Market Abuse Policy & Enforcement in the UK
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Speech by Sally Dewar, Director of Markets Division, FSA
BBA and ABI Market Abuse Seminar
22 May 2007
Good afternoon. I'm delighted to be here today. As you know, Market Abuse and our efforts to combat it is a key priority for the FSA so today I'd like to take you through the work that we are doing in this area.
Agenda
The key message I'd like to emphasise in my remarks today is our strong belief that the FSA and the regulated community need to work together 'in partnership' to achieve clean, efficient financial markets in the UK. To put into context first of all I'm going to outline the findings from our statistical study of market cleanliness, which is one way of trying to measure how much insider trading there might be, and then talk about our Enforcement history to date and the challenges we face trying to secure successful Enforcement outcomes.
You will hear us keep coming back to the importance of this partnership approach which we began just over a year ago in earnest. To illustrate how it is starting to pay dividends I'm going to set out some important examples of successes to date.
A partnership approach
We strongly belive that tackling market abuse should not be seen as a job for the regulator alone - it has to be a collaborative effort with the market. So what do we mean by a partnership approach:
- Agreeing the priority areas for focus by having a strong formal and informal dialogue on important matters and understanding on new risk areas
- Strengthening systems and controls at firms to mitigate market abuse, keeping a high focus on training and awareness and learning from good practices - identified by the industry or by FSA thematic work
- Reporting wrongdoing, and
- Each taking tough action when abuse is identified
The FSA is not an enforcement led regulator, but aims to maintain clean markets and deter abuse through a combination of enforcement action and preventative measures. We are investing heavily in upgrading the FSA's securities transactions monitoring system, which will improve our ability to detect and pursue market abuse.
In the last 18 months, we have invested considerable time and effort to increase our engagement with the industry, discuss a range of issues and to provide feedback on the good practices we have observed. We have undertaken a wide range of thematic work– this work enables us to provide training to firms, acts as a deterrent measure, and helps us to make high quality referrals to our enforcement division.
This year our objective is to step up our dialogue with the industry even further and to continue to foster a partnership approach to tackling market abuse.
What we expect from firms
On a number of occasions in 2006 and 2007 we spoke about our high level expectations of firms, and particularly senior management at firms. These concepts are still very much valid today and so it is worth spending the time for a quick refresher of the key messages.
Our high level expectations of firms focus on the need for senior management to take responsibility for ensuring that firms identify risks, having due regard to the operation of financial markets as a whole, and to ensure firms develop appropriate systems and controls to manage the risks. In particular, we have stressed the need to properly manage conflicts of interest and the need for self-reporting by firms if senior management suspect that their own staff have engaged in misconduct. Key to that, it is important that we, the FSA, recognise these efforts. Our commitment to you is that if you do this and can demonstrate your firm has good systems and controls and is complying with them, and an individual within the firms commits market abuse, we won't pursue the firm in an enforcement action just the individual. I have two important examples of this to take you through later.
Market Cleanliness – the study
The prevalence of insider dealing puts two of the FSA's statutory objectives at risk. First, market confidence; maintaining confidence in the financial system and secondly the reduction of financial crime; reducing the extent to which it is possible for a business to be used for a purpose connected with financial crime.
In developing this statistical measure of what we call market cleanliness, the FSA has published statistics which will demonstrate over time and in a very transparent way the impact of regulatory requirements on market practice.
The methodology measures market cleanliness by looking at the extent to which share prices move ahead of significant, potentially price sensitive, regulatory announcements that companies are required to make to the market. This analysis was conducted for two types of statements – trading statements made by FTSE 350 issuers and Public take-over announcements related to UK companies.
The figures for FTSE 350 show a marked improvement in the level of untoward activity down from 19.6% in the period 1998-2000, to 11.1% in 2002/03 to only 2.0% in 2004/05. However, although the figures show that there is an improving trend there is still a lot of work to be done on mergers and acquisitions activity.
Market Cleanliness – results for takeovers
This table is worth looking at. Three things stand out to me
- that there has been an improvement between 2004/2005
- that in 2005 the figure close to 24% is still high
- in overall terms there has been only the slightest improvement since N2 so clearly much to do.
Even before we had the confirmation of this statistical analysis, we believed this to be an area of concern so towards the end of last year we launched a major thematic project to review the controls over inside information in respect of public takeovers. We plan to publish the results of this at the end of June. We have particularly welcomed the frank and open debate that we have been able to have with many of the firms represented here today.
