Ad-hoc disclosure - A law and economics approach

Outline:

A. Introduction
a. Importance and motivation
b. Outline

B. Role of information in capital markets and price influence
a. Efficient capital market hypothesis
b. Behavioral finance
i. Information traders and noise traders
ii. Publications effects
iii. Ease-of-processing effects
iv. Bounded willpower and emotional influences
v. Halo effect
vi. Conformity effect
c. Random walk hypothesis and technical analysis
d. Empirical pricing process
e. Summary

C. Necessity of rules for ad-hoc disclosure
a. Protection of information as public and collective good
b. Motivation of investor participation
c. Guarantee of information processing
d. Avoidance of future market ignorance
e. Protection of informed investor choices
f. Prevention of agency conflicts
g. Prevention of the destruction of company value
h. Rather insufficient results in efficiency measures
i. Summary

D. Ad-hoc-disclosure
a. German law
i. Object of legal protection of regulations concerning ad-hoc disclosure
1. Efficiency of capital market and price integrity
2. Investors as a group
3. Individual investor
4. Summary
ii. Duty of ad-hoc disclosure
iii. Defective ad-hoc disclosure
iv. Legal protection in criminal liability
v. Legal protection in civil liability
1. Licit plaintiff
2. Defendant
a. Issuer
b. Board
c. Both issuer and board
3. Bases for claims
a. Pre-2002 bases
b. §§ 37b, c German Securities Trading Act (WpHG)
c. § 826 German Civil Code (BGB)
d. Summary
4. Culpability
a. § 37b, c German Securities Trading Act (WpHG)
b. § 826 German Civil Code (BGB)
5. Damage
a. §§ 37b, 37c German Securities Trading Act (WpHG)
b. § 826 German Civil Code (BGB)
6. Loss causation and burden of proof
a. §§ 37b, 37c German Securities Trading Act (WpHG)
b. § 826 German Civil Code (BGB)
c. Facilitation of proof
7. Assertion of rights
8. Statute of limitation and exclusion
9. Summary
b. US law
i. Duty of ad-hoc disclosure
ii. Legal protection in civil liability
1. Licit plaintiff
2. Defendant
3. Basis for claims: Rule 10b-5 Securities Exchange Act
4. Culpability
5. Damage
6. Causation and burden of proof
7. Statute of limitation
8. Assertion of rights
iii. Summary

E. Mathematical determination of damages awarded
a. Rescission
b. Out-of-pocket measure
i. Damage according to German Law
ii. Damage according US Law
iii. Flaws of those methods
iv. Finance-mathematical models of damage computation
1. Damage as price minus true value
a. Fundamental analysis
b. Comparable index approach
c. Event study approach
d. Summary
2. Damage according to the Capital Asset Pricing Model

F. Economic analysis of the duty of disclosure
a. Issuer as cheapest cost avoider
b. Issuer’s self-interest
c. Prevention of detrimental behavior inside the issuer’s company
d. Risk of over-information
e. Risk of liability for advice
f. Negative 3rd-party effects such as free-riders’ gains
g. Summary

G. Economic analysis of liability of board members
a. No duty of disclosure
b. Infringement on the liability system
c. Economic efficiency of enterprise liability
d. Risk of misuse
e. Deterring effect on business decisions
f. Additional cost to the company/all shareholders
g. Preferential treatment of shareholders
h. No additional security for plaintiffs
i. No additional incentive for correct behavior
j. Summary

H. Economic analysis of damage
a. No damage at all
b. Out-of-pocket expense
c. Trivialized damage and shift of the burden of proof
d. Out-of-court settlements
e. Rescission
i. Shift of the risk of investment
ii. Bounded rationality and negative externalities
iii. Over-compensation and over-deterrence
iv. Inequality between shareholders
v. Summary
f. Duty to mitigate damage

I. Economic analysis of the assertion of rights
a. US-law: Class action
b. German Law: Representative Proceedings
c. Summary

J. Conclusion

A. Introduction

a. Importance and motivation

In the late 1990s, a multitude of people grasped the chance to make a quick fortune in speculating at the stock market: enterprises with a new-technology background, i.e. internet services, information and computing technology, boomed, reached positive corporate figures as well as sharp growth rates and went public. Positive publicity about the companies, the expected profit and the business development led to enormously rising share prices. The investor’s eagerness to take part in this rapid wealth accelerated the cycle – more capital, growth, higher profits, rising stock prices. Nevertheless, the greed cycle came to a quick and devastating end when investors discovered that the figures published did not have sufficient or any materialization at all. Share prices collapsed, in some cases to 10% of their original value^[1]. Even worse, investors learned that the positive view on some companies had been provoked by material misstatements and/or omissions of and ad-hoc disclosure. EM.TV, Comroad, Infomatec, Met@box and Biodata were in the news again, but this time it was negative publicity.

