Alert October 23, 2012

U.K. Development of Note - Tax and Chancery Chamber Upholds FSA Sanctioning of Swiss Fund Manager and Brokers for Marking the Close

The Upper Tribunal, Tax and Chancery Chamber of the United Kingdom (the “Tribunal”) issued a decision (the “Decision”) upholding the United Kingdom, Financial Services Authority’s (the “FSA”) decision to ban and fine the Switzerland-based manager (the “Manager”) of a hedge fund (the “Fund”), and two traders at a London-based broker (the “Broker”) for committing “market abuse” by deliberately manipulating the market price of certain securities in order to increase the valuation of certain of the Fund’s holdings on certain portfolio valuation dates in violation of Section 118 of the Financial Services and Markets Act of 2000 (the “FSMA”).   In general terms, Section 118 defines market abuse to include effecting transactions that (a) “give, or are likely to give, a false or misleading impression as to the supply of, or demand for, or as to the price of, one or more qualifying investments [securities traded on a regulated market within the European Union], or (b) secure the price of one or more such investments at an abnormal or artificial level.”

The Manager’s Trading Activity.  Through an investment adviser (the “Adviser”) which he wholly owned, the Manager advised a private fund (the “Fund”), in which he held a roughly one-quarter interest, with the remainder held by family and close friends.  On December 31, 2007, the Manager gave orders to the Brokers to be executed in various stocks on European and U.S. exchanges represented in roughly half of the Fund’s portfolio at the close of business with (as the FSA alleged, but the Manager denied) the intention to increase the closing price of the securities which in turn would increase the value of the Fund.  Most of the stocks were comparatively illiquid and subject to wide price spreads such that even small trades could have a significant impact on their prices.  The Manager and the traders then engaged in similar activities on behalf of the Fund on January 31, 2008.

Finding of Market Abuse.  The Tribunal accepted as a finding of fact that the Manager did not place the orders to increase the management fees that he received from the Fund, which were based on year-end and month-end Fund net asset values, but partly for reasons of pride to make him look more like a competent manager and to dissuade investors from leaving the Fund and partly to support the relevant companies in which the trades were made.  Nonetheless, the Tribunal found that the instructions to trade in particular securities to support/increase their prices and the transactions implementing those instructions constituted market abuse under the FSMA irrespective of the particular motives underlying them, and on that basis, upheld the FSA’s determination that the conduct of the Manager and the traders constituted market abuse under Section 118 of the FSMA.

Sanctions.  The Tribunal ordered that: (a) the Manager pay a fine of £900,000 and pay disgorgement in the amount of £362,950 representing the amount of the Manager’s illicit gains from the activity, (b) the status of the senior trader at the Broker as an “approved person” be revoked (effectively, a ban with respect to the UK financial services industry) and that he be required to pay a fine of £650,000, subject to adjustment following a future proceeding relating to his personal circumstances, and (c) that the status of the junior trader at the Broker as an “approved person” be revoked.

Analysis.  The Tribunal’s decision illustrates the following important points:

  1. The FSA is willing to take, and the Tribunal is willing to uphold, action against fund managers outside of the United Kingdom.  The result here is consistent in this regard with the FSA’s decision in January 2012 to fine the manager of a U.S.‑based hedge fund for engaging in market abuse in violation of Section 118 of the FSMA.
  2. The Tribunal is prepared to increase fines imposed by the FSA when it does not deem them to be sufficient.  Noting that the conduct of the Manager and the traders was “as serious a case of market abuse of its kind as one might conceive,” and finding that the FSA was originally too lenient, the Tribunal increased the fine to be paid by the senior trader from £550,000 to £650,000.
  3. Brokers effecting abusive trades based on instructions by a manager may also be fined or banned from participation in the financial service industry.  Despite the fact that neither the Broker nor the traders received any particular benefit from the conduct other than the commission earned in executing transactions for an important client, the Tribunal sanctioned the traders based on a finding that they should have realized that the transactions were abusive and refused to execute them.  (No action was taken against the Broker, which dismissed both traders following an internal investigation and disciplinary inquiry.)