What happened to Tesco?
The Financial Conduct Authority ("FCA") issued a final notice against Tesco plc and Tesco Stores Limited (together "Tesco") on 28 March 2017 (the "Final Notice"). The Final Notice requires Tesco to pay compensation of up to £85m (plus interest) to investors after the FCA found Tesco committed market abuse. The compensation will be payable as part of a redress scheme to those investors that suffered financial loss as a result of Tesco plc's publication of an incorrect trading update on 29 August 2014 (the “August Statement”). The FCA stated in the Final Notice that it has exercised its discretion under s123(3) of the Financial Services and Markets Act 2000 (“FSMA”) not to impose a financial penalty against Tesco, preferring to publish a public statement regarding Tesco's market abuse and establishing the redress scheme.
The decision not to impose a financial penalty is largely driven by the fact that Tesco Stores Limited has agreed in principle to the terms of the Deferred Prosecution Agreement (“DPA”) with the UK Serious Fraud Office (“SFO”) resulting from events surrounding the August Statement. Details of the DPA were released the same day as the Final Notice was published. The DPA is set to be approved by Southwark Crown Court1 on 10 April 2017.
Once concluded, the DPA will allow the prosecution of Tesco Stores Limited to be suspended for a defined period, providing certain requirements are fulfilled, including the payment of a financial penalty of almost £129 million.
The Tesco case therefore provides an example of how regulators in the UK are increasingly working together when deciding how to handle instances of regulatory breach. The case also indicates how it is essential that a company that is being investigated by regulators considers the concerns of all the agencies investigating it when deciding which strategies to employ, although it may be difficult to balance their competing objectives.
Tesco is not regulated by the FCA as a financial services firm (although certain members of its group are regulated). Tesco is however subject to enforcement by the UK Listing Authority, and the UK’s securities regulator which is part of the FCA. The market abuse regime therefore extends beyond the regulated financial services sector, impacting all listed entities and those that deal with information regarding entities caught under the Market Abuse Regulation (“MAR”).2
What led to the publication of the Final Notice?
On 29 August 2014, relying on incorrect information provided by its wholly-owned subsidiary, Tesco Stores Limited, Tesco plc published a trading update (the “August Statement”) stating that it expected that the trading profit for the previous six months ending 23 August 2014 to be in the region of £1.1 billion. The information supplied by Tesco Stores Limited did not disclose the fact or risk of the inaccuracy and those who were aware of the accurate financial position did not alert the Board of Tesco plc.
Tesco issued another trading update on an urgent basis before trading opened on 22 September 2014 (the “September Statement”) announcing that it had “identified an overstatement” of expected profit for the first half of the year “principally due to the accelerated recognition of commercial income and delayed accrual of costs”.3 Tesco plc has admitted that its total overstatement of actual and expected profit was £284 million.
The FCA has said that the August Statement contained false or misleading information in relation to certain instruments, in particular, Tesco plc shares and certain publicly traded Tesco group bonds. What is more, Tesco knew, or could reasonably have been expected to know, that the information was false or misleading.
Tesco has therefore been found to have engaged in market abuse contrary to s118(7) of FSMA, a provision that has been repealed following the coming into force of MAR which contains similar provisions to but expands the scope of the former civil law offences.
The FCA has stressed that it does not suggest that any member of the Board of Tesco Plc knew, or could reasonably be expected to have known that the information in the August Statement was false or misleading. The FCA has however found that there was knowledge at a sufficiently high level but below the level of the Tesco plc Board as to the false and misleading nature of the August Statement. Such knowledge therefore constitutes the knowledge of Tesco plc for the purposes of market abuse.
Market abuse and restitution
The market abuse created a false market in the particular securities causing purchasers of such securities to pay a higher price than they would have paid if there had been no false market. The FCA said it believes that the false market was present between the publication of the August and September Statements and those investors that purchased securities as a result of the August Statement and still held these securities when the September Statement was issued therefore suffered loss as a result.
Accordingly, the FCA has exercised its power under s384(5) of FSMA for the first time, requiring Tesco, to pay restitution for market abuse to those investors that suffered loss.
Although this may signal the start of a trend towards this method of enforcement, the FCA’s guidance stresses that ordering formal restitution under s384 is rare and is often an act of last recourse; where possible the FCA will instead consider more efficient and cost effective ways to obtain redress.
Under the compensation scheme, Tesco will pay an amount to each purchaser of Tesco shares and bonds who makes a claim that is equal to the inflated amount for each share or bond. The inflated amount has been decided with the assistance of an independent expert engaged by the FCA. The scheme will be administered by accountancy firm KPMG. The FCA has said its data indicates that around 10,000 retail and institutional investors will be eligible as part of the scheme.
The impact of the DPA
The FCA’s decision not to impose a financial penalty on Tesco largely because Tesco has agreed a fine with the SFO is a welcome departure from the often unfair approach favoured in the US, where agencies frequently do not take into account fines paid to other agencies when imposing their own penalties.
The FCA also said that Tesco had taken an “exemplary co-operative approach” with both the FCA and the SFO and did not feel it was necessary to impose an additional financial penalty. As part of this cooperative approach, Tesco is said to have been proactive in offering information and responding promptly and constructively to requests from both regulators. What is more, Tesco did not, at the FCA’s request, interview witnesses or take statements and disclosed voluntarily material which appeared to Tesco to be significant.
What’s next for Tesco
Providing that the DPA is approved by the Court and Tesco complies with its terms, the SFO’s investigation into Tesco is now concluded, as are the FCA’s proceedings. However, the SFO has charged three former Tesco executives with offences of fraud and false accounting. These defendants will stand trial at Southwark Crown Court later this year.
Tesco will still have to deal with shareholder class actions currently underway against Tesco. Investors will need to choose between accepting redress under the FCA scheme or pressing on. However, as the relevant period4 for the purposes of the Final Notice and the compensation scheme is fairly short and some of the class actions are concerned with events that pre-date the relevant period, the impact may be reduced.
What can firms do now?
The fact that the FCA views Tesco’s decision not to interview witnesses or take statements as part of its investigation as “cooperative” may be concerning to firms under investigation that want to speak to witnesses with a view to strengthening systems and controls in place to prevent a repeat. In other cases, the firm may want to start disciplinary proceedings or prepare their defence to regulatory action or third party claims.
Certainly, the emphasis on cooperation can be viewed as part of a growing trend by the SFO and FCA to look more kindly on those companies that have allowed the regulator access to witnesses before internal legal teams of law firms acting on behalf of companies. In a speech delivered in January 2017, Mark Steward, the FCA’s Director of Enforcement and Market Oversight said that internal investigations contain “an inherent conflict of interest” and have “limited determinative value” for the FCA making it important that the FCA pursues its own “thorough” investigation. However, unlike regulated or listed firms under investigation by the FCA, there is no obligation on firms to cooperate with the SFO and firms need to carefully consider whether their interests are better serviced by a more rigorous defence strategy.