Thus, several courts were concerned with claims of deceived investors, and developed rules for the civil liability of both the issuing company and the responsible board members. Furthermore, the legislator enacted in 2002 regulations intended to ameliorate the protection of investors and to ensure the integrity of the capital market by establishing bases for claims for special liability concerning defective or omitted ad-hoc disclosure.

As the phenomenon of intentionally defective ad-hoc disclosure or intentional admission is well-know in the US since the Wall Street crash of 1929, and the principles of legal protection and sanctions have evolved steadily in the course of several cases, US law often served as an example for the newly enacted German law. In the US, the majority of households possess shares, whereas in Germany, a growing, but still meager 16.7% takes part in the stock market^[2]. From this, we must conclude that investor protection does influence investor behavior. If investors are aware of risks and fairly evaluated expected returns, they will be able to make informed decisions, thus ensuring due functionality of the capital market, whereas the falsification or omission of information leads to loss of confidence, ineffective allocation of capital and finally market failure.

Thus, the legislator must thrive to enforce the flow of correct information by on the one hand prescribing regular disclosure for relevant financial data and entrepreneurial information, and by on the other hand sanctioning behavior aimed at blurring information, i.e. withholding or intentionally falsifying it^[3], as only sanctions will provide sufficient incentives to act accordingly. Whereas the principles of regular publicity will not be treated in the following, existing and intended rules and regulation for ad-hoc disclosure will be discussed and analyzed as to whether they provide the intended results.

b. Outline

In its beginning, the paper will sum up the role of information in capital markets and its influence on pricing, whereas the most known concepts, such as Fama’s efficient capital market hypothesis and the principles of behavioral finance will be discussed. After detailing the necessity of rules for ad-hoc disclosure, the paper will lay down the rules for legal protection of investors and the sanctions concerning intentionally defective ad-hoc disclosure, be it misstatements or omissions, according to German and US law. This background being clarified, an economic analysis of the distribution of the duty of disclosure, and the liability of board members follows. Furthermore, the damages and their measures will be analyzed in both the finance-mathematical principles of how to compute the actual amount of damage and the economic efficiency of the damage awarded will be determined. The paper will furthermore evaluate the possibilities for the assertion of rights. At last, the economic analysis will provide arguments for the conclusive judgment of the current legislation and for further legislative proposals.

B. Role of information in capital markets and price influence

Information being the price-governing factor on capital markets, the principles of its distribution and absorption are the key to its efficient functioning. Therefore, any rules and regulations concerned with capital market efficiency should thrive to incorporate the key concepts of capital markets, as “the findings of capital market research have severe implications for a sensible definition of the liability for information”^[4]. Thus, in the following, the most common scholarly concepts are detailed.

a. Efficient capital market hypothesis

The efficient capital market hypothesis, developed by E. Fama in the 1970s, claims that share prices at any time reflect available information^[5], whereas three forms exist: According to the strong form, security prices reflect all information, public or not, whereas the semi-strong form would agree only as to already public news^[6]. The weak form at last claims that share prices only contain past, but not actual and future information^[7].

The information analysis and thus its incorporation in the prices are effectuated by professional traders, who constantly gather information and react on it^[8]. This advantage in information provides them with above-average gains, and those gains, vice versa, provide an incentive for further gathering of information^[9]. Nevertheless, it must be underlined that those above-average gains are not made “at the expense of the general investing public, [but] are incentive and adequate compensation for the effort undertaken in the interest of all market participants”^[10], i.e. correct market prices which reflect the true value of a share with all information incorporated. Due to the work of professional traders, individual investors in small shares can rely on the correctness of prices. They do not need to costly gather information and can be simple “price takers”^[11].

Empirical studies have proven both the content of the efficient capital market hypothesis and the enormously short amount of time (only several minutes) after which a piece of information becomes incorporated^[12]. Nevertheless, the concept has as well been criticized:

At first, we must keep mind the so-called efficient capital market hypothesis paradox: if too many investors believe the share price to incorporate all information available and rely on it, market prices cease to incorporate all information as too few investors gather it, and vice versa. If only few investors rely on price integrity, the efficient capital market hypothesis works, as investors gather avidly information to reach an insider status which allows them to make gains.

Furthermore, the efficient capital market hypothesis is contested by the fact that insider knowledge actually does exist and can be used by some individual to reap extraordinary benefits, whereas according to the efficient capital market hypothesis in its strong version, it must be expected that all information is incorporated in the price. This is even more pertinent as insiders might play with the market mechanism to enhance gains. Thus, we might negate at least the strong form of the efficient capital market hypothesis.

