FCA has concerns about investment firms’ personal account dealing controls

The FCA has published Market Watch 62, in which it expresses significant concerns about authorised firms’ systems and controls when it comes to Personal Account Dealing (“PAD”).

Investment firms are required to establish appropriate policies and procedures governing PAD that are designed to minimise conflicts of interest and prevent market abuse. Whilst many firms have implemented a policy and other controls the adequacy and effectiveness of those arrangements, to manage financial crime risks and prevent harm to clients and the market is being called into question by the Regulator in this latest publication.

Using available information, namely suspicious transaction and order reports (STORs) and transaction reports, the FCA can identify suspicious transactions, particularly those conducted by employees of regulated institutions. As a routine part of any investigation, it will engage with firms to determine what processes exist and if the identified activity was in violation of them.

From this engagement the FCA has identified a number of apparent breaches of firms’ internal policies, ranging from trading in prohibited products, dealing in the opposite direction to professional decisions and recommendations, and following or front running client orders.

Coupled with this, the FCA has also found in some firms a general ignorance of the existence of such policies, or their content, or a lack of understanding by employees of internal PAD policies (despite acknowledgment and understanding undertaking being signed) as well as deliberate circumnavigation of internal requirements by, for example, not declaring external accounts or those which the individual has influence over. The existence of any of these failings will suggest to the FCA that arrangements implemented by firms across the financial services industry are generally unsuccessful in managing the risks inherent in PAD activity.

Additionally, as part of a recent market abuse review, specifically in the wholesale broking sector, the FCA assessed PAD activities and controls. The findings varied from firm to firm, however generally the view is that the sector is not doing enough to assess and address specific risks relevant to their business model. The FCA suggests that this may stem from a “culture which has not sufficiently identified the potential for harm”.

Key learnings for all firms

Despite the focus being on the wholesale broking sector, there are learnings for all financial services firms in the findings. Noteworthy points include:

• Use of attestations to signify an understanding of and compliance with PAD policies was common but in a number of instances the supporting arrangements – for example, monitoring and controls – were lacking.
   
• Low volumes of PAD indicated to the FCA that not all trades were being reported to the firm by employees, further suggesting that the firm was not aware of all accounts which the employee was involved in trading for. In these instances, the Firm is unable to be confident that associated approval conditions (i.e., pre-approval or pre-trade restrictions on certain instruments) are being complied with nor that it is able to adequately manage any ensuing conflict.
   
• Significant quantities of PAD, especially during normal working hours, should cause a firm to question an individual’s ability to discharge their role for the firm effectively. An assessment of the extent to which the trading may impact on the individual’s duties or responsibilities to clients and, specifically, their best interests should be conducted.
   
• The FCA is keen to see proactive identification of breaches of PAD arrangements by firms, however noted in the sample of firms selected this was generally low, with no corresponding submission of STORs. This statement was accompanied by a comment which indicated the Regulator’s surprise of such and suggestions of an indication of weaknesses in culture and compliance.
   
• The amount and frequency of pre- and post-trade analysis of PAD activities varied greatly between Firms from some that did little, to those that surveyed for price movements or corporate news on a post-trade basis and those that used automated trade surveillance systems and upload PAD records to them.

Employee attestations are not enough

Previous enforcement action has shown that use of attestations, even when their content is abundantly clear, is not enough. These attestations should be used at the outset, and then repeated at least annually (or when significant change occurs). This is an administrative challenge in itself, however it is important to supplement the attestation processes with frequent reminders of the firm’s policy and requirements – either through internal alerts or periodic training.

The attestation process should to be accompanied with pre- and post- trade monitoring of activity in light of client activity and market movements, as well as independent verification of transactions, such as by obtaining annual statements and cross referencing such with notified transactions or use of technology systems with automated broker feeds. These reviews in particular can serve to highlight non-notified transactions which might otherwise have not been identified.

The key cannot be relying on individuals to comply; that’s not to say all employees are out to disregard internal processes but the education process should inform them of the importance and relevance of the requirements and control the risk that information obtained in a professional capacity can be used for personal gain or in detriment to another client.

The FCA’s guidance on designing internal PA policies and procedures

The FCA also takes the opportunity in Market Watch 62 to give guidance on what firms should consider when designing internal PA policies and procedures, with the starting point being a risk assessment that appropriately considers the inherent PAD risks, namely conflicts of interest management and market abuse, in light of its particular business model and considering the availability of markets which employees may wish to trade.

Those risks then need to be mitigated and attention should be given to different business areas and the potential for the effectiveness of existing controls, processes or business practices to mitigate such identified risks. Something seriously worth considering as part of the risk mitigation is the involvement of the firm’s senior management and whether they are ‘leading by example’; cultural challenges should not be underestimated.

The third step would be the implementation of effective monitoring and other oversight controls; this is arguably the most challenging, but consideration should be given to employee awareness and over-reliance on their actions (which should be avoided); notification, approval, and assessment processes; and effective post-trade monitoring. The ability to consider PAD monitoring on a holistic basis alongside other tests within a monitoring programme should also be a factor for firms, as taking a step back and considering the ‘bigger picture’ is immensely valuable and often overlooked.

The FCA concludes with ‘Next steps for all firms’ which advocates that firms review the regulatory requirements set out in COBS 11.7 and 11.7A as well as the items raised in the publication and consider their own arrangements in light of the commentary. In light of the seriousness of the concerns, many firms are likely to be able to find at least one area where they might be able to make an enhancement.

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• Recurring trade and employee surveillance and monitoring pitfalls for financial services firms
• Examples of real-life risks resulting from inadequate surveillance policies and procedures 
• Best practices to implement to avoid surveillance failings

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How We Help

Our market abuse solutions include:

• Market Abuse Thematic Review: a deep-dive review, benchmarking, and testing of your firm’s market abuse arrangements to help mitigate the risk of insider dealing, improper disclosure, and market manipulation.
   
• Market Abuse Controls Review: focused and cost-effective assessment of your firm’s policies, procedures, monitoring programme, surveillance techniques, and controls environment.
   
• Personal account dealing surveillance software and advisory services: provides an integrated technology solution for managing your firm’s compliance activities related to employee personal account dealing monitoring, attestations, reporting on gifts and entertainment, outside activities, and more.
   
• Trade surveillance software: applies proprietary algorithms against PAD records, trade and position data, and historical market information to produce “Items of Interest” for further investigation.
   
• ACA Training Solutions: a range of open courses, some of which are in partnership with UK Finance.

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About the Author

Charlotte Longman is a Director focused on UK Compliance. She is responsible for developing a mixed portfolio of clients, with a focus on capital markets firms that provide brokerage and investment trading services across equities, fixed income and FX markets. Within the projects team, Charlotte specialized in the development of our MiFID II services.

Prior to the acquisition by ACA, Charlotte was Senior Consultant at Cordium, where she had undertaken two external secondments acting as Compliance Manager whilst simultaneously enhancing the firm's market abuse compliance monitoring programme. 

Before this, she was Deputy Head of Compliance at a leading FX Broker where she provided day-to-day support for the Global Head of Compliance. Before that, she was the Compliance Officer at a mid-size CFD and Spread Betting provider, holding the CF10 controlled function for three years.

Charlotte obtained her LLB Law from the University of Hertfordshire.