The FSA’s zeal for enforcement has continued unabated. What is particularly noticeable about this last four month period however is the impact that that zeal is set to have on the future.
In the short term, the FSA’s successes are emboldening it to continue its aggressive enforcement plans. Moreover, enforcement will in our view increasingly arise from the thematic reviews the FSA is undertaking. Medium term, its successes have been seized on by the Government in its plans for the new regime. As we report below, the Government is set to build on the FSA’s credible deterrence approach, making it a key pillar of the new regime.
On the Horizon
More criminal cases going through the system
As at 22 March 2011, the FSA’s Business Plan states that 17 defendants have been charged in four pending criminal cases coming up in 2011 and 2012. We report elsewhere in this issue on the FSA Business Plan. (See On the Horizon: FSA's 2011/2012 Business Plan shows no let up in enforcement)
Government sets out its stall for enforcement under the new regime
Most people are aware by now that the FSA is due to be broken up by the end of 2012, to be replaced by two new regulators – the Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA). In February this year, the Treasury issued a consultation paper about the new regime. Its proposals indicate that enforcement is likely to play a big part in the new regime. We draw attention to the following aspects of the paper in particular.
- The Government believes that, under the current regime, regulation of financial services has not always received the attention it requires. It sees the need for a new credible regime. It welcomes the FSA’s strategy of “credible deterrence” and makes it clear that strong enforcement and credible deterrence will be a key pillar of the FCA’s approach.
- Although it has recently had a shift in focus, the FSA has historically tended to act only after detriment has been suffered. The FCA is looking to develop a new model of early and proactive intervention. This will involve, for example, issues based supervision playing a major role, with the FCA examining issues that affect a whole sector, subsector or type of product. The Treasury makes it clear that where issues based supervision identifies problems in individual firms, enforcement action can follow. In our view, issues based supervision is bound to result in increased enforcement action, indeed of a type already seen from the FSA.
- Perhaps most controversially of all, the Treasury wants to legislate to permit it to publish details of enforcement action much earlier than currently. Currently, it may in effect only do so towards the conclusion of a case and, even then, only provided that an adverse finding is made. The Treasury’s rationale for early publication is that it will highlight possible issues to consumers at an early stage, and highlight to firms what behaviours it considers unacceptable. However, it seems to us that early publication carries great risks for the subjects of the enforcement action. They might find the allegations against them unproved but, in the meantime, have lost their business or their reputation as a result of early publication. The Treasury’s suggested safeguards against this appear extremely limited.
FSA presses on with enforcement sanctions changes
In Enforcement Watch 3, we reported on the FSA’s consultation on changes to the Decision Procedure and Penalties Manual and Enforcement Guide. (Looming changes in enforcement sanctions) In February 2011, the FSA published its Policy Statement on the matter, indicating that it had decided to proceed with all proposals in broadly the same terms in which they were initially proposed. The following two matters are of particular interest.
First, the FSA proposed a rule prohibiting firms (save for sole traders) from paying a financial penalty imposed on a present or former employee, partner or director of the firm or an affiliated company. This was no doubt intended to deter individuals from wrongdoing by ensuring that they are personally accountable. Unsurprisingly, this rule went through. The FSA has added two glosses to the rule. The first is that the rule does not prevent firms paying penalties imposed on an affiliate. What they must not do however is to pay fines imposed on an employee etc of an affiliated company. The second is that the rule does not prevent firms from indemnifying employees for the costs of defending an FSA enforcement action. Whilst unsurprising, and clearly sound from a policy point of view, the fact that the FSA has chosen to spell these out is helpful.
Second, there have been some interesting developments concerning the publication of Decision Notices. A Decision Notice is broadly speaking a finding of the FSA internal tribunal (the RDC). If the Decision Notice is not appealed to the Upper Tribunal, it becomes a Final Notice and is binding. If, however, it is appealed, it is then up to the Upper Tribunal to make a finding instead. The Financial Services Act 2010 permitted publication of Decision Notices. The FSA consulted on its proposed approach to publishing Decision Notices. Most respondents disagreed with the proposed approach, although to little avail.
