Although the 18th Century poet Thomas Gray exhorted “Where ignorance is bliss, ‘Tis folly to be wise”, it seems the FCA do not agree with him. At the tail end of last year, the regulator sent two warning shots that ignorance is far from bliss when it comes to market abuse, and can result in a hefty fine and the loss of your career.
New warning, not new law
Shot number one was fired by Julia Hoggett, the Director of Market Oversight, in a speech made on 14 November 2017. Entitled “Effective compliance with the Market Abuse Regulation (MAR) – a state of mind”, the speech made a number of interesting observations, including that although insider dealing was the traditional poster child of market abuse, the FCA would in future focus more on market manipulation. While this statement was in itself an important announcement regarding the FCA’s direction of travel, it was the comments that Ms Hoggett made towards the end of her speech that merit closer attention.
Having explained that the FCA would not be shy of pursuing enforcement action in cases where there were reasonable grounds to suspect that serious misconduct capable of amounting to market abuse had taken place, she went on to say :
“ignorance of the requirements of MAR, or the absence of intent to commit market abuse, are not a defence to breaches of MAR. Abusive conduct committed in ignorance of the rules can be every bit as serious in its consequences as deliberate, dishonest conduct, and we will pursue it accordingly.”
That Ms Hoggett took the time to spell this out is worth examining, the lack of intention in market abuse cases not being new law. Indeed in 2010 the Court of Appeal held in the Winterfloods litigation that the test of market abuse was a wholly objective one, and did not depend on the (then) FSA having to prove a particular state of mind on the part of the accused. A person engaging in market abuse need not have actually intended to abuse the market in order for a finding of market abuse to be made against him.
So why did Ms Hoggett feel the need to reiterate this, and why now? The obvious answer is that we can expect the FCA to concentrate more of its enforcement budget on cases where market participants have erroneously committed market abuse.
Paul Axel Walter
Ms Hoggett’s comments were, it transpires, particularly prescient, as just one week later the FCA published their Final Notice in the case of Paul Axel Walter, an individual whom the FCA found had committed market abuse, not intentionally, but negligently. In the summer of 2014 Mr Walter, an approved person with 20 years of market experience, was working as a bond trader at Bank of America Merrill Lynch International Limited (BAML). He had responsibility for approximately 80 bonds, including Dutch State Loans (DSLs), a form of fixed income bond. In order to trade DSLs, Mr Walter used an electronic inter dealing platform called Broker Tec.
The FCA’s case centred around their case theory that between 2 July 2014 and 8 August 2014, Mr Walter implemented a strategy on 12 occasions that relied on him giving a misleading impression that he was a genuine buyer (or seller in one instance) of DSLs. He would enter quotes on the Broker Tec platform, which had the effect of inducing other market participants who were tracking quotes to raise or lower their own quotes, and he would then benefit from the accompanying price movements.
A number of market participants who traded on BrokerTec used automated systems, such as algorithms, to update their quotes by tracking each bond’s Best Bid and Best Offer. The FCA found that Mr Walter misled the market by inducing these other participants to believe he was a legitimate buyer of DSLs when he really wanted to sell, or vice versa. For example, in circumstances where his real intention was to sell DSLs, he would enter a high bid and offer quote into BrokerTec in order to provide an impression that he wished to buy, and which resulted in his quote being given Best Bid status. Other market participants who were tracking Best Bid and Best Offer would then raise their bids in response. Once Mr Walter could see that he was being tracked he would raise his own bid again, triggering a further response from the trackers. This continued until a price was made by the trackers that Mr Walter was willing to transact at. He would then execute the trade before cancelling his own quote.
In their Final Notice the FCA stated that it regarded Mr Walter’s behaviour to constitute a serious example of market abuse, in that it gave a false and misleading impression as to the price and supply or demand of DSLs, as well as securing an artificial price for the DSLs. They levied a penalty of £60,090.
Takeaways from FCA findings
The first, and most important takeaway, is that while the FCA accepted that Mr Walter’s actions may have been negligent rather than intentional, this did not stop them from making a finding of market manipulation. Indeed at paragraph 2.9 the FCA noted that while “Mr Walter did not intend to commit market abuse he should have realised that his behaviour constituted market abuse.” The message here is clear and strong – individuals must take the time to acquaint themselves properly with MAR and must think carefully before becoming involved in any form of action that could be termed “sharp”. Not knowing is not an excuse.
Secondly, it seems extraordinary in a case where the FCA itself agreed that the price of the bonds was only momentarily secured at an artificial price, and where Mr Walter made no discernible profit for himself (and a fairly insignificant sum in the region of $22million for BAML), that the regulator has taken such draconian action. This was not a case of spoofing or layering by the FCA’s own admission. Although the fine levied was not eye-watering, the very finding means that Mr Walter will find it difficult if not near impossible to find employment in the same industry.
Thirdly, cases relating to market manipulation and the posting of quotes and prices often ultimately boil down to arguments as to whether the bids made were genuine, and whether the individuals making the offers were prepared to “stand up” to them. In Mr Walter’s case, while the FCA accepted that other market participants could have traded with him on the basis of his quotes – the bids were available long enough for this to have occurred, and indeed this did actually take place on at least two occasions – they still held that dealing was not his real intention and the quotes could not therefore be said to be genuine.
Finally, it seems that the FCA did not feel unduly charitable towards Mr Walters as despite receiving a telephone call from Broker Tec on 22 July 2014, during which he was informed of concerns about his conduct on the platform, he chose to trade again in the same manner rather than taking the opportunity to reflect on his actions. The FCA noted in its response to Mr Walter’s representations that “this exacerbates his negligence”. It may well be that by continuing his conduct, despite being on notice of the concerns, the FCA considered that a line had been crossed, and that formal action should be taken against him.
While it is admirable that the FCA is concentrating its efforts on market manipulation, it should tread carefully and not simply choose the “easy cases” where individuals have unintentionally fallen foul of MAR. The FCA risks undermining its credibility if it concentrates unduly on inadvertent breaches rather than deliberate and repeated systemic abuses that fatally undermine the market.
In light of the FCA’s warning shots, market participants must start to take a more active role in fully acquainting themselves with MAR. Recent experiences in FCA interviews suggest that at the very least a basic knowledge of MAR is expected of approved persons and those who fall within the scope of the Senior Managers and Certification Regime.
So it seems that ignorance is not bliss, at least not as far as the FCA is concerned. To misquote Thomas Gray: “‘Tis prudent to be wise”.
 Winterflood Securities Ltd & Ors v Financial Services Authority  EWCA Civ 243