Winterflood Securities Ltd & Ors v The Financial Services Authority

This is an appeal against a decision of the Financial Services and Markets Tribunal determining two preliminary issues in consolidated references relating to the appellants’ involvement in the trading of shares in a company called Fundamental-E Investments plc (“FEI”) on the Alternative Investment Market (“AIM”) between August 2003 and July 2004. The circumstances which gave rise to the references are not in dispute and I shall therefore describe them as shortly as I can. The following summary is taken from the findings made by the Tribunal.

The first appellant, Winterflood Securities plc (“Winterflood”) is a London-based market-maker specialising in smaller company securities, which provided a market-making service in the shares of FEI which were traded on AIM. At the material times, the second and third appellants, Mr Sotiriou and Mr Robins, were market-makers employed by Winterflood and were responsible for its market-making activities in relation to FEI.

In May 2003 85% of the issued share capital of FEI was owned by the original two shareholders and there was little or no market demand for FEI shares. However, at about that time Mr. Simon Eagle, who was seeking to secure control of an AIM shell company as an investment vehicle, identified FEI as suitable for his purpose. He therefore agreed with the original shareholders to make arrangements to enable them to sell their shares and in July 2003 he entered into an arrangement with Winterflood under which Winterflood would purchase their shares and he would arrange for there to be purchasers of those shares from Winterflood. Mr Eagle then embarked on a share ramping scheme, the effect of which was to inflate the price of FEI shares from around 2.5p on 20^th May 2003 to 4.13p at the end of December 2003, reaching a high point of 11.75p on 5^th July 2004.

The key elements of the scheme were as follows:

The rollover scheme required the involvement of a market-maker. Winterflood executed most of the rollover trades entered into on behalf of the Eagle clients and all of the delayed rollover trades. The number of such trades was extremely high: 30 rollovers in the course of the initial sale of shares between 24^th September and 31^st December 2003; 239 rollovers between January and July 2004; and 27 delayed rollovers between 5^th January and 18^th March 2004.

Accordingly, the involvement of Winterflood, Mr. Sotiriou and Mr. Robins was critical to the success of the share ramping scheme. Between August and December 2003 Winterflood sold all the 140 million FEI shares owned by the original shareholders, of which over 80% were sold to SP Bell and less than 5% were sold in the course of its normal market-making business. Moreover, its involvement in the transactions enabled Mr. Eagle to mask the full extent of his financial interest, in particular the significant commission he stood to earn from the vendors, from the employees and clients of SP Bell and the market generally.

The relationship between Mr. Eagle and Winterflood, and between Mr. Eagle and Mr. Sotiriou in particular, was unusually close. There was obvious and frequent pre-arranging of trades, whereby Winterflood traders spoke first to Mr. Eagle on an untaped line and then conducted the trade with SP Bell on a taped line, and SP Bell brokers were instructed by Mr. Eagle to deal only with Winterflood when trading FEI shares. The level of communication on untaped lines between Mr. Eagle and Mr. Sotiriou was unusually high.

The share ramping scheme had the effect of misleading the market as to the supply, price or value of and demand for FEI shares and of distorting the market in those shares. It caused the FEI share price to be positioned at an artificially high level and resulted in an almost five-fold increase between May 2003 and July 2004. On 15^th July 2004 the share price fell sharply from 11.75p to 7.5p as a result of sustained selling. The London Stock Exchange temporarily suspended trading in FEI shares, because it was of the view that the market was disorderly, which caused the unsettled positions in FEI shares at SP Bell to crystallise. Neither the clients of SP Bell nor SP Bell itself had sufficient funds to settle the resulting debt of over £9 million. On 23^rd July 2004 SP Bell ceased trading and was put into administration. Trading in FEI resumed the same day; the price of FEI shares fell to 4p by the close of business and continued to fall steadily thereafter.

The Financial Services Authority (“FSA”) considered that the involvement of Winterflood, Mr. Sotiriou and Mr. Robins in the FEI share ramping scheme amounted to market abuse within the meaning of section 118 of the Financial Services and Markets Act 2000 (“the Act”) because their behaviour in executing rollover trades and consistently selling FEI shares to SP Bell was likely to give a regular user of the market a false or misleading impression as to the supply of, and demand for, FEI shares, would be regarded by a regular user of the market as likely to distort the market in those shares and fell short of the standard of behaviour reasonably expected of persons in their position. Having complied with the appropriate procedure, the Regulatory Decisions Committee of the FSA issued decision notices finding that all three appellants had engaged in market abuse and imposed financial penalties of £4 million on Winterflood, £200,000 on Mr. Sotiriou and £75,000 (reduced to £50,000 on the grounds of personal financial circumstances) on Mr. Robins.

