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Legal and Conduct Risk in the Financial Markets, 3rd Edition by McCormick, Roger; Stears, Chris (22nd March 2018)

Part VIII Examples of Legal Risk, 27 Vague Laws

Roger Mccormick, Chris Stears

From: Legal and Conduct Risk in the Financial Markets (3rd Edition)

Roger McCormick, Chris Stears

Subject(s):
Financial regulation

(p. 485) 27  Vague Laws

… the courts will ordinarily construe general words in a statute, although literally capable of having some startling or unreasonable consequence, such as overriding fundamental human rights, as not having been intended to do so.1

Parliamentary sovereignty means that Parliament can, if it chooses, legislate contrary to fundamental principles of human rights. The Human Rights Act 1998 will not detract from this power. The constraints upon its exercise by Parliament are ultimately political, not legal. But the principle of legality means that Parliament must squarely confront what it is doing and accept the political cost. Fundamental rights cannot be overridden by general or ambiguous words. This is because there is too great a risk that the full implications of their unqualified meaning may have been missed in the democratic process.2

A.  Over-ambitious Legislation

27.01  President George W Bush of the US was apparently of the view that it is possible to pass laws that ‘guarantee honesty’ in the financial markets and the boardrooms of companies.3 In the UK, we have not perhaps gone that far in our ambitions, but we do tend to pass laws with ambitious titles, that suggest they can, for example, ‘prevent’ fraud or terrorism.4 Why not, if this works, simply pass a law ‘preventing’ (p. 486) murder, maiming, or theft? The truth of the matter is, of course, that no amount of legislation will ever eradicate bad behaviour simply by making it an offence. Over time, legislation may have an influence on moral perceptions in society (eg, the laws against certain kinds of racialist activity, introduced in the UK in the 1960s) and that, in turn, may affect the way a substantial number of people behave. But you cannot stop someone from behaving badly simply by passing a law against what he is doing. (In all likelihood, he is probably breaking an existing law already.) Ultimately, the enforcement of acceptable behavioural standards is a matter for the executive and the judiciary, not the legislature.5 And society will generally demand that the executive’s powers are properly controlled and exercised in accordance with law and that the judiciary imposes, and observes, certain basic norms that recognize the right to a fair trial. Keeping this ‘balance’, to ensure that those accused of crimes are treated fairly, can at times seem inconvenient to the executive, and it may well have the result that not as many wrongdoers are punished as is desirable, but we lose this balance at our peril.

27.02  The danger with over-ambitious legislation is that it tends to be oppressive. One could, for example, probably achieve a reduction in some crime figures by imposing a curfew on the entire population from dusk until dawn. One could extend the executive’s powers of detention without trial. The social price, however, would be too high. Nevertheless, the political imperative to combat serious crimes such as drug trafficking and terrorism is very strong (and since the terrorist incidents in the US on 11 September 2001 has become even stronger than before). This has had the result that, in recent years, lawmakers have resorted to more extreme forms of legislation in an effort to catch serious criminals. The new legislation tends to require those who may know, or suspect, that something untoward is going on, especially in relation to the financial proceeds of crime, to take responsibility for bringing it to the attention of the executive. Thus the ‘primary’ offences of, say, insider dealing or drug-trafficking are now joined by new laws requiring those who know about transactions involving the proceeds of the primary offence (or suspect it, or have enough information that they should reasonably suspect it) to inform the relevant authorities, on pain of committing a criminal offence themselves if they fail to do so. Such laws have a particular impact on banks and the providers of financial services because in their ordinary line of business they are likely to come into possession of information about financial transactions and money transfers generally that may point to ‘something suspicious’.6 They also lead to a series of practical difficulties, for example:

(p. 487)

  1. (1)  Which crimes should be the subject of such reporting requirements?

  2. (2)  Should it matter if the ‘crime’ is not in fact a crime in the country where the event takes place, even though it would be a crime if committed in the UK?

  3. (3)  What if the event or crime took place a long time before the relevant information came to the attention of the potential informer?

  4. (4)  Is it practical to expect potential informers to have enough knowledge of the law in all relevant countries to be capable of anything other than identifying the most obvious signs of activity that is widely accepted in most societies as criminal?

  5. (5)  Is it fair to impose a test that is more severe than actual knowledge or actual suspicion of a crime (eg, requiring reporting because an individual ‘should reasonably have been suspicious’)?

  6. (6)  How can the authorities cope with banks and others who, erring on the side of caution, report transactions to an excessive degree?

  7. (7)  If employees of banks are to be put under greater duties than others, what should the duties of the ‘ordinary citizen’ be?

  8. (8)  Should lawyers, who come into possession of information in circumstances that are arguably unique to them because of their role in society, be put under the same obligations to inform as everyone else?

B.  The Proceeds of Crime Act 2002

27.03  The legislation in the UK which has illustrated these difficulties most fully is the Proceeds of Crime Act 2002 (POCA 2002), particularly Part 7 of the Act (which is concerned with ‘Money Laundering’ and is the implementation of EU directives on the subject).7 This law was the subject of criticism by the Financial Markets Law Committee (FMLC) as giving rise to legal uncertainty, especially with regard to ‘in what circumstances conduct outside England and Wales is criminal within the meaning of POCA’.8 This uncertainty, in turn, leaves banks (p. 488) and many other businesses in ‘the regulated sector’9 unclear as to ‘who has to be reported to the UK authorities as a suspected money-launderer and which transactions need consent’. The 2002 Act, which has been amended several times, has been controversial from the outset and has given rise to litigation, going as far as the Court of Appeal,10 on difficult issues of interpretation arising under section 328, which applies to everyone, not just the regulated sector, and provides (in its first two subsections)11 that:

  1. (1)  A person commits an offence if he enters into or becomes concerned in an arrangement which he knows or suspects facilitates (by whatever means) the acquisition, retention, use or control of criminal property by or on behalf of another person.

