Approved persons, controlled functions, training and competence 92. Record keeping and reporting information 98

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2 Chapter6 The regulatory framework Approved persons, controlled functions, training and competence 92 Record keeping and reporting information 98 Market conduct and financial crime 102 Complaints handling, the Financial Ombudsman Service and the Financial Services Compensation Scheme 110

3 Chapter 6 The regulatory framework In this chapter, we examine some of the key elements of the regulatory framework for investment firms set by the Financial Services Authority (FSA). The FSA was replaced by the Financial Conduct Authority and the Prudential Regulation Authority on 1 April We begin by examining the high level standards for approved persons in controlled functions. We then examine the record keeping requirements for firms. The financial crime legislation for insider dealing and money laundering is covered, along with the requirements relating to market conduct. Finally, we cover requirements relating to redress complaints and compensation. The government has announced its intention to reform the institutional framework for financial regulation. The new Financial Conduct Authority has taken on the FSA s responsibility for consumer protection and conduct regulation. The timing and impact of these changes on the material in this chapter were not known when this training manual went to print, and therefore candidates are encouraged to check the CFA Society of the UK website for updates: /imc. Chapter 6 Section 1 Approved persons, controlled functions, training and competence Section aims By the end of this section, you should be able to: Define an approved person. Define a controlled function. Identify the types of controlled functions defined within the FCA handbook (SUP 10). Identify the main assessment criteria in the FCA s fit and proper test for approved persons (FIT). Explain the application procedure for approved persons and demonstrate an understanding of how the PRA may be involved (SUP 10A). Explain the procedure for an approved person moving within a group and demonstrate an understanding of how the PRA may be involved (SUP 10A). Explain the requirements relating to training and competence. Explain the professionalism requirements that have to be met by retail investment advisers. 92

4 Section 1 Approved persons, controlled functions, training and competence 1 Approved persons and controlled functions Anyone undertaking a controlled function must be approved by the regulator before undertaking that function. Those people granted approval to undertake controlled functions are deemed to be approved persons. For firms that are only regulated by the FCA there are is little change to the list of controlled functions that applied under the FSA. Under this regime there are five categories of controlled functions, as follows: Governing functions: chief executive and directors. Required functions: apportionment and oversight function, compliance oversight function, money laundering reporting function, etc. Systems and control function: the person in a firm responsible for reporting to the governing body in relation to its financial affairs, risk controls and internal systems and controls. Significant management function: only relevant to large firms where a significant management function is allocated to a senior manager. Customer functions: the customer functions are giving advice on, dealing and arranging deals in and managing investments. All of the functions, except those in the category of customer functions, are classed as significant influence functions. An appointed representative undertaking a controlled function would have to have been granted approved person status. For firms that are regulated by both the FCA and PRA (dual-regulated firms) the significant influence functions that existed under the FSA are split between the PRA and FCA (shown below). This split is designed to minimise the duplication of approvals by the two regulators (although it will not completely eliminate it). PRA SIFs PRA Governing functions FCA SIFs FCA Governing functions CF1 Director CF2 (PRA)* PRA Non-executive director CF2 (FCA)* FCA Non-executive director CF3 Chief executive CF4 Partner CF5 Director of an unincorporated association CF6 Small friendly society PRA Required functions FCA Required functions CF12 Actuarial CF8 Apportionment and oversight CF12A With-profits actuary CF10 Compliance oversight CF12B Lloyd s actuary CF10a Client assets CF28 Systems and controls CF11 Money laundering reporting Significant management function CF29 Significant management Customer functions CF30 Customer function * New controlled function 93

5 Chapter 6 The regulatory framework Where an individual will carry on both PRA and FCA significant influence functions (SIFs), an application may need only be made to the PRA, and not to the FCA, under specified circumstances (effectively where two functions overlap). For example, where the Chief Executive of a firm (controlled function CF3) is also carrying out the apportionment and oversight function (CF8) they will only need to apply to the PRA. The PRA approval will expand to cover the FCA approval. This arrangement will only apply where the individual is applying for both roles at the same time. Where the person takes on different roles or changes their role they will need to apply to both the PRA and FCA separately. Where an application is made to the PRA for both a PRA and FCA significant influence function the PRA will need the consent of the FCA before they can grant approval. Either regulator may withdraw approval from a person who is carrying on a SIF in connection with a dual regulated firm, regardless of which regulator granted approval. If withdrawing an approval given by the other regulator, it must consult that regulator first. FCA will only grant approved person status if it is satisfied that the individual is fit and proper to undertake the controlled function. In assessing fitness and propriety, the FCA will have regard to a number of factors, including: Honesty, integrity and reputation (for example, has the individual been convicted of a criminal offence, has the individual been the subject of any previous disciplinary hearing by the FCA, etc). Competence and capability (has the individual satisfied the relevant training and competence requirements). Financial soundness (for example, has the person been adjudged bankrupt). Approval can either be granted or withheld by the regulator. The regulator will not grant conditional approval. The firm must inform the regulator within seven business days if the approved person ceases to perform the controlled function. The FCA sets out four statements of principle with which all approved persons must comply, and a further three that apply to all approved persons with significant influence functions. These are set out in APER in the FCA handbook. These statements of principle are: (1) An approved person must act with integrity in carrying out his controlled function. (2) An approved person must act with due skill, care and diligence in carrying out his controlled function. (3) An approved person must observe proper standards of market conduct in carrying out his controlled function. (4) An approved person must deal with the FCA and with other regulators in an open and co-operative way, and must disclose appropriately any information of which then FCA would reasonably expect notice. (5) An approved person performing a significant influence function must take reasonable steps to ensure that the business of the firm for which he is responsible in his controlled function is organised so that it can be controlled effectively. 94

