The FSA has fined John Shevlin, an IT technician, £85,000 for trading a contract for difference (CFD) referenced to the share price of the Body Shop International plc (the Body Shop) on the basis of inside information.

Key points

  • The FSA has successfully concluded a market abuse (insider dealing) case based on circumstantial evidence.
  • This is the first of what the FSA hopes will be a steady stream of cases that visibly demonstrate its commitment to tackling market abuse.
  • Although firms can do little to prevent the deliberate abuse of a position of trust of the kind in this case, it would be prudent for firms to assess their policies and procedures in the light of the FSA's recently published Principles of Good Practice.

The facts

Mr Shevlin worked in the Body Shop's head office as part of its desktop support team. He was responsible for providing IT support to staff including senior executives in the head office. His salary was approximately £28,000.

During the period leading up to the Body Shop's Christmas trading announcement, originally scheduled for 13 January 2006, senior executives had access to inside information. Various emails were circulated, from 16 December 2005, which gave details of the company's performance, of the fact that it would not meet its forecasted target profit, and that the announcement might have to be brought forward. From 8 January 2006, emails indicated that the announcement would be brought forward to 11 January, and the draft text was also circulated.

During this period, Mr Shevlin had the passwords of senior executives, which gave him full access to their email accounts. At 16:03 on 10 January 2006, Mr Shevlin sold a CFD in the Body Shop, borrowing £29,000 to do so. This trade accounted for over a quarter of the daily trading volume in that stock. The Body Shop share price fell 18% after the announcement on 11 January, and Mr Shevlin closed out his position at a net profit of £38,472.

FSA findings: insider dealing

In the Final Notice, the FSA concluded that Mr Shevlin, by trading the Body Shop CFD, had engaged in market abuse. Most of the elements required to prove market abuse (insider dealing) under section 118(2) of the Financial Services & Markets Act 2000 were not matters of dispute:

  • the CFD was a related investment within the meaning of section 118(1) of FSMA;
  • the trading occurred in the UK;
  • Body Shop shares were traded on the London Stock Exchange;
  • Mr Shevlin had access to the emails through the exercise of his employment;
  • the emails contained inside information which, if generally available, would have been likely to have had a significant effect on the price of Body Shop shares.

The FSA accepted that it could not confirm with any precision when Mr Shevlin was alleged to have accessed the inside information (any access would have been "as" the account holder).

Mr Shevlin claimed that in making the CFD trade, he had relied on his own research and observations of the Body Shop price pattern and the price/earnings ratio, and not on inside information. Those explanations were not, however, entirely consistent with the timing of the trade.

He also claimed that he had twice previously traded in Body Shop CFDs on the day before an announcement - however, on those two prior occasions, the announcements had been made on the scheduled dates, and he had traded in anticipation of a price increase, whereas here the announcement had been unexpectedly brought forward, and he was trading in anticipation of a loss. Mr Shevlin's explanation for the size of the trade was that he believed that there would only be a small movement in share price.

The FSA also relied on various other factors suggesting insider dealing, including the following:

  • the trade was carried out the day before the announcement, which was made earlier than the market expected;
  • the sum Mr Shevlin borrowed in order to carry out the trade, £29,000, was more than his annual salary. To obtain the loan, Mr Shevlin falsely stated that the funds were for home improvements;
  • prior to this trade, Mr Shevlin's had cumulative net trading losses of which £4,000 remained outstanding;
  • the CFD trade was of considerable size and accounted for approximately 26.7% of the trading volume in Body Shop stock that day;
  • the trade was significantly larger than any CFD that Mr Shevlin had previously traded (the underlying value was more than twice Mr Shevlin's net assets);
  • despite the risk of the trade (a potential £800 loss with each penny move upwards in the share price), it was executed without guaranteed stop price, or indeed, initially, any stop price.

The FSA considered that these additional factors indicated that Mr Shevlin had "the ability, the opportunity and the motive to commit market abuse, and that he was willing to take on significant additional debt in order to maximise his profit from what was otherwise a very risky trade in the face of market expectations".

A circumstantial case

In a recent speech at the FSA's Enforcement Conference, Margaret Cole, the FSA's Head of Enforcement, confirmed that the FSA intended "to be bolder and more resolute about proceeding with insider dealing cases". She described such cases as tough to prosecute, because the evidence is usually circumstantial.

Circumstantial cases are undoubtedly "risky" to prosecute, because a successful outcome for the prosecution is so heavily dependent on the credibility (or lack thereof) of the defendant's explanations. This does not mean that such cases should not be brought. It is important that the FSA should be seen to take the hard cases if it is to achieve its stated aim of credible deterrence, "getting all the market players to take the issue seriously".