  2. (2)  But a person does not commit such an offence if—

    1. (a)  he makes an authorised disclosure12 under section 338 and (if the disclosure is made before he does the act mentioned in subsection (1)) he has the appropriate consent;

    2. (b)  he intended to make the disclosure but had a reasonable excuse for not doing so;

    3. (c)  the act he does is done in carrying out a function he has relating to the enforcement of any provision of this Act or of any other enactment relating to criminal conduct or benefit from criminal conduct.

27.04  There are other, more onerous provisions creating new offences that are specific to the regulated sector alone, considered further below. As regards section 328, the Court of Appeal’s decision in Bowman v Fels concerned what the court itself described as:

… an issue of public law of very great importance which is causing very great difficulties in solicitors’ offices and barristers’ chambers and in the orderly conduct of litigation through the country. … Since the Act came into force lawyers have become concerned that this section may mean that they themselves are exposed to the threat of criminal sanctions if they do not make ‘an authorised disclosure’ of any information which leads them to know or suspect their client—or some other person, often the opposing party in family proceedings—is involved in the acquisition, retention, use or control of property derived from criminal conduct, however (p. 489) minor. They then feel obliged to wait for ‘the appropriate consent’ before they take any further steps for their client.13

27.05  Although the issue raised in Bowman v Fels (considered in more detail below) is, at first sight, of more importance to lawyers than to banks,14 the case illustrates the difficulties that vague, ‘catch-all’ drafting can cause. In any event, the issues raised by the case have implications that extend beyond the legal profession. The ambit of the words ‘enters into or becomes concerned in an arrangement which he knows or suspects facilitates (by whatever means)’ is wide enough to trouble those involved in many kinds of financing transaction, especially when the broad definition of ‘criminal property’ (considered further below) is taken into account. The importance of the case beyond the specific concerns of solicitors and barristers may be summarized as follows:

  • •  It provides an illustration of how a court might approach the construction of language in a statute like POCA 2002, which includes references to not only ‘entering into an arrangement’ but also ‘the vaguer concept of “becom[ing] concerned in an arrangement” ’.

  • •  It demonstrates the extremely broad ambit of the definition of ‘money laundering’: the case concerned a dispute over ownership of a house that had been the subject of certain works which one of the parties had wrongfully put through the books of his company as business expenses. This had the effect, under the Act, of potentially causing the house to be ‘criminal property’ and causing those advising on a dispute about it in the courts (or any settlement (p. 490) of such a dispute) to be guilty of money laundering if they did not make the required disclosures to the authorities. (The relevant definitions are considered further below.)

  • •  The judgment makes a number of observations about how the UK legislation goes significantly further than necessary for the implementation of the EU directives. For example, the legislation ‘defines money laundering to include property known or suspected to constitute or represent a benefit from criminal activity’ and, also, it applies to ‘any type of criminal conduct’ (not just serious crime). The FMLC, in its paper of October 2004, was particularly critical of the latter point and the absence of a de minimis threshold:

In the domestic context, this means that a person is under the same onerous duties both to report and, more importantly, to suspend transactions pending consent from the authorities, in circumstances where the criminal conduct does not raise the same public interest issues as serious crime involving matters like fraud, corruption, drugs, pornography, such as: a breach of intellectual property laws; regulatory or technical breaches (e.g. some offences under the Financial Services and Markets Act 2000 and Part X of the Companies Act 1985); events in the past which are so stale as to be of no practical interest or use to law enforcement agencies (e.g. unlawful confiscations during the Second World War).

27.06  The potential practical difficulties created by section 328 for the regulated as well as the unregulated sector are also illustrated in an example set out in the FMLC 2004 Paper:

… in the context of a corporate transaction where something comes to the attention of a professional adviser which prompts him to make a report, the professional adviser in question may not take any steps in relation to the transaction for fear of committing the offence under section 328 of POCA 2002. Nor may he explain the situation to his client for fear either of tipping off15 or prejudicing an investigation: if the professional adviser is a lawyer, English law principles of client confidentiality and legal professional privilege are modified in this context … It is disproportionate to deny the client access to his advisers at the very point at which he needs them: it might not even be the client, but a counterparty, who is implicated in a crime.

27.07  Although the court in Bowman v Fels achieved the ‘right result’ (and held that section 328 did not apply), in order to do this it had to rely extensively on analysis of the two EU directives that gave rise to the legislation combined with an application of ‘fundamental principles’ (of human rights or otherwise ‘not lightly to be interfered with’, ie the right to have ‘access to legal advice on a private and confidential basis’) in order to conclude that (in reaching its decision on the central issue): ‘Parliament cannot have intended that proceedings or steps taken by lawyers in order to determine or secure legal rights and remedies for (p. 491) their clients should involve them in “becoming concerned in an arrangement which … facilitates the acquisition, retention, use or control of criminal property”.’ Some ‘linguistic’ arguments were also used (‘to describe a judgement or order as an “arrangement” is a most unnatural use of language’) but, whilst one may applaud the result, one cannot help feeling some disquiet both at the uncertainty involved in having to appeal to an argument based on human rights (a point which also troubled the FMLC)16 and also at the vast range of ordinary professional and financial activity that does not qualify for the ‘Bowman v Fels exemption’ (because it does not involve legal proceedings).