Reducing the leakage of information in relation to takeovers is a key priority for us and there will be no let up in our efforts in this area.
Market Cleanliness – the Press
Before moving onto our Enforcement Action, and the difficulties we face in trying to achieve successful insider dealing cases, I thought I'd put up a few of the press headlines generated by the Market Cleanliness study, many of the headlines focused on the need for more significant Enforcement outcomes to act as a deterrent to market abuse, my particular favourite being – "sadly we can do sweet FSA about insider dealing". Seriously though, a clear message that more and tougher fines are required in order to make a difference as well as recognition that this is very difficult to achieve.
Enforcement Action
Since 2001, we have completed 19 cases involving fines against 17 individuals and 10 firms. This includes cases involving insider dealing, other market abuse offences, such as improper disclosure and breaches of FSA Principles for Business or Principles for Approved Persons. The most recent cases reflect our prioritisation of institutional market abuse cases and I am going to talk about two cases in a moment.
The level of financial penalties ranges from £1,000 to £13.96m in the Citigroup case and £17m for Shell. In setting fines, the guiding principle is that individuals or firms should not benefit from misconduct and thus a financial penalty always includes an element to cover the disgorgement of any potential profits or repayment of loss avoided.
Challenges to successful Enforcement outcomes
Bringing successful Enforcement action in this area is extremely challenging for a variety of reasons. It is worth my emphasising again that the FSA is not an Enforcement-led regulator, our approach to market conduct is to use a combination of enforcement tools together with deterrent measures and improving standards through guidance and training
Notwithstanding this, we have stated that we intend to be bold in our approach to levying penalties overall and particularly for areas like market conduct where the regulatory requirements have been clear for some time and where we need to ensure that regulatory fines are not simply regarded as just another cost of doing business.
We are sometimes asked why we do not have more Enforcement outcomes under the criminal insider dealing or the civil market abuse regimes.
Insider dealing cases are amongst the most difficult cases we are called upon to prove, they are time consuming and complex and we may not be able to establish all of the facts necessary to support an insider trading charge. Insider dealing may have been conducted by a number of defendants, involved multiple trades over a number of months and have been of a sophisticated nature. The trading may have been conducted through a number of accounts and attempts made to the distribution of proceeds. The investigation into such activities increasingly involves a number of foreign jurisdictions.
It is rare to find a "smoking gun;" and often cases hinge on circumstantial evidence. It is quite common for insider traders to come up with alternative rationales for their trading strategies that can be difficult to disprove. In the Consultative document preceding the legislation, the Government stated it would be inappropriate to impose criminal penalties if the individual did not realise that the information he had was inside information. This is something which can be very difficult to establish, for example in the face of a defendant who states that he was simply fortunate in the timing of his dealing.
It was anticipated that a civil process with the accompanying benefits like a civil burden of proof, a jury not being required, the ability to settle, a quicker process with non-custodial outcomes and the ability to have a specialist Tribunal for difficult issues of fact and law would result in more successful actions against insider dealing. The FSA was also provided with the ability to take action for breaches of the FSA's Principles for Business , particularly Principle 3 – management and control – and Principle 5 – market conduct.
We have found, in reality, that a number of the same evidential challenges face us for civil cases. We have however had some successful outcomes in Principles based cases.
Partnership in action – STRs & Sharing Market Intelligence
As an example of where we are starting to work well together I want to say a few words about the STR regime.
We have found the new Suspicious Transaction Reporting regime to be very valuable. 12 months into the new regime we stood back to review all of the STRs received to assess for quality.
We published our findings in our Marketwatch in December 2006 and encouraged firms to review their systems and controls and benchmark themselves against the good practice we identified.
Following the review, some firms have asked us whether we have changed our stance in terms of the earlier message we gave about wanting firms to focus on the quality rather than the quantity of STRs. Some felt that the very fact that we had undertaken a review implied that we were not happy with the level and quality of existing STRs. The answer is that there has not been a change - our review is not about asking you to send us more STRs rather it is noting that, some time into a new regime, it is appropriate for firms to step back and review their controls to ensure that they are properly picking up potentially suspicious trades and for us to give you feedback about good practice we have seen.