6 Section 1 Approved persons, controlled functions, training and competence (6) An approved person carrying out a significant influence function must exercise due skill, care and diligence in managing the business of the firm for which he is responsible in his controlled function. (7) An approved person performing a significant influence function must take reasonable steps to ensure that the business of the firm for which he is responsible in his controlled function complies with the relevant requirements and standards of the regulatory system. One of the effects of the approved persons regime is that it allows an individual who breaches one or more of the statements of principle (listed above), ignoring appropriate arrangements put in place by the firm, to be disciplined without the firm as a whole being disciplined. For example, an individual may mislead a client about the likely performance of an investment by providing inappropriate projections of future investment returns, despite appropriate procedures being put in place by his or her employer. Each regulator (PRA and FCA) can discipline an approved person who has breached a statement of principle irrespective of whether it has approved the person. One of the changes to the APER statements of principle introduced by the Financial Services and Markets Act 2012 is that they now relate not just to conduct of persons in respect of the controlled functions they perform, but also to any other functions they perform where those functions relate to the firm where they hold their approval carrying on regulated activities. 2 Training and competence There is a requirement that all staff employed in an authorised investment firm are competent. In addition, for those employed for performing certain specified activities that affect retail customers, the firm must ensure: The employee has been assessed as competent in that activity. The employee is supervised. Firms should ensure that employees are appropriately supervised at all times. It is expected that the level and intensity of that supervision will be significantly greater in the period before the firm has assessed the employee as competent than after. A firm should therefore have clear criteria and procedures relating to the specific point at which the employee is assessed as competent, in order to be able to demonstrate when and why a reduced level of supervision may be considered appropriate. At all stages, firms should consider the level of relevant experience of an employee when determining the level of supervision required. Where a firm permits an employee to give advice on packaged products to retail customers under supervision (having not been assessed as competent), it must ensure that: The supervisor has passed an appropriate examination. The employee has an adequate level of knowledge and skill. 95

7 Chapter 6 The regulatory framework Where a firm permits an employee, under supervision, to engage in: Advising on investments, dealing with or for clients in securities and/or derivatives; The activity of a broker fund adviser; Advising on syndicate participation at Lloyds; The activity of a pension transfer specialist; the firm must ensure that the employee has passed the appropriate qualification. Maintaining competence A firm must review, on a regular and frequent basis, employees competence and take appropriate action to ensure that they remain competent for their role. A firm should ensure that maintaining competence for an employee takes into account such matters as: Technical knowledge and its application. Skills and expertise. Changes in the market and to products, legislation and regulation. 3 Professionalism requirements for retail investment advisers The FSA has conducted a review of retail advice in the UK (the retail distribution review (RDR)), which has resulted in new professionalism requirements for retail investment advisers with the aim of improving trust in the retail investment sector. With effect from 1 January 2013, advisers will need to: Subscribe to a code of ethics. Hold an appropriate qualification, including any qualification gap-fill. Carry out at least 35 hours of continuing professional development a year. Hold a statement of professional standing (SPS) from an accredited body. These standards will be maintained and enforced by the FSA (and its successor). Firms will be required to submit data, such as the occurrence of three complaints involving the adviser over any 12 month period, to the FSA about their individual advisers. Accredited bodies will inform the FSA of any advisers who are not meeting the standards required to obtain the SPS. If existing advisers do not meet these standards, they will not be able to make personal recommendations to retail customers from 1 January Ethical standards Ethical standards are seen by the FSA as central to achieving its aim of increased professionalism. 96