The case also supports the trenchant criticism of POCA 2002 made by Chamberlain:

… poor legislation produces poor compliance which shows itself in a number of ways. The first is that the person subject to the requirement simply misunderstands its scope and application, and inadvertently fails to comply. The second arises where, driven to distraction by the range of possibilities of construction, the person affected simply decides to operate on the basis of what he thinks would be a sensible law. The third kind of compliance, which is equally problematic for the authorities, is compliance with a literal interpretation. As noted by the FMLC, in the case of POCA the effect of such an approach is that the authorities will receive a mass of information which is of no use in countering the real crime that damages society and which should be the proper subject of anti money-laundering legislation.17

27.08  As indicated above, the facts of the case concerned a dispute over the ownership of a house where the parties had lived for ten years. In the course of routine fact-finding inquiries by one of the solicitors involved, it became apparent that one of the parties had been involved in some suspicious-looking bookkeeping, having ‘included the cost of the work he had carried out at the property within his business accounts and his VAT returns, even though these works were unconnected with his business’. His solicitors believed that section 328 of the 2002 Act might apply and therefore made the disclosure to the authorities which is, in effect, required by section 328(2)(a). This led to delays and, ultimately, a question—to be considered by the Court of Appeal—as to whether or not the section really did apply to this situation. The point turned on whether or not section 328 ‘applies to the ordinary conduct of legal proceedings or any aspect of such conduct—including, in particular, any step taken to pursue proceedings and the obtaining of a judgement’. A related question was whether or not the section could apply to ‘any consensual steps taken or settlement reached during legal proceedings’.

27.09  The Court of Appeal determined that section 328 did not apply. Even though the literal wording of the section evidently gave rise to some difficulties, the (p. 492) Court was clearly influenced by the fact that the sections of POCA 2002 that apply to the regulated sector do in fact provide a defence for ‘a professional legal adviser’ if the relevant information ‘came to him in privileged circumstances’.18 This is in line with Article 14(4) of the fourth money laundering directive (EU) (2015/849), which provides that the requirement to verify the identity of the customer and the beneficial owner before the establishment of business relations or the carrying out of the transaction19 shall not apply to ‘notaries, other independent legal professionals, auditors … only to the extent that those persons ascertain the legal position of their client, or perform that task of defending or representing that client in, or concerning, judicial proceedings, including providing advice on instituting or avoiding such proceedings’. A similar disapplication applies with respect to the requirement to file a suspicion transaction report.20

27.10  The court felt that the fact that ‘the absence from s 328 of any equivalent protection to that contained in respect of the regulated sector in s 330(10) is a strong argument for a restricted understanding of the concept of “being concerned in an arrangement” ’.

27.11  The court also made an important statement about settlements out of court:

The consensual resolution of issues is an integral part of the conduct of ordinary civil litigation. If, as we consider, article 7 was intended to leave unaffected the ordinary conduct of litigation, then it seems implausible to suggest that it was intended to apply to legal professionals negotiating or implementing a consensual resolution of issues in a litigious context … Similar considerations apply with regard to s.328 of the 2002 Act … It would be a strange policy which treated the ordinary conduct of litigation as outside the scope of s.328, but only to the extent that the parties refrained from agreeing on any step involved in its conduct and/or from agreeing to resolve any of the issues arising by settlement rather than by litigation to judgement.

27.12  It was noted that this resulted in a distinction between deals done to resolve litigation and other types of transactions, but this seemed to be an inevitable consequence of the structure of the Money Laundering Directives.

27.13  Bowman v Fels was a welcome decision. The Law Society’s Gazette, reporting the case, expressed the relief felt by the legal profession (or at least those with contentious practices):

The ruling in Bowman v Fels [2005] EWCA Civ 226 puts an end to a wide interpretation of the rules that has caused considerable difficulties for lawyers and delays in litigation.

(p. 493)

Thousands of family cases in particular had been affected, with solicitors believing they were obliged to report suspicions of minor tax evasion to the National Criminal Intelligence Service (NCIS) and then be unable to work on the case until they received NCIS consent … Robin Booth chairman of the Law Society’s money laundering taskforce said, ‘… What this judgement does is to protect the whole process of litigation. It does not just depend on professional privilege, but on the principle that people should have access to justice and the courts without having their action disrupted by executive action.’21

27.14  Indeed, this is reflected in the Law Society’s anti-money laundering practice note22 that acknowledges that an ‘arrangement’ is not defined in Part 7 of POCA and refers to the effect of the decision in Bowman v Fels. Paragraph 5.4.3 of the practice note states the Law Society’s view that:

… supported by Counsel’s opinion … dividing assets in accordance with the judgment, including the handling of the assets which are criminal property, is not an arrangement. Further, settlements, negotiations, out of court settlements, alternative dispute resolution and tribunal representation are not arrangements. However, the property will generally still remain criminal property and you may need to consider referring your client for specialist advice regarding possible offences they may commit once they come into possession of the property after completion of the settlement.

The recovery of property by a victim of an acquisitive offence will not be committing an offence under either s 328 or s 329 of the Act.

27.15  The practice note does, however, refer to the legal risk with regards to the conduct of transactional work. Thus while the process of litigation may now be protected from POCA 2002, most routine banking and financial business is not. As mentioned above, these businesses are in the ‘regulated sector’ for the purposes of the 2002 Act, and therefore they are not only subject to section 328 but also to section 330, the first part of which provides that, subject to certain conditions, a person (below called the ‘information holder’) commits an offence if he knows or suspects23 or has reasonable grounds for knowing or suspecting that another person is engaged in money laundering and does not make the required disclosure. For the section to apply, the information or other matter on which the knowledge or suspicion is based must be received in the course of a business in the regulated sector and the information holder must be able to identify the suspect or the whereabouts of any of the laundered property or he must believe (or it is reasonable to believe he believes) that the information he has would or may assist in either such identification. It must also be the case that he does not make the required disclosure as soon as is practicable after the information or other matter comes to him.

