Hector Sants, chief executive of the Financial Services Authority (FSA), recently put his cards on the table:
‘There is a view that people are not frightened of the FSA. I can assure you that this is a view that I am determined to correct. People should be very frightened of the FSA.’
Banks and financial institutions may begin to sense that this rhetoric is being put into action following several recently successful and high-profile FSA enforcement cases.
In particular, the decision of the Financial Services and Markets Tribunal (the Tribunal) in April 2009 to uphold the FSA’s £4m fine of Winterflood Securities Ltd and two of its traders for playing ‘a pivotal role in an illegal share-ramping scheme’ is a significant indicator of the FSA’s tougher approach towards regulation of the financial services industry. The proceedings also demonstrate that the regulator is putting into action its new strategy of ‘credible deterrence’. Banks and financial institutions at the forefront of their respective markets (Winterflood is the largest market maker of AIM securities) should be aware that they are prime targets of the FSA’s enforcement regime.
Action against Winterflood
In June 2008 the FSA held that in 2004 Winterflood and two of its traders, Stephen Sotirou (SS) and Jason Robins (JR), had engineered an illegal share-ramping scheme through the misuse of rollovers and delayed rollovers (moving positions from one client to another) to deliberately create a distortion in the market for shares in AIM-listed Fundamental e Investments plc (FEI). The FSA fined Winterflood £4m and SS and JR £200,000 and £50,000 respectively.
Banks and financial institutions should note that the FSA highlighted the fact that Winterflood ought to have been alerted to the clear and substantial risks of market manipulation due to the unusual features apparent in the share trades in the relevant period. The FSA will clearly not tolerate a lack of proactivity on the part of regulated businesses in identifying and dealing with warning signals for this type of behaviour. In this case the FSA found that Winterflood had in fact continued with its highly profitable price-ramping practice, making around £900,000 from trading in FEI shares in the relevant period, which was the most profitable in Winterflood’s portfolio. The FSA would have expected Winterflood to check that this trading was above board but this was not the case as it did not take any steps to verify the legitimacy of the trading in FEI shares. Furthermore, the FSA held that Winterflood’s involvement had been critical to the success of the share-ramping scheme, which saw the share price in FEI rise by 300% from 4p in December 2003 to 12p by June 2004 before trading was suspended.
Winterflood contended before the Tribunal that, in a market abuse case, ss118(2)(b)-118(2)(c) of the Financial Services and Markets Act 2000 require the FSA to demonstrate that there had been a subjective mental element (an ‘actuating purpose’) on the part of the defendants to mislead or distort the market. Significantly in this case, and more generally, the Tribunal held it was not necessary for the FSA to demonstrate an actuating purpose. Reports suggest that Winterflood is seeking to appeal the Tribunal’s decision to the Court of Appeal.
Margaret Cole, director of enforcement at the FSA, commented that:
‘There were clear warning signs that should have made Winterflood think something was amiss but it failed to recognise and react to them…’
Clearly the message for banks and financial institutions is that they must be alert to the possibility of financial crime within their organisation or face enforcement action by the FSA.
Trends in enforcement action
Banks and financial institutions leading their respective markets should pay close attention to this case. Senior management, in-house lawyers and risk professionals at all regulated businesses should acknowledge the size of the fines imposed on the business and individuals involved. Significantly, organisations should be aware that this marks a continuing trend in which the FSA has taken successful action against market abuse:
- Mr Vukelic, Alternative Solutions: this case provides a significant warning to senior management. Here, the FSA banned Vukelic, former CEO of Alternative Solutions (AltSol), from working in the financial services industry in the UK. AltSol developed and marketed complex financial reinsurance products that were in some circumstances misused by struggling insurance companies seeking to disguise their true financial position. In April 2009 the Tribunal upheld the FSA’s decision, finding that Vukelic had ‘turned a blind eye’ to the true nature of the certain non-genuine transactions and was ‘reckless as to whether they were intended to mislead auditors and others’.
- Christopher McQuoid: this represented the FSA’s first criminal prosecution for insider dealing. On 27 March 2009 Christoper McQuoid, former general counsel at TTP Communications, and his father-in-law were found guilty of insider trading, with the court finding that McQuoid had passed inside information on to his father-in-law who traded and made a profit using the information. The FSA also obtained a court order freezing the profits made from the trade.
- Loic Montserret: on 29 April 2009 the FSA announced the imposition of a ban from carrying out any function in relation to regulated activity and a fine of £35,000 on former BlueCrest Capital Management portfolio manager, Loic Montserret. This is the first time the FSA has both banned and fined an individual for mismarking trading positions. Here, Montserret had mismarked four positions in an attempt to avoid losing his job over losses he was making on his trading book, with the result that a fund was over-valued at its maximum to the tune of $8.6m.
The FSA has not stopped there. On 31 March 2009 the FSA announced the arrest of a senior corporate finance adviser and another individual in relation to suspected organised insider dealing following raids on several London addresses.
A new era of FSA action?
The FSA’s action against Winterflood and the run of market abuse enforcement cases reflects the general policy messages coming from the FSA. Margaret Cole acknowledged that:
‘Taking this action against Winterflood shows that we are determined to tackle abusive behaviour and to deter market participants from threatening the integrity of our markets.’
The case is also in line with the FSA’s recently published Financial Risk Outlook and Business Plan, which highlighted the risk of an increase in market abuse and financial crime in current market conditions (particularly misselling, market abuse, fraudulent valuation of investments and the inappropriate handling of market rumours).
A tougher enforcement regime forms part of several regulatory measures of which banks and financial institutions must be aware. The FSA has already bulked up its enforcement team, signalling a clear commitment to increase its enforcement activity. For example the FSA recently appointed David Kirk, currently the director of the Fraud Prosecution Service (a specialist unit of the Crown Prosecution Service), as chief criminal counsel. That said, the FSA’s enforcement team will be hoping to receive much greater financial and human resources if it is to be truly effective in achieving its enforcement objectives.
Greater numbers of enforcement cases are likely to be a by-product of the closer scrutiny that the FSA will place on regulated businesses. The FSA is likey to adopt an enhanced supervision programme. Hector Sants has indicated that a more ‘instrusive and direct style of supervision’ will replace ‘principles-based’ regulation.
Conclusion
Many suggest that the recent successful enforcement of market abuse signals a new and tough stance being taken by the regulator against behaviour that threatens the credibility of the markets. Several lessons emerge for regulated institutions:
- Expect a pro-active (and not reactive) approach from the FSA.
- Adopt a pro-active approach to combatting financial crime within your organisation.
- Consider undertaking a review of existing policies and procedures.
- Do not expect the FSA to tolerate the turning of a blind eye to financial crime by regulated businesses.
- Ensure that senior management are fully up to speed on the FSA’s expectations. Hector Sants has stated that the FSA would:
‘Seek to make judgments on the judgment of senior management and take actions if in our view those actions will lead to risks to our statutory objectives.’
- When issues arise regulated businesses should consider, along with their advisers, whether voluntary disclosure to the authorities is appropriate.
- Consider a policy of co-operation with the regulator. Significant discounts in the fines levied by the regulator are available to businesses that co-operate in formal FSA proceedings.
The current political and economic environment will create a domino effect in the regulation of banks and financial institutions. Closer scrutiny and supervisions will lead to greater numbers of regulatory investigations, which will result in more and higher profile enforcement proceedings. Indeed, regulated institutions should note that the FSA is already turning the idea of tougher regulation into a reality with some success.
By Chris Warren-Smith, partner and Ian Pegram, professional support lawyer in the disputes practice, Fulbright & Jaworski International LLP.
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