Within our feedback we also reiterated our message that we would like to encourage firms to report to us matters of suspicion in relation to peers. Some firms have noted that they don't think that it is appropriate for firms to be "whistleblowers" on their peers and have noted that neither SUP15.10 nor Principle 11 cover such a scenario. I understand that some firms are concerned that FSA is suggesting that there is a formal reporting obligation. I would like to confirm that this is not the case. What we want is for you to be good corporate citizens and to work with us to help to identify instances of potential market abuse in the interest of a cleaner market.
Similarly, the requirements set out in the Supervision Manual within the FSA Handbook are not prescriptive. Firms are only required, under the letter of the STR rule, to report to us if something appears suspicious at the time that a trade is placed. Clearly it would not be within the spirit of the rule not to report something to us if the firm only identified it as being suspicious after the event. Thus, whilst we do not require firms to undertake retrospective compliance monitoring, where firms have chosen to do this we have welcomed this as good practice and as being extremely helpful to us.
I am pleased to report that since we have done this work and published Market Watch, we have been receiving more complex STRs in areas such as the credit markets and a greater flow of market intelligence generally where firms see activity by peers that they regard as suspicious.
Partnership in action – Enforcement (Pignatelli)
Finally then, a few words on institutional market misconduct. As I have said before, we consider that there are some firms, or individuals at firms, where standards of market conduct may still be falling below the required levels. The two most recent FSA Enforcement cases, breaches of Principles by two Approved Persons – Mr Sean Pignatelli and Mr Robert Casoni seem to have hit the mark with the industry – we understand that compliance teams have been receiving questions from their traders about what is acceptable practice and at what point traders should escalate matters to Compliance, which we see as a very positive outcome.
In the case involving Mr Sean Pignatelli (a fine of £20,000 for breaches of Principles 2 and 3 of the FSA's Statements of Principle for Approved Persons), Mr Pignatelli, was employed as a US equity salesman at Credit Suisse First Boston (Europe) Limited. He received an analyst's email on the evening of 24 May 2005 concerning a US company called Boston Scientific Corporation. The email was worded in such a way as to appear that it might have contained inside information about Boston Scientific's prospects, including phrases such as: "quick heads up ahead of tomorrow's analyst meeting" and "Don't want to get in trouble ….keep btwn us for now".
Although it transpied that the email did not in fact contain inside information, we concluded that Mr Pignatelli acted without due skill, care and diligence when, despite these warning signals, he failed to consider whether or not the email might have contained inside information and as a result he did not discuss the email with his senior manager or compliance as required by Credit Suisse's procedures.
Despite the warning signals in the email, very shortly aftewards he embarked on a series of calls to clients passing on this information. During these calls he used language that embellished the information in such a way that we considered that he gave the impression that the email contained inside information. By passing on the information in this manner he failed to observe proper standards of market conduct.
A key message from this case is that whenever sales people receive material which appears to contain inside information, they should stop and think before passing it on and, where appropriate, discuss it first with their senior manager or compliance officer.
Partnership in action – Enforcement (Casoni)
In the case involving Mr Robert Casoni (a fine of £52,500 for breaching Principle 3 of the FSA's Statement of Principles for Approved Persons), Mr Casoni was a research analyst for Citigroup Global Equity Research in London, where he was head of the Italian small-mid cap team whose areas of coverage included the Italian leasing sector. On 9 January 2006 Mr Casoni began the Citigroup approval process to initiate coverage on the Italian leasing and factoring bank, Banca Italease. However prior to its publication, Mr Casoni selectively disclosed details of his valuation methodology, final recommendation and the target price. In one case he also told a client the expected date of publication.
By disclosing this information, after he had formed an opinion about Bance Italese and had initiated the Group's internal approval procedure, Mr Casoni failed to observe proper standards of market conduct.
Both these cases are excellent examples of situations where large firms have taken on board our message about the need to self report and have themselves brought these matters to our attention. In line with our commitment, being satisfied about the controls at these firms, our Enforcement action then focussed only on the individuals and not the firms.
Conclusion
So to conclude, I feel that together we have made positive strides in the last year in establishing the framework to enable us, going forward, to work together towards cleaner capital markets. We have tried to be clear in setting out our expectations about what we expect of firms and to help educate and advise the industry by sharing good practice points that we find. We greatly appreciate the efforts that you, in turn, have made to increase the flow of quality STRs and other market intelligence. There is clearly a lot more we can do and we hope that the work we are doing will enable us to make further positive steps in our fight against market abuse.
Finally, I should just mention that we plan to host an FSA seminar covering market abuse matters in September this year to keep you updated on developments – we hope to see you there.
Thank you.