(p. 494) 27.16  This section is potentially tougher than section 328 because the offence does not depend on actual knowledge or suspicion (which is what is required for the section 328 offence). However, the real problem with the section is the definition of money laundering itself, which, as Bowman v Fels shows, catches activity that many would not have thought would generally be covered by a law whose ostensible purpose was to combat serious crime. The definition is worth close analysis. Money laundering is any offence under sections 327, 328, or 329 of POCA 2002. All of these sections are concerned with some kind of misbehaviour (eg, concealing, converting, or using) with respect to ‘criminal property’. By virtue of section 340(3), property is criminal property if:

  1. (a)  it constitutes a person’s benefit from criminal conduct or it represents such a benefit (in whole or part and whether directly or indirectly), and

  2. (b)  the alleged offender knows or suspects that it constitutes or represents such a benefit.

27.17  There are numerous provisions which expand on the basic concept. For example, it is stated to be immaterial who carried out the criminal conduct, who benefited from it, and whether or not the conduct occurred before or after the passing of the Act. In section 414(1), property is defined to be:

… all property wherever situated and includes—

  1. (a)  money;

  2. (b)  all forms of property, real or personal, heritable or moveable;

  3. (c)  things in action and other intangible or incorporeal property.

27.18  The definition of criminal property, however, must be read with the definition of ‘criminal conduct’ (and it is here that criticisms from the FMLC and others have been most fierce). This is defined (in section 413 (1)) to mean:

… conduct which

  1. (a)  constitutes an offence in any part of the United Kingdom, or

  2. (b)  would constitute an offence in any part of the United Kingdom if it occurred there.

27.19  If these words are taken literally, money laundering could arise as a result of dealing with the proceeds of an activity carried out overseas, which did not constitute a crime in the country where it was carried out, and which did not result in any offence being committed in the UK (although it would have done if the activity had been carried out in the UK). In other words, money laundering may occur in circumstances where no other crime of any kind (let alone a serious crime) has actually been committed. Further, the activity that triggers the money laundering may have occurred a long time ago and may have been relatively minor.24

(p. 495) 27.20  The FMLC Paper of October 2004 reflects on whether, to take an extreme example, driving (in France) on what would be the ‘wrong side’ of the road in England (but is the right side in France) could trigger the legislation. It concludes, with certain misgivings, that it would not. More difficult, however, are activities that are permitted elsewhere (such as bullfighting in Spain) but are illegal in the UK. As the FMLC point out, ‘the Spanish matador who buys a house in England is, under POCA 2002, laundering the proceeds of criminal conduct’. It follows that those in the regulated sector who might come to know of the matador’s house buying must notify the authorities if they are not to be at risk of committing an offence themselves. This result is, of course, patently absurd. Real practical difficulties have resulted for banks and other regulated entities. For example, to quote once more from the FMLC Paper of October 2004 paragraph 11:

The ambiguities of the legislation make it particularly difficult for large financial institutions to develop clear and consistent guidelines for their myriad customer-facing staff. The fact that the Home Office has declined to issue material guidance on the legislation’s interpretation, despite calls from many corners of the regulated sector, only worsens the sense of unease. Some global institutions have considered avoiding the pressures which difficulties in interpreting POCA have placed on certain areas of their business, by simply transferring whole teams of staff into a different jurisdiction. Even if this has not occurred in any particular case, the fact that it has been considered makes this an influential factor in determining where to locate a business, and could be detrimental to the UK economy…

The consequences of making a report are extremely difficult to reconcile with the ongoing duties that a financial institution such as a bank normally owes to its customers. When a client seeks to recover what they consider to be their money from an account, only to be told that it is not currently available to them (because a report has been filed without their knowing), conflict is inevitable; there have been cases of customers making threats of physical violence to bank staff. When consent is subsequently given to the transaction, it is very difficult to explain to a client why their account is functioning normally, without revealing why it did not do so previously (as this could be tipping off).25 It has even been known for customers to claim damages from the bank for the loss of a business opportunity during the period of the account’s suspension pending NCIS response.

27.21  The government responded to the FMLC’s criticisms (particularly the ‘Matador point’) with the amendments to POCA 2002 contained in the Serious Organised Crime and Police Act 2005 (SOCPA 2005),26 which do not change the definition of criminal conduct but, instead, create a new defence27 to the various potential money laundering charges for a person who is able to show that he knew (p. 496) or believed on reasonable grounds that the relevant criminal conduct took place outside the UK, as long as the conduct is not unlawful in the country where it did take place and as long as it is not of a description to be prescribed by order.28 It is helpful that a defence is available to cover acts which are not criminal where they took place. However, it would have been more helpful if the offence itself had been redefined (not least because the result would, one might hope, have been law that is rather more accessible and comprehensible than is currently the case). The onus on the (potential) defendant, when deciding whether or not to make a disclosure, may be considerable, since the new provision requires him to establish that the act in question is lawful where it takes place; it is not sufficient that he believed this, or had reasonable grounds to believe this, to be the case. As the FMLC comments in the January 2005 Paper:

The only course would be to conduct due diligence as to actual compliance with local law, which would be disproportionate in an ‘all crimes scenario’, and in many cases could be impossible … The defence places an obligation on the person concerned to inquire into and definitively establish the criminal law of a foreign jurisdiction. He would have to do so, whether or not the conduct raises public interest issues such as those involved in serious crime, or whether it involves other historic, strict liability or other offences which might not be considered to be of interest to the UK authorities.

