FSA Market Watch July 2007: Issue No 21

Ensuring good practice is principles-based and proportionate

Originally published in the July 2007 issue

On the back of the FSA’s disturbing findings that M&A market cleanliness isn’t improving, we have heard the FSA become increasingly vociferous about the penalties that will be meted out to wrong-doers. I agree with hefty punishments for those who are guilty, and those whose negligence has allowed others to abuse the market. However, for this message to resonate with those who are wilful it needs to be backed with some real, visible and tough activity.

Sometimes a disproportionate amount of effort applied to telling those trying to ensure they operate their business well of the further steps they should take, as opposed to the effort we see spent on bringing the guilty to trial. While the FSA explains that firms should take a proportionate approach, such musings are interpreted as de-facto guidance by many.

Firms need to take the FSA at their word: The good practices contained in the FSA’s Market Watch, July 2007, should not be taken as a tick list, and the FSA must not use it as such. From the top of the FSA you will hear confirmation that this will not be the case. But the FSA has been here before: when they drove the need for AML documentation it required huge processes to be put in place to gather electricity bills up and down the country, whilst money laundering continued to grow. The so called ‘futility of the utility’ ended last year with a move to a risk-based approach to customer identity checking but not without huge expense to the industry.

Firms need to be prepared to push back when asked why they don’t have a written protocol for engagement with journalists, or why they haven’t disabled outlook functionality. But, firms can only push back with confidence if they have carefully considered what controls they need to have in place. While the FSA are not saying that their good practices must be adopted they have made it clear that publication of articles such as Market Watch means that all firms should have a heightened awareness of the risks and issues involved.

So what should hedge fund managers do? Well, I am not going to give you a tick list. Perhaps a more ‘principles-based’ approach is best. The key topics (but not the only ones) currently being discussed are shareholder activism and leaks of non-public information.

Shareholder activism

The FSA’s Market Watch newsletter in May this year was admirably clear. If a manager has a strategy to acquire a stake to enable it to launch a full takeover bid, or exercise other shareholder rights, then acquiring that stake without disclosing strategy is NOT viewed by the FSA as abusive of the market.

The FSA’s reasons behind this are perhaps the key to exploring what will be regarded as abusive behaviour and what will not. The FSA has said, in a straightforward case of a manager building a stake with a view to launching a bid, or some other action, he is simply taking advantage of his own expert analysis of otherwise public information. This seems to be the fundamental tenet of successful, and legitimate, fund management. This key statement from the FSA leads us to question whether your strategy is based on something other than your expert analysis of otherwise public information.

A manager is unlikely to build a multi-million pound strategy on the back of their regular Sunday morning golfing partner casually remarking that the board members of his company were in dispute over strategic direction. However, if because of hearing this the manager found other, public research to support the idea of there being value in the company, and, scenting turmoil built an investment strategy to exploit it, could he claim the strategy is based on only his expert analysis of otherwise public information?

This is not a very complicated argument, and it shouldn’t be. At its heart, compliance should be simple and defined by high standards of business practice. Firms are taking a wrong turn if they rely on detailed legal analysis to properly conduct their day to day business. Another simple principle that managers should consider is whether their actions are designed to get around a particular rule or requirement. If they are, the chances must be higher that their behaviour will be regarded as abusive.

The simplest example of this is acting in consort. If you devise a strategy with others to build stakes that individually do not need to be notified, with the intention or likelihood of acting together in the future, could you defend yourself against the charge that you were abusing the market by deliberately avoiding a rule or requirement? This is where understanding the FSA’s desire to move to a principle based system of regulation, and benchmarking your business activities against those core principles becomes so important.

Leaks of non-public information

It is very easy to slip into the mindset that leaking non-public information is a risk faced by investment banks rather than fund managers. But that does not mean that you do not receive non-public information!

Hedge fund managers regularly receive inside information on forthcoming new issues and re-financings. These wall-crossings occur very close to the deal being announced and result in the manager being unable to deal in the securities until the announcement is made.

By contrast, there are occasions when investment banks take ‘market soundings’ when more general information is given, often at an early stage of a deal. It is sometimes difficult to distinguish whether it is inside information being passed or not; it depends on the content of the message. The FSA’s Market Watch newsletter emphasises the importance of training but also recognises that smaller firms have greater difficulty in prioritising market abuse training.

The risks of information inadvertently slipping into the wrong hands, and being used inappropriately can be as high with hedge fund managers as they are with investment banks. We can narrow down the protections firms must operate at a more principled level.

  • Who do I really need to pass this information on to? The more people who know, the greater the risk of leakage. So do I need a second opinion?
  • Does my recording of the information mean that others are aware of it that don’t need to be? This can be as inadvertent as recording meetings in the visitors book or a diary.
  • Do I record things in a way that others can access and make themselves aware of? These others aren’t necessarily members of your firm, IT support or cleaning firms for example.
  • Am I discrete in the way I discuss or view information? Do I need to talk about it/read it on a busy train or coffee shop?
  • Can I be confident that others who will have access to the information will be as discrete and disciplined with it as I will? This is particularly important to consider when individuals other than market professionals may see it.
  • Do you still bounce ideas off friends who knowing you can put two and two together?


I don’t want to knock the FSA for producing lists of good practice, many market participants ask for them, but we must all remember that these are not rules and must not de-facto become so. We must avoid anti market-abuse measures which require the good to spend increasing amounts evidencing they are good rather than tackling the more difficult subject of catching the wrong-doers. Firms may think that not adopting every suggested good practice is taking a brave stance; at IMS we advocate that compliance must be proportionate and that by looking even at difficult subjects like anti-market-abuse in this, more principle-based way, we can help to de-mystify much that you have to do.