Each of the appellants sought to challenge the decision and the matter was referred to the Tribunal. One of the grounds relied on by the appellants in each case was that, in the light of the Code of Market Conduct (“the Code”) published by the FSA pursuant to section 119 of the Act, a person cannot commit market abuse by entering into artificial transactions or price positioning unless he has an actuating purpose to mislead or distort the market. (“Actuating purpose” is defined in the FSA Handbook as a purpose which motivates or incites a person to act.) The FSA accepted that it could not establish the existence of any actuating purpose in this case and the appellants accepted that if an actuating purpose was not required, they would not pursue the reference. Accordingly, since the issue would be determinative of the appeal, the Tribunal directed that it be determined as a preliminary issue. Having heard argument it held that no actuating purpose to mislead or distort the market is necessary in order to commit market abuse in the manner alleged and dismissed the references. It is against that decision that the present appeal is brought.

Both the statutory provisions and the Code have been significantly amended since the proceedings before the Tribunal. For convenience, however, I shall refer to them as if they were still in force in the form which they then took.

Section 118 of the Act provides (so far as material for present purposes) as follows:

“118.— Market abuse

(1)

For the purposes of this Act, market abuse is behaviour (whether by one person alone or by two or more persons jointly or in concert)—

(a)

which occurs in relation to qualifying investments traded on a market to which this section applies;

(b)

which satisfies any one or more of the conditions set out in subsection (2); and

(c)

which is likely to be regarded by a regular user of that market who is aware of the behaviour as a failure on the part of the person or persons concerned to observe the standard of behaviour reasonably expected of a person in his or their position in relation to the market.

(2)

The conditions are that—

(a)

the behaviour is based on information which is not generally available to those using the market but which, if available to a regular user of the market, would or would be likely to be regarded by him as relevant when deciding the terms on which transactions in investments of the kind in question should be effected;

(b)

the behaviour is likely to give a regular user of the market a false or misleading impression as to the supply of, or demand for, or as to the price or value of, investments of the kind in question;

(c)

a regular user of the market would, or would be likely to, regard the behaviour as behaviour which would, or would be likely to, distort the market in investments of the kind in question.”

Section 119 relates to the Code. It provides (so far as material) as follows:

“119.— The code.

(1)

TheAuthority must prepare and issue a code containing such provisions as the Authority considers will give appropriate guidance to those determining whether or not behaviour amounts to market abuse.

(2)

The code may among other things specify—

(a)

descriptions of behaviour that, in the opinion of the Authority, amount to market abuse;

(b)

descriptions of behaviour that, in the opinion of the Authority, do not amount to market abuse;

(c)

factors that, in the opinion of the Authority, are to be taken into account in determining whether or not behaviour amounts to market abuse.

. . . ”

The effect of the Code is dealt with in section 122, which provides as follows:

“122.— Effect of the code.

(1)

If a person behaves in a way which is described (in the code in force under section 119 at the time of the behaviour) as behaviour that, in the Authority's opinion, does not amount to market abuse that behaviour of his is to be taken, for the purposes of this Act, as not amounting to market abuse.

(2)

Otherwise, the code in force under section 119 at the time when particular behaviour occurs may be relied on so far as it indicates whether or not that behaviour should be taken to amount to market abuse.”

The Code contains four kinds of provisions that are relevant for present purposes: (a) those which describe behaviour which, in the opinion of the FSA, does not amount to market abuse; (b) those which describe behaviour which in the opinion of the FSA does amount to market abuse; (c) those which identify factors that in the opinion of the FSA are to be taken into account in determining whether behaviour amounts to market abuse; and (d) those which contain guidance which is not binding and does not have evidential effect. Provisions of type (a) are binding by virtue of section 122(1) and can be relied upon in the knowledge that such behaviour does not constitute market abuse. They are known as “safe harbours” and are identified by the designation “C”. Provisions of types (b) and (c) are evidential in nature. They reflect the opinion of the FSA and may be taken into account when deciding whether behaviour constitutes market abuse. They are identified by the designation “E”. As indicated, provisions of type (d) contain guidance only. They are identified by the designation “G”.