The publication of a Decision Notice could have a serious reputational impact on the subject of the Notice, particularly unwarranted where the Decision Notice is subsequently overturned by the Upper Tribunal. The FSA, however, considers that the benefits of publication outweigh the risks of doing so. Accordingly, whilst it states that it will not publish if it would be unfair to do so, it makes it plain that its expectation is that it will normally publish a Decision Notice if the subject of it refers it to the Upper Tribunal. One concession made is that the FSA will now tell the recipient (and any relevant third party) of the Decision Notice that it intends to publish and that it will consider any representations made to it regarding publication. Negative impact on reputation will not be sufficient to prevent publication.
The move towards early publication is echoed in the Treasury consultation on the new regime. The Treasury consultation goes much further however and provides for publication at a far earlier stage of proceedings. See On the Horizon: Government sets out its stall for enforcement under the new regime.
Retail Conduct Risk Outlook spells out FSA areas of concern
On 28 February this year, the FSA published its first ever Retail Conduct Risk Outlook (RCRO). Consistent with the FSA’s more proactive interventionist approach, the purpose of the RCRO is to identify risks and intervene before customer detriment is suffered. It informs how the FSA will set its priorities and deploy its resources. In doing so, it highlights areas in which we might well see future enforcement activity. The FSA considers that current issues include:
- the sale and marketing of structured investments The FSA is concerned to ensure that the design, marketing and distribution of these products results in consumers being provided with suitable products which are marketed to them in a way that is clear, fair and not misleading. (Readers will recall that the FSA’s review into the marketing and sale of Lehman backed structured investment products found many failures, including that advice was unsuitable in nearly half of all cases assessed. This led to enforcement activity. See Enforcement Watch 1: Heavy Penalties in respect of structured products and pension switching.)
- the sale and marketing of structures investments and deposits. The FSA is similarly concerned in relation to structured deposits.
- complaints handling in major banks. In April 2010 the FSA published a review into Complaints Handling in Banking Groups which found poor standards in most of the banks that were assessed. See Enforcement Watch 1: Poor Complaints Handling. The FSA attribute these poor standards to the wrong culture at the banks and a lack of adequate systems and controls. Enforcement activity was then seen. See Enforcement Watch 3: RBS and Natwest fined £2.8m for poor complaints handling . The FSA's focus for 2011 will be to make further intensive and intrusive assessments of banks whose processes remain a concern and to take enforcement action if required.
The FSA considers that emerging risks include:
- implementation of the Banking Conduct of Business Sourcebook/Payment Services Directive. Early reviews by the FSA suggest that there is widespread failure by banks to engage with the new regime. One area of concern relates to poor conduct in the context of refunding unauthorised transactions. The FSA states that it will continue to review compliance with the new regime and to take enforcement action as it sees necessary.
- Specific products that constitute emerging risks includes unregulated collective investment schemes (UCIS). The FSA’s research suggests that UCIS are increasingly being sold to consumers who are not eligible or appropriate for them. The FSA’s concerns include:
(i) that investment managers advise on and manage UCIS without any regard for the suitability of these products;
(ii) that intermediaries are promoting UCIS to retail clients without regard to the statutory limits on such sales;
(iii) that UCIS are being promoted to ineligible investors by intermediaries who do not understand the product;
(iv) that unsuitable advice is being provided.
The FSA undertook a thematic review in relation to UCIS and found a lack of understanding in firms (both investment managers and advisers) of the restriction on the promotion of such products. See elsewhere in this edition of Enforcement Watch for action taken last month in precisely this area, see 14 April 2011: Thematic UCIS visit leads to Enforcement Action.
The FSA considers that risks that might emerge in the future include:
- Risks associated with bundling and cross-selling of products. Banks are offering bundles of fixed term deposit accounts with investment products (e.g. a capital at risk bond). The FSA is concerned that bundling can lead to increased complexity for consumers to understand and to increased switching costs. It is also concerned that an attractive interest rate might attract customers for whom the bundled investment product is unsuitable. The FSA expects firms to have strong point of sale and other controls to ensure that products meet the needs of the investor/depositor.
