The UK Financial Services Authority is taking a hardline approach to insider trading, increasingly carrying out criminal investigations. But at the same time it is asking firms to work with it by providing information to build a bigger picture of what’s happening in the market Financial firms are at the frontline of the regulatory battle now being waged by the UK’s enforcement agencies against insider trading. The campaign indicates an increased strictness against the offence, as the agency unsuccessfully attempted to fight off government demands for its closure. Sources in the FSA have expressed concern about their ability to maintain their pressure against insider trading and market abuse once the UK government’s recently announced changes are implemented. The FSA’s enforcement unit, which prosecutes insider trading and market abuse, will be combined with the Serious Fraud Office and the Office of Fair Trading to create an economic crime agency. Tracey McDermott, the head of wholesale in the enforcement division at the FSA and a deputy to Margaret Cole, the head of enforcement, says information firms provide assists regulatory best practice and the efficiency of its policing of market behaviour. The division wants firms to report more rather than less and leave the decision whether to undertake the investigation to the authorities. “The markets are on the front line; they know what is going on, on a day-to-day basis. However good our monitoring systems are, we are always going to be looking at these things after the event,” says McDermott. “Firms might see something strange out there, in relation to this stock; or they might see people who keep coming out on the right side of making deals. We encourage people to share such information with us. Often you can add information to what we have. Again, it gives you a picture. We encourage people to do this generally, not only for market abuse cases, which have no relationship with the regulator. It is in everybody’s interest that the markets are clean.” McDermott says the report can either be informal, between the firm’s compliance officer and the FSA, or it can take the form of a suspicious transaction report (STR). But the important point is that it adds to the Authority’s information base. “There is an obligation to submit suspicious transaction reports. The institution must report orders placed that it believes are suspicious. It could be one of its clients buying at the last minute and then selling out the very next day. “Without that data, we find it difficult to feed into our own analysis and to follow up on our own inquiries. We need to know if the trade reported is a buy one or a sell, it will not give the same signal as to whether it is suspicious or not. There could be situations where there is not necessarily a trigger for one of those formal reports, but someone might tell us: ‘I have seen this going on, and I don’t really know who is doing it or what it is, but it looks a bit strange.’ We encourage them to tell us this because obviously we will have a lot of knowledge they don’t have.” This request for support from the regulated sector comes as the FSA steps up its campaign to bring insider traders to book. This campaign was most visibly demonstrated when 143 police, IT experts and financial investigators woke up members of the City’s great and good at the crack of dawn in March, took their computers and relevant documents from their homes and dragged them through a painful process of questioning. It would take the blindest or most hardened operator to fail to notice something had changed in London’s treatment of financial crime. When it emerged that the offence being investigated was not terrorist financing or drug money laundering but insider trading, any lingering doubts about London’s firmness of resolve would very quickly dissipate. The individuals were named as coming from firms as illustrious as Deutsche Bank, Exane BNP Paribas (the French broker) and Moore Capital, a hedge fund. These firms have said they are co-operating with the investigation and they deny participation in any illegality. The move was designed to send out a warning that the era of leniency was at an end. “There is a forceful crackdown going on at the moment in relation to commencing insider-dealing criminal investigations. This has been going on for a while,” says Sarah Douglas, a partner at law firm Irwin Mitchell. The view that insider trading has become a particular target of the authorities is confirmed by some recent successful prosecutions of insider traders. For example, earlier in the year, Malcolm Calvert, a former partner of leading broker Cazenove, was convicted of five counts of insider dealing and sent to prison. He had made £100,000 dealing in three stocks involved in takeovers. His accomplice had co-operated with the authorities. In another case, a young trainee broker at Hoare Govette, Mathew Uberoi, and his father were convicted of insider trading and sent to prison. Christian Littlewood, a former banker at Kleinwort Benson, and his Singaporean wife were also charged with insider trading. It is believed a number of further cases are in the pipeline. The campaign has been signalled by Hector Sants, the head of the FSA, who is set to join the newly restructured Bank of England, as a deputy governor. Sants has boosted the resources of the division, both financially and in terms of manpower. He has been quoted as saying market abuse is at the top of his agenda. His comments come as the FSA admits insider trading is a growing menace. He has said he actively seeks publicity for the FSA’s campaign against market abuse and insider trading: “We do want publicity. We do want people to be afraid, to say, ‘Hold on, maybe I don’t want to do this. Maybe the FSA will catch me’.” New figures published from the FSA show insider trading has risen to its worst level in six years. Of the 144 takeover bids launched in the year to April, the FSA identified suspicious activity before 44 deals. The number has risen by almost a third since 2008. It has not reached these levels since 2004. As concerns grow about the City’s reputation, City firms welcome the FSA’s new drive says Simon Morris, a lawyer at CMS Cameron McKenna. “The FSA is saying financial crime is a major threat to the UK market. If the UK is not viewed as a clean market, it will wreck confidence and we are all losers. The markets welcome this initiative because a clean market is a prosperous