8 Section 1 Approved persons, controlled functions, training and competence The FSA has amended its statements of principle for approved persons (APER) see part 1 of this section to emphasise personal accountability and how actions affect public perceptions. These statements of principle apply to all approved persons, not just those subject to the RDR. To obtain an SPS, advisers are required to make an annual declaration to their accredited body that they have complied with APER. Modernised qualifications The FSA has modernised the qualification requirements to better reflect the actual role of advisers and give them the skills and knowledge to meet the demands of today s investment market. The FSA has listed qualifications that are appropriate for investment advice activities in its handbook. This list comprises a combination of old qualifications requiring qualification gap-fill, marked (b), and new qualifications that meet the modernised exam standards, marked (a). From 1 January 2013, an adviser must have a qualification marked (a) or (b) in the list of appropriate qualifications. Keeping knowledge up to date Continuing professional development (CPD) is seen by the FSA to be as important as modernising qualifications. From 1 January 2013, advisers will need to complete a minimum of 35 hours of CPD each year for retail investment activities, of which 21 hours should be structured. Structured learning activities include seminars, lectures, conferences, workshops or courses and completing appropriate e-learning. Accredited bodies Accredited bodies are responsible for: Ensuring that all of the advisers who use their services are subscribing to a code of ethics that is consistent with the statements of principle for approved persons. Checking that all of the advisers who use their services hold an appropriate qualification, including verifying 100% of their gap-fill where required. Carrying out a random 10% CPD sample check (the body can exceed this requirement if it chooses). Recognising CPD activity from a range of providers, including firms own in-house schemes. Note that FSA approved person status is the only legal licence to operate as a retail investment adviser in the UK. An accredited body has the role of ensuring that the adviser to retail clients continues to meet the professional standards set out by the FSA. 97

9 Chapter 6 The regulatory framework Chapter 6 Section 2 Record keeping and reporting information Section aims By the end of this section, you should be able to: Apply the rules relating to record keeping. Apply the rules relating to occasional reporting to clients (COBS 16.2). Apply the rules relating to periodic reporting to clients (COBS 16.3). Explain the rules relating to reporting information to unitholders in authorised unit trusts (COLL 4). 1 Record keeping Investment firms are required to keep various records to comply with FSA rules. Some examples of the record keeping requirements are: Firms must keep records of client classifications, with supporting information. This requirement applies to retail clients, professional clients and eligible counterparties. The records must be kept for five years from the end of the business relationship for MiFID or equivalent third country business and for life and pension contracts and three years for other regulated business. Suitability records in relation to MiFID business and life policies and pensions must also be kept for five years from the date of the advice. Again, for other business the transaction record keeping requirement is for three years except for pension transfers or opt-outs where records should be kept indefinitely. Investment firms must keep detailed records for five years of every order received from a client and for portfolio management services of every dealing decision. This requirement applies to retail clients, professional clients and eligible counterparties. Records of client classification before any pension transfers or opt-outs must be kept indefinitely. Other important record keeping requirements are outlined under other sections of this manual. 2 Occasional reporting If a firm has carried out an order in the course of its designated investment business on behalf of a client (except where the firm is managing investments), it must: 98

10 Section 2 Record keeping and reporting information Promptly provide the client, in a durable medium, with the essential information concerning the execution of the order. In the case of a retail client, send the client a notice in a durable medium confirming the execution of the order and such of the trade confirmation information as is applicable: As soon as possible, and no later than the first business day following that execution; or If the confirmation is received by the firm from a third party, no later than the first business day following receipt of the confirmation from the third party. Supply a client, on request, with information about the status of his or her order. Essential information includes: For transactions in a derivative: The maturity, delivery or expiry date of the derivative. In the case of an option, a reference to the last exercise date, whether it can be exercised before maturity and the strike price. If the transaction closes out an open futures position, all essential details required in respect of each contract comprised in the open position and each contract by which it was closed out, and the profit or loss to the client arising out of closing out that position (a difference account). For the exercise of an option: The date of exercise, and either the time of exercise or that the client will be notified of that time on request. Whether the exercise creates a sale or purchase in the underlying asset. The strike price of the option (for a currency option, the rate of exchange will be the same as the strike price) and, if applicable, the total consideration from or to the client. 3 Periodic reporting Where a firm manages investments on behalf of a client: In the case of a retail client, it must provide a periodic statement once every six months, except in the following cases: If the retail client so requests, the periodic statement must be provided every three months. If the retail client elects to receive information about executed transactions on a transaction-by-transaction basis and there are no transactions in derivatives or other securities giving the right to acquire or sell a transferable security or giving rise to a cash settlement determined by reference to transferable securities, currencies, interest rates or yields, commodities or other indices or measures, the periodic statement must be provided at least once every 12 months. If the agreement between a firm and a retail client for the managing of investments authorises a leveraged portfolio, the periodic statement must be provided at least once a month. 99