- Risks associated with cross-selling. Over the past year, banks have sought to increase their cross-selling, usually using current accounts and mortgages for cross-selling strategies. Whilst there can be advantages, it does create risks of mis-selling and product design risks, identified by the FSA. It spells out what is and is not acceptable.
The RCRO is in some respects a useful guide to where firms can expect the FSA to focus attention on intervention and, accordingly, where enforcement activity may well result in the next year or years.
FSA's 2011/2012 Business Plan shows no let up in Enforcement
The FSA's Business Plan for the year 1 April 2011 to 31 March 2012 (published on 22 March 2011) shows no let up in enforcement. Indeed, in his opening remarks, Chairman Lord Turner talks of the recent “revolution in FSA effectiveness as [it has] built a credible deterrence approach based on a far more robust use of [its] civil enforcement and criminal prosecution powers.” The Business Plan makes it clear that the FSA (and its successor bodies) will continue that approach. We detail below the enforcement issues coming out of the Business Plan.
The FSA has a wide ranging commodities agenda for 2011 and 2012, likely to result in enforcement action. Hector Sants (Chief Executive of the FSA) states that the FSA’s principal objectives in respect of commodities trading markets are to combat market manipulation and to control or limit price movements.
The FSA proposes to use enforcement powers to reduce market abuse, particularly insider dealing. It trumpets its success to date, including a record fine on an individual of £2.8m in May 2010. See Enforcement Watch 1: New Record Individual Fine for Market Abuse. It explicitly states that it will develop its civil enforcement caseload of market abuse and transaction reporting cases, and that it will further its new penalties policy published in March 2010. See Enforcement Watch 1: Harsher Penalty setting Introduced.
The FSA also proposes to undertake a programme of thematic work to review anti market abuses systems and controls in certain key areas. The 2011 focus is set to include discussions on controls over pre-soundings, improving the quality of suspicious transaction reports (STRs), work on high frequency trading and a review of regulatory issues caused by market fragmentation. As with most FSA based thematic reviews, we consider that increased enforcement activity is almost certain to follow.
As at the date of the Business Plan, 17 Defendants had been charged with criminal offences in four cases pending for trial in 2011 and 2012.
There is also tough talking on consumer protection. The FSA refers to its March 2010 new consumer protection strategy with earlier, more robust, supervisory interventions, backed up with stronger enforcement and a focus on redress. It makes clear that it will continue to take strong action to protect consumers, including prompt redress.
The FSA will take tough action where it finds evidence that firms have been failing to meet it standards and consumers have lost out or are at risk of losing out. It expects its 2011 investigations to include:
- mis-selling of structured products
- insurance fraud
- failure to treat customers fairly in relation to mortgage arrears; and
- firms failing to provide proper protection for client money or client assets.
We have seen client assets enforcement action in such cases before, and the FSA is clearly signalling that we are likely to see more. See Enforcement Watch 2: The FSA Gets Tough on the Client Money Rules.
Increased enforcement activity in relation to wealth management is possible. The FSA has been carrying out a review of the suitability of wealth management firms’ clients’ portfolios, covering both discretionary and advisory services. It has seen poor results in many firms in the first stage of the review. Increased enforcement activity is possible, especially where the issues in a firm are systemic.
The enforcement and financial crime budget for the year is up from £66.1m to £67.8m. This follows last year’s 23% increase.
Serious market abuse case provides interpretation of offence
2 February 2011:
David Massey was a corporate financier who, it was alleged, had used inside information in effecting a short sale that netted him a profit of just over £100,000. The FSA’s internal tribunal (the RDC) found that Massey had engaged in market abuse, fined him £281,474 and banned him. Massey appealed to the Upper Tribunal, who also found that he had engaged in market abuse. The Upper Tribunal fined him less (£150,000), although it did also ban him. The case threw up some new analysis on the meaning of market abuse.
Details of the case
Massey previously worked as a consultant at Eicom plc. Eicom was a company traded on AIM, whose stock was relatively illiquid. At the time of the trading in issue, Massey was employed at Zimmerman Adams International (a corporate finance advisory firm).