market.” Controlling the flow and possession of information is critical to any system that seeks to guard against insider trading. Possession of information should be limited to those who need to know, says McDermott. Moreover, access to information should be restricted to those that need to know it at any one time and access to sensitive information needs to be constantly reviewed, in line with changes in an individual’s role or the status of the deal. “One thing we have flagged a number of times is simply the number of insiders on a transaction,” she says. “The more people there are, the more risk there is of a leak, whether deliberate or inadvertent. That is really one of the biggest challenges, controlling who really needs to know because of their specific role rather than those for whom it might be merely convenient to know. People should also not be kept in the loop for longer than they need to be. You might need someone in at the beginning of a transaction, but then the transaction might change. Then you might not need their particular technical expertise. So do you keep copying them in on stuff or do you take them out again? Apart from practical things like that, you should also think in terms of your support teams, such as IT people. How do you control them? Are they on your inside as well?” Peter Haines, who runs a consultancy advising the compliance management in financial institutions, says a large onus falls on the compliance department. “You need to control the flow of insider information; you need Chinese walls or ‘information barriers’ to prevent the flow of such information; you need watch-lists that will contain that information, and will be highly confidential, and monitors of the watch-list of all stocks on which the firm has information,” he says. “For example, any unpublished takeover bids being worked on, any rights issues, or bonds or securities will be on a watch-list. These are not circulated within the firm. Many corporate financiers or investment bankers would know individual items on the list, but they would not know the whole thing. Chinese walls include the philosophy of ‘need to know’ – you are not told insider information unless you have a need to know, or you are involved in the deal. The compliance function alone should have all this information on one list.” These lists can easily be extensive, including not only the names of bankers handling a deal, but also the lawyers and accountants advising on the deal, managers and directors overseeing the institutions and even the printers handling the prospectus. The task of matching names to (usually quite legitimate) trades is onerous and fraught with complications. Firms are advised to keep their lists up to date and comprehensive as regulators will demand them when there is a hint of any insider trading, says Haines. Failure to deliver a comprehensive document will attract censure. “The regulators will want a list of everyone who was aware of a deal, if they see something untoward going on. It is the first scan after spotting something suspicious. They will go to the advisory bank concerned, or the securities firm where they see deals emerging. They will see who was an insider, who was aware, and they will get that list. It would often include dates of when people were aware of information.” The heavy hand of the regulator is evident in the quality of documentation it demands, says Chris Bates, a partner at law firm Clifford Chance. “We have seen over the past decade much heavier focus on documented policies. This is reinforced by the FSA’s increasing use of its Section 166 powers, to appoint skilled persons to investigate firms at their own expense. This is a remedy that is used quite widely. It effectively requires the firm to appoint an accountant or someone to report to the FSA on the firm’s policies, procedures and practices. Reports typically focus on a firm’s own policies and the extent to which they are documented. Historically the emphasis is on policies that are visible to the front office; people also ask about the policy when the matter was ‘reported to compliance’.” Information distribution and sharing is likely to reflect an organisation’s structure and internal relationships, says Wolfgang Fabisch, the managing director of b-next, a German compliance software producer. “We do not look at one single silo within the bank. We look at the whole bank and the compliance officer gets the chance to understand if there is something connected between London, Singapore and Frankfurt. There might be something going wrong between their security and their bond departments. They need to ask two questions. One, is there a pattern that seems to be suspicious? And two, are one of our key rules being violated? Is there somebody who is working on an merger transaction, doing his own business? Maybe it is for himself, or for friends or family. They really want to understand what is going on.” Changes in definitions of insider trading and market abuse are yet another challenge for the regulated firm operating in the securities markets. Bates says the FSA is “pushing out the boundaries of what amounts to price-sensitive information”. He cites the case of two investment managers from Kleinwort Benson who were censured for trading while in possession of information about a new issue of debt securities. “The information didn’t appear to be price-sensitive in the classic sense. In other words, it was not likely to cause material change to the price of the securities. Yet it was seen as inside information because it was information a reasonable investor would have been likely to use as a basis for their investment decision. That is the so-called ‘reasonable investor’ test. This creates more difficulties for firms managing information, because it is less easy to identify what is relevant for investors, and what is price-sensitive to the market.” Even the best systems are open to abuse, and the employer is likely to be helpless, says the FSA’s McDermott. “No matter how brilliant your systems of control are, if someone is determined to flout the rules, to act in a dishonest way – as in every other case of fraud – then there is not a lot employers can do to stop it. Employers can certainly make it a lot more difficult, by discouraging it, and making it clear that, when someone does it, it was obvious that they were trying to get round a clear and defined system.”...
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