Thus, related to ad-hoc disclosure, the Efficient capital market hypothesis teaches us that sooner (strong form) or later (semi-strong or weak form) the disclosed piece of information will be contained in the stock prices.

b. Behavioral finance

Behavioral finance takes on opposite view on capital markets and claims that “individual psychology affects prices”^[13], whereas the concept is based on the observation that individuals do not “maximize the expected value of a utility function”^[14], but modify such rational considerations with psychological behaviors.

i. Information traders and noise traders

According to the behavioral finance models, share traders are two-fold: information traders “use a […] learning rule to form estimates of returns”^[15], whereas noise traders act without such rules and thus generate errors. Behavioral finance argues that in a market fully composed by information traders, the Efficient capital market hypothesis would be true, while it fails in all other (and thus all real) markets^[16]. Whereas the efficient market possesses a key single driver who would change prices, i.e. new information, an inefficient market where noise traders participate displays a second driver, i.e. behavior, which drives prices away from efficiency^[17].

Thus, “noise traders do not process information rationally”^[18] – a most valuable conclusion. As we must assume that most individual investors are such noise traders due to their lacking experience and lacking means of efficient information processing, we can expect that they will over- or underestimate information given, or mismap probabilities of its occurrence^[19] due to their “particular cognitive errors”^[20]. Those are sustained by so-called “bounded rationality”, i.e. the fact that the human being is only able to absorb a certain amount of information^[21]. Thus, everyone would, if they were given the same piece of information, derive the conclusion which fits with their general assumptions and beliefs derived by recent history^[22] regardless of the content of the information.

ii. Publications effects

Experiments suggest that the form in which information is presented influences investors’ behavior, and thus eventually share prices: performance information “is valued more when it is explicitly recognized, […] and perceptions also depend on how items are grouped”^[23] or whether they are included in the disclosure’s main part or as footmarks only. Thus, we must conclude that the way ad-hoc disclosure is published influences strongly its impact. Empirical evidence suggests that even “irrelevant, redundant or old news affect security prices”^[24] if published in a way which provokes investor’ reactions. Thus, it must be a clear goal of regulation to define the form in which ad-hoc disclosure must be made in order to avoid overreactions by the investing public.

iii. Ease-of-processing effects

We must acknowledge that every individual only possesses “limited attention, memory and processing capacities”^[25] for the evaluation of information given. Thus, an overflow of information would “trigger associations that influence judgments”^[26] – exactly what happened in ad-hoc disclosure. Several pieces of positive news, be it of the same or related issuers, caused investors to judge the market segment or the issuer as a whole (although this was not inferred by the individual ad-hoc disclosures) – and this judgment was, necessarily, wrong, as it was based on faulty assumptions. Such a process is heavily supported by “salience and availability effects”^[27], i.e. the fact that ad-hoc information differs heavily from formerly know information and contains events of the normal course of business, which are recalled more easily.

The most severe influence, nevertheless, is the so-called “illusion of the truth”^[28]: people will infer the truth of a statement if it is easy to process. As the ease of processing is a prescription for ad-hoc disclosure^[29], investors will infer truth for each and every disclosure and not spend the necessary critical attention to determine whether it indeed is. This is reinforced by the phenomena of “cue competition”^[30], which describes the fact that salient cues weaken the effect of less salient ones, and of confirmatory bias, which means that “people are often too inattentive to new information contradicting their hypotheses”^[31], or even misread adverse evidence as support for their initial hypothesis. Thus, although defective ad-hoc disclosure has been corrected, its effect might remain, as investors continue to trust in it.

iv. Bounded willpower and emotional influences

Both concepts offer an explanation for the mass reactions to news: people tend to conclude “that the probability of an event […] is greater if they have recently witnessed an occurrence of the event”^[32] – if, then, a sufficient amount of investors would have reaped benefits while investing in share x, they themselves would believe in its profitability regardless of contradicting signs. Such a structure will be nourished by “bounded willpower”^[33], i.e. the fact that people do for short-term well-being even things which are in conflict with their long-term aims. Applied to the share market, this means: even if investors know that they run a higher risk to their long-term goal of financial security, they will engage in actions which provide them with short-term gains, e.g. risky investments. This might be reinforced by fact that portfolio considerations are subject not only to rationale, but as well to “emotions that can overpower reason”^[34], which trigger mentally uncontrollable mechanisms. Thus, greed or the necessity to earn money quickly may limit investors’ rationality.

