Ian Mason is a Partner and Head of the UK Financial Services and Regulatory team at Gowling WLG. Ian was formerly a Head of Department in the Enforcement Division of the Financial Services Authority (FSA). He is a member of the Practical Law Financial Services consultation board.
On a regular basis, Ian shares his thoughts with Practical Law Financial Services subscribers on topical developments in the area of market conduct. In his column for June 2019, Ian considers some current Financial Conduct Authority (FCA) market abuse themes.
To read Ian's previous columns, see Practice note, Ian Mason’s market conduct columns.
Some current FCA market abuse themes
STORS and SARS
The FCA's thematic review on understanding the money laundering risks in the capital markets, published in June 2019, will be of interest not just to Money Laundering Reporting Officers (MLROs), but also to those responsible for detecting and monitoring market abuse. The review looks at the relationship between submitting a suspicion of market abuse by means of a suspicious transaction and order report (STOR) under Market Abuse Regulation (MAR), and submitting a suspicious activity report (SAR) when money laundering is suspected under the Proceeds of Crime Act 2002 (POCA).
The review notes the lack of specific industry guidance on whether to submit a STOR, a SAR, or both, and consequent diverging approaches across the industry. While some firms disclosed a SAR every time that a STOR is submitted, others did not disclose a SAR for attempted suspicious activity where no actual transaction had occurred. The review does not, in fact, offer express further guidance in this area. It notes that:
"We expect firms to have regard to their obligations under the Proceeds of Crime Act, for submitting a SAR, and the Market Abuse Regulation, for submitting a STOR. Reporting a STOR is a civil requirement and does not discharge a firm or an individual's legal obligation to report a SAR."
What is interesting, is that the review indicates that the FCA found "little evidence" that firms considered their market abuse surveillance and anti-money laundering (AML) transaction monitoring together. The review notes that some market abuse practices (for example, wash trading) may also be indicative of money laundering. Generally, firms did better where there was a growing synergy between the AML and trade surveillance functions, rather than where they operated independently of each other. Where larger firms had a lead relationship manager with oversight of a customer's overall transactions and their business model, the FCA considered this was helpful in terms of avoiding a siloed approach to market abuse and other financial crime monitoring.
The implication, therefore, seems to be that firms should take a holistic approach, and firms will need to overcome narrow organisational structures and responsibilities to achieve this.
Manual and automated transaction monitoring: A linear approach?
Is manual or automated transaction monitoring better? The review suggests that neither may be sufficient in itself, and therefore a combination of both seems preferable. The review notes that effective automated transaction-monitoring systems are particularly important, where there is no human involvement, where the trading is electronic. Having said that, automated systems for AML monitoring have their limitations, and the review notes that:
"Several participants told us that the most valuable monitoring of alerts or referrals came from manual monitoring or observation by the first line of defence rather than from systems."
Talking of transaction monitoring, the recent case of Linear Investments Ltd v FCA  UKUT 0115 (TCC) (FS2018/054), which reached the Upper Tribunal, highlighted the importance of STORs and effective post-trade surveillance systems.
Linear offers brokerage services to clients, and also acts as principal for a number of appointed representatives. Trading is primarily conducted via electronic direct market access (DMA), which Linear routes to its own broker for transmission to the market. The difficulty was that Linear's business model changed over time. At one stage, it operated on the basis that it could rely upon post-trade surveillance undertaken by underlying brokers. The FCA's view was that this was insufficient, and that Linear was also responsible for undertaking its own checks. Linear carried out limited manual oversight, but then the volume of trades routed by Linear to its brokers increased significantly, with tens of thousands of trades being reported per month, so that manual monitoring was no longer adequate. Linear then decided to install an automated post-trade surveillance system, but the deployment of the system did not proceed smoothly, the system had not been appropriately calibrated, with the result that Linear had to disable alerts on the automated system relating to insider dealing and spoofing for some periods, with no alternative surveillance in place.
Following the Upper Tribunal's decision, the FCA issued a final notice imposing a penalty on Linear of £409,300 for breaching Principle 3 of its Principles for Businesses by failing to maintain an appropriate control environment to detect and report potential instances of market abuse.
The Linear case highlights the importance the FCA (and the Upper Tribunal) attaches to firms carrying out effective post-trade monitoring, and also the importance of automated monitoring systems, and pitfalls in their installation.
The case is also interesting as it is one of the first cases involving a focused resolution agreement (FRA), where the facts were agreed by the firm and the FCA, but the penalty was disputed. The case is a good illustration of the FCA's five-step penalty policy. One of the key issues was the appropriate indicator for the level of seriousness of the breach. There is a considerable gap between the Level 2 (5%) and Level 3 (10%) in the range of seriousness, which in the Linear case amounted to a difference of some £324,856. Linear appears to have been slightly unlucky, as the Upper Tribunal stated that it was initially persuaded that the case was in the lower range of Level 3, but then appeared to change its mind, so that the full Level 3 10% factor was applied, as it held that the negligence was of a serious kind and in relation to a serious matter, and was a key failing in the firm's business model.
The FCA business plan and market abuse
Finally, it is worth noting that market abuse does feature in the FCA's planned activities in its Business Plan 2019/20, although it is not as prominent as some of the other themes.
The FCA's market abuse workstreams include:
- Continuing to work with issuers to increase their knowledge of MAR, and ensure that their systems and controls match the market abuse risks they and their investors face.
- Producing guidance on the assessment, handling and disclosure of inside information for other industry regulators and public bodies, which will support them in understanding their obligations under MAR.
- Focusing on key areas in firms' control frameworks, such as the control of inside information within M&A businesses and corporate broking functions. The chapter on the risks of insider dealing and market manipulation in the FCA's Financial Crime Guide (FCG) is referenced, and the FCA's supervisory engagement will focus particularly on surveillance of fixed income markets.
- Developing new monitoring and detection tools focusing on:
- delayed disclosure and misleading statements by issuers; and
- secondary market behaviour, including crossmarket manipulation, abuse in fixed income markets and equity insider dealing.
So, combatting market abuse remains a high priority for the FCA.
This document is published by Practical Law and can be found at: uk.practicallaw.com/w-020-9546