The Financial Conduct Authority: How It Functions And How Best To Respond To It
Any corporate or senior business figure facing an FCA investigation will require representation from experts who will navigate the best way through it.
As the business world does not stop for an FCA investigation, Rahman Ravelli manages such situations in a way that ensures our clients can keep functioning.
The FCA has an important role, a wide remit and works with many professional groups, regulators and legislators. It can wield significant power when investigating and prosecuting whatever it believes to be misconduct in the financial markets.
The FCA can bring both criminal proceedings and regulatory enforcement proceedings. It has the power to compel individuals or companies to attend an interview or produce documentation. Its investigations are often complex, which makes it necessary for anyone under investigation to respond carefully and seek specialist expert legal representation from those who know how the FCA functions.
In these pages, we explain what the FCA does, the areas of business conduct it looks to police and some of the UK and European legislation it has at its disposal. The legal definition of insider dealing and the forms it takes are examined as are the approaches the FCA takes to its work. We also outline the importance to individuals and businesses of taking advice on how to avoid legal problems with the FCA.
The Importance Of A Robust Strategy
Rahman Ravelli has been dealing with the FCA – and its predecessor, the Financial Services Authority (FSA) – for many years. We have the expertise and experience to challenge its assumptions and protect a client’s interests as strongly as possible
Our specialist teams are experienced assessors of FCA investigations. We examine the strength of a case, identify the weak points and manage all aspects of an investigation so that our clients can carry out their usual activities, with little or no disruption. Rahman Ravelli is a leader in the fields of FCA investigation, regulation and compliance, trusted and relied on by many major organisations and individuals.
We represent a wide range of corporate clients, from major PLC’s through to SME’s, and the senior individuals who either work for or run such enterprises and organisations.
Rahman Ravelli negotiates civil settlements for clients in some of the biggest and most complex cases the FCA has brought.
Lawyers in our internal investigations and crisis management teams advise companies and the senior figures involved in relation to any matter that has prompted FCA attention. We plan and conduct internal investigations to get to the heart of the matter that has attracted the FCA’s interest and plot a course of action based on its findings. Corporate Investigations
The Role Of The FCA
The FCA’s Work
The FCA regulates 58,000 financial services firms and financial markets in the UK. It aims to ensure the financial markets function in an honest manner. Its work is defined by the Financial Services and Markets Act 2000 (FSMA). Section 1A of the Act states that the FCA is responsible for maintaining market confidence and financial stability, raising public awareness of the markets, protecting consumers and reducing financial crime.
The FCA’s enforcement teams investigate and penalise UK businesses for breaching financial regulations. It regulates banks, building societies and credit unions and investigates mortgage lenders, pensions and insurance providers, electronic payment systems, fintech companies, finance and investment advisors and (from April 2019) claims management firms.
The FCA and Enforcement
The 2018 publication of the FCA’s “Approach to Enforcement’’ document emphasised its wish to achieve justice rather than solely concentrate on deterrence and its belief that its remit goes beyond insider trading and the wrongdoing at retail banks.
The publication outlined the areas of potentially serious misconduct in which it takes an interest:
- misconduct resulting from a lack of integrity
- serious failings in a firm’s systems and controls; including governance and failings by senior managers
- mis-selling of unsuitable products
- anti-competitive behaviour
- financial crime; including insider dealing, money laundering, false market information and market manipulation
- failing to make proper disclosure in primary markets
- the carrying out of regulated activity without FCA authorisation
Financial Regulation In The UK
The Financial Services and Markets Act 2000 (FSMA)
The Financial Services and Markets Act 2000 (FSMA), which was amended by the Financial Services Act 2012, defines the scope of the UK’s financial regulation.
It outlines the scope of the FCA’s activities and details the limits and responsibilities faced by those who want to operate in the UK’s financial markets.
The Act contains many sections and we do not intend to outline them all here. Essentially, it specifies the activities and entities that fall within the UK’s ‘regulatory perimeter’. These activities are then subject to the general prohibition in Section 19 of FSMA. Section 19 states that nobody can carry out a regulated activity - or appear to be doing so - unless they are either authorised to do so or exempt from the prohibition. Applications for authorisation should be made to the FCA. Carrying out regulated activities without authorisation is a breach of general prohibition.
