The recent Financial Services Authority (FSA) enforcement action against Sean Pignatelli, a US equity salesman, seems to signal a new front for the FSA in its battle against abusive conduct based on inside information.
Dealing in securities on the basis of inside information has been a criminal offence in the UK since the enactment of the Companies Act in 1980. The offence is now defined by the Criminal Justice Act 1993 (CJA 1993).
But it has been notoriously difficult to prosecute in cases of insider dealing in the UK's criminal courts, a problem reflected by the infrequency of prosecutions and the low conviction rate. Calls for an alternative to the criminal regime were answered when the Financial Services and Markets Act 2000 (FSMA) was enacted on December 1 2001.
The FSMA created a new civil offence of market abuse, which could be committed in three different ways. Although a finding of market abuse does not result in a criminal sanction, the FSA, through its Regulatory Decisions Committee, could impose unlimited financial penalties and, if appropriate, withdraw a firm's and/or individual's authorization to conduct regulated activities. To date, the FSA has brought about 16 successful cases of market abuse. The subjects of this enforcement action have ranged from middle ranking managers of publicly listed companies to leading players in the London hedge fund market.
The market abuse regime was designed to be a more flexible tool to punish those who abused the UK financial markets. The scope of the market abuse regime was further widened in July 2005, with the partial implementation of the Market Abuse Directive. There are now seven categories of market abuse in total.
The FSA has identified market abuse and market misconduct, particularly in the area of systemic and organized insider dealing, as a priority for 2006/2007. In March 2006, the FSA published the results of its research into the cleanliness of the UK financial markets by examining the movement in share prices before regulatory announcements to the market.
The FSA research looked at takeover bid announcements between 2000 and 2004, and trading performance announcements of FTSE350 companies between 1998 and 2003. In total the FSA examined 1500 announcements. Although the FSA could not categorically show that market abuse had occurred in respect of these announcements, it did identify that suspicious trading had taken place in just under 30% of takeover announcements and in just over 20% of FTSE350 trading announcements.
The action against Sean Pignatelli is a new angle for the FSA against abusive conduct based on inside information.
On November 23 2006 the FSA fined Pignatelli £20,000 ($39,500) for failing to exercise due skill, care and diligence contrary to Principle 2 of the FSA's Statements of Principle for Approved Persons (APER), and failure to observe proper standards of market conduct contrary to Principle 3 of the APER.
The market abuse regime can be directed at anyone who participates in the UK's financial markets, but only approved persons (that is, those who are registered by the FSA to conduct and advise on certain forms of financial and/or investment business) have to abide by the FSA's Statements of Principle.
The case focused on Pignatelli's use of an email received from an analyst on May 24 2005 regarding a US medical supplies and technology company. The email contained information about the company's prospects and was sent to Pignatelli just before an analysts' meeting. Shortly after receiving the email Pignatelli embarked on a series of telephone calls in which he passed on information about the email to various clients. Pignatelli's employer discovered what he had done and reported the matter to the FSA.
In the FSA's Final Notice to Pignatelli (which records its decision) the FSA concluded that the email had not contained inside information (as defined by the (CJA 1993)) because the information was already in the public domain at the time Pignatelli passed it on. But this proved irrelevant with regards to whether Pignatelli was guilty of misconduct.
The FSA concluded that Pignatelli had failed to consider the warning signals that the email might have contained inside information, and so had breached Principle 2. Although the FSA found that Pignatelli had not deliberately set out to give the impression that he was passing on inside information, he used language that, in the FSA's view, gave his clients the impression that the email did contain inside information and so breached Principle 3.
Commenting on the case Sally Dewar, FSA director of markets, said:
"We are grateful to the firm for bringing this case to our attention having detected it through its usual compliance procedures. This case demonstrates the importance we attach to market participants giving due care and attention to the impact on the quality of markets of the information they disseminate... Whenever salesmen receive material which appears to contain inside information, they should stop and think before passing it on and, where appropriate, discuss it first with their senior manager or compliance."
The FSA also considered whether Pignatelli had failed to observe the proper standards of market conduct as set out in the FSA's Code of Market Conduct (MAR1), although the FSA did not allege that Pignatelli had failed to comply with MAR1. In its final notice the FSA commented:
"Although in many cases of a breach of Principle 3 there will also be non-compliance with MAR 1, it is not necessarily so and the FSA considers that, as in this case, Principle 3 may be breached although the individual has not failed to comply with MAR 1."
So the FSA seems to be widening the scope of Principles 2 and 3. The FSA did not conclude that Pignatelli's behaviour amounted to market abuse. But there seems to be a clear inference from the final notice that, to crack down on abusive behaviour (whether criminal or not), it is necessary to deter and punish those whose behaviour could be said to facilitate misconduct in the market.
The Pignatelli case is also an excellent illustration of good practice by an authorized firm. Firms need to train their staff to identify both inside information and market abuse. Firms also need robust systems and controls to detect market abuse. In addressing the industry at the FSA's wholesale conference in May 2006 Dewar stated:
"Our message is simple – if staff engage in misconduct and firms know it has happened, we require firms to inform us. If a firm has good systems and controls and can show it is complying with them, we won't pursue the firm in enforcement action. Instead we will pursue the individual. So in all cases we expect to be informed of an individual's abusive behaviour."
The FSA would, no doubt, prefer to reduce the misuse of financial information by encouraging training and compliance functions, but the case of Pignatelli demonstrates that the FSA is now prepared to widen its investigatory net. In taking action under Principles 2 and 3, the FSA has discovered a useful new weapon in its armoury to tackle the misuse of financial information.
By Richard Burger of Mills & Reeve and George Davies, barrister, One Temple Gardens