This appeal is concerned primarily with three parts of the Code: the “regular user” test, artificial transactions and price positioning.

The regular user test is established by section 118 of the Act. A regular user is defined in relation to a particular market as a reasonable person who regularly deals on that market in investments of the kind in question. His estimation of the standard of behaviour reasonably to be expected in the particular market is the essential yardstick and a failure to meet that standard is the criterion of abuse. Section 1.2 of the Code contains provisions relating to the regular user. MAR 1.2.5E draws attention to the fact that the definition of market abuse in section 118 does not require the person engaging in the behaviour in question to have intended to abuse the market and accordingly that it is not essential for such an intention or purpose to be present for behaviour to fall below the objective standards expected. It continues:

“However, in some circumstances the determination of whether behaviour falls short of those standards will depend on the purpose of the person in question (for example, MAR 1.6.4E). In those circumstances, the regular user is likely to consider the purpose of the person in question in addition to the other relevant considerations listed at MAR 1.2.3E. This need not be the sole purpose but should be an actuating purpose.”

Artificial transactions

Artificial transactions fall within Section 1.5 of the Code which deals generally with behaviour which creates a false or misleading impression. Two provisions which lie at the heart of this appeal are MAR 1.5.8E and MAR 1.5.9E.

MAR 1.5.8E provides as follows:

“Behaviour will constitute market abuse where:

(1)

a person enters into a transaction or series of transactions in a qualifying investment or relevant product; and

(2)

the principal effect of the transaction or transactions will be, or will be likely to be, to inflate, maintain or depress the apparent supply of, or the apparent demand for, or the apparent price or value of a qualifying investment or relevant product so that a false or misleading impression is likely to be given to the regular user; and

(3)

the person knows, or could reasonably be expected to know, that the principal effect of the transaction or transactions on the market will be, or will be likely to be, as set out at MAR 1.5.8E(2);

unless the regular user would regard:

(4)

the principal rationale for the transaction in question as a legitimate commercial rationale; and

(5)

the way in which the transaction is to be executed as proper.”

MAR 1.5.9E provides as follows:

“A transaction which creates a false or misleading impression will not normally be considered to have a legitimate commercial rationale where the purpose behind the transaction was to induce others to trade in, or to position or to move the price of, a qualifying investment or relevant product. This need not be the sole purpose for entering into the transaction or transactions, but must be an actuating purpose. Equally, transactions will not automatically be considered to have a legitimate commercial rationale simply because the purpose behind the transaction was to make a profit or avoid a loss (whether directly or indirectly).”

Price positioning

Price positioning is covered in Section 1.6 which deals with market distortion. MAR 1.6.9E and MAR 1.6.10E are of particular importance. MAR 1.6.9E provides as follows:

“Behaviour will constitute market abuse where a person enters into a transaction, or series of transactions, with the purpose of positioning the price of a qualifying investment or relevant product at a distorted level (the purpose need not be the sole purpose for entering into the transaction or transactions, but must be an actuating purpose).”

The relevant part of MAR 1.6.10E provides as follows:

“It follows that behaviour which incorporates a purpose of positioning the price at a distorted level cannot have a legitimate rationale. . . . trading significant volumes with the purpose of controlling the price of a qualifying investment or a relevant product and positioning it at a distorted level will amount to market abuse.”

Submissions

Mr. Flint Q.C. submitted that not only is the Code intended to provide clear guidance about what does and does not amount to market abuse, but that by virtue of section 122(2) of the Act market users are entitled to rely on it so far as it indicates whether or not any particular behaviour should be taken to amount to market abuse. It follows that if the Code specifically identifies behaviour which does amount to market abuse, market users are entitled to rely on it to the extent that it indicates that behaviour not falling within that description does not amount to market abuse. Moreover, MAR 1.2.5E is to be understood as meaning that some types of behaviour will not fall short of the standards to be expected if the person concerned was not motivated by an improper purpose and provides an important part of the context in which those paragraphs which refer to actuating purpose are to be construed. Accordingly, he submitted that the passage in MAR 1.6.9E which identifies entering into a transaction with the purpose of positioning the price of a qualifying investment at a distorted level as market abuse necessarily means that there is no abuse if the transaction is entered into without any such purpose. Similarly, he submitted that the passage in MAR 1.5.8E, which provides that it is a market abuse to enter into a transaction with the purpose of positioning the price of a qualifying investment, necessarily means that to do so without any such purpose does not constitute market abuse. Finally, he submitted that any doubt must be resolved in favour of the appellants, since the regime is penal in nature.

