EU-US Coalition on Financial Regulation The Transatlantic ... · Comparative Legal and Regulatory Analysis: ... Trading in equities and equity derivative securities ... France and

CCoommppaarraattiivvee LLeeggaall aanndd RReegguullaattoorryy AAnnaallyyssiiss:: VVoolluummee IIII CCoommppiilleedd bbyy

TThhee TTrraannssaattllaannttiicc DDiiaalloogguuee iinn FFiinnaanncciiaall SSeerrvviicceess::

TThhee CCaassee ffoorr RReegguullaattoorryy SSiimmpplliiffiiccaattiioonn aanndd TTrraaddiinngg EEffffiicciieennccyy

American Bankers Association Securities Assocation (ABASA)

Bankers' Association for Finance and Trade (BAFT)

British Bankers' Associaton (BBA)

Futures Industry Association (FIA)

Futures and Options Association (FOA)

Securities Industry Association (SIA)

EEUU--UUSS CCooaalliittiioonn oonn FFiinnaanncciiaall RReegguullaattiioonn

EU-US Coalition on Financial RegulationThe Transatlantic Dialogue in Financial Services:

Comparative legal and regulatory analysis of US and EU

Volume II

TABLE OF CONTENTS

Part A - Equities and equity derivatives law and regulation: comparison spanning the EU (including at Member State level: France, Germany, Spain and the UK) and the US (in respect of equities)

1. Implementation of EU financial market directives...............................................................................................................................................................................................................5

2. Equity and equity derivatives market .....................................................................................................................................................................................................................................9

3. Restrictions on trading of equities, equity derivatives and other instruments ................................................................................................................................................................39

4. Trading practices subject to regulatory review....................................................................................................................................................................................................................51

5. Trade reporting.........................................................................................................................................................................................................................................................................65

6. Client classification...................................................................................................................................................................................................................................................................74

7. Market abuse/ Insider dealing ................................................................................................................................................................................................................................................82

8. Licensing requirements............................................................................................................................................................................................................................................................95

9 Approved persons/ training and competence .....................................................................................................................................................................................................................102

10. Conduct of business rules ......................................................................................................................................................................................................................................................109

11. Redress and investor protection ...........................................................................................................................................................................................................................................138

12. Anti-money laundering ..........................................................................................................................................................................................................................................................141

13. Client assets and client money ..............................................................................................................................................................................................................................................151

Part B Equity derivatives law and regulation in the US

1. Overview................................................................................................................................................................................................................................................................. 159

2. Licensing requirements ......................................................................................................................................................................................................................................... 161

3. Client relationships: retail v. institutional clients ............................................................................................................................................................................................... 162

4. Conduct of business requirements ........................................................................................................................................................................................................................ 162

5. Trading in equities and equity derivative securities ............................................................................................................................................................................................ 164

6. Abusive trading practices ...................................................................................................................................................................................................................................... 166

7. Redress and investor protection............................................................................................................................................................................................................................ 167

8. Anti-money laundering: ........................................................................................................................................................................................................................................ 167

SCHEDULE A - Customer definitions ................................................................................................................................................................................................................................ 168

- 2 -

- 3 -

EU-US Coalition on Financial RegulationThe Transatlantic Dialogue in Financial Services:

Comparative legal and regulatory analysis of US and EU

Volume II

Part A – Equities and equity derivatives law and regulation: comparison spanning the EU (including at Member State level: France, Germany, Spain and the UK)and the US (in respect of equities)

Overview and some implications of the contents of Volume II Volume 1 of the Report sets out the reasoning of the Participating Associations for undertaking the writing of this Report. Volume 1 also contains priority areas for regulatory action and makesthe transatlantic industry case for such action to occur.

This Volume is divided into two sections. Section A addresses inter alia licensing and business conduct rules, financial promotion and solicitation, customer documentation, standards ofexecution, anti-money laundering requirements, market abuse, the handling of customer assets and the recognition of qualifications and licensing requirements for key employees in respect ofequities and equity derivatives in the UK, France, Germany and Spain (including recent EU developments) and equities in the US. Section B addresses largely the same issues as Section A, butin respect of equity derivatives in the US. We considered that a separate section to examine the position as regards regulation of equity derivatives in the US was necessary, in light of theoverlapping areas of regulation of equity derivatives' markets by the SEC and CFTC. We have included a comparison of the different definitions of "customer" used in the UK, Spain, Germany,France and in the US equity market in the schedule to this Volume.

The information contained in this Volume is derived from legal reviews conducted by Clifford Chance LLP lawyers in France, Germany, Spain, the UK and the US of inter alia EU legislativerequirements, CESR standards, national legislation and national regulatory material.

Although there is a considerable amount of information contained in this Volume II, it should be noted that the objective is only to summarise the regulatory regime applicable to wholesaleequities/equity derivatives' business in the UK, France, Germany, Spain and the US (as well as recent developments on an EU level). As such, it is not intended to be, nor should be construed as,legal advice as to the regulatory position in each of these jurisdictions. Where legal advice is required in respect of a particular "real life" matter or query, tailored advice should be sought fromlocal counsel as the relevant legal position will often depend on the specifics of the transaction/arrangements in question.

Some implications of legal and regulatory analyses in Volume IIA number of implications can be drawn out of legal and regulatory analysis. What follows is not an exhaustive list of implications. It is too ambitious to expect that a small number of people,working within the confines of a particular set of professional skills (i.e. those of a lawyer who works in an international law firm), can draw out every matter of significance from material asdeep and detailed as the reader will find in Volume II.

The underlying products are not homogenousRemarkable though it may seem, when viewed in a cross-border context, equities and equity derivatives have subtle differences as well as comforting similarities. Each country has its ownstraight-forward equity securities of major public companies located in that jurisdiction. Those securities can be bought and sold. At this point, divergences of practice or of law and regulation,start to appear.

- 4 -

Short selling of securities Spain, for example, prohibits the short selling of securities. There are restrictions on certain entities in Germany. In the first half of 2005, senior German politicians saw fit to criticise short selling as an unpleasant aspect of market based capitalism. Other countries, including the UK, periodically have concerns about the relationship between a large volume of short selling and thenumber of underlying securities available for delivery. The ability to short sell a security is a necessary tool for the bank or broker who is constructing customised equity derivatives or, indeed, engaged in trading standardised equity - related futures and or option contracts on exchange.

On exchange or off exchange? The EU Investment Services Directive ("ISD")created a choice for Member States. They are permitted to require trading in equities to take place on the national Stock Exchange. This was not mandatory and a number of countries did not follow it either because they did not wish to at that time or because they had a history of permitting trading in alternative venues. These so called concentration rules are now in the process of being twisted into different shapes by the Markets in Financial Instruments Directive ("MiFID "). The long-term consultation around MiFID continues. Due to be implemented by April 2007, MiFID contains some pre-trade transparency obligations that will affect equities in particular. A number of investment banks are deeply concerned as to the detailed implementation requirements for the MiFID concentration provisions. They are concerned about these impacting on the way in which business is currently done, in addition to being concerned as to the transitional costs associated with such revisions to existing market structure. The concentration provisions of the ISD and MiFID are not the primary focus in Volume II. It is mentioned here in the context of implications to be drawn out of Volume II because it illustrates how a range of broker dealer compliance requirements are intimately connected to the structure of, and the manner in which, business in these products is conducted.

Products at the edge of the mainstream In the UK, equity contract for differences (cash settled instruments in respect of which no delivery of underlying securities is effected) is thought to constitute a third of total UK equity trading. Driven by a desire to circumvent legitimately the circumstances in which stamp duty (a governmental tax) is levied on transfer of property, intermediaries and their most active customers have been responsible for changing the nature of trading in the mainstream equity product. Whilst a contract for differences is, taken on its own, a relatively straight forward equity derivative, there are others which are much more complex. Take, for instance, the self-referenced credit derivative. One might argue that this is not an equity derivative but its significance is sufficiently substantial for those who do hold the equity in a company or have exposure to a company's equity through other types of equity derivative, that it is worth mentioning. A self-referenced credit derivative is a bet by a company on its own future. The extent to which such transactions have been done is not clear. They raise a host of legal, regulatory and accounting questions to be resolved on each occasion when someone contemplates executing such a transaction. With their origins firmly embedded in the corporate law of each jurisdiction, it is natural that the analysis of this product becomes a country by country process.

Customer definitions for account opening and for KYC/AML due diligence requirements It is understandable that the industry is keen to see homogeneous definitions of key terms and concepts. The reality of today's position is complex and based on different starting points and thinking processes. Nowhere is this better illustrated than the context of customer definitions. In some ways this goes to the question of whether regulators and the laws which they are responsible for policing draws a distinction as fundamental as that of a professional/retail divide. Some regulatory schemes appear to draw such a distinction. Others do not. For example, the SEC regime in the US can be viewed as a "one size fits all" scheme. In practice it is not because the SEC grants exemptions and reliefs where it considers it prudent to do so. By doing this, it is able to reduce the regulatory burden on institutional business. However, as each regulatory scheme is different, the challenge for regulators to look across national borders with a view to creating similar arrangements for institutional and retail business is substantial.

- 5 -

1. Implementation of EU financial market directives

1.1 General

Much of the financial services legislation in force in EU Member States derives from common EU directives. However, national implementation of such directives has resulted in national variations as to application.

The existing timetable for national adoption (October 2006) and implementation (April 2007) of the Markets in Financial Instruments Directive ("MiFID") is considered to be more realistic than previously proposed. On a high level basis, MiFID is unlikely to materially affect large aspects of securities regulation in the four jurisdictions. Nevertheless, a substantial rewrite of national regulations (particularly as regards Conduct of Business rules) is envisaged at a more detailed level.

The Market Abuse Directive, despite officially having had to be implemented in all four jurisdictions by 12 October 2004, looks only set to be implemented in Spain in the third quarter of 2005.

1.2 Intra-country differences

United Kingdom Germany Spain France EU Developments US Equities

Investment Services Directive

The Investment Services Directive was implemented in the UK by way of statutory instrument amending the Financial Services Act 1986 (subsequently repealed and replaced by the Financial Services and Markets Act 2000 ("FSMA") and by way of amendment to the Handbooks of the former Self Regulatory Organisations, such as the Securities and Futures Association.


The Investment Services Directive was implemented by way of amendment to various laws, including the enactment of the German Securities Trading Act (Wertpapierhandelsgesetz) and the establishment of a securities regulator.


Implementation of the Investment Services Directive coincided with substantial changes to securities regulation (i.e. amendment of the Securities Market Act and enactment of a Royal Decree on the legal regime applicable to investment services companies).


The Investment Services Directive was implemented by way of a law adopted in 1996 for the more general purpose of modernising the financial industry. This law is now codified in the French Financial and Monetary Code (Code monétaire et financier, "FFMC").

Not applicable

- 6 -


(Section 1.2 continued - Implementation of EU financial market directives - Intra country differences)

MiFID

The Financial Services Authority ("FSA") intends to "copy out" MiFID, adding guidance or rules where helpful/ justifiable and avoiding gold-plating unless deemed absolutely necessary. It is envisaged that this will result in a significant rewrite of the FSA's Conduct of Business Rules.

MiFID

It is believed that banking and investment services laws and regulations will be amended as necessary in accordance with MiFID as the provisions of MiFID replicate a number of existing provisions.

MiFID

It is believed that securities regulations will be amended as necessary in accordance with MiFID as the provisions of MiFID replicate a number of existing provisions. However, there is a risk that the Spanish authorities may simply choose to replicate MiFID into Spanish law without making consequent amendments to existing regulation.

MiFID

It is believed that banking and investment services laws and regulations will be amended as necessary in accordance with MiFID as the provisions of MiFID replicate a number of existing provisions. According to a draft law currently pending before the French parliament, the French government intends to implement the directive by way of ordinances ("ordonnances").

Not applicable

Market Abuse Directive

Limited aspects of the UK implementing legislation came into force on 17 March 2005 but the main substantive changes came into force on 1 July 2005. Related changes to the FSA Handbook also came into effect on 1 July 2005.


The Directive has officially been implemented by the Investor Protection Enhancement Act (Anlegerschutzverbesserungsgesetz – "AnSVG") which amended certain capital markets and securities laws (including the Securities Trading Act) and entered into force on 30 October 2004. Three regulations have since been enacted which detail the changes made by the new Act as regards insider dealing, market manipulation and financial analysis. The Federal Financial


The Directive is unlikely to result in a substantial re-write of existing legislation and regulation.

Indeed, the Spanish Market abuse regime was imple-mented based on the anticipated form of MAD. Level 2 legislation is expected to be implemented in late 2005. In this respect, the Ministry of Economy has published a draft for a future Royal Decree that sets out (i) new definitions relating to inside


Most of the Level 1 provisions of the Directive have been implemented by the General Regulations (Règlement Général) issued by the Autorité des Marchés Financiers ("AMF") on 12 November 2004 (to which a draft amendment has recently been issued). What has not been implemented by the General Regulations either had already been implemented in the main by the so-called financial security law adopted in August 2003 (e.g. regarding the single enforcement

Not applicable

- 7 -


(Section 1.2 continued - Implementation of EU financial market directives - Market abuse directive - Intra country differences)

Supervisory Authority (Bundesanstalt fur Finanzdienstleistungsauf-sicht; "BaFin") has issued a guidance paper for issuers (Emittentenleitfaden) detailing its interpretation of the legislative changes to implement MAD.

information and market abuse; (ii) new disclosure obligations in respect of relevant information which issuers of listed securities must submit to the Spanish securities regulator (the CNMV); (iii) new disclosure requirements on directors and executives; and (iv) new rules about impartial recommendations to clients.

authority), or were recently implemented by:

�

Law no 2005-811 (20 July 2005) which aims to implement those MAD provisions relating to whistle-blowing obligations, insider lists and disclosure duties with respect to personal trading by insiders; and

By and large, the implementation appears to be consistent with the requirements of the Directive.

The focus is now on the various regulations pursuant to which the requirements of

the Investor Protection Enhancement Act are explained and implemented in further detail.

� Law no 2005-842 (26 July

2005) which includes provisions on investment recommendations made to

the public, extra-territorial

powers of the AMF and aims to bring into line the administrative and criminal definitions of insider dealing, market manipulation, and dissemination of false or misleading information with those employed in MAD.

..

By and large, the implementation of MAD appears to be consistent with the requirements of the Directive. It should be noted that the AMF has expressed concern about its lack of supervision powers in respect

- 8 -


(Section 1.2 continued - Implementation of EU financial market directives - Market abuse directive - Intra country differences)

of potential market abuse taking place on unregulated markets which are not covered by MAD.

- 9 -

2. Equity and equity derivatives market

2.1 Trading in securities vs trading in derivatives

2.1.1 General

Trading in equity derivatives may be advantageous for counterparties in comparison to trading in the underlying securities. However, consideration must be given to the voting rights which accrue to a party by virtue of his acquisition of equity derivatives in a company. Large scale transactions could cross shareholding thresholds giving rise to disclosure obligations or triggering the requirement to make mandatory offers for the company's share capital. Counterparties in complex transactions should also be aware that the use of derivatives in multi-party structured transactions could cause the regulator to aggregate holdings according to the rules on acting in concert.

2.1.2 Intra-country differences


Approximately one third ofequities trading volume inthe UK is represented bycontracts for differences("CFDs"). As CFDs areexempt from stamp duty, itis an attractive method ofacquiring economicexposure to equities.

It is thought that despitenot owning the underlyingsecurity, investors in CFDsmight be informallyendowed with the votingrights in respect of suchsecurities by the brokerholding the actual equity asa hedge of the broker'sexposure to the market.

However, publiclyavailable data on this pointis limited. This entitlementto voting rights and theincreasing influence ofCFD holders

Investors in Germany arestill more likely to trade insecurities than equityderivatives.

Although parties are morelikely to trade in securities,trading in equity futuresand options on IBEX-35 isvery popular.

The securities market isactive and dynamic inFrance, although trading(through the centralelectronic system (NSC))decreased in 2003 (878billion euros in 2003compared to 1,002 billioneuros in 2002).

Trading in equityderivatives is active inFrance and increased in2003 compared to 2002(2004 figures notavailable).

Trading in equities (bothUS and international) andequity derivatives ispopular in the US.

- 10 -


(Section 2.1.2 continued - Disclosure obligations - Intra-country differences)

has been a cause forconcern to the Panel onTakeovers and Mergerswhich has recentlyconsulted on, andproposed, variousamendments to thedisclosure requirements asregards holdings of CFDsand equity derivatives - seepage 19 below for furtherdetails of the Panel'sactivity.

Disclosure obligations:

Disclosure obligations ariseunder Part VI of theCompanies Act 1985 (the"Act") in respect ofinterests in shares in publiccompanies whetherconcluded on- or off-exchange. A distinction isdrawn in the Act betweenpersons who havenotifiable interests inshares that are "materialinterests" (e.g. voting rightsover shares) and personswho have notifiableinterests in shares that fallwithin the residual categoryof non-material interests.


The Securities Trading Actimposes disclosureobligations in respect ofinterests in German listedcompanies whose sharesare admitted to trading on astock exchange in aMember State of theEuropean Union or in acontracting state to theAgreement on theEuropean Economic Area.If voting rights in such alisted German companyreach, exceed or fall belowthe relevant thresholds of 5,10, 25, 50 or 75% both theBaFin and the companyneed to be notified.


Pursuant to article 1 ofRoyal Decree 377/91, of 15March, on significantshareholdings ("RD377/91"), when any personor group acquires ordisposes of shares in acompany listed on aSpanish Stock Exchange,and:

(i) in the case of anacquisition, suchacquisition results inthat person or groupholding 5% (orsuccessive multiplesthereof) of the sharecapital of thatcompany; or


Shareholders of listedcompanies who attain thethresholds of 5%, 10%,20%, 33.33%, 50% or66.66% must inform theAMF within five businessdays following the datewhen the threshold wasreached. In such cases, theAMF discloses suchinformation publicly bypublishing a notice in itsbulletin. In addition, anissuer may provideadditional thresholds fornotification by itsshareholders in accordancewith its bylaws, (whichmay be as low as 0.5%).


The TransparencyDirective (which is to beimplemented in EUmember states by the endof 2006) imposesdisclosure obligations onMember States in respectof shareholders whoacquire or dispose of sharesof an issuer whose sharesare admitted to trading on aregulated market and towhich voting rights areattached. Member Statesmust ensure thatshareholders notify theissuer of the proportion ofvoting rights of the issuerheld by the shareholder as aresult of the acquisition ordisposal where that


Section 13(d) of theExchange Act requires thatany person (or group) thatacquires beneficialownership of more than 5percent of a registeredcompany's equity securitiesmust file a disclosuredocument with the SEC.The filing, known as aSchedule 13D, mustdisclose:

(i) identificationinformationconcerning theacquirer and any groupmember;

(ii) the source and amountof funds for makingthe purchases;

- 11 -



Specifically the Act:

imposes an obligationon companies to giveautomatic disclosurewhen a particularpercentage holding of apublic company's"relevant share capital"is reached;

sets those percentageholdings at, broadly, 3%in respect of so-called"material interests" and10% in respect of non-material interests;

requires groupcompanies to aggregatetheir interests for thepurposes of satisfyingthe disclosurerequirements;

requires the aggregationof interests of two ormore persons whoacquire relevant sharecapital in a companypursuant to anagreement; and

This notificationrequirement appliesirrespective of whether thetransaction is concludedon- or off-exchange.

The Securities Trading Actprovides that voting rightsover shares in the listedcompany:

that belong to anundertaking controlledby the notifying party;

that belong to a thirdparty and are held bythat party for theaccount of the notifyingparty or an undertakingcontrolled by it;

that the notifying partyhas transferred assecurity to a third party,unless such third partyis authorised to exercisethe voting rights arisingfrom those shares andstates its intention ofdoing so;

in which a usufruct(right to use and deriveincome from the shares)is created in favour ofthe notifying party;

(ii) in the case of adisposal, such disposaltakes any existingholding of that personor group below athreshold of 5% (orsuccessive multiplesthereof) of the sharecapital.

The company whose sharesare affected, the CNMVand the governing body ofeach Spanish StockExchange on which thecompany is listed must benotified of such acquisitionor disposal (within sevenbusiness days following thedate of the agreement).

The percentages in (i) and(ii) above are both 1%, orits successive multiples, ifthe acquirer (or a personacting on its behalf) isresident in a tax haven or ina country that does nothave a securities marketssupervisory body or, if ithas such a supervisorybody, where that body doesnot exchange informationwith the CNMV.

Any acquirer of 10% or20% or more of the votingrights or capital of a listedcompany must file a noticedisclosing its futureintentions in respect ofsuch shareholding. Suchnotice must be filed withthe AMF and the issuer.Regulations for filingdeadlines are the same asthose governing ownershipnotification (as discussedabove). The notice ofintent is then made publicby the AMF and by a pressrelease published by theacquirer. The notice muststate whether or not theacquirer intends, within aperiod of twelve months,to:

(i) continue buying shares;

(ii) acquire control overthe issuer; or (iii)request a seat on theissuer's Board ofDirectors, Directorateor Supervisory Board.

The notice must alsodisclose whether theacquirer is acting alone orin concert with otherpersons.

proportion reaches, exceedsor falls below thethresholds of 5%, 10%,15%, 20%, 25%, 30% (orone-third), 35%, 50% and75% (or two-thirds).

Certain exemptions applyin respect of custodians,market makers and sharesacquired for the solepurpose of clearing andsettling within the usualshort settlement cycle.

By virtue of Article 10,these notificationrequirements shall alsoapply to a natural person orlegal entity to the extent itis entitled to acquire,dispose of, or exercisevoting rights in certaincases (e.g. parties acting inconcert; shares held ascollateral where the holderhas the right andinformation to exercise thevoting rights; holdings ofequity derivatives whichgive rise to voting rights).

Article 12 of theTransparency Directive setsout the information thenotifications shouldinclude:

(iii) the number of thetarget's shares held bythe acquirer;

(iv) any arrangements thatthe acquirer has withothers concerningshares of the target;and

(v) the acquirer's purposesfor the acquisition andhis intentions withrespect to the target.

Any tender offer for aregistered company's equitysecurities that would resultin the bidder holding morethan 5 percent of thetarget's securities is subjectto disclosure requirementsunder Section 14(d) of theExchange Act.

Depending on the activitiesconducted by the issuer,acquisitions of more than 5percent of an issuer's votingsecurities by a BHC (ornonbank affiliate thereof)may be subject to theFederal Reserve Board'sprior approval under theBank Holding CompanyAct.

imposes an obligationon companies to makedisclosure in response toan enquiry made by thepublic company

- 12 -



1 Recent case law has defined what might constitute "acting in concert" in the context of takeovers of listed companies (see below). However, these decisions have also an impact on the

interpretation of "acting in concert" in the context of the notification and disclosure requirements in the event of changes in the percentage of voting rights held in listed companies pursuant to

sections 21 et seq. of the Securities Trading Act, in particular with respect to the calculation and attribution of voting rights.

concerned (but with nopercentage thresholdrequired).

A person is deemed to havean interest in shares where

in respect of which thenotifying party or anundertaking controlled by itmay demand a transfer of title;

RD 377/91 provides for theaggregation of shares in thecase of (i) group companies(in which case the abovenotifications will have to bemade by the parentcompany) and (ii)

Any agreement betweenthe shareholders of thetarget (or any personsacting in concert withthem) that may affect the

(a) the resulting situationin terms of votingrights;

For these purposes,interests that areimmediately convertible

he enters into a contract fortheir purchase; or, notbeing the registered holder,he is entitled to exerciseany right conferred by theholding of the shares or isentitled to control theexercise of any such right;or he has a right to call fordelivery of the shares; or hehas a right to acquire aninterest in shares or isunder an obligation to takean interest in shares.

Therefore, where a CFDholder is entitled toexercise voting rights inrespect of shares, he will bedeemed to have an interestin such shares and,therefore, an obligation tomake disclosures under theAct. Likewise, the holding

that are entrusted to thenotifying party forsafekeeping insofar as itmay exercise the votingrights arising therefromat its own discretion inthe absence of specialinstructions from theshareholder; and

that belong to a thirdparty with whom thenotifying party or anundertaking controlledby it has concluded anagreement committingboth parties to pursuelong term commonobjectives in respect ofthe management of thelisted company byexercising their votingrights in concert1

are attributed to the notifyingparty.

shareholders' agreementswith regard to the exerciseof voting rights "inconcert". Disclosureobligations also arise whenthe above thresholds arereached when actingthrough an intermediary oragent. For these purposes,Spanish law presumes thata holder is acting as anintermediary or agent ofanother when the lattercovers totally or partiallythe financial risks ofacquiring or transferringthe shares.

The acquisition by foreignentities of shares in Spanishcompanies (whether listedor unlisted) must bereported for statisticalpurposes to the General

shareholders' decision orthe outcome of the offerentered into must bedisclosed immediately tothe companies involvedand the AMF. This wouldcover arrangementsbetween the target'sshareholders and a whiteknight, a new shareholders'agreement and agreementsconcerning key assets ofthe target. Agreements ofthis type must also bedisclosed to the publicthrough press releasespublished in at least onefinancial daily newspaperwith a national circulation.

The disclosure obligationsset out above applyregardless of how theshares are acquired (i.e.regardless of the thresholdacquired).

(b) the chain of controlledundertakings throughwhich voting rights areeffectively held, ifapplicable;

(c) the date on which thethreshold was reachedor crossed; and

(d) the identity of theshareholder, even ifthat shareholder is notentitled to exercisevoting rights under theconditions laid downin Article 10, and ofthe natural person orlegal entity entitled toexercise voting rightson behalf of thatshareholder. CESRhas drawn up astandard form to beused by an investorwhen notifying therequired information.

into voting securities at theoption of the holder aredeemed to be votingsecurities.

In lieu of Schedule 13D, ashort-form statement onSchedule 13G may be filedin certain circumstances,pursuant to Section 13(g)of the Exchange Act andRule 13d-1 promulgatedthereto. Schedule 13G maybe used by three categoriesof certain beneficial ownerswhose ownership positionexceeds 5%, but is less than20%, of a given class ofequity securities. The threecategories are: (1) certaintypes of institutionalinvestors, (2) passiveinvestors, and (3) certainexempt persons.Institutional investors andpassive investors mustcertify that the securitieswere not acquired with the

- 13 -



of future or optioncontracts where the holderhas a right to call fordelivery of the shares; orhas a right to acquire aninterest in shares or isunder an obligation to takean interest in shares givesrise to disclosurerequirements.

Disclosure obligations alsoexist in the UK in respectof takeovers of companies:

� the SubstantialAcquisition Rules applyto transactions in sharesof listed companies oncea holding of shares orrights over shares(including options oragreements to acquireand receipt ofirrevocablecommitments) reach anaggregate of 15% of thevoting rights. Wheretwo or more persons actby agreement orunderstanding in theacquisition of sharescarrying voting rights,or rights over suchshares, their holdingsand acquisitions requireto be aggregated and are

With respect to options,voting rights will only beattributed to the optionholder if the option grantsthe right to demand a directtransfer of title (instead ofmerely granting the optionholder the right to buy therespective securities).

In addition to the SecuritiesTrading Act, there areadditional disclosureobligations such asdisclosure obligationspursuant to corporate lawand supervisory law. Inparticular, the acquisitionof a qualified participationinterest (bedeutendeBeteiligung) in a credit orfinancial servicesinstitution or in a directinsurance company triggersdisclosure obligationsunder the German BankingAct (Kreditwesengesetz)and the InsuranceSupervisory Act(Versicherungsaufsichtsgesetz) respectively.

In this regard, a qualifiedparticipation interest isdeemed to exist if at least10 % of the capital of orthe voting rights in an

Directorate of Commerceand Investments (DireccionGeneral de Comercio eInversiones) of theMinistry of Economy andFinance.

Finally, disclosureobligations and restrictionsmay also arise inconnection with theacquisition or disposal ofshares in certain regulatedcompanies (whether listedor unlisted) such as utilitiescompanies, credit entities,investment servicescompanies and insurancecompanies.

Any person or institutionintending to acquire,directly or indirectly, asignificant shareholding ina Spanish credit institutionor investment firm isrequired to give priornotice to the Bank of Spain.

purpose or effect ofchanging or influencingcontrol of the issuer. Forinstitutional investors andexempt persons, Schedule13G must be filed within45 days after the calendaryear end where thebeneficial ownershipexceeds 5%. However,institutional investorswhose beneficial ownershipexceeds 10%, must file theinitial Schedule 10G within10 days after the end of thefirst month in whichbeneficial ownershipexceeds 10%. For passiveinvestors, Schedule 10Gmust be filed within 10days after the acquisition ofthe securities. Schedule13G must disclose (1)identification informationconcerning the acquirer andany group member, and (2)the number and descriptionof the shares, and thenature of the acquirer'sinterest. Securities futures(i.e. single stock futuresand narrow based stockindex futures) areconsidered equity securitiesso the notificationsrequirements listed above

- 14 -



treated as a holding oracquisition by oneperson.

The Takeover Code alsorequires disclosuresduring any "offer

enterprise are held directlyor indirectly through one ormore subsidiaries.

Specifically, the BankingAct:

� requires anyoneintending to acquire aqualified participationinterest in a creditinstitution to report thisfact without delay toboth the BaFin and theDeutsche Bundesbank;

�

requires the holder of aqualified participationinterest to notify the

are applicable to them also.Broad-based stock indexfutures are not subject tothe notificationrequirements.

period" of dealings(including the change inownership of shares; thetaking, granting orexercise of options; andthe acquisition of,entering into, closingout, exercise of anyrights under, or avariation of a derivativereferenced to therelevant shares)however small thedealings.

BaFin and the DeutscheBundesbank without;delay of the intention toincrease the amount ofthe qualifiedparticipation interest insuch a way that thethresholds of 20%, 33%or 50% of the votingrights or capital of theentity concerned arereached or exceeded orthat the institutioncomes under its control.

� requires the holder of aqualified participationinterest to notify the

•

•

•

•

- 15 -



FSMA requires persons(as well as the targetregulated entity) togenerally obtain theFSA's prior approvalwhen they intend toacquire in a FSMA-regulated business: 10%or more of the shares inthe target (or its parent);exercise significantinfluence over themanagement of thetarget through theirproposed shareholdingin the target (or itsparent); are entitled toexercise, or control theexercise of, 10% ormore of the votingpower in the target (orits parent). The above

requirements will generally also applywhere the person inquestion ceases to havesuch control and where the existing controllerincreases or decreases their control so that thepercentage of shares orvoting power concernedbecomes or ceases to beequal to or greater than 20,33 or 50%. Persons arerequired to aggregate their

BaFin and the DeutscheBundesbank of theintention (i) torelinquish a qualifiedparticipation interest inan institution or(ii) to reduce the amountof the qualifiedparticipation interestbelow the thresholds of20%, 33% or 50% of thevoting rights or of thecapital of the entityconcerned or (iii) tochange the participationinterest in such a waythat the institution is nolonger a controlledenterprise.

The Insurance SupervisoryAct contains similarprovisions with respect todirect insurance companies.

Following the launch of amandatory take-over bid(see below), the bidder isobliged to publish and tonotify the BaFin of the totalnumber of securities of thetarget company to whichthe bidder, the personsacting in concert with itand subsidiaries of thebidder are entitled,including the number and

•

- 16 -


(Section 2.1.2 continued - Disclosure Obligations - Intra-country differences)

holdings/voting rights in targets and parents in much the same manner as under the Companies Act 1985 in order to

control thresholds arecrossed.

proportion of voting rightsto which it is entitled andwhich are attributable to it,as well as the number ofsecurities subject to theoffer (including the numberand proportion of securitiesand voting rights) inrespect of which it hasreceived declarations ofacceptance.

Obligation to launch amandatory take-over bid:

The Takeover Code alsorequires that when a personacquires, whether by aseries of transactions over aperiod of time or not,shares which (takentogether with shares held oracquired by persons actingin concert with him) carry30% or more of the votingrights of a company, ageneral cash offer must bemade to all shareholders.

So called "Rule 9 offers"must be in cash, or beaccompanied by a full cashalternative, at not less thanthe highest price paid bythe offeror or any of itsconcert parties in thepreceding 12 months. The


Under the Takeover Act,with respect to Germanstock corporations, amandatory takeover offerhas to be published if ashareholder has eitherdirectly or indirectly gainedcontrol over a Germanstock corporation whoseshares are admitted totrading on an organisedmarket.

German law assumes thatcontrol is established assoon as a shareholder holds30% or more of the votingrights in the targetcompany.

In certain cases (forexample, if the shares in

Obligation to launch a

Pursuant to Article 1 of theRoyal Decree 1197/1991,of 26 July, on theregulation of take-over bids("RD on Take-over Bids"), any offeror intending to acquire sharesof a target company listedon the Spanish StockExchange (or any othersecurities such as pre-emptive rights, convertiblebonds, warrants or similarinstruments directly orindirectly entitling theholder to subscribe for oracquire such shares) that,together with their existingshareholding, gives rise toa "significant shareholding"in the voting capital of thecompany is required to


Once an acquirer (orseveral acquirers acting inconcert) holds one-third ofthe shares or voting rightsof a French listed company,it must immediately informthe AMF and commence atender offer unless anexemption is granted by theAMF in this regard.

Failure to do so results inthe automatic loss of votingrights held in excess of theone-third threshold.

The mandatory offerrequirement may resultfrom all types oftransactions such as the on-exchange acquisition ofsecurities or through a


There are no mandatoryobligations to launch atake-over bid under U.S.federal law based on one'spercentage shareholding orotherwise.

mandatory take-over bid:

determine whether the

- 17 -



2 Persons are acting in concert when they have concluded an agreement with a view to acquiring or transferring voting rights or with a view to exercising voting rights to implement a common policy vis-a-vis the target company.

offer can only beconditional on the offeroracquiring shares carryingmore than 50% of thevoting rights. This leavesopen the possibility of anofferor receivinginsufficient acceptances toenable it to acquire theminority compulsorily(which requires 90% of thevoting rights). The Codealso provides thatacquisitions of sharesshould not be made whichwould trigger Rule 9 if the

on any other conditions, forexample, shareholderapproval.

The notes to Rule 9 of theCode state that the primeresponsibility for makingan offer under Rule 9normally attaches to theperson who makes theacquisition that imposes theobligation to make theoffer. However, the Codegoes on to say that if suchperson is not a principalmember of the group actingin concert, the obligation to

the target company belongto a subsidiary of a bidder,if they belong to a thirdparty that holds the sharesfor the account of thebidder or if the bidder hastransferred the shares to athird party as collateral(unless the third party isauthorised to exercise thevoting rights attaching tosuch shares and shows anintention to exercise suchvoting rights independentlyof the instructions of thebidder)), voting rightsattaching to shares in thetarget are attributed to thebidder.

Voting rights attaching toshares in the targetcompany and belonging toa third party with whom thebidder or its subsidiarycoordinates its conduct inrespect of the targetcompany on the basis of anagreement or otherwise areattributed in full to thebidder. Such voting rightswill be attributed to boththe bidder and the thirdparty since "double

launch a mandatorytakeover bid for thecompany in question.

For the purposes of the RDon Take-over Bids, a"significant shareholding"generally means anyshareholding representing apercentage equal to orhigher than 25 or 50% ofthe share capital of thetarget company, as the casemay be.

However, lowerpercentages may triggerdisclosure where suchshare capital gives rise tosignificant rights as regardsthe appointment ofdirectors.

The launch of a take-overbid is mandatory: - andmust be made over sharesrepresenting at least 10% ofthe target company:

(i) where the offerorintends to reach a stakethat is equal to orhigher than 25% of theshare capital of thetarget company; or

block trade, the acquisitionof double voting rights(resulting from the lapse ofthe two-year ownershipwaiting period), thesubscription to newlyissued securities, mergersor contributions of assets inexchange for shares.

The mandatory offer may

resulting in an action inconcert2 among partieswhich together hold one-third of the shares or votingrights, even if the enteringinto of such an agreementis not coupled with anyacquisition of securities(subject to an exemption).

In a mandatory offer, theacquirer cannot make itsoffer conditional on thetender or exchange of aspecified minimum numberof shares and is hencebound to purchase allshares tendered, whateverthe result of its offer is.

An acquirer (acting aloneor in concert with otherparties) whose holdings are

even result from the mere entering into of an agreement

`

- 18 -



make an offer may attachto the principal member ormembers of the groupacting in concert. Thiscould include a member ofthe group who, at the timewhen the obligation arisesdoes not hold any shares.

A group of companies willneed to aggregate allholdings across the groupfor Rule 9 purposes unlessthe Panel grant adispensation from the

counting" is not prohibited.Agreements on the exerciseof voting rights inindividual cases, however,will not be attributed to thebidder.

Recently, the BaFin and theRegional Appellate CourtFrankfurt(OberlandesgerichtFrankfurt am Main) havedefined what mightconstitute "acting inconcert".

(ii) where a stake in thetarget company equalto or higher than 25%of its share capital, butlower than 50%, isalready held by theofferor and the offerorintends to increase thisstake by at least 6%within a period of 12months; or

(iii) where the offerorintends to acquire a

already between one-thirdand one-half of the sharesor voting rights of thetarget company is alsorequired to make an offer ifit increases its holdings by2% or more during anyone-year period, or if itbecomes the majorityholder of the company'sshares or voting rights.

Acquirers subject to thisprovision must report allchanges in the number ofshares or voting rights heldrequirement to aggregate

holdings. Large groups ofcompanies therefore put inplace procedures tomonitor on a continuingbasis all holdings in UKlisted companies in order toensure Rule 9 is nottriggered or inadvertentlybreached.

The above requirements(both those relating toreporting of significantshareholdings and theobligation to launch a take-

According to the BaFin, thesimultaneous acquisition ofshares in a company byseveral buyers might beconsidered as "acting inconcert" and, hence,require a takeover bidprovided that the buyershave coordinated hepurchase with regard topreviously specified mutualstrategic objectives such asa lasting influence on thecorporate management ofthe company or the

stake which is lowerthan 25% of the sharecapital of the targetcompany and suchstake is to allow theofferor to appointdirectors representingmore than 1/3 but lessthan half plus one ofthe total directors of thetarget company.

− and must be made overshares representing100% of the targetcompany:

to the AMF.

The General Regulationsinclude a provisionimposing a mandatory offerwhen an acquirer takescontrol of a company(whether publicly traded ornot) (the "acquiredcompany") which holdsone-third or more of theshares or voting rights of alisted company, providedthat this stake can be seenas a substantial portion of

3

2 In October 2003, Allianz AG sold a block of shares in Beiersdorf AG to three buyers (inter alia, Tchibo Holding AG). Voting rights attaching to the shares amounted to 32.6% of the voting

rights. Following the acquisition, the BaFin investigated whether the buyers had acted in concert.

- 19 -



over bid) may have animpact on holders of equityderivatives and CFDswhere their holdings giverise to voting rights and/ortitle to the underlyingshares.

It should be noted that theTakeover Panel hasproposed extending theapplication of the TakeoverCode to interests inderivatives and CFDswhich do not give rise tovoting rights and/or title tothe underlying shares butwhere effective control inthe underlying sharespasses to the CFD holderwith effect from November2005.

The current rule 8.3 of theCode requires thosecontrolling more than oneper cent of the equity orother relevant securities ofa target company topublicly disclose suchholding.

intention to secure theeconomic future of acertain location of thecompany). In the so-calledTchibo-case2, the BaFincould not establish proof ofsuch a coordinatedapproach by the bidders.

The Pixelpark ruling of theRegional Appellate Courtof Frankfurt 4

(OberlandesgerichtFrankfurt am Main) on 25June 2004 is the first courtdecision on theinterpretation of "acting inconcert". The court rejecteda broad interpretation of therelevant provisions by theBaFin and emphasised that"acting in concert" requirescontinuous cooperation ofthe shareholders based on aprevious arrangement. Inaddition to the coordinatedacquisition of shares in acompany, the acquirershave to make arrangementsas to the exercise of theirvoting rights in order to

(i) where the offerorintends to reach a stakewhich is equal to orhigher than 50% of theshare capital of thetarget company; and/or

(ii) where the offerorintends to acquire astake which is lowerthan 50% of the sharecapital of the targetcompany but such stakeis to allow the offerorto appoint directorsrepresenting more than1/2 of the totaldirectors of the targetcompany.

