18 November 2019 - Post by:
In its latest Market Watch newsletter, the FCA has reported on the ‘varied’ quality of firms’ personal account dealing (PAD) controls and set out points that it says all firms should consider when reviewing their PAD controls.
The requirement for firms to have PAD controls
The FCA requires firms to establish adequate PAD controls in order to minimise the risk that PAD conflicts with the interests of firms’ clients, results in market abuse (e.g. through front-running client orders) or creates a conflict between an employee’s personal interests and their regulatory obligation to escalate suspicious transactions and orders (FCA Handbook, COBS 11.7 and 11.7A).
FCA review of firms’ PAD controls
The FCA noted how ‘concerned’ it is by the number of apparent breaches of firms’ PAD policies that come to its attention, usually as a result of issues that come to light as a result of trading that has been undertaken by employees in breach of these policies. In particular, the FCA has identified the following concerns through its work in this area:
- The FCA has found that employees in front office roles sometimes do not appear to understand their firm’s PAD policy, despite having signed attestations which confirm that they have read, understood and complied with that policy.
- The FCA has identified instances where employees (including in front office, compliance and surveillance roles) have ‘deliberately not declar[ed] external accounts to their employer’ or have been found to have circumvented their firms’ PAD controls. For example, the FCA has identified instances where employees have executed trades through undeclared PAD accounts that are held in the names of relatives.
- Some firms and employees have given the FCA the impression that they think that ‘ignorance of PAD policies provides reasonable mitigation for PAD in breach of that policy’.
- The FCA has identified instances where employees have traded in breach of their firms’ PAD policies by, for example, trading in prohibited products (e.g. spread bets on their firms’ own shares), trading in a way which conflicts with their professional decisions and recommendations (e.g. analysts trading against their own recommendations or fund managers buying securities they have advised their funds to sell), following client orders and front-running client orders.
The FCA has also reported that it is ‘not evident’ that some firms are taking appropriate action to identify, investigate and, if appropriate, report suspicious PAD by their employees. The FCA has also commented that these firms do not seem to be considering how to mitigate the PAD risks associated with those employees and/or taking appropriate disciplinary action against employees who are found to have breached their PAD policies.
Specific findings from review of wholesale broking firms
The FCA reported that it has recently undertaken a review of PAD controls at a sample of wholesale broking firms. The FCA stated that the way in which these firms controlled and monitored PAD ‘varied considerably’ and expressed concerns that ‘some firms may not have established appropriate PAD rules and processes in line with’ its requirements.
- Even though many firms require employees to sign regular PAD attestations, the FCA found that some firms did not seek to monitor or control PAD that may be in breach of their internal requirements.
- Some wholesale broking firms reported very high volumes of PAD, with some employees trading several times per day (which the FCA described as ‘extreme’). The FCA noted that some firms apply limits on the number of PAD trades that employees can place per day, in order to reduce the risk that frequent PAD by employees could impede their ability to carry out their function and to serve their clients’ best interests.
- Other wholesale broking firms reported very low volumes of PAD. The FCA speculated that ‘low PAD volumes may indicate that not all trades are being reported by employees’.
The FCA also noted the ‘low’ number of PAD breaches that had been identified by the wholesale broking firms that it reviewed and also highlighted that, unlike other types of firms, none of these firms had submitted any Suspicious Transaction and Order Reports to the FCA to report suspicious PAD by employees.
Food for thought for all firms
Although the FCA singled out wholesale broking firms for feedback, the FCA’s comments about PAD controls are of broader relevance to regulated firms. With this in mind, the FCA has urged all firms to consider these comments and, in particular, give thought to:
- How they manage conflicts of interest and the risk of market abuse;
- How they inform and effectively train employees about their PAD requirements;
- How they monitor PAD by employees; and
- How they respond to PAD-related issues that arise, including considering whether they need to revise their PAD controls.
The FCA also reminded firms that, depending on the severity of a breach of their PAD requirements, such a breach may need to be notified to the FCA under Principle 11 of the FCA’s Principles for Businesses.
In the event that an employee is found to have failed to comply with their firm’s PAD requirements, their firm may need to consider whether they have breached any applicable regulatory requirements, as well as considering whether it may be appropriate to take disciplinary action against them. For example, a firm may need to consider whether an employee remains fit and proper to perform their role, as well as whether they have breached Individual Conduct Rules 1, 2 and/or 5 which require employees to act with integrity, with due skill, care and diligence and in accordance with proper standards of market conduct. The FCA’s non-exhaustive list of examples of conduct which may breach Individual Conduct 1 and/or 2 includes an employee’s failure to disclose PAD in accordance with their firm’s PAD requirements.