Eicom had issued an RNS in November 2006, about its arrangement for raising working capital up to £2.7m by issuing five tranches of new shares at a 45% discount. Save for one small drop in price, none of the announcements of the take up of the tranches caused any drop in Eicom’s price. Part way through, the company raising the money went into administration and Eicom was left with a shortfall of £800,000 to raise.
In late October 2007, Eicom offered Massey an option under which it would issue 3m shares to him at 3.5p. In knowledge of this, Massey agreed to sell Shore Capital 2.5m shares at 8p per share. Shortly afterwards, he exercised his option to purchase 2.6m shares at 3.5p. Then, on 2 November 2007 Massey instructed that up to 100,000 shares in Eicom be sold at 8p.
On 2 November 2007, Eicom issued two RNSs. The second RNS announced the discounted issuing of shares at 3.5p (both to Massey and to another purchaser) at an average discount of nearly 60%. After seeing the second RNS, two of three market makers moved their prices downwards. The FSA’s internal tribunal (the RDC) found that Massey had engaged in market abuse, fined him £281,474 and banned him. Massey appealed to the Upper Tribunal on a variety of grounds. Those of main interest are covered below.
The information in question as possibly giving rise to market abuse was the information about Eicom’s willingness to issue 3 million shares at 3.5p. This information was in line with, but not the same as, information that was generally available concerning Eicom.
Massey argued that the information was not sufficiently “precise” under the terms of the Act1. An interesting part of the judgment concerns the meaning of the word “precise”. The Act states amongst other things that it must be “specific enough to enable a conclusion to be drawn as to the possible effect of [circumstances that it indicates exist or may reasonably be expected to occur]2”. The Upper Tribunal considered how definite the conclusions about impact needed to be. For example, whereas “specific enough to enable a conclusion to be drawn" suggests a strong requirement of being definite, that is diluted by the phrase “possible effect”. Did it for example mean that it was enough that it could have a possible effect on price, even if it was not known whether it would more likely be an increase or a decrease? It concluded that a possible effect on price must relate to an effect in a particular direction. In the Massey case, an effect on price was possible and, if so, it would no doubt be a price decrease. The Upper Tribunal concluded that the information was sufficiently precise.
The next issue was whether such information was “inside information” for the purposes of the Act. Massey argued that it was not. Inside information under the Act is information likely to have a “significant effect”3 on price. The Upper Tribunal concluded that “significant effect” did not bear its ordinary meaning. Instead, it concluded that there was an extended meaning of the phrase by virtue of another part of the Act that states4: “Information would be likely to have a significant effect on price if and only if it is information of a kind which a reasonable investor would be likely to use as part of the basis of his investment decisions.” The Upper Tribunal found that, as long as a reasonable investor would be likely to use the information as part of the basis of his investment decisions, that alone was sufficient to constitute inside information. In other words, it was not a requirement that the information would be likely to have a “significant effect on price” as that term is usually understood. In this case, it found that the information was inside information.
Massey would have had a defence if he could have shown that he believed on reasonable grounds that his behaviour did not fall within the definition of market abuse. The Upper Tribunal accepted that he genuinely believed that it did not. However, it concluded that “wishful thinking” was not the same as having a belief on reasonable grounds, and accordingly the defence was not made out.
The Upper Tribunal imposed a penalty of £150,000. This was just over half of the penalty originally imposed by the RDC (£281,000). This was because, whilst the RDC considered that Massey traded knowing full well that he was committing market abuse, the Upper Tribunal took a very different view, deciding that he was guilty rather of wishful thinking. Nevertheless, the Tribunal also imposed a prohibition, although it made clear that this may not be a lifetime ban.
This is an important case as it provides an interpretation of critical aspects of the ingredients of this type of market abuse. However, we are not convinced that the Courts would adopt the same interpretation of this part of the Act as the Upper Tribunal has done. However, as the matter was not referred to the Court of Appeal, we shall not hear what it has to say on the matter, at least not in relation to this case. In the meantime, the above is the best guidance that there is on the meaning of this part of the Act.