11 Chapter 6 The regulatory framework A firm must inform a retail client that he has the right to request the provision of a periodic statement every three months. If a firm: Manages investments for a retail client; or Operates a retail client account that includes an uncovered open position in a contingent liability transaction, it must report to the retail client any losses exceeding any pre-determined threshold, agreed between it and the retail client. The firm must report: No later than the end of the business day in which the threshold is exceeded; or If the threshold is exceeded on a non-business day, the close of the next business day. 4 Record keeping A firm must make, and retain, a copy of any occasional or periodic statement: For MiFID or equivalent third country business, for a period of at least five years from the date of despatch; or For business that is not MiFID or equivalent third country business, for a period of at least three years from the date of despatch. 5 Reporting information about authorised funds to unitholders 100 In order to provide the unitholders with regular and relevant information about the progress of the authorised fund, the authorised fund manager must: 1. Prepare a short report and a long report half-yearly and annually; 2. Send the short report to all unitholders; and 3. Make the long report available to unitholders on request. These reports must be prepared every annual accounting period and half-yearly accounting period. The short report for an authorised fund or, for a scheme which is an umbrella, its sub-fund, must contain for the relevant period: (a) (i) The name of the scheme or sub-fund; (ii) Its stated investment objectives and the policy and strategy pursued for achieving those objectives; (iii) A brief assessment of its risk profile; (iv) In the case of a UCITS scheme, the figure for the synthetic risk and reward indicator disclosed in its most up-to-date key investor information document and any subsequent changes to that figure during that period; and (v) The name and address of the authorised fund manager;

12 Section 2 Record keeping and reporting information (b) A review of the scheme or sub-fund s investment activities and investment performance during the period; (c) A performance record so as to enable a unitholder to put into context the results of the investment activities of the scheme during the period; (d) Sufficient information to enable unitholders to form a view on where the portfolio is invested at the end of the period and the extent to which that has changed over the period; (e) Any other significant information which would reasonably enable unitholders to make an informed judgement on the activities of the scheme or sub-fund during the period and the results of those activities at the end of the period; and (f) A statement that the latest long report is available on request. The long report essentially contains the accounts and reports prepared by the fund manager, the depository and the auditor. An authorised fund manager must also draw up a short document in English containing key investor information for investors. Key investor information must include appropriate information about the essential characteristics of the UCITS scheme which is to be provided to investors so that they are reasonably able to understand the nature and risks of the investment product that is being offered to them and, therefore, to take investment decisions on an informed basis. More information on this is given in chapter 7, section 4 of this manual. 101

13 Chapter 6 The regulatory framework Chapter 6 Section 3 Market conduct and financial crime Section aims By the end of this section, you should be able to: Explain the various sources of money laundering and counter-terrorism regulation and legislation, including: FSA rules Money laundering regulations Proceeds of Crime Act 2002 Explain the role of the Joint Money Laundering Steering Group (JMLSG). Explain the main features of the guidance provided by the JMLSG. Explain the three stages involved in the money laundering process. Explain the four offence categories under UK money laundering legislation. Explain the meaning of inside information covered by CJA Explain the offence of insider dealing covered by the CJA. Identify the penalties for being found guilty of insider dealing. Explain the FSA s powers to prosecute insider dealing. Understand the nature of behaviours defined as market abuse (MAR 1.3, 4, 5, 6, 7, 8 & 9). Explain the enforcement powers of the FSA relating to market abuse (MAR 1.1.4, 5 & 6). Explain the main features of the Bribery Act Money laundering and terrorist financing 102 Money laundering is the process by which criminals disguise the source of their proceeds of crime. Its secondary objectives include providing a safe haven for those proceeds and providing a financial return on those proceeds by using legitimate business. The Proceeds of Crime Act 2002 (POCA) replaced all previous anti-money laundering legislation. It extended the offence of money laundering to the proceeds of any crime and not just serious crime, drug trafficking and terrorist offences. Specific obligations to combat terrorist financing were set out in the Terrorism Act POCA imposes an objective burden of proof for suspicion. Under previous legislation, it was only a criminal offence to fail to report suspicion of money laundering. Under POCA, it is a criminal offence to fail to be suspicious of behaviour that would ordinarily give rise to such suspicion. In other words, an offence is committed where the person ought to have suspected that another

14 Section 3 Market conduct and financial crime person was laundering the proceeds of crime. Members of staff within a financial firm are provided with a defence against not reporting knowledge or suspicion of money laundering if their employer did not provide them with the training required under the regulations. The laundering process is accomplished in three stages, which may comprise many transactions that could alert an investment business that criminal activity is being undertaken: Placement: the physical injection into the financial system of cash proceeds obtained from criminal activity. Layering: the separation of criminal proceeds from their source by creating complex layers of financial transactions designed to disguise the audit trail. Integration: the provision of apparent legitimacy to criminally derived wealth. Integration schemes place the laundered proceeds back into the economy in such a way that they appear to be legitimate investment funds. As cash settlement of investment transactions is extremely unusual in the UK, it is more likely that the placement stage will involve banks and building societies. However, bearer securities delivered other than through an established clearing system should merit special attention. Investment businesses are more likely to find that they are used in the second and third stages of money laundering. 2 The money laundering regulations (2007) The money laundering regulations (2007) implement the Third EU Money Laundering Directive and came into effect in December They impose on firms a risk-based approach to combat money laundering. This breaks down into four key questions: 1. What are the firm s money laundering and terrorist financing risks? This requires consideration of the following: What risks arise as a result of the jurisdictions in which the firm does business? What risks arise as a result of the products and services the firm offers? What risks arise because of the type of customers that the firm does business with, e.g. what jurisdictions with weak anti-money laundering rules are those customers from, what type of activity is required, are they high net worth individuals or potential recipients of bribes, etc? 2. What steps could be taken to reduce those risks? 3. What policies and procedures therefore need to be adopted in light of those risks? 4. What procedures are appropriate? There is an obligation on firms to pursue customer due diligence (CDD), essentially verifying the identity of the customer and determining the basis for the client relationship. Under the 2007 regulations, firms must: Identify the customer and verify the customer s identity on the basis of documents, data or information obtained from a reliable and independent source. Identify the beneficial owner and take adequate measures on a risk-sensitive basis to 103