This is not the first such case that the FSA has brought. In the Baldwin case, the Financial Services and Markets Tribunal (the Tribunal) had refused a submission, made at the close of the FSA's case, and before the defence case, that Mr Baldwin had no case to answer: there was, it found, no clear-cut defect in the FSA's case, and the issues would depend on findings of fact. In the event, Mr Baldwin's evidence proved pivotal to the decision of the Tribunal, which, with the aid of a full hearing over three days, and the benefit of live evidence and cross-examination, arrived at a different answer from the FSA's Regulatory Decisions Committee (RDC). That result did not render the initial decision unreasonable¹.

In the present case, the Tribunal did not, in the event, hear Mr Shevlin's evidence. His reference was dismissed because of repeated failures to file his evidence on time - notably, his own witness statement. Nevertheless, on the basis of the points relied on by Mr Shevlin before the RDC, it seems likely that the Tribunal would have reached the same conclusion as the FSA.

Although Margaret Cole suggested in her speech that circumstantial insider dealing cases may not be "jury friendly", the human judgments which need to be made in such cases are quintessentially jury issues. This case would probably not have greatly vexed a jury had the FSA chosen to initiate criminal rather than civil proceedings. Where, however, investment strategies and timing of the transactions depend on a high degree of technical expertise, and extensive expert evidence is needed to support or challenge explanations for the strategy and timing, these issues may well be less accessible for a jury.

The French regulator, the Autorité des marchés financiers (AMF), has brought a number of insider dealing cases based on circumstantial evidence, including perhaps most notably the case against Banca Popolare di Milano (“BPM”). The AMF fined BPM €950,000 and Fabrizio Viola, its Chief Executive and CFO, €100,000, for insider dealing in respect of the purchase of 33,604 shares in an issuer. Although Viola said he undertook the transaction of his own initiative, the AMF held that the only explanation for this purchase (which was exceptional, large, and unexpected in the light of BPM’s trading) was the possession of inside information. It was accepted that Viola acted solely on behalf of BPM and made no personal profit; Interestingly, BPM's chairman, Roberto Mazzotta, who had been charged with disseminating inside information to Viola, and of insider dealing, was acquitted. The AMF concluded that the inside information could have come to Viola through a number of routes, not all of which involved Mazzotta, who was given the benefit of the doubt.²

Credible deterrence

The size of the fine imposed by the FSA, although modest by the standards of fines imposed against institutions, reflects the FSA's stated aim of achieving "credible deterrence". Viewed in the context of Mr Shevlin's annual salary of some £28,000, and given that the profit from the trade was some £38,000, a fine of £85,000 should be seen as delivering a strong message. Mr Shevlin also lost his employment with the Body Shop.

Although this is the first market abuse case concluded by the FSA since the Pignatelli case in November 2006, it is apparently the beginning of what the FSA hopes will be a steady stream of cases. At the Enforcement conference, Margaret Cole confirmed that there were some 31 market abuse cases in the Enforcement pipeline and that this year the FSA had brought 3 criminal prosecutions for insider dealing, and had others in view. The FSA hopes that more visible activity in relation to market abuse will demonstrate its determination to bring about a change of culture in the City.

The Principles of Good Practice for handling inside information

This decision is a reminder that the market abuse regime applies to everyone, not just to regulated firms. As an issuer, the Body Shop was subject to the Disclosure and Transparency Rules (DTRs), and would have had in place policies and procedures on dealing with inside information.

The FSA has recently published its Principles of Good Practice for the Handling of Inside Information in Market Watch 27. The Principles cover issues such as policies and procedures, awareness and training, and IT security. Although the principles and good practice points are aimed at the unregulated community, the FSA has stressed that aspects of them could also provide assistance to other market participants (including issuers).

Adherence to the measures advocated in the Principles of Good Practice may not necessarily prevent a determined insider in a position of trust from executing a deliberate plan to commit insider dealing. It is clear from the FSA's press release that no fault was attributed to the Body Shop in this case.

Many insider trades are, however, opportunistic, involving a degree of naivety (sometimes even stupidity) on the part of otherwise law-abiding individuals. If the FSA is able to produce a steady stream of cases such as this one, which demonstrate that there is a real risk (perhaps eventually a likelihood) of detection, then an active training programme dealing with market abuse, and the FSA's focus on it as a priority, should help to provide a credible deterrent to opportunistic insider trading.