Capital Markets Law (International)

by Jan von Hein

1. Introduction

International capital markets law, like its counterpart in substantive law (capital markets law), is an area which combines elements of private, public and criminal law. The regulatory approaches to conflict of laws (private international law (PIL)) in this field turn out to be accordingly heterogeneous. While, for example, questions of company, contract or tort law are in principle connected according to the general conflict of law rules in a multilateral way and without consideration of the respective jurisdiction of the authority or court (company law (international); contractual obligations (PIL); non-contractual obligations (PIL)), in international capital markets supervision law the principles of international public law have to be observed, ie each supervisory authority is basically authorized to apply its respective domestic law. Therefore, international capital markets law is not characterized by multilateral, but by unilateral conflict of law rules. However, by the special connection of international mandatory rules (Art 9(3) Rome I (Reg 593/2008)) or in the form of local data in the framework of the applicable substantive law (§§ 138, 826 Bürgerliches Gesetzbuch (BGB)), foreign public law can also have an impact on private law questions raised by transactions on the capital market. With regard to the sanctions envisaged by the capital markets criminal law (eg concerning insider dealing), the conflicts rules of international criminal law have to be respected. As is the case in international company law (company law (international)), a general European legal framework regulating the question of the applicable law is missing in international capital markets law.

2. Regulatory models

While the capital market has been economically europeanized and globalized for a long time, the legal regulation, which takes place primarily at the national or regional level, has lagged behind. Currently, a number of companies are listed on two or more stock exchanges, increasing the danger of conflicting duties and at any rate leading to higher costs due to a redundant duplication of control. This danger of a cumulation of norms is a typical result of unilateral conflict of law rules. Vice versa, a lack of norms may arise if no country claims regulatory power in cases involving heterogeneously connected circumstances. Six different regulatory strategies for conflicts of capital markets law can be distinguished.

a) ‘Extraterritorial’ application of law

First and foremost, the approach traditionally followed in the United States has to be mentioned. US capital markets law is also applicable to foreign issuers if they are listed in the United States or exceed a certain threshold of US investors. With a pejorative nuance, this approach is often called the ‘extraterritorial’ application of law in German and European literature; however, it is basically consistent with international law, which merely demands a genuine link between the exercise of regulatory powers and the object of the regulation. In practice, the extended application of domestic law to foreign issuers is frequently softened by exemptions (eg regarding the duty to comply with US accounting standards or with US corporate governance requirements). From a European point of view, the Sarbanes-Oxley Act of 2002 has severely disturbed the previous balance between matters of organizational law, which have traditionally been subject to the home country of the issuer, and matters of capital markets law, which have traditionally been submitted to the US market law. With regard to securities fraud, US law has traditionally been applied if either the conduct or the effect of a tortious act could be located in the United States. The Supreme Court has, however, rejected this approach in Morrison v National Australia Bank Ltd (130 S.Ct. 2869 (2010)) because it lacked a firm statutory foundation. The Dodd-Frank-Act of 2010 immediately reinstated the conducts/effects-test for SEC actions. Insofar as civil actions filed by private claimants are concerned, however, the Morrison ruling still excludes this test. Further legislative action in this area seems to be likely.

b) Laissez faire and issuer choice

As a contrary position, it has been proposed to grant the issuers party autonomy -just as in international company law- and allow them the choice of the capital markets law applicable to them (particularly the publicity requirements which are to be complied with). This promises a competition between legal systems which shall, just as in company law, lead to a race to the top as a result of the pressure of the market in order to enforce the most efficient regime. This ultraliberal approach in its unrestricted form has not yet been established in any legal system. This may be attributed not only to the fear of a race to the bottom. Moreover, serious concerns exist with respect to the loss of standardization advantages and the lacking comparability of the capital market information, which may lead to negative externalities to the detriment of investors.

c) Unification of the substantive capital markets law

This approach follows the old adage: ‘without conflicting laws, there is no conflict of laws’. A supranational unification, eg by an EU regulation, always evokes the danger of a petrification, which may reduce efficiency particularly concerning a dynamic area of law such as capital markets law. Therefore, the EU prefers the more flexible regulatory mode of a directive, which traditionally only indicates a minimum standard to the Member States and leaves them a margin in this respect. This in turn is associated with the risk of the erection of protectionist hurdles (so-called gold-plating).

d) Special supranational financial tools

Here particularly, American Depositary Receipts have to be mentioned, which enable German stock companies to be listed on US stock exchanges without abandoning securitization in the form of bearer shares, a form which is common in Germany but not accepted at American stock exchanges. However, the reform of the German law on registered shares (NaStraG 2001) has reduced the need for such workarounds.

e) Harmonization and mutual recognition

Nowadays, this strategy dominates in the EU. Several directives—MiFID (Dir 2004/39), Prospectus Directive (Dir 2003/71), Takeover Directive (Dir 2004/25)—harmonize the substantive capital markets law and in this context determine supervisory jurisdiction as well. Here, basically the country of origin principle is followed (MiFiD, Prospectus Directive; the Takeover Directive follows a more complicated approach). Despite the adherence to unilateral conflict of law rules, the danger of a lack of a cumulation of norms can largely be excluded due to the harmonization of the connecting factors.

