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 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 2020, Ian considers developments in market abuse over the COVID-19 period.
To read Ian's previous columns, see Practice note, Ian Mason's market conduct columns.
Developments in market abuse over the COVID-19 period
In my column this month, I consider some updates from the Financial Conduct Authority (FCA) on its expectations on market abuse, and a helpful best practice note on inside information. The FCA has also provided updated information on reporting market abuse, including a new report for submitting a market observation. I also review a recent important litigation case which considered the FCA's and London Stock Exchange's role in investigating market manipulation.
The FCA's expectations on increased risk of market abuse resulting from COVID-19: Market Watch 63
COVID-19 has presented many challenges and one of those challenges is the increased risk of market abuse. This impacts on listed companies, regulated firms and other market participants. In Market Watch 63 (published on 27 May 2020), the FCA highlighted the increased risks of market abuse, and its expectations around what actions it expects listed companies and firms to take. As companies seek to raise capital in difficult conditions, there needs to be a particular focus on controls around inside information. With most office-based staff working from home, the normal controls around the protection of inside information will be weaker. There is a higher risk that confidential documents are left lying around the home or are not disposed of securely. Some firms prohibit the printing of work-related documents at home. In addition, the current volatility of financial markets makes suspicious patterns of trading or transactions harder to spot. It has not been clear what is "normal" in some markets. Firms will need to need to consider what the "new normal" is in relation to parameters previously set for price changes or profits generated.
Due to home working, some firms are also finding it harder to record telephone calls for market monitoring purposes. The FCA has stated that where firms are encountering difficulties, they should notify the FCA, and conduct other forms of enhanced monitoring, and retrospective reviews after the situation has been resolved.
In Market Watch 63, the FCA also highlighted the potentially heightened risks of personal account dealing (PAD) for staff working from home, and recommended that firms should consider and ensure that they have appropriate controls around PAD in accordance with COBS 11.7 and 11.7A, including assessing how they manage conflicts of interest and the risk of market abuse. This follows on from the FCA previously highlighting its concerns about PAD in Market Watch 62, so this is clearly an area where the FCA has identified some problems in firms.
FCA Best Practice Note on inside information
In June 2020, the FCA published a final version of its Best Practice Note on identifying, controlling and disclosing inside information as part of FCA Primary Markets Bulletin No 29. Although intended primarily for government departments, industry regulators and public bodies to help them in complying with the relevant obligations under the Market Abuse Regulation (596/2014) (MAR), it is a helpful and concise summary for market participants generally.
Some interesting points are highlighted in the note:
- Minimise the number of people classified as "insiders" so that a "need to know" basis is applied. A smaller population of insiders is easier to monitor, and reduces the risk of inadvertent disclosure. Some companies operate a large list of "permanent insiders" who may as a result of their position have access to inside information, but do not actually on closer examination actually possess inside information. This is not to be encouraged.
- On timing of announcements to the market, the note states that in circumstances involving issuers with financial instruments which are traded on other markets outside the UK, or in more than one jurisdiction involving different time zones, it may be appropriate to take this into account when planning the timing of the announcement, to minimise its impact.
- For public bodies subject to the Freedom of Information Act 2000 (FOIA), disclosing inside information following a FOIA request will not in itself make the disclosure lawful. The relevant body will first need to be satisfied that the disclosure would be lawful under Article 10 of MAR. The note references the relevant exemptions within FOIA and the need for the relevant bodies to seek legal advice in this area.
Reporting market abuse
In June 2020, the FCA updated its webpagefor reporting market abuse . As well as highlighting the need for firms and trading venues to submit a market observation to notify the FCA of activity they have observed in the market that is not required to be reported by way of a suspicious transaction or order report (STOR), the FCA appear to have devised a new form of report, known as a "market observation". This could arise, for example, where the firm or trading venue is not involved in the activity and therefore does not have complete information. The report is made through a notification on the FCA's Connect system.
Presumably, the reporting of a market observation is voluntary (compared with making a STOR which is a regulatory requirement). However, it will be interesting to see whether, on supervision visits, the FCA reviews whether a firm has made any market observation reports (as well as reviewing the number of STORs made).
From the FCA's perspective, one can understand why it may be useful to receive a market observation, as this may be a potential indicator of suspicious activity, and while the firm may not have the complete picture, the FCA may be able to build up a broader picture with the huge volume of data now reported to it as a result of MiFID II.
Investigating market manipulation: Burford v London Stock Exchange
The judgment of the Commercial Court given recently in Burford v London Stock Exchange  EWHC 1183 (Comm) is an important decision in financial services regulation, and the role of the FCA and the London Stock Exchange in investigating possible cases of market manipulation.
Muddy Waters, a US investment advisory business, had engaged in short selling (lawfully) in the shares of Burford, a litigation funder. Burford's share price had fallen significantly over the relevant period. Burford alleged that the price had fallen not only because of the short selling, but also because its share price had been impacted by unlawful market manipulation, and in particular alleged "spoofing" and "layering". Specifically, Burford alleged that a large number of sell orders in Burford shares were submitted without any genuine intention to trade, which gave (or were likely to give) a false or misleading impression of the market in Burford's shares. This would have breached MAR. Burford was seeking a disclosure order (known as a Norwich Pharmacal order) to require the Exchange to disclose the identities of those trading in its securities over the relevant period so it could further analyse the trading data and institute claims against any wrongdoers.
The court (Andrew Baker J) rejected Burford's case and held that there was no "good arguable case" that market manipulation had occurred. The court noted that both the FCA and the Exchange had reviewed the trading in Burford's shares over the relevant period and concluded independently and after detailed investigations that there was no evidence of spoofing and layering. The judge noted that Burford had, as part of its case, launched a highly critical attack on the motivations and competence of the FCA and the Exchange, questioning their seriousness, resources and aptitude in the battle to detect and take action against market abuse. He stated: "I am not persuaded that any of those criticisms was justified". This will be a welcome relief to the FCA and the Exchange. It could also have undermined their regulatory role if disclosure of confidential client data had been ordered.
The judgment also contains a helpful detailed analysis of the relevant MAR provisions on market manipulation. The judge found that, in terms of giving false or misleading signals as to supply, demand or price, this could not always be an entirely objective enquiry, as it depends upon the signal given out (or likely to be given out) by a particular activity or behaviour. Depending on what that signal is (an objective question), falsity might involve some subjective enquiry.
Since the FCA has stated that it is investigating a higher proportion of market manipulation cases, and that these now comprise 40% of market abuse investigations (see my April 2020 column), this case will be a helpful precedent and source of reference for the future.