Posts Tagged ‘UK’

The Financial Services Authority (FSA) published yesterday (5 June) Market Watch 27, an update of the thematic review of controls over inside information, following the publication of Market Watch 21 in July last year.

The update includes a set of Principles of Good Practice (“The Principles”) for the handling of inside information that were drawn up by industry practitioners representing different areas involved in M&A activity, such as issuers, corporate finance houses, lawyers, accountants, public relations firms and financial printers.

The Principles, which highlight the importance of restricting access to price sensitive information, are voluntary to adopt, broad based and largely focused on the areas identified as requiring the most attention:

1. Policies and procedures
2. Awareness and training
3. “Need to know” and other information controls
4. Passing price sensitive information to third parties
5. Information technology security
6. Personal dealing policies

Work, in partnership with the industry, to reduce the leakage of price sensitive information relating to M&A activity therefore improving market cleanliness is a core part of the FSA’s strategy for tackling market abuse. Insider dealing is a criminal offence which the FSA will prosecute vigorously.

Richard Lambert, director-general of the CBI, welcomed the Principles published by FSA: “It is vital that investors have faith and confidence in honest and open capital markets. Insider trading destroys trust and these principles of good practice will help ensure transparency and fairness in the markets.”

Adam Kinsley, director of Regulation at the London Stock Exchange, said: “We support the FSA and the industry bodies who drafted this guidance, and share their objective to ensure that UK markets continue to be regarded as well-regulated and clean. These principles published by the FSA today provide helpful guidance to anyone who comes into contact with inside information. They will help ensure the UK remains a world-leading financial centre with high standards and good practices.”

Market Watch 27 also provides a detailed update on the follow up work that FSA has undertaken with FSA regulated firms and contains examples where individual firms strengthened their controls. It also reports on industry dialogue on two important topics: how to increase the focus at firms on the need to properly consider when to undertake internal leak enquiries, and whether more can be done to reduce the number of insiders on deals.

See full text of the official press release

The UK FSA has published the latest edition of its “Market Watch” newsletter (issue 26) which focuses on the FSA’s strategy and main objectives for tackling market abuse.

According to Sally Dewar, FSA Managing Director of Wholesale and Institutional Markets, clean markets are vital to the continuing success of London as an international financial centre. Market misconduct, particularly in the form of insider dealing and market manipulation is, put simply, cheating and reduces investor confidence in the UK markets. FSA’s aim is to have a regime which achieves “credible deterrence” and ensures a level of market quality we can all be proud of.

One of the most significant components of credible deterrence is ensuring that there is a genuine fear that wrongdoing will be identified and that the punishment received will be meaningful. Market Watch 26 therefore expands on the FSA’s enforcement approach, reiterating that sanctions will be imposed against wrongful behaviour that will be severe enough to have a deterrent effect. To this end the FSA has enhanced its in-house criminal investigation and prosecution skills and has begun a criminal insider dealing prosecution. There will be also increased financial penalties in cases pursued through the civil route.

FSA seems to be particularly concerned about the extent of informed price movements prior to M&A announcements and it intends to tackle this. The FSA’s review in 2006/07 of the systems and controls at several firms (regulated and unregulated) involved in M&A transactions identified a number of weaknesses which are contributing to the leakage of inside information.

Market Watch 26 elaborates more on the initiatives and activities for 2008 aimed at reducing the leakage of inside information. These will include number of very useful and practical deliveries:

• Report on the steps taken by the FSA to improve its enquiry work into the cause of leaks in specific takeover situations;
• Publication of “Principles of Good Practice for the Handling of Inside Information”, a document aimed at non-regulated firms to assist them in developing and demonstrating robust controls for handling inside information; and
• Report on steps taken by FSA authorised firms to improve their controls.

The newsletter is available http://www.fsa.gov.uk/pubs/newsletters/mw_newsletter26.pdf

Official press release is available: http://www.fsa.gov.uk/pages/Library/Communication/PR/2008/036.shtml

Financial Times wrote that Traders and investors are being cold-called by the City regulator in its latest bid to gather evidence of potential insider dealing crimes. The Financial Services Authority has started to call individuals directly without any warning in cases it wants to examine. Lawyers say they are aware of about 15 such cases.