Notable FSMA Sections
Section 22 of FSMA defines regulated activity as activity of a speciﬁed kind carried out by way of business in relation to investments of a speciﬁed kind. The FSMA (Regulated Activities) Order 2001 (RAO) speciﬁes these activities as including buying, selling or subscribing for investments as principal (Article 14), making arrangements for another person to buy, sell or subscribe for a particular investment (Article 25), managing investments in circumstances which involve the exercise of discretion (Article 37) and advising on buying, selling or subscribing for a particular investment (Article 53). The RAO’s Article 51 provides that the establishing, operating or winding up of a collective investment scheme (CIS) is a regulated activity.
Subject to certain exemptions, a CIS is deﬁned in Section 235 of FSMA as a scheme comprising of arrangements with respect to property of any kind, including cash or shares. The purpose or effect of such a scheme is to enable the persons taking part to participate in, or receive, proﬁts or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such proﬁts or income. The participants do not have day-to-day control over the management of the property and a CIS involves a pooling of investors’ contributions with proﬁts, income and/or the property being managed as a whole by, or on behalf of, the scheme operator.
Section 21 makes it a criminal offence to issue a financial promotion – an invitation to become involved in an investment activity – in the UK unless that promotion is issued or approved by an authorised firm.
Section 71 allows private persons to sue a firm for damages if a person performing a controlled function is not approved. An approved person is an individual who is approved by the FCA to do one or more activities – that it calls controlled functions - for an authorised firm. Such a person must know and meet the FCA’s regulatory requirements, understand how it applies to them, pass the FCA’s fit and proper test and follow its principles.
Section 118 outlined the penalties for market abuse. Under this part of the FSMA, market abuse was defined as insider dealing, improper disclosure of inside information, manipulating transactions, manipulating devices, dissemination or misleading behaviour and market distortion. This section has now been repealed with the introduction in 2016 of the European Regulation on Market Abuse (MAR), which also created a new offence of attempted market manipulation. MAR contains rules on insider dealing, unlawful disclosure of inside information and market manipulation that cover the whole of the European Union. It expanded the market abuse regime to cover not only financial instruments traded on EU-regulated markets but also those traded on many non-regulated markets.
EU Law And Market Abuse
In replacing Section 18 of the UK’s Financial Services and Markets Act 2000, the 2016 European Regulation on Market Abuse’s (MAR) expansion of the market abuse regime has required many of those covered by the prior regime to make changes to their compliance procedures. On a wider scale, FSMA and other relevant legislation has been amended to ensure that UK law is compatible with MAR. The changes to such legislation were set out in a new statutory instrument, The Financial Services and Markets Act 2000 (Market Abuse) Regulations 2016.
MAR is not the only European Union piece of legislation to have an effect on the UK financial markets. The Markets in Financial Instruments Directive (MiFID) is the EU legislation that regulates firms who provide services to clients linked to financial instruments - such as shares, bonds, units in collective investment schemes and derivatives - and the venues where those instruments are traded.
MiFID applied in the UK from November 2007. It was revised and extended by MiFID II, which came into effect in January 2018, to improve the functioning of financial markets in light of the financial crisis and to strengthen investor protection. The investor protection framework set out in MiFID II aims to ensure that investment firms act in the best interests of their clients, using a number of different approaches. It seeks to improve governance and organisational requirements for firms, strengthen conduct of business rules that cover firms’ relationships with all categories of clients and introduce new powers to supervisors at both national and European level.
MiFID II extended MiFID by introducing extra requirements regarding market structure, transparency, research and inducements and product governance and by the introduction of a harmonised commodity position limits regime.
Insider dealing is now attracting more official attention. In 2018, the FCA decided to add a chapter devoted to insider dealing and market manipulation to the Financial Crime Guide. This came after a year in which it started 84 insider dealing investigations, its highest ever number in a 12-month period. The FCA no longer appears content to cherry pick its insider dealing cases. It has an appetite to go for as many cases as possible; including those that may appear tricky or difficult to resolve. This means that anyone at risk of becoming involved in insider dealing needs to know what it is, how to prevent it and how to defend themselves against any allegations.
