On 1 March, the UK Financial Services Authority ("FSA") published its new framework for financial penalty-setting. Explaining the tri-partite objectives of the new policy of deterrence, discipline and disgorgement, Margaret Cole (Director of Enforcement and Financial Crime) said:

"Despite industry opposition we have decided to implement these proposals as we believe enforcement penalties are a powerful tool to help change behavior in the industry."

On 17 March, the FSA published its Business Plan 2010/11 (Delivering Financial Stability/ Delivering Market Confidence/ Delivering Consumer Protection/ Delivering a Reduction of Financial Crime) and in it, the much respected outgoing CEO of the FSA, Hector Sants, noted:

"The focus of our enforcement action has shifted to taking a harsher stance.... In support of our market confidence objective we have a pipeline of significant cases. In the first half of the year, three insider dealing prosecutions are due to be heard and charges in other cases anticipated.... [We will] continue to aggressively pursue criminal prosecutions alongside civil action. Market participants who commit or are involved with insider dealing or other market misconduct must be aware that we will take tough action and hold them accountable for their behavior."

And sure enough...

On 23 March, the FSA issued a press release confirming that, following the UK's largest ever operation against insider dealing and in the first joint operation between the FSA and the Serious Organized Crime Agency (involving 143 personnel from the FSA):

"... Six men including two senior city professionals at leading city institutions and one city professional at a hedge fund have been arrested on suspicion of being involved in a sophisticated and long-running insider dealing ring."

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Set out below is the third in a series of updates on the FSA's enforcement action regime.

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New Penalties Policy

A core part of the FSA's "new" credible deterrence policy is the implementation of new methodology for imposing penalties on those who breach the FSA rules. The FSA believes that the change will provide more transparency and consistency and it results in an overall increase in the level of penalties that the FSA can impose on market participants who engage in abusive activities.

In July 2009, the FSA published a Consultation Paper proposing changes to its Decision Procedure and Penalties Manual, its Regulated Covered Bonds Sourcebook and its Enforcement Guide, arising as a result of a new and structured five-step penalty-setting framework. The FSA received 20 responses to its consultation paper -- whilst respondents agreed that introducing greater transparency and consistency was a "good thing", they generally thought the FSA's proposals would not achieve these objectives. Nonetheless, the FSA has decided to proceed with the new framework, which came into force on 6 March 2010, and consists of the following steps:

  • Removing any profits made from the misconduct;
  • 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.

Under the new framework, fines will be linked more closely to income and will be based on:

  • Up to 20% of a firm's revenue from the product or business area linked to the breach over the relevant period;
  • Up to 40% of an individual's salary and benefits (including bonuses) from their job relating to the breach in non-market abuse cases; and
  • A minimum starting point of £100,000[1]for individuals in serious market abuse cases.

The new framework will allow the FSA to impose harder hitting financial penalties. But, has the FSA's track record in market abuse fines been lackluster? In fact, the statistics appear to reveal otherwise: (i) At the top of the list for the 10 largest fines imposed by the FSA to date is a fine imposed on the Royal Dutch Shell Group of companies for £17,000,000 -- for market abuse! (ii) Until six weeks ago, the largest fine imposed on an individual by the FSA was against Philippe Jabre (a former managing director of hedge fund GLG Partners) who was fined £750,000 for market abuse offences in 2006. (iii) Earlier this year, the FSA imposed a record-breaking fine on an individual (Mehmet Sepil, CEO Genel Enerji A.S.) of £967,005 for market abuse in relation to dealings in Heritage Oil plc. Whilst there have indeed been headline grabbing fines imposed in market abuse cases, the numbers of these cases are few and far between -- this is what the FSA is proposing to change.

Criminal Prosecutions for Insider Dealing

Following the landmark criminal prosecution of Christopher McQuoid in June 2009, the FSA followed this by successfully pursuing Matthew Uberoi and his father Neel Uberoi on 12 counts of insider dealing committed during summer 2006 when Matthew Uberoi was an intern at a corporate broking firm working on takeovers and other price sensitive deals. He passed inside information to his father in relation to deals in three companies who in turn acquired shares and made substantial profits off the back of these trades. The criminal prosecution which has really rocked the City of London, however, is the 12-month prison sentence imposed on the former Cazenove partner for insider dealing. Malcolm Calvert, a former equities market maker at blue-blooded stock broker Cazenove, was found guilty earlier this month on five counts of insider dealing (which took place between June 2003 and October 2004) from which he made approximately £100,000. In one of its harshest statements, the FSA said of the case, "Our markets operate on honesty and trust and insider dealing makes a mockery of both these values." More criminal prosecutions are yet to follow. The FSA are currently investigating three other insider dealing criminal cases. Neil Rollins (see Client Update 30 October 2009) is on charges for insider dealing relating to transactions conducted in 2006 in relation to PM Group plc. Andrew King (a Finance Director) and two lawyers Michael McFall and Andrew Rimmington have been charged with insider dealing relating to Neutec Pharma plc. Christian Littlewood (a former Dresdner broker) and his wife Angie Littlewood are facing prosecution for dealing in a number of junior and main London Stock Exchange market companies between 2000 and 2009. The case of the Littlewoods is interesting as it is the first time that a suspect has been extradited on charges raised by the FSA. The FSA is clearly raising its game on a number of fronts. The Neutec Pharma case has been set for trial on 19 April (the other two have yet to be fixed) -- let us see whether the FSA scores yet another hat trick.

Dawn Raids

As will be noted from the dates of the offences successfully prosecuted and the dates of conviction, the insider dealing and market abuse cases pursued by the FSA have taken considerable time to prosecute. The FSA is mindful that "justice delayed may be regarded by the market as justice denied". Whilst some progress has been made recently -- in the case of Chhabra and Patel -- the first market abuse case based on circumstantial evidence (untapped telephone conversations between a former research analyst at a UK broking firm and his long-time friend -- there are many other cases which demonstrate the difficulty in bringing these cases to prosecution.

In July 2008, the FSA along with the City of London arrested eight people linked to an insider trading circle. The individuals (whose identities have been kept confidential), former employees of two bulge bracket investment banks, were arrested on the grounds that they used leaked deal prospectuses to inform spread-betters and accountants of imminent and anticipated share price movements. The case known as "Project Saturn" has been under investigation by the FSA for the past two years and charges are expected to be handed down this week.

The identities, however, of six of seven other persons arrested last week in a monumental effort involving 140 police officers and 143 FSA personnel, have been revealed to a numb-struck City of London. The 16 dawn raids in premises across London and South East England resulted in arrests of seven people, including "two senior city professionals at leading city institutions and one city professional at a hedge fund ... on suspicion of being involved in a sophisticated and long-running insider dealing ring. It is believed that the city professionals passed inside information to traders (either directly or via middlemen) who traded based on this information...." (FSA Press Release, 23 March 2010). Although the UK press has revealed the identities of the individuals allegedly involved, the FSA has refused to confirm the identities at this stage; neither has it confirmed the identity of the target companies to which the alleged insider dealing trades relate. It will be months before charges are handed down in this case.