31/03/2010 Author: Tony Griffiths

A matter of principle

The recent FSA investigation into insider trading has seen the much-discussed spectre of hedge fund regulation translated into tangible action, sending a clear message to the sector that market abuse contols are an essential part of hedge fund due dilligence requirements

Swooping to apprehend seven individuals on suspicion of insider trading last week, the Financial Services Authority (FSA) validated its newly defined hawkish reputation in the most high-profile manner possible. Among those arrested were employees of BNP Paribas, Deutsche Bank and hedge fund heavyweight Moore Capital, in what the UK regulator has called the largest operation of its kind.

“These arrests send a strong signal to the City,” said Jérôme de Lavenère Lussan, CEO of hedge fund consultancy Laven Partners, following the news. “The FSA’s actions show that they are fully committed to seeking criminal convictions for insider dealing.”

The arrests may have hit the headlines, but three weeks prior a similarly significant development had been announced, minus the media fanfare, on the FSA’s website. On 6 March, a new framework for fines, linked more closely to income, came into force, with the potential to see penalties treble in size. Introduced “despite industry opposition”, the regulator said, the new fines could see firms charged up to 20% of revenue from the product or business area linked to the breach and individuals up to 40%.

This is about “taking tougher action and tougher enforcement, and providing credible deterrents” an FSA spokesperson told HFMWeek, and, they added, it would see “more cases” brought to light.

The FSA has a newly improved armoury at its disposal and avoiding market abuse is no longer enough to escape the regulator’s wrath, firms need to be able to prove that they have taken adequate steps to prevent it. “More will get caught out because they’re following the rules but not the principle,” explains Andrew Shrimpton, a member of regulatory consultants Kinetic Partners.  

“The key message is that even the smaller firms need to have tangible systems and controls to mitigate as far as possible the risk of market abuse,” adds Peter Moore of IMS Consulting. “When inquiring about anti-market abuse systems or controls, what the FSA doesn’t want to hear from a firm of any size is that a) they don’t do it [market abuse], and b) they don’t do it because they hire honest, experienced people. That’s not good enough for the FSA.”

Warnings have been forthcoming. Back in October, two bond managers accused of maket abuse at Dresdner Kleinwort escaped fines after successfully arguing that they were unaware at the time that they were acting in an abusive manner. “Future offenders will be likely to face significantly more severe sanctions,” Margaret Cole, the FSA’s director of enforcement, warned afterwards.   

“With examples like the Dresdner case, people are following market practice, but the FSA argued that market practice was not acceptable,” says Shrimpton. “You need more principles-based training of individuals. It’s not just about the rules, you have to be whiter than white in terms of market abuse issues.”

The message appears to be getting through. Shrimpton has seen managers of all sizes focusing on market conduct controls. “There’s been a particular focus also on improving personal account dealing policies and procedures, such as people bringing minimum holding periods,” he says.

“The Moore Capital arrest is interesting because it appears that the issue being investigated is personal dealing rather than people dealing on behalf of the firm,” agrees IMS’s Moore. “The firms in question will take comfort if they have had adequate systems and controls and it appears that the individuals in question have been acting in breach of those systems as action will be against the individuals rather than firm itself.”

Recent developments, both heralded or otherwise, therefore, should act as further warning. “That’s the key message we have been giving clients – have systems and controls, and educate staff of these systems and controls,” Moore concludes. “When and if the regulator looks at these events, the actions will be against the individuals rather than firms. That is the best way for a firm to keep themselves safe from harm.”