Tackling market abuse continues to be a strategic priority for the FCA. In late 2014, the FCA undertook a thematic review into asset management firms and the risk of market abuse, the results of which were published in February 2015. Overall, the FCA found that most asset management firms had in place some controls to address the risk of market abuse. However, the FCA identified room for improvement on the part of some firms, particularly in relation to controls relating to the identification and receipt of inside information, as well as post-trade surveillance.

The FCA's feedback, as well as a recent enforcement case concluded by the FCA relating to the senior partner of an asset management firm, also provides some helpful guidance as to how asset management firms may go about effectively managing and mitigating the risk of market abuse or assisting others to commit market abuse. This guidance is explored in this article. There will be an expectation on the part of the FCA that asset management firms will review and take into account this guidance when reviewing their own systems and controls for preventing market abuse.

Background

Tackling and taking action against those found to have committed market abuse remains a strategic priority for the FCA. In accordance with this priority, in late 2014 the FCA undertook a thematic review into asset management firms and the risk of market abuse.

As part of this thematic review, the FCA reviewed the systems and controls of 19 asset management firms, including long-only asset managers, hedge fund managers and an occupational pension scheme. The sample of firms reviewed included both large and smaller firms, with global assets under management ranging from approximately GBP 200 million to over GBP 100 billion.

The FCA published a report, setting out the findings of the thematic review, in February 2015.

Key areas of focus for the FCA

The FCA's key areas of focus, both in practice as well as in the thematic review, are as follows:

•  Managing the risk that inside information could be received but not identified.
• Controlling access to inside information and managing the risk of improper disclosure.
• Pre-trade controls to prevent market manipulation and insider dealing.
•  Post-trade surveillance.
• Personal account dealing policies.
• Training.

The feedback provided by the FCA in relation to each of these key areas in relation to its thematic review, as well as practical guidance for asset management firms in relation to them, is set out below.

Managing the risk that inside information could be received but not identified

Wall crossings

Although the FCA found that most firms had effective policies to identify and capture inside information that is intentionally received through wall crossings initiated by investment banks, most firms did not have similarly effective policies for when inside information is unintentionally received. For example, there is a risk that a person working in an asset management firm may unintentionally receive inside information from a conversation about a proposed wall crossing (known as a ‘sounding’) if sufficient information is given for the person to deduce the company involved and the nature of the forthcoming event. The FCA recommended that firms review their practices in this area.

Checklist for firms

• What level of independent assessment is there at your firm in order to determine whether inside information has been received by fund managers during soundings?
• Who has overall responsibility for assessing whether inside information has been received during soundings within your firm? Is this person independent from the fund managers?
• What records are kept by your firm of the assessment undertaken?
• Are fund managers required to confirm whether inside information has been received following a sounding? How is adherence with this process monitored and enforced in practice?

Company-specific research

All firms assessed by the FCA had practices to avoid the unnecessary receipt of inside information when conducting company-specific research. However, the FCA found that these practices were typically informal and inconsistently applied. For example, one situation highlighted by the FCA in its feedback was informal meetings between fund managers and consultants, during which inside information may be passed to the fund manager. The FCA concluded that if firms receive inside information but it is not identified as such, there is a significant risk that this information could be acted on in a way which constitutes market abuse. As a result, the FCA encouraged asset management firms to do more to promote the identification of inside information during informal discussions and meetings.

Checklist for firms

• What controls are in place to record and monitor information provided to fund managers during informal meetings?
• What monitoring is undertaken in relation to fund managers or trades who trade in securities after or around the time they have attended meetings with the issuer?
• What, if any, criteria are in place to determine whether an informal meeting should go ahead? For example, is a firm happy for fund managers to meet with representatives of listed companies during close periods or for them to meet with consultants who have recently worked for listed companies?
• What reminders or alerts do employees at your firm receive in order to reinforce the risk that they could receive inside information inadvertently?
• Are fund managers encouraged to confirm at the outset of informal meetings that they should not be provided with any inside information?
• What processes are in place to allow employees to discuss any concerns that they have about inadvertent receipt of inside information? Are these processes clearly publicised to relevant employees?
• Is there a log of informal meetings held? What information is stored about these informal meetings?  

Controlling access to inside information and managing the risk of improper disclosure

Most of the firms reviewed by the FCA considered all employees to be restricted from trading in certain securities when inside information had been received by the firm, as opposed to only restricting certain individuals. In most asset management firms, employees are told that they are restricted from trading in certain securities and no other information is provided.