15 Chapter 6 The regulatory framework 104 verify their identity, so that the firm is satisfied that it knows who the beneficial owner is. Obtain information on the purpose and intended nature of the business relationship. Keep the documents, etc, obtained for the purpose of applying CDD up to date. Conduct ongoing monitoring of the business relationship. The requirement in the regulations is that firms upon identifying a beneficial owner who is not the customer take adequate measures, on a risk-sensitive basis, to verify his or her identity so that the relevant person is satisfied that he knows who the beneficial owner is. See chapter 3 for a definition of beneficial owner. Firms are also required to undertake enhanced or simplified CDD in certain circumstances. The simplified due diligence (SDD) regulation provides that certain CDD measures do not need to be applied to specified types of customers and products. For example: Credit or financial institutions subject to the Third Money Laundering Directive. Supervised credit or financial institutions in states with comparable AML controls. Listed companies on regulated markets with specified disclosure obligations. The beneficiaries of solicitor s accounts. Certain defined public authorities. Certain insurance products and pension schemes. Certain other types of defined products, such as child trust funds. Enhanced due diligence (EDD) applies in four circumstances: Where business is conducted on a non-face to face basis. In respect of correspondent banking relationships. Where a situation by its nature can present a higher risk of money laundering or terrorist financing. Where the customer is a politically exposed person (PEP). As regards PEPs, a firm is obliged to have in place procedures to ascertain whether an individual is a PEP. The 2007 regulations provide that a firm has to have in place: A requirement that all PEP relationships must be approved by senior management. Adequate measures to establish source of funds and source of wealth. Enhanced ongoing monitoring procedures. A PEP is defined as a person who discharges, outside the UK, prominent public functions (which are defined in the regulations), an immediate family member of such a person and known close associates. The 2007 regulations also place emphasis on ongoing monitoring of relationships with customers. The FSA rules require firms to appoint a money laundering reporting officer (MLRO). The MLRO is responsible for the oversight of the firm s anti-money laundering activities and is the key person in the firm s implementation of anti-money laundering strategies and policies. The 2007 money laundering regulations require investment businesses to establish

16 Section 3 Market conduct and financial crime and maintain specific policies, procedures and training programmes to prevent their business being used for the purposes of money laundering. In brief, these regulations are designed to achieve two purposes: To enable suspicious customers and transactions to be recognised and reported to the authorities (the Serious Organised Crime Agency (SOCA)). To ensure that if a customer comes under investigation, the firm can provide its part of the audit trail. The FSA no longer provides detailed rules on combating money laundering, but instead has a set of high level principles and informal guidance relating to money laundering contained in SYSC (see chapter 4). The FSA places emphasis on the guidance provided by the Joint Money Laundering Steering Group (JMLSG) and states that the FSA, when considering whether a breach of its rules on systems and controls against money laundering has occurred, will have regard to whether a firm has followed relevant provisions in the guidance for the UK financial sector issued by the JMLSG. The JMLSG is made up of the leading UK trade associations in the financial services industry. Its aim is to promulgate good practice in countering money laundering, and to give practical assistance in interpreting the UK money laundering regulations. The main requirements are: Internal controls, policies and procedures Firms are required to ensure that policies, procedures and controls are introduced to deter criminals from using their facilities for money laundering. All firms should establish a central point of contact with the law enforcement agencies (i.e. a money laundering reporting officer). Identification procedures Firms are required to obtain satisfactory evidence of the identity of those with whom they do business in a timely manner. Record keeping Records must be retained for at least five years after the completion of the business. Firms should retain records concerning, inter alia, customer identification, transactions, suspicion reports and training and competence monitoring. This enables the firm to provide a clear audit trail. Recognition and reporting of suspicious transactions A suspicious transaction is one which is inconsistent with an investor s known legitimate business or personal activities. Thus, the first key to recognition is to have sufficient knowledge of the investor s business to recognise that a transaction, or a series of transactions, is unusual. There is an obligation on all staff to report suspicious transactions to the money laundering reporting officer (MLRO). The MLRO is also required to report to SOCA where they have received an internal report and have knowledge, suspicion or reasonable grounds to suspect money laundering. Training In order for procedures and recommendations above to be effective, it is important that staff are made aware of their obligations and are trained to provide a prompt report of any suspicious transactions. 105

