How to view the reasonable investor under MAR?
The concept of a “reasonable investor” is the key element in determining when information is price-sensitive and inside information, the public disclosure of which is subject to the EU’s Market Abuse Regulation (“MAR”). Although the MAR has been in force already since July 2016, the definition of inside information is still causing headaches. One of the problems is that the MAR does not really define what type of an investor a “reasonable investor” is. Therefore, it is sometimes very hard for companies to determine if a certain type of information is inside information and when it should be disclosed to the public.
It is now four years since the MAR entered into force, but there is still no greater certainty on how to interpret the definition of inside information. One of the reasons is that there is no explicit rule to determine when information is sufficiently precise to be considered inside information. Another thing which is unclear is when information should be sufficiently likely to be considered price-sensitive (that is to say, material) under the MAR.
Under the MAR, the latter is to be defined by way of a so-called reasonable investor test. According to Article 7(4) price-sensitive information means information that “a reasonable investor would be likely to use as part of the basis of his or her investment decisions“. MAR recital 14 further clarifies that a reasonable investor is an investor which bases its investment decision on information already available at the time of its investment decision (i.e. on ex ante available information). However, it remains unclear what type of investor a reasonable investor is. Is it a hypothetical average investor acting in the market as suggested by some legal scholars or should we consider the reasonable investor to be something else? To fully understand the difficulty of the question, one must first consider what would be an average investor. Is it something that can be defined? Is it something that evolves over time? Are there certain types of investors that should not fall under the category of a MAR reasonable investor?
What is the average investor? What types of investors there are?
There are no answers to either of these questions– at least not very precise. According to statistics, in Finland an investor is, on average, an institutional investor. Only approximately 25 to 30 per cent of all shares in companies listed on Nasdaq Helsinki are held by private individuals (source Euroclear statistics, June 2018). The same appears to be the case in many other countries as well. However, this does not yet really tell us what information an investor would likely use as a part of the basis of his or her investment decision. This is because investors have different strategies and pursue different goals. Therefore, a piece of information that is relevant to one investor is not necessarily relevant to another investor. For instance, a long term investor is likely more interested in a company’s long term plans and leadership than an investor who holds shares only for a short period of time.
To better illustrate differences between investors and their goals and capabilities, it is worth describing some other investor types as well. For example, two investors’ needs and abilities to analyse information are likely different if we compare professional and non-professional investors. Further there are passive and active investors, long-term and short-term investors, investors who are day traders, swing traders, position traders and investors who deploy a buy-and-hold strategy, all of whom differ from each other. There are also differences in how investors take advantage (are able to take advantage) of computer programs and algorithms. The need for information of a high-frequency trader holding shares only for a very short period is completely different when compared with an investor who has a long-term investment strategy. Moreover, investors have different expectations on the returns on their investment.
“During the last 5 years or so, more and more investors have started to take into account environmental, social and governance (ESG) factors in their investment decisions.”
Although investors generally expect to receive financial returns, investors may have other goals as well. During the last 5 years or so, more and more investors have started to take into account environmental, social and governance (ESG) factors in their investment decisions. Also impact investing (i.e. investing with the intention to generate a measurable, beneficial social or environmental impact alongside a financial return) has gained ground during the past few years. Throughout history, many investors have been also guided by their religion, beliefs or moral standards meaning that not all investors invest in the so-called sin stocks (shares in companies which are involved or associated for instance with alcohol, tobacco, gambling, weapons, adult entertainment, birth control products, the meat industry etc.). History has also shown that, at different times, different types of information are relevant to investors. Whereas during Apartheid many investors boycotted South African companies, nowadays many investors avoid investing for example in companies associated with coal mining or child labour. Therefore, the materiality of certain types of information changes over time.
To sum up, investors are not a homogeneous group. Quite the contrary. Due to different strategies, abilities and goals, investors’ information needs vary. As there are no two investors alike, it is not possible to define exactly what an average investor is. It is also not possible to define what information is such that “a reasonable investor would be likely to use as part of the basis of his or her investment decision” – unless the concept of a reasonable investor under the MAR is understood as something other than the hypothetical average investor in the market, who carefully analyses all available information prior to its investment decision.
How to interpret the concept of a reasonable investor?
The concept of the reasonable investor used in the MAR has certain flaws. In addition to the inherent level of vagueness, the definition has certain theoretical issues as well. The concept of the reasonable investor is based on the assumption that, in efficient markets, each piece of new, publicly available information that an investor would use as part of the basis of his or her investment decisions would be reflected in the share price. However, the assumption does not take into account that investors have different and sometimes opposing drivers for their investment decisions. For one investor (e.g. for a high frequency trader) information on changes in the share prices may be sufficient for an investment decision while another investor may require a substantial amount of detailed financial and non-financial information before taking an investment decision. Secondly, in reality some markets are inefficient, meaning that the price formation mechanism does not function in all cases as assumed under the MAR. Thirdly, the assumption does not take into account irrational speculation, which undoubtedly has an effect on the market prices.
Then who should we consider as a reasonable investor under the MAR? In broad terms there are two major methods for investment analysis; one is fundamental analysis and the other is technical analysis. In fundamental analysis, a share’s intrinsic value is measured by examining a company’s business, financial performance (historical and expected), competitive advantages, management and other similar real-world factors (including, if relevant to the investor’s strategy, also ESG-factors). Technical analysis is an analysing methodology, which attempts to forecast a share’s future price through the study of historical market data, primarily price movements and volume. Whereas in the fundamental analysis an investor is interested in a share’s intrinsic value (“true value”), in technical analysis an investor is interested rather more on the future share price movements than a company’s performance.
Then, if we consider that the assumption under the MAR is that all material information is reflected in the share price, it seems obvious that the reasonable investor must be an investor relying on fundamental analysis rather than on technical analysis, as publicly available price information itself is not inside information within the meaning of MAR Article 7(1)). This means that material information is information that is relevant in assessing the shares’ intrinsic value.
How to define, what information is relevant?
In practice there are differences in what type of information is relevant to each company, as for instance a company’s size, business, industry, market conditions, competition and the geographical coverage of the company’s business affect what information is material. Therefore, the materiality of information must be examined individually for each company. It is also important that a company knows its investor base and their information preferences to be able to sufficiently evaluate whether a piece of information is such that a reasonable investor would use it as a part of the basis of his or her investment decisions. As a general rule, information can be however considered material at least in the following cases:
- The type of information has been considered material information or listed as an example of material information in a law or regulation, in a guideline, decision or Q&A of an authority, in the case law of the courts or by the rules or guidelines of the market place;
- Similar information has been disclosed earlier as inside information by the company or by its competitor or by a company of the same type acting in the same market;
- The type of information has been defined as material in the company’s disclosure policy; or
- The information is such that it would likely have a material effect on the share price if it would be made available to the public or if it would prematurely leak to the public.