UK: Recent Market Conduct Developments - Practical Industry Insight And Reaction

Last Updated: 22 August 2012
Article by David Berman

For the financial services industry, there have been a number of significant developments of late in the market conduct arena; including the recent Greenlight, Osborne and Kyprios cases and the FSA's on-going thematic initiatives in relation to pre-soundings and the filing of suspicious transaction reports.

Many (buy-side and sell-side) institutions have taken the opportunity to review their internal policies, procedures and protocols, in light of these developments. This article summarises our recent observations and highlights certain practical "hot-spots" on which firms might usefully focus (to the extent that they have not already done so).

Of course, there is not necessarily a "right" or "wrong" approach, with different institutions implementing their own tailored (and risk-based) measures to suit their respective organisational and operational frameworks. Whilst approaches will therefore differ across firms, there nevertheless appears to be a common desired outcome: namely, to ensure that the firm has (and is seen to have) taken all reasonable measures to prevent any form of (actual or perceived) market misconduct with which it might be associated – most obviously, through the actions of an employee. Put another way, an errant employee must be afforded no legitimate excuse to allege that (s)he was not adequately trained; or that internal procedures were too vague, inconsistent or confusing.

PRACTICAL "HOT-SPOTS"

In practice, certain commonly-encountered scenarios can involve a significant degree of inherent risk for both buy-side and sell-side institutions. We consider below some specific areas on which, it might prudently be assumed, the Regulator's attention is likely to remain focused1.

Company meetings

Company meetings are generally regarded as playing an important role, benefitting shareholders, prospective investors and the wider market – for example, in portfolio managers' and research analysts' fact-finding endeavours; and in the facilitation of (the increasingly topical area of) shareholder stewardship.

However, it is important to ensure that attendees at such meetings are not inadvertently made "insiders"; and that all participants (on both sides of the table) are clear as to the rules of engagement.

In practice, buy-side firms will employ (one or more of) a number of safeguards, including:

  • laying down a clear "marker" at the very outset of the meeting, reminding the company's representatives and advisers that under no circumstances does the individual wish to be made an "insider" (and hence become restricted);
  • requesting confirmation from the company (or its advisers) at the end of the meeting that no sensitive information has been divulged2;
  • prohibiting portfolio managers / research analysts from asking questions which might be considered unduly provocative and as overtly inducing the disclosure of sensitive information;
  • requiring attendees to complete a short post-meeting internal form, summarising (amongst other things) information disclosed and listing other participants in the meeting;
  • providing a clear instruction to consult with Compliance immediately in the event that a portfolio manager or research analyst considers that (s)he may inadvertently have been made an "insider" (and to take no related action unless instructed otherwise); and
  • enhancing (and practically-focused) guidance and training to ensure that portfolio managers and research analysts are alert to "red flags" and know how to react appropriately.

On the sell-side, firms have (amongst other things):

  • instituted enhanced practically-focused training for all personnel who participate in company meetings - this will often include case studies and take an interactive (workshop) format; and
  • reviewed (and if necessary, revised) internal protocols and guidance to ensure that they remain in line with prevailing regulatory expectations.

Within these measures, an observed common theme is the focus upon the context, substance and entirety of a passage of dialogue – perhaps unsurprising in the wake of the Greenlight and Osborne findings. In particular, the communication of a reinforced message that:

  1. single pieces of information divulged during the course of a conversation or a connected series of dialogues will likely be aggregated and viewed in the round and in the specific context (and with the benefit of hindsight);
  2. disclaimers and/or confirmations will not, of themselves, necessarily suffice to prevent an information recipient from becoming an insider; and
  3. the repetition by a sell-side broker of a piece of information already communicated by a company representative may still amount to a disclosure for the purposes of the regulatory regime (as indeed Mr Osborne discovered).