“This is a new tactic and something for the market to be aware of,” said Jonathan Kelly, head of the finance litigation group at Simmons & Simmons. Individuals are being interviewed “under caution”, meaning the conversation is a dmissible in court. They are being asked if they conducted particular trades and what the reasons were. “This is about the FSA dopting a punchier approach and trying to get the evidence hot and from the hor se’s mouth,” said Ian ason, a partner at Barlow Lyde & Gilbert and a former senior enf-orcement lawyer at the regulator.

The FSA has previously given several weeks’ notice for interviews. The regulator’s research has shown that almost a quarter of all takeover deals are preceded by suspicious trading. But it has proved hard to gather enough evidence to prosecute.

Margaret Cole, director of enforcement at the FSA, said: “We are getting on with the job of investigating and prosecuting insider dealing and market abuse. Sometimes we carry out early telephone interviews. It is a fast and efficient way of gathering the facts and it would be disappointing if firms hindered this.” This week, the FSA announced mandatory recording of phone, e-mail and messaging conversations between clients and brokers that involved trading deals. In January, it brought its first prosecution of insider trading.

Martyn Hopper, litigation partner at Herbert Smith and a former senior FSA lawyer, questioned how effective the strategy would be. Mr Mason said: “We’ve told our clients to say thank you for the call, but that you’ll check with legal and compliance then get back to them. To start with, you don’t actually know it
really is the FSA on the phone.”

FT.com wrote that Alistair Darling last night signalled his willingness to grant the City watchdog US-style plea-bargaining powers to clamp down on market manipulation. The chancellor believes investigators at the Financial Services Authority may need powers to offer lesser sentences or immunity from prosecution to insider dealers in order to effectively prosecute market abuse.

His backing for the tougher powers comes a week after the FSA launched an investigation into the share trading around the “false rumours” and scaremongering that destabilised HBOS. In an interview with the Guardian, Mr Darling said: “I can’t allow us to get into a situation where people quite deliberately manipulate markets for personal gain and with the potential to destabilise the financial system.”

He added: “We have a duty to ensure we have clean and efficient markets. We will come down hard on people manipulating the system.” The FSA entered talks with the Treasury about introducing such powers last year, amid fears that insider trading was becoming a problem in London’s markets.

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The UK FSA published its Financial Risk Outlook (FRO) on 29 January 2008.

Tighter economic conditions could increase the incidence of some types of financial crime, including market abuse and fraud, among other priority risks identified under central risk scenario of the FRO.

There is a risk to wider market confidence if investors do not have confidence in the cleanliness of the markets according to the FRO. This risk is heightened when market volatility is high as both the opportunity for and harm caused by market abuse increase.

While identifying and then successfully proving market abuse is difficult, FSA will aim to achieve credible deterrence using all the options available to it. In this context, it is very important that firms have a strong focus on effective anti market abuse systems and controls. Firms that fail to do this could face high legal, reputational and regulatory risk.

FSA points out that there is a particular need to strengthen the controls over inside information relating to public takeovers where the leakage of information is too prevalent.

FSA finds also that many firms are complacent about the strength of their own controls in this area and may underestimate the threat from organised financial criminals who seek the information. Weaknesses in controls include the large number of insiders on deals, the ease of access to sensitive information on IT systems, insufficient training and a need to enhance personal-account dealing policies.

All firms who are insiders on such deals should undertake a detailed review of their systems and controls and compare them to the findings of FSA’s earlier thematic work. Firms also need to focus on ensuring that there is sufficient focus on training.

Given the more difficult market conditions, all listed issuers, in particular financial services firms, need to pay particular attention to ensuring they have appropriate systems and controls in place so that they meet their announcement obligations with respect to the disclosure of inside information.

FRO is available: http://www.fsa.gov.uk/pubs/plan/financial_risk_outlook_2008.pdf

The FSA launched its first criminal prosecution for insider dealing on 22 January against Christopher McQuoid and James William Melbourne who have allegedly traded ahead of a £103m offer by Motorola, the US telecommunications company, for TTP Communications in June 2006.

