UK: Merrill Lynch Receives Substantial Fine For Transaction Reporting Failures

The FCA has imposed a fine of £34,524,000 on Merrill Lynch International (MLI) in the first enforcement action against a firm for failing to report details of trading in exchange traded derivatives under the European Markets Infrastructure Regulation (EMIR). MLI received a 30% discount for early settlement. Without this discount, the fine would have been £49,320,000.

Factual Background

The reporting requirement set out in Article 9 of EMIR (the ETD Reporting Requirement) came into effect from 12 February 2014.  In advance of that date, MLI took steps to design and implement internal policies, procedures, systems and controls to ensure the firm would be in a position to comply with its obligations. From implementation date, it commenced making reports to a trade repository.    It was later discovered that as a result of an error in the static data table within

MLI's ETD reporting system, certain reports in relation to particular categories of transactions were not being reported. The error meant that MLI had failed to submit any report in relation to certain market facing transactions between 12 February 2014 and 6 February 2016 (68.5 million reports in total).

Breaches of Regulatory Principles

As such, MLI had failed to comply with its reporting obligations under Article 9 of EMIR.  The FCA considered that MLI had contravened Principle 3 as it had failed to organise and control its affairs responsibly and effectively with adequate risk management systems in relation to its compliance with the ETD Reporting Requirement.

The following factors were relevant to that finding:

• At various different points during the relevant period, MLI did not assign sufficient resources and/or resources with the appropriate level of transaction reporting experience and subject matter expertise to undertake the ETD Reporting Requirement. Relevantly, MLI was aware of this problem.
• MLI failed to adequately test the reports being submitted for completeness and accuracy.  Specifically, between 12 February 2014 and October 2015, MLI did not undertake any appropriate testing.  From October 2015, it introduced a manual testing program, which MLI knew did not adequately address the risk of incomplete and inaccurate reporting.   In addition, between 12 February 2014 and January 2016, MLI failed, and was aware that it had failed, to conduct automated testing notwithstanding that it had identified the need for automated testing (and the issue internally considered "high risk") 14 months earlier in the course of two self-identified audit issues (SIAIs). 
• Although MLI had operating oversight arrangements, the relevant oversight forums provided updates on day to day operations of the reporting requirement rather than a detailed review of MLI's compliance with the requirement itself.  The FCA noted that MLI did not address this issue. This was despite the fact that it had already identified internally, in the February and December SIAIs, structural deficiencies in its oversight and testing processes.

The FCA applied the five-step framework set out in DEPP in assessing the appropriate penalty.  It set the basis figure at stage 2 as £102,750,000 (by attributing a value of £1.50 to each of the transactions which MLI failed to report) and assessed the breaches to be of level 4 seriousness (where level 5 is the most serious).  This was because, although MLI did not make any profit from the breaches and there was no loss to investors or potential significant effect on market confidence or any evidence that the breach was committed deliberately or recklessly, the breaches:

• revealed weaknesses in MLI's procedures, management systems and internal controls relating to the ETD Reporting Requirement;
• were multiple and discrete events that in some instances continued undetected for a long period of time;
• in the case of the lack of automated testing, were known about since the 2014 SIAIs, yet remediation was not progressed in a sufficiently timely manner. 

The breaches were aggravated by the fact that MLI had previously been issued with two Final Notices in respect of transaction reporting failures and that the FCA had generally communicated the importance of EMIR reporting requirements.  In mitigation, the FCA accepted that MLI's ability to adequately test the relevant systems was undermined by issues in the trade repository data and that it had already commenced planning remedial work for its systems and controls (including using the automated testing system).  The FCA also noted that MLI had self-reported and fully co-operated, acting in an open and transparent manner, including taking steps to rectify the breaches of Article 9 of EMIR once they had been identified.   

Comment

By any standards, the level of fine is substantial. By levying a fine of this magnitude, one matter that the FCA appears keen to signal is that it takes transaction reporting very seriously.

• Proper transaction reporting is a priority for the FCA. 
• One of the FCA's operational objectives is to protect and enhance the integrity of the UK financial system. In order to help it do so, it has spent a considerable sum on software to analyse transaction reports. Appropriate transaction reporting is a precondition for its policing to be effective.  In this connection, readers may be interested in the speech we cover elsewhere in this issue FCA pulls no punches in its quest for clean markets.
• It is perhaps no coincidence that this level of fine was levied so close to the introduction of MiFID II, and all the reporting requirements that that brings with it. Whilst the FCA may want to give firms some grace period before taking enforcement action in respect of MiFID II reporting failures, it will want firms to know how seriously it regards compliance with the reporting transaction regime.

As for the way the sum was calculated, one aspect of particular note was that the FCA increased the Step 2 figure by a huge 60% to reflect the aggravation/mitigation factors in the case. In applying that level of uplift, the FCA principally had regard to the fact that MLI had previously been subject to enforcement action for similar failings.  In that respect, it is worth noting that one of the actions was published as long ago as the summer of 2006. The FCA is telling firms that they need to learn their lessons.

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