UK Upper Tribunal upholds FCA’s decision on penalty targeting Linear Investment Services

Andrew Bartlett QC, Judge of the Upper Tribunal, has earlier today issued a written decision in a case involving the Financial Conduct Authority (FCA) and Linear Investments Limited, an FCA-authorised firm offering brokerage services.

In this case, Linear Investments Limited appeals against the amount of a penalty decided upon by the FCA for breach of Principle 3 of the Principles for Businesses. The breach comprised a failure to take reasonable care to organise and control its affairs responsibly and effectively with adequate risk management systems in relation to the detection and reporting of potential instances of market abuse between January 14, 2013 and August 9, 2015. The penalty at the heart of the dispute is £409,300.

Back in November 2017, the FCA and Linear made a Focused Resolution Agreement (FRA).

The FCA’s penalty policy explains that where the Authority has entered into an FRA it will apply a 30% reduction to the penalty that would otherwise be imposed if, as here, the agreement is concluded during “Stage 1”. A 30% reduction has therefore been applied regarding Linear.

In its decision notice, the FCA says that up until November 2014 Linear operated on the basis that it could rely upon post-trade surveillance undertaken by underlying brokers to discharge its regulatory obligations. This was incorrect. Regardless of post-trade surveillance checks being undertaken by underlying brokers, Linear was also responsible for undertaking its own checks using information available to it. Linear was at all times responsible for ensuring that it had effective post-trade surveillance systems in place to enable it to detect and report potential instances of market abuse. Later in the Relevant Period, as a result of discussions with a broker in November 2014, Linear became aware of the need to conduct its own post-trade surveillance. Only after this did Linear take steps to source and install an automated post-trade surveillance system.

There was a further period of time after deployment of the system on May 11, 2015 before Linear had appropriately calibrated and tested the system so that it was operating effectively relative to the nature of its business. This included periods of time during which Linear had to disable alerts on the automated system in relation to spoofing and insider dealing, because the system had not been appropriately and correctly calibrated. When the firm disabled these alerts it did not have suitable alternative surveillance in place. This rendered it incapable of effectively detecting spooling and insider dealing whilst the alerts were disabled.

According to the FCA, during the Relevant Period Linear failed to take reasonable care to ensure that it could effectively conduct market abuse surveillance, which increased the risk that potentially suspicious trading would go undetected.

Although the draft Warning Notice included in the FRA proposed a penalty of £649,713 (to be reduced to £454,700 by the 30% discount), in the Decision Notice the FCA assessed a penalty of £584,700, which by application of the discount was reduced to £409,300.

Linear’s skeleton argument states that the grounds reflect three basic points: that Linear’s conduct was not as serious as the Authority contends; that there were mitigating circumstances which were initially ignored altogether by the Authority and subsequently given insufficient weight; and that the financial penalty is wholly disproportionate. The Applicant’s case can therefore be summarised as being concerned with (1) seriousness, (2) mitigation, and (3) the overall result.

Linear’s reference notice contends that it is not appropriate in this case to use revenue as a yardstick, because it is not proportional to the risk. But the Tribunal saw no merit in this argument. Revenue reflects both the number of transactions and their size. As a broad starting point, the level of risk involved in a particular kind of business is likely to be proportional to the volume of business, other things being equal.

Regarding the seriousness of the breach, the Judge notes that Linear’s core business involved obtaining access to the market on behalf of clients so that they could participate in the market. He said that market abuse is a serious matter. To advance the regulatory objective of preventing or detecting market abuse, Linear needed to have in place a proper system of surveillance of its execution business.

In addition, the Judge stressed that multiple reminders of the importance of such a system were issued by the Authority or its predecessor the FSA. Linear failed to implement such a system from January 2013 to May 2015. In this period there were tens of thousands of trades per month. The limited manual oversight of transactions which took place was wholly inadequate. Linear had no other system of its own. Instead of fulfilling its surveillance duty, it left it to others to monitor the transactions, in particular Linear’s broker.

Linear’s second submission on proportionality is that the financial penalty, as set in the Decision Notice, amounts to 30% of net profit. This is said to be too much.

The Tribunal has considered this argument in the context of the Tribunal’s findings and concludes that is not a persuasive argument. Given that market abuse is a serious matter, the implementation of effective monitoring measures to prevent or detect it is similarly a serious matter.

“No doubt the size of the penalty is painful to Linear, given its financial resources and level of profits. The Tribunal does not consider this to be inappropriate in the circumstances of the case”.