1 : The Financial Services and Markets Act 2000
2 : Section 118C (5)
3 : Section 118C (2)
4 : Section 118C (6)
Christian Littlewood sentenced
2 February 2011:
We reported in Enforcement Watch 3: The FSA continues to pursue criminal proceedings, that a senior investment banker (Christian Littlewood) and his wife pleaded guilty to insider dealing, as a result of which they were alleged to have made £590,000 profit, and that sentencing was due to take place later. The offences related to shares in a number of LSE and AIM listed shares between 2000 and 2008.
Sentencing has now taken place. Christian Littlewood was sentenced to three years and four months in custody, his wife to 12 months suspended for two years and a family friend to two years in custody.
These are the longest sentenced imposed to date. They are a very real expression of the FSA’s desire to tackle insider dealing and market abuse by the use of “credible deterrence”.
FSA bans individual for performing controlled function without approval
7 February 2011:
Daniel Hassell has been banned from working in regulated financial services. He knew that the FSA was not satisfied that he was a fit and proper person to perform a significant influence function, yet he performed such a function for four years without obtaining FSA approval.
Details of the case
We reported in Enforcement Watch 2 the case of Vantage Capital Markets LLP (VCM). (Performing controlled functions without approval) VCM was an interdealer broker, that was fined £700,000 for allowing Hassell to carry out a controlled function without approval.
At the time of its authorisation, VCM applied for Hassell to be an approved person as a partner at Vantage. However, he was the subject of an FSA investigation and, after the FSA informed VCM of its concerns, VCM withdrew the application. The FSA then discontinued the investigation and VCM applied again for approval for Hassell. The FSA indicated that it would not approve Hassell to perform a significant influence function and VCM again withdrew its application in respect of him. However, in reality, Hassell continued to exercise significant influence over the firm, despite being described as a "consultant". The FSA concluded that he was in reality performing the controlled function of partner. It made a prohibition order against him on the basis that his actions demonstrated a lack of integrity such that he was not fit and proper.
The FSA has shown how seriously it views Hassell's actions by making a prohibition order against him. In the first and second editions of Enforcement Watch, we commented that legislative changes would in future permit the FSA to fine individuals who perform controlled functions without approval, rather than simply the firms that permitted them to do so. Personal liability is important to the FSA’s message of credible deterrence. The legislation was not in place at the time that Hassell carried out his activities. Had it been, the FSA would no doubt have imposed a substantial financial penalty on Hassell in addition to his ban. Serious punishments for such culpable behaviour can be expected in future.
Client asset review leads to further enforcement action
15 March 2011:
ActivTrades Plc is a broker specialising in foreign exchange and CFD's. In relation to its handling of client money, it breached both Principle 10 (Clients’ assets) and Principle 3 (Management and control). It was fined £85,750 (after taking account of a stage 1 discount of 30%).
In addition, on 9 May 2011, the FSA fined its head of compliance David McGrath £3,000 (reduced from £20,000 on the basis of a stage 1 discount and discount for financial hardship) and made a prohibition order against him in relation to his performance of the CF10 role (compliance oversight).
Details of the case
ActivTrades was in breach of Principle 10 of the FSA’s Principles for Business in failing to arrange adequate protection for consumer assets. It failed to: (i) segregate client money and ensure that it was not holding client money in its own bank accounts; (ii) perform client money calculations/reconciliations accurately and in a timely way; (iii) pay interest on client money; (iv) confirm in its client agreement the circumstances in which money would cease to be treated as client money. This resulted in breaches of various CASS rules.
Furthermore, ActivTrades breached Principle 3 of the FSA's Principles for Businesses in that it failed to organise its affairs responsibly with adequate risk management systems. In particular: (i) there was a failure to ensure that adequate policies and procedures were in place in relation to client money; (ii) there was a failure to provide senior management with reports regarding the adequacy of systems and controls in place in relation to client money.
No ActivTrade customers suffered any loss, but client money was put at risk in the event of ActivTrade’s insolvency.
As for McGrath, he was the compliance officer at the firm for part of the relevant period. The FSA determined that he failed to ensure that ActivTrades complied with the relevant CASS rules. This included a failure by McGrath to demonstrate an appropriate knowledge of the CASS rules, to implement risk management systems or to provide the ActivTrades board with regular management information to enable them to monitor the firm's compliance with CASS rules. McGrath relied heavily on the services of an external consultant to fulfil his duties. However, he did not ever evaluate the quality of the advice he was receiving nor whether it was reasonable for him to rely upon it.