v. Halo effect

Another effect pertinent to our discussion is the so-called halo-effect, which would transfer one outstanding characteristic of a person or thing to all other characteristics to be considered^[35]. This excessive optimism often deludes people in expecting more favorable outcomes. Thus, investors might be wrongly informed about one characteristic influencing the share price, say current revenue, but their final evaluation is due to the fact that they transfer this favorable evaluation to risk, capital structure and general business forecast. Thus, it would not (or, at least not only) be the defective information which drives stock prices, but the investors’ behavior upon it.

vi. Conformity effect

One of the most acknowledged theories of behavioral finance is the conformity effect, which states that “people tend to conform with the judgments and behaviors of others”^[36]. Thus, if a sufficient number of people believes in the truth of a concrete share pricing of the market, the others will concur whether the first group’s evaluation is rational or not. “People reciprocate [a displayed opinion], they don’t counteract [it]”^[37]. Such effects are enhanced by the fact that during communication, people would “sharpen and level”^[38], i.e. emphasize the main point and forget to mention details which might confuse it, or oversimplify the information given. The resulting phenomenon is based on her mentality or momentum/positive feedback-trading^[39]. Applied to ad-hoc disclosure, this means that the multitude of investors did, in fact, not rely on the actual disclosure, but on the disclosure’s evaluation by other people.

c. Random walk hypothesis and technical analysis

The random walk hypothesis, at last, claims that the share price will alternate around the intrinsic value of the issuing company^[40], and that those adjustments are not influenced by changes in the intrinsic value, but entirely random. These cycles being well researched, an analyst familiar with the technique could predict whether the prices would fall or rise according to know price change patterns.

The technical analysis, at last, assumes that not only the issuers situation, but as well the general economic performance, political events and psychological facts influence share prices. As those are not quantifiable^[41], technical analysis analyses past performance of a share and forecasts from those data future performance^[42].

Thus, one would have to conclude that information (which normally indicates the positive or negative development of the intrinsic value) does not have any influence on share prices.

d. Empirical pricing process

According to financial research, on the publication of either positive or negative news, stock prices will react instant and incorporate this new piece of information into the value of the stock, which is reflected by its price. The mechanism is simple: after the disclosure of positive news, professional traders will consider those and give their bids, i.e. estimate how much more value the event published added to the share. The law of supply (shares on the market) and demand (investors’ bids) will then incorporate the investors’ estimate into the share price^[43]. The same must be acknowledged for negative news, or a correction of positive news: investors will consider the negative value, and thus some of them will decide for a sale of their shares. Thus, more shares will be offered on the market – the price drops^[44].

Even if no information is published to the broad majority of investors, share prices will react to new information available due to insider trading and information-oriented technical trading: it is a widely acknowledged fact that for each and every share issuance, some insiders exist. Thus, they will use their advantage in information and either buy or sell (or even short sell) their shares, which will adapt the price to its fair value^[45]. To maximize gains, they will do this slowly and in several bunches, as this stealth trading secures them a sustainable advantage over regular traders^[46]. This slow incorporation of information into the share price is reinforced and accelerated by the technical trading: specialized traders will analyze the market and conclude from their observations about insiders’ expectation about its development. Thus, they can take part in the expected insider gains without knowledge of the concrete information, and will force shares to react in the same direction as insider trading would.

e. Summary

This chapter laid the foundation for the economic understanding of capital market functioning: whereas the efficient capital market hypothesis stated that changes in information would change prices. The behavioral finance model, on the contrary, claims that only psychological perceptions would have price effects: either investors would judge information differently, or they would judge rather the form than the content. The existence and success of technical analysis, which is the application of the random walk hypothesis, leads to a similar conclusion: ad-hoc disclosure would be judged as superfluous, as prices would not be influenced by reactions on information, but by other, mostly emotional behavioral patterns.

Nevertheless, we must acknowledge that even if those theories are somewhat valid, they have not led to any model which would explain the process of information incorporation in a share price, or the effects of professional information gathering. Even more, empirical research proves the strong correlation of new information and its procession on share prices. Thus, the alternative theory may be taken into account, but must be judged as “less plausible”^[47] in comparison to the efficient capital market hypothesis when analyzing information on capital markets.

C. Necessity of rules for ad-hoc disclosure

For an efficient capital market, it is crucial that the market value reflects the true value of a paper, as only in this case investors can safely rely on the correctness of the market prices, and will endow the market with the necessary capital. Thus, correspondence of intrinsic asset value and market price must be the aim of all regulation, whereas the legislator must ensure price incorporation of two-fold information: Whereas current disclosure, i.e. the communication of balances, profit/loss accounts and similar data provides only basic information about a company, ad-hoc disclosure completes the picture in publishing additional information in a timely fashion. As current disclosure regulation must be viewed as sufficient, the paper will concentrate on the ad-hoc information.