Pre-soundings

Pre-soundings are another common and important aspect of market operations. However, these exercises can involve inherent tensions, notably:

  1. the desire of the buy-side to make a properly informed decision as to whether to be wall-crossed; and
  2. the desire of the sell-side not to inadvertently overstep the mark and disclose inside information, without the informed consent of the recipient (where to do so may also amount to a form of market abuse).

Accordingly - and as illustrated in the Greenlight and Osborne cases - pre-sounding exercises must be handled extremely carefully. Measures implemented by buy-side firms include:

  • all pre-marketing enquiries are re-directed as a matter of course to Compliance (or another designated function);
  • all wall-crossing conversations to be conducted jointly by a portfolio manager, together with a Compliance representative;
  • written communications issued to all key sell-side relationship firms, informing them of the new (or updated) wall-crossing protocol;
  • only certain designated (predominantly, senior and specially-trained) portfolio managers are permitted to have wall-crossing conversations;
  • prohibition of any "open calls", such as occurred in Greenlight;
  • a clear instruction to consult immediately with Compliance in the event that a portfolio manager considers that (s)he may inadvertently have been made an "insider" (and to take no related action unless instructed otherwise); and
  • enhanced (and practically-focused) guidance and/or training to ensure that portfolio managers are alert to "red flags"; including in relation to initial wall-crossing enquiries (during which a certain amount of information will be divulged).

On the sell-side, institutions have instigated reviews of their internal protocols and training content to ensure that the following areas feature appropriately:

  • consideration of whether there is a real and justifiable need to wall-cross the third party (and their suitability);
  • use of generic ("needle in a haystack") enquiries where there is no need to effect a wall-crossing;
  • obtaining a form of confidentiality undertaking from the recipient:

    • written and/or oral (on taped line);
    • use of a clear script (typically, pre-agreed with Legal or Compliance) – outlining the restrictions on, and the responsibilities of, the recipient; and
    • follow-up confirmatory e-mails.;
  • ensuring that no sensitive information is disclosed prior to obtaining the recipient's express agreement; and, again, reiterating: (a) the importance of focusing upon the context, substance and entirety of a passage of communication; (b) the potential limitations of disclaimers and confirmations; and (c) that repetition can still be viewed as amounting to a "disclosure" (see above);
  • obtaining issuer consent; and
  • "cleansing" considerations – which can prove to be a particularly difficult issue in practice, if not managed carefully.

"Routine" broker dialogue

Portfolio managers, dealers and research analysts will routinely engage in conversations with market brokers. It can sometimes be unclear as to whether a broker may have disclosed some sensitive information. Buy-side firms have adopted a number of measures in order to address such situations, including:

Enhanced practical guidance as to how to react – for example: challenging the "insider" status of the broker: Are you an insider? What is your source? How do you know?

Employing a working assumption that a market broker will not be an insider – unless, in the circumstances, there is reason to believe otherwise (for example, where the broker is representing an issuer as part of an organised pre-marketing exercise).

Enhanced (and practically-focused) guidance and/or training to ensure that portfolio managers, dealers and research analysts are alert to "red flags"'.

Conclusion

We have highlighted above some practical measures taken by firms in response to a (well-publicised) series of recent regulatory pronouncements and sanctions in the market conduct arena.

Whilst these observations will not represent an exhaustive catalogue of the responsive measures taken by financial services institutions, they may at least serve as a helpful reference or starting point.

It might prudently be assumed that a firm's response to significant regulatory developments will feature prominently on its supervisors' agenda. In the present environment, it takes a brave institution to allow such developments to pass by – without at the very least re-assessing existing policies, protocols and procedures to ensure that they remain consistent with prevailing regulatory expectations. Would your market conduct policies and processes stand up to close regulatory scrutiny?

Footnotes

1 It should also be presumed that the Regulator will maintain an interest in all other areas of potential market abuse/misconduct – for example, unauthorised personal account dealing.

2 Although, as evidenced by the Greenlight / Einhorn case, this is unlikely, of itself, to be determinative.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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