The FSA and enforcing the market abuse regime
Speech by Jamie Symington, Head of Wholesale Department, FSA
City and Financial Market Abuse Conference
6 November 2008
A year ago I addressed a conference similar to this one hosted by City and Financial. It hardly needs saying that the world of financial markets only a year ago was a very different one from today. At a time such as now, I expect you are particularly interested in what the regulators and thinking and doing.
In times of a financial crisis such as we are going through now it is critical that we maintain and are seen to maintain order in the markets. And maintaining order in the markets by monitoring and enforcing remains a top priority for us even – if not especially - during times such as these.
I would like to start this talk, therefore, by saying a little about how we are policing the market abuse regime in the current conditions and how we have had to respond to meet particular risks. I will then step back a bit to talk about the FSA’s ongoing programme to enhance our work to tackle market abuse over the last year or so. And in particular, I would like to focus in on what I consider to be one of the most significant changes in our fight against market abuse, and that is the strategy of increased use of criminal prosecutions to sit alongside our other regulatory powers.
Current market conditions
We live in “interesting times” people keep saying to me. There have been seismic shifts in the financial markets in the last few months, as we all know, and the landscape has changed in ways that seemed unimaginable. For the regulators (along with governments, central banks and the banking industries) the world over, it has been all hands to the pumps to fight the fires that have raged through the markets. It has been an extremely busy time for all of us.
But no-one should make the mistake of thinking that this means that the business of ordinary regulation of the markets does not go on. Our remit is to maintain clean as well as orderly markets at all times. The FSA’s commitment to combating market abuse remains as high as ever. We may have other immediate and pressing priorities, but the effort and resourcing that we put into the prevention, detection, investigation and prosecution of market abuse has not diminished. On the contrary, it has been enhanced in the last year.
Markets and the outlook for the economy are changing on a daily basis. This makes it difficult to predict what the future holds for us in terms of the risks of market abuse.
Take mergers and acquisitions, for example. This has been identified as a key risk area for us. Unusual trading around takeovers is something we have monitored closely. It is an indicator of the incidence of market abuse. It has been the source of many of our enforcement referrals. Who knows what will happen to M&A activity in the near or medium term? M&A activity may increase or decrease during a recession. It is hard to say. Sometimes harsh economic conditions lead to consolidation of enterprises in particular sectors. Sometimes there isn’t the money there to finance it.
But even if the corporate merger sector is less active there will still be particular risks to abuse of information in the markets. For example, information concerning re-financing packages. One of the FSA’s landmark market abuse cases, our record fines for GLG and Philippe Jabre in 2006, concerned misuse of information about the re-capitalisation of a Japanese bank. That, Sumitomo bank, was going through a similar re-financing process in the aftermath of Japan’s financial crisis to what many of our own banks are doing today. Also, if we are entering into a recession, the likelihood is that we will see more examples of companies needing to give profit warnings, or even announcements concerning liquidity. Again, this poses a high risk of market abuse. Ordinary investors need to be protected.
So we are keeping a very close eye on the changing world and the developing trends in markets. Also, as you have all seen, we have demonstrated that we are prepared to use all our regulatory tools as necessary to prevent and deter market abuse in response to the challenging market conditions.
One example is the introduction of new rules concerning short selling. While the FSA still regards short-selling as a legitimate investment technique in normal market conditions, the current extreme circumstances have given rise to disorderly markets. As a result, the FSA has taken decisive action, after careful consideration, to protect the fundamental integrity and quality of markets and to guard against further instability.
In July we introduced the provisions requiring disclosure of net short positions over a certain threshold. In September we took more targeted measures to prevent short selling completely in the shares of financial institutions. These provisions have been reviewed and will remain in place until January. Meanwhile, a wider review of short selling is ongoing and we will seek to look at, amongst other things, legal issues, the cross-border landscape and the quantitative impact of ban/disclosure requirements. We aim to publish a Consultation Paper in early January.
Another example is the thematic work we have done concerning market rumours. Disseminating false or misleading information, particularly in nervous market conditions, can be very damaging. This has been the case particularly in the recent months, when unfounded rumours contributed to substantial share price movements in a number of UK financial institutions. While the most publicised cases pertained to falls in share prices resulting from the spread of unsubstantiated stories, all price movements triggered by unfounded rumours have the potential to distort markets and undermine market confidence.
Since spring 2008, our Market Conduct team has investigated a series of unfounded rumours which were circulated in the market and we reported on this work at the start of August. We also began a tailored review of firms’ policies in relation to handling of market rumours. Obviously different firms have different compliance resources. Unsurprisingly, we identified a great disparity amongst firms’ approach to the issue of rumours.
