Market Watch 77: the threat to market integrity posed by organised crime

Imagined scenario: One of your staff, originally a recreational drug user, has been tempted into supplementing their income by dealing drugs to friends and contacts in finance. At some point, they have attracted the attention of an organised crime gang who pressure (blackmail) them into passing on inside information about upcoming M&A deals which your firm has been wall-crossed on. After a series of cases of suspected insider dealing, the FCA spot a pattern which narrows down to your firm being the source of the inside information. This is followed up with surveillance which ultimately leads to your member of staff and a number of their associates being successfully prosecuted by the FCA and receiving prison sentences. Although cleared of direct involvement, your firm suffers major reputational damage, an outflow of clients and eventual closure.

Not the usual start to our regulatory updates, but this scenario is a fictional representation of what the FCA is warning about in its latest Market Watch 77 newsletter. A more typical narrative anticipated by financial firms is one where inside information has been inadvertently received or has been acquired by an overzealous analyst/trader who is motivated to make extraordinary profits for their clients. The nightmare scenario described above, exposes a different area of risk: that one of your staff may proactively seek and exploit inside information acquired by your firm for direct financial gain (including the possibility that they have been manipulated into doing so).

Market Watch 77 follows the announcement of a major FCA and National Crime Agency (“NCA”) operation launched on 1 February 2024. The operation saw three men charged with multiple insider dealing and money laundering offences and a fourth having been interviewed under caution and still under investigation. Although no further details are available at the moment, the FCA and NCA clearly suspects the presence an organised crime group (“OCG”) – defined under the Serious Crime Act 2015, as the FCA notes, as one that has as its purpose, or as one of its purposes, the carrying on of criminal activities, and consists of 3 or more persons who act, or agree to act, together to further that purpose.

Characteristic OCG activity

Market Watch 77 notes that understanding the characteristic activities of such groups is key to firms mitigating the risks of being conduits for such criminal activity. The FCA believes that the following are typical of OCG activity, particularly in equity spread bets and contracts for difference (“CFD”).

• A pattern of trading before M&A announcements or press speculation about them;
• Pro-active recruitment of sources of inside information;
• Using intermediaries who broker inside information;
• Using umbrella accounts at overseas broking firms where safeguard standards may be lower, and which hide the identities of account holders;
• Using facilitators, including employees of authorised firms, to open accounts with such overseas firms;
• Planting stories about M&A, both true and false, in the media to benefit from the ensuing price movements; and
• Links with other types of serious crime.

Identifying suspicious activity

In terms of identifying potential OCG activity - and, by implication, trading that should be generating Suspicious Transactions and Order Reports (“STOR”) - the FCA point to:

• Clients frequently trading before announcements of M&A activity;
• Clients opening positions shortly before press speculation about M&A and closing those positions immediately after this is published;
• Several clients trading in the same security for the first time; and
• Clients known to have connections with current or former clients about whom the firm has concerns, or whose trade has resulted in STORs.

Advisory firms also need to be alert to staff with access to inside information being approached by OCGs with a view to disclosing inside information.

What firms can do to guard against OCGs

The FCA recommends the following actions to mitigate the risk of facilitating insider dealing by OCGs:

• Communicate to clients a zero-tolerance approach to market abuse, including an open relationship with the FCA and a willingness to submit STORs, terminate accounts based on very low thresholds of suspicion, and liaise with other law enforcement agencies;
• Requesting all overseas broking firms that are clients to submit documentary evidence of adequate surveillance arrangements and a zero-tolerance approach to market abuse; and
• Regarding trades placed before media reports of M&A, as potentially suspicious and submitting STORs where appropriate.

Measures that advisory firms should take to guard against staff being recruited by OCGs as inside information sources:

• Advising staff who work in M&A advisory not to reference having access to inside information in their social media profiles (particularly in the case of junior staff); and
• Reviewing the appropriateness of referencing the names of staff engaged in M&A advisory in the firm’s own social media profiles, beyond its principal senior contacts.

Cosegic comment:

Although Market Watch 77 focuses on the broking and advisory sectors, this guidance is relevant to all buy and sell-side firms. Good people management involves an element of trust for people to do the right thing, nonetheless firms must be at least open to the possibility that their staff are not what they appear to be. This has clear implications for recruitment and background checking processes, ongoing checks on fitness and propriety, and pro-active surveillance of communications and PA dealing activity.