27.22  The criticism is amplified by Margaret Chamberlain:

In many cases it will not be worth the expense and effort involved in ascertaining that the defence would be available and firms will be left with the choice as to whether or not to make a report to NCIS and obtain NCIS’ consent to their particular involvement in a transaction. The prospect that this defence will reduce the number of reports to NCIS, or assist in resolving the uncertainties, is therefore illusory.29

27.23  The potential consequences of firms erring on the side of caution in making ‘disclosures’ and swamping the authorities with an enormous number of unnecessary reports is a practical difficulty that has to be managed. ‘Suspicious Activity Reports’ (SARs) numbered some 90,000 in 2003–4.30 According to Blair and (p. 497) Brent,31 ‘Approximately 200,000 SARS are made each year.’32 These authors have concerns that there is little public knowledge about what the authorities do with the information when they get it:

Without fuller information as to the outcomes to which SARs lead and the intelligence contribution made by the reports, it is not possible to form a view one way or the other as to whether the AML regime imposes a proportionate burden on the banking industry. What is clear is that the costs of compliance are high, and the benefits have not been clearly measured.

27.24  In its 2008 document summarizing responses to its earlier consultation exercise on the consent regime, the Home Office reported (in paragraph 2.4) that:

… the large majority of industry respondents took the view that the current regime has serious flaws, was not sustainable and required reform. The law should be made clear; this was the only way to provide certainty. It was neither appropriate nor reasonable to expect the regulated sector to place itself at risk of serious criminal sanctions for the sake of achieving practical solutions. This view was particularly prevalent in the banking sector.

27.25  However, the Home Office document concluded that there was insufficient consensus on how to change the law and stated that no legislative changes to the consent regime were being planned. There was, instead, a proposal for some form of Memorandum of Understanding with the regulated sector.

C.  Market Abuse

27.26  The requirement to report suspicious transactions relating to money laundering under POCA 2002 is echoed in the EU Market Abuse Regulation,33 which ‘establishes a common regulatory framework on insider dealing’ and other forms of ‘market abuse’. Article 16, the Market Abuse Regulation relating to the prevention and detection of market abuse, provides that:

… (2)  Any person professionally arranging or executing transactions shall establish and maintain effective arrangements, systems and procedures to detect and report suspicious orders and transactions. Where such a person has a reasonable (p. 498) suspicion that an order or transaction in any financial instrument, whether placed or executed on or outside a trading venue, could constitute insider dealing, market manipulation or attempted insider dealing or market manipulation, the person shall notify the competent authority as referred to in paragraph 3 without delay.

(3)  Without prejudice to Article 22, persons professionally arranging or executing transactions shall be subject to the rules of notification of the Member State in which they are registered or have their head office, or, in the case of a branch, the Member State where the branch is situated. The notification shall be addressed to the competent authority of that Member State.

27.27  The relevant requirements within the FCA’s Handbook are contained in the Supervision Manual, at paragraph 15, which states that:

15.10.4 G (1) Notification of suspicious transactions or orders to the FCA requires sufficient indications (which may not be apparent until after the transaction has taken place) that the transaction or order might constitute market abuse. In particular, a person subject to article 16 of the Market Abuse Regulation will need to be able to explain the basis for the suspicion when notifying the FCA. Certain transactions or orders by themselves may seem completely devoid of anything suspicious, but might deliver such indications of possible market abuse, when seen in perspective with other transactions, certain behaviour or other information (though persons subject to article 16 of the Market Abuse Regulation are not expected to breach effective information barriers put in place to prevent and avoid conflicts of interest so as actively to seek to detect suspicious transactions).

(2) Assistance in identifying the elements constituting market abuse can be found within the Market Abuse Regulation

27.28  The European Securities and Markets Authority has issued technical standards on various aspects of the Market Abuse Regulation (which in most respects replaces the guidance previously issued by the FCA). The standards include matters relating to the notification provisions in Article 16 including notification templates.34 As noted above, suspicious orders (as well as suspicious transactions) must be reported, (as well as ‘attempted market abuse’. Under the Regulation, such reports are referred to as ‘suspicious transaction and order reports’ (STORs)35 and are submitted to the FCA through its ‘Connect’ system. The notification forms are split into six sections, as follows:

  1. (1)  Identity of Entity / Person Submitting the STOR

  2. (2)  Transaction / Order

  3. (3)  Description of the Nature of the Suspicion

  4. (p. 499) (4)  Identity of Entity / Person Suspected

  5. (5)  Additional Information

  6. (6)  Documentation Attached

Just prior to submission, the firm is reminded of its legal and regulatory obligation (including those relating to ‘tipping off’). Specifically, the FCA states that the firm must:

  • •  Under MiFID, secure all relevant documents and records, including emails, Bloomberg messages and any message on any instant messaging systems and under COBS 11.8.10, secure tapes of telephone conversations for a minimum six-month period;

  • •  Under MAR, maintain the confidentiality of any STOR submitted to the FCA; and

  • •  Under MAR, maintain a record of every STOR submitted to the FCA for a period of five years.

27.29  It will be noted that these provisions, like those that apply to regulated entities under POCA 2002, apply an objective test. A firm will not be excused for failing to report on the grounds that it genuinely suspected nothing if there are ‘reasonable grounds’ for suspicion. Having regard to the fact that such a test, in the event of any dispute, will of necessity be applied by a regulator which has the benefit of hindsight, it might prove to be somewhat exacting. Should one’s suspicions always be aroused, for example, by orders that emanate from certain kinds of client, from certain parts of the world, or in relation to certain kinds of investment? The FCA does provide some insights as to its own thinking with some ‘Indications of Possible Suspicious Transactions’,36 which are considered below. First, however, we should look more closely at what the expression ‘market abuse’ actually means. If POCA 2002 may be criticized for requiring reporting based on ill-defined criminal conduct, the definition of market abuse surely gives rise to similar concerns, both in relation to the risk of being found in contravention of the reporting requirement and also the substantive ‘offence’37 itself (although, in this context, as explained below, there is a considerable amount of official guidance available as to interpretation).