17 Chapter 6 The regulatory framework Offences under the law are as follows: Assistance: any person assisting money laundering is punishable on conviction by a maximum of 14 years imprisonment, or a fine, or both. Tipping-off: where a person informs anyone connected with an investigation into money laundering that such an investigation is occurring, the punishment on conviction is a maximum of five years imprisonment, or a fine, or both. Failure to report: where a person fails to report knowledge or suspicion of money laundering, the punishment on conviction is a maximum of five years imprisonment, or a fine, or both. Failure to comply: failure to comply with the requirements of the regulations, (e.g. failure to implement satisfactory identification procedures) constitutes an offence punishable by a maximum of two years imprisonment, or a fine, or both. 3 Insider dealing 106 The law covering insider dealing is the Criminal Justice Act 1993, Part V (CJA), which came into force in April This Act gave effect to an EU directive on insider dealing. The overall objective of insider dealing laws is to protect corporate confidences and to prevent insiders privy to such confidences from benefiting from an unfair advantage when they deal in the market. There are three principal insider dealing offences: Dealing while in possession of inside information. Encouraging another to deal, knowing, or reasonably believing, that dealing will occur. Dealing, in this context includes any communication that refers to a security that a person may hold and encourages them not to sell. Disclosing information to another other than in the proper performance of one s duties. The investments covered by the CJA include shares, debentures, options, warrants and public sector debt instruments. The dealings in such securities that are covered by the CJA are those on any investment exchange, as well as off-market deals facilitated by professional intermediaries (professional intermediaries include UK and overseas market makers and brokers, but not usually accountants and solicitors). Thus transactions like arranging underwritings and firm placings are covered by the legislation. The CJA defines information as price-sensitive information of a specific and precise nature. If such information were to be made public, it would be likely to have a significant effect on the price. The CJA provides the following main defences to insider dealing: An individual passed on information in the proper performance of their duties but did not expect the recipient to deal. The deal was not done to make a profit or avoid a loss. A new issue was stabilised under the strict terms of the FSA s stabilisation rules.

18 Section 3 Market conduct and financial crime A market maker had inside information in the course of his/her business but acted bona fide for that business. The person dealing only had the information that certain securities were to be or had been issued, acquired or disposed of, and it was therefore reasonable to deal. For example, this defence would cover predator companies purchasing shares in target companies before announcing a bid, or institutional shareholders not announcing their intentions of buying or selling a large volume of securities before doing so. A person acting in such a capacity on a recognised investment exchange is not prevented from dealing while in possession of unpublished price-sensitive information if such information was obtained by him/her in the normal course of his business. An individual found guilty of insider dealing shall be liable: On summary conviction (in a magistrates court), to a fine not exceeding the statutory maximum or imprisonment for a term not exceeding six months, or both. On conviction or indictment (in a crown court), to a fine or imprisonment for a term not exceeding seven years, or both. 4 Market abuse On 1 July 2005, the Financial Services and Markets Act 2000 (Market Abuse) Regulation 2005 (the regulations ) came into force in order to implement the EC directive on insider dealing and market manipulation (market abuse). The directive also introduced into the UK a new requirement for firms to report transactions giving rise to suspicions of market abuse. A person who engages in conduct amounting to market abuse may find that it is also in breach of the provisions of the criminal law which runs in parallel to the FSMA market abuse regime. Sections 401 and 402 of the FSMA give the FSA power to prosecute a number of offences under FSMA and other legislation. The offences for which the FSA can take criminal action are broad. Some of the most important are: Offences relating to breaches of the FSA listing rules, including that of offering new securities to the public in the UK before publishing a prospectus, if required by listing rules. Making misleading statements and market manipulation. Misleading the FSA. Insider dealing under Part V of the Criminal Justice Act 1993 (see above). Breaches of prescribed regulations relating to money laundering. In the majority of cases, the FSA is likely to commence an investigation based on breaches of the civil market abuse regime. For market abuse to occur, the behaviour must relate to a qualifying investment traded on a prescribed market. A prescribed market is essentially a recognised investment exchange located in the UK and all other regulated markets in the EEA. A qualifying investment is essentially a security, right or interest traded on a prescribed market. 107

