Khepri's A to Z: Market Abuse - Buy and Sell-Side Compliance

Introduction

This article covers market abuse and suspicious transaction reporting.

What is insider dealing?

Insider dealing is where all of the following elements is present.

• Non-Public Information: Information of a precise nature, which has not been made public, relating, directly or indirectly, to one or more issuers or to one or more financial instruments, and which, if it were made public, would be likely to be used by a reasonable investor as part of the basis of his or her investment decisions for financial instruments or related derivative financial instruments

• Precise: Indicates a set of circumstances which exists or which may reasonably be expected to come into existence, or an event which has occurred or which may reasonably be expected to occur, where it is specific enough to enable a conclusion to be drawn as to the possible effect of that set of circumstances or event on the prices of the financial instruments or the related derivative financial instrument.

• Dealing on the basis of: Where a person possesses inside information and uses that information by acquiring or disposing of, for its own account or for the account of a third party, directly or indirectly, financial instruments to which that information relates. This includes making recommendations to another person.

• Prescribed Market: An issuer that has securities or debt admitted (or a request to be admitted has been made) to trading on a Regulated Market, Multilateral trading Facility, Organised Trading Faculty. Including Instruments where the price depends on those venues.

• Presumption of guilt: Where a someone is in position of inside information acquires or disposes of, or attempts to acquire or dispose of, for his own account or for the account of a third party, directly or indirectly, financial instruments to which that information relates, it should be implied that such person has used the inside information

How may one obtain inside information?

Common ways of obtaining inside information include:

• Being told by an “insider” at an issuer

• Wall crossing (to be discussed later)

• Overhearing a conversation in the office on the private side

• Having access to shared documents with the private side

• Having sight of orders from other traders (i.e. front running, pre-positioning, etc)

What should you do if you receive inside information?

It is your obligation to consider whether you have inside information and you cannot rely on an “Insider” to disclose to you that the information they are telling you is inside information. Once you have inside information you should make a record of what it is, when you received it and, if know, when it will cease to be inside information.

What is unlawful disclosure?

This occurs where an insider discloses inside information to another person otherwise than in the proper course of the exercise of his employment, profession or duties

Key point: Keep things on a need to know basis.

What is market manipulation?

False or misleading signals as to the supply and demand of a financial instrument. This may include the following:

• Wash trades: Transactions undertaken with no risk or beneficial ownership transfer

• Pre-arranged trader: As per wash trades but between colluding parties

• Circular trading: Executing an order in the knowledge that an offsetting buy order is being places at the exact same time.

• Layering: stacking orders in a particular order to create an impression of demand

• Spoofing: A pattern of entering orders to push a price high or lower then removing the orders – giving an impression of demand/activity

Securing the price at an artificial level. This may include the following:

• Marking the close: Buying or selling at the close of the market with effect of misleading investors acting on the basis of closing prices

• Abusive squeeze: Taking advantage of a significant or dominate position in order to materially distort, or likely to distort the price

• Momentum Ignition: A series of orders over a short space of time intended to start or exacerbate a trend with the view to unwind/open a position at a favourable price

• Ramping: effecting trades to deliberately push the price up or down

Dissemination. This may include the following:

• Disseminating information through the media, including the internet, or by any other means, which gives, or is likely to give, false or misleading signals as to the supply of, demand for, or price; and where the person who made the dissemination knew, or ought to have known, that the information was false or misleading (the UK regulator will expect you to ought to have known)

Trading based on a fictitious device. This includes the following:

• Entering into a transaction, placing an order to trade or any other activity or behaviour which affects or is likely to affect the price of one or several instruments which employs a fictitious device or any other form of deception or contrivance

Benchmark manipulation is transmitting false or misleading information or providing false or misleading inputs in relation to a benchmark where the person who made the transmission or provided the input knew or ought to have known that it was false or misleading, or any other behaviour which manipulates the calculation of a benchmark.

Market soundings

Market sounding is defined as communication of information to one or more investors, prior to the announcement of a contemplated Transaction, in order to gauge the interest of potential investors in a contemplated Transaction and the conditions relating to it such as its potential size or pricing.

What should be done prior to a market sounding:

• Will inside information be disclosed?

• Which employees will be present? (log attendance)

• Should I be disclosing anything?

• What is the minimum information I should disclose?

• Is the telephone line recorded?

• Who is taking the minutes?

What should be done during a market sounding:

• Ensure call recorded

• Follow pre-determined sequence of disclosure

• Make clear that this is a Market Sounding

• Explain if inside information is about to be disclosed

• Obtain consent to wall cross

• Remind investor of their obligations of confidentiality

• Estimate of when information will cease to be inside information

What should be done after a market sounding:

• Write up minutes and document log

• Disclose to participant when it ceases to be inside information

What are the market abuse surveillance obligations?

Suspicious transaction reporting

You have an obligation to establish and maintain effective arrangements, systems and procedures to detect and report suspicious orders and transactions.

Where you have a reasonable suspicion that an order or transaction in any financial instrument, whether placed or executed on or outside a trading venue, could constitute insider dealing, market manipulation or attempted insider dealing or market manipulation, you should notify your relevant internal individual.

Suspicion is more subjective and falls short of proof based on firm evidence. Suspicion has been defined by the courts as being beyond mere speculation and based on some foundation, for example:

• “A degree of satisfaction and not necessarily amounting to belief but at least extending beyond speculation as to whether an event has occurred or not”

• “Although the creation of suspicion requires a lesser factual basis than the creation of a belief, it must nonetheless be built upon some foundation”

• “Whilst it was misleading to use the words "inkling" or "fleeting thought", suspicion in this context meant only that the defendant must "think that there is a possibility, which is more than fanciful, that the relevant facts exist. A vague feeling of unease would not suffice”