Two high-profile decisions have been published in the last two weeks regarding actions brought by UK Financial Services Authority ("FSA") against members of the financial services industry. Both cases show signs of an increased willingness on the part of those subject to FSA enforcement action to challenge the enforcement wing of the FSA but with variable levels of success.
- FSA Regulatory Decisions Committee overturns sanctions in FSA enforcement notice in market abuse case: In the first case, the FSA issued a decision on 7 October 2009, found two former Dresdner bankers had committed market abuse in March 2007 (by engaging in what was commonly known as "front running"), but following an appeal by the bankers (Christopher Parry and Darren Morton) to the FSA’s Regulatory Decisions Committee ("RDC") they escaped a fine and ban from working in controlled functions in the financial services sector. The two successfully appealed the financial and disciplinary sanctions the FSA proposed to impose with the RDC finding that public censure was sufficient punishment.
- Court of Appeal Ruling on FSA powers to prosecute for offences not specifically part of the law governing financial markets: In the second case by contrast, the Court of Appeal issued a judgment (delivered on 9 October 2009) ruling that the FSA could bring prosecutions for offences that were not specifically part of the law that governs financial markets. This judgment upholds an expansive view of the regulator’s criminal enforcement powers. The Court found that the FSA had the power to charge Neil Rollins and Michael McInerney for money laundering in addition to offences specifically governed by the UK Financial Services and Markets Act.
FSA Market Abuse Enforcement Action against former Dresdner bankers:
Darren Morton and Christopher Parry worked in the Structured Investment Unit ("SCI") of Dresdner Bank AG managing the bank’s Structured Investment Vehicle ("K2"). Morton (a director and co-head of the Portfolio Management Team) and Parry (a Vice President in the SCI), were FSA approved to conduct controlled functions.
On the morning of 15 March 2007, Morton received a call from Barclays to see what certain key investors’ appetite was for a proposed new issue. K2 was one of Barclays’ top three accounts for lower tier floating rate notes (FRNs) already issued by Barclays and regarded as essential to the successful launch of a new issue. Morton was told that this was "a very early heads up", that it was before the issue was public, that the information should be kept to himself and that the new issue would be "a Barclays lower tier two transaction" in "US dollars" with "10 year non call five or thereabouts" structure with a deal size of "about a billion dollars" and given information on the discount margin.
Morton passed the information regarding the new issue to Parry. Parry then sold $30 million in Barclays current FRNs within two hours of Morton’s call with Barclays. Having initially told Morton that the new issue would not be announced for a few days, Barclays called Morton shortly after Parry’s first trade to say that the issue might be announced that very day. Approximately three minutes after this second call, Parry executed a second trade, selling a further $35 million in Barclays current FRNs. The new issue was announced by Barclays about an hour and a half after the second call to Morton.
Morton authorised both trades executed by Parry. The two trades resulted in a loss of $66,000 to the counterparties who were clearly unaware of the pending new issue at the time of acquisition.
Parry and Morton challenged the FSA’s allegation of market abuse on a number of fronts including that there was insufficient evidence that Morton had received "inside information" in relation to the new issue of Barclays FRNs and therefore Parry did not act "on the basis of" the inside information. Parry also argued that the allegations were based on circumstantial evidence, that the information was not precise and both bankers argued that FSA had a high burden of proof given that this was a case of alleged serious market abuse. Morton further argued that the behaviour was not reckless, deliberate or dishonest — such book building was standard practice and the OTC credit markets operated differently to the equity markets!
Underlying the FSA’s acceptance that Parry did not believe he was committing market abuse was an acknowledgement that at the time "front running" was indeed market practice. The FSA has since corrected this serious misunderstanding in the market and the in various guidance. The FSA stated that "in these circumstances it is noted that Parry was working in an environment where until a deal had closed, the accepted view was that, in the absence of information generally regarded as inside information, that information was not regarded as specific or price sensitive and therefore any activity related to such information could not be abusive".
Nonetheless, the RDC found the pair guilty of market abuse. While the two bankers were censured publicly for committing market abuse, they were not fined and no ban or suspension was placed on their approvals as persons approved to undertake controlled functions following their appeal to the RDC. Indeed, one of the bankers works within the same division which is now part of Commerzbank.
In applying the same reduced censure to both Parry and Morton, the RDC had regard to the following mitigating factors:
- They did not make any personal profit;
- They had subsequently undertaken further training in market abuse;
- No clear guidance was available to them or the OTC credit markets at the time of the offence; and
- They had no adverse previous disciplinary record or compliance history.
The bankers’ successful appeal is seen by some commentators as a significant step which may result in more appeals against FSA warning notices, to the RDC. Whilst it may be a good example of push back against the war which Margaret Cole has been waging against "cheating" in the City, we are less convinced that this fairly specific case will open the floodgate to challenges.
Court of Appeal Ruling on FSA’s right to proceed with private prosecutions for offences outside the financial services regulatory regime:
Neil Rollins faces charges for offences of insider dealing under the Criminal Justice Act 1993 and offences of money laundering contrary to the Proceeds of Crime Act 2002. The former offence relates to the sale of shares in a company by which he was employed and the latter relate to the transfer of part of the proceeds of this sale from his bank account to a bank account in his father’s name.
Michael McInerney faces charges alleging that he and his company committed offences contravening the general prohibition under the Financial Services and Markets Act ("FSMA") against carrying on a regulated activity in the UK without being authorised to do so by the FSA or ensuring that there was a relevant exemption. Those offences allegedly include involvement with various illegal "boiler room" activities, in particular processing the proceeds of sales of shares. He also faces similar same money laundering offences charges as Rollins under the Proceeds of Crime Act 2002.
Both men challenged their respective charges for money laundering offences and their appeals to the Court of Appeal to stop the FSA’s prosecution of the money laundering charges were heard together. The case of both defendants against the FSA was that the FSA’s powers were defined and limited by the Financial Services and Markets Act and that since that legislation did not confer the power to prosecute offences under the Proceeds of Crime Act the FSA did not have such a power. The defendants’ case was that the FSMA laid down a complete code within which the FSA had to operate, precluding the FSA bringing prosecutions for offences outside the regulatory functions conferred on the FSA by the FSMA.
The Court of Appeal, in a strong affirmation of the regulatory remit of the FSA, concluded that the FSA has the power to prosecute offences beyond those referred to in sections 401 and 402 of the Financial Services and Markets Act and, in particular, that the FSA had the power to prosecute for offences contrary to sections 327 and 328 of the Proceeds of Crime Act (the money laundering offences faced by Rollins and McInerney).
The Court rejected the defendants’ submissions, stating that the relevant statutory provisions should be given a more expansive interpretation and should be read as permissive and not limiting upon the powers of the FSA.
These prosecutions will therefore go forward and this judgment therefore paves the way for further private prosecutions by the FSA of offences before the financial services regulatory regime.
The bigger picture — … "When the walls are crumbling around you …"
As these wars and battles with and involving market participants and the FSA continue, UK politicians have been occupied by a different battle — the very future of the FSA. The opposition party are keen to dismantle the FSA in its entirety. The incumbent are convinced there is life yet in this once hailed ‘super supra-regulator’. Whilst this debate on exemplar supervision and regulation continues in full force, Margaret Cole (the superlative Director of the FSA’s Enforcement Division) has heroically vowed to continue the fight against insider dealing … this is the firm hand that the City needs.