19 Chapter 6 The regulatory framework 108 The seven types of behaviour that can constitute market abuse are listed below, together with an example of the behaviour taken from the FSA Code of Market Conduct: Insider dealing: where an insider deals, or attempts to deal, in a qualifying investment or related investment on the basis of inside information (this sits alongside the criminal offence of insider dealing described above). An example of insider dealing is where A, a director at X PLC, has lunch with a friend, B. A tells B that his company has received a takeover offer that is at a premium to the current share price at which it is trading. B enters into a spread bet priced by reference to the share price of X PLC, based on his expectation that the price of X PLC will increase once the takeover offer is announced. Improper disclosure: where an insider discloses inside information to another, other than in the proper course of the exercise of his employment, profession or duties. An example of encouraging another to engage in market abuse (improper disclosure): X, an analyst employed by an investment bank, telephones the finance director at B PLC and presses for details of the profit and loss account from the latest unpublished management accounts of B PLC. Misuse of information: behaviour based on information that is not generally available but which would affect an investor s decision about the terms on which to deal. An example of misuse of information is where X, a director at B PLC, has lunch with a friend, Y. X tells Y that his company has received a takeover offer. Y places a fixed odds bet with a bookmaker that B PLC will be the subject of a bid within a week, based on his expectation that the takeover offer will be announced over the next few days. Manipulating transactions: this includes practices that give a false or misleading impression of the price or demand of a qualifying investment. An example of manipulating transactions type behaviour is where a trader simultaneously buys and sells the same investment (that is, trades with himself) to give the appearance of a legitimate transfer of title or risk (or both) at a price outside the normal trading range for the investment. The price of the qualifying investment is relevant to the calculation of the settlement value of an option. He does this while holding a position in the option. His purpose is to position the price of the investment at a false, misleading, abnormal or artificial level, making him a profit or avoiding a loss from the option. Manipulating devices: effecting transactions or orders to trade which employ fictitious devices or other forms of deception. An example of behaviour that amounts to manipulating devices is that of taking a short position in an investment and then disseminating misleading negative information about the investment, with a view to driving down its price. Dissemination: the dissemination of information which gives a false or misleading

20 Section 3 Market conduct and financial crime impression as to a qualifying investment by a person who knew, or could reasonably be expected to know, that the information was false or misleading. An example of this type of behaviour is where a person posts information on an internet bulletin board or chat room which contains false or misleading statements about the takeover of a company whose shares are qualifying investments, and the person knows that the information is false or misleading. Misleading behaviour and distortion: behaviour that gives a false or misleading impression of either the supply of, or demand for, an investment; or behaviour that otherwise distorts the market in an investment. An example of this behaviour is the movement of physical commodity stocks, which might create a misleading impression as to the supply of, demand for, or price or value of a commodity or the deliverable into a commodity futures contract. The FSA can ask the courts to impose a fine for insider dealing or make a statement to the effect that a person has engaged in market abuse and issue a sanction in the form of a financial penalty. Market abuse is therefore a civil offence, and does not replace or modify any existing criminal legislation. 5 UK Bribery Act 2010 The Bribery Act 2010 came into force on 1 July The Act repeals and replaces the old laws on bribery with a new comprehensive anti-bribery code. There are four offences: 1. Paying bribes. It is an offence to offer, promise or give a financial or other advantage with the intention of inducing a person to perform a relevant function or activity improperly or to reward that person for doing so. 2. Receiving bribes. It is an offence to receive, request or agree to receive a financial or other advantage intending that a relevant function or activity should be performed improperly as a result. 3. The bribery of foreign public officials. 4. Failure of commercial organisations to prevent bribery. Relevant function or activity includes any function of a public nature and any activity connected with a business. The person performing that activity must be expected to perform it in good faith or impartially or be in a position of trust. Improper performance will be judged by whether it breaches the expectation of what a reasonable person in the UK would expect in relation to the performance of the type of function or activity concerned. However, the function or activity need have no connection to the UK. The last offence is probably the most important change, as it places the onus on a company to have in place anti-bribery procedures. The most controversial offence is this 109

21 Chapter 6 The regulatory framework new offence, which can be committed only by commercial organisations (companies and partnerships). It will be committed where: A person associated with a relevant commercial organisation (which includes not only employees, but agents and external third parties) bribes another person (i.e. commits one of the offences 1 or 3 above) intending to obtain or retain a business advantage; and The organisation cannot show that it had adequate procedures in place to prevent bribes being paid. Under the old law (and under the new general offences 1 and 2), a company was likely to be guilty of a bribery offence only if very senior management were involved. Under this new corporate criminal offence, the company may be guilty even if no one within the company knew of the bribery. The company s defence is limited to showing that it had adequate procedures to prevent bribery. That effectively creates a burden on corporates to ensure that their anti-corruption procedures are sufficiently robust to stop any employees, agents or other third parties acting on the corporates behalf from committing bribery. The government has published illustrative guidance on what amounts to adequate procedures. This requires procedures to be tailored to the individual circumstances of each business based on an assessment of where the risks lie. Ultimately, it will be left to the courts to assess whether a corporate has adequate procedures in place, and it will be for the corporate body to prove that it has. Penalties The Act raises the maximum jail term for bribery by an individual from seven years to ten years. A company convicted of failing to prevent bribery could receive an unlimited fine. Chapter 6 Section 4 Complaints handling, the Financial Ombudsman Service and the Financial Services Compensation Scheme Section aims 110 By the end of this section, you should be able to: Explain the FSA rules relating to handling of complaints (DISP 1.3). Explain the role of the Financial Ombudsman Service (DISP introduction and DISP 2). Distinguish compulsory from voluntary jurisdiction (DISP introduction). Explain the procedure and time limits for the resolution of complaints (DISP 1.4, 1.5 and 1.6). Apply the rules relating to record keeping and reporting (DISP 1.9, 1.10). Apply the rules relating to determination by the Ombudsman (DISP 3).