Shares or other securitiesowned or acquired bycompanies belonging to thesame group, by members oftheir boards of directorsand by any other personsacting in their own namebut for the account of, or inconcert with, the offerorshall be deemed to beowned or acquired by theofferor.

the assets of the acquiredcompany.

The rules also apply whena group of acquirers actingin concert holds more than50% of the capital orvoting rights of theacquired company evenwhere none of the acquirersalone controls the acquiredcompany.

The above requirements(both those relating toreporting of significantshareholdings and theobligation to launch a take-over bid) may have animpact on holders of equityderivatives where theirholdings give rise to votingrights (and/or title to theunderlying shares).

4 Two shareholders each acquired 20% in the target. Both shareholders supported a joint strategy paper concerning the restructuring of the target, but the BaFin did not succeed in proving any coordination of their conduct).

- 20 -



Under the newly proposedregime, this will beextended to includedisclosure requirements inrespect of derivatives sothat individuals withaggregate gross longpositions of more than oneper cent in relevantsecurities are required todisclose all dealings in suchderivatives.

Under the proposed newrule 8.3, cash positions, calloptions, written putoptions, long derivativesand general control of allvoting rights would allqualify as long positions.The position will becalculated on an aggregatedgross basis, regardless ofwhether it is in or out of themoney and whether there isnetting off with a shortposition. There would beno disclosure requirementunder this regime if theonly position held is short.

achieve a previouslyspecified mutual objective.In contrast, coincidental(and unconscious) "parallelbehaviour" is not sufficient.

The above requirements(both those relating toreporting of significantshareholdings and theobligation to launch a take-over bid) may have animpact on holders of equityderivatives where theirholdings give rise to votingrights (and/or title to theunderlying shares).

- 21 -

2.2 Entities dealing in equity derivatives

2.2.1 General

The entities most active in the European equity derivative market tend to be banks.



The market is dominated by banks and investment banks

German universal banks and US investment banks dominate the German equity derivatives market

Universal local banks are the main players in the market.

The market is dominated by banks

The equity derivatives markets in the United States are generally dominated by commercial and investment banks.

- 22 -

2.3 Regulatory Profile

2.3.1 General

The hierarchy of regulation and the documentation containing the rules of each regime is different across the jurisdictions.



Hierarchy: Primary Legislation Secondary Legislation FSA Handbook

Hierarchy: Laws Regulations Leaflets/Circulars/Notes

Hierarchy: Laws (Parliament) Royal Decrees (Cabinet) Orders (Minister of Economy and Finance) Circulars (Bank of Spain/CNMV)

Hierarchy: Laws Regulations ("réglement") Ordinances ("ordonnances")

Although one of the primary aims of MiFID is to establish a comprehensive regulatory regime governing the execution of transactions in financial instruments throughout the European Union, this is to be achieved through regulatory bodies in each of the Member States.

The Securities and Exchange Commission ("SEC") is a bipartisan, US federal agency under the Executive branch of the US government charged with administering and enforcing the US federal securities laws.

The FSA Handbook is divided into a number of blocks:

(a) High level standards; (b) Business standards; (c) Regulatory processes; (d) Redress; and (e) Specialist sourcebooks.

Regulations and ordinances are pieces of delegated legislation. The German Banking Act (Kreditwesengesetz) for example enables the Federal Ministry of Finance to make delegated legislation in the field of banking supervision (the Ministry may also, where permitted, sub-delegate its powers to the BaFin).

Circulars issued by the Bank of Spain and CNMV set out the technical rules of the regulatory regime. The Bank of Spain also issues guidance notes, most of which are issued in reply to consultations by CECA (the association of Spanish savings banks) and AEB (the Spanish private banking association).

Decrees AMF Regulations AMF guidelines ("instructions") AMF recommendations

In addition to the AMF, other regulators will continue to be in charge of supervising providers of investment services further to the implementation of MiFID.

Article 48 states that each Member State is to designate the competent authorities to carry out each of the duties provided for under MiFID. Provided that all supervisory requirements of MiFID are met, Member States are free to organise their internal systems as they so wish. Therefore, whilst MiFID will undoubtedly increase the uniformity of securities regulation in Member States, the regulatory profile, as discussed in this table, is unlikely to change materially in each of the four countries.

The SEC is authorised to oversee the US securities markets, exchanges and over-the-counter markets and industry participants. The SEC handles its broad mandate by regulating, to a large extent, through a public-private partnership with private membership organisations ("self regulatory organisations "or "SROs").

- 23 -


(Section 2.3.2 continued - Entities dealing in equity derivatives - Hierarchy of regulation)

The high level standards include 11 Principles for Business which form the basis for all other rules in the FSA Handbook. Other relevant high level standards include Senior Management Arrangements, Systems and Controls. Business standards include the prudential requirements for authorised firms; Conduct of Business rules; Client Asset rules; the Code of Market Conduct and money laundering requirements.

The circulars and notes that are published by the BaFin provide guidance on the likely regulatory treatment of certain matters. Even though these publications are technically not binding, public confidence in the continuity of the administrative practices of the BaFin is protected to a certain extent by their publication. Such continuity of application is required by the principle of "equal treatment" under the German constitution.

From 1996 to 2000, the CNMV issued a number of no-action letters (cartas circulares) which reflected the criteria applied by the CNMV in respect of certain issues at the time such letters were issued. In 2001 all the no-action letters then outstanding were abrogated, although the criteria set out in some such letters are in practice still applied by the CNMV.

The reason why several regulators are, and will continue to be, in charge of supervising providers of investment services lies with the fact that in France, since the implementation of the first Investment Services Directive in 1996, there have been two different categories of providers of investment services in France: investment firms and credit institutions. For example, the licensing and passport procedures are split between the Comité des Etablissements de Crédit et des Entreprises d'Investissement and the AMF.

The SEC takes responsibility for the "big picture" areas, while much of the direct, day-to-day regulation of securities market participants is done by firms themselves and by the SROs. The principal securities regulatory entities in the United States are the National Association of Securities Dealers Inc. ("NASD"), the Municipal Securities Rule Making Board ("MSRB") and the major stock exchanges, such as the New York Stock Exchange ("NYSE").

Regulatory Processes govern the authorisation and supervision of authorised firms and any enforcement action that is required against them. Redress concerns the complaints procedures and compensation arrangements that authorised firms and the FSA must have in place. The Handbook contains rules, guidance and evidentialprovisions. Breach of FSA Handbook provisions does not amount to a breach of UK laws but can give rise to administrative sanctions from the FSA.

There are no high level standards, such as the FSA's Principles for Business, issued by the BaFin. However, the BaFin has published a number of statements covering minimum requirements on, for example trading activities, lending business and internal audit. These statements have to be observed by all credit institutions (whilst financial services institutions/ investment firms are expected to observe these requirements to the extent

Notwithstanding the above, the Council of the CNMV issued new no-action letters in September 2003 and March 2005 reflecting their interpretation in connection with two particular issues. This would appear to suggest that, where appropriate, the CNMV will continue to use no-action letters.

The SEC exercises its jurisdiction over securities. Securities include, amongst other things, notes, stocks, shares, bonds, debentures, evidence of indebtedness, certificates of interest and participation in profit-sharing arrangements. The primary laws, rules and regulations governing the equities market are: (1) The Securities Act of 1933 and rules promulgated thereunder;

- 24 -



applicable to their business activities).

(2) the Securities Exchange Act of 1934 and rules promulgated thereunder;

(3) SRO rules (each of which

is approved by the SEC); and

(4) interpretative guidance, including no-action letters.

In the course of implementation of the requirements of pillar II of Basel II, the current statements will be consolidated into one statement on Minimum Requirements for Risk Management that will apply to credit institutions and financial services institutions.

The SEC manifests its control over public offers and private placements of securities, exempt securities and exempt transactions under the Securities Act of 1933 ("Securities Act"); secondary market activities under the Securities Exchange Act of 1934 ("Exchange Act"); the packaging of securities in the guise of mutual funds and investment companies under the Investment Company Act of 1940 ("Investment Company Act "); and advice on securities, including registered investment companies and other collective investment vehicles, via the Investment Advisers Act of 1940 ("Advisers Act ").

Federal regulation of public securities offerings, broker-dealers, and investment

- 25 -



advisors operates in tandem with parallel state regulations.

Unlike federal securities laws, however, securities laws in many states regulate the merits of particular offerings by empowering state officials to decide on whether the offering is deserving of the attention of investors in the state ("merit regulation"). In contrast, state securities laws do not attempt to regulate securities exchangesor other interstate trading markets, or to regulate disclosures by public companies in connection withshareholder trading or voting.

There are no high level standards issued by the SEC, the NASD, however, each regulator actively publishes proposed rules, interpretative guidance, and other materials

to assist regulated entities in meeting their regulatoryobligations.

These materials include, but are not limited to, no-action

- 26 -



letters issued by the SEC, NASD Notices to Members and regulatory compliance alerts, and NYSE Information Memoranda.

An SEC no-action letter, while not a legal precedent per se, is generally used by the SEC as a mechanism to provide regulatory guidance to regulated firms on issues of common interest. There is joint jurisdiction by the Commodities Futures Trading Commission ("CFTC ") and the SEC of the trading of futures on single securities and on narrow based security indexes collectively. "Security Futures Products). Broad-based security index futures, which are not considered Security Futures Products, trade under the sole jurisdiction of the CFTC.

In addition, the National Futures Association ("NFA"), an SRO, and the commodity exchanges regulate trading of broad-based security index futures, while the NFA and commodity exchanges and the NASD and stock exchanges regulate the trading

of Security Futures Products.

- 27 -



Documentation: The FSA publishes and continually updates a Handbook detailing all of the above regulation. An interactive version of the Handbook is also available on the FSA's website, along with electronic versions of the FSA's latest Publications, Consumer Information and various FSA registers.

Documentation:

The BaFin does not issue a comprehensive regulatory handbook. However, the relevant German laws and regulations as well as the BaFin's official announcements can be found on the BaFin's website.

Documentation: In 2000, the CNMV issued a handbook that contains relevant Spanish laws and regulations and a number of important circulars. No comprehensive handbook exists. However, most CNMV and Bank of Spain publications and applicable regulations can be found on the CNMV and Bank of Spain websites.

Documentation: In 2004, the AMF enacted its General Regulations, which are available online on its internet website.

The AMF does not issue a comprehensive regulatory handbook, although its AMF General Regulations contain most of the applicable rules. The relevant French laws and regulations in addition to the AMF's official announcements can be found on the AMF's website.

Documentation: The SEC does not issue a comprehensive regulatory handbook, but the Securities Exchange Act, Securities Act and related rules and regulations can be accessed through links on its webpage, www.sec.gov. SEC Divisions also publish "bulletins", "no-action" letters", "concept releases, and other interpretative guidance that is available through its website.

In addition, both the NASD and the NYSE maintain active websites containing, among other things, each SRO's rules and regulations, enforcement cases and interpretative materials. The NASD regularly publishes "Notice to Members" that contain NASD guidance on rule filings, issues impacting the securities industry and other regulatory matters.

- 28 -



The CFTC does not issue a comprehensive regulatory handbook but the Commodity Exchange Act and related rules can be accessed through links on its webpage, www.cftc.gov

The NFA publishes and continually updates a manual detailing its compliance rules. An interactive version of the manual is also available on the NFA's website, www.nfa.futures.org

- 29 -

2.4 Role of Exchanges

2.4.1 General

The regulatory role of exchanges is effectively limited to maintaining and improving market integrity and the proper functioning of the exchange in the UK, Spain, Germany or France. However, exchanges in the US perform an important regulatory role.



In the UK exchanges play a distinct role from that of the FSA. Rather than regulating member firms (which is the domain of the FSA - see below) exchanges are concerned with maintaining and improving market integrity and the proper functioning of the exchange. Exchanges also undertake some administrative functions such as the admission to trading of securities (in addition to the admission to listing by the UK Listing Authority - a division of the FSA).

Each exchange maintains a self-regulatory body (the Trading Surveillance Office (Handelsuberwachungsstelle - (" HUST ") which supervises trading and settlement.

....

In Spain exchanges play a distinct role from that of the CNMV.

In France, exchanges regulate their members and the financial instruments admitted to trading.

Article 36 of MiFID provides for Member States to authorise exchanges in their jurisdiction as regulated markets operating under the governing law of the Member State.

Exchanges in the US perform an important regulatory role along with the likes of the SEC, CFTC etc.

The FSA's Enforcement Division investigates when firms admitted to an exchange breach FSA rules. The FSA may take the following action:

withdrawing a firm's authorisation;

Trading on each exchange is also supervised by the competent Exchange Supervisory Authority (Borsenaufsichtsbehorde) of the respective German federal state in which the exchange is located. The Exchange Supervisory Authority may give instructions to the HUST and assume jurisdiction in respect of any particular matter.

On a federal level exchange supervision is also performed, to a certain extent, by the BaFin. For example, the BaFin investigates and examines possible violations of insider trading prohibitions and

.. ..

..

Exchanges' powers are generally limited to the control of internal matters and the organisation and functioning of the exchange, but they can also request the CNMV to suspend membership of those members who breach payment obligations.

Exchanges also undertake some administrative functions such as the admission to listing of securities (in addition to the verification of such listing by the CNMV) and approval of certain transactions which fall outside of legally acceptable thresholds.

Exchanges are regulated by French authorities (e.g. their governing rules are approved by the AMF), to the extent that they are "regulated markets" within the meaning of the FFMC, or to the extent that they provide regulated services.

The French authorities are in charge of protecting investors and financial markets, and share these goals with exchanges.

Member States must require the operator of the regulated market to perform tasks relating to the organisation and operation of the regulated market (e.g. access to or membership of the regulated market and removal and suspension of instruments from trading) under the supervision of the Member State's competent authority.

Member States must also ensure that competent authorities regularly review the compliance of regulated markets with the provisions of MiFID.

In the US, the SEC oversees exchanges under the broad authority of the Exchange Act. Section 3(a)(26) of the Exchange Act requires exchanges to be self-regulatory organisations. Thus, exchanges possess the advantage of being their own rulemakers and fee-setters (subject to SEC approval), rather than being subject to the authority of other SROs.

Among the characteristics of Exchange regulation as set forth generally in Section 6 of the Exchange Act are:

- 30 -


(Section 2.4.2 continued - Role of exchanges - Intra-country differences)

disciplining authorised firms and people approved by the FSA to work in those firms;

imposing penalties for market abuse;

applying to the Court for injunction and restitution orders; and

prosecuting various offences.

FSMA also gives the FSA powers to take action under the insider dealing provisions of the Criminal Justice Act 1993 and the Money Laundering Regulations 1993.

disclosure obligations as well as any market manipulation activities.

Various provisions of MiFID (e.g. Articles 26(2) and 41) also recognise that competent authorities will remain primarily responsible for the investigation and prosecution of incidents of market abuse.

In order to perform all the above activities, the FSA necessarily retains a close working relationship with exchanges allowing for the sharing of information as appropriate.

Prior to their publication, prospectuses for securities that were offered to the public in Germany previously had to be approved by either the Board of Admission of the competent exchange (if admission to trading on the exchange or regulated market has been sought) or otherwise by the BaFin.

The CNMV is, however, in charge of supervising and inspecting the Spanish stock markets and the activities of all the participants in those markets.

For example, exchanges very

often provide for conduct of business rules reflective of those conduct of business rules issued by the French authorities.

As a result of the above, it is clear that exchanges will continue to only have a limited regulatory role under MiFID and that primary regulatory responsibility will continue to rest with the competent authorities in the relevant Member States.

However, it should be noted that recent integration of European exchanges has, from the perspective of traders, helped to unify the European markets.

For example, the establishment of Euronext (through the merger of the Amsterdam, Brussels, Paris and Portuguese securities markets, as well as the

Self-Regulation. An exchange must demonstrate that it has the proper rules, organisation and staff to carry out its fundamental role: to enforce the federal securities laws in its market. Therefore, an exchange is required to ably self regulate its members, i.e. enforce compliance by its members and associated persons of members with the federal securities laws and the rules of the exchange. An exchange is also required to adequately represent it has procedures to prevent fraud and manipulation and promote just and equitable principles of trading, including those concerning: (i) surveillance; (ii) listing standards; (iii) audit trails; (iv) conflict of interests; and (v) a fair and appropriate disciplinary process.

After the implementation of the Prospectus Directive into German law5, the BaFin is the central competent authority for the approval of all prospectuses in Germany, irrespective of whether or not admission to trading on a German exchange or the regulated market has been sought.

5 The Prospectus Directive has been implemented by the Act on the Preparation, Approval and Publication of the Prospectus for Securities (Wertpapierprospektgesetz, WpPG) which took

effect as of 1 July 2005.

- 31 -



However, exchange rules are of a contractual nature, contrary to the rules issued by the French authorities, which do not have to be agreed upon to be enforceable and the violation of which can lead to extreme sanctions such as terms of imprisonment.

Although exchanges may impose sanctions against their members for breach of regulatory rules issued by the French authorities, this is only possible to the extent that the exchange rules have contractually imposed on their members the duty to comply with such regulatory rules, and the sanctions which can be imposed by exchanges can at worst include exclusion from membership and fines, but not imprisonment.

As a result once a person (individual or corporate entity) has been admitted by a Euronext market undertaking as a member, such a person should be entitled to trade on all Euronext markets under EEA passporting rights, provided that it has provided evidence to its original Euronext exchange that valid clearing arrangements are in place for each of the new markets.

Nevertheless, although effectively functioning as a single market, from a regulatory point of view, they

remain separate markets supervised by the relevant national authority.

Fair Representation. An exchange must be able to ensure its administration is equitable to all market members and participants. Flexibility exists as to how a proprietary system may fulfil

this obligation. In applying as an exchange, an Alternative Trading System must demonstrate processes whereby governing boards vote on matters materially impacting its members, and that such boards adequately represent the membership. Similarly the disciplinary procedures should ensure fairness and reflect a review process by an independent board comprised of representative members.

Options Exchange) has resulted in a uniform IT trading platform for the exchanges and the implementation of common membership rules.

London International Financial Futures and

. A registered exchange must have rules to admit members and persons associated with those members. Further, under the Exchange Act, members must be persons registered as a broker-dealer or associated with a broker-dealer.

Membership Standard.

- 32 -



The Exchange Act prohibits registered exchanges from denying access to, or discriminating against, members. Thus, exchanges must develop and implement reasonable standards for access to the exchange. Similarly, exchanges are prohibited from adopting anti-competitive rules.

An exchange's systems must be sufficient in their capacity to handle foreseeable trading volume, i.e. adequate computer system capacity, integrity and security.

Fair Access.

Compliance with AutomatedSystems Review.

Exchanges, as a minimum, must comply with the SEC's automated review program ("ARP") and must co-operate with reviews conducted by the SEC.

Securities traded on an exchange must be registered with the SEC and approved for listing on the exchange. An exchange's rules must require securities to be registered under the

Trading of RegisteredSecurities.

- 33 -



Securities Act and the Exchange Act. Also, the exchange must have in place and apply rules for trading the class and type of securities contemplated.

An exchange must become a participant in the market-wide transaction and quotation reporting plans currently operated by the exchanges and the NASD. Certain of these plans have procedures for new entrants and charge fees. Participants in the plans then share in the income and expenses associated with the plan.

National Market SystemParticipants.

Certain rules of a registered exchange must be consistent with the rules of other markets, as well as conform with certain Exchange Act rules. For instance, exchanges must impose trading halts for individual securities, classes of securities and for its system as a whole under appropriate circumstances. Also, exchanges must implement

Uniform Trading Standards.

- 34 -



uniform circuit breaker rules that temporarily halt trading during periods of extreme market volatility.

Approval of Rule Changes.

rules changes must be submitted to the SEC for approval.

All

- 35 -

2.5 Clearing and settlement

2.5.1 General

Although the Investment Services Directive sought to open up the clearing and settlement markets, national requirements in certain European jurisdictions have effectively prohibited the cross-border provision of services in this respect.



6 In the course of implementation of MiFID, access to clearing and settlement in Germany is to be facilitated so as to promote cross-border transactions.

7 Branch offices of non-EEA companies would also qualify as credit institutions.

Remote and physical access to clearing and settlement is possible (both theoretically and practically) in the U.K.

Although foreign access to clearing and settlement is theoretically possible , the German Safe Custody Act (Depotgesetz) requires that securities subject to collective safe custody must be held with a central securities depository (Wertpapiersammelbank). A Wertpapiersammelbank is an appropriately licensed credit institution designated as a central securities depository by the competent authority of the German federal state in which the credit institution has its seat. Currently, Clearstream Banking AG is the only institution licensed as a central securities depository in Germany (although other credit institutions are able to apply to become a central

IBERCLEAR is the Spanish Central Securities Depository which is in charge of both the register of securities held in book-entry form and the clearing and settlement of all trades from the Spanish Stock Exchanges, the Public Debt Market, the AIAF Fixed Income Market, and Latibex - the Latin American stock exchange denominated in Euros. The Government may authorise other financial entities to carry out the functions currently entrusted solely to IBERCLEAR, but at present no such competition exists.

Remote and physical access to clearing and settlement is possible (both theoretically and practically) in France, at least as far as the main clearing and settlement providers in France are concerned, i.e. LCH.Clearnet and Euroclear. Indeed, French legislation does not impose any exclusive vertical arrangement in the area of clearing and settlement.

MiFID reasserts the importance of open access to regulated markets (Article 33), and to clearing and settlement systems (Article 34), whether physically or by remote access. Article 34 stipulates that Member States shall require that investment firms from other Member States have the right of access to central counterparty, clearing and settlement systems in their territory for the purposes of finalising or arranging the finalisation of transactions in financial instruments. Access of those investment firms to such facilities must be subject to the same non-discriminatory, transparent and objective criteria as apply to local participants.

The US clearance and settlement system operates in a utility-based structure that has developed substantially since the Commission approved the full registration of National Securities Clearing Corporation ("NSCC") in 1983.

depositary for securities).

The Clearing House Procedures of LCH.Clearnet specifically allow EEA investment firms and other firms exempt/excluded from FSA authorisation requirements, as well as banks with appropriate authorisation and supervision in their "home" country to apply for Clearing Member status. There is no express requirement for the application to have a physical presence in the UK. All members must, however, have cash settlement arrangements with London-based banks. LCH.Clearnet is the appointed clearing service provider for the

Remote access to clearing and settlement of the Public Debt Market and the AIAF Fixed-Income Market is possible (although no entity has as yet requested remote

However, the provisions of the Euronext Rule Book and LCH.Clearnet S.A.'s Clearing Rule Book at the present time reveal a number of restrictive contractual requirements: (i) Euronext Paris trading members must clear transactions with Clearnet SA in the case of securities transactions executed on

In recent years, there has been further consolidation in clearing organisations. For example, in 1999, the Depository Trust & Clearing Corporation ("DTCC") was created as a holding company for NSCC and The Depository Trust Company ("DTC"). DTCC has grown to include the Government Securities Clearing Corporation ("GSCC"), the Mortgage-Backed Securities Clearing Corporation ("MBSCC"), and the

6

7

- 36 -


(Section 2.5.2 continued - Clearing and settlement - Intra-country differences)

London Stock Exchange as regards domestic market securities that are traded electronically.

The German Exchange Act (Borsengesetz) provides that admission to trading on an exchange may only be granted if an applicant can guarantee the proper settlement of transactions. This provision is specified by the admission rules of various German exchanges. In theory this can also be ensured by non-German clearing and settlement houses. However, in practice, the admission rules of German exchanges often require a Wertpapiersammelbank and therefore exclude non-German providers. The English version of the Frankfurt Stock Exchange Rules also allows for the clearing of electronically traded shares by Eurex Clearing AG.

access to the AIAF Fixed-Income Market).

A physical presence is however essentially required for clearing and settlement in respect of the Spanish Stock Exchanges. This is mainly due to the fact that membership of the Spanish Stock Exchanges also generally requires a physical presence in order for the relevant formal and technical requirements to be satisfied (despite the fact that the relevant membership rules do not explicitly provide for discrimination in terms of residency).

Euronext Paris; and (ii) LCH.Clearnet SA clearing members must settle transactions with Euroclear France or through Euroclear Bank.

Member States are also not permitted to restrict the use of those facilities to the clearing and settlement of transactions in financial instruments undertaken on a regulated market in their territory.

In response to the second Giovanni report on obstacles to cross-border clearing and settlement, the European Commission issued a Communication in April 2004, outlining "the actions it intends to undertake in order to improve Clearing and Settlement arrangements" and subsequently set up a Clearing and Settlement Advisory and Monitoring Expert Group: (a) to monitor, evaluate and report on progress in removing barriers; and (b) to help the

Emerging Markets Clearing Corporation. Then, in January 2003, GSCC and MBSCC merged to create the Fixed Income Clearing Corporation, continuing as a DTCC subsidiary.

..

The CREST Rules also allow for non-UK entities to apply for admission, subject to certain requirements (e.g. appointment of an agent for service of process if not an EU-incorporated entity; legal opinion if required by CRESTCo; installation of a gateway computer in specified jurisdictions (including certain EU Member States or the US)).

It is possible to set up new clearing organisations in the UK, provided certain criteria set out in FSMA are complied with (i.e. access criteria designed to protect the orderly functioning of the market and the interests of investors).

European Commission undertake a cost-benefit analysis of removing the barriers and of providing an integrated environment in the EU.

Most intermediaries in the US clearance and settlement system operate as registered clearing agencies. Given the economies of scale enjoyed by participants of the DTCC subsidiaries, few entities have sought to enter the clearing agency business.

A bank's lending of a customer's equity securities to an affiliated broker-dealer in connection with providing that customer with securities clearing and settlement services may implicate restrictions set forth in sections 23A and 23B of the Federal Reserve Act, which govern the treatment of transactions between a bank and its affiliates.

- 37 -


(Section 2.5.2 continued - Clearing and settlement - Intra-country differences)

Two further expert groups have recently been set up by the Commission to determine the legal and fiscal issues with regard to removal of barriers in the EU.

Efforts are also currently underway by the European System of Central Banks and CESR to develop harmonised standards aimed at increasing the efficiency of securities clearing and settlement activities in the EU.

Currently trades in equities on the LSE can be settled in CrestCo or indirectly through Euroclear Bank. However, only CrestCo holds the securities register (although there is no restriction on the number of approved operators) and the vast majority of trades in UK equities settle through it.

Settlement of most trades in equity and corporate debt securities occurs on the third business day after the trade date (T+3), with money payments among financial intermediaries made in same-day funds. However, the SEC has in the recent past sought comments on reducing the settlement cycle for these securities from T+3 to T+1.

Foreign access to clearing and settlement is possible (both theoretically and practically) in the US.

The SEC has stated that Section 17A of the Exchange Act (registration of clearing and agencies) requires a national clearance and settlement system that should, among other things, provide access, either directly or indirectly, to all brokers and dealers and financial institutions and enable participants to compare, account for and settle through one entity all trades in securities included in the system, regardless of the location of the other party to

- 38 -



There iss no express requirement in Section 17A of the Exchange Act (registration of clearing agencies) that a clearing

agency maintain a physical location in the United States.

ection 15c3-3(c)(4) allows a firm to keep customer securities "in the custody of a foreign depository, foreign clearing agency or foreign custodian bank which the Commission upon application from a broker or dealer, a registered national securities exchange or a registered national securities association, or upon its own motion shall designate as a satisfactory control location for securities."

the trade or the market in

which the trade is executed.

S

- 39 -

3. Restrictions on trading of equities, equity derivatives and other instruments

3.1 Trading of domestic securities off-exchange

3.1.1 General

Counterparties may enter into off-exchange transactions as they:

(a) provide a means of dealing in physically settled equity derivatives;

(b) provide a means for dealing in block trades or transactions of substantial shareholdings; and

(c) provide tax arbitrage opportunities for the counterparties.

There has traditionally been a risk that off-exchange transactions of listed securities could violate the concentration principle in continental Europe. Care must also be taken to follow correct procedures and reporting requirements for off-exchange block trades in some jurisdictions.

There does not appear to be any tax treatment (e.g. stamp duty) in any of the jurisdictions which renders off-exchange transactions less advantageous than on-exchange transactions.



Off-exchange trading of domestic securities is possible in the UK. However, off-exchange trading will still be subject to a number of disclosures:

Under the concentration rule specified in section 22 of the Exchange Act, orders for the purchase and sale of securities admitted to trading on a German exchange or included in the Regulated Unofficial Market (Freiverkehr) of a German exchange must be generally executed through trading on an exchange where the primary place of abode or business management of the customer is located in Germany.

The concentration principle in Spain requires dealing in listed securities to occur on-exchange.

However, market members may apply opposite-side orders or execute Block Market trades within trading hours, provided that such transactions meet the following block trade volume and price requirements:

Transactions carried out by an investment services provider for the benefit of an investor habitually resident or established in France and relating to securities traded on a regulated market must be carried out on this market, or face being declared void.

Transparency of the market is an objective of MiFID and the Directive therefore requires that transactions involving listed securities be reported.

There are two principal markets for public trading of securities in the United States: exchange markets and over-the-counter markets.

(i) substantial shareholding requirements (see section 2.1.2 above); and

(ii) transaction reporting to the FSA (see section 5.2 below).

Although block trades will be subject to certain favourable treatment in the FSA

This principle of centralisation of orders only applies when the transaction is carried out for the benefit of an investor by an investment services provider.

Article 25.1 lays out this general principle and Article 25.3 states that Member States shall require investment firms which execute transactions in any financial instruments admitted to trading on a regulated market to report details of such transactions tothe competent authority as

In addition to the exchanges and the OTC markets, electronic trading networks ("ECNs") create possibilities for public investors to trade directly without the need for trading intermediaries.

- 40 -


(Section 3.1.2 continued - Trading of domestic securities off-exchange - Intra-country differences)

Handbook (e.g. no client agreement necessary), undertaking a transaction at a non-market price may amount to market abuse unless the firm in question can satisfy the FSA that there is a legitimate reason for such a transaction.

This concentration rule will not apply where the customer has expressly given other instructions in respect of a particular order.

If the customer is not a consumer (e.g. a financial institution) it may also give general instructions with respect to an unspecified number of orders. The concentration rule does not apply to fixed price transactions

(Festpreisgeschafte) (i.e. where the parties agree on the price prior to execution).

(i) Trading of Agreed Blocks

+/- 1% fluctuation from the mid point of the range between the best bid and ask positions and the effective amount of the trade must total a minimum of €600,000 and represent at least 2.5% of the average daily trading volume of the stock over the last complete calendar quarter.

The expression "for the benefit of an investor" is interpreted by legal commentators and by market practice as being the carrying out of orders for the personal account of the third party investor.

On the other hand, in a situation where a provider carries out futures sales, options and, more generally, resorts to private financial futures trading activities for its own account and not for a third party the provider and its contract counterparty will not be subject to the principal of centralisation of orders.

quickly as possible, and no later than the close of the following working day.

This obligation applies whether or not such transactions were carried out on a regulated market.

8 Fixing is used for less liquid stocks in the Spanish Automated Quotation System. All buy and sell orders are grouped together twice during the session (at 12:00h. and 16:00h.)

so as to reduce volatility and making pricing of these stocks more efficient.

9 New Market: this system is generally used by technology sector companies.

Block trades will necessarily also be subject to the rules of the relevant exchange upon which they are conducted. The London Stock Exchange rules, in certain cases, restrict the use of its block trade facility to registered market makers and, in general, in respect of UK securities where the transaction is either: (i) at least 75 times the normal market size for a security with a normal market size of 2,000 shares or above; or (ii) 50 times the normal market size for a security with a normal market size of 1,000 or 500 shares. The London Stock

Block trades and acquisitions/disposals of strategic holdings, however, can be arranged off-exchange. There is no strict definition or minimum size requirement for a block trade. However, the substantial shareholding disclosure requirements discussed under section 2.1.2 above still

(ii) Parameterised Block Market

The permitted maximum divergence from the static price is 15% for main trading and fixing8 securities and 25% for New Market securities9 and the effective amount of each order must total a minimum of €1,200,000

Two major exemptions allow transactions to be executed off exchange:

(i) The "conventions complexes": these are transactions which involve shares listed on a regulated market and which constitute a

The SEC has defined an ECN as any electronic system that widely disseminates to third parties orders entered into it by an exchange market maker or OTC market maker, and permits such orders to be executed in whole or in part. ECNs are registered in most cases as broker-dealers pursuant to Regulation ATS.

..

- 41 -



Exchange rules also allow for delayed publication of the transaction.

require to be complied with in respect of block trades and acquisitions/disposals of strategic holdings. Furthermore, the notification requirement for dealings in

and represent at least 5% of the average daily trading volume over the last complete calendar quarter.

necessary element thereof. Such transactions may be executed outside a regulated market by way of private agreement. This exemption is as of right.

The Euronext.liffe Trading Procedures also limit block trades to those holding the appropriate trading right in specified products, subject to minimum volume thresholds and that such trades take place during the trading hours of the product in question. The Euronext.liffe Trading Procedures also require members underwriting such transactions to act with due skill, care and diligence and so as not to prejudice the interests of clients (e.g. underwriting such trades at fair value). Block trades in Euronext.liffe are subject to trade reporting, data retention and exchange authorisation.

securities under the Securities Trading Act also applies in respect of block trades and acquisitions/disposals of strategic holdings (for further details please refer to section 5.2 below).

Moreover, issuers of securities admitted to trading on a German exchange have to comply with certain continuing obligations such as the general obligation to treat all holders of admitted securities equally in similar circumstances. When entering into a block trade, and in particular when making an offer to buy a large amount of their own securities in a single transaction, issuers of listed securities must consider this principle of equal treatment.

Block Market Trades in

compliance with (i) or (ii) above are unlikely to amount to market abuse.

In addition, parties may enter into sales outside the Exchange with the intervention of a market member, provided that the following requirements are met:

(i) the transfer price must not deviate more than 5% from the market weighted average price/market closing price on the date of transfer, and

(ii) the size of the transfer must be greater than both €300,000 and 20% of the average daily traded amount for the relevant securities in the last complete calendar quarter.

(ii) Block trade transactions": these must comply with the following conditions:

(a) the transaction must be in respect of either shares or securities granting direct or indirect access to the issuer's capital or voting rights, or debt securities;

(b) and the amount of the transaction must be above 5% of the market capitalisation or EUR 7.5 million for shares or other securities and EUR 30,000 for debt securities.

The competent authorities are, in accordance with Article 58, to establish the necessary arrangements in order to ensure that the competent authority of the most relevant market in terms of liquidity for those financial instruments also receives this information.

A block trade is a large trading order defined by the NYSE as an order that consists of 10,000 shares of a given stock or a total market-value of $200,000 or more. A block transaction may be executed either on or off the exchange trading floor. In such block trades parties prefer receiving a single, negotiated price, even if the price is slightly discounted from the current market, to avoid the risk of receiving multiple, unknown fills to execute their large future order. Typically, a brokerage firm is a party to the block trade with one of its customers, but the firm can also be used to bring two customers together in what is referred to as an "agency" block trade.

Following the implementation of MiFID, it would thus appear that off-market activity will be subject to similar reporting requirements as on-market trades (detailed in Articles 27-28).

- 42 -



Block trades are also subject to insider dealing laws (see section 7.1.2 below). Where a potential investor acquires insider information by way of due diligence performed before entering into a block trade, the transaction may violate German insider dealing provisions. Neither the Securities Trading Act nor the issuers' guide grant a general exemption from the application of the insider dealing laws to block trades.

Finally, transactions at a non-market price may amount to market abuse and/or violate the BaFin's statement covering minimum requirements for trading activities.

Should any off-exchange sale fail to comply with such requirements, it must be authorised by the governing body of the exchange. Authorisation will only be granted where the relevant transaction meets certain requirements, (including that the size of the transaction exceeds both €1,500,000 and 40% of the average daily traded amount for the relevant securities in the last complete calendar quarter; or where such governing body holds that there is any other reason that permits granting such authorisation).

The shareholding disclosure requirements discussed under section 2.1.2 must still be complied with in respect of Block Market trades and off-exchange transactions.

The demand to conduct an off-exchange trade must be given in writing by the investor to the investment services provider.

Moreover, the investment services provider can execute a transaction with a client off exchange for its own account if the amount of such transaction is equal to or above EUR 500,000 and the transaction is made at a price agreed prior to the transaction within a range of 1% of the weighted average price of the stock price during a contractually determined period.

- 43 -

3.2 On-Exchange Trading of Equity Derivatives

3.2.1 General

On-exchange trading of equity derivatives is possible in each of the jurisdictions and such trading will occur subject to the standard terms and conditions and public disclosure obligations required by the relevant exchange. It is generally unlikely that wagering legislation in any of the jurisdictions could act to void or render such contracts unenforceable.

3.3 Trading of foreign securities

3.3.1 EU

There are no currency restrictions or exchange controls in any of the European jurisdictions which could impede dealing in foreign securities both on- and off-exchange.

However, international sanctions may prevent dealing in certain securities, and consideration should be paid to the differing tax regulations to which foreign securities may be subject.

3.3.2 US

Stocks of most foreign companies that trade in the US market are traded as American Depositary Receipts ("ADRs") issued by US depository banks. ADRs are receipts that represent an ownership interest in non-US securities. Any type of non-US security can be represented by an ADR, including common stock and debt securities. Physical receipts are not necessary, and both ADRs can be cleared by book entry means through facilities such as those of the Depository Trust Company. US investors often prefer ADRs to non-US securities because ADRs trade and settle in the US as if they were US securities, ADRs are traded in US dollars, dividends on the underlying securities are converted into US dollars, and the existence of an ADR facility means that investors do not have to make separate custody arrangements for their non-US shares. Although most foreign stocks trade as ADRs in the US markets, some foreign stocks (e.g. Canadian) are traded in the US in the same form as their local market.

3.4 Trading of equity derivatives of underlying foreign securities

3.4.1 General

Foreign securities underlying equity derivative transactions in all jurisdictions and all counterparties are generally entitled to invest in them. However, regulations, constitutional documentation and investment criteria may prohibit or restrict certain entities (e.g. insurance companies and pension funds) from trading in equity derivatives related to foreign securities in each of the jurisdictions.

In addition, where foreign securities are the underlying in equity derivative transactions, it needs to be verified in each individual case whether or not notification and disclosure provisions under the relevant foreign laws apply.

- 44 -

3.5 Writing of self-referenced equity derivatives

3.5.1 General

Regulatory guidance in respect of self-referenced equity derivatives10 is unclear, in particular, where the company sells protection to third parties against its own solvency risk. In each jurisdiction there are various concerns which create considerable unenforceability risk (e.g. improper treatment of corporate assets; directors acting outside the scope of their duties; auditor disapproval etc.).



It is possible that the issue of self-referenced equity derivatives could amount to a mistreatment of company assets.

It is possible that the issue of self-referenced equity derivatives violates mandatory corporate law provisions (restrictions on the acquisition of own shares, financial assistance, restrictions on the repayment of shareholder contributions, requirement of equal treatment of shareholders) as well as provisions in respect of avoiding insolvency laws. Unfortunately, there are neither any court decisions nor any meaningful legal literature on the treatment of self-referenced equity derivatives. Therefore, each individual structure will need to be reviewed on a case-by-case basis.

It is possible that the issue of self-referenced equity derivatives could amount to the mistreatment of company assets.

It is possible that the issue of

self-referenced equity derivatives violates mandatory corporate law provisions (restrictions on the acquisition of own shares, financial assistance, restrictions on the distributions of dividends to shareholders, requirement of equal treatment of shareholders, corporate misuse of assets of the company (abus de biens sociaux)).

Please refer to section 5 of Part B of this Volume for the

US analysis in respect of self-referenced equityderivatives.

10 e.g. a credit default swap written by a company, with the referenced credit event being the company's own default.

It is also possible that such issues could be deemed to amount to misfeasance or be challengeable in the case of a company's insolvency. Liability may extend to the officers of the company.

Such concerns could result in unenforceability of such transactions and sanctions for senior management.

The sanctions in relation to FSMA regulated activities are greater in the sense that the FSA could exercise its powers to take control of the business out of the hands of its owners/managers.

