The FCA’s Approach To Cum-Ex

Syed Rahman of Rahman Ravelli details the Financial Conduct Authority’s case against Sapien Capital Ltd in relation to Cum-Ex trading

The Financial Conduct Authority (FCA) imposing a £178,000 fine on the broker Sapien Capital for money laundering failings was the first action to be taken over Cum-Ex by a regulator not based in a country affected by the scandal. 

Sapien was said to have acted as a broker for purported over-the-counter (OTC) trades worth £2.5 billion in Danish equities and £3.8 billion in Belgian equities. The FCA took the view that Sapien was only likely to have seen one side of the trades, and also believed that the trades were being conducted to gain tax rebates via Cum-Ex.

Cum-Ex trading was a practice that saw shares traded on or just before the last cum-dividend date, which meant a party could then claim a rebate on withholding tax. Those countries whose treasuries paid out millions in such rebates are now looking to bring criminal and / or civil action against those they believe were involved.

The FCA’s Course of Action

The action brought by the FCA against Sapien involved the regulator alleging the broker did not properly monitor and scrutinise the money laundering risk associated with the trades. This, in effect, provided the FCA with a “back-door route’’ into investigating those who took part in Cum-Ex trading. 

The main focus of the FCA in this case was Sanjay Shah and the trading that he coordinated to generate Cum-Ex rebates. Its case against Sapien related to the laundering risk posed by four of Mr Shah’s firms - known as the Solo Group - yet it did not touch upon the legality or otherwise of Cum-Ex trading. 

The FCA imposed the fine on Sapien in accordance with section 206 (1) of the Financial Services and Markets Act 2000: If the Authority considers that an authorised person has contravened a requirement imposed on him by or under this Act, it may impose on him a penalty, in respect of the contravention, of such amount as it considers appropriate. 

Grounds for the FCA Action

The Money Laundering Regulations and the rules in the FCA’s Handbook require firms to create and implement policies and procedures in order to prevent and detect money laundering and counter the risk of them being used to facilitate financial crime. Firms have to have systems and controls in place to identify, assess and monitor money laundering risk, must conduct customer due diligence (CDD) and are compelled to monitor business relationships and transactions.

As a UK-based corporate finance advisory and brokerage firm that offered diverse capital services to its clients, Sapien’s carried out broking on a matched principal basis. This involves the broker interposing themselves between the buyer and the seller in the transaction in a way that means it is never exposed to market risk throughout the execution of the transaction. Both sides of the transaction are executed simultaneously, and it is concluded at a price where the broker makes no profit or loss apart from the previously disclosed commission or charge. Sapien offered matched principal broking on fixed income securities, convertible bonds, floating rate notes and depository receipts. 

Sapien was permitted to execute trades for professional clients and eligible counterparties only. Its clients were offshore companies, including BVI and Cayman Islands-incorporated entities, and a number of individual US 401(k) pension plans previously unknown to Sapien, which were introduced to it by the Solo Group. 

On behalf of clients, Sapien executed the purported OTC trades of approximately £2.5 billion in Danish equities and £3.8 billion in Belgian equities, receiving gross commission of £297,044. The Solo trading was characterised by a purported circular pattern of extremely high-value OTC equity trading, back-to-back securities lending arrangements and forward transactions, involving EU equities on or around the last day of cum- dividend. Following the purported cum-dividend trading that took place on designated days, the same trades were subsequently purportedly reversed over several days or weeks to neutralise the apparent shareholding positions. 

The FCA referred to the trading as "purported" as it found no evidence of ownership of the shares by the Solo clients or custody of the shares and settlement of the trades by the Solo Group. The FCA took the view that the way these trades were conducted by the Solo Group and its clients and the scale and volume of them were highly suggestive of financial crime, and appeared to have been undertaken to create an audit trail to support withholding tax reclaims in Denmark and Belgium.

Sapien onboarded 166 Solo clients over three months, some of which emanated from jurisdictions which did not have AML requirements equivalent to those in the UK. It showed a willingness to cut corners to obtain the business by bypassing some of its procedures for gathering information about the source of the funds and the purpose of the trading. 

The Relevant FCA Principles

Sapien was accused of breaching Principles 2 and 3 of the FCA’s Principles. It breached Principle 3 by having inadequate systems and controls to identify and mitigate the risk of being used to facilitate fraudulent trading and money laundering in relation to business introduced by four authorised entities (the Solo Group). 

In particular, Sapien had failed to:

• Give adequate guidance on how to conduct risk assessments and what factors to consider.
• Set out adequate processes and procedures for enhanced due diligence (EDD).
• Set out adequate processes and procedures for transaction monitoring, including how transactions are monitored and with what frequency.
• Set out adequate processes and procedures for how to identify suspicious transactions. 

Sapien breached Principle 2, as it had failed to properly assess, monitor and mitigate the risk of financial crime in relation to the Solo clients and the purported trading.

In particular, Sapien had failed to:

• Properly conduct customer due diligence. This was done by not following CDD procedures set out in the firm’s policies and by amending customer due diligence forms in response to complaints from Solo clients, to reduce the information required in respect of Solo clients.
• Gather information to enable it to understand the business that the customers were going to undertake, the likely size or frequency of the trading intended by 126 (out of 166) of the Solo clients or the source of funds for 126 of the Solo clients.
• Undertake and document a risk assessment for each of the Solo clients.
• Complete EDD for any of the Solo clients. This was despite the fact that none of the Solo clients were physically present for identification purposes and a number of other risk factors were present, including that 40 of the entities disclosed that they had a net worth of less than €2 million but were purportedly going to execute 25 trades of €100 million.
• Assess each of the Solo clients against the categorisation criteria set out in 3.5.2R of the FCA’s Conduct of Business Sourcebook (COBS). It also failed to record the results of such assessment and provide sufficient information to support the categorisation, contrary to COBS 3.8.2R(2)(a).
• Conduct transaction monitoring of the Solo clients’ purported trades.
• Recognise numerous red flags with the purported trading, including failing to consider whether it was plausible and/or realistic that sufficient liquidity was sourced within a closed network of entities for the size and volumes of trading conducted by the Solo clients. It also failed to consider or recognise that the profiles of the Solo clients meant that they were highly unlikely to meet the scale and volume of the trading purportedly being carried out, and/or failed to at least obtain sufficient evidence of the Solo clients’ funding sources to satisfy itself to the contrary.
• Report to the FCA the payment from Elysium Global (of which Mr Shah is chief executive officer),  after several employees questioned a number of red flags regarding the payment and the FCA had conducted an unannounced visit, alerting Sapien to possible issues with the Solo Group.

Conclusion

The Sapien case is of obvious significance for being the first Cum-Ex action taken by a regulator not based in a country whose treasury paid out Cum-Ex rebates. But it may also prove notable for being the case that revealed the tactics that such regulators are likely to adopt when trying to penalise those they believe are responsible for Cum-Ex.

Regulators, like the FCA, are looking for ways to hold Cum-Ex perpetrators to account. Time will tell if other regulators choose to take the route favoured by the FCA in this case.