22 Section 4 Complaints handling, the Financial Ombudsman Service and the FSCS Explain the purpose of the Financial Services Compensation Scheme (FSCS) (COMP 1.1.7). Identify the circumstances under which the FSCS will pay compensation (COMP 1.3.3, (1) & (2), & 2 (1) to (6)). Identify the limits on the compensation payable by the FSCS (COMP , 2 & 3). 1 Complaints and the Financial Ombudsman Service The FSA has established a system for the consideration of complaints against a firm by customers who feel aggrieved and entitled to seek redress. The system involves: Consideration of the complaint by the firm itself. If the customer is not satisfied and is eligible to use the Financial Ombudsman Service, independent investigation of the complaint, involving both a mediation stage and a possible subsequent determination stage by a Financial Ombudsman. A firm must have in place and operate appropriate and effective procedures for handling complaints. These procedures need to be written down, and all staff need to be made aware of them. A firm must publish its own internal complaints handling procedures. A firm receiving a complaint must, by the end of eight weeks after its receipt of the complaint, send the complainant: A final response; or A written response which: Explains why it is not in a position to make a final response and indicates when it expects to be able to provide one. Informs the complainant that he may now refer the complaint to the Financial Ombudsman Service. Encloses a copy of the Financial Ombudsman Service standard explanatory leaflet. A firm must retain records of complaints for at least five years for MiFID business and three years for other types of business. Most firms must also provide the FSA with a twice-yearly report on (among other things) the number of complaints, completions of complaints within four weeks, eight weeks and over eight weeks from receipt, and the number of complaints accepted as valid by the firm. The Financial Ombudsman Service (FOS) has two jurisdictions: Compulsory jurisdiction automatically covers firms regulated by the FSA for certain types of complaints. Voluntary jurisdiction covers firms for certain types of complaints not covered automatically by law under compulsory jurisdiction. Firms sign up to join the voluntary jurisdiction by contractual agreement with the FOS. 111

23 Chapter 6 The regulatory framework The Financial Ombudsman Service operates a scheme to facilitate the settlement of disputes between a customer and a firm where a complaint has not been resolved to the satisfaction of the complainant. The scheme can be used by a customer where a complaint has not been settled within two months. However, the complaint must be referred to the Financial Ombudsman within six years of the event complained of, or within three years of the customer knowing of the problem and within six months of the firm s final response. The Ombudsman may dismiss a complaint without considering its merits if, for example: It is satisfied that the complainant has not suffered financial loss, material inconvenience or material distress. It considers the complaint to be frivolous or vexatious. It considers that the firm has already made a reasonable offer of compensation. When the Ombudsman investigates a complaint, the firm must co-operate with the Ombudsman. When the Ombudsman considers that there is a reasonable prospect of resolving the complaint by mediation, he will attempt to negotiate such a settlement between the parties. If there is no prospect for a mediated settlement, then he will investigate the complaint. During this investigation, both parties are given the opportunity to make representations. A provisional assessment of the complaint is then made. If either party disagrees with this, the Ombudsman will then present a written statement of the determination and the reasons for this. If the complainant accepts the determination, it is binding on the firm. If the complainant rejects the determination, the firm is not bound by it. The maximum money award the Ombudsman can make is 150,000. For awards over this the firm is invited to pay the excess but is not compelled to do so. 2 Financial Services Compensation Scheme (FSCS) FSCS deals with claims against authorised firms that are insolvent or are no longer trading. Where a firm is still trading, redress must be sought through the Financial Ombudsman Service. Only certain kinds of claim are eligible for compensation. In relation to investment business, these are known as protected investment business and are defined as: Designated investment business carried on by the relevant person with the claimant or as agent on his or her behalf. The activities of the manager or trustee of an AUT, provided that the claim is made by a unit holder. The activities of the authorised corporate director (ACD) or depositary of an ICVC (e.g. an OEIC), provided that the claim is made by a share holder. A claim must be brought to the FSCS within a set time (normally within six years of the date on which the event giving rise to the claim occurred). The maximum payout for a claim against an investment firm (i.e. in relation to protected investment business) is 50,000. This limit was raised in January 2010 (from 48,000). Separate FSCS arrangements exist to protect deposit accounts at UK authorised banks and policy holders of UK authorised insurers. 112