The entering into derivatives in respect of treasury shares may be restricted by a number of issues such as (i) financial assistance; (ii) corporate rules on acquisition of treasury shares (which may impact on physically-settled transactions); (iii) corporate accounting rules in relation to treasury share reserves; (iv) Spanish rules on the acquisition of treasury shares through an intermediary; (v) Spanish rules on payment of dividends; (vi) the principle of equal treatment of shareholders; and (vii) the purpose of the transaction.

In addition, self-referenced equity derivatives might lead to offences of market manipulation or insider trading.

Liability may therefore extend to the officers of the company.

- 45 -


(Section 3.5.2 continued - Intra-country differences)

Unfortunately, there are no court decisions nor any meaningful legal literature on the treatment of self-referenced equity derivatives. Therefore, each individual structure will have to be reviewed on a case-by-case basis.

- 46 -

3.6 Repurchase transactions

3.6.1 EU

Repurchase transactions are permitted in the UK, Spain, Germany and France. The restrictions and reporting requirements applicable to repurchase transactions are the same as those applicable to the sale/purchase of the underlying asset (see, for example, section 2.1.2 above and section 5.2 below). Furthermore, the entering into of repurchase transactions by counterparties falling under a special regulatory regime (e.g. insurance companies) may be restricted.

3.6.2 US

Repurchase transactions are treated as purchases and sales of the underlying security for securities law purposes. Thus, repurchase transactions involving equity securities by US banks or US branches or agencies of non-US banks may trigger the GLBA push out provisions applicable to dealing activities. Such transactions also may be prohibited under the Glass-Steagall Act. Repurchase transactions in equity securities by nonbank affiliates of banks may be subject to restrictions on the extent of such activities depending on whether the nonbank affiliate is owned by a BHC that qualifies as an FHC under US banking law.

3.7 Stocklending

3.7.1 General

Stocklending transactions are permitted in the UK, Germany, Spain and France, although certain restrictions apply. Stocklending transactions are also permitted in the US.

3.7. 2 Intra-country differences


Stocklending is permissiblein respect of client assetsprovided customer consenthas been obtained andappropriate terms andconditions have beenentered into.

Insurance companies,investment fund companiesand other regulated entitiesare subject to certainrestrictions in respect ofstocklending.

The main handicap for thedevelopment of an activemarket in relation to stockloans in Spain is that, as ageneral rule, stock loanstrigger capital gains taxesunless entered into inaccordance with theEighteenth AdditionalProvision of Law 62/2003,of 30 December ("18 AP").

French law imposes somerestrictions on stocklending activities carriedout by regulated entitiessuch as insurancecompanies or collectiveinvestment schemes.

Recital 26 of MiFID statesthat in order to protect aninvestor's ownership andother rights in respect ofsecurities and his rights inrespect of funds entrustedto a firm, those rightsshould be kept distinctfrom those of the firm (seesection 13 for furtherdetails in respect of clientassets and client money).

Engaging in the business oflending and borrowingsecurities as a principal(collectively "securitieslending") has historicallybeen generally viewed bythe SEC as a type of"dealer" activity thatrequires the securitieslender to register as abroker-dealer with theSEC, without theavailability of anexemption.

Such restrictions do notapply in respect of theassets of marketcounterparties.

A firm conducting suchtransactions should warnprivate customers of taximplications and other

According to legalcommentators,stocklending transactionsdo not trigger any reportingrequirements pursuant tosection 9 of the SecuritiesTrading Act (see alsosection 5.2 below).

This provision howeverdoes not give rise to capitalgains taxation in respect of,amongst others, stock loansover securities listed on

The dominant view is thatstock lending transactionstrigger disclosurerequirements applicable tothe acquisition or sale ofshares and voting rightsand to the takeover oflisted companies, sincestock-lending implies thattitle to the loaned securities

However, this principledoes not prevent a firmfrom doing business in itsname but on behalf of the

Amendments to RegulationT in 1997 made sweepingchanges in the provisions

- 4 7 -


(Section 3.7.2 continued - Stocklending - Intra-country differences)

11 i.e. (a) operate on a regular basis, (b) offer protection equivalent to the protection granted by Spanish official securities exchanges, and (c) have operating procedures, information, access, and

listing conditions similar to those of Spanish official secondary securities exchanges.

consequences that mayresult from thestocklending activities.

When carried out for thebenefit of a collectiveinvestment fund,stocklending transactionsmust be carried out withauthorised persons andcollateral obtained.

In the UK stocklendingagreements, whilst fallingwithin the definition of anFSA "designatedinvestment" are notreportable transactions (asfurther discussed in section5.2 below).

Nevertheless, as it operatesunder English law standardform documents,stocklending may bedescribed as a processwhereby one person (thelender) transfers title tosecurities (e.g. an ordinaryshare of a company) toanother person (theborrower) in return for a

However, changes invoting rights could triggerreporting requirements tothe BaFin and thecompany, for both thelender and the borrower,provided that thethresholds defined insection 21 of the SecuritiesTrading Act are met (seesection 2.1.2). Indeed, ingeneral during the term ofthe loan, the borroweracquires legal title and fullownership of the securities.

The borrower is alsoentitled to all membershiprights ensuing from theshareholding without anyrestriction

Therefore, voting rights aregenerally with theborrower (provided it hasnot transferred thesecurities to a third party)and therefore reportingobligations will betriggered.

regulated exchanges ormultilateral tradingfacilities which each satisfycertain conditions1 locatedin member countries of theOECD and where the stockloans themselves complywith the followingrequirements:

− that the relevant stockloan is discharged bymeans of the borrowerredelivering to thelender securities of anidentical type andamount to thesecurities borrowed;

that the lenderreceives a fee (in cash)and that the borrowerpasses on to the lenderthe cash amountsrelating to theeconomic rightsattached to thesecurities borrowed orany other interest orother distributions ofany kind whatsoeverwith respect to those

is transferred to theborrower.

Where securities collateralis taken by the borroweralso by way of an outrighttransfer of title, the samerule applies.

It should be noted,however, that under theCollateral Directive (whichis now implemented inFrance), a borrower takingcollateral without transferof title permitted to act asif he owns the securities,which could, in our view,also trigger theaforementioned disclosureobligations.

investor, where that isrequired by the very natureof the transaction and theinvestor is in agreement,for example in respect ofstocklending.

MiFID also requires thatwhere a client transfers fullownership of financialinstruments or funds to aninvestment firm to secureor cover present or future,actual or contingent orprospective obligations,such financial instrumentsor funds should no longerbe regarded as belonging tothe client and, therefore,outside the scope of theclient asset rules, enablingeasier use to be made ofsuch assets for thepurposes of stocklendingetc.

regarding securitiesborrowing and lending.

Among other things, theamendments:

(i) eliminated the collateralrequirement of the rule;

(ii) through the adoption ofthe good faith account,effectively limited theapplication of the ruleto the borrowing andlending of equitysecurities;

(iii) extended the specialrule applicable to non-US-traded foreignsecurities to all foreignsecurities; and

(iv) created exclusions fortransactions by"exempted borrowers.

Banks may engage in equitysecurities lendingtransactions and services aspart of their custodialbusiness.

−

- 48 -



contractual obligation onthe part of the borrower totransfer to the lendersecurities of an equivalenttype (e.g. another ordinaryshare in that company).

The lender will takecollateral (generally in theform of securities or cash)in respect of thecontractual obligations ofthe borrower and, upon thetransfer back of equivalentsecurities, undertakes torepay or transfer back tothe borrower collateralequivalent to that whichwas originally provided.

As such both the borrowerand the lender may havedisclosable interests undersuch a transaction inrespect of the CompaniesAct 1985 and the TakeoverCode (see further details insection 2.1.2.)

It should be noted thatcertain investment vehicles(e.g. insurance companiesand pension funds) may berestricted by theirinvestment criteria andconstitutionaldocumentation as to the

In addition, notificationrequirements may alsoneed to be observed by thelender (including, whereapplicable, any attributionof voting rights with regardto the agreed redelivery ofthe securities).

securities during theterm of the loan;

− that the term of thestock loan does notexceed one year; and

− that a financialinstitution establishedin Spain is either thelender, the borroweror the arranger(mediador) and that allpayments to the lenderare carried out throughsuch financialinstitution.

Certain types of investorssuch as pension funds,insurance companies andinvestment funds may, inaddition, be subject torestrictions as regardsstocklending.

Stock loans are subject to:

(i) significantshareholding reportingrequirements:

(ii) trade reporting; and

(iii) tax reporting.

In addition, Exchange ActRule 15a-11 permits a bank,acting as a conduit lender oragent, to engage in, or effect,equity securities lendingtransactions and serviceswith and on behalf of aperson the bank reasonablybelieves to be a "qualifiedinvestor" (see above) or anyemployee benefit plan thatowns and invests on adiscretionary basis at least$25,000,000 in investments.

- 49 -



type of investments theycan purchase andstocklending may not

(i) Significantshareholdingreporting requirements:

Although the shares thatare the object of the stockloan will be assigned to the

therefore be permissiblefor such entities.

Stocklending transactionswill also be subject toreduced conduct ofbusiness rules in the UK.

borrower for the purposesof significantshareholdings as discussedunder section 2.1.2 above,such shares will also beassigned to the lender,giving rise to dualreporting.

(ii) Trade reporting:

Financial intermediarieswill also have to providethe relevant clearing house(e.g. IBERCLEAR) withcertain information aboutthe stock loansintermediated by them onthe date on which suchstock loans are enteredinto. The clearing house,in turn, will notify thegoverning body of therelevant market, which willmake public certain detailsrelating to such stockloans.

- 50 -



18 AP sets out certainreporting requirementsrelating to stock loans.

These reportingrequirements require thefinancial entitiesintermediating suchtransactions to file adeclaration providinginformation about thetransactions undertakenwith the Spanish TaxAuthorities.

(iii) Tax reporting:

- 51 -

4. Trading practices subject to regulatory review

4.1 Short Selling

4.1.1 General

The regulation of short selling differs considerably between the jurisdictions.



There is currently noprohibition on short sellingin the UK as the FSAbelieves that short sellingaids the liquidity andefficiency of the markets.

However, in April 2003 theFSA announced measuresto increase transparency inrespect of short selling -CrestCo (the UK securitiessettlement system) agreedto publish aggregatestocklending data for FTSE350 securities on a monthlybasis.

Certain institutionalinvestors are prohibitedfrom short selling (e.g.insurance companies,mortgage banks andinvestment fundcompanies). Othercorporates, banks andregulated German hedgefunds may engage in shortselling.

Under German law, shortsales would normally nottrigger a reportingrequirement since,according to the BaFin,only the actual transfer oftitle in securities triggersreporting and notificationobligations.

Article 64 of the StockExchanges Regulations1967 prohibits short-sellingin relation to spottransactions by providingthat the seller must havefull title to the securitiesbeing sold prior to therelevant sale.

However, there isuncertainty as to whetherArticle 64 is still in force orhas been superseded andtacitly abrogated by thelaws and regulations on theSpanish Exchanges enactedas from 1988.

Short selling is generallynot prohibited per se.However, certain regulatedentities such as insurancecompanies and collectiveinvestment schemes are notpermitted to carry outactivities falling outside thelimited scope of theirregulated activities.

For example, a standardcollective investmentscheme could engage inshort-selling activities, butgenerally not other than forhedging purposes or for thepurpose of meeting itsmanagement objectives.

Although the vast numberof short sales in the US arelegal, abusive short saleseffected to manipulate theprice of a stock areprohibited. For example,an individual is prohibitedfrom engaging in a seriesof transactions to createactual or apparent activetrading in a security todepress the price or inducethe sale of the security byothers.

Congress did not addressthe permissibility of shortselling in enacting theExchange Act, but insteadgranted the SEC broadauthority to regulate shortsales to prevent abuse ofthis practice.

Moreover variousinitiatives to improve thesettlement process forliquid stocks (for examplewhere such illiquidity is aresult of short selling) weresuggested.

The London StockExchange is alsoconsidering imposingdisclosure requirements on

In this respect, short-sellingis not specifically includedin the lists of infringementsset forth in the SecuritiesMarket Law.

Although such lists containfall-back provisionsreferring to anyinfringement of theexchanges laws and

More generally, where acommercial companyenters into a short sellingtransaction for purelyspeculative purposes, thequestion arises as towhether the transaction stillfalls within the scope of thecompany's objects.

Exchange Act Rule 10a-1establishes restrictions onshort sales in any securityregistered on a nationalsecurities exchange iftrades are reported pursuant

- 52 -


(Section 4.1.2 continued - Short selling - Intra-country differences)

members such as marketmakers and brokers inrespect of their shortpositions.

This position has beenadopted by the LondonStock Exchange followingthe FSA's decision inrespect of EvolutionBeeson Gregory Limitedand Christopher Potts whowere held to havecommitted market abuse bytheir short selling of 252%of the issued share capitalof Room Service Group Plcin anticipation of a newissue of shares by thecompany.

Short transactions arelikely to give rise to bothtrade reporting obligations(see section ** below) butsignificant shareholdingdisclosure obligations areonly likely to arise uponactual settlement of thetrade (see section ** above.

It should be noted thatcertain entities may be

regulations, there is asignificant number ofcommentators who are ofthe view that such "blanketreference" to anyinfringement of exchanges'laws and regulations iscontrary to the SpanishConstitution and, therefore,null and void.

In any case, internalregulations ofIBERCLEAR (the SpanishCentral SecuritiesDepositary) do not permitshort-selling.

Pursuant to Rule 25 of theCircular 7/2004, 17November, short-sellerswill be fined.

The amount of such finewill be 1/1000 of the saleprice multiplied by thenumber of business daysbetween the date of theshort sale and the dateon which the sellerpurchased the relevantsecurities, plus anadditional fine equal to the

Short selling only triggersdisclosure requirements(applicable to theacquisition or sale of sharesand voting rights) uponsettlement, since noacquisition occurs when theshort sale is made.

to an "effective transactionreporting plan" and ifinformation on such tradesis made available inaccordance with such planon a real time basis tovendors of markettransaction information.

The rule creates a "ticktest" that provides, subjectto certain exceptions, thatan exchange-listed securitymay only be sold short at aprice above theimmediately precedingreported price ("plus tick")or at the last sale price if itis higher than the lastreported price ("zero-plustick"). Thus, short sales ona down tick are prohibited.

In addition, NASD Rule3350 prohibits short salesby NASD members innational market securitiesat or below the current best(inside) bid when that bid islower than the previousbest (inside) bid, and iscommonly known as the"bid test."

Regulation SHO wasrecently enacted by the

restricted fromparticipating in shortselling due to provisions in

difference between the saleand purchase prices.

- 53 -



their constitutionaldocumentation.

It should be noted that Rule25 also applies where theshort-seller acquires therelevant shares byborrowing them on a dateafter that of the short-sale.

However, no fine will beimposed in this case if suchborrowing allows for theshort sale to be settled onthe due settlement date(T+3).

Spanish entities wishing toengage in short sellingmust do so "off-shore" (e.g.through Euroclear). Asdetailed below, even suchoff-shore transactions couldamount to a breach ofSpanish regulations (andtherefore expose therelevant party to the risk ofa fine under Article 64).However, in practice, it isunlikely that the SpanishExchange will be aware ofany transactions entirelycarried out throughEuroclear accounts.

In terms of short-sellingreporting requirements, as ageneral rule, all trades inrelation to securities listedon the Spanish Stock

this regulation was required to commence onJanuary 3, 2005.

The SEC has described thegoals of Regulation SHOas: (i) establishing certainrequirements to addressproblems associated withfailure to deliver includingpotentially abusive nakedshort selling (i.e. where aseller fails to borrowsecurities in time to makedelivery to the buyer withinthe standard three daysettlement period); (ii)temporarily suspendingSEC and SRO short saleprice tests in a group ofsecurities to determine theeffectiveness and necessityof such restrictions; and(iii) creating uniform order

marking requirements forsales of all equity securities,requiring that orders be

marked "long," "short" or "short exempt."

The SEC has deferredconsideration of a proposalto replace the tick test in

SEC to update short saleregulation. Compliance with

Rule 10a-1 with a new

- 54 -



Exchanges are subject toSpanish Exchangeregulations and must beexecuted through orvalidated by a member ofthe relevant Spanish StockExchange.

Although not yet in force,Law 24/1988 hasintroduced the concept of"extraordinarytransactions" which may becarried out withoutcomplying, fully orpartially, with the rulesapplicable to exchangetransactions, although stillhaving to be reported to thegoverning body of theStock Exchange.

According to Law 24/1988,"extraordinarytransactions" can be carriedout where:

(i) all the relevant tradeparties have theirresidence or areestablished outsideSpain;

(ii) the relevant trade isnot carried out inSpain; or

uniform bid test restrictingshort sales to a price abovethe consolidated best biduntil the completion of thepilot program.

- 55 -



previously authorisedan investment firm ora credit entity,expressly and inwritten form, that therelevant trade wouldbe carried out withoutbeing subject to theexchange regulations.

Unfortunately, Article 36of Law 24/1988 whichregulates theaforementioned"extraordinarytransactions" is subject tofurther development bysecondary legislation whichhas yet to be enacted.

Until enactment of suchsecondary regulation takesplace, "extraordinarytransactions" cannot becarried out in Spain.

In light of the above, anduntil enactment ofsecondary regulation on"extraordinarytransactions" takes place,"off-shore" transfers (e.g.short selling) would, inprinciple, require"validation" by a memberof the relevant Spanishstock exchange and

(iii) both parties have

- 56 -



reporting to the governingbody of the StockExchange.

However, it remainscontroversial whether "off-shore" transfers of sharesbetween accounts outsideSpain have to be validatedand reported, particularlywhere the transfers do notgive rise to registration inthe securities account of amember of IBERCLEAR.

It is a fact that thesignificant majority (if notall ) of "off-shore" transfersof Spanish shares betweentwo securities accounts inthe same Central SecuritiesDepositary outside Spainare never notified to thegoverning bodies of therelevant Spanish Exchange.

As far as we know, theCNMV, IBERCLEAR andthe Spanish StockExchanges are perfectlyaware of this fact.

- 57 -

4.2 Pre-hedging of convertible and exchangeable bond issues

4.2.1 General

Where the launch of convertible or exchangeable bonds is required to be disclosed to the market, dealing or arranging in the underlying shares or related products before disclosure to the market and while in possession of information about the launch, is likely to strictly fall within the definition of market abuse. This has implications for "icing" (that is, locating and reserving shares from prospective lenders), a practice which is commonly used in the UK market. The FSA has identified two different types of icing:

(a) icing the underlying shares on a formal basis such that the arrangements are contractual in nature and so binding on the parties (such as "pay to hold" arrangements); or

(b) informal, non-contractual, icing arrangements (for example, where the icing of the underlying shares involves the informal reservation of the shares, the terms not being offered or agreed until after disclosure to the market).

It does not appear that either form of "icing" has been explicitly exempted from the European market abuse regime.



Both forms of icing could amount to market abuse. The FSA has however stated that it may be acceptable behaviour for the manager of the bond issue to arrange to borrow shares from the issuer or a related party of the issuer before the announcement of the launch of the issue. Borrowing shares from the issuer or related party is likely to be acceptable practice where:

Up to now, there has not been any significant literature concerning pre-hedging nor any case law. The position of the BaFin is also unclear.

Both forms of icing could amount to market abuse. However, borrowing shares from the issuer or a related party could be acceptable practice where:

Up to now, there has not been any significant literature concerning pre-hedging nor any case law.

Directive 2003/6/EC, one of various level 2 MAD Directives (which has regard to accepted market practices for the purposes of MAD), sets out that Member States should ensure that a number of (non-exhaustive) factors are taken into account by competent authorities when assessing whether they can accept a market practice as acceptable for the purposes of MAD.

Please refer to Section 6 of Part B of this Volume for the US analysis in respect of pre-hedging of convertible and exchangeable bond issues.

There is also no guidance from the AMF as regards icing. (i) there is a genuine

need to pre-arrangeto borrow the sharesto facilitate the issue;

From a German lawperspective, however, pre-hedging could qualify as aviolation of insider dealinglaws (see section 7.1.2below).

Both forms of icing could amount to market abuse where the icing transactions involve price manipulation.

(ii) the parties to the pre-arranged borrowingare all aware of theforthcoming bondissue; and

- 58 -


(Section 4.2.2 continued - Pre-hedging of convertible and exchange bond issues - Intra-country differences)

It remains to be seen whether the UK government will adopt secondary legislation or whether the FSA will make amendments to the FSA Handbook to recognise "icing" as an accepted market practice.

In addition, the definition of insider information explicitly

includes information on the purchase and sale of financial instruments by third

parties.

The draft for a future Royal Decree developing the market abuse regime referred to under section 1.2 above provides that the CNMV will determine whether a market practice is an accepted market practice and it may be that the CNMV will consider "icing" in this regard.

(d) how the relevant practice takes into account the trading mechanism of the relevant market and enables market participants to react properly to the new market situation;

Accordingly, the launch of convertible or exchangeable bonds should qualify as price sensitive insider information since such a launch will be relevant to the investment decision of a prudent investor.

Moreover, pre-hedging transactions would not fall within the safe harbour from the insider trading prohibition for share buy-back programmes and/or stabilisation measures.

Both forms of icing could amount to market abuse where the icing transactions involve price manipulation.

(ii) the parties to the pre-arranged borrowingare all aware of theforthcoming bondissue; and

(iii) other marketparticipants are notdisadvantaged.

(i) there is a genuineneed to pre-arrangeto borrow the sharesto facilitate the issue;

(iii) other marketparticipants are notdisadvantaged.

Under the current legal regime, future events may constitute insider information if their occurrence is sufficiently likely.

Such factors include:

(a) the level of transparency of the relevant market

the operation of market forces;

(c) how the relevant

an impact on market liquidity and

efficiency;

(b) the need to safeguard

market practice has

practice to the whole market;

It remains to be seen whether French rules will be adopted to recognise "icing" as an accepted market practice (assuming that "icing" will be used on French markets.

There is no guidance from the CNMV as regards icing.

- 59 -


(Section 4.2.2 continued - Pre-hedging of convertible and exchange bond issues - Intra-country differences)

It remains to be seen whether the German legislator will adopt a regulation clarifying, inter alia, the activities that are deemed to be accepted market practices in light or MAD, the procedures for the recognition of an accepted market practice and whether this will cover icing.

The Directive also provides that market participants should be consulted by competent authorities as to the designation of any market practices as "acceptable".

Member States should also ensure that competent authorities regularly review the market practices they have accepted.

(g) the structural characteristics of the

relevant market, the types of financial instruments traded and the type of market participants.

(f) the outcome of any investigation of the relevant market practice by any competent authority or other authority; and

(e) the risk inherent in the relevant practice for the integrity of related markets, whether regulated or not, in the relevant financial instrument;

- 60 -

4.3 Portfolio Trading/ Program Trading

4.3.1 General

In pitching for the reallocation of a client's portfolio, an investment bank is likely to be furnished with information which it could use in advance of any such trade (whether it gets the mandate or not) and there is some uncertainty in each of the jurisdictions as to what extent such activities will amount to market abuse.



(Section 4.3.2 continued - Intra Country differences)

It is still a grey area as to whether the investment bank is permitted to pre-hedge (i.e. procure securities) in anticipation of being awarded the trade. However, it is highly likely that any proprietary trade on the basis of the information obtained at the pitch will amount to market abuse on the basis of amounting to front-running.

Under German law, pre-hedging as described above might be considered as "front-running".

It is still a grey area as to whether the investment bank is permitted to pre-hedge (i.e. procure securities) in anticipation of being awarded the trade. However, it is highly likely that any proprietary trade on the basis of the information obtained at the pitch will amount to market abuse.

It is still a grey area as to whether the investment bank is permitted to pre-hedge (i.e. procure securities) in anticipation of being awarded the trade. However, it is highly likely that any proprietary trade on the basis of the information obtained at the pitch will amount to market abuse.

In respect of MiFID, CESR's level 2 advice provides that an investment firm should take reasonable steps to refrain from "front running" or dealing ahead.

"Front running," also referred to as "forward trading," occurs when a broker trades ahead of a customer order to take advantage of anticipated price movement caused by the customer order. Front running is considered manipulative and inconsistent with the NASD's requirement that a broker's conduct be consistent with fair and equitable principles of trade as expressed in NASD Interpretive Material 2110-3. NYSE Rule 92 also addresses front running, providing that - subject to certain exceptions - members or member

- 61 -


(Section 4.3.2 continued - Intra country differences)

Front-running is understood as the practice of a broker placing his own order before a customer order that he anticipates will move the market.

As a rule, front-running constitutes a breach of the rules of conduct.

Moreover, front-running may violate the prohibition on insider dealing. The purchase or sale of securities by a bank for its own account or for the account or on behalf of a third party before the customer order is publicly disclosed is deemed to be an example of the bank taking advantage of its knowledge of inside information.

MAD also states in its preamble that Member States should "tackle the practice known as 'front running' including 'front running' in commodity derivatives, where it constitutes market abuse".

organisations are prohibited from "causing the entry of an order to buy or sell any Exchange-listed security for any account in which such member or member organisation or any approved person thereof is directly or indirectly interested" if the person entering such an order has knowledge of any particular unexecuted customer order that could be executed at the same price.

- 62 -

4.4 Minimum Tick Size



The London Stock Exchange operates a number of different tick sizes according to the relevant trading service.

The Deutsche Börse Group 12:

Prices for securities that are quoted in units (e.g. shares, warrants, subscription rights and participation certificates) move in increments of EUR 0.01.

The minimum tick size for shares is EUR 0.01 for prices up to EUR 50 and EUR 0.05 for prices over EUR 50.

The tick sizes are defined by bandwidths. Order limits in the respective bandwidth are only accepted for trading if they comply with the defined tick size.

In June 1997, the NYSE reduced the minimum tick size of NYSE-listed stocks from one-eighth to one-sixteenth of a dollar.

Tick sizes undergo a quarterly review.

If the price is less than or equal to EUR 0.10 in floor trading, prices for these securities move in increments of EUR 0.001.

For bonds: EUR 0.01 or 0.01%

The SEC subsequently introduced decimalisation and required market centres to reduce the minimum tick size of stocks to 1 cent in 2000, and both the NYSE and Nasdaq implemented this change in 2001.

12 The Deutsche Börse Group only includes the Frankfurt Stock Exchange and Xetra. The other German stock exchanges are not part of the Deutsche Börse Group.

The current London Stock Exchange tick sizes are as follows:

In respect of SETS

(the fully electronic order book trading service for the securities comprising the FTSE 100 index, the most liquid FTSE 250 securities and equities that have a LIFFE traded equity option); SETSmm (trading service for mainly FTSE 250 securities, FTSE 250 Reserves and leading Irish securities); and IRS (trading service for international equity market securities) are:

Separate tick sizes apply in respect of bonds (dependent on remaining maturity).

EUREX Deutschland:

The minimum tick size varies from product to product and is set out in the "Contract Specifications for Future Contracts, Option Contracts at EUREX Deutschland and EUREX Zurich."

For securities included in the Next Track segment: EUR 0.01

For other securities:

From EUR 0 to EUR 50: EUR 0.01



Up to EUR 500: EUR 0.50

These tick sizes are also applicable for currencies other than the Euro.

Exceptions are available and if applicable they will be listed in a separate notice issued by Euronext.

- 63 -


(Section 4.4.1 continued - Minimum tick size - Intra-country differences)

0.01 for prices less than 10p;

0.25 for prices from 10p to 499p;

0.50 for prices from 500p to 999p

1.00 for prices from 1000p and above;

0.0025 for prices less than 5 euro;

0.005 for prices from 5 euro to 10 euro; and

0.01 for prices from 10 euro and above.

The current London Stock Exchange tick sizes are as follows in respect of SEAQ (the trading service for the majority of small to mid- cap UK securities); and the Alternative Investment Market:

0.0001 for prices less than 10p; and

0.25 for prices from 10p and above.

The current London Stock Exchange tick sizes are as follows in respect of IOB (the trading service for the depositary receipts of international securities); and IBB (the trading service for

- 64 -


(Section 4.4.1 continued - Minimum tick size - Intra-country differences)

a range of international equities for listed and non London listed securities):

0.01 for prices less than $50;

0.10 for prices from $50 to $100; and

0.25 for prices above $100.

The current London Stock Exchange tick sizes are as follows in respect of IOB (the secondary market trading in liquid, large and mid-cap Dutch equities):

0.01 for prices less than EUR 50;

0.05 for prices from EUR 50 to EUR 100;

0.10 for prices from EUR 100 to EUR 500; and

0.50 for prices from EUR 500 and above.

- 65 -

5. Trade Reporting

5.1 General

Generally both on- and off-exchange trades must be reported to relevant regulators and/or exchanges in all the EU jurisdictions reviewed - this obligation stems from Article 20 of the Investment Services Directive. If the transactions are sufficiently sizeable, the obligation to report to the target company the acquisition/disposal of substantial holdings of its shares will also arise(please refer to section 2.1.2 above). Similar reporting requirements exist in the US.



In the UK regulated firms are required to report transactions to the FSA. This obligation applies to both on- and off-exchange transactions.

Credit institutions, financial services institutions authorised to conduct proprietary trading (i.e. own account trading as a service for others), German branches of enterprises domiciled in a state that is neither a member of the European Union nor a contracting state to the agreement on the European Economic Area and entities domiciled in Germany and admitted to trading on a German stock exchange are subject to trade reporting requirements.

Information in respect of computerised trades between 9:00 a.m. and 5:30 p.m. on the Automated Quotation System linking the four Spanish stock exchanges is made public immediately, and information with respect to trades outside the computerised matching system must be reported to the Sociedad de Bolsas (which operates and regulates the Automated Quotation System) by the end of the trading day and published in the Stock Exchange Official Gazette and on the automated computer system by the beginning of the next trading day.

Upon execution of a transaction, an investment services provider must report this transaction to Euronext as soon as the transaction has occurred.

MiFID includes a section on market transparency and integrity (Section 3). Article 25(3) establishes the rule requiring firms to report transactions and maintain records of financial transactions involving securities listed on exchanges so as to enable home state regulators to monitor the activities of investment firms.

Section 11A of the Exchange Act provides for a uniform method among the various US securities markets for reporting quotations and transaction information on a continuous basis as well as the collection and dissemination of this information. In implementing this system, the SEC sought to impose a system that requires the reporting of transaction information on a real time basis.

A firm however need not make a transaction report to the FSA if the firm complies with a requirement on it to report the transaction to its home state regulator or the reportable transaction is transacted on one of the exchanges listed in the FSA's Supervision Manual and the firm reports the reportable transaction to that exchange.

This report must detail the methods used, place, number of securities, price, amount, date, time, beneficiary and counterparty in respect of the transaction.

The draft Commission Regulation on reporting transactions in financial instruments (ESC/7/2005-rev2 13/05/05), due to come into force on 30 April 2007, sets out that securities loans and repurchase agreements and reverse repurchase agreements are not to be considered as transactions

Exchange Act Rule 11Aa3-1(a)(4) defines a "reported security" as "any equity listed security or NASDAQ security for which transaction reports are required to be made on a real-time basis pursuant to an effective transaction reporting plan."

- 66 -


(Section 5.2 continued - Trade reporting - Intra-country differences)

Such entities are obliged to notify any transaction in securities13 and derivatives14 admitted to trading on an EU/EEA organised market15 or traded on the Regulated Unofficial Market (Freiverkehr) of a German exchange to the BaFin where the transaction in question is executed in connection with an investment service or for own account.

The transfer of shares arising from the settlement of physically settled OTC equity derivative transactions will amount to an off-exchange sale and therefore will be subject to authorisation by the exchange unless such transfer meets the requirements for such transaction to be exempt from authorisation (please refer to section 3.1.2 above).

and therefore do not need to be reported. MiFID also provides for such information to be shared with the "competent authority of the most relevant market in terms of liquidity for those financial instruments".

13 Under the Securities Trading Act securities are (i) shares, certificates representing shares, bonds, participation certificates, warrants and (ii) other securities which are comparable to shares or

bonds if they can be traded on a market. Securities also include units that are issued by a German investment company or a foreign investment company.

14 Pursuant to section 2 (2) of the Securities Trading Act, derivatives are forward transactions whose price directly depends on (i) the exchange or market price of securities, (ii) the exchange or

market price of money-market instruments, (iii) interest rates or other returns, (iv) the exchange or market price of goods or precious metals, or (v) the price of currencies.

15 Pursuant to section 2 (5) of the Securities Trading Act, an organised market is a market which is regulated and supervised by state-approved bodies, which is held on a regular basis and is

directly or indirectly accessible to the public.

The definition of a "reportable transaction" excludes:

(i) stock or bond lending and borrowing, repurchase or reverse repurchase agreements;

The reporting requirements apply to both on- and off-exchange transactions.

The same notification requirements apply to non-German entities admitted to trading on a German exchange in respect of transactions executed on a German exchange or the

Even if this is not the case, in practice, authorisation of off-exchange sales arising from the settlement of equity derivatives is never refused, provided that the Sociedad de Bolsas is provided with an execution copy of the relevant agreement.

This obligation applies to both on- and off-exchange transactions. Euronext must then report to the AMF on a daily basis in respect of such transactions and orders it has received.

The draft Commission Regulation also sets out, in Articles 7a and 7b, two options for the exchange of information between regulators: bilateral inter-regulatory exchange or provision of information to a pan-EU central depository.

Article 25(4) of MiFIDsets out examples of the data that should be included in trade reporting, such as

The information filed pursuant to such plans under Rule 11Aa3-1 is collected, processed, consolidated and reported pursuant to the Restated Consolidated Tape Association Plan.

(ii) asset trading transactions, including novation, assignment and sub-participation; and

(iii) issues, market allotments and syndications that are not dealt in on a regulated market.

In general, transactions, other than those in derivative products, between the issuer of an instrument and the first principal purchasers are not reportable transactions.

- 67 -



Regulated Unofficial Market (Freiverkehr) of a German exchange.

Article 8 of Royal Decree 1416/1991, of 27 September, provides that off-exchange transfers of securities listed on a Spanish Stock Exchange (including those transfers made pursuant to a loan agreement) must be notified by the transferee to the governing body of the relevant Exchange or the Sociedad de Bolsas through a member of such Exchange within seven days of the completion of the transfer.

the names and numbers of instruments bought or sold, the quantity, the dates and times of execution and the transaction prices and means of identifying the investment firms concerned.

The notification requirement also applies to the purchase or sale of rights to subscribe for securities in so far as these securities are to be traded on an organised market and transactions in shares and warrants in respect of which an application for admission to trading on an organised market or for admission to trading on the free market has been made or publicly announced.

Such notice must include the identity of the transferor and the transferee, the securities transferred, details of the transaction or circumstance causing the transfer, the date of the transfer and the consideration, if any.

CESR's level 2 advice expands on this by specifying minimum content for transaction reports and what information should be exchanged between regulators.

specifies that reports are to be made to regulators either by the firm itself, a third party acting on its behalf or by a trade-matching or reporting system approved by the relevant regulator/regulated market or multilateral trading facility through whose systems the transaction was completed.

However, if an instrument is already dealt in on a regulated market, secondary issue transactions are reportable if the new issue ranks equally with those already in issue and the issue is already traded or listed on a regulated market.

All secondary market transactions carried out on- or off-exchange, before or after the instrument is issued, are reportable.

"Reportable transactions" include transactions in some instruments that are not traded on a regulated market at all - for example instruments only traded over the counter or through a trading facility such as OFEX (other than non-equity or bond related CFDs and commodities).

The reporting obligations vary according to the nature of a firm's business and the number of transactions which a firm ordinarily enters into. Firms are generally expected to report transactions through FSA-

Article 25(5) of MiFID

- 68 -



In order to comply with Article 25(5) of MiFID, reports shall be made in an electronic form except under exceptional circumstances (when they may be made in another form) and the report shall be made to the competent authority within the timeframe established in Article 25(3) of MiFID.

A trade-matching or reporting system shall be approved by the competent authority for the purposes of Article 25(5) of MiFID if the arrangements for reporting transactions established by that system satisfy specified conditions and the arrangements are operated by an entity which is subject to monitoring by a competent authority in respect of continuing compliance with specified conditions.

approved electronic systems, but firms that enter into relatively few transactions may report those transactions manually, by fax or e-mail.

A transaction report must be made as soon as practicable and in any event, before the end of the next business day after the day on which the firm entered into the transaction.

On 22 July 2005 the FSA imposed a £40,000 fine on Bear Stearns International Limited for failure to make transaction reports in respect of contract for differences trades.

- 69 -



details post trade disclosure principles which investment firms must follow.

This sets out that Member States shall, at least, require investment firms which, whether on own account or on behalf of clients, conclude transactions in shares, whether on-or off-exchange, to make public the volume and price of those transactions and the time at which they were concluded.

This information is to be made public as close to real-time as possible on a reasonable commercial basis, taking into account the characteristics of the trading venue where the transaction was executed and the complexity of the trade (and in any case not later than three minutes after the transaction was executed) and in a manner which is easily accessible to other market participants.

Article 28 of MiFID

- 70 -



C ESR's level 2 advice sets out the specific information that should be made public.

However, the provisions of MiFID recognise certain exceptions to the general requirement of post-trade transparency.

For example, Article 45 recognises the possibility of deferred reporting. The publication of post-trade information may be deferred when the following requirements are met: (a) the transaction includes the participation of an investment firm acting as a principal in the transaction as a direct result of the facilitation of third party business; and (b) the size of the trade is above the relevant threshold to qualify for deferral.

The Commission working document ESC/20/2005 sets out requirements in respect of post-trade transparency for regulated markets, MTFs and investment firms.

- 71 -



Article 12 requires that the information that investment firms, regulated markets, investment firms and market operators operating an MTF should make public in respect of a transaction, should be made public either by reference to each transaction or in a form aggregating the volume and price of all transactions in the same share taking place at the same time.

Article 13 of ESC/20/2005 sets out that a regulated market, market operator or investment firm operating an MTF required to make information in respect of a transaction public may defer publication of that information where: (i) the transaction is between an investment firm dealing on own account and a client of that firm, and the size of that transaction is equal to or exceeds the relevant

- 72 -



minimum qualifying size; or (ii) where there is a transaction arising from an order which was subject to a pre-trade transparency obligation, the order was considered as large in scale compared to normal market size.

Article 14 of ESC/20/2005 requires that post-trade information shall be made public as close to real time as possible taking into account the characteristics of the trading venue where the transaction was executed and the complexity of the trade and no later than three minutes after the relevant transaction.

Post-trade information referring to transactions taking place outside normal trading hours shall be made public before the opening of the next trading day of the execution venue on which the transaction took place or is intended to take place.

- 73 -



Post-trade information for transactions that take place outside a regulated market or MTF shall be made public before the opening of the next trading day of the most relevant market in terms of liquidity for that share.

Pre and post trade information will be considered to have been made public if made available: (i) through the facilities of a regulated market which has admitted the share to trading or an MTF where the share is traded; (ii) through the offices of a third party; or (iii) through proprietary arrangements.

- 74 -

6. Client classification

6.1 General

The UK is unique in its detailed client classification regime which applies applies across the investment spectrum. However, all jurisdictions do draw a broad distinction between


For the purposes of the FSA regime in general and application of the conduct of business rules in particular, clients are classified into "market counterparties" and "customers".

Under German law, there is no generally applicable client classification regime. Neither is there a consistent definition of the legal term "consumer". Instead, different laws and regulations define "consumer" in different ways.

Clients are generally classified as either institutional or retail only for purposes of security offerings. After full implementation of the Prospectus Directive in Spain, the "institutional investor" concept will be replaced by the broader concept of "qualified investor", which may include individuals under certain circumstances.

As a general rule (based both on case law and on a conduct of business duty set out in the FFMC and the AMF General Regulations), providers of investment services should take account of each potential client's needs, knowledge and objectives from the commencement of the relationship to the performance of the requested service. Case law refers to the concept of "warned investors" and excludes them from the scope of protection of the information/advisory/warning duty imposed on providers of investment services. Under the AMF General Regulations, there is a presumption that "qualified investors", other specified types of institutional investors and professional dealers are warned investors who,

MiFID generally operates under a dual classification: customers are defined as either professional clients (who must meet a set of criteria set out in Annex II of the Directive) or retail clients (who are defined as all clients other than professional clients).

Clients are generally classified as

either institutional or retail.

protection and attention.