By contrast, Mr. Thanki Q.C. pointed to the fact that the essential principles of market abuse are to be found in section 118 of the Act to which the Code is ancillary. Save as is provided in section 122(1), the Code merely expresses the opinion of the FSA and is not binding. Moreover, he submitted that MAR 1.5.8E and MAR 1.6.9E, in common with other provisions of a similar kind, are intended to direct the attention of market users to what is considered to be market abuse, rather than to what is not.

In my view Mr. Thanki was right in saying that one must start with the Act itself. Section 118 defines market abuse in terms of behaviour which is either likely to have a certain effect (the creation of a false or misleading impression) or which would be regarded by a regular user as likely to have a certain effect (distortion of the market). As such the test is wholly objective; it does not require any particular state of mind on the part of the person whose behaviour is under consideration. However, Mr. Flint is right in saying that section 118 of the Act forms only one part of a regulatory regime which includes sections 119 and 122 and the Code itself. The Code is an integral part of the regime. In so far as it describes behaviour which, in the FSA’s opinion, does not amount to market abuse, that is conclusive. However, section 122(2) also provides that the Code may be relied on in so far as it indicates whether behaviour of a certain kind does or does not amount to market abuse. In principle it is possible that the identification of a particular kind of behaviour as constituting market abuse could amount to a statement that, in the absence of one or more constituent elements, there would be no market abuse. However, that would be the case only if there was a true dichotomy, so that it followed as a necessary and inevitable conclusion.

In essence, Mr. Flint’s submission was that such a conclusion is necessary and inevitable in the case of each of the substantive paragraphs of the Code with which this appeal is concerned. He said that the identification of what constitutes market abuse in MAR 1.5.8E and MAR 1.6.9E is inherently exhaustive, or at any rate is meant to be understood as exhaustive, and so excludes any other kind of behaviour. Such an argument is easier to advance in relation to MAR 1.6.9E, because a simple statement that “behaviour will constitute market abuse where a person enters into a transaction with the purpose of positioning the price of a qualifying investment at a distorted level” is capable in the right context of meaning that such behaviour alone will constitute such an abuse. (There is greater difficulty in reading MAR 1.5.8E in the same way, as I shall explain in a moment.) However, whether that is the right way in which to read that paragraph of the Code depends on wider considerations, in particular the function which it is seeking to fulfil.

Nonetheless, that still leaves open the effect of section 122(2), in particular what is meant by the words “may be relied on”. Mr. Flint’s submission amounted to saying that any identification in the Code, even by implication, of behaviour that does not constitute market abuse is to be regarded as conclusive, in the same way that an express description is rendered conclusive by section 122(1). However, I find that difficult to accept. Section 122(1) gives the FSA the power through the Code to determine that certain kinds of behaviour do not constitute market abuse and where it has done so it has made that clear, both in express terms and by the use of the designation “C”. Section 122(2), by contrast, merely provides that “otherwise” the Code may be relied on in so far as it indicates whether or not behaviour should be taken to amount to market abuse. Thus, the section creates a clear distinction between the two cases: one is specific and conclusive; the other is general and provides simply that it may be relied on for evidential purposes, both by market users and the FSA itself. That distinction is reflected in the Code itself by means of the “C” and “E” designations. The safe harbour provisions are all identified in MAR 1.1.10G. It would be surprising if the FSA had intended through the medium of the Code to provide other safe harbours by implication and without identifying them as such. In any event, I do not think that it has power to do so. Section 122(1) refers to behaviour that is described in the Code and is stated not to amount to market abuse. Section 122(2) does not have the same effect in relation to other kinds of behaviour, whether expressly described or identified only by implication, however persuasive in evidential terms the Code may be in relation to them.

Mr. Flint submitted that the reference in section 118(2)(c) to what a regular user would regard as behaviour likely to distort the market inevitably opens up the question of purpose because it is a factor which such a person would or might consider relevant in deciding whether the person said to have committed market abuse had failed to observe the standard of behaviour reasonably to be expected of him, as is required by subsection (1)(c). That may be right, but I do not think it takes the matter any farther. In particular, it does not mean that the FSA has purported to, or has power to, provide safe harbours otherwise than by describing expressly behaviour that does not constitute abuse. In my view an examination of MAR 1.5.8E, MAR 1.5.9E and MAR 1.6.9E shows that it has not sought to do so.