However, the combination of a (minimum) harmonization and recognition is not restricted to Europe; the US Securities and Exchange Commission (SEC) also recognized the International Financial Reporting Standards (IFRS) as equivalent to the US Generally Accepted Accounting Principles (GAAP) in December 2007 and thus liberated European issuers from the time-consuming and expensive reconciliation which was previously necessary to enter the US capital market. With regard to differing corporate governance provisions, the US stock exchanges and the SEC frequently combine exemptions from compliance with US rules with respective obligations of the issuers to account for deviations from the US standard, inter alia, in the annual report (comply or explain). Thus, the final judgment about the ‘equivalence’ of European corporate governance-practices with US demands is left to investors. This creates an indirect pressure for a harmonization of European law.

f) Self-regulation of stock exchanges

In the academic literature, a stronger control of the issuers by way of listing requirements is frequently recommended as a way to a more flexible and market-oriented regulation. However, the US example shows that the SEC was frequently able to realize its aims by virtue of its ‘raised eyebrow’ power over the stock exchanges formulating the listing requirements.

3. Players

The central players in capital market regulation are—apart from the national and international lawmakers (EU)—the capital market supervisory authorities, in Germany the BaFin, and the stock exchanges. On the international level, the cooperation of the national capital market supervisory authorities is supported by the International Organization of Securities Commissions (IOSCO). On a European level, the Committee of European Securities Regulators (CESR) has to be mentioned, which has important tasks to perform concerning the implementation of the European regulation targets. A supranational capital market supervisory authority for the internal market, which would be comparable to the US SEC in relation to the separate federal states, was for a long time missing in the EU. However, steps for a further consolidation entered into force in 2011 in the form of the European system of financial supervision. Moreover, an institutionalized exchange with the SEC takes place in the framework of the Transatlantic Financial Markets Regulatory Dialogue.

4. Legislation

Faced with a widespread criticism of the Community’s legislative process in the area of capital markets law as lengthy and inefficient, a ‘Committee of Wise Men’ under the head of Alexandre Lamfalussy was set up in July 2000 by the EU ministers for economic affairs and finance, which elaborated a four-level approach in order to accelerate legislation. Its outstanding feature was that political questions of principle were largely decoupled from the elaboration of more detailed technical provisions. While the former were decided adhering to the common legislative process, the latter were left to the second level where two new committees became active, namely the EU Securities Committee as well as CESR. At the third level, CESR ensured a uniform implementation und interpretation of the passed legal acts. Finally, at the fourth level, the Commission supervised the application of the legal acts in the Member States and intervened with sanctions if necessary. In the transatlantic context, the Memorandum of Understanding is the preferred form of coordination between the SEC and the European capital market supervisory authorities. The structures established by the Lamfalussy process have been replaced by the European system for financial supervision in 2011. The successor to CESR is the new European Securities and Markets Authority (ESMA).

5. Investment Services in general (MiFID)

The Directive on Markets for Financial Instruments (MiFID) is based upon the principles of mutual recognition and control by the Member State of origin (European passport); in the case of legal persons, by the state in which the registered office is located. The danger of an evasion of laws is to be allayed by the fact that the head office of an investment company must always be situated in its Member State of origin and actually be operating there. In cases of an obvious circumvention of laws admission to the market shall be denied. The practicability of supervision by the Member State of origin shall be ensured by duties of information and cooperation with the responsible authority. The host Member States are not allowed to impose additional requirements, but retain an emergency competence for urgent measures. The law applicable to contracts concluded in the framework of a multilateral trading system is determined by Art 4(1)(h) Rome I (contractual obligations (PIL)). In this respect, consumer protection in the conflict of laws does not restrict party autonomy (Art 6(4)(e) Rome I).

7. Liability for capital market information and market abuse

a) Prospectus liability

Under Rome II (Reg 864/2007), prospectus liability claims (prospectus liability) are generally characterized as belonging to tort law. The exceptions for securities and company law according to Art 1(c) and (d) Rome II do not apply to prospectus liability. A connection to the affected (positioning) market has been proposed, which may be based on the escape clause included in Art 4(3) Rome II. However, in view of the growing European and global integration of the capital markets, a connection of prospectus liability to the affected market has to overcome difficulties concerning the precise definition of the relevant market. Thus, an advancing view endorses an accessory connection of prospectus liability to the obligation to publish a prospectus.

b) Other liability for capital market information

Likewise, further liabilities for capital market information (eg liability of the board members of the issuer in case of false or misleading ad hoc messages under § 826 Bürgerliches Gesetzbuch (BGB)), ( mandatory disclosure (securities markets)) are subject to the law determined by the conflict of law rules of international tort law (Rome II), as far as the already mentioned exceptions do not intervene.

c) Market abuse

Article 10 of the Market Abuse Directive (Dir 2003/6) follows a market-oriented approach: ‘Each Member State shall apply the prohibitions and requirements provided for in this Directive to a) actions carried out on its territory or abroad concerning financial instruments that are admitted to trading on a regulated market situated or operating within its territory or for which a request for admission to trading on such market has been made; b) actions carried out on its territory concerning financial instruments that are admitted to trading on a regulated market in a Member State or for which a request for admission to trading on such market has been made.’ Violations of a foreign prohibition of insider trading can also entail criminal proceedings in the domestic country in a case of equivalence (§ 38(5) WpHG). However, a parallel application of foreign private law liability rules as international mandatory law encounters the obstacle that Rome II does not, at least not explicitly, permit a special connection of foreign mandatory law.