As it can be assumed that such information will not be given voluntarily, and even that there are incentives for material misstatements and intentional omissions to pursue differing private or corporate goals, the legislator will have to consider the following factors as key determinants of successful legislation:

a. Protection of information as public and collective good

To start with, information, furthermore, must be viewed as a public good^[48]: everyone can take part in it without additional cost to himself or the community. Thus, information asymmetries and especially its use for personal enrichment are perceived as “the ultimate manifestations of greed and dishonesty”^[49]: information which could have been shared by all and led to a small profit (or the avoidance of a small loss) to all community members was exploited to reap an abnormal gain. If, then, the legislator wants to make sure that information really stays a public good, i.e. to avoid “monopolizing or withholding information”^[50], it has to make sure that all once private information is spread – the aim of rules for ad-hoc disclosure.

Closely linked to that is the fact that information is collective: it is non-exclusive, which means that there is no way of permitting access for some and excluding others^[51]. Thus, the reverse form of the tragedy of the commons takes place: “when a common obligation to provide a resource is shared, there is an incentive to under-produce”^[52]: as all issuers perceive that so much information about other companies and theirs is available, they feel not compelled to issue any information at all, even more so as this incurs costs to create and distribute this information. Although a distribution of information might bear advantages in terms of competitiveness^[53], the cost-saving behavior is stronger and finally results in market failure. So, to ensure that issuers publish, the legislator must set an incentive (i.e. a duty to do so and a sanction if it is not observed).

b. Motivation of investor participation

Furthermore, the perception of potential investors must be taken into account. Due to extensive media coverage, they are well aware of many cases in which information was abused either for insider trading (by not publishing it) or for misleading investors (by publishing untrue facts). They as well know that liability, in the absence of legal regulation, will have to be established in a difficult and often not successful application of general norms. Thus, investors will restrain from investing, as “participation is perceived as too risky under capriciously developed rules”^[54].

If the legislator establishes clear rules for the publishing of information and for sanctions in case of non-observation, investors share a “consensus that financial markets are worthy of private investment”^[55].

Furthermore, the more information available, the more liquid a capital market is^[56], which can be explained by the increased willingness of investors to participate and to endow their money into the capital market. Increased participation, on the other hand, leads to cheaper cost of capital. Thus, if the legislator wants to secure that the private economy has access to capital, and this in a sufficient amount at a cheap premium, it proves advantageous to secure the flow of information^[57].

c. Guarantee of information processing

Furthermore, it must be considered that in case of no regulation, professional market analysts would disappear as “insiders would consistently beat market analysts”^[58] due to superior knowledge, thus not leaving them sufficient profit to assume the work of information processing. But, overall, the analysts’ work assumed to gain personal profits produces positive externalities such as variable information sources and the divergence of opinions, which evens out possible misjudgments. Therefore, the analysts’ work profits the capital market by ensuring price correctness and informed investors, whereas those externalities would be completely lost if analysts left the market.

This would be reinforced by the fact that insiders would possess and store information over time and use it in the moment it is most valuable^[59]. Whereas finally, market efficiency would be reached by insiders acting upon information and technical traders reinforcing this trend, a major time span might have elapsed in which the share price was in-/deflated due to the non-incorporation of the insider information.

d. Avoidance of future market ignorance

A forecasting experiment showed that “the market may respond to a firm’s [long-term] misleading signals by ignoring its future communications”^[60], as the first information is too strongly believed to allow for corrections. Thus, if the legislator wants to make sure that the evaluation of a company reflects its true (but continually changing) value, it must avoid that investors rely to strongly on old information, e.g. in yearly current disclosure, which is best be done by prescribing a constant flow of new (and correct) information – ad-hoc disclosure.

e. Protection of informed investor choices

A further point to consider is that only few investors are intimate with the core activities of the businesses they invest in. Whereas current disclosure only conveys an idea of the financial performance of the company, ad-hoc disclosure links current (and often macroeconomic) events with the company’s development and thus gives investors a reasonable fact basis to evaluate the future success of their investment. This is especially pertinent for companies dealing with “new products or services, new markets or new methods for purchasing, production or distribution”^[61]: those companies are innovative and thrive after quick growth in market segments, but share as well risks such as minor equity and reserves.