We take this matter very seriously. We will publish the findings of our rumours thematic review, including a case study, in Market Watch 30 - this is due out later this month and will build on what I have said here.
In short, therefore, in answer to the question what is the FSA doing about market abuse in the current market conditions I would say three things:
One – we are staying on the beat. We are busy with other things, but we are continuing to monitor market abuse and enforce with our usual rigour.
Two – we are carefully watching events and developments in market conditions. We are monitoring what risks areas are emerging for market abuse in the changing world.
And three - we are using all the tools we have to respond rapidly but thoughtfully to market conditions. Where necessary, we are changing the rules to address the needs of the day.
What does this mean for you? Well, we would expect firms to respond in a similar way. First, we appreciate that there are and will continue to be immediate pressing issues for firms to deal with. But it is essential that firms do not become distracted from their own compliance obligations. Monitoring and prevention of market abuse within their firms must go on, now more than ever. Reporting suspicious activity, especially, must go on.
Second, firms, like the FSA, should be monitoring attentively the changing market conditions. They should consider the impact for their business models and the impact on the risk of market abuse. In particular, firms should be aware of what the changing market means for where the high risks of inside information arising and being handled are and should respond appropriately.
And lastly, like the FSA, firms should be able to show that they can respond rapidly and flexibly to changing market conditions. They must manage the risk of market abuse to keep pace with the changing world.
More Generally
Leaving the current market conditions to one side for a minute, I want to step back a few months. I don’t have time today to deal with this in detail, but I think it is important that everyone understands that our programme to enhance our work against market abuse began well before the financial crisis started (or its full implications were appreciated). This programme is a long term-strategy that has not been and will not be derailed by current events.
Our aim is to change the behaviour of those investors and market professionals who might be tempted to commit market abuse. Market abuse should be seen for the wrong that it is and it does to the investment community and should be shunned by proper professionals. We want people to feel deterred from engaging in such activity by fearing the consequences of punishment if they do. But we also want people to help us with the prevention, detection and investigation of market abuse.
What are we doing? Market abuse is difficult to detect, investigate and prosecute. Our strategy involves making full use of all the tools we have available (enforcement and non-enforcement tools) as well as seeking new powers (such as the power to grant statutory immunities) where we think these are needed.
Part of the battle – arguably the most important part - is about prevention. On that front we have engaged with the industry to enhance the systems and controls that firms have in place to prevent and combat market abuse. Through a series of thematic projects, we have sought to tighten up on the controls over inside information and on the awareness and training that firms have as regards market abuse.
We have particularly sent clear messages that we expect senior management of firms to take responsibility for the standards of conduct and behaviour in their firms. Senior management are accountable for the adequacy of the systems and controls in place to prevent market abuse occurring.
Clearly, combined with prevention, there must be credible deterrence. Detection is key. To that end we have invested significant resources in our transaction surveillance capability, SABRE 2. This will enhance our ability to collate and analyse transactions, price movements and other data and data patterns in the markets to alert us to potential misconduct. We have also consulted on and will bring into force next year new requirements for broker-dealers and discretionary fund-managers to record their telephone calls. This is not a panacea, we know that, but taken with the other measures we are putting into place, it will significantly improve detection and the quality of evidence needed to pursue market abuse cases.
We are also assisted substantially in detection by the mandatory suspicious transaction reports. Our efforts in that area have helped to improve the quality of those reports and hence the leads to possible misconduct. Over time, the number and the quality of the STRs we have seen has improved. In the last year we had over 300. These are a very important source of information to us and each one we receive is looked at carefully. Many are followed up with further enquiries and STRs still remain the largest single source of referrals of cases to Enforcement.
Enforcement is an area where significant effort has gone into delivering more public outcomes that will create credible deterrence, and I will come on to that in just a minute.
But to summarise what I have been saying before I move on in two short points:
one, we are pursuing a long-term strategy as well as responding rapidly to the changing market conditions. This strategy was embarked on before the credit crisis and its overall aims are not altered by it. Two, the strategy spans all the regulatory tools at our disposal, and are aimed at prevention and detection as well as enforcement.
Criminal prosecutions
There are a number of initiatives which the FSA has adopted over the last year or so to enhance enforcement against market abuse. However, I would like to focus particularly on the use of criminal prosecution powers as I consider this to be one of the most significant changes in our approach to have occurred in the last year.
Obviously I am bound by reporting restrictions on our ongoing criminal prosecutions. What I can say is that the fact in the last year we have commenced 3 criminal prosecutions and expect to continue to bring more in the future.
There is plenty to talk about in relation to this matter, and I expect we will explore some of the issues in more detail in the panel discussion which follows, but there are three points in particular that I would like to emphasise. The first is that our aim here is to get people to take the threat of the consequences of their actions more seriously, and for the conduct to be viewed for what it really is: criminal.