8. International takeover law

The Takeover Directive (takeover law) provides for a splitting of the connection into matters of capital markets law and company law. According to Art 4(2)(a) Takeover Directive, the supervisory authority of the Member State where the target company has its registered office is responsible for the supervision of the bidding process if that company’s securities are admitted to trading on a regulated market in that Member State. The competence remains with the supervisory authority of the country of registered office—subject to a delisting—if the shares of a company have been listed there on a regulated market, even though its securities are later admitted to trade in another Member State. Even if the shares of the target company have first been listed in a Member State other than the country where it has its registered office, the competence remains with the supervisory authority of the country of registered office if the shares are also traded there, pursuant to an argumentum e contrario based upon Art 4(2)(b) Takeover Directive. The competent authority under Art 4(2)(a) Takeover Directive always has to apply its own law; this follows from of the synchronization principle anchored in Art 4(2)(e) Takeover Directive. If the target company’s securities are not admitted to trading on a regulated market in the Member State in which the company has its registered office, Art 4(2)(b)1 Takeover Directive determines that the authority competent to supervise the bid shall be that of the Member State on the regulated market of which the company’s securities are admitted to trading.

Matters relating to the consideration offered in the case of a bid, in particular the price, and matters relating to the bid procedure are subject to the substantive law of the market country (Art 4(2)(e)1 Takeover Directive). These include in particular the information on the offeror’s decision to make a bid, the contents of the offer document and the disclosure of the bid (Art 4(2) (e)(1) Takeover Directive). In contrast, according to Art 4(2)(e)(2) Takeover Directive, in matters relating to the information to be provided to the employees of the offeree company and in matters relating to company law, the applicable rules shall be those of the Member State in which the target company has its registered office. ‘Matters relating to company law’ are considered to be particularly the percentage of voting rights which confers control and any derogation from the obligation to launch a bid as well as the admissibility of defence measures. The consumer-protecting choice of law barriers of Rome I do not apply to rights and obligations constituting the terms and conditions governing the issuance or offer to the public and public take-over bids of transferable securities (Art 6(4)(d) Rome I).

9. Investment business

The Directive on Undertakings for Collective Investment in Transferable Securities (UCITS), which has been implemented into the InvG in Germany, follows the principles of mutual recognition and control by the Member State of origin (country of registered office). Concerning rights and obligations defining the requirements for subscription or re-purchase of shares in UCITS, the consumer-protecting choice of law barriers of Rome I do not apply (Art 6(4)(d) Rome I).

10. Outlook

Despite its unilateral regulatory approach, which formally dominates, European capital markets conflict law is characterized by a considerable degree of harmonization, which is based on the principles of either minimum or full harmonization, control of the country of origin and mutual recognition. The Lamfalussy process and the recent creation of the European system of financial supervision have contributed to an improvement of the implementation of the law based on directives. In the transatlantic context, regardless of the irritations provoked by the Sarbanes-Oxley Act, the SEC shows tendencies to adopt a closer coordination with the European supervisory authorities and a willingness to accept foreign or supranational rules (eg IFRS) as equivalent to US rules. The recent restrictive ruling of the US Supreme Court in Morrison has also been welcomed by European issuers.

Literature

Harald Baum, ‘Globalizing Capital Markets and Possible Regulatory Responses’ in Jürgen Basedow and Toshiyuki Kono (eds), Legal Aspects of Globalization (2000) 77; Herbert Kronke, ‘Capital Markets and Conflict of Laws’ (2000) 286 Recueil des Cours 245; Roberta Romano, The Advantage of Competitive Federalism for Securities Regulation (2002); Michael A Perino, ‘American Corporate Reform Abroad: Sarbanes-Oxley and the Foregn Private Issuer’ (2003) 4 EBOR 213; Larry E Ribstein, ‘Cross-Listing and Regulatory Competition’ (2005) 1 Review of Law and Economics 97; Onnig Dombalagian, ‘Choice of Law and Capital Markets Regulation’ (2008) 82 Tul L Rev 1903; Jan von Hein, Die Rezeption US-amerikanischen Gesellschaftsrechts in Deutschland (2008) 313–54, 597–615; Jan von Hein, ‘Die Internationale Prospekthaftung im Lichte der Rom II-Verordnung’ in Perspektiven des Wirtschaftsrechts—Beiträge für Klaus J Hopt (2008) 371; Alexander Hellgardt and Wolf-Georg Ringe, ‘Internationale Kapitalmarkthaftung als Corporate Governance’ (2009) 173 ZHR 802; Anton K Schnyder, ‘Internationales Kapitalmarktrecht’ in Münchener Kommentar zum Bürgerlichen Gesetzbuch, vol 11 (2010) 1136.