There have been a number of client money cases reported on in previous editions of Enforcement Watch, with very significantly higher fines. The ActivTrade case, however, is interesting for two main reasons. First, it shows that client money cases have continued to be pursued by the FSA.
Second, the case came about as a result of a thematic review initiated by the FSA. The FSA visited ActivTrades as part of a thematic review into the management of client assets and money held by firms. Based on the FSA’s initial findings, ActivTrades was required to engage a skilled person under s.166. The skilled person identified a number of failures, ultimately leading to enforcement action. This is a good example of how the FSA’s relatively new thematic approach is likely to uncover shortcomings at firms, which in turn is likely to lead to more enforcement action than the FSA’s previous approach did.
Thematic UCIS visit leads to enforcement action
14 April 2011:
IFA Specialist Solutions Limited (SSL) has been fined £35,000 (after applying a 30% stage 1 discount) for failings relating to the sale of unregulated collective investment schemes (UCIS). The failings were first brought to light in an FSA thematic visit to SSL relating to the promotion of UCIS.
Details of the case
The FSA visited SSL in February 2010 as part of a thematic review into the promotion of UCIS. Following the visit, the FSA raised concerns about recommendations that SSL had given to its customers to invest in UCIS. During the relevant period, SSL had advised approximately 3000 customers, advising 101 of them to invest in one or more of three UCIS. The total invested was just over £11m.
In October 2010, the FSA required SSL to appoint a skilled person under s.166 FSMA to review the firm’s promotion of UCIS and advice given to customers about UCIS. The skilled person reviewed the 101 customer files and found a number of failings.
The FSA found breaches of Principle 3 (Management and Control)5 as follows in relation to UCIS:
- in each of the 101 files, SSL had promoted a UCIS without first determining whether the customer was eligible to receive a promotion pursuant to an exemption. In fact, it turned out that almost half were not eligible;
- SSL’s internal compliance procedures made no specific provision for the rules regarding the promotion of UCIS;
- SSL failed to implement and maintain an adequate training and competence programme in relation to UCIS;
- SSL had not carried out adequate due diligence on the products in that they had failed to recognise the significance of the products being UCIS.
Further, the FSA found that SSL was in breach of Principle 9 (Customers: relationships of trust)6. The skilled person analysed 20 files in relation to the suitability of advice to invest in a UCIS. In only three cases could suitable advice be demonstrated. Of the remaining files, 9 demonstrated unsuitable advice and 8 could not be determined because the documentation on the file was insufficient.
SSL also undertook a past business review and agreed in principle to contact customers who may have been unsuitable to invest in UCIS with a view to providing redress to any of those customers who suffered detriment.
The FSA considered that the failings identified were mitigated to a considerable extent by the significant changes SSL had implemented to its sales processes and compliance arrangements since the failings were identified. In all the circumstances, SSL was fined £35,000, after having taken account of the stage 1 discount applicable to cases settled at an early stage. Without the discount, the fine would have been £50,000.
In one sense, SSL is a relatively small IFA which demonstrably breached relevant rules regarding the sale of UCIS. In that sense, the fact that it was punished is unsurprising. In another sense, the case is interesting for two principal reasons,
First, it is a good example of precisely the kind of conduct about which the FSA has expressed concern specifically in relation to UCIS. This is a topic covered elsewhere in this edition of Enforcement Watch see Retail Conduct risk outlook spells out FSA areas of concern. Together, these indicate that action in relation to UCIS is unlikely to be at an end.
Second, it provides yet another example of how thematic reviews can lead, and often have led, to enforcement action.
5 : Principle 3 states : “A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems”
6 : Principle 9 states: “A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment”.
£1.4m fine and £51m redress in respect of advice to invest in Keydata
15 April 2011:
Norwich and Peterborough Building Society (“N&P”) has been fined £1.4m (after taking into account including a 30% stage 1 discount). The fine comes as a result of advice to a large number of clients to invest in Keydata products that were unsuitable for them.
