On 27 September 2018, the Financial Conduct Authority (“FCA”) published a Decision Notice in relation to Linear Investments Limited ("Linear"). The Decision Notice seeks to impose a financial penalty of £409,300 on Linear for failing to take reasonable care to organise and control its affairs responsibly and effectively to ensure potential instances of market abuse could be detected and reported.
Linear has agreed the facts set out in the Decision Notice and its liability for the breaches identified by the FCA. However, it disputes the level of penalty and has referred this discrete issue to the Upper Tribunal. This is therefore the first case to be completed under the FCA’s partly contested cases process. This process allows firms or individuals to agree to certain elements of the case and to contest others, while remaining eligible for a discount of up to 30% on any financial penalty. In this case, it allows Linear to benefit from a settlement discount of as much as £175,400 (30% of the penalty imposed by the RDC before settlement reduction), despite continuing to contest the case.
Linear is a FCA-authorised brokerage firm. It provides customers with a range of services, including trade execution, and acts as a principal for several appointed representatives. It conducts its training primarily via electronic Direct Market Access ("DMA"), which Linear routes to its own broker for transmission to the market. This has the consequence that trading involved very little, if any, contact with Linear’s front office, meaning that compliance-based surveillance is the primary method by which Linear can monitor trading activity.
Principle 3 of the FCA’s Principles for Businesses provides that "A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems".
In respect of market abuse risks, firms are obliged to establish appropriate systems and controls to identify and manage the particular market abuse risks to which they are exposed. This includes a requirement to identify where there are reasonable grounds to suspect market abuse has occurred and to submit Suspicious Transaction Reports ("STRs") or, after 3 July 2016, Suspicious Transaction and Order Reports ("STORs") to the FCA. To conduct effective monitoring for suspected market abuse, firms need to have trade monitoring systems which are appropriate relative to the nature, scale and complexity of the business they are undertaking and to the market abuse risks to which that business is exposed.
The FCA found that Linear breached Principle 3 by failing to organise and control its affairs responsibly and effectively with adequate risk management systems in relation to the identification and reporting of possible market abuse. It relied on the following factual findings in reaching this assessment:
- Prior to November 2014, Linear operated on the basis that it could rely upon post-trade surveillance undertaken by underlying brokers to discharge its regulatory obligations. It therefore did not have its own post-trade surveillance system in place, and relied on limited manual oversight of transactions executed via its outsourced trading platform. Even when Linear's business model changed and the volume of trading increased significantly, it failed to consider whether the risk of market abuse had been elevated and whether it needed to install an automated post-trade surveillance system. The FCA therefore found that Linear failed to discharge its obligations. It found that regardless of post-trade surveillance checks being undertaken by underlying brokers, Linear was also responsible for undertaking its own checks using information available to it, to enable it to detect and report potential instances of market abuse.
- On 11 May 2015, Linear installed an automated post-trade surveillance system. However, there was a further period of time before the system had been appropriately calibrated and tested so that it was operating effectively relative to the nature of the business. This included periods of time during which alerts on the automated system in relation to spoofing and insider dealing were disabled. During those periods, Linear did not have suitable alternative surveillance in place. This rendered it incapable of effectively detecting spoofing and insider dealing. As a result, Linear failed to take reasonable care to ensure that it could effectively conduct market abuse surveillance, which increased the risk that potentially suspicious trading would go undetected.
Firms and individuals subject to FCA enforcement proceedings before 1 March 2017 had two choices: either settle or fight the case. That changed upon the introduction of the partly contested cases process. This is no doubt the first of many cases in which this process will be used.
In this case, the benefits of this process for the firm are clear to see. Linear accepted all issues of fact and liability at an early stage of the investigation. However, had the partly contested process not been available, Linear could only have benefitted from any settlement discount had it managed to agree through negotiation the level of penalty with the FCA (or accepted the FCA’s proposal). The FCA will usually set a relatively tight timetable for settlement discussions, particularly in order to benefit from the full 30%. This can prove difficult to achieve where there is significant divergence between the parties’ views on the appropriate penalty.
The summary of Linear’s representations annexed to the Decision Notice demonstrates that there was significant divergence between the parties in this case. Amongst other matters, Linear argued before the RDC that its “relevant revenue” for penalty calculations should be calculated on a net basis, based only on the revenue of part of the business and after deduction of third party sales/commissions. It also argued that the step 2 figure should be reduced by 50% on the grounds of disproportionality. Whether any of these points will be successful if pursued before the Upper Tribunal is yet to be seen. Nevertheless, by virtue of the partly contested cases process, Linear has the opportunity to run those arguments while remaining eligible for a discount of up to 30% on any penalty ultimately imposed (as much as £175,400, based on the penalty imposed by the RDC before settlement discount). Many firms and individuals in the past may not have been willing to put that amount of discount at risk. It is therefore expected that the partly contested cases process will lead to more cases being fought before the RDC and the Upper Tribunal.