The Enforcement Regime of the UK Financial Services Authority — Who’s Next?

December 6, 2011

Overview — It’s not just a numbers game …

Since overhauling its financial penalty framework in March 2010, the UK Financial Services Authority (FSA) has gone a long way to dispel views that it has a lacklustre approach towards levying market abuse fines.  However, harsher fines are just one feature of its tougher enforcement regime.  Recent cases show that the FSA has generally stepped up its enforcement activity, improving the range of resources and evidence available to successfully investigate market abuse.  This will particularly be the case due to the introduction of the Zen monitoring system and requirement for firms to tap employee mobile phones. 

Ready to take on the "tricky" cases

The regulator has also shown increased willingness to expunge novel/unusual forms of  market abuse involving both non-equity securities, and instruments that do not in themselves fall squarely within the ambit of the Financial Services and Markets Act 2000 (the "Act").  The FSA has also levied fines in respect of individuals that live abroad, yet engage in abusive transactions in UK markets.  Although in general, the harshest hitting penalties have been issued to high profile individuals, or those involved in very serious cases of market abuse, recent enforcement action has signalled that the FSA has the potential also to come down on firms that do not take appropriate steps to supervise and manage market abusers.  It remains to be seen whether this tougher enforcement regime will transfer to the FSA successor agencies once the regulator is abolished. 

This alert looks at a few examples of FSA enforcement action in 2011 in the market abuse area and considers how this heralds a more robust enforcement regime.  

Lacklustre No More

Record Fines: In our Client Update of 1 April 2010[1], we evaluated the FSA’s tougher financial penalty framework, which now allows it to impose harsher fines on market abusers in a more credible manner consistent with the stated goals of deterrence, discipline and disgorgement.  The full effects of this framework can now be seen, with there being a step change in the frequency and level of fines handed down to market abusers[2].  For instance, a record fine of £6,108,707 (after discount) was imposed on an individual investor based in Dubai, Rameshkumar Goenka, being twice the size of the previous record fine handed down to an individual[3].  Whilst this was a landmark fine, this case has also gone some way to dispel a long standing urban myth that the FSA is not as robust when penalising individuals engaged in market abuse involving non-equity instruments. 

Remember the net spreads to non-equity instruments: Goenka was found to have manipulated the closing price of global depositary receipts ("GDRs") in Indian company, Reliance Industries Limited ("Reliance"), seconds before the closing bell.  This was in order to avoid a loss that he would have otherwise suffered under a structure product that was linked to the price of Reliance GDRs.  In addition to fining Goenka, the FSA required him to pay restitution of US$3,103,640 to the counterparty to the structured product.  Whilst there were aggravating factors contributing to the level of fine[4], it shows that severe fines will be levied regardless of whether the securities are debt or equity.  An individual, Michiel Visser was also fined £2,000,000[5] for engaging in market manipulation in relation to PLUS securities for the purpose of inflating the net asset value of a fund.  These sizeable fines followed hot on the heels of a £1,094,900 fine (after discount) imposed on Samuel Khan earlier this year for market manipulation.  Goenka, and to a lesser extent Visser, demonstrate that the FSA is equally committed to investigating and levying fines in respect of individuals that live and work abroad, yet commit market abuse on UK markets[6].

"But … I did not deal!": The FSA has been particularly committed towards cracking down on insider dealing/disclosure, which former FSA enforcement director, Margaret Cole has termed the FSA’s "specialist remit"[7] — a reminder that the scope of the offence goes well beyond pure dealing activities but also covers improper disclosures.  This area has seen stringent fines being levied against market abusers, as was seen in the cases of Perry Bliss and William Coppin, both employees of the same firm.  The pair was found to have disclosed inside information, and received prohibition orders and fines of £30,000 (after discount) and £70,000 respectively.  These fines are particularly large, despite the fact that Bliss and Coppin only disclosed inside information to their customers, and did not themselves deal in the securities.  While the FSA accepted that the pair worked for a firm that had a poor regulatory and compliance culture, which encouraged aggressive sales tactics at any cost, it nonetheless took the view that the disclosures allowed the pair to benefit from sales commission, and demonstrated that they were unfit to perform any controlled functions.