Market counterparties include governments, central banks, supranationals and authorised firms (UK or EEA passported).

"Customers" are made up of two sub-categories: "intermediate customers" and "private customers".

"Intermediate customers" include local authorities, listed companies, corporates with called-up share capital or net assets of at least £5 million, special purpose vehicles, collective investment schemes, UK Recognised Investment Exchanges, regulated markets and clearing houses.

Clients are generally classified as retail investors (consumers) or entrepreneurs (broadly speaking, professional business undertakings).

In terms of the German conduct of business rules, in most cases, no distinction is made with respect to rules applicable to retail or institutional investors.

However, a distinction is made between retail customers and institutional investors in respect of an investment services provider's duty to furnish

There is no strict definition of institutional clients; although the definition contained in article 7.1.a) of RD 291/92 is generally used. This Article does not define the legal nature of institutional investors, but provides examples of certain types of institutions that qualify as such. These include pension funds, collective investment undertakings, insurance companies, credit institutions

Article 71(6) of MiFID envisages "grandfathering" to the extent that investment firms will be permitted to continue considering existing professional clients as such provided that this categorisation was originally granted by the investment firm on the basis of an adequate assessment of the expertise, experience and knowledge of the client.

However, a certain amount of repapering will be necessary in that investment firms are obliged to inform all clients about the conditions established in MiFID for the categorisation of clients.

As identified in the Schedule there are a number of different definitions of the term "customer" within U.S. securities laws and regulations.

Retail clients generally refer to individuals or entities with a net worth valued below a certain threshold amount that varies depending on the context in which the term is employed. Since the federal securities laws are intended to protect retail clients, there are greater restrictions on the recommendations and types of behaviour that securities professionals must use when dealing with them.


therefore, need less

professional and retail clients.

- 75 -


(Section 6.2 continued - client classification - Intra-country differences)

"Private customers" are customers who are not intermediate customers.

information to customers. Under the conduct of business rules, an investment services provider

or broker-dealers (provided that the above institutions carry out investments in securities on a regular and professional basis).

However, in respect of best execution and the handling of client orders, the AMF General Regulations do not make any distinction between investors i.e. all types of investors should be treated on an equal footing.

There is no explicit retention duty in respect of client classification duties, but all firms observe a retention duty both to meet any legitimate request for information made by the regulator (who is generally entitled to investigate into whether firms are complying with all their duties) and to reject claims made by supposedly aggrieved investors.

Business with private customers is most regulated, with business with market counterparties often only being subject to "light touch" regulation. It should be noted, however, that the system allows for a series of opt-downs and opt-ups which, for example, enable intermediate customers to be classified as market counterparties by firms, thereby reducing protections to which they are entitled.

A firm must make a record of the classification established for each client, including sufficient information to support that classification. A firm must retain the record referred to for a minimum period after the date on which the firm ceases to carry on business with or for that client (generally three years).

must assess each customer's individual level of experience in respect of the proposed investment service, the customer's aims in respect of those transactions and their financial situation. Against this background, the provider has to classify its customers. The classification of the customer needs to be observed when providing information to customers and the disclosure material required by the conduct of business rules as well as when executing any of the customer's orders.

In relation to transactions with certain institutional investors, the conduct of business rules grant an exemption from requiring customer information and providing information to such investors. If transactions involve other investment services providers or market participants who,

In terms of Spanish conduct of business rules, the division of client types is only relevant with respect to the "suitability rules" contained in Article 5 of the Spanish conduct of business rules pursuant to which firms must provide their clients with all information they are aware of that may be relevant to allow the clients to make investment decisions and must afford each of their clients the time and attention required to find out the products and services that are most suitable to their objectives.

Other Spanish conduct of business rules apply uniformly to clients irrespective of their classification.

In order to ensure that conduct of business rules (including rules on best execution and handling of client orders) are enforced in respect of those investors most in need of protection, and to reflect well established market practice throughout the European Union, MiFID provides that conduct of business rules may be waived in the case of transactions entered into or brought about with "eligible counterparties".

Article 24 defines eligible counterparties to include investment firms, credit institutions, insurance companies, UCITs and their management companies, pension funds and their management companies, other authorised/regulated financial institutions authorised or regulated under

Community legislation or the national law of a Member State, national governments and their corresponding offices, central banks and supranational organisations.

Institutional clients are perceived as more sophisticated and/or experienced in the securities arena and thus are not viewed as requiring the same degree of protection. Generally, institutional clients include banks, savings associations, insurance companies, or registered investment companies. The term "institutional clients" may also include corporations, partnerships and trusts, with total assets of at least $10 million.

- 76 -



in connection with their business activities regularly execute transactions in securities and/or derivatives

to an extent which, because of their economic relevance, require such special expertise, an investment services provider may refrain from observing the customer information requirements if: (i) the provider informs the customer in writing before the investment service is provided that due to the customer's experience no information is to be requested from or provided to the customer, (ii) the customer does not immediately object to this assumption; and (iii) the provider has recorded in writing the reasons for the respective classification of the customer.

Member States will also be able to classify other entities (whether based in the EU or not) as eligible counterparties where they satisfy pre-determined national requirements, including quantitative thresholds. The Commission Working Document ESC/23/2005 has proposed allowing Member States to recognise an undertaking as an eligible counterparty where it meets two of the following size requirements on a company basis: balance sheet total: EUR 20,000,000; net turnover: EUR 40,000,000; own funds: EUR 2,000,000.

Entities classified as eligible counterparties, will retain the right to "downgrade" their status (whether generally or on a trade-by-trade basis) so as to have the benefit of the conduct of business rules applicable to other investors. For all other purposes eligible counterparties are likely to fall under the classification of professional clients.

Please refer to the Schedule of this Volume for an analysisof client classifications.

A natural person is generally not considered an institutional client unless he or she is considered to be an extremely high net worth individual.

CESR's level 2 advice provides that if an investment

- 77 -



firm intends to classify any of its clients as eligible counterparties, it must implement appropriate written internal policies and procedures for the categorisation of eligible counterparties in accordance with the applicable requirements. The latter are responsible for keeping the firm informed about any change that could affect their current categorisation.

Where an undertaking that is not an eligible counterparty informs an investment firm that it wishes to be treated as an eligible counterparty, the investment firm may treat the undertaking as an eligible counterparty provided that: (a) it ensures that the undertaking meets at least two of the following criteria: (i) balance sheet total: EUR 20,000,000; (ii) net turnover: EUR 40,000,000; (iii) own funds: EUR 2,000,000; (b) it promptly notifies the undertaking in writing of the new classification; (c) it promptly gives the

undertaking clear written information about the protections it will lose and

- 78 -



investor compensation rights it may lose; (d) it obtains a statement from the undertaking in writing and in a separate document from the contract, that the undertaking

is aware of the consequences of losing such protections.

An investment firm may also, either upon request or on its own initiative, treat a client that is an eligible counterparty as a professional client or retail client provided: (a) the client shall be classified as a professional client or retail client and benefit from the protections under MiFID in respect of conduct of business rules, best execution and handling of client orders; and (b) the investment firm must promptly notify the client in writing of its classification, specifying any limitations that apply to the classification.

It should be noted that clients meeting the eligible counterparty criteria specified in MiFID cannot be treated as eligible counterparties if they have previously requested non-professional status.

- 79 -



Documentation

In general a private customer or intermediate customer must be provided with a firm's terms of business, setting out the basis on which the designated investment business is to be conducted with or for the private or intermediate customer. The FSA Handbook prescribes the information to be included in the terms of business.

Documentation

Credit institutions and financial services providers are subject to a number of record-keeping and documentation requirements (in particular, regarding the execution of orders as provided under the conduct of business rules).

Documentation

The existence of a contract entered into by the relevant parties will be required in the following situations:

Documentation

The AMF General Regulations impose on providers of any investment services a duty to enter into a written service agreement (containing compulsory clauses) with any investor, save for qualified investors or specified institutional investors requesting services which do not include any clearing services or involve any reception of securities or cash by the service provider acting as account keeper.

Documentation

Article 19(3) of MiFID requires appropriate information to be provided to clients or potential clients (other than eligible counterparties) about: (i) the investment firm and its services; (ii) financial instruments, investment strategies and risk warnings; (iii) execution venues; (iv) costs and associated charges; and (v) the firm's conflicts policy. Article 19(7) goes on to specify the minimum requirements for retail client agreements.

Documentation

Exchange Act Rule 10b-10 mandates that brokers provide their customers with certain information at or before the completion of a transaction, including the date, time, identity, price, and number of shares involved; its capacity (agent or principal) and its compensation; and other information, both general (e.g., if the broker-dealer is not a SIPC member) and transaction-specific (such as the yield, in most transactions involving debt securities).

In general if a firm intends to manage investments on a discretionary basis, conduct designated investment business relating to a contingent liability, perform stocklending etc with or for a private customer its terms of business must take the form of a client agreement (requiring both parties' signatures).

Before entering into a transaction with a consumer, the services provider has to furnish written information concerning the specific risks of financial derivative transactions. This is normally done by way of the so-called information sheet (Informationsmerkblatt uber Verlustrisiken bei Finanztermingeschaften) which is published as a standard disclosure document by the German banking industry. In addition, the consumer has to confirm receipt of the information by signing a copy of the information sheet.

..

..

(i) where a standard agreement (contrato tipo) is required. Standard agreements are required to carry out the following transactions:

(a) portfolio management;

(b) safe custody of securities when the nominal value of the securities which are the object of the agreement does not exceed €120,202.42 and the client is not a financial entity; and

(c) repurchase transactions over securities listed

on organised secondary markets for an amount lower than €60,101.21.

CESR's level 2 advice and the Commission Working Document ESC/23/2005 in respect of Articles 19(3) and (7) is largely addressed to investment firms in respect of retail clients and is therefore outside the scope of this Report. However Article 6 of the Commission Working Document ESC/23/2005 provides that where an investment firm provides information about a financial instrument to any client and that financial

A broker-dealer must make certain disclosures with any U.S. customer who wishes to engage in margin and/or options transactions, which shall include, a disclosure of the broker-dealer's credit terms and an options disclosure document, and must obtain the clients written consent prior to performing necessary functions associated therewith (e.g., hypothecation of securities,

- 80 -


(Section 6.2 continued - client classification - Documentation - Intra-country differences)

In entering into a contract with private customers, an investment firm is required to provide the private customer with certain risk warnings in respect of: warrants and derivatives; non-readily realisable investments; penny shares; securities subject to stabilisation; stock lending activities; and structured capital-at-risk products. Such risk warnings, however, do not apply in respect of investments entered into with market counterparties and intermediate customers and are therefore outside the scope of this report.

Standard business terms may set out the basis on which the designated investment services are to be conducted. However, standard business terms have to be incorporated into the contract and must not contain terms and conditions which are either statutorily prohibited (sections 308 et seq. of the German Civil

(ii) in transactions that due

nature are not included

prospectus;

instrument is the subject matter of an offer to the public in connection with which a prospectus has been published, the investment firm must provide the client with a copy of the prospectus or inform him where it is made available to the public.

etc.). Agreements may be obtained by paper, electronically, or by any other valid method of establishing a contract. In addition, the broker-dealer must gather and review information regarding the "essential facts" related to non-institutional customers in accordance with NYSE Rule 405 and/or NASD Rule 2310 and 2340, such as the client's financial status and investment objectives, in determining whether certain recommendations are suitable. In order to meet its suitability

A firm must make a record of each terms of business it provides to a customer, and any amendment to them, as soon as the terms of business come into force. A firm must retain each record referred to above for a certain period of time (generally three years).

Code) or which place the other party at an unreasonable disadvantage.

These provisions only apply to a limited extent to agreements concluded with persons acting in pursuance of their commercial or professional activities or private or public law entities. Nevertheless, even in such cases the standard business terms must not alter substantial principles of German law or lead to seriously disadvantageous consequences for the investor.

(iii) in relation to repurchase transactions over securities not listed on organised secondary markets; and

(iv) whenever the client so requires.

The existence of a contract is also required in connection with certain stock loan arrangements (please refer to section 3.7.1 above).

Written agreements are unlikely to be required for arrangements with financial institutions/ the government etc. - although record-keeping requirements will demand a written confirmation.

obligations to institutional customers (as specified in NASD IM-2310-3), a broker-dealer should also gather information from institutional accounts.

In addition, firms must disclose that brokerage products are not guaranteed and may lose value. With respect to penny stocks, broker-dealers have enhanced suitability and disclosure obligations to their customers under

to their particular

in the firm's fee

- 81 -


(Section 6.2 continued - client classification - Documentation - Intra-country differences)

If the agreements entered into with German counterparties contain standard business terms, German law provisions on standard terms and conditions may need to be observed.

Moreover, mandatory German consumer protection provisions (such as the provisions on general terms and conditions) will apply even if the parties have not chosen German law as the governing law of the relevant agreement where the agreement qualifies as a consumer contract. In the event the agreement is not governed by the laws of a Member State of the European Union or contracting state to the EEA, mandatory consumer laws can apply irrespective of the law that has been chosen by the parties in order to ensure that EU citizens are not deprived of their EU consumer protection rights.

In the Spanish Business Code of Conduct there is a general principle that information provided to clients is clear, correct, precise, sufficient and timely so as to avoid its incorrect interpretation and states the risks implicit in every transaction (especially in respect of high risk financial products) so as to ensure that clients are aware of the possible results of any transaction. In light of this, it is advisable to include risk disclosure warnings in derivative documentation, although there is no standard wording.

Exchange Act Rules 15g-2 through 15g-9. Broker-dealers must also provide their customers with annual privacy notices, pursuant to SEC Regulation S-P, that set forth the nature of private client information collected, and the manner in which it will be used.

- 82 -

7. Market abuse/ Insider Dealing

7.1 Overview

7.1.1 General

On-exchange transactions will be subject to insider dealing laws and usual market abuse prohibitions will apply in all jurisdictions. The treatment of OTC transactions (both cash and physically settled) differs slightly between the jurisdictions.



UK regulations currently operate on a super-equivalent basis as regards the underlying EU Directives and market abuse/insider dealing laws cover both OTC transactions and exchange-traded instruments.

Under German law, market abuse and insider dealing laws cover exchange traded instruments and, to a certain extent, OTC transactions.

Spanish regulations operate on a super-equivalent basis as regards the underlying EU Directives and market abuse/insider dealing laws cover both OTC transactions and exchange-traded instruments.

As regards the offence of insider dealing, as already set out in section 1.2 above, French legislation already provided for such an offence, but the current scope of the French definition was, to a certain extent, not as broad as the MAD definition (for example, under MAD, mere attempts to use inside information fall within the scope of insider dealing). This discrepancy has obviously disappeared with the implementation of MAD in France.

French law previously contained provisions setting out a definition of the offence of market manipulation but these

MAD stipulates the general principles to which Member States must adhere when dealing with market abuse. However, in its preamble it states that Member States should ensure that there is a degree of uniformity in regulation and it urges cooperation between the competent national supervisory authorities.

No express statutory definition of insider trading exists under the US securities laws.

Insider dealing legislation in the UK prevents dealing in shares, debt securities, warrants, options, futures, depository receipts and contracts for difference where the underlying security is a security listed on an EU regulated market and when the person in question is in possession of inside information.

The Securities Trading Act as amended by the AnSVG contains a statutory prohibition on insider transactions, i.e. certain activities with respect to insider securities carried outusing16 insider information.

16 Under German law, simply using (rather than taking advantage of) insider information when entering into transactions in respect of insider securities is covered by the insider trading prohibition.

Indeed, MAD envisages a method by which one national regulator can request another national regulator to gather information on its behalf or conduct an investigation at its request.

The Securities Market Act ("SMA") prohibits the following insider offences:

Specific types of insider trading are addressed by Exchange Act Section 16(b), which prohibits short swing profits by designated statutory insiders, and Exchange Act Rule 14e-3, which prohibits anyone other than a tender offeror from acquiring any securities while in possession of material information that he knows or has reason to know is non public and was acquired from the bidder, the target or any person associated with either one of these.

- 83 -

United Kingdom Spain France EU Developments US Equities

(Section 7.1.2 continued - market abuse/ insider dealing - Intra-country differences)

Inside information (broadly defined as specific, non-public, price-sensitive information relating to particular securities or issuer(s) of securities) is non-public information that may be considered to have a significant effect on the price of a security or that a reasonable investor would be likely to consider important in making an investment decision. Information that has been "made public" is not inside information. Insider dealing carries a maximum penalty of 7 years imprisonment and/or an unlimited fine.

Insider securities are defined as financial instruments17 that are (i) admitted to trading on the official market (amtlicher Markt) or regulated market (geregelter Markt) or regulated unofficial market (Freiverkehr) of a German stock exchange, (ii) admitted to trading on another EU or EEA organised market, (iii) for which a request for admission to or inclusion on such market has been made or (iv) the price of which is linked directly or indirectly to any of the financial instruments described above. Therefore, the applicability of insider dealing laws to OTC transactions depends on the underlying security. If the underlying security is listed, insider dealing prohibitions will apply irrespective of whether or not the instrument itself is

(a) preparing or carrying out any kind of transaction in respect of negotiable securities or financial instruments to which inside information refers or any other securities, financial instruments or any type of agreement whose underlying assets are the negotiable securities or financial instruments to which the inside information refers;

The offences under MAD include the following:

The parameters of liability have been established through SEC administrative enforcement actions and court decisions, which have defined illegal insider trading as buying or selling a security in breach of a fiduciary duty or other relationship of trust and confidence while in possession of material, non public information about the security.

17 Financial instruments within the meaning of the Securities Trading Act are securities, money-market instruments, derivatives and rights to subscribe in securities. Other instruments which are

admitted to trading on an organised market are also deemed to be financial instruments.

Instead, the basis for liability has been premised on the general antifraud language of Exchange Act Rule 10b-5, which renders it unlawful for any person ìto employ any device, scheme or artifice to defraud or "to engage, in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person".

in this respect, by bringing into force a definition of market manipulation in line with MAD.

Committing insider dealing or a market manipulation offence gives rise to imprisonment (up to 7 years) and substantial fines.

provisions were never used in practice. The recently adopted law no 2005-842 constitutes a major change

Germany

exchange- traded.

Under the new Disclosure Rules implemented as a result of the UK's implementation of MAD and the Prospectus Directive a new obligation is imposed on companies to keep insider lists. The company must ensure that it, and each person acting

(b) disclosing such information to third parties; and

the prohibition of insiders who possess inside information information from using that information

by directly or indirectly acquiring or disposing of financial instruments to which that information relates or recommending or inducing others to do so;

(c) recommending or procuring a third party, on the basis of such information, to acquire or dispose of negotiable securities or financial instruments to which the information relates.

the prohibition on market manipulation;

the improper disclosure of inside information; and

- 84 -


on its behalf or on its own account (including, for example, professional advisers) draws up a list of people working for them (under a contract of employment or otherwise) who have access to insider information relating directly

or indirectly to it, whether on a regular or occasional basis. The information that the insider lists must contain is extensive and must include the name of each person having access to such information, the reason why such person is on the insider list and the date on which the insider list was created and

Insider information is defined as concrete non-public information18 relating, directly or indirectly, to one or more insider securities or their issuers and which, if made public, would likely have a significant impact on the market or exchange price of such insider securities. The question of whether or not the information is price sensitive depends on whether a prudent investor would consider the information important in making an investment decision. The BaFin's issuers' guide provides a non-comprehensive list of examples of facts that the BaFin deems as price sensitive insider information (such as the transfer or closure of core business areas of the issuer, the acquisition or disposal of significant interests, certain corporate actions etc).

Insider trading violations may also involve "tipped" such information, trading by the "tipped" individual, and trading by those who misappropriate such information.

18 Information is publicly known if an indefinite number of persons have access to the information. However, it is not necessary for the information to have been published in the media. Instead, so-called sector

disclosure to market participants is considered to be sufficient.

The SEC can bring an enforcement action for insider trading pursuant to Rule 10b-5, while the Department of Justice can bring a criminal action if there is proof that the defendant acted "willfully" in violating the securities laws.

Exchange Act Rules 10b5-1 and 10b5-2 were adopted by the SEC in response to conflicting court decisions regarding insider trading issues.

The contravention of the offences on insider dealing constitutes an infringement of the SMA and is punishable by administrative sanctions. In addition, insider dealing may constitute a criminal offence and be punishable

updated. The lists must be kept for five years from when they are created or updated and must be provided to the competent national authority as soon as possible upon the competent national authority's request.

by imprisonment, a fine and disqualification from conducting business.

The SMA also generally prohibits manipulative behaviour by any person operating in the securities markets. The following is considered to be manipulative behaviour:

� the non-dissemination

information to the public as soon as possible.

MAD envisages the possibility of both criminal and administrative sanctions for breaches of the above offences.

Rule 10b5-1 provides that a person trades on the basis of material non public information if a trader is

(a) transactions or orders which give, or are likely to give, false or misleading signals as to the supply of, demand for or price of negotiable securities or financial instruments or

�

CESR's level 3 advice on MAD sets out examples of various types of practice which would constitute market manipulation: false and misleading transactions, price positioning, fictitious devices and false or misleading information. The acceptable market practice defence is only available in respect of false and misleading transactions and price positioning.

Article 6 (9) of MAD requires any person professionally arranging transactions in


instruments of insideby issuers of financial

- 85 -


To satisfy the insider list requirement, the company must maintain a list of its own employees with access to inside information and a list of the issuer's principal contacts at any other firm or company acting on its own behalf or on its account with whom it has had direct contact and who also have access to inside information about the company. It is the company, and not its adviser or agents, which is ultimately responsible for maintenance of these lists.

Pursuant to section 14 of the Securities Trading Act, insiders are prohibited from:

Under the FSA regime individuals must also not:

�

acquiring or disposing of insider securities, for their own account or for the account of a third party,

�

"aware" of material non public information when making the purchase or sale, and also sets forth several affirmative defences or exceptions to liability.

Rule 10b5-2 clarifies the application of the misappropriation theory to certain non-business relationships, providing that a person receiving confidential information under circumstances specified in the rule would owe a duty of trust or confidence and as a result could be liable under the misappropriation theory.

which secure the price of one or more financial instruments at an abnormal or artificial level (unless the person who entered into the transaction or issued the orders proves that his reasons for so doing were legitimate and that these transactions or orders conform to accepted market

disclosing or making available insider information to a third party without being authorised to do so, and

recommending the acquisition or disposal of securities based on insider information.

� make false or misleading statements, promises or forecasts;

� dishonestly conceal any material facts; or

recklessly make a statement, promise or forecast which is misleading, false or deceptive in a material particular.

The intentional (or grossly negligent) acquisition or disposal of insider securities using insider information is a criminal offence (imprisonment up to five years or a fine). The intentional disclosure of insider information to a third party and the recommendation to, or inducement of, a third party to acquire or dispose of securities constitutes a

practices on the relevant regulated market);

(b) transactions or orders which employ fictitious devices or any other form of deception or contrivance; and

Broker-dealers are subject to sanctions for failure to institute supervisory measures designed to prevent the improper use of material non-public information ("inside information") .

financial instruments who reasonably suspects that a transaction may constitute insider dealing or market manipulation to notify the competent authority. MAD also sets out in Article 9(2) and Article 10 the method of reporting suspicious transactions.

As a practical matter, the primary means of policing the use of inside information is through use of information barriers, or Chinese Wall procedures

CESR's level 3 advice on MAD sets out guidance as to what suspicious

(c) dissemination of information through the media, including the internet, or by any other means which gives or may give false or misleading signals as to financial instruments (including the dissemination of rumours and false or misleading news) where the person who

transactions are and how to report suspicious transactions. In particular, it sets out that persons subject to the suspicious transactions requirement should decide on a case-by-case basis where there are reasonable grounds for suspicion concerning the relevant transaction. However, blanket pro forma notifications to the authorities of all transactions conducted through an institution would not be in conformity with the provisions of the notification regime.


- 86 -


�

criminal offence only if committed by a primary insider19 (imprisonment up to five years or a fine). If committed by a secondary insider (acting with intent or gross negligence), such violation of the insider trading prohibition only constitutes an administrative offence (fines up to EUR 200,000). The mere attempt

19 Under the Securities Trading Act, a primary insider is any person possessing insider information (i) in his or her capacity as a member of the management or supervisory board of the issuer,

(ii) by virtue of his or her shareholding in the issuer, (iii) by virtue and within the scope of his or her profession, employment or duties (such as credit institutions and financial services

institutions, mandated auditors, management consultants, lawyers, notaries etc. and their employees as well as employees of the issuer and other persons contractually related to the issuer) or

(iv) by virtue of the preparation or commission of a crime.

It is a criminal offence to do so. Such conduct may result in criminal prosecution and/or an action under the common law for damages. The penalty on conviction of the criminal offence is up to seven years imprisonment and/or a fine.

UK market abuse broadly covers:

insider dealing;

to commit insider trading in a form that would constitute a criminal offence is also prohibited.

Under German law, certain notification duties exist (e.g. the duty to make ad hoc disclosures, reporting duties concerning directors' dealings and the duty to maintain an insider list of those persons who work for a listed company and have access to insider information) to prevent insider trading.

disseminated the information knew, or ought to have known, that the information was false or misleading.

Breach of the above prohibitions may constitute a "very serious

employed, typically, on a firm-wide (i.e. global) basis. Specifically, Section 15(f) of the Exchange Act requires that registered broker-dealers "establish, maintain and enforce written policies and procedures, reasonably designed, taking into consideration the nature of such broker's or dealer's business, to prevent the misuse in violation of ... [the federal securities laws], or the rules or regulations thereunder, of material non-public information by such broker or dealer or any person associated with such broker or dealer."

Under Section 21A(b) of the Exchange Act, treble damages can be imposed on

infringement" or a "serious infringement" of the SMA.

In the case of a "very serious infringement" of the SMA, one or more of the following sanctions could be imposed on the offender:

(a) a fine of no less than the amount of the gross profit obtained as a result of the actions or omissions of which the infringement consists and no more than five times that amount; or, where such sum is not appropriate, up to the greater of the following

CESR's level 2 advice in respect of Article 13(2) of MIFID (compliance and personal transactions) requires firms to prevent employees entering into personal transactions or causing others to do so

improper disclosure;

when they have access to price sensitive information unless certain exemptions are satisfied (e.g. use of a discretionary portfolio manager).

a broker-dealer if the SEC proves that the broker-dealer "knowingly or

The draft Commission Regulation on organisational requirements and identification, management and disclosure of conflicts of interests by investment firms sets out, that an investment firm shall take all reasonable steps to prevent each person, who is subject to a conflict of interest or who has access to price sensitive information by virtue of an activity

misuse of information*;

manipulation;

manipulating transactions;


The civil offence of

- 87 -


disclosure obligation (in particular the failure to publish important information, the delay in the publication, or the inaccuracy of the publication) may give rise to a claim for damages by investors against the issuer. Moreover, the violation of such disclosure obligation is an administrative offence (fines up to EUR 1,000,000).

recklessly failed to establish, maintain, or enforce any policy or procedure required under Section 15(f) ... and such failure substantially contributed to or permitted the occurrence of the ... violation."

�

In addition to the duty to make ad-hoc disclosures is the statutory obligation of German listed companies to maintain (and to update regularly and promptly if changes occur) an insider list of persons acting on behalf of the company or on account of the company (under a contract of employment or otherwise) who have access to insider information. Upon request, the insider list has to be

In order to establish a broker-dealer's liability under Section 21A(b), the SEC is not required to demonstrate that the broker-dealer's failure to establish insider trading procedures was essential to the violation, only that the failure "provided some assistance to the ... violations."

Insider information has to be published immediately. A violation of such ad-hoc

submitted to the BaFin.

amounts: 5% of the offender's equity; 5% of the funds used in the infringement or Euro 300,000);

While Section 15(f) authorises the SEC to promulgate specific information wall procedures, the SEC has never in fact formally specified a set of required procedures.

carried out by him on behalf of the firm, from entering into specified personal transactions and from advising, procuring or communicating in specified ways. An investment firm should also ensure that adequate arrangements are established to ensure that each relevant person is aware of the restrictions on and measures established in respect of personal transactions, that the firm is informed promptly of any personal transactions entered into by a relevant person and that records are made of personal

�

(b) suspension or restriction of the type or volume of transactions or business which the offender may carry out in the securities market for a period not exceeding five years;

(c) suspension of membership of an official secondary market for a period not exceeding five years;

(d) cancellation of the offender's authorisation in the case of investment services companies or other entities registered with the CNMV. In the case of branches of investment services companies authorised in

transactions notified to it or identified by it including any authorisation or prohibition in connection with such a transaction.

The restrictions on personal transactions do not apply in respect of personal transactions effected under the provisions of a discretionary portfolio management service where there is no prior

another EU Member State, any such offending branch will be

manipulating devices;

dissemination;

misleading behaviour and distortion*; and

requiring and encouraging others*

The UK implementation retains elements of superequivalence21 as regards the MAD which will be reviewed three years after implementation in order to assess whether they should be retained.

21 Highlighted by an asterix above.

All but the remaining super-equivalent offences will extend beyond instruments trading on FSA Recognised Investment Exchanges (as was formerly the "market abuse" position in the UK) to all European regulated markets.


- 88 -


�

Moreover, any member of a management, administrative or supervisory body of the issuer and any other executive who has access to insider information on a regular basis and is authorised to make significant management decisions, as well as any person closely associated with such person (such as spouses, children or other relatives who have lived in the same household as a "director" subject to the reporting obligation for at least one year) have to notify the issuer and the BaFin in writing within five working days of any transaction for their own account in shares of the issuer or in financial instruments linked to such shares.

With respect to market abuse laws, the scope of protection extends to all financial instruments, including derivatives, that are admitted to official trading on a German exchange or traded on the

Following the adoption of Section 15(f), however, the SEC staff conducted a study of broker-dealer insider trading prevention procedures with the aims of identifying adequate procedures and determining whether specific rulemaking was required. It ultimately released a report noting certain elements of information wall procedures that, although not technically mandated, would be regarded by the SEC as essential.

communication in connection with the transaction between the portfolio manager and the relevant person for whose account the transaction is executed or in the case of personal transactions in units in collective undertakings that comply with the conditions necessary to enjoy the rights conferred by the UCITS-Directive, where the relevant person and any other person for whose account the transactions are effected are not involved in the management of that undertaking.

In addition to disgorgement and other remedies, the Exchange Act allows the SEC to recover enhanced penalties for insider trading violations, including up to treble the profits gained or the loss avoided by the defendant. Criminal penalties include a fine of no more than $5 million and/or imprisonment of not more than 20 years. Recently, Section 807 of the Sarbanes-Oxley Act of 2002 added a new crime entitled "Securities fraud" which provides that it is unlawful:

�

�

�

forbidden from undertaking new activities in Spain;

(e) public censure (publication in the State Official Gazette (Boletin Oficial del Estado));

(f) removal of offending individuals from the management of a financial entity and disqualification from holding managerial or executive office with the same entity for a term not exceeding five years; and

(g) removal of offending individuals from the management of any financial entity and disqualification from holding managerial or executive office positions in any other financial entity for a term not exceeding ten years.

The new offence of market abuse covers a wide range of activity. Market abuse:

�

Covers both on and off-off-market conduct, including trading activity

� As stated above, it applies to conduct relating to investments for which recognised exchanges in the EU are the primary trading market (e.g. EU listed securities and on-exchange derivatives) and also investments only incidentally traded on those exchanges (e.g. on the London Stock Exchange's international equity or fixed income markets).

� In addition, in terms of the insider dealing and improper disclosure offences it also applies to conduct relating to derivatives on those "qualifying investments" (e.g. OTC derivatives on listed securities)


- 89 -


regulated unofficial market (Freiverkehr) of a German exchange or that are admitted to trading in an organised market in another Member State of the European Union or in another of the contracting states to the agreement on the European Economic Area. Manipulations which demonstrably affect the stock exchange or market price are criminal offences. If they do not have such an effect, the offence is punishable as an administrative offence.

The market manipulation rules do not explicitly deal with the place of the manipulative activity. However, it is generally accepted that German market manipulation rules apply if the manipulative activity is committed in Germany or (alternately) if the German market is affected by an activity conducted from abroad20.

20 Please note that the German prosecution authorities might, depending on the individual circumstances, even prosecute extra-territorial manipulative activities that are neither committed in Germany nor

have an impact on the German market provided that the market participant violates a foreign prohibition (section 38 para. 5 of the Securities Trading Act).

(ii) to knowingly execute or attempt to execute a "scheme or artifice" to obtain money or property by

means of false pretences or representations "in connection with the purchase or sale of any security" of a reporting company under the Exchange Act.

The maximum penalty for violations of this provision is a fine or imprisonment of not more than 25 years, or both.

In the case of a "serious infringement" of the SMA, one or more of the following sanctions could be imposed on the offender:

(i) public censure (publication in the Official State Gazette (Boletin Oficial del Estado));

(ii) a fine of not less than the amount of the gross profit obtained as a result of the actions or omissions to which the infringement relates; or, where such sum is inappropriate up to the greater of the following amounts: 2% of the offender's equity; 2% of the funds used in the infringement or Euro 150,000;

� The offences of misuse of information and misleading behaviour and distortion apply to both conduct relating to derivatives on those "qualifying investments" (e.g. OTC derivatives on listed securities) and conduct relating to instruments underlying exchange traded investments (e.g. commodities or securities underlying exchange traded derivatives or structured notes or warrants);

� has extra-territorial reach (the offence can be committed overseas); and

� does not require intent (unlike the insider dealing offence) but must involve behaviour that would not be acceptable to a regular user of the market in question. Accepted


(i) to knowingly execute or attempt to execute a "scheme or artifice" to defraud any person " in connection with anysecurity of " a reporting company under the Exchange Act; and

Although Rule 106b-5 requires proof of knowledgeand only wilful violationsare punishable as a crime, itis an open question as to whether loss will be

required to establish

- 90 -


�

�

Moreover, manipulative activities might, depending on the individual circumstances, break the relevant market's rules. Such a violation of market rules can be sanctioned by the competent stock exchange supervisory authorities of the federal

states (see item 2.4.2 above) and might lead to an exclusion from trading on the relevant market.

(iii) suspension or restriction on the type or volume of transactions or businesses which the offender may carry out in the securities market for a period not exceeding one year;

(iv) suspension of membership of a secondary market (official or unofficial) for a period not exceeding one year;

(v) suspension of individuals from holding managerial or executive office positions in the entity in which the infringement has been made for a term not exceeding one year.

In addition to the above sanctions which may be imposed on the offender themself, additional sanctions may be imposed upon those holding managerial or executive office positions who are responsible for the infringement.


market practice may not always correspond to the

acceptable standards of behaviour expected by a regular user.

Breaches of the market abuse regime can give rise to unlimited fines; public censure; compensation/ disgorgement orders; injunctions/asset freezes; industry bans; authorisation restrictions etc.

criminal liability for aknowing scheme or artificeto defraud under this newprovision.

Although most of theliability provisions of USsecurities laws focus ondisclosure and registrationrequirements, severalprovisions of the ExchangeAct prohibit manipulativeconduct in connection withsecurities trading. Section 9expressly prohibitsmanipulative activity inconnection with securitiestraded on a nationalexchange and includes aprivate remedy for investorsinjured by such conduct.

This provision issupplemented by Section10(b), which grants the SECauthority to promulgaterules prohibitingmanipulative and deceptivedevices in connection withthe purchase or sale of

securities and broadly

Section 15(c) also permits the SEC to

applies to both securitiesregistered on a nationalexchange and any securitiesnot so registered.

- 91 -


Furthermore, manipulative behaviour may constitute a criminal offence and be punishable by imprisonment.


broker-dealers from engaging in fraudulent and manipulative behaviour.

Courts have held that the mere fact that prices are affected is not sufficient to establish manipulation. However, conduct reasonably calculated to directly affect the price of a security could form the basis for liability, such as artificially creating the false impression of an active market.

Violations of these provisions may entail civil penalties, disgorgement of ill-gotten gains, public censures, injunctions, asset freezes, and/or industry bars. As discussed above, criminal fines and/or imprisonment may be imposed for wilful violations of the securities laws.

promulgate rules specifically prohibiting

- 92 -

7.2 Equity derivatives

7.2.1 General

Currently, the trading in equity derivatives can amount to market abuse if the dealing occurs as a result of inside information or if the deal was an artificial transaction or involved price positioning. There is little specific regulatory guidance as regards the application of the market abuse regime for equity derivatives in Germany, Spain and France although, cases heard by the regulators help illustrate the position in each jurisdiction.



Dealing in investments which are the subject matter of/or whose price or value is determined by reference to a qualifying investment (i.e. investments traded on UK prescribed markets such as Euronext.liffe and LSE) can amount to market abuse. As a result, the trading of equity derivatives can amount to market abuse if the equity derivatives themselves are exchange-traded (and will include dealing in respect of the underlying whether listed or not) or, in the case of OTC derivatives, if the underlying securities are listed. This will remain the case following UK implementation of the Market Abuse Directive (although market abuse will not cover dealing in the unlisted underlying of listed securities).

There have been no particularly relevant cases in Germany as regards the abusive use of equity derivatives. The BaFin's investigations however have included two cases of "marking the close", (i.e. purchasing or selling a security at the close of the day's trading in an effort to alter the closing price of the security in order to avoid margin calls, to support a flagging price or to affect the value of a portfolio).

There has been one particularly relevant recent case in this respect:-

We are not aware of any court decision specifically dealing with insider dealing or market manipulation crimes connected with equity derivatives.

The overriding principle of MAD is to create an integrated and efficient financial market which enables the smooth trading of securities and engenders public confidence.

There has been one particularly relevant recent case in this respect:

One of the two cases involved the manipulation of the market price of a listed security that was used as the underlying for another product, namely a certificate that featured a "knock-out" clause according to which the certificate would be rendered worthless if the closing price of the

Crédit Suisse

This case concerned the manipulation of the IBEX-35 index by Credit Suisse through substantial share sales prior to the close of the Spanish stock exchanges. The aim was to lower the IBEX-35 to profit from a linked derivative. Resulted in fines for Credit Suisse.

As such it has regard to "securities" and "derivatives" (including equity swaps and equity derivatives).

Indeed, recital 35 of MAD stipulates that Member States must apply market abuse sanctions to both OTC derivatives where the underlying is a financial instrument (as defined in section 7.1.2 above) and exchange-traded derivatives (which in themselves qualify as "financial instruments").

In Caiola [295 F.3d 312] the court upheld a customer's securities fraud claim as to a bank's material misrepresentation in respect of the customer's engagement in synthetic securities (equity swaps and cash settled options) trades. The customer alleged that the bank falsely told him that their synthetic trading relationship would not change after the bank's merger transaction, that had he known that the relationship would change, he would have closed his account, and that the bank exposed him to risks that it advised him he could avoid through use of synthetic trading when

`

- 93 -


(Section 7.2.2 continued - Equity derivatives - Intra-country differences)

There have been a number of relevant cases in the UK:

(i) Henri Laurent / Bertrand Fleurose

Concerned the manipulation of the FTSE index through substantial share sales in respect of 5 companies heading the list of stocks in the FTSE index prior to the close of the London market and well below market levels. The aim was to ensure that an associated index option was out of the money at close of business. Resulted in fines and expulsion/suspension of the offenders from the list of Securities and Futures Association (predecessor of the FSA) registered persons.

underlying listed security fell below a certain level during the term of the certificate. Trading activities (by managers of the certificate) caused the closing auction price of the listed security on the XETRA exchange to drop below the respective threshold and, hence, the "knock-out" clause was triggered. Accordingly, the outstanding certificates held

CESR's level 3 advice in respect of MAD sets out that price positioning would constitute market manipulation. This practice involves deliberately buying or selling securities or

buying and selling exchange-traded stock and options on his behalf without disclosing these activities to him.

by investors became worthless. The BaFin filed criminal charges against the traders for manipulation by deceptive practices in deliberately influencing a reference price.

derivatives contracts at the close of the market in an effort to alter the closing price of the security or derivatives contract. This practice may take place on any individual trading day but is particularly associated with dates such as future/option expiry dates or quarterly/annual portfolio or index reference/valuation points.