MAR 1.5.8E and MAR 1.5.9E are structured in a very careful way. MAR 1.5.8E begins by describing in sub-paragraphs (1) to (3) certain behaviour that will normally constitute market abuse. It then provides a qualification on that position in sub-paragraphs (4) and (5) by reference to legitimate commercial rationale. MAR 1.5.9E then creates one specific exception upon the exception by describing circumstances in which a transaction will not normally be regarded as having a legitimate commercial rationale. Mr. Flint submitted that there was a stark dichotomy between a transaction which has a legitimate commercial rationale and one which has an improper actuating purpose, but that is not how these paragraphs are constructed. It is, it seems to me, possible for a properly executed transaction to create a false impression to the knowledge of the person entering into it (sub-paragraphs (1)-(3)) in circumstances where the regular market user would not think that it had a legitimate commercial rationale (sub-paragraph (4) and (5)) for some reason other than an improper actuating purpose of the kind described in MAR 1.5.9E. I am unable to accept, therefore, that these provisions contain an implicit statement that where no actuating purpose is present there can be no market abuse. If that is what the FSA had intended to say, it could easily have done so by altering the wording of MAR 1.5.9E to read:

“A transaction which creates a false or misleading impression, but which has a legitimate commercial rationale, will not be considered to constitute an abuse unless the purpose behind the transaction etc. . . . ”

Much the same may be said of MAR 1.6.9E. Mr. Flint drew our attention to MAR 1.6.4E, which deals in general terms with the test for distortion, of which price positioning is an example. It provides, so far as material, as follows:

“In order to fall within the distortion test:

(1)

the behaviour must be such that a regular user would, or would be likely to, regard it as behaviour which would, or would be likely to, distort the market in the investment in question. Behaviour will amount to market abuse if the behaviour engaged in interferes with the proper operation of market forces with the purpose of positioning prices at a distorted level.”

He submitted that it formed an important part of the context in which MAR 1.6.9E was to be construed and indicated that in the absence of an actuating purpose entering into a transaction which affects the price of an investment will not amount to market abuse.

I have already referred to the terms of MAR 1.6.9E. The FSA does not appear to have thought that it was creating a safe harbour, since it did not use the designation “C” in relation to that paragraph. Nonetheless, Mr. Flint submitted that it was intended to stand as an all-embracing statement of what constitutes abuse in terms of price positioning and that therefore it is to be understood as containing a positive statement that a person who enters into a transaction or series of transactions in relation to a particular investment which has the effect of positioning the price at a distorted level does not commit market abuse if his purpose is anything other than that of distorting the market. In my view, however, that is not how the paragraph is to be read. If that had been the FSA’s intention, it could easily have achieved it, as Mr. Flint accepted, by altering the language slightly so that it read:

“Behaviour will constitute market abuse only where a person enters into a transaction, or series of transactions, with the purpose of positioning the price etc. . . .”

A similar addition could easily have been made to MAR 1.6.4E.

In fact, I think it is clear that the FSA’s intention was not to make a statement of that kind, but was simply to identify one specific type of conduct that constitutes market abuse, without implying that others do not. Mr. Flint drew our attention to MAR 1.1.11G, which (reflecting section 122(2) of the Act) states that:

“. . . some of the provisions of the Code identified by the letter “E” may be relied upon so far as they describe behaviour which, in the opinion of the FSA, amounts to market abuse.”

but I do not think that it advances his case. The purpose of the evidential (“E”) provisions is to provide those who use the market and those who are responsible for maintaining market discipline (principally the Regulatory Decisions Committee) with principles that, although not definitive, can be regarded as having persuasive authority. To that extent they can be relied on, but that does not touch the question whether they are to be read as permitting by implication any conduct not specifically identified in that way.

For these reasons I do not think that the provisions of the Code on which the appellants rely are to be read as restricting market abuse of a kind which creates a false impression or distorts the market to cases in which the transaction was motivated, at least in part, by an intention to achieve either of those results. In my view this is not a case in which there is any serious doubt about the meaning or effect of the Code. Nor do I think, despite Mr. Flint’s submissions, that the regulatory regime which has been introduced by the Act and the Code offends against the principle of legal certainty, once it is appreciated that the provisions of the Code, other than those falling within section 122(1) of the Act, are intended to have no more than evidential effect.

For all these reasons I would dismiss the appeal.

I agree.

I also agree.