Keeping it in the family: Conversely, in another father-son insider dealing case (see the case of the Uberois, Client Update 1 April 2010), Jeff Burley, a 73 year old pensioner, was fined £35,000 after discount for insider dealing.  He received inside information from his son Jeremy Burley, in respect of a Ugandan company.  Jeremy directed his father to telephone his broker to instruct the broker to dispose of Jeremy’s shares in the company.  Jeremy was fined £144,200.  Notably, Jeff’s fine was considerably large, despite the fact that the FSA acknowledged that the dealing was instigated by his son, and did not result in any financial benefit for Jeff. 

A Novel Analysis

Bring it on …: Recent enforcement cases have also demonstrated that the FSA is both able and willing to successfully investigate more novel and complicated forms of market abuse, even if this means interpreting the Act widely. The confidence of the FSA to take on these trickier cases is seen by some as the benefits of its recent investment in human capital — senior recruits from industry with greater and sophisticated market experience.

"Layering": This was seen in the case of Swift Trade Inc., a firm that directed its traders to carry out a form of market abuse known as "layering".  Traders placed large block synthetic orders of stocks in the LSE order book, creating a false impression of liquidity.  The traders would then quickly withdraw their block orders, and make a real trade once the price had moved to their advantage.  This was the first successful case involving this type of activity; however, it was particularly interesting as Swift’s traders were actually placing orders in respect of swaps and contracts for difference.  While the FSA acknowledged that these instruments are not "qualifying investments" for the purposes of the market abuse provisions in the Act, the regulator was of the opinion that they were related to underlying qualifying investments (i.e. shares) and therefore fell within the terms of the Act.  As a result, Swift Trade was fined £8,000,000. 

Hedge Funds and "unusual" practices: Similarly, the above cases of Swiss Trade, Goenka, Khan and Visser could be seen as indicators that the FSA is widening the scope for penalising individuals for market abuse further still.  In these cases, the FSA acknowledged that whilst banks often hedge their positions in various ways, these individuals were engaged in "unusual" transactions that were "not in conformity with accepted market practice".  It remains to be seen whether this will narrow the scope for traders and other market participants to engage in novel forms of hedging and other trading techniques, without running the risk of being found to have committed market manipulation.

Smart and reasonable regulation: Nonetheless, despite this willingness to tackle novel and complicated forms of market abuse, the FSA has generally taken a fairly measured approach to choosing the appropriate battles to fight — a shift from its initial approach when it started its "let’s get tough" approach to enforcement which saw a number of "easy wins" for the FSA. Generally, it has been initiating the harshest forms of enforcement action only if it will serve as a credible deterrence for others, which in some cases has meant taking action against the most wealthy[8] and high profile[9] individuals in order to maintain market confidence.  This more reasonable side of the regulator came through in the case of Jeff Burley, when the FSA chose not to initiate criminal proceedings against the 73 year old due to his health condition; however a less lenient side was shown in the case of Adrian Bancroft, who was imprisoned and given a prohibition order for various financial crimes.

What Next?

Watch Out — Are you watching your employees?: Interestingly, there have been a string of FSA enforcement cases that indicate that individuals engaging in market abuse may not only be the ones at risk of FSA enforcement action.  Whilst the FSA will most certainly commence enforcement action against firms that actively encourage their employees to engage in market abuse[10], it has been recently fining firms[11] that fail to "supervise" its employees, in breach of Principle 3 of the FSA’s Principles for Businesses[12].  These cases have tended to be instances when there is general widespread failure to supervise employees, but it is not certain whether the FSA could also begin initiating enforcement action against firms that do not take steps to adequately supervise/prevent employees from engaging in market abuse.