It also sets out that trading on one market to improperly position the price of a financial instrument on a related market may amount (ii) Nomura

Concerned the manipulation of the Australian All Ordinaries Index by aggressive selling of shares before the close of the market and, to ensure that all stocks closed, the placing by Nomura of a series of buy

to market abuse. This practice involves undertaking trading in one market with a view to improperly influencing the price of the same or a related financial instrument in another market.

- 94 -


orders at a discount of 10% or more to the last traded price for the relevant stock. Resulted in fines and expulsion/suspension of the offenders from the list of SFA registered persons.

(Section 7.2.2 continued - Equity derivatives - Intra-country differences)

(iii) Paul Davidson ("The Plumber")

Concerned Mr. Davidson's purchase of a spread bet through City Index over shares in his company (Cyprotex) which was the subject of an initial public offering. The size of the spread bet resulted in City Index hedging the bet by purchasing a CFD over Cyprotex from Dresdner Kleinwort Wasserstein. Dresdner Kleinwort Wasserstein in turn hedged its exposure to City Index by purchasing shares in Cyprotex which resulted in a successful IPO for the company. The FSA held the initial spread bet purchase amounted to market abuse as it was solely intended to give rise to the chain of events that unfolded so as to support the IPO.

Examples might be conducting trades in an equity to position the price of its derivative traded on another market at a distorted level or trading in the underlying product of a commodity derivative to distort the price of the derivative contract.

- 95 -

8. Licensing requirements

8.1 US financial institutions doing business in Europe

8.1.1 General

All four EU jurisdictions considered have licensing requirements for firms carrying out financial transactions in their jurisdictions. Generally foreign firms are not exempt from the local requirements. Firms from other EEA states can be passported into EEA jurisdictions, but this would not be available for a US entity.

Foreign firms may transact business in the four jurisdictions without triggering a licence requirement if such business was initiated by the local client and was entirely unsolicited. The interpretation of unsolicited business can be very narrow and firms should be aware that this exception may not apply in all cases. Generally it is not possible for firms to establish a robust global platform by solely relying on this unsolicited business exemption.

8.1.2 European regulatory framework

To support the comprehensive European regulatory regime, the free operation of investment firms in all Member States is of primary importance: however, this is limited to firms (and not merely branches) established within Member States. Article 5 of MIFID lays out the broad principles which must be applied when authorising investment firms and the freedom of authorised firms to provide services within Europe is enshrined in Article 31.

Article 15 of MIFID sets out a guide for the relationship between Member States and third countries whereby Member States shall inform the Commission of any general difficulties which their investment firms encounter in establishing themselves or providing investment services in any third country (such as the US). Whenever it appears to the Commission, on the basis of information submitted to it, that a third country does not grant Community investment firms effective market access comparable to that granted by the Community to investment firms from that third country, the Commission may submit proposals to the Council for an appropriate mandate for negotiation with a view to obtaining comparable competitive opportunities for Community investment firms. A procedure also exists enabling the Commission to request Member States to limit or suspend authorisation decisions in respect of non-EU firms where EU firms face difficulty in performing investment activities in the country in question.


(a) UK

There is a general prohibition on the performance of regulated activities by way of business in respect of specified investments in the UK unless such activities are excluded or the performing entity is exempt.

Specified investments are widely defined and include shares, debt instruments, warrants, certificates representing securities, options, futures, contracts for differences and rights to or interests in investments.

Regulated activities are widely defined and include dealing in investments (as principal or agent), arranging deals in investments, managing investments, safeguarding and administering investments, advising on investments and agreeing to carry on most of the above regulated activities.

Breach of this general prohibition could result in criminal sanctions, contracts being unenforceable and/or damages.

- 96 -

Where authorisation is required, a firm must seek "Part IV Permission" by completing an FSA application pack in respect of the firm and the persons controlling it. The FSA has 6 months from receipt of all required information to approve/reject the application.

Performance of activities in the United Kingdom is interpreted broadly and will include, for example, activities carried on by a US firm where the activity is carried on from an establishment in the UK or where, despite not having a place of business in the UK, the US firm conducts activities through the internet or by way of occasional visits to the UK.

However, in terms of the wholesale market, it is likely that a US firm will be able to rely on the "overseas persons" exclusion to authorisation where it conducts business solely with or through authorised persons or on an unsolicited basis. An "overseas person" is defined as a person who carries on what would be regulated activities but who does not do so, or offer to do so, from a permanent place of business in the UK.

The overseas persons exclusion is available in the two broad cases set out below:

(i) Where the nature of the regulated activity requires the direct involvement of another person and that person is authorised or exempt (e.g. where the person with whom the US firm deals is an authorised person or where the arrangements he makes are for transactions to be entered into through such person); or

(ii) Where a particular regulated activity is carried on as a result of a "legitimate approach" - i.e. an approach to the US firm that has not been solicited by him in any way, or has been solicited in a way that does not contravene the financial promotions regime (see section 10.1.2 below). In such circumstances, the US firm can, without requiring authorisation, enter into, deal with (or through) a person in the UK, give advice in the UK or enter into agreements in the UK to carry on certain regulated activities.

(b) Germany

Any person who intends to conduct banking business or to provide financial services in Germany on a commercial basis needs to be licensed by the BaFin under the Banking Act.

However, licence requirements under the Banking Act only apply if banking business is conducted or financial services are provided (or are deemed to be provided) "in Germany".

Banking and financial services are clearly performed in Germany if the service provider has a physical presence in Germany. Such a physical presence could consist of business premises, a mobile sales force or any assistance by third parties.

By issuing a note dated 16 September 2003 (and revised in April 2005), the BaFin indicated that non-German providers would be deemed to be conducting banking business or providing financial services "in Germany" if they turn to the German market in a "targeted manner" in order to repeatedly and commercially offer banking or financial services to enterprises and/or persons who normally have their habitual residence in Germany or are domiciled there. Therefore, a physical presence in

- 97 -

Germany is no longer determinative.21 Where EEA passporting is not available, a non-German provider must establish a branch or a subsidiary in Germany to obtain a banking/financial services licence.

However, no licence requirement would apply in cases where the foreign institution does not actively solicit customers in Germany but, instead, the enquiry in respect of its services comes from the German customer on his/her own initiative (so-called "passive freedom to provide services" - passive Dienstleistungsfreiheit). Therefore, unsolicited business does not give rise to a licensing requirement.

Furthermore, the BaFin stated that, in the case of existing customer relationships (i.e. pre-September 2003), new transactions might benefit from the "passive freedom to provide services" concept. Inasmuch as existing customer relationships are continued or if there is a prior initiative by the customer to conclude the agreements in question (which the BaFin deems to be normally the case for major business accounts or institutional investors), this will not trigger a licence requirement in Germany. However, the BaFin note is not very clear as to which types of new business transactions could benefit from such "grandfathering". In our view, the new transactions to be entered into would have to be at least comparable to the ones already in place.

In cases where a non-German bank acquires new customers in Germany for banking and/or financial services by way of a targeted visiting of potential German customers, the BaFin would require a licence. However, if such visits are requested or initiated by the German customer (as is frequently the case in respect of institutional investors), such cases are deemed to fall under the freedom of passive rendering of services.

If a non-German institution acquires new customers in Germany by building up and using sales teams provided by German institutions or (freelance) sales agents (i.e. a form of intermediation by German banks), the BaFin normally requires the non-German bank to obtain a licence for the banking and financial services offered to the customer in Germany. This also applies in the event that the domestic bank or the domestically active (freelance) sales agents are already in possession of a licence for the intermediation activity.

A targeted "turning" to the German market is deemed to exist if the contractual relationship or the actual structuring of the business relations between the non-German provider and the German licensed institution give rise to the conclusion that the non-German bank uses the German institution as a sales network to offer services. In particular, this is assumed to be the case if commission is paid for the intermediation of the customers or if the banking and financial services of the non-German provider are advertised to the customer.

However, where all services in respect of an activity (e.g. new account opening, order processing, customer contact, entering into of contractual arrangements) are performed by an EEA passported entity (e.g. a subsidiary of the US firm incorporated in an EEA state) vis-à-vis German customers and the EEA passported entity then enters into back-to-back transactions with the US firm (i.e. hard intermediation), there will be no licensing requirement for the US firm.

In addition, an EEA passported entity within a US firm's group can engage with clients in Germany and outsource some of the services to the US entity. Under such an arrangement, the EEA passported entity can initiate business with German clients while allowing US staff to contact the clients and provide some of the services. The US personnel must take care to only provide the services arranged by the EEA passported entity: should they be deemed to be soliciting other financial services to German clients a licensing requirement will be triggered. If the US firm is effectively providing all of the activities except booking the trade, it may be deemed to be

21 A recent interim decision of the Higher Administrative Court (Verwaltungsgerichtshof) of Kassel calls into question the current extensive administrative position as to licensing requirements in respect of the

provision of cross-border business by service providers without a physical presence in Germany. However, the decision does not represent an authoritative precedent since it is not generally binding. Neither the Higher Administrative Court of Kassel nor any other administrative court in Germany is required to follow the decision in subsequent cases.

- 98 -

engaging in a "partial activity" which would also trigger a licence. Consequently, outsourcing arrangements may not be a reliable means of avoiding the German regulatory requirements. The outsourcing arrangement needs to be set out in writing and comply with the requirements on outsourcing agreements under the Banking Act.

If either relevant services are provided "in Germany" or if cross-border services that are provided by a non-EEA institution do not benefit from the aforementioned "passive freedom to provide services" concept (and thus would require a licence in Germany), the relevant entity might rely on a statutory exemption or apply to the BaFin for an exemption in accordance with section 2 (4) of the Banking Act. According to the latter provision, the BaFin may exempt non-German providers from the duty of obtaining a banking or financial service licence in Germany as well as from other supervisory provisions of the Banking Act upon application.

However, such exemption will only be granted if the non-German provider is effectively supervised in its home country in accordance with international standards and if the competent supervisory authority of the home country effectively cooperates with the BaFin. According to BaFin's current practice, an exemption will only be granted if the competent supervisory authority in the home country of the relevant entity confirms that (i) such entity was granted a licence for the banking and/or financial services which it intends to provide on a cross-border basis into Germany, (ii) that there are no supervisory restrictions against the commencement of the intended cross-border services into Germany and (iii) that in the event that such reservations arise at a later date such reservations will immediately be communicated to the BaFin. A US entity might therefore apply to the BaFin for an exemption from licence requirements in respect of business with institutional investors, subject to the fulfilment of the aforementioned criteria, in particular the co-operation between the BaFin and the competent supervisory authority in the US. To date, no such exemptions have been granted.

Anyone who conducts banking business or provides financial services without the required licence commits a criminal offence (subject to imprisonment of up to 3 years or a fine up to EUR 500,000). The above penalties could be imposed against corporate entities (only fines), directors and possibly against other relevant personnel.

The breach of licensing requirements does not have an immediate impact on the enforceability of contracts. However, the BaFin (with the consent of the respective counterparty) may request the breaching entity to unwind any transaction.

(c) Spain

A US firm doing pure cross-border equity and/or equity derivative business into Spain will need to be licensed in Spain. Although a licence is theoretically available to US firms engaging in cross-border securities business in Spain, in practice it is extremely unlikely that a US firm will be able to obtain such a licence (on the grounds that there are no reciprocal arrangements for Spanish firms in the US) and, to date, no single US firm has been granted a licence.

A breach of the licensing requirement constitutes a serious infringement under the Securities Markets Act and can lead to the imposition by the Spanish regulator of a fine and/or the issuance of a public censure in respect of the unlicensed entity. The CNMV could also notify the SEC pursuant to the memorandum of understanding signed by both regulators in 1992. However, we are not aware of any case where the CNMV has brought enforcement action against a well-established US entity. The status of contracts concluded by an unlicensed firm is not entirely clear, but we are of the opinion that they would be valid and enforceable.

The general view in Spain is that unsolicited business will not trigger the licensing requirement in Spain provided that the "solicitation test" is met. The requirements of the test are unclear because the test is not prescribed by law. Even so, the general view is that the key requirement of the "solicitation test" is that no active solicitation in relation to investment services or investment products takes place in Spain. "Solicitation" is generally interpreted to mean any selling or marketing effort in Spain or the use of pre-existing client relationships arising from a solicited business and therefore is extremely difficult to satisfy. Cases are analysed on an individual basis and the firm must be able to prove that the business was unsolicited. A firm must therefore be extremely careful in documenting unsolicited

- 99 -

relationships. It should be borne in mind that where a firm has a large number of clients, it will be difficult to persuade the CNMV that all the business was unsolicited.

Soft intermediation22 will not work in Spain. However, in the case of hard intermediation23 there will be no licensing requirement for the US firm. Outsourcing from an EEA passported entity to the US firm may also be an option, but if the US firm is found to have initiated any of the business which is subsequently transacted, or if the role of the EEA passported entity is merely that of an introducer, the CNMV may find a partial provision of services and licensing requirements will apply.

(d) France

As a general rule, the "habitual" provision of investment services in France can only be carried out by providers of investment services licensed in France (which requires a physical presence to be established in France) or by holding an EEA passport wide enough to cover the activities contemplated in France. Breach of the so-called investment services monopoly gives rise to criminal sanctions, including fines and imprisonment. Contracts entered into in violation of the investment services monopoly could be declared void by courts. Note that risks concerning liability cannot be excluded in a contract.

As set out above, EEA firms holding a sufficiently wide passport can carry out business in France. As regards dealing in certain derivatives, it may be that an EEA firm’s passport to carry out business in France is not wide enough. In such a case there is no top-up licence available which would enable the firm to carry out business in France. The only alternative would be to apply for a full investment firm licence in France. This would mean that a legal entity would have to be set up in France.

Firms incorporated and licensed outside the EEA may not provide investment services in France on a “habitual basis”. General exemptions are, however, available, including the unsolicited provision of services in France. Until recently, firms had been prone to relying on the so-called “one-shot exemption”, whereby the carrying out of a single transaction with a French resident could be regarded as falling outside of the scope of the French investment services monopoly. Such a stance has been, however, questioned due to recent case law regarding the French banking monopoly, under which the one-shot exemption may not be used by entities carrying out banking business on a professional basis in their home country.

On the basis of the implicit unsolicited exemption, non-EEA firms are generally regarded by market practitioners as falling outside of the scope of the investment service monopoly if: (i) the provision of services to French residents does not result from solicitation activities carried out by the non-EEA firm (or a third party acting on its behalf); and (ii) the service in question is provided outside France. This may not be an issue in respect of services which are easily spotted (e.g. execution services provided by a broker on the NYSE), but may be an issue in respect of services which cannot be easily spotted (e.g. managing portfolios).

Where a non-EEA firm wishes to do business on a wider and on a more robust basis than relying on the implicit passive provision exemption, a legal entity must be set up in France if the EEA firm in question is a credit institution and also wishes to provide banking services in France. A branch may also be set up in France. As regards the question as to whether the French regulator would be tempted to slow down the licensing process for applicants incorporated in a particular country on the

22 i.e. where all client-facing activities are performed by an EEA passported entity (e.g. a subsidiary of the US firm incorporated in an EEA state) in respect of Spanish customers but the customers actually enter into

contractual arrangements and book transactions with the US entity. 23 i.e. where all services in respect of an activity (e.g. new account opening, order processing, customer contract, entering into of contractual arrangements) are performed by an EEA passported entity (e.g. a subsidiary

of the US firm incorporated in an EEA state) vis-à-vis Spanish customers and the EEA passported entity then enters into back-to-back transactions with the US firm.

- 100 -

undisclosed ground that French firms face difficulties in carrying out business in that country, we are aware that for example Japanese banks trying to set up a licensed entity in France were indeed discriminated against in the 1980s.

An alternative for non-EEA firms to seeking a licence or relying on the above exemptions would be to rely on an EEA firm (whether a group company or not), either under a back-to-back structure whereby the non-EEA firm provides its services and products to the EEA firm (often chosen from within the same group, for obvious reasons), or in respect of own-account and passive trading intermediated and structured by the EEA firm i.e. soft intermediation.

8.2 Non US Licensed Dealers dealing in Equities in the US

Section 15(a) of the Exchange Act requires any person that effects transactions in securities by means of interstate commerce for his own account as a regular business or for the account of others to register with the SEC as a broker-dealer.

Once registered, a broker-dealer is subject to regulatory and supervisory oversight to ensure basic competency, provide the public with information regarding its business, promote financial solvency, safeguard the interests of public investors, and ensure the integrity of US securities markets.

Registration gives rise to various record-keeping financial, compliance and financial reporting obligations.

Registration is by way of standard-form application.

A broker-dealer must also register with an SRO (typically the NASD, and in some cases multiple SROs) and join the Securities Investor Protection Corporation (“SIPC”), created to provide insurance for brokerage firm customers against losses arising out of financial failures of brokerage firms.

Exchange Act Rule 15a-6 is an exemption under which non-US persons seek relief from US broker-dealer registration requirements under the Exchange Act. It permits non-US persons to make securities-related contacts with “US institutional investors” and “major US institutional investors” without registering under the Exchange Act, provided that any resulting transactions are effected through an SEC registered broker-dealer, information on such transactions are available to the SEC upon request and the registered broker-dealer effecting such transactions takes supervisory responsibility for the transactions and the non-US person’s securities-related activities. Rule 15a-6 also requires that contacts with certain types of institutional investors be “chaperoned” by licensed representatives of the responsible registered broker-dealer. However, pursuant to Rule 15a-6(a)(4)(i), these restrictions do not apply if the securities-related contacts are limited to SEC-registered broker-dealers or US banks acting in a broker or dealer capacity as permitted under US law (the “Rule 15a-6(a)(4)(i) Exemption”).

In general, non-US persons will be exempt from US broker-dealer registration to the extent they restrict their activities to certain permissible contacts with US investors. Permissible contacts include executing unsolicited transactions or providing research to certain large institutional investors that have, or have under management, total assets in excess of $100 million without any involvement of a US broker-dealer intermediary. Rule 15a-6(a)(2) generally allows a non-US broker-dealer to send research directly to major institutional investors under certain conditions which, among other things, restrict the firm from contacting any of the recipients to induce a trade based upon the research report. This exemption also allows the non-US broker-dealer to use a US broker-dealer to distribute its research to major institutional investors without requiring the US broker-dealer to accept responsibility for the research.

Rule 15a-6 provides a safe harbour exemption from US broker-dealer registration for foreign broker-dealers who have limited contacts with certain US persons, principally US institutional investors. Whenever a foreign broker-dealer engages in any direct contacts with a US person to effect a securities transaction, such as sending research into the United States, or executing a transaction for a US person, the foreign broker-dealer would be triggering US jurisdiction, requiring US broker-dealer registration or compliance with the safe harbour exemption of Rule 15a-6.

- 101 -

US banks and US branches and agencies of non-US banks are not permitted to underwrite or deal in equity securities in the United States, but may do so through so-called ìfin ancial subsidiariesî, pr ovided specified supervisory requirements are met (e.g. the banks satisfy prescribed ì well capitalisedî and ì well managedî standards).

US banks and US branches and agencies of non-US banks however may engage in a limited number of equity securities transactions on a riskless principal basis (up to 500 per calendar year) without registering with the SEC as dealers.

US banks and US branches and agencies of non-US banks are permitted under US banking law to broker transactions in equity securities for customers, and at present may conduct such activities without having to register with the SEC as a securities broker. However, once the broker ìpush outî provisions of t he Gramm-Leach-Bliley Act (GLBA) are implemented, banks will become subject to these registration requirements and, as a practical matter, will be required to transfer (ì push outî) th eir equity security brokerage activities to SEC-registered broker-dealers. These push-out provisions are scheduled to be implemented on September 30, 2005, although this date remains subject to change by the SEC.

SEC-registered nonbank affiliates of US banks may underwrite and deal in equity securities, however, there may be restrictions on the extent of such activities, depending on whether the nonbank affiliate is owned by a bank holding company (ìBHCî) that qu alifies as a financial holding company (ìFHCî) under US banking law.

8.3 Introduction of third parties

In all EU jurisdictions reviewed, a locally licensed firm or an EEA passported firm may utilise staff and expertise from third parties (e.g. unregulated or non-EEA/US firms) in the provision of financial services in the jurisdiction provided that the business is arranged and executed by the licensed/passported firm (see paragraph 8.1 above). However, if the role of the licensed/passported body is merely that of an introducer, and the business is substantially conducted by the third party, licensing requirements are likely to be triggered. The same is true in the US, as evidenced by the intermediation requirements of a US registered broker-dealer discussed in paragraph 8.2 above.

- 102 -

9. Approved persons/ training and competence

9.1 Approved Persons

9.1.1 General

Licensing and registration requirements applying to individuals within financial institutions differ significantly between the jurisdictions.



The "Approved Persons" regime applies to persons performing "controlled functions". There are 27 controlled functions, which fall into two categories: significant influence functions (i.e. governing functions such as directors, required functions such as the compliance officer, systems and controls functions such as the risk officer, and other significant management functions) and customer functions (advisory, trading and investment management functions). Persons performing such functions are required to obtain FSA approval before undertaking any work and the entity for which they are conducting the activities is required to complete a detailed application in this regard. Upon approval, the Approved Person's details will be kept on the FSA's Approved Person's register.

For individuals, there are no specific licence or registration requirements under the German Banking Act. However, depending on the scope of activities, a licence might be required under the German Trade Act (Gewerbeordnung).

Individuals within firms are not subject to licensing/registration requirements.

There is an "approved persons" regime in France (but this is not as extensive as the regime in the UK). Providers of investment services (i.e. credit institutions and investment firms) are subject to the following requirements:

Although MiFID does not introduce a European-wide Approved Persons regime in the EU, certain provisions have regard to required functions that investment firms are required to fill.

Any individual associated with a NASD member firm who is engaged in the securities business of the firm - including partners, officers, directors, branch managers, department supervisors, and salespersons - must register with NASD.

There is also a requirement that management are fit and proper to conduct their business. Managers must be reliable and trustworthy. Under German law, there is a principle of "joint responsibility" according to which all managers are responsible for ensuring the proper organisation and monitoring of trading activities irrespective of their internal competencies. Managers are accountable for their employees' activities and may be liable for employing incompetent staff.

Managers, however, are required to meet the following requirements: (i) good reputation (e.g. no insolvency, criminal record in respect of financial offences, inability to act as a director as a result of a judicial or administrative resolution); and (ii) sufficient knowledge and experience (at least three years as a director, controller or advisor in similar entities).

Managers can be fined/ disqualified if their business is found to be in breach of the regulations.

"Four-eye rule": at least two persons must be responsible for the effective direction of the business (the so-called "dirigeants responsables " , or "Managers in Charge"). The CECEI24 requires that these two persons have sufficient authority within the firm to carry out their responsibilities (they would ideally be chosen from amongst senior management and could include, for example, the chairman of the board of directors, the chief executive, or individuals who have been delegated sufficient authority); are

Indeed, CESR's level 2 advice in respect of Article 13(2) of MiFID (compliance and personal transactions) requires firms to maintain a permanent and effective compliance function and for all staff to be subject to a code of conduct designed to promote professionalism and integrity. CESR's level 2 advice in respect of Articles 13(4) and 13(5) (obligations related to internal systems, resources and procedures) requires some investment firms to fill a risk control function and an internal audit function.

The registration application requires information about the individual's prior employment and disciplinary history. NASD prescribes two basic levels of qualification and registration:

(i) Registered representatives, generally sales personnel;

(ii) Principals, generally officers of the firm and other management personnel involved in the day-to day operation of the firm's investment banking or securities business.

24 Comité des Etablissements de Crédit et des Entreprises d'Investissement .

- 103 -


(Section 9.1.2 continued - Approved persons - Intra-country differences)

Approved Persons must be fit and proper and are required to comply with a set of seven high level principles, which are supported and developed by a Code of Practice and backed by disciplinary sanctions (including withdrawal of approval).

Four of the Principles apply to all Approved Persons and the remainder only apply to those who perform "significant influence" functions.

In the FSA consultation paper CP05/10 "Reviewing the FSA Handbook, Money Laundering, Approved Persons, Training and Competence and Conduct of Business rules", the FSA

Individual employees can be held liable (under criminal or tort law) for any illegal acts

articulate in French (at least as far as one of them is concerned); ideally reside in

proposes to abolish the Approved Persons regime in respect of those individuals who deal only with wholesale

Comments on this proposal have been requested by the FSA by 31 October 2005.

they commit in the course of business, but the regulator does not operate a public register from which such employees may be banned, nor does it censure such employees.

Depending on their size and activities, credit and financial services institutions are required to maintain certain minimum functions (e.g. money laundering officer, compliance officer, internal audit, data protection officer, etc.).

There is no equivalent of

Principles.

Individual employees can be held liable (under criminal or tort law) for any illegal acts they commit in the course of business, but the regulator does not operate a public register from which such employees may be banned, nor does it censure such employees. However, a firm's licence may be revoked on the grounds of the poor reputation of its management if the relevant persons do not resign within a month following a request to do so from the CNMV.

Certain regulated functions exist. In particular, Spanish regulations provide for three specific positions to be filled: (i) money laundering officer (if the firm has more than 25 employees); (ii) officer responsible for the maintenance of client relationships; and (iii) compliance officer. In addition, firms may appoint a

France (subject to negotiation); and, have adequate experience and a good reputation. Every appointment of a Manager in Charge is monitored by the French regulator who must be provided with a duly completed file (showing that the newly appointed Manager in Charge is fit for the role) as soon as the Manager in Charge is appointed internally.

Credit institutions and investment firms are also generally required to appoint a risk officer, a compliance officer and anti-money laundering "correspondents".

Investment firms must also appoint an Investment Services Supervisor ("ISS") to ensure that the investment

investment s.

More generally, investment firms are required to employ staff with appropriate skills, knowledge and expertise, relevant to the services provided and the activities performed by the investment firm.

The draft Commission Regulation on organisational requirements and identification, management and disclosure of conflicts of interest by investment firms sets out various organisational requirements with which investment firms have to comply, in accordance with article 13 and article 18 of MiFID.

The draft Commission Regulation, in Article 3, sets out in respect of general organisational requirements that, in order to comply with paragraphs (2) to (8) of Article 13 of MiFID, an investment firm shall ensure

Futures commission merchants and brokers are required to register with the CFTC.

guardian or "defender" of client interests.

that it clearly establishes and communicates its decision making procedures and

with the rules governing

services provider, its employees and agents comply

the UK Approved Persons'

(i.e. not retail) customers

- 104 -


There is no equivalent of the UK Principles, although such

principles can be inferred

from Spanish regulation.

services. The compliance officer is often appointed an ISS as well. The ISS must hold a professional ISS card. The card is issued by the AMF if the following conditions are met: (i) an application form is filed with the AMF; and (ii) tests to establish the fitness and propriety of the individual concerned (including passing an exam organised by the AMF, unless an exemption is granted by the AMF based on similar experience of at least two years) are satisfactorily completed by the applicant to ensure that he or she has adequate qualifications and integrity, is of good repute and has sufficient knowledge of the relevant rules of conduct.

Like the ISS, négociateurs d'instruments financiers (traders in financial instruments) and compensateurs d'instruments financiers (clearing members

organisational structure (which should clearly specify reporting lines and allocate functions and responsibilities) to personnel, creates adequate controls to secure compliance with internal decisions and procedures and employs personnel with requisite skills necessary to discharge allocated responsibilities.

The draft Commission Regulation, in Article 4, sets out that in order to comply with the obligations set out in Article 13(2) of MiFID, an investment firm shall maintain a permanent, independent and effective compliance function and should ensure that the compliance function has the necessary authority, expertise, resources and access to relevant information and that the


of financial markets) must undergo tests in respect of their fitness and propriety.

compliance function reports directly to senior management.

- 105 -


The tests are similar but vary in detail according to the market in question. If the market is regulated, the entity

in charge of such market issues the trader and clearing with member cards. In relation to OTC markets, it is up to the firms themselves to issue them.

Where firms produce investment research, French legislation requires them to appoint an Investment Research Supervisor ("IRS") to supervise the production and dissemination of investment research. Firms will also have to provide individual research analysts (provided they are deemed to be fit and proper by the ISS) with a research analyst card.

The draft Commission Regulation also sets out that, in order to comply with Article 13 (5) of MiFID, an investment firm shall establish adequate risk management policies and procedures and should establish an internal audit function.

Article 9 of MiFID applies a requirement on certain individuals with management responsibility. The Article stipulates that those individuals who effectively direct the business of an investment firm must be of "sufficiently good repute and sufficiently experienced as to ensure the sound and prudent management of the investment firm".


Where firms carry out solicitation activities, there is a requirement that their employees carrying out such activities are registered as financial canvassers and hold a canvassing card, unless an exemption is available (e.g. where the solicitation activities are only carried out with qualified investors).

Firms are also required to notify their regulators of changes in management and to provide all information needed to assess whether the new staff appointed to manage the firm are of sufficiently good repute and sufficiently experienced.

- 106 -

9.2 Training and competence

9.2.1 General

In general, firms are obliged to ensure that their staff are competent to undertake the role they are performing. However, the FSA Handbook and applicable US provisions provide considerably more detail in this respect than the relevant regulations applicable in Germany, Spain and France.



The FSA's Training and Competence sourcebook sets out the standards that the FSA requires authorised firms to meet in respect of the training and competence of their staff. The first part contains an overarching set of industry commitments to training, to which all firms should aspire, and the second contains detailed rules and guidance applicable to certain investment business activities carried on by firms. The sourcebook also sets out the "appropriate examinations" that an employee must pass in order to be able to carry on particular activities and the exemptions from the requirement to take appropriate examinations.

Training and competence requirements are scattered throughout German legislation and ordinances. Under the general organisational requirements, management is responsible for ensuring the proper training of staff at all levels. In addition, money laundering laws and minimum requirements for training activities apply.

Personnel must be sufficiently competent to perform certain roles (i.e. the positions detailed under 9.1.2 above) and the firm should have internal systems in place to ensure this. Indeed, a CNMV Circular exists in respect of internal systems and risks.

There is an implicit general requirement for firms to ensure that their staff are trained and competent. This requirement is based on the explicit conduct of business rule concerning adequacy of means, under which firms must have the resources and procedures necessary to conduct their business properly and must use such resources and procedures efficiently.

MiFID requires firms to provide their employees with sufficient training in order to meet the organisational requirements of Article 13.

As part of the NASD registration process, securities professionals must pass an examination administered by the NASD to demonstrate competence in the areas in which they will work. These mandatory qualification examinations cover a broad range of subjects on the markets, as well as the securities industry and its regulatory structure, ensuring a minimum level of understanding and expertise.

The Securities and Investment Institute announced in July 2005 that it had signed a three-way agreement with the New

In accordance with the above Circular, firms must establish training and evaluation plans for their staff (in particular, for those who undertake commercial functions; elaborate analysis and research for distribution among clients; manage and measure risks or carry out activities the complexity and development of which require continuous development and training).

Firms must also have a control unit, consisting of one or more persons who are

In addition to the implicit general requirement, the French regulator has issued, from time to time, regulations covering specific matters which have often included an explicit requirement to train staff. For example, anti-money laundering procedures have made it necessary, at least in the eyes of the French regulator, to provide for an express duty for firms to train

Article 13.1 stipulates that an investment firm must establish adequate policies and procedures sufficient to ensure compliance of the firm including its managers, employees and tied agents with its obligations under MiFID as well as appropriate rules governing personal transactions by such persons.

Mandatory education on the firm's business and personal account dealing will therefore be likely to continue to be required across the EU jurisdictions.

All registered securities professionals must also fulfil certain continuing education requirements in order to maintain their registered status. In addition to the examination for General Securities Representatives (Series 7), there are additional exams designed to address more specialised responsibilities within a firm.

- 107 -


(Section 9.2.2 continued - Training and competence - Intra-country differences)

York Stock Exchange and the National Association of Securities Dealers to create a common qualifications exam for capital market professionals. If approved by the FSA, the test would allow market professionals to move with ease between the UK and the US. The exam is expected to be launched in late 2006.

There are also specific anti-money laundering training requirements imposed in the UK (please refer to section 12).

not involved in the functions of contracting, risk management, client relationship, administration, settlement or payments. This

their staff in order for them to

be well aware of the internal procedures, the firm's duties and to understand the various ways in which money laundering can be carried out.

The NASD and NYSE announced in July 2005 that they had signed a three-way agreement with the UK Securities and Investment Institute to create a common qualifications exam for capital market professionals. If approved by the SEC, the test would allow market

The FSA consultation paper 05/10 "Reviewing the FSA Handbook, Money Laundering, Approved Persons, Training and Competence and Conduct of Business rules", sets out proposals to reduce the scope of detailed rules on training and competence so that they

control unit is responsible for ensuring compliance with the regulation of internal systems of control, follow-up and continuous evaluation of risks.

The control unit must prepare an annual report on the degree of compliance with internal control rules and the

professionals to move with ease between the US and the UK. The exam is expected to be launched in late 2006 and will allow U.S. candidates to choose to take the new exam rather than the Series 7.

do not apply to individuals who only deal with wholesale (or non-private) customers.

procedures established for such purposes. A copy of such report must be submitted to the CNMV. Firms must keep all documentation proving compliance with the above Circular for a minimum of three years.

Securities advisers, dealers and specialists in US

wholesale capital markets currently certified under the Series 7 would not have to requalify under the proposal.

Prospective principals of securities firms must pass additional examinations that test their knowledge of supervisory rules in the areas of investment banking,

trading, and market making; retail sales activities; and financial responsibility rules.

- 108 -


Financial and operational principals must further demonstrate a thorough knowledge of the requirements regarding recordkeeping, net capital, customer reserves, financial reporting, and credit.

Registered securities professionals who function as research analysts are also required to pass an additional qualification exam.

Any individual applying to become an Associated Person

of a futures commission merchant or an introducing broker will not be granted

(Section 9.2.2 continued - Training and competence - Intra-country differences)

NFA registration, unless such person has passed the National Commodity Futures Examination (Series 3) on a date which is no more than two years prior to the date the application is received by the NFA or since the date the applicant last passed such examination, there has been no period of two consecutive years during which the applicant has not been either registered as a principal of a futures commission merchant or an introducing broker.

- 109 -

10. Conduct of Business Rules

10.1 Financial promotions

10.1.1 General

Although all EU states have some form of regime applicable to the approval of promotional material, the UK financial promotions regime is wider and more detailed than the regimes applicable in Germany, Spain and France. Extensive regulations also exist in the US in respect of marketing material.



The UK regime restricts any communication - whether oral or in writing and including communications made available electronically - where those communications constitute "invitations or inducements" to participate in any form of investment related activities and which are distributed in the UK.

Cold calling, including emails and faxes, is prohibited under both the Unfair Competition Act25 and the Securities Trading Act26.

Unsolicited calls for the purposes of direct marketing by means of automated calling systems, or by fax, are only permitted if the investor has given prior consent. Unsolicited calls by other means are permitted unless the investor has indicated that he or she does not wish to receive such calls.

There are various grounds for potential liability against firms who promote financial services or products in an unclear, unfair or misleading way.

Article 19(2) of MiFID requires that all information, including marketing communications, addressed by investment firms to clients or potential clients is clear, fair and not misleading and that marketing communications are clearly identifiable as such.

The Federal Communications Commission ("FCC") has implemented regulations aimed at stopping deceptive telemarketing acts by preventing patterns of unsolicited telephone calls that are coercive or abusive or invade privacy, restricting the hours, day or night, when unsolicited calls can be made, and imposing requirements that persons making telemarketing calls disclose to the consumer that the purpose of the call is to sell goods and services.

25 The Unfair Competition Act distinguishes between cold calling consumers and cold calling other market participants. Cold calling consumers is only permitted with their prior consent, whereas cold calling other market participants is permitted where the presumption of consent has not been rebutted. Nevertheless, the use of electronic communication (such as email or fax) is only permitted when consent has been given. However, if the advertiser receives the email address of a customer in connection with the advertiser's sale of a product or provision of a service, he may, under certain conditions, use the address for the direct advertisement of similar goods or services.

Unsolicited letters are permitted.

Liability either results from specific rules governing the finance industry (i.e. canvassing and public offering rules and conduct of business rules), or more general rules applicable to every professional (based on the information/ warning/advisory duties owed to clients by virtue of case law).

26 Under the Securities Trading Act cold calling is not permitted except to existing clients or to (professional) investors within the scope of their business activities, i.e. within the scope of purposes that can be considered as professional or vocational activities of the investor.

- 110 -


(Section 10.1.2 continued - Financial promotions - Intra-country differences)

Any financial promotion must either be issued or approved by an entity that is regulated by the FSA or the promotion has to fall within one of the exemptions to the regime. Authorised firms must comply with a variety of conduct of business rules as to the form and content of such promotions (unless the promotion is exempt) - relevant rules will depend on whether the communication is solicited or not and whether it is "real-time" (i.e. personal visits, telephone calls and other interactive dialogues (not e-mail)) or not.

Publicity activities within Spain are subject to the principles established in Law 34/1988, of 11 November. This Law on Publicity renders illegal any kind of publicity which may be: (i) contrary to the individualís dignity; (ii) misleading; (iii) unfair; (iv) subliminal; or (v) expressly prohibited by regulations governing specific sectors.

CESR's level 2 advice in this respect and the Commission Working Document ESC/23/2005 principally has regard to communications directed at retail clients (e.g. presentation of benefits and risks; format and consistency of information; tax treatment; prohibition on use of simulated historic returns; references to past performance and forecasts of future performance; and comparisons) and is therefore outside the scope of this report. From a wholesale perspective, the level 2 advice only sets out the investment firm's name as a basic requirement that all marketing communications must contain and that the name of its regulator must not be used in such a way as to indicate endorsement or approval of its products or services. The level 2 advice

In addition, in 1995, the SEC approved an NASD proposal that requires brokerage firms to set up procedures for " do not call"lists, a list of person who do not wish to receive telephone solicitations. Following concerns expressed as to the effectiveness of such lists, the SEC asked the self-regulatory bodies to adopt rules that would conform to the Federal Trade Commission ("FTC ") rules in respect of cold-calling. The NASD amended its rules to, among other things, prohibit cold calls to an individual's residence for the purpose of soliciting the purchase of securities or related services at any time other than between 8 a.m. and 9 p.m. local time at the individual's residence, unless prior consent has been obtained.

Failure to comply with the financial promotion regimes is a criminal offence in the UK and may render underlying agreements unenforceable.

There are a number of available exemptions which allow for communications to be made to certain categories of persons without the restrictions applying. In particular, as regards the wholesale

Any marketing material needs to comply with the marketing restrictions set out in the Unfair Competition Act, the conduct of business rules, the Banking Act and the German Investment Act.

Furthermore, the prospectus liability provisions under the Exchange Act regarding incorrect or incomplete material information in a prospectus may apply. These provisions impose liability on those persons who have accepted responsibility for the content of a prospectus as well as on those who have caused the prospectus to bepublished.

Credit entities must submit any publicity (i.e. any form of communication through which financial transactions, services or products are offered) in which reference is made to the cost or yield of the financial transaction, services or products to which the publicity refers to the Bank of Spain for prior approval.

The publicity materials of any marketing to be undertaken in connection with offers of securities inSpain must be available at all times for inspection by the CNMV.

The registration of a prospectus with the AMF, in the case of a public offering, enables investors to benefit from risk warnings underlined by the AMF and from the observance of a general duty imposed on issuers to provide clear and comprehensive information. This will include, under certain circumstances, a requirement that the prospectus is drafted in French.

Where solicitation activitiesare carried out within the wide scope of the definition of canvassing (démarchageunder French law (which includes not only unsolicited contact by any means, but also making solicited or unsolicited visits at homes, workplacesor any other places which are not dedicated to the marketing of financial or banking products), investors

)

also allows national regulators to consider the use of factual claims in any such communication.

must be provided with the information needed for them to make their decision in a clear and understandable way.

- 111 -


As detailed in section 6.2 above, MiFID provides that the above conduct of business rules may be waived in the case of transactions entered into or brought about between "eligible counterparties".

The NASD rules require brokers to disclose certain information regarding the purpose for the call and identification information about the broker and the firm.

market, there are exemptions which allow promotions to be made to investment professionals (i.e. FSA regulated firms) or any high net worth

The Prospectus Directive, which is in the process of being implemented in EU Member States, will have an impact on all companies who want to offer their securities to the public or list them within the EU and on the requirements in respect of prospectuses. The Prospectus Directive creates a common regime across EU Member States enabling companies to offer

The NASD restrictions on hours of calling do not apply to communications with existing customers where the purpose is to maintain or service the customerís account.


corporate (for this purpose qualifying high net worth corporates are those with more than 20 shareholders with called-up share capital or net assets of at least £500,000 and in any other case corporates with called-up share capital or net assets of at least £5,000,000).