Despite their ignorance of core fields, shareholders “must make decisions for the corporation”^[62] e.g. in annual meetings, and then face a collective action problem: to decide, they must collect and analyze information – but together. Nevertheless, everyone wants other shareholders to assume this timely and costly duty, so the tragedy of the commons arises: no one does the job; decisions will be made upon opinions and feelings rather than on sound information^[63]. If this is to be avoided, investors must be given updated information about company development (e.g. important sales contracts) as soon and as often as possible to have a solid basis for their decisions without having to gather the information themselves.

f. Prevention of agency conflicts

Agency theory claims that, every time an agent acts, he not only does this in the interests of his principal, but as well in his own interests^[64]. Conferred to the corporate situation, this means that the board would not (only) publish for the shareholders’ and potential investors’ sake, but as well to communicate their successes and to gain fame and further influence. Thus, there is a strong incentive to publish or overstate favorable results or business developments, and to suppress negative ones.

Furthermore, management might not only thrive for fame and recognition, but as well pursue own financial interests, as most board salaries contain stock option plans and a rising share price or the prevention of its fall adds value to the board members’ private fortune. This is especially pertinent as management possesses far more information than normal investors would^[65]. Thus, such information can be used to reap above-average gains on the stock market in insider trading, which must not only be avoided for reasons of justice and equality between investors, but as well to safeguard a company’s name and recognition and to secure its future capital equipment by the capital market and trusting investors. If then, there are rules for the instant disclosure of such facts, they can no longer be abused. Thus, “ad-hoc publicity is the flipside of insider law”^[66] and a means to prevent fraudulent activities on the side of management^[67].

g. Prevention of the destruction of company value

Furthermore, it must be considered that non-disclosure also damages the issuer itself: people who come in contact with potential insider information such as R&D results, trade secrets, intellectual property and sensitive negotiations will use the information in a way that maximizes their gains. Nevertheless, the untimely “disclosure” to the outside destroys its worth for the company, and the withholding within the firm “prevents valuable information from reaching the management in a timely fashion”^[68].

If a duty of disclosure exists, management can hold employees accountable for publishing the information to them as part of their job requirement, and then publish to outsiders. Thus, ad-hoc disclosure by an early publishing of information prevents that insider knowledge can be used to destroy company value. Thus, by establishing such rules, the legislator also protects companies of the actions of their employees.

h. Rather insufficient results in efficiency measures

All theory put aside, many empirical studies determined the actual information efficiency of stock markets.

As to Germany, a most recent survey among professional traders concluded that, on the one hand, only 23% of share prices differ systematically from their true value, whereas 66% differ from time to time and 10% of shares continually reflect the true value^[69]. This indicates that at least the semi-strong form of the Efficient capital market hypothesis is realized at the German capital market, and that the flow of information is sufficient. On the other hand, the surveyed traders concurred that the situation had sharply improved – a sign that the regulation for ad-hoc disclosure, which had been enacted in 2002, was the right approach^[70].

According to a recent research done by Solomon, the DAX’s displays an overall efficiency of 19.50%. A 2002 study ranks the Frankfurt Stock Exchange as the 13th of the efficient markets – thus far behind^[71].

The US market, on the other hand, is far more efficient, as it has been proven that it realizes the strong form of the Efficient capital market hypothesis^[72] which means is incorporates all information at least with a certain high probability^[73]. Thus, according to Solomon’s measure, the S&P 500 would have an overall efficiency of 23.97%, the Dow Jones of 20.00%. The ranking of 2002 provides the New York Stock exchange with the pole position on efficiency^[74].

As the rules for current disclosure are not equal, but at least comparable in the two countries^[75], the findings suggest that the well-established rules for ad-hoc disclosure enhanced information efficiency in the US stock market, and that the path of the German legislator was the right approach and should be continued.

i. Summary

Shavell states that three factors will influence the necessity of disclosure rules: whether buyer or seller possesses information, whether incentives to acquire information would be undesirably reduced, and whether information is socially valuable or merely has private value^[76].

This is applicable on the stock market: there is a strong information asymmetry between buyer and seller, and the incentive to acquire information must be reduced to a minimum to achieve the socially desirable state for reasons of bounded rationality of investors. At last, the information concerned is of social value, as its incorporation in share prices secures the efficiency of the stock market.

Thus, it is the legislator’s duty to provide “disclosure obligations [as] transmission of information that otherwise would not have been forthcoming”^[77] and ensure the flow of “comprehensive and reliable information about the share itself and its issuer”^[78] to protect information as a public good, ensure investor participation and market liquidity as well as informed investor choices. Recent research provides evidence that the US regulation has been very successful in this regard, and that the German path is the right way.

D. Ad-hoc-disclosure

Ad-hoc disclosure is the publishing of both positive and negative information concerning a stock-listed company. Similar to current disclosure, it is aimed at providing insight into the company’s business standing, financials or performance, but consists of limited and often unlinked pieces of information, which often concerns day-to-day events. In the following, the principles governing the legal duty of ad-hoc disclosure and the consequences of its lesion will be detailed for both German and US law.

a. German law

i. Object of legal protection of regulations concerning ad-hoc disclosure

Before detailing norms concerned of ad-hoc disclosure, it is crucial to understand why ad-hoc disclosure is subject of regulation. Thus, it must be considered why the intended object of legal protection.