Details of the case
In the period November 2005 - March 2009, N&P advised 3200 customers to invest approximately £53m in products offered by Keydata. The products involved investment in corporate bonds which in turn invested in life insurance policies. The FSA determined that N&P breached Principle 9 of the FSA's Principles for Businesses (Customers: relationships of trust)7 and the FSA conduct of business rules on ensuring suitability of personal recommendations. This was because, in many cases, the N&P advisers failed to properly assess the personal circumstances and needs of those investing in the Keydata products. Customers were assessed as having a higher tolerance to risk than was appropriate given their stated preference, actual personal circumstances (e.g proximity to retirement) and their investment experience. Consequently, many recommendations (the FSA estimate 65% or more) to invest in Keydata products were unsuitable.
In June 2007, having realised that Keydata products formed a large part of what its customers were being advised to invest in, N&P commissioned an internal review. This review highlighted concerns regarding the suitability of advice, but no effective action was taken as a result of the review, and Keydata sales remained consistently high.
There were a number of mitigating factors. Following discussions with the FSA, N&P agreed to reimburse customers who bought a Keydata product their initial investment plus interest but net of any payments received from the product. These payments total around £51m. Furthermore, N&P made interest free loans available to those customers facing an income shortfall as a consequence of investing in a Keydata product. Finally, N&P co-operated fully with the FSA throughout and agreed to the appointment of an external third party review of advised sales of other financial products sold by them.
The N&P case very much sits alongside the FSA’s report on suitability that we covered in Enforcement Watch 3: The FSA sends a tough message on Suitability. In that report, the FSA stated that the high number of unsuitable investment selections in the pensions and investments markets was still a significant concern. It went on to say that it would continue to take tough action to address failings within individual firms. This action is clearly part of that. It is difficult to escape the conclusion that, had it not been for the significant redress N&P is paying, its fine would have been that much higher.
It is perhaps not surprising that the FSA is clamping down on mis-selling, especially in the current climate. In that context, see also the fine levied on Barclays, as reported on in Enforcement Watch 3: Barclays Bank fined £7.7m for investment advice failings.
7 : Principle 9 states: “A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment”.
First ever Decision Notices published
12 May 2011:
The FSA has for the first time published Decision Notices for enforcement decisions that have been referred to the Upper Tribunal.
Details and Comment
A Decision Notice is the notice that sets out the findings of the internal FSA tribunal (the RDC) in disciplinary cases. Up until the coming into force of the Financial Services Act 2010, the FSA was not permitted to publish Decision Notices. Either the matter would not be appealed to the Upper Tribunal, in which case the Decision Notice would effectively become a Final Notice and be published, or the matter would be appealed to the Upper Tribunal and the public would await the Upper Tribunal’s ruling.
The Financial Services Act 2010 permitted the FSA to publish Decision Notices, even where the matter had been appealed to the Upper Tribunal. In this edition of Enforcement Watch, we comment on the FSA's policy statement on the circumstances in which it will and will not publish such notices. See FSA Presses on with enforcement sanctions changes.
The FSA has now published its first ever Decision Notices. These relate to Stuart Unwin8 and Derek Wright9, both of whom have appealed to the Upper Tribunal. This marks the beginning of the new publication regime.
The direction of travel appears to be towards early publication, in light also of the proposal to give the new regulator a power to publish at a far earlier stage. See Government sets out its stall for enforcement under the new regime.
8 : The Decision Notice regarding Unwin (2 March 2011) contained a prohibition order. It was based upon his lack of competence and capability whilst exercising a significant influence function in relation to occupational pensions transfers written by Unwin Financial Services Limited.
9 : The Decision Notice regarding Wright (23 February 2011) contained a prohibition order, based on his lack of honesty and integrity, and competence and capability, whilst effectively exercising significant influence functions at Moorgate Insurance Agencies Limited. Wright was not approved to perform such roles (it was possible that he would not have obtained approval had he sought it, having been found guilty of misconduct whilst employed at Lloyds). It was Wright's wife (who received a prohibition order which was not appealed to the Upper Tribunal) who ostensibly held these roles. In addition, the Firm breached regulatory requirements and the significant influence functions (which were effectively operated by Mr Wright) were not properly exercised.