A company whose securities are to be admitted to listing by the UK Listing Authority must comply with the Financial Services and Markets Act 2000 ("FSMA") and the listing rules. From 1 July 2005, a new set of rules governing listing, prospectuses and disclosures have been implemented and the Prospectus Rules have replaced the former listing rules relating to the preparation and approval of a listing document.

Even if no special prospectus liability arises (e.g. in the case of a private placement of investment funds in Germany), both the issuer and the distributor of securities in Germany are under certain circumstances liable for the content of any written information material which qualifies as a prospectus for the offered investment, irrespective of how such investment would qualify legally (securities or units or participations or loans etc.). Apart from special statutory provisions on prospectus liability, German courts have developed case law on general (civil law)

Pursuant to the SMA, the responsibility for the information given in a prospectus attaches to, amongst others, the issuer, the offeror, the person asking for the admission to trading on an official secondary market or the guarantor, as the case may be, as well as their directors. Pursuant to secondary legislation lead managers can also be held responsible. The above persons shall be liable for all damages incurred by holders of the securities acquired as a consequence of any false information contained in, or material omissions from, the

Even if the marketing activities are carried out on a private placement basis or outside of the French canvassing rules (e.g. towards "qualified investors" such as banks or investment firms or large investors), licensed firms, or firms holding a passport to carry out investment services business in France would need to comply with conduct of business rules requiring them to ensure that investors fully understand what they are subscribing to.

their securities to the public in any EU Member State or to seek admission to tradingon any regulated market of an EU Member State, usinga single prospectus approved by a single regulator (the "passport" concept).

The NASD advertisements and sales literature rules require review of electronic transmissions that constituteadvertisement or sales literature, including computer communications, network bulletin boards and fax transmissions.

prospectus liability. According to German courts, any written selling material, which is provided to an actual or potential customer and contains information on an investment, can qualify as a sales prospectus and give rise to a general prospectus liability. It is up to the German courts to determine whether information is material enough to qualify

prospectus. No liability arises in relation to the summary contained in the prospectus, including anytranslation thereof, unless itis misleading, inaccurate orinconsistent when read in accordance with the otherparts of the prospectus.

Even where the above rules do not apply (e.g. in respect of non-EEA firms carrying out "passive" bu siness with French investors on a private placement basis), there is a general civil liability based on case law, under which an

The rules require that advertising and sales literature, including electronic transmissions, be approved by an appropriately registered principal before their use.

information/warning/ry duty is owed by

professionals to their clients. The requirement to market products in French (if the marketing takes place in France) is also aimed at ensuring that French

adviso

- 112 -


as a prospectus in this regard27. The courts apply the standard of an average investor. This general prospectus liability cannot be avoided by the use of a disclaimer.

A company that is seeking to offer either transferable securities to the public in the UK or who is making an

application for admission to trading of transferable securities on a regulated market in the UK (e.g. the London Stock Exchange) Marketing material does not

have to be approved by the BaFin in advance. However, the BaFin may prohibit certain kinds of advertisement to counteract misleading advertising by institutions. This applies particularly to

Article 31.2 of the RD 291/92 requires lead managers to "take such actions and carry out such verifications as are appropriate to ensure the accuracy and completeness of the information set out in

27 Recently, the German Federal Supreme Court has decided that ad-hoc announcements normally cannot be seen as prospectuses triggering general prospectus liability since ad hoc

announcements only give information about single events whereas a prospectus generally evokes the impression of giving information about all facts relevant to making an investment decision.


must comply with the Prospectus Regulations 2005 (which implement the Prospectus Directive) which require a prospectus to be produced. The regulations set out the content and format of the prospectus required, the procedure for approval of the prospectus and exemptions from preparing a prospectus.

FSMA and the rules governing listing and prospectuses require the company to publish a prospectus containing detailed information about itself and its business that investors and their

advertisements using statements which may misleadingly give the impression of a particularly favourable offer and to advertisements which refer to the BaFin's powers.

the relevant prospectus".

Moreover, Article 20.3 of the RD 291/92 requires that the relevant prospectus contains a representation bthe lead manager, whereby it represents and warrants that:

y

investors fully understand what they are being invited to subscribe to.

However, the above-mentioned rules are generally complied with by taking into account whether investors concerned are sophisticated or not.

Certain communications that qualify as advertising or sales literature must also be filed with the applicable SRO at least 10 days prior to first use. For example, under NASD Rule 2210, NASD approval must be granted prior to using or publishing advertisements and sales literature relating to registered investment companies, or advertisements concerning collateralised mortgage obligations or security futures. Also, broker-dealers must file all advertisements and sales literature with their applicable SRO during their first year of operation.

The rules apply to network

Breach of the

(i) it has carried out the relevant verifications to confirm that the information set out in the prospectus is true, accurate and complete; and

aforementioned rules can lead to criminal and civil liability, as well as disciplinary sanctions.

(ii) that those verifications do not show any circumstances which may contradict or alter the information set out

bulletin boards as well as messages sent directly to particular individuals or groups.

The rules of the SROs require supervisory review of communications with the

- 113 -


the Financial Services and Markets Act 2000 (Official Listing of Securities) Regulations 2001 list the persons responsible for prospectuses. These include the issuer, its directors and any person who accepts and is stated in the prospectus as accepting responsibility for or for any part of the particulars.

Liability in respect of prospectuses may fall under a number of different heads:

in the prospectus or any omission of significant facts or information which may be relevant to the investors.

public. The scope of that review is construed broadly by NASD and NYSE regulations. The term "communication" includes, but is not limited to, advertisements, market letters, research reports, sales literature, electronic communications, communications in and with the press, and wires and memoranda to branch offices or correspondent firms which are shown or distributed to customers or the public.

�

Section 90 of FSMA provides that the persons

The omission of material information or the inclusion

Electronic communications that "relate to the business"

professional advisers would reasonably require. This is not limited to matters withinpersonal knowledge alone but includes other information which it wouldhave been reasonable to obtain by making enquiries.

Section 79(3) of FSMA and

of misleading information in the prospectus may constitute a "very serious infringement" of the SMA where the amount of the offer or the listing or the number of affected investors is significant. Otherwise the offence will be considered a "serious infringement". Please refer to Section 7.1.2 above for a summary of the sanctions that may be imposed in respect of "very serious infringements" and "serious infringements".

are required books and records of the firm and must be retained, subject to a planof supervision by the broker-dealer.

In addition, every registered broker-dealer must be a member of the Securities Investor Protection Corporation ("SIPC"), unless its principal business

responsible for the prospectus are liable to pay compensation to a person who has acquired any of the securities in question and suffered


is conducted outside of the United States or consists exclusively of the sale or

- 114 -


loss in respect of them as a result of an untrue or misleading statement in the prospectus or the omission from them of a matter required to be included. The person responsible is liable not only to an original purchaser of securities but also to subsequent purchasers whether or not in reliance on the misleading statement or omission.

� A person is not to be liable solely on the basis of a summary (or any translation of it) in a prospectus unless the summary is misleading, inaccurate or inconsistent when read with the rest of the prospectus.

distribution of investment company shares, variable annuities, or insurance. SIPC protects customer securities up to $500,000,


Misrepresentation under the general law (whether innocent, negligent or fraudulent).

and is tasked with restoring funds to investors with assets in the hands of bankrupt and otherwise financially troubled brokerage firms. A SIPC disclosure is required on advertising and sales literature, including electronic media, and requires the broker-dealer to

disclose that it is a member of SIPC. This disclosure can be as simple as: "Member SIPC."

The Securities Act of 1933 requires any company or underwriter making a public offering of securities to disclose certain information to investors and prohibits fraud in connection with the distribution of those securities. Adequate disclosure for SEC purposes requires (1) registration of

the offered securities with the SEC, and (2) distribution of a prospectus containing essential

- 115 -



� The criminal offence under Section 397 FSMA of: making a statement, promise or forecast which the issuer knows to be misleading

,

false or deceptive in a material particular; concealing dishonestly any material fact; recklessly making (dishonestly or otherwise) a statement, promise or forecast which is misleading, false or deceptive in a material particular; or doing something which creates a false or misleading impression as to the market in or the price or value of investments.

Private investors may seek three types of remedies based on an issuer's violation of provisions of the 1933 Act. Section 11 of the 1933 Act provides that an issuer will be strictly liable for losses incurred by a buyer purchasing a security within three years of the offering if the registration statement or prospectus contained material misrepresentations or materially false or misleading statements or omissions which caused the losses. The issuer's board of directors, underwriters, executive officers, attorneys, accountants and other experts, controlling persons of the issuer, and other signatories of the registration statement can also be held liable under Section 11, for failure to

disclosures about the issuer's finances, business, and the offering itself to potential investors.

Market abuse. (See section 7 above.)

perform a reasonable investigation into the accuracy of the misstatements or otherwise if they did not have a reasonable belief that

- 116 -



Plaintiffs generally need not show reliance on the registration statement.

The SEC recently adopted rules to streamline the registration, communication and offering processes under the Securities Act of 1933. The reforms make the following changes to the rules relating to communications during public offerings:

1 permit issuers and other distribution participants, after the filing of a registration statement, to disseminate written, graphic and broadcasted information concerning a securities offering through the use of a "free-writing prospectus". The free-writing prospectus is not required to contain the information called for in a traditional preliminary or final statutory

statements were true and not misleading (the due diligence defence).

- 117 -



potential investors with a statutory preliminary prospectus that precedes or accompanies the free-writing prospectus;

2 encourage issuers to open access to electronic roadshows to a broader audience in certain types of offerings. Unlike other types of free-writing prospectuses, electronic roadshows will not have to be filed with the SEC, so long as potential investors have access to at least one version of a bona fide roadshow and any issuer free-writing prospectus (such as roadshow slides) used at the roadshow is filed with the SEC.

prospectus. Unseasoned issuers, including those making IPOs, are required to provide

freely communicate

3 permit a newly defined class of issuers ("well-known seasoned issuers" or "WKSIs") to

- 118 -



with the market at any stage of the securities offering process, including prior to the filing of a registration statement;

4 create a bright-line safe-

harbour for issuer communications made at least 30 days prior to the filing of a registration statement. Such communications, which cannot make any reference to the anticipated securities offering, are excluded from the definition of "offer" under the Securities Act; and

5 permit all issuers,

including new issuers in the IPO context, to continue to publish regularly released factual business information during a securities offering. WKSIs and other reporting issuers are permitted to continue publication of regularly-released forward looking information.

- 119 -

10.2 Other relevant conduct of business rules

10.2.1 General

Whilst conduct of business rules are harmonised to a certain extent throughout Europe, there remains a number of differences between rules applicable in the UK, Spain, Germany and France. In addition, there are certain technical differences between the harmonised European position and the position adopted in the US.



Aggregation of orders

Firms are not permitted to aggregate private or intermediate customers orders with the firm's own orders, orders of market counterparties or orders of other private and intermediate customers unless such aggregation is not to the disadvantage of the private and intermediate customers and the firm has disclosed, whether specifically or in the terms of business generally, that effecting such aggregation could lead to disadvantages for the private or intermediate customer.


As a rule, the investment services provider may only engage in transactions for its own account after having fulfilled the respective competing (or concurrent) customers' orders. In order to avoid conflicts of interest between several customers, the provider generally has to execute all orders and instructions in the order they were received.


The aggregation of orders is not expressly contemplated under Spanish law. However, Article 1 of the Spanish Conduct of Business Rules provides than when orders are aggregated (both clients' orders and a firm's own orders), the distribution of securities acquired or sold or of the potential benefits, must ensure that no client is prejudiced.


We are not aware of any explicit prohibition set out in the AMF General Regulations in respect of the aggregation of orders.


In accordance with CESR's level 2 advice in respect of MiFID, if an investment firm that carries out an order aggregates that order with one or more other orders and the aggregated order is partially executed, the firm must allocate the related trades on a proportional basis, unless it has a different order allocation policy and each client has been notified accordingly before the order was carried out.


Aggregation of orders is principally a concern for investment advisers, not broker-dealers.

However, exceptions from this restriction on the aggregation of orders are accepted provided that the customer is thoroughly informed and that effecting such aggregation does not lead to disadvantages for thecustomer. In particular, firms are allowed to combine several individual orders into a bundle provided that each transaction alone is not

Aggregation of orders is expressly prohibited in the case of transactions in the Block Market and application of opposite-side orders by market members.

Aggregation restrictions apply in respect of all types of clients.

According to the AMF General Regulations, firms must define allocation rules prior to transmitting an aggregated order on behalf of several customers to a regulated market.

More explicit guidance can be found in the market rules. For example, under the conduct of business rules issued by Euronext, market members may not

If an investment firm that carries out an order aggregates that order with a transaction for own account and the aggregated order is partially executed, allocation to the client must take priority over allocation to the firm, unless the firm is able to demonstrate on

Registered investment advisers frequently aggregate trade orders to reduce execution costs. The SEC has concluded that combining orders for the sole purpose of reducing commission costs is not prohibited by the Investment Company Act of 1940 or the Investment Advisers Act of 1940, as amended, as long as the adviser is not aggregating trades for its own account and the following criteria are met: (1) such trading arrangements are properly disclosed to all clients; (2) no advisory account is favoured over any other account; (3) each account is part of an aggregated order

offset group orders for the purchase and sale of financial instruments, except as specifically authorised by the relevant Euronext market undertaking and without prejudice to the possibility

- 120 -


(Section 10.2.2 continued - Other relevant conduct of business rules - Aggregation of orders - Intra-country differences)

executable. However, firms are prohibited from matching orders in-house if a transaction is available at better conditions on other markets.

reasonable grounds that without its own participation it would not have been able to carry out the order on such advantageous terms, or at all, in which case the transaction for own account may be treated in the same way as an order when carrying out an allocation.

at the average sales price; (4) only advisory clients' accounts are aggregated and (5) individual investment advice is given to each account.

Aggregation restrictions also apply in respect of professional counterparties.

The Commission Working Document ESC/23/2005 provides that in order for an

investment firm to comply with Article 22 of MiFID, investment firms shall: (a)

General fiduciary concepts require advisers to treat all clients fairly and equitably and to disclose all potential conflicts of interest. Although there is no rule

requiring aggregation of orders, it is generally recognised that aggregating orders may result in lower per share commission costs and a better overall price fora block trade.

The SEC has clarified in No-Action letters, that it would not recommend enforcement action under Section 17(d) of the Investment Company Act if a firm aggregated fund

ensure that orders executed on behalf of clients are promptly and accurately recorded and allocated; (b) client orders are carried out sequentially and promptly unless the nature of the order or prevailing market conditions make this impossible or the interests of the client require otherwise; (c) inform clients in advance that they may act on own account in relation to the carrying out of an order and the risks or impediments to the proper carrying out of orders. The

that a market member may place a single buy or sell order on behalf of several clients to whom the member provides portfolio management services (subject to allocating the financial instruments in a manner agreed upon before placing such single order).

The aforementioned aggregation provisions apply to both retail and professional orders.

trades with those for accounts in which affiliates had an interest. It is important that details of orders be kept by the adviser. Thus, an aggregated order should specify the accounts that are

- 121 -


Commission Working Document also requires that aggregation of orders should only occur where this is not disadvantageous to any client, clients have been informed of the risks of aggregation and the firm operates an effective aggregation policy.

The Commission Working Document also provides that following aggregation, orders shall not be allocated in a detrimental way to a client. Moreover, where an investment firm aggregates


a client order with a transaction for own account and the aggregated order is partially executed, the related trades are to be allocated to the client in priority to the firm, unless the firm is able to demonstrate on reasonable grounds that without the combination it would not have been able to carry out the order on such advantageous terms or at all.

participating and the amount of the participation of each account.

With respect to broker-dealers handling client orders, absent a connection with odd-lot orders, firms may not aggregate orders, must maintain separate order tickets and documentation regarding each order, and must execute all orders and instructions in the order they were received.

Block orders are not prohibited by the CEA or the NFA rules. With respect to block orders on CFTC regulated products, any procedure for the general allocation of trades

or the allocation of split and partial fills must be designed to meet the overriding regulatory objective that allocations are non-preferential, such that no account or group of accounts receive consistently favourable or unfavourable treatment; are

- 122 -


As detailed in Section 6.2 above, MiFID provides that the above conduct of business rules may be waived in the case of transactions entered into or brought about between "eligible counterparties"


sufficiently objective and specific that the appropriate allocation for any given trade can be verified in any audit by NFA, the CFTC or the FCM's own accountants; and consistently applied by the member firm.

- 123 -


Best execution

In the UK firms generallyowe a duty of best executionto private customers andintermediate customers(although it is possible toagree otherwise withintermediate customers).There is no requirement ofbest execution in respect ofmarket counterparties.

The best executionrequirement requires firmsto take reasonable care toascertain the best availableprice for a customer order inthe relevant market at thattime for a transaction of thatkind and size. The firm issubsequently required toexecute the order at a pricewhich is no lessadvantageous to thecustomer, unless it has takensteps to ensure that it wouldbe in the customer's bestinterests not to execute theorder.

Best execution

The best executionprovisions under theGerman conduct of businessrules require investmentfirms to execute orders atthe best available price forthe size and kind of thetransaction concerned.

When determining the modeof execution and, inparticular, the market ortrading platform, firms haveto consider charges andtransactions fees in additionto the available price. If theinvestment firm agrees withthe customer on a fixedprice for an individualtransaction, the customermust be informed that thisagreement forms the basisof the purchase contract30.Orders which are obviouslynot in line with thecustomer's interest may onlybe executed or transmitted ifthe risks involved have beenexplained to the customerbeforehand.

Best execution

Spanish conduct of businessrules do not provide for thepossibility of the duty ofbest execution beingexcluded. However, generalcontract law may permitsuch exclusion as regardsprofessional counterparties.

Internalisation of orders isonly possible when, havingmade them publiclyavailable, no counterpartyexists at an equal or morefavourable price. Firmsmust give precedence toclients' interests at all timesand prior to the execution ofthe transaction the fact thatthe firm is acting in its ownname and on its own behalfmust be acknowledged inwriting by the client.

Best execution

The AMF GeneralRegulations set out conciseinformation in respect ofthe best execution rule,which is defined as theduty imposed on firms toexecute client orders in thebest possible way, havingregard to a clientís requestand the situation of themarket and the financialinstruments concerned.French law does notprovide for any exemptionsfrom the duty to complywith the best executionrule, even where the clientis an institutional investor.

Best Execution

Article 19 of MiFID sets outspecific conduct of businessrules for investment firmswhich aim to ensure thatfirms act honestly, fairly andprofessionally in accordancewith the best interests oftheir clients. Article 19 setsout a non-exhaustive list ofrecommended practices forconduct of investmentbusiness. CommissionWorking DocumentESC/23/2005 containsdetailed restrictions on thefees, commissions and non-monetary benefits that afirm can receive or offer tocomply with the spirit ofArticle 19.

MiFID specifically requires"best execution" practices tobe effected by investmentfirms. In addition, MiFIDrequires that an investmentfirm, when establishing abusiness relationship with aclient, should ask the clientto consent to its execution

Best Execution

Broker-dealers in the US aresubject to a duty of bestexecution that is derivedfrom common law agencyprinciples and fiduciaryobligations. SRO and SECrules and enforcementactions as well as judicialdecisions have incorporatedthese principles, whichrequire that a broker-dealerto obtain the mostfavourable terms"reasonably available underthe circumstances" for itscustomers' orders.

NASD Rule 2320 codifiesthe best execution obligationby requiring a broker-dealerto use "reasonablediligence" to determine thebest inter-dealer market forobtaining the mostfavourable price possible foran order under prevailingmarket conditions.

Reasonable diligenceconsiders factors such as the

30 As the price in case of proprietary trading on behalf of third parties must generally be related to the market price.

policy and to the possibilitythat orders may be executed

- 124 -


(Section 10.2.2 continued - Other relevant conduct of business rules - Best execution - Intra-country differences)

There is no generalexemption from the duty ofbest execution fortransactions involving otherinvestment firms or marketparticipants.

The German concentrationrule under section 22 of theExchange Act may alsoapply (see section 3.1.2above).

There is no need for firms to

have access to competingexchanges or all or aminimum number ofcompeting price sources.However if the firm canaccess such sources to makea direct and immediatecomparison in respect ofpricing, the firm shouldexecute the order at the bestprice possible if this is in thebest interests of thecustomer.

off-exchange (whereappropriate).

Article 21 requires MemberStates to ensure thatinvestment firms take allreasonable steps to obtain,when executing orders, thebest possible result for theirclients taking into accountprice, costs, speed,likelihood of execution andsettlement, size, nature orany other considerationrelevant to the execution ofthe order. This implies thata best execution obligationwill apply, for the first time,to fixed income and otherOTC markets (i.e. not justequities). It is worth notingthat professional clients willbe able to indirectly opt-outof best execution by optingup to eligible counterpartystatus.

CESR's level 2 adviceprovides that the relativeimportance of such criteriashall be determined byreference to thecharacteristics of the client,the order to be executed, thefinancial instruments andthe execution venue of the

character of the market forthe security, the size andtype of transaction, thenumber of primary marketschecked, and the locationand accessibility to thecustomer's broker-dealer ofprimary markets andquotation sources. Broker-dealers must regularly andrigorously review executionquality. Best executionobligations generally do notdraw a distinction betweenretail and institutionalorders.

The SEC has declined toadopt a best execution rule,but has adopted two rulesconcerning disclosure oforder routing and executionpractices.

Exchange Act Rule 11Ac1-5requires market centres tomake available monthlyelectronic reports to thepublic that include uniformstatistical measures ofexecution quality.

Exchange Act Rule 11Ac1-6requires broker-dealers toprovide information to theircustomers detailing themanner in which they routecustomer orders to market

order. The CommissionWorking Document

- 125 -



ESC/23/2005 specifies thatthe following factors mustbe taken into account indetermining the relativeimportance of the abovefactors with a view toobtaining the best possibleresult for the client: (a) thestatus of the client as retailor professional; (b) thenature of the client order; (c)the type of financialinstruments that are thesubject of that order; and (d)the nature of the executionvenues to which that ordercan be directed.

Firms are required toestablish and implementspecific policies for thispurpose. Firms are requiredto monitor the effectivenessof these policies and todemonstrate to clients ifnecessary that they haveexecuted their orders inaccordance with the firm'sexecution policy.

CESR's level 2 adviceprovides that investmentfirms must review theirorder execution policy atleast every 12 months, ormore frequently whenever

makers and stock exchangesfor execution.

Additionally, these broker-dealers must publishquarterly reports that setforth their performance inexecuting customer orders.

The CFTC has establishedconduct of businessrequirements for futurescommission merchants andintroducing brokers. Theseintermediaries are requiredto adopt procedures andcontrols that ensure thatorders for proprietaryaccounts and accounts ofaffiliated persons are notplaced before customers'orders that are executable ator near market. Futurescommission merchants andintroducing brokers may notexecute orders for customersunless the transaction isspecifically authorised bythe customer or thecustomer consents in writingthat particular types oftransactions may be madewithout its consent.

reasonably necessary toverify that the execution

- 126 -



policy enables it to obtainthe best possible executionfor client orders. TheCommission WorkingDocument ESC/23/2005provides that an investmentfirm shall review itsarrangements and executionpolicy whenever it becomesaware, or the circumstancesare such that it should beaware, that a materialchange has occurred thataffects its ability to continueto obtain the best possibleresult for the execution of itsclient order on a consistentbasis using the venuesincluded in its executionpolicy.

CESR's level 2 advicessuggests the factors that aninvestment firm may takeinto account in consideringwhether to maintain orinclude execution venues inits order execution policy,where relevant, include, butare not limited to: executionquality, creditworthinessand ability to avoid marketimpact. Costs that aninvestment firm may takeinto account in consideringwhether to maintain or

include execution venues inits order execution policy

- 127 -



where relevant, include, butare not limited to:transaction fees andsettlement costs. TheseMiFID provisions willrequire significantadditional resources fromfirms given that firms notonly need to establish andimplement such an orderexecution policy, but willalso need to review andupdate it where appropriate.

Investment firms must alsoprovide information toclients on the orderexecution policy, obtainprior customer consent tothe policy, be able todemonstrate to a client thatan order has been executed

in accordance with thepolicy and notify clients ofmaterial changes to theirorder executionarrangements or executionpolicy.

By virtue of Article 21 ofthe Commission WorkingDocument ESC/23/2005 theinformation required to beprovided by an investmentfirm to its clients on its bestexecution policy is toinclude a description of howthe investment firm

- 128 -



in the order execution policyprovide for the best possibleresult for the customer.This will also requiresignificant additionalresources for firms giventhat the monitoringrequirement will beconstant.

By virtue of Article 21 ofthe Commission WorkingDocument ESC/23/2005 ifan investment firm acceptsspecific instructions that

proposes to fulfil its duty toobtain the best possibleresult for clients, including(i) an account of the relativeimportance the firm assignsto the factors cited above orthe process by which thefirm determines the relativeimportance of these factors;and (ii) a complete list ofthe execution venuesincluded in the executionpolicy.

Investment firms are alsorequired to monitor theeffectiveness of orderexecution arrangements andtheir execution policy inorder to identify and correctdeficiencies - investmentfirms should assess on aregular basis whether theexecution venues included

- 129 -



or otherwise) MiFID seeksto ensure regularity in themarket by requiring that

procedures andarrangements which providefor the prompt, fair andexpeditious execution ofclient orders, relative toother client orders or thetrading interests of theinvestment firm. Whilethese rules are subject tosome exceptions (e.g. whereclients require that tradingoccurs in a limited fashion

services must implement

instructions where these aregiven.

Article 22 states thatinvestment firms thatprovide execution only

conflict with its bestexecution policy, a clear andprominent warning that suchinstructions may prevent thefirm from implementing itsbest execution policy toobtain the best possibleresult for the execution ofthose orders.

In addition to the obligationto provide best execution,the MiFID/CESR rulesrequire orders to be

executed in accordance witha customer's specific

- 130 -



investment firm is not tocarry out a client order

The draft CommissionRegulation onorganisational requirementsand identification,management and disclosureof conflicts of interest byinvestment firms sets out, inArticle 13 that an

out orders for clientssequentially. Therequirements to carry outorders promptly andsequentially do not applywhere the characteristics ofthe order or prevailingmarket conditions make this

certain clients are notafforded preferentialtreatment by virtue of theirsize, importance or theirtechnical capabilities.Commission WorkingDocument ESC/23/2005requires certain records oforders and aggregatedorders to be made to complywith Article 22.

CESR's level 2 adviceprovides that generally aninvestment firm must carry

impossible or requireotherwise in the interests

of the client.

- 131 -



immediately make a recordof specified information inrespect of, and the date andtime of, orders it receivesand ensure that this recordcorresponds to the clientinstructions.

As detailed in section 6.2above, MiFID provides thatthe above conduct ofbusiness rules may bewaived in the case oftransactions entered into orbrought about between"eligible counterparties".

unless the order includes allinformation necessary tocarry it out. An investmentfirm should also

- 132 -

11. Redress and investor protection

11.1 Redress

11.1.1 General

Authorised entities are required to have mechanisms to deal with customer complaints in the UK, Spain and Germany. However, the FSA Handbook provides considerably more detail in this respect than the relevant regulations applicable in Germany and Spain.

There are various mechanisms in place for dealing with customer complaints in the US.



UK authorised firms are required to have in place internal complaint handling procedures under both a specific FSA Sourcebook and by virtue of the FSA's high level standard rules and guidance on systems and controls and its overriding Principles. Such procedures specify the requirements in respect of receiving and responding to complaints, the appropriate investigation of complaints and the notification to complainants of their right to go to the Financial Ombudsman Service ("FOS").

Firms are under an obligation to address complaints made against them, but there is no prescribed method of doing so.

All firms must have a complaints department to deal with complaints. Each firm will set its own complaints procedure (although the minimum content of such procedure is established by a Ministerial Order). Firms will be obliged to attend to the clients' complaints within a two month period.

We are not aware of any rules under French law requiring investment service providers to have in place internal complaint handling procedures.

CESR's level 2 advice in respect of Article 13(2) of MiFID requires investment firms to:

Investors may pursue several options when deciding how to deal with a complaint against a broker or dealer. The first option is to go back to the broker-dealer itself and explain the problem. The customer might also try contacting the Branch Manager of the firm or write a letter to the compliance department. If these options are not successful, the customer may go directly to the Office of Investor Education and Assistance ("OIEA") at the SEC and fill out a form describing the complaint.

Banks must have a complaints handbook which details their internal procedures, but there is no requirement that these conform to any formal standards.

Many banks in Germany have voluntarily agreed to settle possible disputes with the help of private arbitrators, referred to as ombudsmen.

Complaints must be made to the firm prior to being made to the CNMV or the Bank of Spain, as the case may be.

A firm's annual report must provide details in respect of complaints.

However, it is best practice for investment firms to do so.

maintain effective and transparent procedures for handling complaints in a reasonable and timely way;

keep a record of each complaint and the measures taken for its resolution; and

regularly verify whether complaints are effectively processed.

- 133 -


(Section 11.1.2 continued - Redress and investor protection - Intra-country differences)

It should be noted that the definition of a "complaint" is very wide and includes any expression of dissatisfaction, whether oral or written, and whether justified or not, from or on behalf of an eligible complainant about a firm's provision of, or failure to provide a financial service. Such formal procedures will typically not apply provided the firm notifies the FSA that it does not conduct business with retail customers.

Sometimes a complaint is successfully resolved when the SEC asks a firm to report to the customer and to OIEA. But in many cases, the firm or company denies wrongdoing, and it remains unclear as to who is wrong or whether any wrongdoing occurred at all. If this happens, OIEA cannot act as a judge or an arbitrator and force a broker, brokerage firm, or company to resolve the complaint. But the law allows the customer to take legal action on his or her own. The FSA views any failure

to handle complaints appropriately as a serious matter: in 2003 Friends Provident Life and Pensions Limited was fined £675,000 and in 2004 Allied Dunbar Assurance plc was fined £725,000 for failures identified in handling complaints. In 2005 Abbey National plc was fined £800,000 for failing to ensure that it investigated each mortgage endowment complaint adequately and by failing to take reasonable

Both federal and state securities laws provide important legal rights and remedies if a customer has suffered wrongdoing. Acting on his or her own, the customer may seek to resolve his or her complaint through the courts, arbitration, or mediation.

The ombudsmen have been established within the industry associations to which the respective firms belong. However, it should be noted that the ombudsman service is fully independent and impartial.

A firm's annual report normally provides details in respect of complaints and it is signed off by an auditor and reviewed by the BaFin. Finally, direct complaints to the BaFin are possible.

Article 53 of MiFID requires Member States to encourage the setting-up of efficient and effective complaints and redress procedures for the out-of-court settlement of consumer disputes concerning the provision of investment and ancillary services provided by investment firms.

To take advantage of these laws, the customer must take legal action promptly or he or she may lose the right to recover funds. Time restrictions, called "statutes

The draft Commission Regulation on organisational requirements and identification, management and disclosure of conflicts of interests by investment firms sets out, in Article 8, that an investment firm must maintain effective and transparent procedures for handling complaints received from retail clients or potential retail clients. Complaints and measures taken should be recorded and there should be regular verification of whether complaints are effectively processed.

- 134 -


steps to ensure that it handled mortgage endowment complaints fairly and consistently.

If a firm does not deal with a complaint to the satisfaction of the complainant, or if he is dissatisfied with the delay in dealing with it, the complainant may refer the matter to the FOS (which operates independently from the FSA) who may decide either to dismiss or accept the case. The amount of awards made by the Ombudsman is limited to £100,000 and its judgement is binding if accepted by the complainant.

of limitations," vary from state to state. Federal securities laws generally require that the customer bring a court action within two years of the date that he or she should have reasonably discovered the wrongdoing, but in no case later than five years from the date the wrongdoing actually occurred.

Eligible complainants are generally obliged to attempt to resolve complaints initially through the firm's internal complaints procedure before approaching the FOS. However, customers also always have the right at any time to take the matter immediately to court. Direct complaints to the FSA are

Brokerage customers will probably have agreed to use only arbitration to settle all disputes with their broker or the firm in contractual documentation and consequently most broker-customer disputes are decided by arbitration proceedings rather than courts. But even if the customers did not, they may


choose to use arbitration to settle disputes. In arbitration, the arbitrators will apply either a federal or state statute of limitations, depending on whether the claim involves a violation of federal or state law. Generally, a customer cannot pursue an issue

- 135 -


not possible (unless the complaint has regard to the actual administration of the FSA).

through arbitration if it is more than six years old.

There is no strict requirement to include information about complaints in annual reports in the UK, although by way of good practice firms may choose to do so.

The NASD is by far the most important forum for securities arbitration. The NYSE handles a much smaller, but still significant, number of arbitrations.

The principal SROs (the NASD and the NYSE) have rules on their books


requiring members to arbitrate disputes with each other and with others.

These SRO arbitration rules are binding on members and others subject to SRO jurisdiction, whether or not the parties to a dispute have executed an arbitration agreement. In fact, the rules themselves are deemed to constitute a binding contract between the SRO and its members. Since most large brokerage firms are members of the NYSE and virtually all brokerage firms are required to be members of the NASD, the SRO arbitration rules are generally applicable to the

- 136 -


broker-dealer community. The NYSE, the American Stock Exchange and the NASD have adopted rules which preclude the bringing of class actions by way of arbitration.

Under the rules adopted by the NASD, arbitration is available to settle " any dispute, claim or controversy" that results from the business activities


of any member of the NASD. The rules further provide that any dispute between a customer and a member that results from the

ordinary business activities of the member and that can be submitted for arbitration can be arbitrated if the customer demands that arbitration procedures be used or if a "duly executed and enforceable written agreement" to submit disputes to arbitration exists.

- 137 -


If a customer uses NASD Dispute Resolution, Inc. and the claim is $25,000 or less, the customer generally will not have to appear in person at a hearing and an arbitrator will make a decision by reviewing documents and written descriptions of what happened from the customer and his or her broker. Under NYSE rules, the threshold is $10,000. This is a less costly alternative because the customer does not have to travel to a hearing and appear in person to give testimony and answer questions.


Mediation is also an option that customers may consider before going to arbitration. Mediation may save time and money because it is quicker than arbitration and voluntary, and if a customer is unable to reach an agreement through mediation he may still proceed to arbitration.

- 138 -

11.2 Investor protection schemes

11.2.1 General

The UK, Germany, Spain and France all operate investor protection schemes, although they are unlikely to apply in the case of institutional investors in the UK, Spain and France.

Limited investor protection schemes also operate in the US in accordance with the Securities Investors Protection Act.



UK regulated firms are covered by the Financial Services Compensation Scheme ("FSCS") in the event that a regulated entity whose act or omission gave rise to the claim is unable to meet the claim or is, in the view of the FSA or FSCS, likely to be unable to satisfy a claim. Eligible claimants are effectively limited to private investors but the definition of eligible claimants may allow certain smaller corporates the right to make a claim under this scheme. The compensation payable will depend on the type of business and circumstances of the claim. However most types of investment business are covered for 100% of the first £30,000 and 90% of the next £20,000 (i.e. a maximum compensation

In Germany, investor protection is achieved by a system consisting of two components, namely a mandatory deposit protection scheme and an additional voluntary one that is maintained by the respective banking association.

Under Royal Decree 2606/1996, of 20 December, all credit entities are obliged to cover their deposits through membership of a mandatory guarantee scheme (Fondos de garantia de depositos en Establecimientos bancarios, Cajas de ahorro y Cooperativas de crédito).

Pursuant to the FFMC, where a provider of investment services (other than a portfolio management company) holds in custody financial instruments belonging to their clients, such clients benefit from an investor protection scheme enabling them to be compensated by an amount up to EUR 70,000 if the custodian fails to return the financial instruments and related cash it has been holding in custody.

Article 11 of MiFID requires competent authorities to ensure that, upon being granted authorisation as an investment firm, the applicant in question satisfies existing EU requirements in respect of investor-compensation schemes.

The Securities Investor Protection Corporation "(SIPC)" which administers the Securities Investors Protection Act "(SIPA)" replaces missing stocks and other securities (where possible) when they are stolen by a broker or put at risk when a brokerage fails, for other reasons. SIPC gets involved when a brokerage firm fails, owing customers cash and securities that are missing from customer accounts. SIPC usually asks a federal court to appoint a trustee to liquidate the firm and protect its customers. The cash and securities (such as stocks and bonds) held by a customer at a financially troubled brokerage firm are protected by SIPC. Among the investments that are ineligible for SIPC protection are commodity amount of £48,000).

Under the Deposit Guarantee and Investor Compensation Act ("ESAEG"), all deposit-taking credit institutions under private and public law as well as all securities trading firms are obliged to cover their deposits and liabilities arising from their investment business through membership of a mandatory guarantee scheme.

Likewise, under Royal Decree 948/2001, 3 August, investment services companies are obliged to cover their liabilities arising from their investment business through membership of a mandatory guarantee scheme (Fondo de GarantÌa de Inversiones).

The protection provided by the statutory deposit protection scheme is limited to a maximum of EUR 20,000 per depositor.

However, this scheme is not available to institutional investors such as insurance companies, collective investment schemes, credit institutions, investment firms, etc.

- 139 -


(Section 11.2.2 continued - Investor protection schemes - Intra-country differences)

Firms are charged a levy for the FSCS according to the financial sector that they operate in.

Pursuant to SEC Rule 15c3-3, every broker-dealer must maintain a "special reserve bank account for the exclusive benefit of customers" which is separate from any other bank account of the broker-dealer. This requirement protects client assets in the event of default, and seeks to ensure that the firm has sufficient reserves and possesses sufficient securities so that customers promptly receive their property and there is no need to use the SIPC fund. The amount in the account is calculated according to a "Re serve Formula"provided in Rule 15c3-3a.

The protection provided by the statutory deposit protection scheme is limited to 90% of unfulfilled deposits and claims and the equivalent of EUR 20,000 per depositor for each of protected deposits and claims arising from investment business.

The CFTC and SEC have adopted joint rules that require all firms conducting business in security futures

futures contracts and currency, as well investment contracts (such as limited partnerships) that are not registered with the SEC under the Securities Act of 1933.

The voluntary Deposit Protection Fund of the Association of German Banks fully secures the deposits of each and every customer at the participating private commercial banks up to a ceiling of 30% of the relevant liable capital of the relevant bank as at the date of the last published annual financial statements of the bank. All liabilities of banks to non-banks (in particular private persons, business enterprises and public agencies, and investment companies and their custodian banks inasmuch as investment fund assets are concerned) are protected.

Institutional investors (as this term is defined under section 6.2 above) may not avail themselves of investor protection schemes generally available in Spain.

- 140 -


regulatory schemes that are not applicable to their accounts. Furthermore, the rules require that all firms engaged in this business that are fully-registered both as futures commission merchants and as broker-dealers establish written procedures regarding how customer security futures products will be held.

with respect to protections provided by both the 1934 Act and the Commodity Exchange Act, the regulatory schemes that are applicable to their accounts, and, conversely, the

products to make disclosures to customers

However, liabilities arising from the issue of bearer bonds, liabilities to foreign affiliates of the bank, liabilities arising from security repurchase transactions as well as redelivery obligations arising from stocklending business are not protected under the voluntary Deposit Protection Fund of the Association of German Banks. Liabilities to certain specified persons connected with the bank (e.g. managers, shareholders etc.) are also not protected.

Institutional investors (except for banks) are eligible claimants under the voluntary Deposit Protection Fund of the Association of German Banks.

(Section 11.2.2 continued - Investor protection schemes - Intra-country differences)

- 141 -

12. Anti-money laundering28

12.1 General

All jurisdictions considered have anti-money laundering requirements. Those applicable in the UK, Germany, Spain and France are primarily based on European Anti-Money Laundering Directives. However, there are considerable differences between the architecture of national regimes and the specific detail.