Definition of Insider Dealing
Insider dealing is defined by s52 of the Criminal Justice Act 1993 as being committed when an individual has information as an insider and he then either:
- Deals in securities that are price-affected securities, in relation to that information.
- Encourages another person to deal in securities that are (whether or not that the other person knows it) price-affected securities, in relation to that information.
- Discloses that information – in a way other than in the proper performance of the functions of his employment, office or profession - to another person.
Under s61 of the Act, the maximum penalty for a summary offence is six months imprisonment and seven years on indictment. It is an offence, therefore, that cannot be ignored or taken lightly. But defences are available.
Forms of Insider Dealing
Insider dealing can take a number of forms; depending on the exact circumstances of a particular trade. Examples include:
- Front running/pre-positioning. This is when a person is to carry out a transaction for another and yet they carry out a transaction for themselves first, knowing that the transaction they are set to carry out for another will have an impact on the market.
- Using inside information about a proposed takeover bid of a company to invest in the company that is the subject of the takeover; anticipating a rise in its share price.
- Someone acting on behalf of a person in situation 2 who, on learning of the proposed takeover, then goes on to invest themselves in the company that is the subject of the takeover.
The Act also makes stipulations regarding what can be considered market abuse; including a failure to observe the standard of behaviour reasonably expected of a person in their position in the market, giving a misleading impression regarding supply of or demand for an investment, securing the price of investments at an artificial level, using fictitious devices or deception to trade, behaving in a way that distorts the market and giving a misleading impression about an investment.
Defences to Insider Dealing
If someone is accused of any of the behaviour that qualifies as insider dealing under s52, there are a number of defences available to them.
A person is not guilty of insider dealing or encouraging another to do it if they can show that:
- They did not at the time expect the dealing to result in a profit that could be attributed to the information in question being price-sensitive information.
- At the time they believed, on reasonable grounds, that the information had been disclosed widely enough that no one taking part in the dealing would be prejudiced by not having it.
- They would have done what they did even if they had not had the information.
Regarding disclosure of information, they have a defence if they can show that:
- They did not at the time expect any person, because of the disclosure, to deal in securities.
- Although they had such an expectation at the time, they did not expect the dealing to result in a profit attributable to the fact that the information was price-sensitive information in relation to the securities.
Any defence has to be mounted in a robust manner. The FCA will be looking closely at any allegations it receives and seeking evidence that proves them and, therefore, boosts its chances of a successful prosecution. It is important that any defence counters the allegations and uses all available material to build a case that takes apart the allegations piece by piece.
The Importance Of Compliance
The Need for Advice
The FCA expects businesses and individuals to be aware of the risks of wrongdoing and capable of devising and introducing appropriate preventative procedures. No one in business can afford to be unaware of these responsibilities. If they are, they must seek immediate advice.
Our specialist compliance experts can give the most appropriate advice on how to avoid any future problems with either the FCA or its sister organisation, the Prudential Regulation Authority (PRA); which regulates banks, insurers and investment firms. We also make sure that any potential conflicts of interest between a company and employee, should they both come under investigation, are handled appropriately.
Such advice can be important. The FCA and its predecessor have been criticised in the past for a lack of effectiveness and speed when it comes to supervising and penalising firms. But it is now putting an emphasis on being forward looking to anticipate problems and is focusing on scrutinising the strategy, business models and models of governance that firms are using, with a view to identifying any risk of harm to consumers or the markets.
As an example, we can take the concept of the sophisticated investor. Sophisticated investor is a classification of investor indicating someone who has sufficient capital, experience and net worth to engage in more advanced types of investment opportunities. It is generally understood by the authorities that a sophisticated investor does not need to have investment opportunities explained to them in as much detail as a “normal’’ person – a non-sophisticated investor. But anyone promoting an investment opportunity has to take the time and effort and pay attention to all the details to determine whether they are dealing with a sophisticated or non-sophisticated investor – and make sure they are being given the appropriate amounts of information in a way that they understand.
The FCA most closely scrutinises the firms who could cause most harm if they were involved in wrongdoing. It is also now looking to develop ways of holding firms and individuals to account more forcefully. In 2016, the FCA responded to criticism over the lack of cases brought against directors and senior managers by implementing the Senior Managers and Certification Regime (SMCR), which applies to banks, insurers and some other large firms. This measure, which requires greater awareness from firms and individuals of their responsibilities, will be extended to all regulated firms from 9 December 2019.
