The FCA has fined Linear Investments Limited ("Linear") for failings in its risk management systems in relation to the detection and reporting of potential instances of market abuse. The failings spanned the period from January 2013 to August 2015 (the "Relevant Period"). Significantly, through a focused resolution agreement with the FCA, Linear accepted the facts and agreed liability at an early stage, therefore qualifying for a stage 1 discount. However, Linear has now elected to appeal to the Upper Tribunal (on the question of penalty only). The FCA has sought a penalty of £584,700, reduced to £409,300 following the stage 1 discount.
During the Relevant Period, one service provided by Linear was electronic Direct Market Access (DMA) for its clients. This involved Linear entering into arrangements with wholesale brokers, who would execute the orders on behalf of Linear's clients. The FCA noted that this arrangement meant that Linear had little "front office" engagement with the trading and that therefore it was reliant on "compliance based" surveillance to discharge its obligations. This took the form of manual oversight after the trading. The FCA found that the volume of DMA trades being executed by Linear grew very substantially during the Relevant Period and that its existing manual controls were not proportionate or adequate to meet these increased volumes.
In particular, the FCA found that up until November 2014, Linear had relied on the post-trade surveillance for market abuse undertaken by the underlying brokers to discharge its own regulatory obligations. Whilst Linear had provided further information to the brokers to the extent requested, it had not conducted its own post trade surveillance. The FCA determined that, irrespective of the controls put in place by the underlying brokers and the co-operation between Linear and the brokers, Linear had an obligation to conduct its own adequate checks on the trades based on the information available to it. Linear's failure in this regard was found to be in negligent breach of Principle 3 of the FCA's Principles for Businesses and SYSC 6.1.R (requirements for adequate risk management systems and systems for countering the risk that the firm will be used to further financial crime, respectively).
Whilst Linear became aware of its failings in November 2014, it was not able to quickly remedy them. Its initial project to build its own in-house system was aborted and it did not buy-in an automated post-trade surveillance system until May 2015. Linear then had to calibrate this system. This process involved Linear shutting-down certain aspects of the system from time-to-time, namely the alerts for suspected spoofing and insider dealing. The FCA determined that whilst these alerts were disabled, Linear was effectively incapable of detecting market abuse and insider dealing. The system was not fully up and running until August 2015 (the end of the Relevant Period). The FCA accepted that these issues between November 2014 and August 2015 were to an extent unforeseeable and indeed treated the quick action of Linear as a mitigating factor when calculating penalty.
The FCA noted that it has been repeatedly clear, through its Market Watch publication and through letters sent to all authorised firms in December 2014, that firms have to have in place systems and controls to identify and prevent market abuse and to notify the FCA of concerns (which were during the Relevant Period set out in the SUP chapter of the FCA Handbook). This included a reminder in Market Watch 46 that under ESMA guidelines (Guideline 8), firms providing DMA are responsible for ensuring that client trading is compliant with regulation. Whilst Linear sought to argue that its failings were at worst inadvertent (rather than negligent) and even that the FCA had itself been ambiguous in its communications on the subject, this was not accepted.
Focussed resolution agreements have been available since early 2017, in an attempt to increase the efficient progress of cases through the system, but this is the first published case of one being successfully entered into. It is in a sense not an obvious case for partial settlement. Whilst the fine is no doubt significant, the relevant failure was long-running, systemic and (at least as the FCA saw it) posed a risk to the integrity of the UK markets. As such, the fine does not seem out of step with what might have been expected. Also, even if Linear succeed in bringing about a reduction in the fine, this saving will have to be set against the costs of contesting penalty and now an appeal to the Upper Tribunal.
Based on the representations it made to the RDC on penalty, the core of Linear's appeal will likely relate to the FCA's assessment of the seriousness of the breach and mitigation (steps 2 and 3 in its 5 step penalty setting process). This includes taking issue with the appropriateness of using a gross revenue figure (for the Relevant Period), rather than a net figure or some better indicator of the harm or potential harm caused by the breach. Linear noted in this regard that the FCA had not been able to identify any actual harm, such as instances where Linear should have submitted a suspicious transaction report but failed to do so because of its systems and controls.