12.2 European regulatory framework

The Third Anti-Money Laundering Directive on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing will be implemented by EU Member States within two years after its publication in the EU's Official Journal, which will take place towards the end of 2005. The Directive applies to the financial and other key services sectors and also covers all providers of goods, when payments are made in cash in excess of 15,000 euros. The Directive builds on existing EU legislation and incorporates into EU law the June 2003 revision of the Forty Recommendations of the Financial Action Task Force, the international standard setter in the fight against money laundering and terrorist financing. The Directive requires those subject to it to identify and verify the identity of their customer and of its beneficial owner, and to monitor their business relationship with the customer, report suspicions of money laundering or terrorist financing to the public authorities and take supporting measures, such as ensuring a proper training of personnel and the establishment of appropriate internal preventive policies and procedures. The Directive also introduces additional requirements and safeguards for situations of higher risk (e.g. trading with correspondent banks situated outside the EU).


12.3.1 UK

The anti-money-laundering regime in the UK is made up of primary legislation (the Proceeds of Crime Act 2002 and the Terrorism Act 2000), secondary legislation (the Money-Laundering Regulations 2003), regulatory requirements (the FSA's Money-Laundering Sourcebook) and industry guidance (the Joint Money-Laundering Steering Group ("JMLSG") Guidance Notes).

(a) Proceeds of Crime Act 2002 ("POCA")

The Proceeds of Crime Act 2002 specifies three money-laundering offences:

(i) concealing, disguising, converting, transferring or removing from the UK criminal property;

(ii) becoming concerned in an arrangement which a person knows or suspects facilitates the use or control of criminal property; and

28 This section sets out the architecture of the anti-money laundering regimes in the UK, France, Germany, Spain and the US (as well as EU developments in this domain). As detailed previously in Volume I of this

Report, industry participants have commented on the particular problems associated with the differing requirements and level of detail associated with KYC obligations in each of the jurisdictions. Whilst we consider this to be a likely consequence of the different anti-money laundering architectures in each jurisdiction (which this section considers), this section does not highlight specific KYC differences between the jurisdictions since each such KYC requirement will depend on a multitude of factors (e.g. type of customer, type of product, location of customer etc.) which is impossible to capture in a summary document, such as this Volume II.

- 142 -

(iii) acquiring use or having possession of criminal property.

There is no distinction between the original criminal and a later recipient of the proceeds of crime. The offences have regard to property derived from any conduct which is a criminal offence in the UK or would be an offence in the UK if it occurred there. The above offences carry penalties of a fine and/or imprisonment of up to a maximum of 14 years.

POCA also contains three offences of failure to disclose:

(i) persons in the regulated sector (which includes all bank and investment firm employees) who obtain information in the course of business which gives reasonable grounds for suspecting money-laundering, commit an offence if they fail to make a report;

(ii) a money-laundering reporting officer ("MLRO") in the regulated sector (including the MLRO of a bank or investment firm) commits an offence if an employee makes a report to the MLRO that gives reasonable grounds for suspicion, but the MLRO does not make an onward suspicious transaction report ("STR") to the National Criminal Intelligence Service; and

(iii) MLROs not in the regulated sector (including the MLRO of a financial institution not requiring FSA authorisation (e.g. a company solely performing commercial lending activities)) can also commit an offence if they do not make an STR when they know or suspect as a result of a disclosure to them that a person is engaged in money-laundering.

An offence of tipping-off will be committed if a person knows or suspects that a disclosure has been made under POCA but nevertheless makes a disclosure which is likely to prejudice any resulting investigation.

The above "failure to disclose" and tipping-off offences carry penalties of a fine and/or imprisonment of up to a maximum of 5 years.

(b) The Money-Laundering Regulations 2003

The Money-Laundering Regulations provide anti-money-laundering guidelines for those involved, amongst other things, in the banking or financial services sector. Non-compliance with the Money-Laundering Regulations will give rise to criminal sanctions. The Money-Laundering Regulations relate to various matters, including the setting up of systems and training to prevent money-laundering, such as identification procedures ("Know Your Customer"), internal reporting procedures and external reporting requirements.

(c) The Financial Services Authority Money-Laundering Sourcebook (the "Sourcebook")

The Sourcebook provisions run parallel to, but are separate from, the Money-Laundering Regulations and apply to banks and investment firms regulated by the FSA. The Sourcebook provisions mirror the Money-Laundering Regulations and provide the FSA with the power to prosecute for breaches of the Money-Laundering Regulations as well as the Sourcebook provisions. Therefore, banks and investment firms (and their employees) have to comply with both the Money-Laundering Regulations and the Sourcebook, and can be subject to criminal liability for breach of the Money-Laundering Regulations as well as regulatory sanctions for breach of the Sourcebook. Breaches of the Sourcebook can give rise to fines, public censure and, in extreme cases, the withdrawal of authorisation.

- 143 -

The JMLSG is an association of UK financial services trade associations that aims to encourage good practice in countering money-laundering and to give practical assistance in interpreting the anti-money-laundering legislative regime. The JMLSG Guidance Notes are not mandatory but are intended to indicate good generic industry practice within a number of business areas. Whilst they are not intended to provide an official interpretation of the Sourcebook, the requirements contained in the Sourcebook are referred to where appropriate and the guidance provided on complying with the Money-Laundering Regulations also seeks, as appropriate, to have the practical effect of satisfying the rules in the Sourcebook.

The guidance thereby provides an indication of what is expected and, when tailored to a bank or investment firm's own risk base, can provide a safe harbour to any prosecution for a money-laundering offence.

On 14 March 2005 the JMLSG issued a consultation draft of a complete rewrite of the JMLSG Guidance Notes. The main changes between the draft guidance and the current 2003 edition are an emphasis on senior management responsibility; allowing firms to focus their resources on the minority of customers who carry a higher money-laundering risk; simplification of the documentation requirements by which most individuals have to "prove" their identity; reduction in the documentation needed to verify the identity of non-personal customers; allowing greater account to be taken of identity verification carried out by other regulated firms; and additional guidance, tailored to particular business areas, to take account of special features in a number of sectors.

(e) Terrorism Act 2000

The Terrorism Act 2000 (as amended by the Anti-Terrorism, Crime and Security Act 2001) contains a comprehensive set of provisions to address specifically money-laundering in relation to funds derived from terrorism. It deals with money or property likely to be used for terrorism as well as the proceeds of terrorist acts. It includes a money-laundering offence as well as a reporting requirement, with an offence of failure to report and a tipping-off offence. There is also a "failure to disclose" offence for banks and investment firms in the regulated sector which applies not only to a failure to report any actual knowledge or suspicion, but also to a failure by an institution or person to identify and report "reasonable grounds for knowing or suspecting money-laundering". The penalty for failure to report is a fine and/or up to five years' imprisonment.

12.3.2 Germany

Relevant provisions on the prevention of money laundering are contained in the German Money-Laundering Act, the German Criminal Code and the German Tax Code. In addition, the BaFin has published guidelines concerning measures to be taken by credit institutions and financial services institutions to combat and prevent money laundering.

(a) Criminal Code

The Criminal Code defines money laundering as a criminal offence.

Pursuant to section 261 of the Criminal Code, the following activities qualify as money laundering activities if the object of the activity is derived from a preceding "unlawful act":

(i) hiding or concealing the origin of the proceeds of a preceding "unlawful act";

(ii) frustrating or endangering the tracing of the origins, or the discovery, forfeiture, confiscation or seizure of such proceeds;

(iii) procuring such proceeds for oneself or a third party; or

(d) Joint Money-Laundering Steering Group Guidance Notes (the "JMLSG Guidance Notes ")

- 144 -

(iv) keeping such proceeds in safe custody for oneself or for a third party if this is done in knowledge of the origin of the relevant proceeds.

Intention is not required in order to be held criminally liable for money laundering. Even persons failing, due to their own gross negligence, to realise that the objects they are dealing with derive from a preceding "unlawful act" can be punished by imprisonment or a fine.

The following are all considered "unlawful acts" (i.e. offences which must precede the money laundering activity for such activity to be punishable):

(i) all types of felonies (Verbrechen, i. e. all criminal offences which are punishable by a minimum sentence of one year's imprisonment);

(ii) certain specified types of misdemeanours (Vergehen, i.e. criminal offences which are punishable by a minimum sentence of less than one year's imprisonment); and

(iii) serious tax evasion pursuant to section 370a of the Tax Code (i.e. committing tax evasion to a large extent and in order to generate income, or as a member of a group of organised criminals who have joined forces in order to repeatedly commit such tax offences).

The criminal liability for money laundering pursuant to section 261 of the Criminal Code does not require that the preceding "unlawful act" has been determined by a court judgement or that investigations have been initiated in this regard.

Intentional money laundering is subject to imprisonment for between three months and five years.

(b) Money-Laundering Act

The Money-Laundering Act provides for certain identification, documentation and notification duties for those involved, amongst other things, in the banking or financial services sector. Non-compliance with the Money-Laundering Act amounts to an administrative offence (fines up to EUR 100,000).

Institutions must adopt safeguards against being misused for money laundering purposes. The operation and effectiveness of the internal safeguards required under the Money-Laundering Act and their further development is the joint responsibility of all managers of a credit institution, even if individual managers have been assigned specific responsibility in this regard. Such safeguards are also imposed on managers of German branches of credit institutions from EEA countries conducting banking business in Germany under the European Passport.

According to the Money-Laundering Act, institutions must designate a money laundering officer who has to act as contact person for the law enforcement authorities in the prosecution of money-laundering operations and is responsible for the enforcement of the Money-Laundering Act.

With respect to the prevention of money-laundering, the compliance officer has to develop, update and enforce internal principles, procedures and controls to prevent money-laundering. In addition, he is responsible for the training of, and providing timely information to, the employees on money-laundering methods and the list of duties specified in the Money-Laundering Act.

Institutions must ensure employee training as regards the duties to be complied with under the Money-Laundering Act and the institution's own internal safeguards. In contrast to refresher training, the initial training for new employees should generally take place in the form of attendance courses. In addition, employees must be provided with up-to-date information as to new methods and techniques of money-laundering of which the institution has become aware. For the purposes of training employees on new money-laundering methods and techniques, written information should be provided.

- 145 -

The reporting of suspicious transactions within the meaning of section 261 of the Criminal Code is one of the main duties of institutions. Pursuant to section 11 of the Money-Laundering Act, institutions must report suspicious transactions to the competent police authority. These reports must include all facts which suggest that a financial transaction (whether it involves cash or not) amounts to, money-laundering. Tipping-off the offender is an administrative offence (fines up to EUR 50,000). Therefore, institutions must guard against making any disclosures which may tip-off suspected "launderers" that they are under investigation or which might otherwise prejudice an investigation.

(c) Tax Code

A "know your customer" provision is contained in section 154 of the Tax Code according to which everyone is obliged to identify natural persons and legal entities when opening a cash or securities deposit account or making available a deposit box for safekeeping of physical assets (e.g. coins or physically available securities).

12.3.3 Spain

The anti-money-laundering regime in Spain is made up of criminal legislation (Articles 301 to 304 of the Criminal Code) and regulatory requirements (Law 19/1993, of 28 December, and Royal Decree 925/1995, of 9 June).

(a) Articles 301 to 304 of the Criminal Code

Article 301 of the Criminal Code specifies three money-laundering offences:

(i) acquiring, converting or transferring assets knowing that they have their origin in a criminal offence;

(ii) taking any action to disguise the unlawful origin of any asset or to assist the person involved in the criminal offence to evade the legal consequences of their actions; and

(iii) concealing the real nature, origin, location, destination, movement or rights over assets, in the knowledge that they have their origin in certain criminal offences.

These offences carry penalties, amongst others, of a fine and imprisonment of up to a maximum of 6 years.

Articles 302 and 303 establish special penalties for offences committed within an organisation or by certain professionals.

(b) Law 19/1993

Law 19/1993, the Spanish implementation of Directive 1991/308/CEE, has been recently amended in accordance with Directive 2001/97/CE.

Law 19/1993 establishes obligations, actions and procedures in order to prevent the use of the financial system and other sectors of the economy to launder money.

Law 19/1993 applies to financial entities and other activities such as casinos, estate agents, auditors, accountants, tax advisors and, in certain circumstances, lawyers and notaries. It also applies to the movement of funds and other payment means in excess of certain limits, which must be declared to the authorities in accordance with the provisions of Law 19/1993 and Royal Decree 925/1995.

- 146 -

Law 19/1993 imposes several obligations, including client identification procedures (which include obtaining information on the activities of the clients), special scrutiny of certain transactions, internal control procedures and external reporting requirements. Non-compliance with these obligations will give rise to regulatory sanctions (fines, private or public censure and, in extreme cases, the withdrawal of authorisation).

(c) Royal Decree 925/1995

The recently amended Royal Decree 925/1995 develops the provisions contained in Law 19/1993.

Besides developing the obligations contained in Law 19/1993, Royal Decree 925/1995 provides for new obligations such as establishing additional identification and "know your client" measures for certain activities including, but not limited to, private banking, correspondent banking agreements, distance banking, currency exchange and international funds transfers; and providing and maintaining information on the transfer of funds transfers both within and outside Spain;

Royal Decree 925/1995 further develops the internal control procedures that entities must put in place, and specifies that such procedures will have to be evaluated (subject to certain exceptions) annually by an external expert. This report will have to be available for inspection by the executive service of the Commission during a 6 year period following its preparation.

12.3.4 France

Money laundering is defined under French law (pursuant to the law of 13 May 1966 (reproduced in article 324-1 of the Criminal Code)) as:

"The facilitation, by any means, of the concealment of the true origin of assets or income resulting from a crime or delict which brought some direct or indirect benefit to the person who committed such crime or delict. Money laundering also arises when a transaction which aims to invest, hide or convert the direct or indirect proceeds of a crime or delict is facilitated."

In France, money laundering is punishable by up to 5 years imprisonment and fines of up to EUR 375,000: both penalties can be increased (up to 10 years imprisonment and a fine of up to EUR 750,000) in the case of aggravated money laundering. Fines may in all cases be raised to an amount of up to 50% of the value of the monies or assets laundered. A crime/delict will be considered to be committed if two conditions are met: (i) the facts outlined above in article 324-1 must occur; and (ii) there must be some evidence that the culprit had knowledge of the fraudulent origin of the funds (the intentional aspect of the delict). Further, other sanctions set out in Article 327-7 may be imposed including driving licence suspensions, restraints on the freedom to either remain or leave France and confiscation of the culprits' assets. Companies, as well as individuals, may be sentenced to fines and other sanctions provided for by the criminal law.

(a) French law provides for the suppression of money laundering resulting from drug-trafficking or criminal organised activities.

wlaundering. Law n°93-122 of 29 January 1993 extended the duties imposed on financial organisations by the Money Laundering Law to money-laundering linked to the activity of criminal organisations in general.

The Money Laundering Law is now embodied in the FFMC, “Titre VI”, article L 561-1 through article L 564-3 (as amended by the law 2001-420 dated 15 May 2001).

(b) The Criminal Code also contains provisions in respect of money laundering and the definition of money laundering set out in the Criminal Code is much wider than the definition set out in the Money Laundering Law.

•The Law n° 90-614 of 12 July 1990 (“the Money Laundering Law") contains provisions relating to the involvement of financial institutions in drug related money

- 147 -

The Criminal Code was also slightly amended by article 33 of the Law n°2001-1062 of 15 November 2001 in order to fully comply with the International Convention for the Suppression of the Financing of Terrorism.

Ancillary legal provisions are also contained in the Customs Code (art. 415) to suppress money laundering carried out by means of export, import, transfer or offsetting.

(c) Obligations provided by the legislation

Article L 562-1 FFMC contains a list of the persons/entities who are subject to anti-money laundering legislation. This list includes credit institutions, investment firms, investment firms, insurance companies and insurance and reinsurance brokers.

Financial institutions must appoint one or more money laundering control officers and provide the names of such officer(s) to TRACFIN, the specialised department of the French Ministry of Economy and Finance acting as the money laundering authority.

Financial institutions must also adopt internal written rules setting out the procedures to be followed in order to comply with the requirements provided for under the Money Laundering Law.

The enforcement of anti-money laundering legislation is strictly controlled by the Supervisory Commissions who ensure, in particular, that internal control procedures are implemented.

Financial institutions must satisfy themselves as to the identity of any client by insisting on the production of certain documents, before opening accounts or underwriting any insurance or financial agreements.

This verification of the identity of a potential client must be made by submitting, in the case of entities, the original or certified copy of any deed or excerpts of the Official Registrar which sets out the name, legal form, registered office and the powers of the individuals acting on behalf of the entity.

This therefore means that financial institutions should be prepared to carry out a company search to identify precisely any customer and/or third party acting on behalf of a customer.

(d) Reporting

Under article L 562-2 FFMC, financial institutions are obliged to disclose (either verbally or in writing) to TRACFIN:

· all monies recorded in their books which could be the result of drug-trafficking or of organised criminal activities; and

· all transactions related to monies which could be the result of drug-trafficking or of organised criminal activities.

Financial institutions are also required to notify to TRACFIN of:

· any transaction where the identity of the client or the recipient remains doubtful in spite of the due diligence carried out by the firm in accordance with French legislation; and

- 148 -

· transactions carried out by financial institutions on their own account or on behalf of a third party with persons or entities, (including its subsidiary companies or establishments) acting in the form or on behalf of a fiduciary business, trust or any other asset management instrument where the identity of the recipients is not known.

TRACFIN acknowledges receipt of the notification within the time reasonably required to carry out the transaction in question and can attach to the receipt a notice obliging Financial institutions to delay the carrying out of the transaction for a maximum of 12 hours. However, the President of the District Court of Paris (Tribunal de Grande Instance) can extend the 12 hour deadline or order the provisional confiscation of the funds, accounts or instruments concerned in the notification upon request of TRACFIN (in accordance with the public prosecutor), or upon the request of the public prosecutor.

A notification which is made by financial institutions to TRACFIN cannot, under any circumstances, be disclosed to the customer. Criminal sanctions may be imposed if this rule is violated.

No prosecution or civil or professional liability action can be brought against the persons who made a notification if the notification was made in good faith, even if proof of the criminal character of the facts giving rise to the notification is not provided.

(e)

Large transactions involving sums exceeding EUR 150,000 and which, without appearing to be linked directly to drug trafficking or money laundering, are “carried out in unusual complex circumstances and do not appear to have any economic justification or lawful object”, must form the subject of a specific investigation by financial institutions, even if the client is not a new client.

In such a scenario, financial institutions must request information from the client on the origin and final destination of the sums involved, as well as on the purpose of the transaction and the identity of the person who will benefit from it.

Records relating to the identity of customers, one-off or casual clients of financial institutions must be kept for five years from the date of closure of the accounts or from the end of the relationship with them. The same obligation applies in respect of the documents relating to the transactions carried out by the clients.

(f) Sanctions

Disciplinary sanctions are imposed upon persons and companies who do not comply with the obligations set out by the money laundering legislation. In the event that the managing directors, managers (dirigeants), the agents of a financial institution or the other persons or entities bound by the obligation, tip-off the individual that is the subject of the notification, such individuals or entities could be punishable by a fine of up to EUR 22,500.

The Criminal Code also provides for specific penalties for any person who has committed the offence of money laundering i.e. someone who:

· by any means whatsoever, facilitated or attempted to facilitate the provision of a false explanation in respect of the origin of income or assets of a person or entity who directly or indirectly received profits from a crime or an offence committed by such person or entity; or

· facilitated or attempted to facilitate any transaction for the purpose of investing, concealing or exchanging a profit directly or indirectly derived from a crime or an offence.

Transaction examination

- 149 -

The criminal offence of money laundering (or the attempt to money launder) is punishable by up to 5 years imprisonment and a fine of EUR 375,000. The sanctions could be increased to imprisonment of up to 10 years and a fine of EUR 750,000 where money laundering: (i) is habitually carried out through professional activities; or (ii) is committed through an organisation. Moreover, the amount of the penalties set out above can be increased to up to half of the sums or properties engaged in money laundering.

French law also provides for additional sanctions for entities when they are deemed to be liable for any money laundering. In particular, the fines could be increased to up to five times the amounts set out above in respect of individuals.

In addition to the above, the Court may impose sanctions such as:

· advertising the judgment in public notices or in newspapers or through broadcasting; or

· the permanent closure or the closure for up to five years of the entity which was used to commit money laundering; or

· a prohibition on exercising, directly or indirectly, professional activity permanently or for a maximum period of five years; or

· the dissolution of the company.

12.3.5 US

The US anti-money laundering regime is composed of criminal legislation (18 USC. §§ 1986, 1987, and 1960) and regulatory requirements (implemented by the Bank Secrecy Act and the USA Patriot Act).

(a) US Criminal Money Laundering Statutes

The United States has three money laundering statutes, 18 USC. §§ 1956, 1957, and 1960. The most commonly used US money laundering statute is 18 USC. § 1956. It specifies three money laundering offences which are punishable by fines, imprisonment, or both:

(i) engaging in a financial transaction if the individual knows that the property involved in the financial transaction represents the proceeds of some unlawful activity or if it involves the proceeds of a specified unlawful activity (“SUA”);

(ii) transporting, transmitting, or transferring any proceeds through the United States in order to promote a SUA or while knowing that the funds involved the proceeds of an unlawful activity;

(iii) disguising the nature, location, source, ownership or control of property believed to be the proceeds of a SUA.

As defined in the US Money Laundering statute, there are over 200 SUAs and this number has been extended.

In general, 18 USC. § 1957 provides for criminal and civil liability for two types of activities:

(i) for any person to engage in a financial transaction in the United States with criminally derived property; or

(ii) for a US person to engage in a financial transaction with criminally derived property.

- 150 -

(b) US Anti-Money Laundering Regulations

The United States primarily prescribes its anti-money laundering regulatory requirements through the Bank Secrecy Act (“BSA”) and the USA Patriot Act (“Patriot Act "). Under these acts, various government agencies and self regulatory organisations, including the Financial Crimes Enforcement Network, the SEC, and the NASD have prescribed regulations and guidance. These regulations include special procedures for transacting with a correspondent account, requirements to file suspicious activity reports (“SARs”), requirements to establish anti-money laundering and customer identification programs, requirements to file currency transaction reports and special rules for information sharing to deter money laundering.

In general, these rules apply to financial institutions, including banks, broker-dealers, savings associations and credit unions. However, in certain cases, the regulations also cover additional entities such as currency dealers and exchangers, mutual funds, insurance companies, securities futures industries, variable annuities, futures commission merchants and introducing brokers in commodities, money services businesses, casinos, dealers in precious metals, and travel agencies.

For instance, the regulations enacted pursuant to the Patriot Act require broker-dealers to: (i) implement anti-money laundering ("AML") programs; (ii) implement customer identification programs; (iii) prohibit the opening or maintaining of correspondent accounts for foreign "shell banks;" (iv) file SARs; (v) establish special due diligence controls for private banking accounts; (vi) share information between financial institutions and government agencies; and (vi) take one or more special measures if the Secretary of the Treasury designates a jurisdiction, financial institution, class of transactions, or type of transaction outside of the United States as being of primary money laundering concern. By way of example, Section 352 of the Patriot Act requires broker-dealers to implement an AML program that covers all aspects of the broker-dealer’s business and is tailored to the firm’s specific business, customers and risks of potential money laundering. As part of the AML program, all broker-dealers must develop customer identification programs that: (i) collect identifying information about customers opening an account; (ii) verify that the customers are who they say are they are; (iii) maintain records of the information used to verify their identity; and (iv) determine whether the customer appears on any list of suspected terrorists or terrorist organisations.

The US Department of Treasury’s Office of Foreign Asset Control (“OFAC”) also issues anti-money laundering regulations. OFAC’s regulations require, among other things, that financial institutions freeze funds that enter the United States if they are received from certain countries specified by OFAC.

Non compliance with anti-money laundering regulations may lead to various penalties, including investigation and fines by US regulators, potential referral for criminal prosecution by the US Department of Justice under US criminal statutes, or both.

- 151 -

13. Client assets and client money

13.1 General

Client asset and client money rules exist in all jurisdictions. However, the specific regime that is applicable differs.

13.2 European regulatory framework

Article 13(7) of MiFID requires that an investment firm must, when holding financial instruments belonging to clients, make adequate arrangements to safeguard clients' ownership rights, especially in the event of the firm's insolvency, and to prevent the use of a client's instruments on own account or by other customers except with the client's express consent.

Article 13(8) requires investment firms, when holding funds belonging to clients, to make adequate arrangements to safeguard the clients' rights and prevent the use of client funds by the firm for its own account (e.g. use of accounts with authorised banks).

The draft Commission Regulation on organisational requirements and identification, management and disclosure of conflicts of interest by investment firms sets out, in Article 15, that in order to comply with Article 13(7) and (8) of MiFID, an investment firm should fulfil certain requirements including maintaining certain records which enable an investment firm to ascertain which assets are held for which clients, ensuring client funds are deposited correctly and introducing adequate organisational arrangements. However, if the applicable law in any given jurisdiction means that an investment firm's arrangements are not sufficient to satisfy the requirements of MiFID or prevents an investment firm from complying with the requirements of MiFID, an investment firm should take such alternative measures which will enable it to comply with the MiFID obligations to the fullest extent possible.

The draft Commission Regulation sets out, in Article 16, that an investment firm shall deposit client funds into: (a) a central bank; (b) a credit institution authorised in accordance with Directive 2000/12/EC; or (c) a bank authorised in a third country. Where an investment firm does not deposit client funds with a central bank, it shall exercise skill in the selection, appointment and review of the credit institution or bank where the funds are deposited and the arrangements for holding client funds there.

The draft Commission Regulation also sets out that an investment firm may deposit client financial instruments into an account or accounts opened with a depository provided that the firm exercises skill, care and diligence in the selection, appointment and review of the depository and of the arrangements for the holding and safekeeping of client financial instruments there. If depositories and the holding and safeguarding of client financial instruments are subject to specific regulation and supervision in a jurisdiction, the investment firm shall deposit the client financial instruments with a depository subject to such regulation and supervision. However, an investment firm may not deposit financial instruments with a depository in a third country that does not regulate depositories/holding and safekeeping of financial instruments unless the nature of financial instruments or of the investment services connected with those instruments so requires.

The draft Commission Regulation provides that an investment firm may use financial instruments held by it on behalf of a client for its own account or for the account of another client if: (a) the firm has provided the client with full and accurate information on the obligations and responsibilities of the investment firm/client for whose account the financial instruments may be used and the risks involved (in the case of a retail client); (b) the client has given his prior express consent to the use of the instruments on specified terms, as evidenced by his signature and; (c) the use of the client's financial instruments is restricted to the specified terms to which the client consented. If client financial instruments are held on an omnibus basis, the investment firm may use or enter into arrangements for lending of financial instruments held by it on behalf of a client for its own account or for the account of another client only if: (a) each client whose financial instruments are held together on an omnibus basis has given his consent; or (b) the investment firm has systems and controls in place to ensure that only financial instruments belonging to clients who have given their prior consent are used.

The Commission Working Document ESC/23/2005 provides in Article 8 that investment firms are to inform clients where their assets may be held by a third party on behalf of the investment firm and of any legal responsibility of the investment firm to the client for any acts or omissions of the third party or the consequences for the client of the insolvency of the third party. Clients are also to be informed of the fact that the client's financial instruments may be held on an omnibus basis (and any resulting risks); the client's financial instruments

- 152 -

are not separately identifiable from the proprietary financial instruments of the third party or the investment firm (and any resulting risks); may be subject to the law of a jurisdiction other than the Member State in which the client is resident; and/or any security interest, lien or right of set off in respect of the client's assets held by the investment firm or third party.

CESR's level 2 advice in respect of Article 19(8) of MiFID (reporting to clients) requires investment firms to provide clients with periodic statements of client assets held by the firm, including information as to assets provided as collateral or lent or client accounts where shorting has occurred. Article 15 of the Commission Working Document ESC/23/2005 also requires investment firms to provide clients with annual statements of client assets held by the firm and any benefit that has accrued to the client by virtue of participation in any securities financing transactions.


13.3.1 UK

Client Assets

The "Client Assets" FSA Sourcebook ("CASS") contains the rules relating to the safeguarding and administering of investments held for clients (whether private client, intermediate client or market counterparty). It should be noted that an entity must be providing both "safeguarding and administering" services to be within the scope of CASS. However, MiFID, in articles 13(7) and (8) refers to adequate arrangements to "safeguard" clients' ownership rights and clients' rights in relation to funds' without referring to administration. If the result of the UK implementation of MiFID is that the UK regulatory system is required to regulate all safeguarding (of financial instruments) whether or not administration services are also provided in relation to the same assets, this would be a considerable change from the current regime and would cover various activities which are not currently regulated in the UK.

Firms must accept responsibility for any nominee company which they control and that holds client assets. Where a firm uses the services of a custodian, the firm is required to undertake an "appropriate risk assessment" and (where the assets are to be held outside the UK) provide appropriate risk disclosures to the client.

Where a firm itself holds client assets it must comply with a number of requirements which are designed to restrict the commingling of client and firm's assets and minimise the risk of the clients safe custody investments being used by the firm without the client's agreement or contrary to the client's wishes, or being treated as the firm's assets in the event of its insolvency. The requirements include:

(a) safe custody investments must be segregated from the firm's own investments (i.e. separate entries in account records);

(b) title to safe custody investments must be registered in a manner which provides the client with "appropriate protection" (i.e. client's name, name of nominee company etc). It should be noted that circumstances can exist where clients' assets can be recorded in the name of the firm, where it is believed this is in the client's best interests and appropriate risk warnings have been given;

(c) a firm may not use any safe custody investment for its own account, or the safe custody asset of a customer for the account of another client, unless the owner has consented in writing (if it is a private customer) or has been notified (if it is not).

Where a firm provides safe custody services to a client, it must notify the client setting out the terms and conditions applying to the service. In the case of a private customer, the firm must normally obtain the customer's written agreement to terms on instructions and any lien which the firm may seek over the customer's assets (notification only required in respect of non-private customers).

- 153 -

Where a firm is accountable for custody assets, it must provide, at least annually, a statement in relation to those assets. Reconciliations must also be performed of both a firm's own records and statements obtained from custodians. Appropriate records must be kept and the FSA notified if a firm fails to comply with the reconciliation requirements.

A firm may only lend a private or intermediate customer's securities with the customer's agreement and on written terms which are expected to include provisions contained in CASS and the FSA conduct of business rules. Where stock is lent for a private customer, the firm is responsible for ensuring that appropriate collateral is provided by the borrower. Any dividends, stock lending fees etc received for the customer's benefit will belong to the customer.

Client Money

Client money has a very wide definition in the UK: money of any currency which, in the course of carrying on designated investment business, a firm holds in respect of any investment agreement entered into, or to be entered into, with or for a client, or which a firm treats as client money in accordance with the client money rules. Client money rules apply where firms receive or hold client money.

Market counterparties or intermediate customers may opt-out of the client money rules (provided the client acknowledges in writing that the money will not be segregated and that it will rank only as a general creditor). If a firm holds money on behalf of a market counterparty or an intermediate customer which is not, itself, FSA authorised, in connection with a service which is not governed by the Investment Services Directive or the Banking Consolidation Directive, it can unilaterally opt-out of the client money rules by written notice to the client. When an FSA authorised firm holding client money transfers it to another person (including another firm), it must not agree to opt-out of the client money rules or otherwise represent that the money is not client money.

Client money is held subject to a statutory trust in accordance with the client money rules. In summary, the effect of the rules is as follows:

(a) Client money must be held in a segregated client bank account designated as containing client money.

(b) The client account must normally be held with an "approved bank" (i.e. an FSA authorised bank or building society, an EEA bank or a bank established elsewhere which meets certain specified criteria).

(c) Client money may be held by a non-approved bank only in limited circumstances where required for the settlement of transactions, or receipt of income, outside the UK and where risk warnings have been given and the consent of private customers has been obtained.

(d) The bank holding the client account must acknowledge the trust basis on which the client money is held; if it fails to do so the account must be closed or the client must be notified.

(e) In the case of a private customer, a firm must account to the customer for all interest earned on his money, unless it has notified him in writing of an alternative position (e.g. that no interest will be payable, or that interest will be paid on a specified basis).

A firm must do a calculation every business day to establish that the amount of money it holds as client money is sufficient to discharge its obligations to all its clients. In the event of a shortfall, the firm must make this good. The firm must also conduct reconciliations between its own records and the underlying bank statements at least every 25 days, and discrepancies should be identified and corrected.

There are specific rules on the pooling and distribution of client money to clients on the failure of the firm or the bank holding the account.

- 154 -

A transfer of client money to a third party (other than on the client's instructions) is only permitted for the purposes of a transaction for the client or to meet the client's obligations to provide collateral, and a private customer must be notified that this may happen. In the case of transfers in relation to contingent liability investments the firm must notify an exchange, clearing house, broker or OTC counterparty to which money is paid that the firm is required to keep the money segregated, instruct the person concerned to credit the money to a "client transaction account" and require acknowledgement that the account may not be combined with or set off against any other account.

13.3.2 Germany

Client Assets

Provisions relating to the safeguarding and administering of investments of clients may be found in the Banking Act, Securities Trading Act, the Safe Custody Act and the Special Terms and Conditions for Dealings in Securities used by most of the German banks as standard business terms. Furthermore, on 21 December 1998 the BaFin issued a note on the requirements of safe-custody businesses and securities settlements, which provided detailed requirements as to the performance of safe custody activities by credit institutions.

(a) Banking Act

The receipt of securities in safe custody and administration of securities for the account of others qualifies as banking business in the form of safe custody business under the Banking Act and, thus, triggers German licence requirements if conducted commercially. Under general provisions German credit institutions are required to have appropriate organisation and compliance systems in place when performing safe custody activities.

(b) Securities Trading Act

According to section 34a of the Securities Trading Act, investment services providers which are not authorised to conduct safe-custody business within the meaning of the Banking Act are required to immediately transfer securities which they accept in connection with an investment service or non-core investment service to a credit institution authorised to conduct safe-custody business in Germany or to a credit institution domiciled abroad which is authorised to conduct safe-custody business and with which the customer is granted a legal status equivalent to that under the Safe Custody Act for safe custody. Furthermore, the investment services provider is obliged to immediately inform the customer of the account in which the securities are deposited and whether the credit institution with which the securities are held belongs to an investors' protection scheme as well as of the extent to which the securities are protected by such scheme.

Furthermore so-called "omnibus-accounts" (i.e. accounts in the name of the investment services provider to keep securities of different customers) are not permitted.

(c) Safe Custody Act

Entities to which securities are entrusted for custody ("custodians") are obliged to hold the securities physically separated from their own securities and those of third parties and mark them with the depositor's distinctive features if the securities are not eligible for collective safe custody with a central securities depository or if the depositor requests separate safe custody. Unless requested otherwise by the depositor the custodian may entrust securities eligible for collective safe custody to a central securities depository.

Custodians may also deposit securities with another (including foreign) custodian if certain conditions are met. However, the liability cannot be limited with regard to negligence of the (foreign) sub-custodian. The sub-custodian has to be informed that the securities do not belong to the custodian. In order to ensure the same level of protection for the customer for securities held with a sub-custodian as with a custodian, a so-called "Three-Point-Declaration" is requested from the non-German sub-custodian. This declaration normally states that:

- 155 -

(i) the sub-custodian has taken due notice that the relevant securities belong to customers of the German custodian. The account where they are held has to be designated a "Customer Account";

(ii) with respect to these securities the sub-custodian may assert any security interest lien, right of retention or any similar rights only for such claims as may arise from the purchase, administration, and safe custody of these securities. The sub-custodian will inform the German custodian immediately if a third party levies any attachment upon or takes any other action which affects the securities;

(iii) the securities are kept in safe custody with the sub-custodian in a specific state. Without the consent of the German custodian the sub-custodian is not entitled to entrust a third party with the effective safe custody of such securities or to transfer them to another country.

The custodian is required to keep a commercial book in which the depositor, as well as category, nominal amount and number of the securities and other distinctive features have to be noted.

(d) Special Terms and Conditions for Dealings in Securities

The German Special Terms and Conditions for Dealings in Securities set out the liability of credit institutions in relation to safe custody of securities.

With regard to securities held in safe custody in Germany, a credit institution is fully liable for all its employees and for all persons it appoints to fulfil its obligations (including sub-custodians). As far as the credit institution's customer receives a credit on securities held in collective safe custody, the credit institution is also liable for the performance of Clearstream Banking Frankfurt AG's obligations.

With regard to securities held abroad, the liability is limited to the careful selection and instruction of the foreign sub-custodian. However, in the case of intermediate custody by Clearstream Banking Frankfurt AG or another domestic intermediate custodian or in the case of custody by a foreign branch of the relevant credit institution, the credit institution is liable for any default of those entities.

The Special Terms and Conditions for Dealings in Securities also require the custodian to provide at least annually a statement in relation to the securities held in safe-custody.

Client Money

Provisions relating to the safeguarding and administering of client money may be found in the Banking Act and the Securities Trading Act.

(a) Banking Act

The acceptance of funds from others as deposits or of other repayable funds from the public qualifies as banking business in the form of deposit business within the Banking Act. If provided commercially, it will qualify as licensable banking business within the meaning of the Banking Act (Einlagengeschäft) and thus, triggers German licence requirements.

(b) Securities Trading Act

With regard to client money the same principles as set out above with regard to clients assets under the Securities Trading Act apply (however, the relevant credit institution must be licensed to provide deposit business).

Furthermore so-called "omnibus-accounts" (i.e. accounts in the name of the investment services provider to keep monies of different customers,) are not permitted.

13.3.3 Spain

Where a firm holds client assets or money it must comply with a number of requirements which are designed to restrict the commingling of client and firm's assets and money and minimise the risk of the client's safe custody investments being used by the firm without the client's agreement or contrary to the client's wishes. The requirements include:

(a) Client securities which firms hold on deposit or deposit with other entities, and any collateral (consisting of securities or cash) given in favour of clearing entities, must be registered in individual accounts on behalf of each client, regardless of the relationship existing between the client and the firm.

Firms may use global/omnibus accounts where necessary to perform third party transactions, provided that the following requirements are met:

• The control unit of the firm (please see section 9.2.2 above) must issue a report on each financial entity where the accounts are to be opened, in respect of its credit solvency and any specific, legal and operational risks that may be involved in the transaction. The report must be authorised by the managing body of the firm.

• The firm's own account and that of third parties must be totally separate, and no entity and client positions may be reflected in the same account. The name given to the client account shall expressly indicate that it is a third party account.

• The firm must establish internal procedures so as to enable it to obtain each client's individual position in accounting terms.

• Written authorisation from each client (whether professional or retail) must be obtained, and each client shall be informed of the risks assumed as a result of the transaction, including the identity and credit solvency of the financial entity acting as depository of the global accounts.

Firms cannot use global accounts to process transactions or deposits of securities and instruments on behalf of Collective Investment Schemes.

(b) In principle, investment firms cannot hold client credit accounts. However, client credit accounts used for instrumental and temporary purposes in relation to the execution of transactions on behalf of clients can be opened on an exceptional basis. The balance of those accounts is to be minimised, and express authorisation must be obtained from clients in order to invest each client's available funds (such funds must be invested in certain low risk assets of sufficient solvency).

Firms must establish adequate procedures in order to clearly separate (in accounting terms) the assets invested by the firm in order to comply with its capital adequacy requirements and the funds and assets of their clients.

(c) Firms must ensure that instructions in respect of safe-custody securities are actually made by the appropriate holders or by sufficiently authorised individuals.

(d) Firms shall establish adequate procedures in order to prevent non-compliance with safe-custody requirements as a result of legal and operational risks, theft, or fraudulent activities.

Firms must develop and implement formal procedures in order to (i) authorise, control and follow up on the limits of credit facilities granted to clients and other client debit balances, as well as to (ii) classify unpaid balances as doubtful or bad debts, in compliance with applicable accounting regulations. For these purposes, an

- 156 -

- 157 -

13.3.4 France

Under French law, investment firms may not receive funds from the public and use them for their own account. Only credit institutions may do so. However, both investment firms and credit institutions, as providers of investment services, may hold financial instruments in custody on behalf of their clients. While there is a need for ensuring segregation between financial instruments owned by a firm and financial instruments owned by its clients, the possibility to use cash received from clients depends on whether the firm is a credit institution or merely an investment firm.