FSA’s new penalties applied in serious market abuse case
24 May 2011:
Samuel Kahn has been fined just under £1.1m for committing serious market abuse. Kahn coordinated a scheme to deliberately inflate the share price of a company quoted on PLUS Stock Exchange. He is the first person to have his penalty determined under the new process introduced by the FSA in March 2010. See Enforcement Watch 1: Harsher Penalty Setting Introduced.
Details of the case
Kahn orchestrated a scheme between 24 March 2010 and 30 April 2010 in which repeated orders were placed to buy and sell shares in Global Brands Licensing (GBL). In essence:
(a) he personally placed repeated orders to buy and sell GBL shares on behalf of a charity and a company, neither of which he had any authority to do;
(b) he placed repeated orders to buy GBL shares in his own name; and
(c) he co-ordinated orders to buy GBL shares by other individuals.
This trading consisted of a form of wash trading; it constituted the overwhelming volume of trading in GBL during the period. Kahn’s purpose in orchestrating this trading was to inflate the share price of GBL and thereby to manipulate the market in the shares. Kahn sought to disguise the nature of the scheme and the extent of his involvement in it.
The scheme led to an increase in the price at which GBL’s shares were traded from 2 pence on 24 March 2010 to 5.25 pence at its height on 20 April 2010.
Kahn benefitted from the increase in GBL’s share price by means of profits made by the company on whose behalf he purported to trade. These profits of £210,000 were withdrawn from the company’s bank account on his instructions, and delivered to him in cash.
The penalty against him of £1,094,000 consists of £210,563 disgorgement and a financial penalty of £884,365 (after deducting a 30% discount for early settlement). The penalty is the first to be determined under the FSA’s new penalty setting system.
Kahn was not unknown to the FSA. He had previously been the subject of an injunction by the FSA because it believed that he had been involved in assisting overseas boiler room activities in the UK, and he had subsequently been the subject of a bankruptcy order by the FSA. In connection with the current matter, the FSA obtained its first ever final injunction from the High Court to prevent market abuse.
In one sense, the case is not very interesting. It represents a deliberate case of market abuse, involving duplicity, by an unauthorised person who had previously been guilty of misconduct. The fact that the FSA came down heavily on it is no surprise. Similarly, given the brazen nature of it, it is hardly a case at the fringes that provides useful commentary on the way the FSA views market abuse.
However, it is interesting as being the first case under which the FSA has determined a penalty by reference to the new system it introduced in March 2010. The new framework creates a structured five-step penalty-setting framework. The five steps are essentially:
- Removing any profits made from the misconduct (what is known as “disgorgement”);
- Setting a figure to reflect the seriousness of the breach;
- Considering any aggravating and mitigating factors;
- Achieving the appropriate deterrent effect; and
- Applying any settlement discount.
There is specific guidance appearing in the Decision Procedure and Penalties Manual (DEPP) for how the criteria will be applied, in this case for an individual committing market abuse. Probably the most interesting features of this case were in relation to 2 and 3.
In relation to 2, DEPP provides that where the market abuse is not referable to the individual’s employment, a multiple of between 0 and 4 will be applied to the profit made or loss avoided. This is determined according to a level of seriousness between 1 (least serious) and 5 (most serious), depending on the impact and nature of the market abuse and whether it was committed deliberately or recklessly. The FSA expects that deliberate market abuse will usually be assessed as a 4 or a 5.
The FSA assessed Kahn’s conduct as particularly serious. It considered it to be at a level of seriousness of 4 and accordingly a multiple of 3 was applied to the profit made. Given the way that the Final Notice reads in terms of intent and deception, it is interesting that the level of seriousness was assessed as a 4, not a 5. This may possibly be because the FSA did not assess the impact of the market abuse as being of the very most serious kind.
In relation to 3, the FSA may increase or decrease the amount arrived at after step 2 to take into account aggravating or mitigating factors. The FSA applied an uplift of a further 100%, with particular regard to Kahn’s previous misconduct.
This is the first case to apply the new penalties and we shall have to see how the FSA seeks to apply DEPP in the future.