27.30  Section 118 of FSMA 2000 was replaced by the provisions of the Market Abuse Regulation, which has direct effect in the UK. The nature and extent of the behaviour that can amount to market abuse under the Regulation is not too (p. 500) dissimilar to the now-repealed s 118(1) provisions. It is not appropriate in a work of this kind to analyse the descriptions of relevant behaviour in detail, but they may be summarized as:

  1. (1)  insider dealing;38

  2. (2)  wrongful disclosure of inside information;39

  3. (3)  manipulating transactions.40 This includes the following activities:

    1. (a)  entering into a transaction, placing an order to trade or any other behaviour which:

      1. (i)  gives, or is likely to give, false or misleading signals as to the supply of, demand for, or price of, a financial instrument, a related spot commodity contract or an auctioned product based on emission allowances; or

      2. (ii)  secures, or is likely to secure, the price of one or several financial instruments, a related spot commodity contract or an auctioned product based on emission allowances at an abnormal or artificial level;

        unless the person entering into a transaction, placing an order to trade or engaging in any other behaviour establishes that such transaction, order or behaviour have been carried out for legitimate reasons, and conform with an accepted market practice as established in accordance with Article 13;

    2. (b)  entering into a transaction, placing an order to trade or any other activity or behaviour which affects or is likely to affect the price of one or several financial instruments, a related spot commodity contract or an auctioned product based on emission allowances, which employs a fictitious device or any other form of deception or contrivance;41

    3. (c)  disseminating information through the media, including the internet, or by any other means, which gives, or is likely to give, false or misleading signals as to the supply of, demand for, or price of, a financial instrument, a related spot commodity contract or an auctioned product based on emission allowances or secures, or is likely to secure, the price of one or several financial instruments, a related spot commodity contract or an auctioned product based on emission allowances at an abnormal or artificial level, including the dissemination of rumours, where the person (p. 501) who made the dissemination knew, or ought to have known, that the information was false or misleading;42

    4. (d)  transmitting false or misleading information or providing false or misleading inputs in relation to a benchmark where the person who made the transmission or provided the input knew or ought to have known that it was false or misleading, or any other behaviour which manipulates the calculation of a benchmark.43

27.31  It will be immediately apparent that a number of the concepts that appear in the above descriptions of behaviour (behaviour ‘based on’ information, ‘standard of behaviour reasonably expected’, ‘legitimate reasons’, ‘deception or contrivance’, ‘accepted market practice’ etc) are somewhat vague, even nebulous. However, breach of the provisions regarding market abuse can attract unlimited fines, imposed by the FCA,44 and, as indicated above, failure to report market abuse, if it is (or should reasonably be) suspected, can also be punished by fines. The vagueness of the provisions has been heavily criticized in the past. Criticism that resulted in the government accepting that guidance and ‘safe harbours’ in both the EU legislative (and delegated provisions) as well as the FCA’s Code of Market Conduct. While the specific requirements for market abuse guidance in s 119 FSMA 2000 were repealed in line with the Regulation, such was the importance of the guidance, the FCA retained the code under its powers to give general guidance.45

27.32  Although the publication of regulatory guidance (whether in the form contained with the Annexes to the Regulation, delegated standards, or the FCA’s code) is helpful, it does, of course, result in enormous power (or perhaps more aptly, in view of the status of the EU Regulatory guidance, influence) being placed in the hands of regulators. No doubt the regulator would wish to exercise such power reasonably and fairly, but there is nevertheless cause for concern that an entity which is, in effect, an arm of the executive should have powers to make, enforce, and judge compliance with laws which include the power to impose unlimited fines.46

27.33  The Code of Market Conduct contains the following provisions (among many others) regarding some of the vaguer concepts referred to above. These are set (p. 502) out here by way of example as to how clarification can be provided; they should not be regarded as exhaustive or comprehensive or a substitute for reading the Code in full. They do, however, contain material that may be appropriately converted to internal guidance or principles of behaviour for the purpose of legal risk management.47

27.34  The ‘on the basis of’ concept is dealt with under Article 9 of the Regulation (to which the FCA’s MAR 1.3 defers). To paraphrase the provisions, the Regulation states that it shall not be deemed from the mere fact that a person is or has been in possession of inside information that that person has used that information and has thus engaged in insider dealing on the basis of an acquisition or disposal, where that legal person:

  • •  has established, implemented and maintained adequate and effective internal arrangements and procedures;

  • •  has not encouraged, made a recommendation to, induced or otherwise influenced the person who acquired or disposed of financial instruments to which the information relates;

  • •  for the financial instrument to which that information relates, is a market maker or authorized counterparty and the acquisition or disposal is made legitimately in the normal course of that function;

  • •  is authorized to execute orders on behalf of third parties, and the acquisition or disposal of financial instruments to which the order relates, is made to carry out such an order legitimately in the normal course of the exercise of that person’s employment, profession or duties

27.35  In the context of the Article 12(1) market manipulation offences, the Regulation provides, at Article 13, that behaviour carried on for ‘legitimate reasons’ and which conforms to an ‘accepted market practice’, will not be caught. The Regulation delegates authority to national regulators (overseen by the European Securities and Markets Association) to espouse acceptable market practices. In any event, the Regulation includes, at Annex IA various indicators of manipulative behaviours.48 The FCA’s guidance on factors to be taken into account for determine ‘legitimate reasons’ in relation to Article 12(1)(a) can be found at MAR 1.6.5 G to 1.6.8 G, with further guidance in the reminder of MAR 1.6

27.36  The influence of ‘soft law’49 (such as the rules of prescribed markets and applicable codes of conduct) will be apparent here. It is, perhaps, inherent in the concept of the more nebulous of abstract standards that it is difficult to see how such (p. 503) could be demonstrated to exist (or what it consists of) except by reference to soft law sources. Whether or not the architects and draftsmen of such material would appreciate its ‘hard law effect’ (in providing evidence of whether or not market abuse has occurred) is another matter. As with insider dealing, the existence of an effective Chinese wall may, in certain circumstances, be of great significance.