Mr. McQuoid, TTP’s general counsel at the time, and Mr. Melbourne are accused of acquiring 153 834 shares two days before the announcement was made while they were in possession of inside information about the deal.

Move of the FSA is remarkable, since it has so far relied mainly on civil enforcement instead of its authority to bring criminal charges. According to comments from financial lawyers it is a significant move by the regulator and it is likely that that the FSA may be seeking a prison sentence in this case.

Further details from: http://www.fsa.gov.uk/pages/Library/Communication/PR/2008/006.shtml

John Coffee wrote in FT.com that conventional wisdom holds that the London Stock Exchange is winning the international battle for listings and offerings, in large measure because of the “regulation-lite” policies of the UK’s Financial Services Agency. The reality is, however, more complex. A significant enforcement gap exists between the US and the UK, and its impact creates a regulatory dilemma for both countries.

London’s Alternative Investment Market has been spectacularly successful but does that success prove the value of a “light touch” on enforcement? The answer probably depends on what a country most wants its capital markets to do: either attract foreign listings, transactions and trading volume, or reduce the cost of capital to issuers.

A growing body of economic research shows the cost of equity capital varies with the regulatory and disclosure environment. In particular, these studies show that when a foreign company cross-lists on a big US exchange it incurs a significant reduction in its cost of capital and also displays a valuation premium (often 30 per cent or more) over non cross-listed companies from its home country. This pattern has continued for nearly 20 years, varying only in degree. Conversely, when a foreign company cross-lists on the London Stock Exchange, no valuation premium results and there is no reduction in its cost of capital. This pattern has also persisted since at least 1990.

What can explain this puzzle? The most plausible explanation is that stricter enforcement in the US causes investors to view the cross-listed company’s financial results and projections with greater trust and confidence and assign a higher valuation. Put simply, deterrence works.

Ultimately, stricter enforcement yields a trade-off: it deters many companies from cross-listing, but it also implies a lower cost of capital for both domestic and cross-listed companies. Companies with controlling shareholders may spurn this benefit and avoid the US in order to continue to enjoy the private benefits of control, which is worth more to them. Still, the important point to remember is that a lower cost of capital carries potential benefits for the broader society: namely, a higher gross domestic product and lower unemployment.

A public/private conflict easily arises over the desirability of strong enforcement. From the private perspective of market professionals, low enforcement means increased business. But from a public perspective, low enforcement implies greater insider trading and market manipulation, which in turn raises the cost of equity capital.

How great then is the current enforcement gap? First, viewed in terms of “enforcement inputs” (that is, regulatory budgets and staff size), common law countries invest much more in enforcement than do civil law countries, such as France, and the principal common law jurisdictions – the US, the UK, Canada and Australia – are all roughly comparable.

Second, viewed in terms of “enforcement outputs” (enforcement actions brought and penalties levied), however, the US and Australia are at the high end of the continuum and the UK at the opposite end. Even after adjustment for differences in market capitalisation, the financial penalties levied for securities violations in the US exceed those imposed by the FSA by at least 10 to one.

Third, over recent years, the FSA has allocated between 8 and 12 per cent of its budget to enforcement, while the US allocates about 40 per cent and Australia around 45 per cent. Finally, the US actively uses criminal penalties for insider trading and “cooking the books” by publicly held companies. Criminal enforcement of securities offences is virtually unknown in the UK and even civil insider trading cases remain rare.

Why are these differences so dramatic given otherwise close similarities in the disclosure systems of the two countries? Three reasons stand out: First, the UK probably does have stronger substantive corporate governance rules than the US and to a degree that mitigates the need for enforcement. Second, the City of London and the FSA both tend to view the capital markets as a polite club in which gentle guidance and a regulatory frown are sufficient. Third, the US market is much more retail oriented. Because the American middle class holds its retirement savings in the stock market, there is a stronger political demand for enforcement.

These differences seem likely to persist. But, in a globalising world, the view of the capital market as a gentlemen’s club seems anachronistic. Strangers are increasingly dealing with strangers and gentle guidance does not deter the predatory. Given the hidden costs of insider trading, perhaps the time has come for the UK to take enforcement more seriously.

The writer is the Adolf A. Berle professor of law at Columbia University Law School and director of its Center on Corporate Governance.