1. Efficiency of capital market and price integrity

The efficiency of capital markets is crucial to the well-being of society: for the economy, capital markets provide means to finance various investments^[79], and to integrate stakeholders into their specific company. For citizens, capital markets offer the multiplication of their available funds and are used to amass private funds for retirement^[80]. Thus, the capital market serves “to transform the savings of households […] into the capital share issuers need for investments”^[81].

Thus, one of the legislator’s concerns is to safeguard the capital market’s ability to guarantee the fulfillment of the participants’ expectations, i.e. price integrity and thus allocative efficiency: funds should be spread to the debtors who can guarantee the highest return while developing only a reasonable risk^[82]. Being the very principle of a free market economy^[83], the vast majority of scholars names the efficiency of the capital market as the primary concern of capital market law^[84] in general, and as a consequence as well for ad-hoc disclosure.

2. Investors as a group

Whereas efficiency of the capital market and price integrity have always been in the focus of capital market law, only in modern times protection of investors was named as a possible object of legal protection^[85]. Contrary to the protection of the individual investor, which will be discussed below, this means primarily protection of all current and potential participants in the capital market^[86]. Especially the latter investors are crucial, as their willingness to invest provides liquidity and thus secures the functioning of the capital market as a whole^[87].

Consequently, to guarantee the functioning of the capital market, the legislator will have to establish a certain protection to this pool of investors, so that they will consider adding their funds. It will also thrive to establish reasonable barriers to their exploitation in the course of their involvement in the capital market, as the majority of investors would be citizens.

3. Individual investor

Nevertheless, protection of investors not only means the general investing public, but as well the individual person who relies on the capital market for the creation of private wealth. Thus, the individual investor can be named a suitable object of legal protection, whose safeguarded interest is two-fold: on the one hand, this will be due information, on the other hand, his freedom of choice to in- or divest.

To start with, it is a reasonable expectation that an investor would confide in the correctness of all information available. Due to fact that legal provisions for disclosure exist, the investor expects these information to be correct and to be incorporated in the market price of share, which enables him to make rational investment or divestment decisions^[88]. If, then, information is incorrect, protection of the individual investor would entrain regulations for how to prevent and sanction such defective information.

Furthermore, some scholars claim that the investor’s choice must – additionally to his expectation of correct information – be protected^[89]. He should be free to in-/divest in any share or security without being misled by wrong information. Nevertheless, this opinion is as well vividly criticized: as shown above, behavioral finance teaches investors’ choices do not only depend on information, but as well and even in a high degree on speculation, irrational expectation and peer group pressure^[90].

[...]

---

^[1] Möllers et al., Haftung von Vorständen, p.1648.

^[2] DAI-Factbook, chapter 06.3

^[3] Hopt et al., Prospekt- und Kapitalmarktinformationshaftung, Vorwort p.1.

^[4] Sauer, Kausalität und Schaden, p.27.

^[5] Sauer, Kausalität und Schaden, p.26.

^[6] Swan, Insider Trading, p.74; Escher-Weingart et al., Schadensberechnung, p. 1850.

^[7] Feldhaus, Kursbeeinflussung, p.107, Perridon et al., p.272.

^[8] Gutzy, Ad-hoc Dienstleister, p.9.

^[9] Sauer, Kausalität und Schaden, p.26.

^[10] Sauer, Kausalität und Schaden, p.26.

^[11] Sauer, Kausalität und Schaden, p.26.

^[12] Sauer, Kausalität und Schaden, p.26.

^[13] Hirshleifer, Investor Psychology, p.1533.

^[14] Rabin, Psychology and Economics, p.11.

^[15] Shefrin et al., Behavioral CAP Theory, p.323.

^[16] Shefrin et al., Behavioral CAP Theory, p.323.

^[17] Shefrin et al., Behavioral CAP Theory, p.327.

^[18] Shefrin et al., Behavioral CAP Theory, p.330.

^[19] Shefrin et al., Behavioral CAP Theory, p.331.

^[20] Shefrin et al., Behavioral CAP Theory, p.330.

^[21] Jolls et al., Behavioral approach, p.1477.

^[22] Shefrin et al., Behavioral CAP Theory, p.337.

^[23] Daniel, Investor Psychology, p.169; Schuster, Nachrichtenereignisse, p.16.

^[24] Daniel, Investor Psychology, p.169.

^[25] Hirshleifer, Investor Psychology, p.1541.

^[26] Hirshleifer, Investor Psychology, p.1541.

