Why would it be any different on this side of the Atlantic?
Until now we have been blessed with very few large scale insider dealing and market abuse cases in the UK. Few believe that our markets are cleaner than in the US and the media has now changed its popular stance to give the FSA credit for having taken a tougher stance on market abuse and the regulator is finally starting to emerge as a stronger supervisor of the markets.
Does the FSA have the right tools?
The FSA is armed with an array of tools to help detect, and hopefully deter, possible offenders. One of these tools is the ability to target specific trades through data collection and transaction monitoring of debt and equity trades both on market and OTC. In the UK, all regulated firms are required to report trading data to the regulator through Approved Reporting Mechanisms by trade date plus one (T+1). In addition, the FSA has access to client identification on all these trades, a function that is not currently possible in the US.
The introduction of MiFID in November 2007 has had the effect of unifying key aspects of regulation across Europe, allowing for a much easier flow of information across borders. Hence, coverage of all regulated markets is consistent and transaction reporting is a more powerful weapon than it has ever been in the fight against market abuse.
The Market Abuse Directive, while not containing imprisonment powers, can seriously damage a firm’s reputation and touch those individuals that seek to manipulate our markets through insider dealing. The Directive, popularly called MAD, has wide spread powers. It allows European regulators to impose injunction orders, censure both firms and individuals as well as imposing unlimited fines. The FSA is now starting to make good use of these powers, as well as its criminal powers. This is a step up for the regulator.
The recent Barclays case (where the firm was fined £2.45 million for transaction reporting failures) has highlighted to all firms the importance of quality, complete and accurate transaction reporting. It has shown just how crucial it is for firms to have quality systems and controls in place to detect market abuse early. It also sent a warning to the UK regulated community, as Barclay’s itself was not subject to an investigation; simply, the integrity of the data supplied to the regulator was not correct which was detected when the FSA looked into a matter not involving the firm.
So how can a firm protectitself?
Keeping up to date with messages on the regulatory agenda sent by the FSA through market watch newsletters is essential and expected by the regulator. It should come as no surprise to any regulated firm that if its systems and controls designed to monitor and prevent market abuse are not sufficient it carries a great risk of supervisory action and in some cases enforcement action.
Conducting regular face to face training for staff, as opposed to computer based training, is important to raise awareness and prevention. This is consistent with Market Watch 24 which states that ‘It is essential that staff operating within HFMs receive appropriate and regular training on market abuse. In general, a firm should tailor this to the type of business it undertakes and it should contain practical examples relevant to the business’ .
Regularly updating staff on current market conduct cases and the lessons learnt is another important tool. Firms should analyse and communicate the outcome of the cases published on the FSA website and, if necessary immediately take remedial action in order to adhere to good practice in the area of market conduct controls. For example, reviewing, verifying and improving transaction reporting processes should now be a key operational aspect within any regulated firm. This includes, assessing the reporting mechanism used and analysing transactions conducted and reports made to the FSA.
But is this all?
Insider Dealing is wide reaching. A case like the Galleon case could happen here. However, it must be stressed that a benefit of the UK regulatory system, as opposed to the US, is that in the UK both individuals and firms are authorised based on the activity that they undertake. Anyone dealing in investments, for example, has to be authorised. In the UK a number of individuals involved in the Galleon case would have been authorised persons, and the FSA would have had access to background analysis of the actual persons.
The Galleon case also serves to highlight the breadth of people who can become involved in these cases and that they are not confined, as tradition dictates, to traders. To date 22 arrests have been made in relation to this case including Raj Rajaratnam (Founder and Managing General Partner of Galleon), Rajiv Goel (Director in Strategic Investment for Intel Capital), Robert Moffat (Senior Vice President at IBM), Anil Kumar (Director at McKinsey), Mark Kurland (Senior Managing Director and General Partner for New Castle), Danielle Chiesi (Portfolio Manager for New Castle).
Exposing hedge fund managers can be difficult as many trade in and out of stocks so frequently. Galleon may have done so more than 1,000 times per day. Consequently it is not so easy to link, for example, front running to M&A activity or significant corporate events.
The fund can be hurt in other ways though. Galleon, it is alleged, has made US$25 million out of the illicit trading. For a fund with AUM of US$7 billion at its peak, this does not seem much. But it has wrecked the fund. And it is the end of Rajarantnam. On 21st October 2009 he announced that he would wind down Galleon’s funds.
Whilst over the past few years the FSA has focused mainly on information leakages surrounding M&A deals it is only a matter of time before the focus turns to hedge funds. As mentioned earlier, firms should listen to the FSA warnings.
As a billionaire hedge fund manager, Raj Rajaratnam wooed Wall Street for years with his talent for picking high-flying technology stocks; his so called talent proved to be his downfall. Perhaps it is fair to say that people like Mr Rajaratnam, had he been in the UK, would have been authorised by the FSA in his own right. Or indeed, perhaps persons like him are disinclined to use financial markets for this purpose in the UK as the hurdle of getting authorised is simply too big.
To cite a previous regulator, “eighty percent of the problem should be stopped at the door”, though in America they have another take on this. They would probably say “hurt them where it hurts most, in their pockets and to their freedom”.