By Terry Dawson, Managing Director, StarCompliance
Market abuse regulations are not as prescriptive for publicly traded companies (i.e. issuers of securities) as they are for financial advisors or financial services organisations.
The tools issuers use to protect themselves against potential incidents of non-compliance are also not at the same operational standard as financial firms – but with growing regulatory oversight, perhaps they should be.
Issuers and professional services firms, such as lawyers, accountants and auditors, will often have access to ‘inside’ or non-public information that can be exploited and, as a result, they can find themselves in situations where rules have been breached by employees. This can lead to severe repercussions for both firms and individuals. While issuers are required by regulators, such as the SEC in the US and the UK FCA, to obtain pre-clearance for employees looking to trade in stocks and shares and notify when trades are made, there is currently no explicit obligation for issuers to track employee trading activity.
For firms in financial services, monitoring employing trading activity is second nature; established over many years to ensure they meet the more prescriptive measures detailed in the rules and regulations. They therefore deploy the necessary tools and systems that help to monitor and report on employee activity, perform trade surveillance, and conduct reporting for suspicious activity. In particular, IFAs are obligated under Market Abuse Regulations to report suspicious activities to the appropriate authority (Suspicious Transaction and Order Report (STOR) in the UK and EU and Suspicious Activity Reports (SARs) in the US).
Adhering to financial regulations is so ingrained in financial services firms that employees are acutely aware of their obligations. This is not always the case in public companies or professional services firms, and IFAs must be extra careful to consider an individual’s employment status and any restrictions on their investment activities when giving financial advice.
Under European and UK market abuse regulations Persons Discharging Managerial Responsibilities (PDMRs) and any Person Closely Associated (PCAs) with them such as relatives and co-habitants, may well be under specific obligations.
This is also true under the US Securities Act. Non-compliance by PDMRs and PCAs is not always a deliberate act by bad actors; it can easily be employees of issuers and professional services firms inadvertently falling on the wrong side of Market Abuse Regulations when making personal investments.
Oversight is increasing in this area as regulators are evolving to treat issuers and professional services firms more like financial services organisations. On 12 December, the FCA doubled down on issuers needing to continue to consider their obligations under UK Market Abuse Regulation (MAR) to prevent unlawful disclosure of inside information relating to acquisitions. Similarly in the US, the SEC recently made amendments to Rule 10b5-1 to limit potential abuses of the original rule’s protections and enhance investor protections against insider trading.
Regulators are also getting better at spotting incidents of market abuse. For example, the FCA undertakes the monitoring of 30 million transaction reports and 100 million order reports from firms and venues per day, which are then vetted by its market data processor to detect potential issues. And even though financial services firms are still way ahead of issuers in terms of monitoring and detection of potential market abuse, many still fail to meet the regulatory requirements. This is highlighted by the fact that there were 72 open insider dealing cases as of 31 March 2022, according to the FCA.
At the same time, whistleblowing legislation implemented in the UK and Europe will inevitably lead to more instances of market abuse issues being reported due to the protections and incentives they afford to employees.
Levelling up compliance frameworks
With this increased scrutiny and regulatory reform (with the potential for more to come in the future), issuers and professional services firms need to not only make it a priority to continue educating their employees, but also to have tools in place that safeguard and monitor against instances of potential market abuse.
By doing so, firms will be able to better understand who has access to what non-public, confidential and insider information, and act accordingly. One way issuers can achieve this is by learning from financial services firms and by taking a similar stance to implementing the right policies and procedures.
Given the way regulators administer punitive actions, financial services firms must have in place robust compliance processes to shield themselves and their employees from potential conflicts. This is because the legislation, in cases of insider trading, puts the onus on the organisation rather than the individual for ensuring the necessary steps are taken to prevent market abuse. However, the punishment is much more likely to be levied on the individual. Usually, this is down to the fact that firms have educated their employees; reinforced what they need to report; and have the monitoring tools in place to detect the offence.
While these compliance processes can seem burdensome and intrusive for employees at issuer or professional services firms, without them it is incredibly difficult to identify market abuse quickly and efficiently – leading to gaps that, if deemed to have been exploited, could wind up into a full blown investigation.
Legislators and regulators say that issuers and advisors must have ‘sufficient’ technical and organisational measures in place to guard against market abuse. And today, most issuers interpret ‘sufficient’ as regular training and signed promises from employees not to break the rules. But how long will it be before that is no longer seen as sufficient?
Forward-looking issuers can protect themselves and their employees more effectively by adopting some of the tools and techniques that financial services firms have in place. This will ultimately be beneficial for all parties involved – employees, organisations, and the authorities – while increasing market integrity and protecting all investors.