (14-15, 20-21)7 UCITS (13)8 Public TakeoversEnforcement (18, 22, 25)