However, in the feedback from its thematic review the FCA highlighted one firm that also informed its employees of inside information that had led to trading being restricted in certain securities. The FCA stated that this was an example of poor practice and emphasised the importance of asset managers only disseminating inside information internally on a "need to know" basis given the risk of improper disclosure and insider dealing that wider sharing of such information may give rise to.

Checklist for firms

• inside information shared internally within your firm on a ‘need to know’ basis only?
• Is a list of people who have been provided with inside information maintained?
• Once trading is restricted, is a system block automatically and instantly put in place to prevent traders from trading in the restricted security?

Pre-trade controls to prevent market manipulation and insider dealing

As part of the thematic review, the FCA reviewed three key categories of pre-trade controls that may help to prevent market abuse:

• System "blocks": most firms impose "blocks" on their trading systems. This means that when inside information is received, the trading system is configured so as to prevent traders from trading in restricted securities. In some firms, the FCA found that these systems ‘blocks’ could be overridden. The FCA indicated a preference for firms not having the ability to override system ‘blocks’. However, where this is possible, the FCA emphasised the need for asset managers to have robust controls relating to how any system "blocks" can be overridden.
• Recorded telephone lines: whilst most firms surveyed recorded landline telephones, only a handful also recorded employees’ work mobile telephones.
• Evidencing rationale for investment decisions: many asset managers already document  the rationale for investment decisions as a way to monitor this process. Such documentation can also enable more effective post-trade surveillance, as well as making it easier to handle enquiries - including if enquiries are received from regulators in relation to certain investment decisions that have been made.

Overall, the FCA found that having effective pre-trade controls in place can help to effectively identify individuals who have access to inside information and also monitor the risk of market abuse.

Checklist for firms

• What type of system "blocks" does your firm have? Can they be overridden? If so, by who and what is the process for this?
• How quickly are your firm's system "blocks" implemented? If not instantaneously, how does your firm control and monitor the risk of employees trading in restricted securities in the meantime?
• Are appropriate employees' telephone lines recorded? Is this audited regularly to ensure that no technical errors have occurred?
• Are employees' work mobile telephones recorded? Would recording calls made to and from these devices assist your firm to monitor the risk of market abuse?
• What process does your firm have in place for documenting investment decisions and the rationale for them? How are these records reviewed and stored?

Post-trade surveillance

The FCA has identified post-trade surveillance as playing a key role in detecting and deterring market abuse, as well as an area where many asset management firms could make improvements to their systems and controls.

There is no "one size fits all" post-trade surveillance method: how an asset management firm undertakes post-trade surveillance will depend on its size and activities. However, senior management within asset management firms must have processes to satisfy themselves that controls to identify and manage the risk of market abuse are working effectively. Examples of "good practice" relating to post-trade surveillance that the FCA has identified and publicised include:

• Using statistical analysis to identify post-trade price movements outside a set probability range to trigger surveillance follow-up. This probability range should be tailored to specific markets as, if the same probability range is applied for all markets, this could lead to an unmanageable number of irrelevant trades being flagged, thereby making trades that are genuinely worthy of investigation harder to identify.
• Regular monitoring of recorded telephone lines of fund managers and traders, whereby a sample of their telephone calls are reviewed.
• Undertaking media searches to check for any activity that could be false or misleading, for example, checking to see if a fund manager has given positive commentary about a company to generate demand in its securities before selling his or her holding in it.
• Promoting awareness of the fact that post-trade surveillance is carried out within firms may also help to deter employees from committing market abuse, due to the risk that their conduct may be uncovered. However, care should be taken in terms of what information about post-trade surveillance methods is provided to employees so as to avoid the risk of employees being able to circumvent these controls.

Checklist for firms

• Are your firm's post-trade surveillance methods commensurate to the size of your firm and the activities that it undertakes?
• How could your firm use statistical analysis to help identify potentially suspicious trades?
• Consider monitoring recorded telephone calls and public statements made by employees (including interviews and posts in online trading forums) and reviewing a sample of these communications to identify any conduct that may warrant further investigation.
• Promote awareness of the fact that post-trade surveillance is undertaken by your firm, but without disclosing too much information about how that surveillance is carried out or what may trigger certain trades for further review.