27.37  In an effort to assist those who may have to decide whether or not a transaction is suspicious enough to justify reporting, the FCA has also given guidance50 by way of ‘examples of indications’ of suspicious dealings ‘as a starting point for consideration’ of whether suspicion is merited, including the following (in relation to insider dealing):

Possible Signals of Insider Dealing

  1. (1) 

  2. (2)  A client opens an account and immediately gives an order to conduct a significant transaction or, in the case of a wholesale client, an unexpectedly large or unusual order, in a particular security—especially if the client is insistent that the order is carried out very urgently or must be concluded before a particular time specified by the client.

  3. (3)  A transaction is significantly out of line with the client’s previous investment behaviour (e.g. type of security; amount invested; size of order; time security held).

  4. (4)  A client specifically requests immediate execution of an order regardless of the price at which the order would be executed (assuming more than a mere placing of ‘at market’ order by the client).

  5. (5)  There is unusual trading in the shares of a company before the announcement of price sensitive information relating to the company.

  6. (6)  An employee’s own account transaction is timed just before clients’ transactions and related orders in the same financial instrument.

27.38  As with the statements in the Code of Market Conduct regarding what constitutes market abuse, these ‘signals’ are potentially very helpful and would no doubt be reflected at the appropriate point in firms’ own in-house guidance literature. Nevertheless, a double level of uncertainty remains for those who have to decide about whether or not to make a report:

  1. (1)  Was what apparently happened within the definition of market abuse, having regard to the provisions of the Regulation and Code of Market Conduct?

  2. (2)  How clear is it that the suspicion is justified?

27.39  The FCA has made it clear that it will not welcome excessively cautious, ‘defensive’ reporting. This might itself be seen as a sign of inadequate internal controls (p. 504) (which may be grounds for a fine under a different head). So it is important that the correct balance is struck.

27.40  On 1 July 2005 (the day that the new market abuse regime came into force) the Financial Times reported (under the heading ‘FSA fears banks may swamp it with their filings’) what would remain a concern for regulators in relation to the reporting of suspicion under the market abuse regime:

… the Financial Services Authority … is concerned that it will be overwhelmed by banks reporting routine transactions as suspicious in order to protect themselves against future fines. That was the experience of the National Criminal Intelligence Service, which has been deluged with ‘suspicious activity reports’ in recent years as a result of new money laundering legislation governing financial institutions. To prevent it being swamped, the FSA last week wrote to companies to warn that it would come down hard on firms that report suspicious transactions for ‘defensive’ reasons.

27.41  Indeed, a ‘sharp upward trajectory’ of suspicious transaction and order reports since the financial crisis, was the subject of another Financial Times article on 22 March 2015.51 The article reported that:

… A total of 1,626 suspicious transaction reports, or STRs, were filed in 2014, compared with 1,308 the previous year. The figures are in stark contrast to the pre-financial crisis era: in 2007, just 328 such reports were sent, according to statistics from the Financial Conduct Authority.

The spike in STRs was due to better reporting rather than an indication of an increase in market abuse in the City, legal experts said. ‘There is a heightened awareness that turning a blind eye to suspicious activity is no longer acceptable,’ said Michael Ruck, a former regulator now at Pinsent Masons, the law firm. ‘In many organisations the FCA’s “credible deterrence” drive has spawned a culture of “if in doubt submit an STR report” ’.

Under UK law, banks and brokers must report each transaction in a regulated security to the FCA every day. EU rules have also stipulated more rigorous reporting requirements and some financial firms have struggled to cope with the added demands.

Those that do not comply with their reporting obligations face a fine and the FCA has not been shy to act against sloppy systems: in August, Deutsche Bank received a £4.7m fine for inaccurately reporting more than 29m transactions to the watchdog. While this concerned transactions that were not suspicious, it was the most recent of 11 similar penalties levied by the FCA against groups including Barclays, the Royal Bank of Scotland, and Société Générale.

Footnotes:

1  From the judgment of Lord Hoffmann in R (Morgan Grenfell & Co Ltd) v Special Commissioner for Income Tax [2002] UKHL 21.

2  From the judgment of Lord Hoffmann in R v Secretary of State for the Home Department, ex p Simms [2000] 2 AC 115.

3  See speech by President George W Bush of 2 June 2005, announcing the nomination of Christopher Cox as the new Chairman of the SEC.

4  See Prevention of Fraud (Investments) Act 1958 and Prevention of Terrorism Act 2005. One might add ‘fiscal responsibility’ and ‘equality’ to this rather dubious list.

5  Peer pressure and a sense of moral responsibility of course have a role to play.

6  It is for this reason that banks were singled out for special attention as long ago as the 1991 EU directive on money laundering, which provides, in Art 6, that:

Member States shall ensure that credit and financial institutions and their directors and employees co-operate fully with the authorities responsible for money laundering:

  • •  by informing those authorities, on their own initiative, of any fact which might be an indication of money laundering,

  • •  by furnishing those authorities, at their request, with all necessary information, in accordance with the procedures established by the applicable legislation.

