The Upper Tribunal recently upheld the decision by the Financial Conduct Authority (the FCA) to fine and ban three traders for market abuse and manipulation: Lopez Gonzalez, Sheth and Urra v The FCA. The Tribunal's lengthy decision includes detailed consideration of specific trades, trading strategies which the traders claimed to have pursued during the relevant period, testimony from two experts, the actions of compliance and management, contemporaneous documentation, and the role of memory. In this article, we summarise the case and highlight key takeaways.
The traders, the trading activity and the FCA's findings
Mr Urra, Mr Lopez, and Mr Sheth were traders at Mizuho International Plc at the time the relevant trades took place. Mr Urra, an experienced trader, was the head of the European Government Bonds (EGB) desk at the time. Mr Lopez was also an experienced trader, while Mr Sheth was a junior trader not considered by the Tribunal to be an 'experienced industry professional' at the time of the relevant events; both Mr Lopez and Mr Sheth reported to Mr Urra.
The FCA alleged that all three traders engaged in 'spoofing' the Italian Government bond (BTP) futures market between 1 June and 29 July 2016. Specifically, the FCA identified a pattern whereby the traders placed large orders of futures on the EUREX Exchange (the 'Large Orders') which they had no real intention of executing. The FCA alleged that these Large Orders were intended to assist the execution of smaller orders on the opposite side of the book (the 'Small Orders') by creating the impression of additional demand or supply in the market. Once a Small Order was executed, the trader(s) would cancel the Large Order(s), usually within seconds or fractions of a second.
The FCA determined that this activity constituted market abuse under s118 Financial Services and Markets Act 2000 (FSMA) which was in place until 2 July 2016 and then market manipulation under the Market Abuse Regulation (MAR) which entered into force on 3 July 2016.
The FCA found that the traders knew that the Large Orders would create false and misleading signals. It considered that the conduct of each trader in deliberately engaging in market abuse was dishonest and lacked integrity; this dishonest conduct was highly likely to adversely impact on other market participants and was repeated many times.
As a result, the FCA considered that each of the traders was not a fit and proper person, and that this finding warranted prohibition orders and penalties of £395,500 on Mr Urra, £100,000 on Mr Lopez and £100,000 on Mr Sheth.
The traders' case
The traders challenged the FCA's decision in the Upper Tribunal and denied having engaged in spoofing.
The traders made submissions in relation to witnesses not called by the FCA, to information that would have been available to them at the time of trading but was no longer available or had not been disclosed to them, and to the 8.5 years which had elapsed between the alleged conduct and the first hearing. They claimed the unavailability of contemporaneous information and delay in the FCA's investigation was unfair and prejudicial to them.
The Tribunal accepted that although they could remember their Trading Strategy, the traders were unable to recall the details of specific trading activity and considered this to be almost inevitable.
The Decision reviews the leading authorities on assessing the fallibility of human memory and the need to assess witness evidence in its proper place alongside contemporaneous documentary evidence and evidence upon which undoubted or probable reliance can be placed.
The traders came close to asserting that the FCA had failed to comply with its disclosure obligations. Given that they had made no application for disclosure which would have enabled suggestions of non-compliance to be addressed, the Tribunal was 'not persuaded that it would be procedurally fair' to reach a conclusion about the FCA's compliance with disclosure obligations. Nonetheless, it did consider the range of information that was no longer available and its potential relevance, including that of potential witnesses not called by the FCA, whose interview transcripts were available to and taken into account by the Tribunal.
The traders argued that their trading reflected legitimate trading practices:
- Mr Urra and Mr Sheth said they were pursuing a 'Price Discovery Strategy' designed to address the informational disadvantage that MHI faced as a small market player and to obtain information about the actual liquidity of the cash market to enable the desk to better price trades. Mr Urra also claimed that certain multiple overlapping large orders he placed were price amendments rather than spoofing.
- Mr Lopez said he was pursuing an 'Anticipatory Hedging Strategy', looking ahead to likely client demand and positioning his trading book and inventory to service that demand and improve MKI's success rate with requests for quotes (RFQs) for cash bonds in the range of €20-30m - (typically) he would place placing anticipatory hedge orders of 200 lots or more several ticks away from the touch, pre-positioning at an attractive price to enable him to meet client orders on an attractive and profitable basis. These Large Orders were unconnected to the Small Orders.
The Tribunal concluded that, as described, the Strategies did not provide plausible explanations for the orders in fact placed:
- 'Price discovery' is a common and legitimate practice used by market makers, having the aim of validating the fair market value of a security for a given size of transaction and it occurs prior to trade. Mr Urra and Mr Sheth's strategy was different - an 'Information Discovery Strategy' to elicit information about the actual liquidity of the market. The Tribunal was unpersuaded that the short periods of time for which the Large Orders were live were sufficient to test for hidden liquidity. Even accepting that MFI was subject to an information disadvantage, the Tribunal was not convinced that this strategy, even if it were being pursued, explained the pattern of trading relied upon by the FCA.
- The Tribunal accepted that Mr Lopez was seeking to win more €20-30m RFQs and that 'Anticipatory Hedging' can be a legitimate trading strategy which could help with positioning the desk to meet expected client flow, where there was a predictable pattern of RFQs and the trading would not impede the desk's other trading activities. However, the Tribunal had significant doubts as to the way in which Mr Lopez in fact operated the strategy, noting amongst its reservations that it did not explain Large Orders placed late in the day, nor the level of overlap between the Large and Small Orders, the coincidence of the cancellation of Large Order shortly after the Small Order was filled, or the fact that none of his Large Orders traded.
It also noted that the alleged strategies were not within the desk's mandate and had not been discussed with line management or compliance.
Outcome
The Tribunal dismissed the traders' challenges finding that the FCA had established market abuse and market manipulation. It upheld the FCA's ban, albeit with reduced penalties for Mr Urra and Mr Sheth.
For Mr Urra, the Tribunal did not agree with the FCA's approach to identifying 'relevant income' for the purpose of the fine. While the regulator had included amounts which had vested in the period and income earned during the period, the Tribunal determined that 'relevant income' was income earned, not 'income received'.
In Mr Sheth's case, the Tribunal recalculated the figure to make it proportionate to those imposed on Mr Urra and Mr Lopez.
Our thoughts
The Tribunal Decision offers an interesting and detailed discussion of market manipulation, in particular 'spoofing', and contrasts several legitimate trading practices. It takes the Tribunal down some interesting paths, ranging from the norms of the EGB futures markets, open-plan environments, opportunities for collaboration and the risk of detection, and how to approach the task of making findings of fact based upon all of the evidence where there is a 'documentary lacuna' and fallible memories.
The case should serve as a reminder of the importance of contemporaneous documents when seeking to establish a plausible position with the Tribunal which challenges an observed pattern of activity. For example, where traders seek to rely on the legitimacy of a particular trading practice, a written rationale for the design and operation of the trading, and where appropriate, management sign-off, would be helpful evidence should the legitimacy of the trading later fall to be scrutinised by the regulator. A contemporaneous record of what was being learned from an information strategy (whether as to price or liquidity) would also be helpful,1 as would a record of the details of any client position which specific trading purports to pre-position.
Footnote
1 See Decision, para 807(1).
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