Markets monitoring: joining the dots

FCA has been investigating UK based brokers involvement in cum/ex dividend arbitrage schemes. As it progresses its investigation the FCA has been working with regulators around the world.

The FCA investigation thus far has centred around four entities known as the Solo Group. Trading carried out by Solo involved OTC equities, securities lending, and forwards, on EU equities on or around the last cum-dividend date. Conducted in a certain way in certain jurisdictions, cum-dividend trades can create an entitlement to a tax rebate on withholding tax, even when not entitled. Solo Group has vigorously denied any wrongdoing.

The FCA’s concern has been that the scale and volume of transactions appear to be highly sophisticated financial crime. One example of the scale and volume, given by the FCA from their investigation, is that some trades represented up to 20% of the shares in Danish listed companies with volumes equating to an average of 36 times the volume of all Danish stocks. The FCA will be liaising closely with the Danish regulator, the DFSA as it progresses its investigation.

Two UK based brokers, Sapien Capital Limited and Sunrise Brokers LLP, have so far been fined £178,000 and £642,400 respectively. FCA says that the UK based brokers they investigated had inadequate systems and controls, a breach of Principle 3. This is because these two brokers did not identify the risks their clients posed to their business specifically of fraudulent trading and money laundering.

The FCA also found that the UK based brokers they have investigated were not exercising due skill, care and diligence in how they applied their financial crime control framework. This is because the brokers were not looking at the market’s activity of their clients from a fraud and financial crime perspective.

The transactions to which the FCA penalties relate were carried out in 2015. Regulatory investigations take a long time to progress and often start years after the transactions took place. Firms involved in investigations often seem surprised to find themselves having to reconstruct transactions years later, whereas FCA will expect you to have those records readily available as part of your compliance with their SYSC rules.

Brokers see a lot of market activity and the nature of their roles puts them at risk of being used by their clients for criminal activity such as market abuse, fraud, and financial crime. As a broker FCA expects you to be carrying out due diligence before you onboard new clients, and to monitor clients activity once onboarded.

The challenge is in making the connections between your anti financial crime monitoring and your markets monitoring as many of the strategies deployed in these cases are perfectly legitimate from a market abuse perspective, it's not until you apply the financial crime lens that you see the potential for fraud and money laundering.

A core part of your control framework should include an assessment of the risks of your business being used to commit either market abuse or financial crime. Make sure you are looking at suspicious orders or transactions from both market abuse as well as fraud and financial crime perspectives.

If your clients are trading equities then be sure to include cum /ex dividend trading, dividend arbitrage and withholding tax reclaim schemes in your market abuse risk assessment.

We can help you with a more detailed market abuse or financial crime risk assessment. If you think an external perspective may be useful do get in touch for a strictly confidential no obligation discussion.