The War Against Market Abuse

The effect of the FSA's first salvo on HMS Hedge Fund?

Originally published in the December 2007/January 2008 issue

This autumn saw the publication of the FSA study on how hedge fund managers currently counter the risks posed by market abuse. The FSA reviewed a range of hedge fund managers from the boutique firms through to larger institutions as well as speaking with some banks to gauge their views on the potential of market abuse in hedge fund activities. The FSA found a range of anti-market abuse awareness by hedge fund managers, however, alarmingly the FSA remarked that it was: "… disappointed by some of what we saw." Following this informal study the FSA intends to undertake formal visits of hedge fund managers in order to assess their anti-market abuse procedures. With the prospect of a formal visit, now is the time for hedge fund managers to mark themselves against the following themes and good practices identified in the study.

Compliance culture

The FSA expects the senior management in all regulated firms to fully accept responsibility for compliance and to encourage a compliance culture. It must have been somewhat surprised to find that some hedge fund managers gave the impression that responsibility for market abuse lay with the compliance department. While all staff must be alert to the risks of market abuse it falls to senior management to set the overriding ethos of the firm.

One of the themes identified by the study was the fact that some hedge fund managers expressed concern about the quality and availability of external compliance consultants. While the FSA accepted some of these views it also stated that it was the responsibility of hedge fund managers to ensure that they received the appropriate advice. The FSA commented: "It is not a valid excuse to claim they are not meeting regulatory standards because of inadequate advice."


The FSA places much emphasis on staff training in particular awareness of financial crime – money laundering, fraud, insider dealing/market abuse. It will be of concern to the industry that the FSA "…were particularly disappointed at the level and standard of training some of the hedge fund managers visited." Although the FSA found examples of good training it also found incidents of no training or training of an inadequate standard. Managers need to train all their staff to identify and address market abuse risks. Such training may be available off the shelf but it needs to be practical and bespoke to that particular manager.

Systems, controls and ongoing monitoring

The study noted that some managers had IT systems which would identify possible market abuse, for example alerts if securities on stop lists were about to be traded. The FSA suggests that they develop these systems further.

The FSA also feels it necessary for managers to have independent monitoring of anti-market abuse measures in place. Hedge fund managers should first assess the market abuse risks applicable to their business profile, develop controls to counter these risks and then monitor the controls.

Such monitoring could include examining the reasons behind a trade in securities shortly before an unexpected trading or regulatory announcement and monitoring of recorded telephone calls. The study found that only a few managers recorded telephone conversations. The FSA has suggested that for those managers who currently do not record calls, they may wish to consider the benefits of such a practice. Such an assessment would need to consider the regulatory dividend over the risk of market abuse.

Inside information

The leakage of inside information during mergers and acquisitions activity was the subject of a FSA report in July 2007. The FSA considered all links in the M&A chain, meeting with firms in the regulated sector such as investments banks and unregulated sectors, for example financial printers and law firms. The FSA found that some firms were too complacent about the effectiveness of their procedures to prevent leakage.

It is therefore not surprising that the study examined how and when hedge fund managers are in receipt of inside information. Some managers reported that at meetings with companies inside information was inadvertently disclosed to them. The FSA suggested that it may assist managers if they explain at the start of such meetings that they did not wish to receive inside information.

The FSA also cited one example of a manager's compliance officer attending such meetings with them. This may not be appropriate or in fact possible for other managers, but they should be able to demonstrate that they have adequate systems in place to manage such disclosures and maintain the confidentiality of the information. Such systems should be reinforced by a clear message from senior management and adequate training for staff.

Remuneration structures and personal account dealing

The study considered how managers were remunerated with some linking remuneration to the individual's performance and others to the overall performance of the firm. The FSA suggested that the latter remuneration arrangement would be beneficial to reduce the incentive of their staff to engage in market abuse for short-term gains.

In addition, robust personal account dealing policies may add value to inhibit market abuse for personal gain. In one example the manager conducted an annual retrospective review of all staff trading.

This study does not suggest that there is actual market abuse in hedge fund activity, but the FSA's interest in them should be of no surprise to the industry. Recent examples of such interest include the FSA fines of £750,000 to GLG Partners and its former Managing Partner Philippe Jabre for market abuse and breach of FSA principles.

This time last year Sean Pignatelli, a US equity analyst, was fined £20,000 by the FSA for breaching Principles 2 and 3 of the FSA's Statements of Principle for Approved Persons. Pignatelli had failed to consider whether information received, via e-mail, from a contact might have contained inside information, in fact it did not. However, he went on to make embellished comments when he conveyed the information to four of his clients.

As the FSA moves away from prescriptive rules-based regulation to more principles-based regulation, it cannot be emphasised enough how important these studies are for senior management and compliance officers to digest. We have already seen this with money laundering; between 2002 and 2004 the FSA took rigorous enforcement action against the banking sectors for inadequate anti-money laundering systems and controls. At the time the FSA had little sympathy for a sector which had been warned about the risks.

Disappointment expressed by the regulator may be the first salvo across the bow of HMS Hedge Fund but if you do not react quickly enough then the broadside of FSA enforcement action could be devastating.

Richard Burger is a senior solicitor in the Regulatory Team at Mills & Reeve LLP. A former FSA Enforcement Lawyer he was the case lawyer in the FSA's first published case of market abuse. Since returning to private practice he has advised regulated firms and approved persons on market abuse. He has written and lectured extensively on the market abuse regime to include a series of lectures on market abuse and financial crime to the membership of the Securities and Investment Institute.