Recent Changes In The Way The FCA Works
The FCA has been criticised for opening large numbers of investigations only for many of them to end up being closed with no formal action being taken. It is clear that opening more investigations has, so far at least, led to no increase in the number of penalties being imposed. But this can at least be seen as an indicator that an FCA investigation will not necessarily end badly for the individual or firm that is the subject of it – especially if the right legal advice is taken as early as possible.
The FCA’s “Approach to Enforcement’’
The FCA’s “Approach to Enforcement’’ document, which we mentioned earlier, makes it clear that voluntary, proactive and swift remedial action carried out by those under investigation will mean lesser sanctions being imposed. The FCA is prepared to cooperate with the subject of an investigation as and when the remedial action is being considered. While this can be of assistance to those being investigated, it is important to have such discussions conducted with the help of legal representatives. Such representatives can not only assess what changes may be expected by the FCA in exchange for leniency, they will also have expertise in this area of the law and experience of negotiating with the FCA.
Taking such an approach to enhance the potential for lenient treatment from the FCA could become increasingly important in the future. The FCA has started to review its penalties policy. The review was at least partly prompted by the Parliamentary Commission on Banking Standards’ comments in 2013, which included the claim that: "To provide greater incentives to maintain high levels of professional standards, both the FCA and the PRA should be prepared to review again their penalty setting framework in the future to allow for a further substantial increase in fines."
The FCA’s Proactive Approach
The FCA’s desire to be more proactive than reactive has seen it adopt an intelligence-driven, data-led approach. This involves investigating information arising from complaints made by consumers and other companies, whistle-blowers, regulatory filings and other regulators. It is looking to take a robust approach to its supervision of financial markets and exchanges. The increased reporting of transactions resulting from the introduction of the second Markets in Financial Instruments Directive (MiFID ll) in January 2018 means the FCA now processes 30 million transaction reports each day – giving it a far more in-depth data base of intelligence for bringing enforcement cases for market abuse.
It is also now more willing to use its criminal powers to tackle money laundering in the capital markets. The FCA’s 2018-19 Business Plan referred to using inspections of high-risk firms and random sampling of firms deemed to be a lower risk in order to “identify and reduce the potential for firms to be used for money laundering and other financial crimes”. The FCA accepted in the Plan that this can only be achieved if it can gain the right intelligence to gain “a better picture of money laundering”.
Its previous reliance on its regulatory powers to fine firms for failures under FCA rules seems to have been abandoned, although time will tell just how often it uses its criminal powers – and what deterrent effect this may have. But those working in the areas supervised by the FCA must be aware that it is looking to be a more forceful organisation. Its 2018-19 Plan talked of making increased collaboration with law enforcement agencies and other organisations a priority. The Plan also outlined the FCA’s wish to determine how “new technology can be used more effectively to fight financial crime”. A similar enthusiasm for new technology and closer cooperation has been expressed by the Serious Fraud Office (SFO). It is possible, therefore, that the FCA may well be working closer with other agencies and be more “high tech’’ in the very near future.
Such developments make it more important than ever that those facing an FCA investigation can respond in exactly the right way at the right time.
The FCA’s Regulatory Decisions Committee
The Regulatory Decisions Committee (RDC) takes certain decisions on behalf of the FCA. These decisions relate to enforcement and supervisory actions and applications by firms for authorisation and by individuals for approval.
The RDC is the final stage of decision-making within the FCA but operates separately from the rest of the Authority. This separation ensures that decisions are not made by FCA staff who are recommending action against a firm or individual. RDC cases are usually conducted by a panel of three members who will consider written or oral representations that you may wish to make on the action that is being proposed or has been taken by the FCA.
The RDC has become arguably more significant now due to the introduction of the FCA’s partial settlement process. This process allows companies to agree some parts of a case against it and challenge other aspects of it before the RDC.
Taking the Right Approach
The FCA is constantly reviewing the way it works, assessing its effectiveness and fine tuning its activities where necessary. Those functioning in the corporate world who are investigated by the FCA must make sure they take the most appropriate approach to obtain the best possible outcome.