^[27] Hirshleifer, Investor Psychology, p.1542.

^[28] Hirshleifer, Investor Psychology, p.1542.

^[29] see below

^[30] Hirshleifer, Investor Psychology, p.1543; Rabin, Psychology and Economics, p.30.

^[31] Rabin, Psychology and Economics, p.26.

^[32] Jolls et al., Behavioral approach, p.1477.

^[33] Jolls et al., Behavioral approach, p.1479; Rabin, Psychology and Economics, p.34.

^[34] Hirshleifer, Investor Psychology, p.1540.

^[35] Hirshleifer, Investor Psychology, p.1542.

^[36] Hirshleifer, Investor Psychology, p.1543.

^[37] Rabin, Psychology and Economics, p.21.

^[38] Hirshleifer, Investor Psychology, p.1562.

^[39] Rabin, Psychology and Economics, p.12.

^[40] Feldhaus, Kursbeeinflussung, p.116.

^[41] Perridon et al., Finanzwirtschaft, p.209.

^[42] Feldhaus, Kursbeeinflussung, p.117.

^[43] Möllers et al., Ad-Hoc-Publizität, p.46.

^[44] Goshen, Insider Trading, p.1239.

^[45] Klöhn, Problem Schadensberechnung, p.729.

^[46] Klöhn, Problem Schadensberechnung, p.729.

^[47] Sauer, Kausalität und Schaden, p.26.

^[48] Krawiec, Fairness, Efficiency and Insider Trading, p.447.

^[49] Krawiec, Fairness, Efficiency and Insider Trading, p.445.

^[50] Krawiec, Fairness, Efficiency and Insider Trading, p.453.

^[51] Krawiec, Fairness, Efficiency and Insider Trading, p.454.

^[52] Krawiec, Fairness, Efficiency and Insider Trading, p.455.

^[53] Posner, Economic Analysis, p.457.

^[54] Salbu, Insider Trading, p.855.

^[55] Salbu, Insider Trading, p.864.; Salbu, Tipper Credibility, p.328.

^[56] Verecchia, Disclosure and Cost of Capital, p. 276.

^[57] Verecchia, Disclosure and Cost of Capital, p. 276.

^[58] Goshen, Insider Trading, p.1234.

^[59] Goshen, Insider Trading, p.1234, 1260.

^[60] Stocken, Credibility, p.360.

^[61] Möllers et al., Haftung von Vorständen, p.1651.

^[62] Georgakopoulos, Disclosure Rules, p.419.

^[63] Georgakopoulos, Disclosure Rules, p.419.

^[64] Jolls et al., Behavioral approach, p.1495.

^[65] Salbu, Tipper Credibility, p.326.

^[66] Möllers, Progress of German Information Disclosure, p.283; Möllers et al., Ad-Hoc-Publizität, p.74.

^[67] Georgakopoulos, Disclosure Rules, p.418.

^[68] Goshen, Insider Trading, p.1256.

^[69] Meitner, Informationseffizienz, p.3.

^[70] Meitner, Informationseffizienz, p.3.

^[71] Aitken, Ranking World Equity Markets, p.9.

^[72] Ko et al., Daily behaviour of stock returns, p.231.

^[73] For the Dow Jones, this probability would be 59.05%, whereas the S&P 500 displays 80.68%. Cf. Solomon, Efficient Markets, p.3.

^[74] Aitken, Ranking World Equity Markets, p.9.

^[75] The US rules of current disclosure must be judged as stricter.

^[76] Shavell, Foundations of Economic Analysis, p. 333 et seq.

^[77] Shavell, Foundations of Economic Analysis, p. 331.

^[78] Hopt et al., Prospekt- und Kapitalmarktinformationshaftung, p.108.

^[79] Kümpel, Kapitalmarktrecht, p.31.

^[80] Kümpel, Kapitalmarktrecht, p.31.

^[81] Kümpel, Kapitalmarktrecht, p.41.

^[82] Kümpel, Kapitalmarktrecht, p.42.

^[83] Kümpel, Kapitalmarktrecht, p.42.

^[84] Kümpel, Kapitalmarktrecht, p.30.

^[85] Kümpel, Kapitalmarktrecht, p.42.

^[86] Kümpel, Kapitalmarktrecht, p.43.

^[87] Kümpel, Kapitalmarktrecht, p.43.

^[88] Hopt et al., Prospekt- und Kapitalmarktinformationshaftung, p.3.

^[89] Fleischer, Inhalt Schadensersatzanspruch, p. 1869; Fuchs et al., Deliktische Schadensersatzhaftung, p.1063

^[90] Hopt et al., Prospekt- und Kapitalmarktinformationshaftung, p.3.