Personal account dealing policies

The FCA requires all asset managers to have personal account dealing policies (Rule 11.7, FCA Conduct of Business Sourcebook (COBS 11.7R)). The rationale for putting restrictions on personal account dealing is to help reduce the risk of market abuse, including the risk of front-running and insider dealing.

The FCA highlighted that, based on the findings of its thematic review, some asset management firms should make improvements to their personal account dealing policies, in particular relating to prescribing the amount of time that has to pass between a personal account trade and a trade on behalf of a fund.

Checklist for firms

• Consider undertaking a "healthcheck" of your firm's personal account dealing policy. Is it fully up-to-date and does it adequately address the risk of front-running and insider trading?
• How much time does your firm’s personal account dealing policy require between an employee undertaking a personal trade and then undertaking a trade on behalf of a fund? Is this a sufficient amount of time to reduce the risk of front-running?
• How is compliance with your personal account dealing policy monitored? Are regular sample checks carried out?
• Do employees receive mandatory and regular training about your firm’s personal account dealing policy?

Training

Educating employees about market abuse is an integral part of most asset management firms’ training schedules. It is important that employees receive regular and up-to-date training on this topic.

However, the FCA is becoming more demanding in terms of how bespoke it expects training to be. For example, the FCA is unlikely to be satisfied if all employees within an asset management firm are provided with generic training about market abuse. Rather, the FCA will expect those employees to be provided with training about market abuse which is tailored to their specific roles and responsibilities. Using case studies relating to different business areas in training programmes is often a good way to help make training more engaging, as well as more bespoke to certain employees' roles and responsibilities.

In the FCA's thematic review, it was noted that some firms provide market abuse training to their employees via online training courses. In the case of one asset management firm that was reviewed as part of the thematic review, the FCA noted that its training log showed that a number of employees had completed the online training course of market abuse in less than half the stipulated time. In this case, the FCA found that there had been no follow-up to understand why this was the case or whether employees had properly understood and digested the content of the training course.

Checklist for firms

• Review how frequently your firm's employees are provided with market abuse training.
• How bespoke is the market abuse training provided to employees within your firm? Does it specifically address key market abuse risks, indicators and "red flags" that may occur in their area of responsibility?
• Is training on market abuse provided to all employees within your firm, including employees with more administrative responsibilities?
• Is completion of mandatory market abuse training monitored? What steps are taken to ensure that employees undertake this training?
• Are reviews undertaken to identify employees who repeatedly fail to complete market abuse training on time? How are these employees dealt with?
• Are audits undertaken to assess how much time employees spend completing online training courses? Would including short tests or questions at the end of certain online training modules help to provide comfort that employees have understood and digested the training material?

Additional risk: assisting others to commit market abuse

The FCA's thematic review relating to asset management firms and the risk of market abuse focused on the risk that those in asset management firms themselves may commit market abuse. However, those working in asset management firms also need to remain alive to the risk that their dealings with clients could expose them to the risk of assisting a third party to commit market abuse.

For example, in a recent enforcement case the FCA alleged that a senior partner of an asset management firm, Tariq Carrimjee, had acted without integrity in breach of Principle 1 of the FCA's Statements of Principle and Code of Practice for Approved Persons (APER) by recklessly assisting a client to commit market abuse. The basis of the FCA's case was that Mr Carrimjee had participated in discussions with one of his clients about trading strategies and introduced them to a broker despite the fact that he suspected that the client was proposing to commit market abuse (as the client eventually did).

In March 2015, the Upper Tribunal (Tax and Chancery Chamber) handed down its judgment in relation to Mr Carrimjee's case. The Upper Tribunal did not agree with the FCA's finding that Mr Carrimjee had breached APER Principle 1. Rather, the Upper Tribunal held that Mr Carrimjee had failed to act with due skill, care and diligence in relation to his dealings with his client in breach of APER Principle 2. The Upper Tribunal agreed that a financial penalty of £89,004 should be imposed on Mr Carrimjee for his conduct.

Although Mr Carrimjee was not found to have acted without integrity, his case nonetheless highlights the importance of those working in asset management firms remaining alive to the risk of market abuse and escalating any concerns that they have about market abuse (whether relating to colleagues or clients) in an appropriate and timely manner. This is a subject that should also be covered in asset management firms' training programmes.

This article first appeared on www.practicallaw.com and is published with the permission of the publishers.