Client Assets

Provisions relating to the safeguarding and administering of financial instruments of clients may be found in the FFMC and the AMF General Regulations.

To summarise, a firm holding financial instruments (belonging to either professional or retail investors) in custody must:

• protect the ownership rights of investors for whom they keep securities accounts and may not use the securities for their own account without the investor's express consent;

• not use or transfer the ownership of securities without the owner's express consent and must set up internal procedures which guarantee that any movement affecting the preservation of securities is justified by a transaction duly recorded in the owner's account;

• redeliver the securities to the owner upon demand;

• take all steps required to ensure the segregation of assets deposited by clients, those of collective investment schemes for which the firm acts as custodian, and the firm's own assets in the books of central depositories.

Client Money

Provisions relating to the safeguarding and administering of client money may be found in the FFMC and the AMF General Regulations.

Where a firm is a credit institution, the client cash account is treated like any bank account, so that the firm may use the cash for its own account and the client has only a personal claim in restitution.

If the firm is an only an investment firm, under no circumstances may it use cash deposited by clients for its own account, as it does not form part of the firm’s assets.

individual file shall be opened for each client, containing all documentation on the client's identity, agreements signed and other necessary information including data on financial solvency and investment objectives, if applicable to the services supplied. Procedures shall be established to safeguard and permanently update these files.

Clients must be periodically informed of their positions, transactions or balances, in accordance with the criteria established in the Circular 1/1996 from the CNMV. Firms shall send this information directly to their clients, unless a third party is to receive it on behalf of the client.

Firms providing safe custody services to clients must deliver a semi-annual report to the CNMV on such services prepared by an independent expert, the main objective of which is to verify the balances and positions held by their clients.

13.3.5 US

Exchange Act Rule 15c3-3, the Customer Protection Rule, is designed to protect customer funds and securities held by broker-dealers. Under this rule, a broker-dealer must have possession or control of all fully paid or excess margin securities held for the account of customers, and determine daily that it is in compliance with this requirement. The broker-dealer must also make periodic computations to determine how much money it is holding that is either customer money or obtained from the use of customer securities. If this amount exceeds the amount that it is owed by customers or by other broker-dealers relating to customer transactions, the broker-dealer must deposit the excess into a special reserve bank account for the exclusive benefit of customers.

The rule, which can be loosely described as a "segregation" rule, divides the customer and proprietary activities of the firm. The rule protects customer funds, by requiring, in accordance with a prescribed formula, the broker-dealer to deposit into a separate bank account the net amount of funds derived from customer activities. To protect customer securities, the rule requires the broker-dealer to obtain possession or control of securities that the customer has paid for, and prohibits the broker-dealer from pledging them, or otherwise using them in its proprietary business activities.

SEC Rule 15c3-3 is designed:

(i) To insure that customers’ funds held by a broker-dealer (both free credit balances and deposits which may be restricted as to withdrawal) and the cash which is realised through the lending, hypothecation and other permissible uses of customers' securities are deployed in safe areas of the broker-dealer's business related to servicing customers, or to the extent that the funds are not deployed in these limited areas, that they be deposited in a reserve bank account.

(ii) To require a broker-dealer promptly to obtain possession or control of all fully-paid securities and excess margin securities carried by that broker-dealer for the account of customers and to require him to act within designated time frames where possession or control has not been established.

(iii) To accomplish a separation of the brokerage operation of the firm's business from that of its firm activities such as underwriting and trading.

(iv) To require a broker-dealer to maintain up-to-date records, including a daily determination of security locations and periodic computations of the reserve.

(v) To motivate the securities industry to process its securities transactions in a more expeditious manner by penalising a broker-dealer if a security is in a location which the SEC has determined to be unacceptable or has been out of the broker-dealer's possession for too long a period, as for example in transfer.

(vi) To inhibit the unwarranted expansion of a broker-dealer's business through the use of customers' funds by prohibiting the use of those funds except for designated purposes.

All futures commission merchants are required to collect margin for customer accounts in accordance with the rules established by the exchanges on which the contract is traded, even if it is not a member of the exchange.

CFTC Regulation Section 1.20 requires that all customer funds must be separately accounted for and segregated. Any funds accruing to a customer must be treated as belonging to the customer. Thus, a futures commission merchant may not use one customer's funds to purchase margin or settle trades of another person. Customer funds may only be invested in certain specific assets, including commercial paper, obligations of or guaranteed by the United States, general obligations of any United States state, general obligations of a sovereign nation and corporate notes and bonds.

- 158 -

- 159 -

Part B - Equity derivatives law and regulation in the US

Swaps on Equity and Equity Baskets/Indices Broad Based Security Index29 Futures

Narrow Based Security Index30 Futures/Single Stock Futures31

1. Overview

Overall Distinctions Must be individually negotiated by "eligible contract participants" ("ECP")32 and must not be executed on a trading facility

Traded as futures contracts on CFTC33 regulated markets.

Treated as securities and traded on securities and commodities markets; subject to overlapping regulation by SEC34 and CFTC

[CEA35 §§ 2(g)(2) and (3)] [CEA §2(a)(1)(D)]

Selling Entities Only ECPs

[CEA §2(g)(1)]

"Futures Commission Merchants" ("FCM")36 or Introducing Broker ("IB")37

FCM or IB (with notice registration with SEC as a broker dealer ("BD");

Certain natural person CFTC registered floor brokers or floor traders;

29Broad-Based Security Index: Any index of securities that does not meet the legal definition of Narrow-Based Security Index.

30Narrow-Based Security Index: In general, the Commodity Exchange Act defines a narrow-based security index as an index of securities that meets one of the following four requirements (1) it has nine or fewer components; (2) one component comprises more than 30 percent of the index weighting; (3) the five highest weighted components comprise more than 60 percent of the index weighting, or (4) the lowest weighted components comprising in the aggregate 25 percent of the index’s weighting have an aggregate dollar value of average daily volume over a six-month period of less than $50 million ($30 million if there are at least 15 component securities). However, the legal definition in Section 1a(25) of the CEA contains several exceptions to this provision

31Single Stock Future: A futures contract on a single stock. Single stock futures were illegal in the US prior to the passage of the Commodity Futures Modernization Act of 2000.

32Eligible Contract Participant (ECP): an entity, such as a financial institution, insurance company, or commodity pool, that is classified by the CEA as an eligible contract participant based upon its regulated status or amount of assets or any other entity or person so classified by the CEA. This classification permits these persons to engage in transactions (such as trading on a Derivatives Transaction Execution Facility) not generally available to non-eligible contract participants, i.e., retail customers.

33Commodity Futures Trading Commission (CFTC): The Federal regulatory agency established by the Commodity Futures Trading Act of 1974 to administer the Commodity Exchange Act.

34 Securities Exchange Commission

35Commodity Exchange Act: The Commodity Exchange Act, 7 U.S.C. § 1, et seq., provides for the federal regulation of commodity futures and options trading.

- 160 -



BD (with notice filing with CFTC as FCM or IB) if it limits its commodities business to security futures contracts; or

SEC registered floor broker or floor trader if it limits its commodities activities to security futures contracts.

Regulatory framework Not regulated CEA CEA and SEA

Government regulators None CFTC CFTC and SEC

SROs None National Futures Association ("NFA") (for intermediaries) and commodities exchanges (for members),

In commodities market, NFA (for intermediaries) and commodities exchanges (for members)

In securities markets, the National Association of Securities Dealers ("NASD") (for intermediaries) and stock exchanges (for members)

Exchanges None CFTC Designated Contract Market ("DCM")39; or DCM (with notice registration to SEC);

36Futures Commission Merchant (FCM): Individuals, associations, partnerships, corporations, and trusts that solicit or accept orders for the purchase or sale of any commodity for future delivery on or subject to the rules of any exchange and that accept payment from or extend credit to those whose orders are accepted.

37Introducing Broker (IB): A person (other than a person registered as an Associated Person of a Futures Commission Merchant) who is engaged in soliciting or in accepting orders for the purchase or sale of any commodity for future delivery on an exchange who does not accept any money, securities, or property to margin, guarantee, or secure any trades or contracts that result therefrom.

38Securities Exchange Act of 1934

39Designated Contract Market (DCM): A board of trade or exchange designated by the Commodity Futures Trading Commission to trade futures or options under the Commodity Exchange Act. A contract market can allow both institutional and retail participants and can list for trading futures contracts on any commodity, provided that each contract is not readily susceptible to manipulation.

[SEA38 § 15(b)(11)(A), CEA § 4f(a)(2), CEA § 4f(a)(3) and SEA § 15(b)(12) and Security Futures Rule 41.22(d]

- 161 -



CFTC Registered Derivatives Transaction Execution Facility ("DTEF")40

DTEF (with notice registration to SEC);

National Stock Exchange ("NSE") (with notice registration to CFTC)

Alternative Trading System registered with the SEC ("ATS") (with notice registration to CFTC)

[CEA §2(a)(1)(D)(ii)] [CEA §2(a)(1)(D)(ii) and CEA §5f(a)]

2 Licensing Requirements

Licenses necessary to deal in equities derivative contracts

None FCM (as broker, no dealing permitted) BD (as broker)

In what manner can a non-US licensed broker act as broker with respect of US Persons

No restriction Prohibited for US index futures;

Permitted for foreign index futures if (i) CFTC first issues a no-action letter with respect to the index; (ii) and CFTC Part 30 rules exemption requirements are met.

Under Part 30 of the CFTC's regulations, anyone who offers or sells a foreign futures or options contract to a US customer must be registered under the CEA in the appropriate capacity, unless specifically exempted from such registration requirement. Foreign brokers in certain jurisdictions can apply to the National Futures Association (NFA)

Prohibited for US index futures;

No trading in foreign products permitted until the CFTC and the SEC have agreed on joint rules; currently, no such joint rules exist.

May effect a transaction through an SEC registered broker with an SEA Rule 15a-6 exemption (see Section 8.2 of Part A)

40Derivatives Transaction Execution Facility (DTEF): A board of trade that is registered with the CFTC as a DTEF. A DTEF is subject to fewer regulatory requirements than a Contract

Market. To qualify as a DTEF, an exchange can only trade certain commodities (including excluded commodities and other commodities with very high levels of deliverable supply) and generally must exclude retail participants (retail participants may trade on DTEFs through Futures Commission Merchants with adjusted net capital of at least $20 million or registered Commodity Trading Advisors that direct trading for accounts containing total assets of at least $25 million).

- 162 -



to offer foreign futures and options to US customers under a Rule 30.10 exemption.

Regardless of any relief from the registration requirement, all persons are subject to the antifraud provisions of Part 30.9 of the CFTC regulations.

No CFTC restrictions for sale by FCM, IB or Commodities Trading Advisors to customers outside the US.

3. Client Relationships: Retail v. Institutional Clients

No retail permitted An NFA member soliciting an account from an individual is required to collect certain information (e.g. true name, estimated annual income and net worth and an indication of prior futures trading experience) from the customer; [NFA Compliance Rule 2-30(c)];

An NFA member soliciting an account from an individual is required to collect certain information (e.g. true name, estimated annual income and net worth and an indication of prior futures trading experience) from the customer; [NFA Compliance Rule 2-30(c)];

If an NFA member becomes aware of a material change in the financial status of a customer who is an individual, the member is required to update such information and send it to the customer for verification within 15 days; [NFA Compliance Rule 2-30(j)(2)];

NFA member is required to make a reasonable effort to know the current financial status and investment objectives of non-institutional customers; [NFA Compliance Rule 2-30(j)(3)];

4. Conduct of Business Requirements

Advertising: cold calling, use of emails, promotions, communicating with clients

No restriction Under NFA compliance rules, use of promotional material which is likely to deceive the public or contains material misstatements (among other anti-fraud provisions) are prohibited. The NFA compliance director may require a member for a specified period to file copies of all promotional

In addition to the NFA requirements enumerated under the Broad Based Securities Index Futures column, an NFA member registered as Broker Dealers must adhere to additional requirements, including that it shall not use any promotional material that specifically refers to security futures products unless the promotional material (among other requirements): (1)

- 163 -



material. prominently identifies the member; (2) includes the date that the material was first used; (3) provides contact information for obtaining a copy of the disclosure statement for security futures products; (4) states that security futures products are not suitable for all customers; (5) does not include any statement suggesting that security futures positions can be liquidated at any time; and (6) has been submitted to NFA for review and approval at least ten days prior to first use if it reaches or is designed to reach a public audience through mass media (e.g., newspapers, magazines, radio, television, or other electronic media).

(Please see Section 10.1.2 of Part A for NASD and SEC requirements)

Best execution obligations: retail v. institutional requirements

No distinction No distinction SEC staff have asked the NFA to adopt a best execution rule patterned after NASD Rule 2320 requiring a broker-dealer to use reasonable diligence to determine the best inter dealer market to obtain the most favourable price possible for an order under prevailing market conditions. [See Section 4.3 of US Equity Summary for NASD Rule 2320 summary]

Client assets and client money

No restriction except as parties may contract

Under the CEA §4d and Rules 1.20 to 1.25, customer funds and customer securities must be held in segregation by a third party financial institution. A DTEF may authorise FCMs to offer its ECP customers the option to elect to have their funds that are carried by an FCM for purposes of trading on the DTEF not separately accounted for or segregated.

Person who is a full FCM and also a full BD (neither status attained by notice filing) may hold all of a customers security futures products in a futures account or in a securities account or some in a futures account and some in a securities account, and must meet the regulatory regime requirements related to account in which customer funds and customer securities are held.

A person who attains FCM status by notice registration may hold a customer's security futures products only in a securities account and are exempt from the segregation requirements of the CEA.

A person who attains BD status by notice registration may hold a customer's security futures products only in a futures account in accordance with the CEA segregation requirements.

Under SEA Rule 15c3-3, every BD must maintain a specific

[Security Futures Rule 41.41a]

- 164 -



deposit account for customers in a separate account for the exclusive benefit of customers.

Also, BDs are required to promptly obtain and maintain the physical possession and control of all fully paid securities and excess margin securities carried by a BD for the account of customers.

5. Trading in Equities and Equity Derivative Securities

Applicability of :

gaming laws

State gaming and bucket shop laws pre-empted by federal law



contract law Contract laws applicable unless prohibited by regulatory scheme

Contract laws applicable unless prohibited by regulatory scheme

Contract laws applicable unless prohibited by regulatory scheme

Trading of equity derivatives of underlying foreign securities: applicable restrictions

Unrestricted CFTC must first issue a no-action letter with respect to the index;

No sale of foreign products to US persons permitted until the CFTC and the SEC have agreed on joint rules; currently, no such joint rules exist.

Writing self-referenced equity derivatives: applicable restrictions

Anti-fraud and anti-manipulative provisions (including insider trading provisions) of the Securities Act are applicable.

SEA §13 filing requirements (for 5% or greater ownership by insider) and the short-swing profit limitation of SEA §16 applicable.

Not applicable Anti-fraud and anti-manipulative provisions (including insider trading provisions) of the Securities Act are applicable.

For single stock futures, exchanges have position limit rules that may be applicable.

- 165 -



Repurchase transactions: applicable restrictions (Stock Buyback)



Short selling: prohibitions; disclosure; disgorgement

None, but SEA §16 short swing profit rules applicable to insiders.

None None

Minimum ticket size: proposals to make larger or smaller

Trade reporting obligations

None Section 1.55 of the CFTC Regulations prohibit an FCM or IB from opening a commodities futures account for any customer unless the FCM/IB first furnishes the customer with a disclosure statement containing specific language and receives a signed and dated acknowledgement from the customer.

NFA Compliance Rule 2-30 requires that each FCM or IB soliciting a new customer obtain certain information about the customer and provide disclosure of the risk of futures trading at or before the time the customer opens an account.

Each FCM is required to promptly furnish in writing to each customer, as of the close of the last business day of each month or as of any regular monthly date selected, but in any event not less frequently than

Under CFTC Rule 41.41(b) an FCM is required to provide the following information to prospective customers before accepting the first order from such customer: (i) a description of the protection provided under CEA 4d, (ii) a description of the protection provided under SEA Rule 15c3-3, (iii) a statement about whether the customer's security futures product would be held in a futures account or a securities account or whether the customer may make an election and (iv) a statement that if the customer securities futures product is held in a securities account or a futures account, the alternative regulatory scheme is not available to the customer in connection with the account; provided that the information in (ii) and (iv) may be provided no later than 10 business days after a transfer of an account to an FCM.

In addition, certain CFTC's customer reporting requirements will apply to securities futures products transactions and positions in futures accounts but are not applicable to those held in securities

Not applicable

Not applicable Not applicable Not applicable

- 166 -



once every three months, a statement which clearly shows the customer's futures account for the previous month.

accounts.

Section and SEA §17(a) proscribes rules for reporting and recordkeeping for BDs

Clearance/ Settlement

Unrestricted CFTC Derivatives Clearing Organisation ("DCO") Cash settled products cleared by a DCO or an SEC Registered Clearing Agency

Physically settled products cleared by SEC Registered Clearing Agency through a Securities Depository

6. Abusive Trading Practices

Pre-hedging of convertible and exchangeable bond issues; restrictions on "icing" practices

Anti-fraud and anti-manipulative provisions (including insider trading provisions) of the Securities Act and CEA are applicable.

Anti-fraud and anti-manipulative provisions (including insider trading provisions) of the Securities Act and CEA are applicable.

Market practices that would be considered front running

Swaps written in anticipation of an offering

CFTC regulation 155.3 and 155.4 require FCM/IBs to set up and enforce internal rules, procedures and controls to insure, to the extent possible, that firms and their employees do not trade ahead of customer orders that are executable at or near market.

Anti-fraud and anti-manipulative provisions (including insider trading provisions) of the Securities Act and CEA are applicable (e.g. Single-Stock Futures written in anticipation of an offering.)

Insider trading Prohibited Other than trading ahead, the CEA, CFTC regulations and NFA and exchange rules do not generally prohibit trading futures based on material non-public information.

NFA members are required to comply with NFA Compliance Rule 2-37(a) (see summary under "market manipulation activities" below). Insider trading and other forms of trading based on material, non-public information that are violations of SEC Rule 10b-5 would be violations of NFA Compliance Rule 2-37(a).

Not applicable

[Security Futures Rule 41.25(c), SEA§ 17A]

[Section 1.33 of the CFTC

Regulations]

- 167 -



Market manipulation activities

Prohibited Prohibited NFA Compliance Rule 2-37(a) prohibits members who registered as BD solely to effect transactions on securities futures from violating the manipulation of prices and manipulative and deceptive practices provisions of the SEA (SEA §§ 9(a), 9(b) and 10(b) and regulation thereunder).

7. Redress and Investor Protection

Mechanism for customer complaints

None CFTC and NFA customer reparation programs CFTC, NFA and NASD customer reparation programs

Investor protection schemes: NASD rules, mandatory arbitration, active plaintiff's bar

Private lawsuit NFA arbitration / Exchange arbitration, private law suit

NFA arbitration, Exchange arbitration, NASD arbitration

8. Anti-Money Laundering:

Any special requirements for Equity Derivatives?

None Every FCM and IB is required to comply with the Bank Secrecy Act ("BSA") and the regulation promulgated by the Department of Treasury and the implanting regulation jointly promulgated by the CFTC and the Department of the Treasury

BDs, FCM and IB are required to comply with the various governmental agencies and self regulatory organisations (e.g. CFTC, Department of Treasury, SEC, NASD) prescribed regulations and guidance applicable to them

- 168 -

CUSTOMER DEFINITIONS

We have set out below the results of our attempt to obtain a comparison of the different definitions of "customer" used in the UK, Spain, Germany, France and in the US equity market. The methodology employed in order to achieve such comparison was to ask local counsel in each of the relevant jurisdictions to consider a list of customer types and to confirm whether such customers would be classified as retail or institutional customers in their jurisdiction.

As the results reveal, it is currently impossible for an entity active in the UK, Spain, Germany, France and in the US equity market to employ a uniform approach to client classification to determine whether a customer is a retail or institutional customer. Rather, in order to establish whether a customer is a retail or institutional customer in a particular jurisdiction, the entity would ultimately be required to look at the client classification rules specific to that jurisdiction.

SCHEDULE

Preliminary Notes

There is no US securities law or regulation that specifically defines or addresses the majority of the customer types listed in this table or which uniformly addresses whether such persons are classified as retail or institutional investors. Under US securities law, there are various definitions for the term ì customer,î and there is no rigid classificatio n of such persons: (1) retail: typically individuals or entities with a net worth below a certain threshold amount varying based on the context in which the term is employed; or (2) institutional: the term ì qualified investorî was defined in the Gramm Leach Bliley Act ("GLBA") and is codified at Section 3(a)(54) of the Exchange Act to include, among others things, investment companies, banks, small business investment companies, any state-sponsored employee benefit plan, institutional trusts, market intermediaries, and natural persons, corporations, or partnerships that own and invest on a discretionary basis more than $25 million or any government or political subdivision, agency or instrumentality of a government that owns and invests on a discretionary basis more than $50 million. Under several of the GLBAís exceptions for banks from the definitions of ì brokerî and ì dealerî (which are codified, respectively, at Section 3(a)(4) and Section 3(a)(5) of the Exchange Act) securities may only be sold by banks to ì qualified investorsî. Classification as a retail or institutional investor turns on such factors as total assets, or assets under management, the type of entity, and the regulatory context in which the classification is applied.

Under German law, there is no generally applicable client classification regime. In addition, there is little legal and administrative guidance in this regard. Instead, different legal regimes - such as civil law, competition law, the rules of conduct pursuant to the Securities Trading Act, the statutory information requirements concerning financial futures transactions pursuant to section 37d of the Securities Trading Act and the BaFin's administrative practice regarding banking licence requirements for the provision of banking business in Germany on a cross-border basis ñ apply their own client classification standards on a stand-alone basis, i.e. the respective standards are not all uniform. Therefore, the classification of a client in one regime does not anticipate the classification in another regime. As a result, customers should be classified on a case-by-case basis. With respect to banking licence requirements for the provision of banking business in Germany on a cross-border basis, the BaFin has determined the distinction between institutional investors and private persons as follows: institutional investors are (i) the Federal Government, the sixteen German states, local authorities (i.e. cities, municipalities, districts etc.) and their facilities (Einrichtungen, i.e., public institutions, bodies and services), (ii) banks, broker/dealers and investment funds, (iii) private and public German insurance companies and (iv) incorporated companies (i.e., stock corporations (AG), limited liability companies (GmbH) or partnerships limited by shares (KGaA)) which are either of medium size (i.e., they exceed at least two of the three following criteria: (a) a balance sheet amount of Euro 4,015,000, (b) revenues in the last twelve months of Euro 8,030,000 and (c) an average annual number of employees of 50, and do not exceed at least two of the following criteria: (a) a balance sheet amount of Euro 16,060,000, (b) revenues in the last twelve months of Euro 32,120,000, and (c) an average annual number of employees of 250) or of large size (i.e., they exceed at least two of the aforementioned criteria, or they are listed on an organised market as defined in the Securities Trading Act or if an application for listing on such a market has been made. Therefore, natural persons (including high net worth individuals), sole traders, partnerships (other than medium or big KGaAs) and small corporates (i.e., not exceeding at least two of the above-mentioned criteria are not "institutional investors" within the current administrative practice of the BaFin on cross-border licence requirements. However, it is not entirely clear whether this classification can be applied generally or whether it is restricted to the provision of banking business and financial services in Germany on a cross-border basis. German counsel has not (exclusively) applied the BaFin's approach to client classification in the context of cross-border business since this policy is not a general policy applicable in the area of regulatory law. Instead, the BaFin's approach, which is set out above, only refers to client classification in the context of licence requirements (and any relevant exemptions) for the provision of banking business and financial services in Germany on a cross-border basis. Therefore, German counsel has tried to look at all the relevant pieces of legislation on a case-by case basis. Where there are major discrepancies between the BaFin's approach and other pieces of legislation, those discrepancies have been highlighted.

- 169 -

Spanish counsel has only considered client classification distinctions in respect of the public offering of securities in Spain as this is the only area of Spanish law in which there is a general and clear distinction between retail and institutional investors. In other areas of Spanish law, it would be necessary to look at specific legislation on a case-by-case basis to assess the need for making distinctions between customers.

There is no general distinction between retail investors and institutional investors under French law. However, financial institutions do tend to separate their retail business from their institutional business, but this is market practice, not French law. Under French law, one would need to look at every set of regulations (consumer code, public offering rules, canvassing rules, general information duty provided for by case law and the General Regulations of the French financial services regulator (the "AMF"), etc) to assess the need for making distinctions among customers. As a general rule (based both on case law and on conduct of business duties set out in the French Financial and Monetary Code ("FFMC") and the AMF General Regulations), providers of investment services should take account of each potential clientís needs, knowledge and objectives from the very beginning of the relationship and through the performance of the requested service. Case law excludes such "warned investors" from protection. Under the AMF General Regulations, there is a presumption that ì qualified investorsî, some other specified types of institutional investors and professional dealers are warned investors who, therefore, need less protection and attention. Amongst others, the following entities are generally qualified investors: (a) credit institutions and finance companies; (b) the French Treasury and the Bank of France; (c) investment firms; (d) insurance and capitalisation companies, and reinsurance companies; (e) venture capital companies who have opted for qualified investor status; (f) commercial companies governed by the Commercial Code with an audited balance sheet exceeding EUR 150,000,000 who have opted for qualified investor status; (g) entities with securities traded on a regulated market of a State that is a party to the European Economic Area Agreement who have opted for qualified investor status; (h) companies almost entirely owned by one or more of the qualified investors falling into categories (a) to (g) who have opted for qualified investor status; and (i) when acting for the account of a collective investment scheme or one of the above-mentioned entities, the entities falling into one of categories (a) to (d) described above, and portfolio management companies are deemed to be qualified investors. Please also note that there is a client classification in respect of the canvassing of banking or financial services in that the canvassing rules do not apply to contacts made with qualified investors as defined above and with legal entities whose: (a) balance-sheet total exceeds EUR 5 million; or (b) turnover or income exceeds EUR 5 million; or (c) assets managed exceed EUR 5 million; or (d) number of employees exceeds 50 people.

- 170 -

Client Type US Germany Spain France UK

(a) a properly constituted government (including a quasi-governmental body or a government agency) of any country or territory

Probably Institutional

Institutional41 Uncertain42 Probably Institutional Institutional

(b) a central bank or other national monetary authority of any country or territory


Institutional Institutional Probably Institutional Institutional

(c) a supranational whose members are either countries or central banks or national monetary authorities


Institutional Uncertain43 Probably Institutional Institutional

(d) a State investment body, or a body charged with, or intervening in, the management of public debt



41 It is assumed that "quasi-governmental bodies" or "government agencies " qualify as public law entities, i.e. as legal persons whose capacity derives from and is restricted by their statutory constitution. 42 These entities are clearly not retail investors. However, they do not fall within the definition of "institutional investor" (currently contained in article 7.1 a) of Royal Decree 291/92). Nevertheless, in certain

circumstances, the CNMV (the Spanish securities regulator) has treated these investors as "professional investors". The Prospectus Directive is due to be fully implemented shortly in Spain. When full implementation occurs, such entities will fall within the definition of "qualified investor" provided by the Prospectus Directive. In this respect, the current draft Royal Decree implementing the Prospectus Directive in Spain provides the following definition of "qualified investors": (i) legal entities authorised or otherwise permitted to operate in financial markets, including: credit entities, investment service companies, other financial entities authorised or otherwise permitted, insurance companies, collective investment undertakings and their management companies, pension funds and their management companies, commodity dealers, as well as entities not authorised or otherwise regulated whose sole activity is to invest in securities; (ii) national and regional governments, central banks, international and supranational bodies such as the International Monetary Fund, the European Central Bank, the European Investment Bank and other similar international organisations; (iii) other legal entities other than small and medium-sized enterprises; (iv) individuals residing in Spain who have expressly requested that they be considered as qualified investors and who meet at least two of the three conditions below: (a) the investor must have carried out at least ten large volume transactions in the securities markets per quarter, on average, during the four preceding quarters; (b) the volume of the investor's securities portfolio must be greater than EUR 500,000; (c) the investor must be working or have worked for at least one year in the finance sector, in a post which requires knowledge of securities investing; (v) small and medium-sized enterprises, whose registered address is in Spain, that have expressly requested that they be considered as qualified investors. Small and medium-sized enterprises are those which, according to their most recent consolidated accounts (or, if this is not available, according to their latest annual financial statements), meet at least two of the three conditions below: (i) their average number of employees during the entire financial year is less than 250; (ii) their total balance sheet does not exceed EUR 43 million; and (iii) their net annual turnover does not exceed EUR 50 million).

43 See footnote 42. 44 See footnote 42.

- 171 -


(e) a regulated financial services firm, or an overseas regulated financial services institution


Institutional Institutional Probably Institutional Institutional

(f) any associate45 of a regulated financial services firm or of an overseas financial services institution

Probably Retail

Institutional Retail46 Uncertain47 Institutional

(g) a recognised designated investment exchange, regulated market or clearing house



(h) a local authority or public authority Probably Institutional

Institutional49 Uncertain50 Probably Institutional Institutional

(i) a body corporate whose shares have been listed or admitted to trading on any EEA exchange

Probably Institutional51

Institutional52 Retail53 Probably Retail54 Institutional

45 An undertaking in the same group as that person or any other person whose business or domestic relationship with the firm (or its associate) might reasonably be expected to give rise to a commonality of interest

between them. 46 The Prospectus Directive allows Member States to treat certain natural persons as "qualified investors" provided such persons meet certain criteria. Pursuant to the draft Royal Decree implementing the Prospectus

Directive, Spain seems to have chosen to allow certain natural persons to be treated as "qualified investors" if they meet the criteria established for such purposes under the definition of "qualified investors" contained in the current draft Royal Decree implementing the Prospectus Directive in Spain.

47 This does not correspond to any recognised category of investors in France. The situation should be examined on a case-by-case basis. 48 See footnote 42. 49 It is assumed that a "local authority or public authority" is a public law corporation or public law institution as defined in item (a) above. 50 See footnote 42. 51 NASD Rule 2310(c) defines a “non-institutional customer” as “a customer that does not qualify as an ‘institutional account’ under Rule 3110(c)(4).” Rule 3110(c)(4): defines “institutional account” as, among other

things, “any other entity (whether a natural person, corporation, partnership, trust, or otherwise) with total assets of $50M.” Therefore, should this customer-type not have total assets of at least $50M, the entity will not be considered an institutional account for the purposes of NASD Rule 2310(c), although it may be considered an institutional account in another context.

52 It is assumed that the relevant EEA exchange qualifies as an organised market as defined in section 2 (5) of the Securities Trading Act according to which an organised market is a market which is regulated and supervised by state-approved bodies, is held on a regular basis and is directly or indirectly accessible to the public. Organised markets in Member States of the EU or contracting states to the Agreement on the EEA will be considered an organised market for the purposes of the Securities Trading Act.

53 A body corporate is sometimes treated as a professional investor by the CNMV. It may fall within the "qualified investor" concept once the Prospectus Directive is fully implemented in Spain (see definition of "qualified investors" contained in the current draft Royal Decree implementing the Prospectus Directive in Spain).

54 See preliminary notes in respect of France.

- 172 -


(j) a body corporate whose shares have been listed or admitted to trading on the primary board of any IOSCO member country official exchange


Probably Institutional55

Retail56 Probably Retail57 Institutional

(k) a body corporate (including a limited liability partnership) which has (or any of whose holding companies or subsidiaries has) (or has had at any time during the previous two years) called up share capital or net assets of at least £5 million (or its equivalent)

Possibly Institutional/ Retail


55 Provided that a "primary board of any IOSCO member country official exchange" is an organised market as defined in section 2 (5) of the Securities Trading Act, this classification would comply with the BaFin's administrative practice on licence requirements for the provision of banking business in Germany on a cross-border basis (see preliminary notes in respect of Germany above). In any other case, the client would not be deemed as an institutional investor by the BaFin in relation to banking licence requirements. However, depending on the individual circumstances of the case, such client might nonetheless be deemed to be an be deemed as an institutional client meets the requirements under the relevant legal regime. We are not aware that the listing on a "primary board of any IOSCO member country official exchange" is, from a German law perspective, a relevant criterion for the classification of a client. However, we assume that such a listed company would qualify as body corporate as defined in items (k) to (l) below and, accordingly, the principles that apply to those client types would apply.

56 See footnote 53. 57 See preliminary notes in respect of France. 58 We assume that "body corporates" are legal persons (inclusive of partnerships limited by shares (KGaA)). From a German law perspective limited liability partnerships (Partnerschaftsgesellschaften) under the

German Act on Limited Liability Partnerships (Partnerschaftsgesellschaftsgesetz- PartGG) do not qualify as a trading company (Handelsgesellschaft). German limited liability partnerships do not carry on a trade (Gewerbe) due to their members exercising so-called liberal professions (freie Berufe) such as doctors, dentists, lawyers, auditors, certified tax accountants and architects. Unless the PartGG explicitly provides otherwise, the provisions for the civil law partnership (GbR) are applicable to limited liability partnerships. However, the PartGG frequently refers to the provisions concerning commercial partnerships (OHG), and the German limited liability partnership is in many respects similar to the commercial partnership. With respect to the classification of limited liability partnerships, therefore, the principles that apply to partnerships or unincorporated entities set forth in item (o) below apply. With respect to incorporated companies that are not listed on an organised market (see item (i) above), client classification primarily depends on the size of the company. In order to determine whether an incorporated company qualifies as small, medium-sized or large company, the decisive criteria are (i) the balance sheet total (ii) the revenues in the last twelve months and (iii) the average annual number of employees (see preliminary notes in respect of Germany above). The share capital or net assets alone do not suffice to determine the type of the customer.

59 See footnote 53. 60 See preliminary notes in respect of France.

- 173 -


(l) a body corporate (including a limited liability partnership) which has (or any of whose holding companies or subsidiaries has) called up share capital of at least £10 million (or its equivalent)


Institutional Retail61 Probably Retail62 Institutional

(m) a body corporate that meets (or any of whose holding companies or subsidiaries meets) two of the following tests: (i) a balance sheet total of EUR12.5 million (or its equivalent); or (ii) a net turnover of EUR 25 million (or its equivalent); or (iii) an average number of employees during the year of 250



(n) a special purpose vehicle66 Possibly

Institutional/ Retail

Possibly Institutional/ Retail67


(o) a partnership or unincorporated association which has (or has had at any time during the previous two years) net


Possibly Institutional70


61 See footnote 53. 62 See preliminary notes in respect of France. 63 From a German law perspective, the client classification of legal persons belonging to a group depends on the respective legal person's own characteristics. Hence, it is not possible to see through to the balance sheet

amount, revenues and average number of employees of other members of the group. 64 See footnote 53. 65 See preliminary notes in respect of France. 66 i.e. a body corporate, explicitly established for the purpose of securitising assets, whose sole purpose is to carry out one or more of the following functions: (a) issuing instruments; (b) redeeming or terminating or

repurchasing an issue of investments; (c) entering into transactions or terminating transactions involving investments in connection with the issue, redemption, termination or repurchase of investments. 67 With respect to business enterprises, the specific purpose of the enterprise is (generally) not decisive for the enterprise's classification. Where an entity conducts business activities on a commercial basis and with the

intention to make profit (instead of non-commercial entities that act without the intention to make profit), the entity is classified on the basis of general and abstract criteria without taking into account the specific purpose of the company and/or the business transactions in question. Please refer to footnote 2 for the relevant criteria.

68 See footnote 53. 69 See preliminary notes in respect of France.

assets of at least $5 million (or its equivalent)

- 174 -


(p) a partnership or unincorporated association which has net assets of at least £10 million (or its equivalent)




(q) a trustee of a trust (other than a pension scheme) which has (or has had at any time during the previous two years) assets of at least £10 million (or its equivalent)



Uncertain75 Not applicable Institutional

(r) a trustee of an occupational pension scheme where the trust has (or has had at any time during the previous two years) at least 50 members and assets under management of at least £10 million (or its equivalent)


Possibly Institutional/ Retail76

Uncertain77 Not applicable Institutional

(s) collective investment scheme Possibly Institutional/ Retail

Institutional78 Institutional Probably Institutional Institutional

70 It is assumed that "partnerships" or "unincorporated associations" are commercial partnerships (offene Handelsgesellschaften) or limited partnerships (Kommanditgesellschaften) organised under the German Commercial Code (Handelsgesetzbuch).With respect to civil law partnerships (Gesellschaft bürgerlichen Rechts), the client classification depends on individual circumstances, in particular on the purpose of the partnership. Hence, partnerships might qualify as a retail investor (consumer) or as institutional investor (entrepreneur).

71 See footnote 53. 72 See preliminary notes in respect of France. 73 See footnote 53. 74 See preliminary notes in respect of France. 75 The concept of trust/trustee does not exist under Spanish law. 76 The fact that an occupational pension scheme conducts its business in the field of retirement provisions is not relevant for client classification under German law. 77 The concept of trust/trustee does not exist under Spanish law. 78 For the purpose of classifying collective investment schemes, it is assumed that the collective investment scheme in question qualifies as investment fund as defined in section 2 (1) of the German Investment Act

(Investmentgesetz). German investment funds lack legal capacity. Instead, the investment management company acts in its own name for the account of the respective investment fund. The client classification of an investment fund therefore depends on the classification of the investment management company. Under German law, investment management companies within the meaning of section 2 (6) of the Investment Act qualify as institutional investors. Where the collective investment scheme does not qualify as German investment fund as defined above, its classification depends on abstract criteria such as its legal form and its financial figures, please see the preliminary notes in respect of Germany above. The purpose of the collective investment scheme would not be relevant for its classification.

- 175 -


(t) an individual Most Likely Retail79

Retail Retail80 Retail Retail

(u) an overseas individual Most Likely Retail81

Retail Retail82 Retail Retail

(v) an individual with knowledge and understanding of financial markets and financial instruments

Most Likely Retail

Retail Retail83 Probably Institutional Retail

(w) high net worth individual Most Likely Retail84

Retail Retail85 Most Likely Retail Retail

79 Unless such individual has total assets of more than a certain threshold amount, the individual would be deemed retail. A natural person with total assets of at least $50 million is considered an “institutional account” under NASD Rule 3110(c)(4).

80 The Prospectus Directive allows Member States to treat certain natural persons as "qualified investors" provided such persons meet certain criteria. Pursuant to the draft Royal Decree implementing the Prospectus Directive, Spain seems to have chosen to authorise certain natural persons to be treated as "qualified investors" if they meet the criteria established for such purposes (see definition of "qualified investors" contained in the current draft Royal Decree implementing the Prospectus Directive in Spain under (a) above).

81 Unless such individual has total assets of more than a certain threshold amount, the individual would be deemed retail. 82 See footnote 80. 83 See footnote 80. 84 A high net worth individual has various meanings and no single definition applies. A natural person with total assets of at least $50 million is considered an “institutional account” under NASD Rule 3110(c)(4). A high net worth individual is an individual with at least $750,000 managed by an investment adviser, or whose net worth an investment adviser firm reasonably believes exceeds $1,500,000, or who is a “qualified purchaser” as defined in section 2(a)(51)(A) of the Investment Company Act of 1940. The net worth of an individual may include assets held jointly with his or her spouse. The SEC’s Regulation D limits the offer and sale of securities without registration of such activity unless such offer and sale is made to an “accredited investor.” An “accredited investor,” under §501 of Regulation D includes any natural person whose individual net worth, or joint net worth with that person's spouse, at the time of the purchase exceeds $1,000,000 and any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.

85 See footnote 80.

American Bankers Association Securities Association (ABASA) : www.aba.com

Bankers' Association for Finance and Trade (BAFT) : www.baft.org

British Bankers' Association (BBA) : www.bba.org.uk

Futures Industry Association (FIA) : www.futuresindustry.org

Futures and Options Association (FOA) : www.foa.co.uk

Securities Industry Association (SIA) : www.sia.com

Secretariat:

Futures and Options Association

2nd Floor,

36-38 Botolph Lane,

London EC3R 8DE

Tel: +44 (0)207 929 0081

Fax: +44 (0)207 621 0223

www.foa.co.uk

E-mail: [email protected]

Documents

EU-US Coalition on Financial Regulation The Transatlantic ... · Comparative Legal and Regulatory Analysis: ... Trading in equities and equity derivative securities ... France and