A recent study by Deloittes for the Office of Fair Trading showed that the prospect of criminal proceedings acts as a significantly greater deterrent to those contemplating misconduct than does a fine of almost any size. The stigma that goes with a criminal conviction and the loss of liberty is not something that professionals want to have. Attracting press attention is not an aim in itself for us, but we are obviously aware that city professionals coming and going from the criminal courts makes for good photo-journalism and news stories. It gives a high profile to our efforts to combat and deter market abuse. So the objective is to up the stakes for people who might risk committing market abuse so that they are deterred by the fact that they face a real prospect of a spell in prison and the publicity and stigma of a criminal conviction.
The second point, which is very important, is that the move towards bringing more criminal prosecutions does not mean that we will not still bring civil market abuse proceedings. Our governing legislation very clearly creates the powers to pursue market abuse by both criminal and civil/regulatory means. As a public authority, we bring criminal proceedings only where the two tests of the Code for Crown Prosecutors are met. First, there must be sufficient evidence for a realistic prospect of conviction. The elements of the criminal offence, the defences available and the standard of proof are different (at least technically). And second, there must be a public interest in bringing a criminal prosecution. On the latter, the Code provides some examples by which we are guided, which include the seriousness of the contravention, whether the perpetrator benefited, and the prevalence of the offence such as to justify deterrence. We have also issued guidance on the sorts of factors we will take into account in deciding whether to proceed down the regulatory or criminal route. These include factors such as the impact on the market and the conduct of the person during the investigation and the extent to which they were co-operative (although we make clear that merely complying with the obligations to co-operate will not avoid prosecution).
The FSA will apply its policy in relation to the prosecution of criminal offences fairly. Each case will be considered on its own facts. The policy is applied within the overall context of what the FSA considers necessary in order to create deterrence. Nobody should read too much into a decision taken in one case as to what that might mean for another. The factors to be considered are very varied. Besides, the FSA retains and stands on its right to be a selective prosecutor. That is to say, we are not bound to prosecute or not to prosecute particular categories of cases or cases which contain (or do not contain) a particular feature. Rather, we consider all the relevant considerations against the backdrop of our statutory objectives and our prevailing policy and guidance. And we do so fairly.
That is why you will have seen that our success this year in launching three criminal prosecutions has been complemented by successes in concluding action under the civil market abuse regime against two other individuals, Mr Shevlin and Mr Harrison, in separate cases.
So the strategy of bringing more criminal prosecutions is not to be regarded in isolation. We can and will continue to bring civil proceedings as well. This brings me onto the last point I wanted to emphasise concerning criminal proceedings.
We have consulted recently on a proposed policy of offering more leniency towards persons who agree to co-operate with the FSA in cases where the misconduct has been carried out by two or more persons acting in concert and that person is prepared to give evidence to secure the conviction of another.
We see this as the carrot which complements the stick of the threat of more prosecutions. We consider it extremely important to secure the convictions that will show that we will pursue suspects rigorously and to the end. But we also wish to incentivise those who will show real co-operation with the FSA in pursuing cases. Similar schemes have yielded important results for other regulators and law enforcers. Undoubtedly this strategy carries a number of risks – too many to go into the detail of now. We will take care to ensure that the policy is applied in general and in specific cases lawfully and properly and where a clear public interest can be made out. So, for example, it would not be right to offer leniency to the offender of greater culpability in a criminal enterprise in order to secure the conviction of a party of lesser culpability. We would also need to be satisfied that the co-operating witness’s evidence is of real value and that that evidence could not be obtained by any other means. We would also need to be sure of the trust we can place in our co-operating witness and the reliability of his evidence. With those public interest considerations and those risks carefully assessed, we believe this policy of leniency towards co-operating witnesses to be right and to bring real benefits.
Conclusion
Taking all of this together, I hope that this morning I have conveyed that: first of all, the FSA continues to monitor closely the changing markets during these turbulent times. It is not de-prioritising market abuse enforcement: on the contrary it is adapting and responding to meet the challenges.
Secondly, that our longer term strategy to combat market abuse – which pre-existed the credit crisis – is not derailed by current events, and continues to pursue a holistic approach comprising all the tools at our disposal to achieve prevention, detection and successful enforcement action.
And lastly that our strategy is underpinned by a determination to take a rigorous and tough enforcement stance to create a real deterrent, in particular by the use of criminal proceedings. We are pushing the boundaries in terms of our investigation and prosecution strategies. We aim to achieve more public outcomes. To do so, we are prepared to use innovative and creative strategies such as our leniency programme for co-operating witnesses.