Tools of the Trade — Taping: However, two new developments are likely to further increase the likelihood of successful FSA enforcement action.  As of 14 November, firms became required to tape work mobile phones[13], which will provide the regulator with additional crucial evidence when investigating market abuse[14].  However, as firms are only required to keep this information for six months, the FSA will need to be swift in its investigations in order to make use of this additional evidence.

Tools of the Trade — the Wisdom of ZEN: Further, the FSA has introduced a new monitoring and surveillance system, Zen, which will vastly increase its ability to monitor market abuse transactions across a range of EU member state exchanges, which involve alternative investment instruments such as interest, currency and commodity related products.  Whilst the roll out of Zen has the potential to lead to more successful enforcement actions, it remains to be seen whether this will be the case.  Zen now requires firms to provide the FSA with daily reports on a wider range of transactions that took place the previous day.  Due to the detail of information now required in these reports, there is a risk that a firm’s failure to provide accurate reports or failure to provide any reports altogether, will hinder the FSA’s ability to effectively monitor market abuse.

All in all, whilst the FSA remains committed to maintaining a tougher enforcement regime in respect of market abuse, it is unclear whether this commitment is capable of continuing after the FSA is abolished, and its various functions transferred to other agencies.  There is a real risk that a fragmentation of current FSA functions could impede the ability to seamlessly investigate and impose robust penalties on all market abusers.  

   [1]   The Four ‘Ds’: Deterrence, Discipline, Disgorgement … and Dawn Raids — Latest on the UK Financial Services Authority’s Enforcement Regime

   [2]   The FSA levied more fines in the first two months of the fiscal year than it did in all of 2009-2010 (the Financial Times 23 June 2011).

   [3]   Previously a record fine of £2,800,000 was handed down to former broker, Simon Eagle.

   [4]   Goenka had attempted to manipulate the market in a similar manner on a previous occasion.

   [5]   Visser was also given a prohibition order. 

   [6]   Goenka lived in Dubai.  Visser appears to be Lithuanian, but it is not clear if he also lived in or worked in the UK

   [7]   Margaret Cole speaking to the Financial Times (23 June 2011).

   [8]   Such as Goenka.

   [9]   Although not a market abuse case, this was demonstrated in the enforcement action involving Sir Ken Morrison, who was fined £210,000 after discount for breaching DTR notification requirements in respect of his shareholding and voting rights in WM Morrisons Supermarkets Plc.  Despite Sir Morrison being a high profile individual, the FSA demonstrated that it was willing to impose harsh penalties on such prominent individuals and institutional investors in order to achieve credible deterrence. 

  [10]   In the case of Bliss and Coppin, the FSA indicated that had their employer, Pacific Continental Securities not been in liquidation, it would have received a £3,000,000 fine due to the firm’s systematic failure to have regard to regulatory and compliance requirements, and its failure to  train staff in respect of the same. 

  [11]   For instance Willis Limited was fined £6,895,000 for breaching Principle 3 when failing to supervise staff (e.g. via formal training), and have effective systems of controls to counter the risks of bribery and corruption. Limited was also fined £28,000 for amongst other things, failing to ensure sales staff were competent in their sales roles, and received sufficient training, also in breach of Principle 3. 

  [12]   Principle 3 requires firms to take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems. 

  [13]   FSA Policy Statement 10/17: Taping of Mobile Phones – Feedback on CP10/7 and Final Rules.

  [14]   The importance of such evidence can be seen in the recent controversial US insider dealing case involving Raj Rajaratnam, a former hedge fund manager, whose successful prosecution (and subsequent 11 year imprisonment) was partly secured as a result of extensive phone tapping operations.

Gibson, Dunn & Crutcher LLP  

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have about these developments.  Please contact the Gibson Dunn lawyer with whom you work, or any of the following lawyers in the firm’s London office:

Selina Sagayam (+44 20 7071 4263, [email protected])
James Barabas  (+44 20 7071 4253, [email protected])
Jeffery Roberts (+44 20 7071 4291, [email protected])

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