7  These are Council Directive of 10 June 1991 (91/308/EEC), Council Directive of 4 December 2001 (2001/97/EEC) and Directive 2005/60/EC of the European Parliament and of the Council of 26 October 2005, known as the first, second, and third Money Laundering Directives respectively. The fourth money laundering directive (EU) (2015/849), amending and replacing the third directive was transposed into UK law on 26 June 2017 principally through the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017, SI 2017/692. Due to the necessities of going to print with this book, the references to POCA 2002 below do not take account of any amendments to the statute pursuant to the 2017 money laundering regulations referred to above.

8  See FMLC Papers of October 2004 and January 2005.

9  Defined initially in Sch 9 to the POCA 2002, but now defined in the Proceeds of Crime Act 2002 (Businesses in the Regulated Sector and Supervisory Authorities) Order 2007 (SI/3287) to include banks and most kinds of financial service providers as well as businesses in the property sector (and casinos). Lawyers fall within the definition if they participate ‘in a financial or real property transaction (whether by assisting in the planning or execution of any such transaction or otherwise by acting for, or on behalf of, a client in any such transaction)’ (see para 1(1)(l) of the Order) and might also be caught by the definition if they give advice in connection with tax matters, trusts, or companies. Accountants are also likely to be caught by the definition.

10  See Bowman v Fels [2005] EWCA Civ 226.

11  See also para 28.19.

12  Disclosures are (with certain exceptions) required to be made, in effect, to the police or a customs officer.

13  Emphasis added. The section is not limited by reference to ‘serious crime’.

14  But for an example of how POCA 2002, s 328 can affect banks and their customers, see Squirrell v National Westminster Bank plc [2005] 2 All ER 784, where it was noted by Laddie J that the provision ‘is … of particular concern to banks’. Squirrell, the bank’s customer, had had its account frozen by the bank and no explanation had been provided. The judge noted that, ‘Natwest says it wishes to comply with Squirrell’s instructions in relation to the account but that it was forced to block it because of … s 328(1) [of POCA]. Furthermore, because of the anti-tip off provisions of that legislation, it was also prevented from explaining to Squirrell the reasons for so acting.’ It emerged that the bank must have had some suspicions falling within the scope of the section (with regard to a possible VAT offence) and Laddie J accepted that its course of action was ‘unimpeachable’; the bank had made the authorized disclosure and had not received the necessary consent to enable the account to be unblocked; the law gave it virtually no choice. However, the judge also had ‘some sympathy for parties in Squirrell’s position. It has not been proved or even alleged that it or any of its associates has committed any offence. It, like me, has been shown no evidence raising even a prima facie case that it or any of its associates has done anything wrong. For all I know, it may be entirely innocent of any wrongdoing … if Squirrell is entirely innocent it may suffer severe damage for which it will not be compensated. Further, the blocking of its account is said to have deprived it of the resources with which to pay lawyers to fight on its behalf. Whether or not that is so in this case, it could well be so in other, similar cases. Whatever one might feel were Squirrell guilty of wrongdoing, if, as it says, it is innocent of any wrongdoing, this can be viewed as a grave injustice.’ In R (UMBS Online) v SOCA [2007] EWHC 664 (Ch) Sedley LJ commented that the state, in setting up SOCA, had ‘set out to create an Alsatia—a region of executive action free of judicial oversight’. See also K v National Westminster Bank, HMRC, SOCA [2006] EWCA Civ 1039.

15  An offence in its own right under POCA 2002, s 333A; the definition is complex but, broadly, covers making disclosures of information that would be likely to prejudice an investigation.

16  See FMLC October 2004 Paper, para 14.

17  See Chamberlain, ‘The Proceeds of Crime Act 2002—FMLC Highlights Key Legal Uncertainties’ (2004) 10 JIBFL 435.

18  See s 330(6)(b) and (10).

19  Per Article 14(1) of the fourth money laundering directive (EU) (2015/849).

20  See Article 33(1) of the fourth money laundering directive (EU) (2015/849) for the requirement to report and Article 34(2) for the ‘disapplication’ in the circumstances described.

21  LS Gaz 10 March 2005, 1.

22  The Law Society, ‘Anti-money Laundering Practice Note’ (October 2013) para 5.4.3

23  If the matter is contested (say, where a bank makes a disclosure about its customer) it will be for the bank to prove it had a suspicion: see Shah and anor v HSBC Private Bank (UK) Ltd [2010] EWCA Civ 31. See also para 25.15 for a discussion of this case in the context of causation and legal risk.

24  According to Blair and Brent, Banks and Financial Crime (Oxford University Press, 2008) at 7.108: ‘Clearly it is not the intent of the AML regime to catch such a person. This net is cast as it is to avoid a situation in which, for example, under the law of a particular country, the trade in narcotics was lawful.’ (‘AML’ is the commonly used abbreviation for ‘anti-money laundering’.)

25  See Bowman v Fels [2005] EWCA Civ 226.

26  See SOCPA 2005, s 102, which contains amendments to POCA 2002, ss 327, 328, 329, 330, and 331. The legislation also introduces the concept of a de minimis ‘threshold amount’ (initially set at £250), which excuses deposit-taking institutions for what would otherwise be money laundering offences involving criminal activity relating to very small amounts.

27  This is set out in subs (3) of s 328.

28  See, eg, the Proceeds of Crime Act 2002 (Money Laundering Exceptions to Overseas Conduct Defence) Order 2006, SI 2006/1070.

29  See Chamberlain, ‘The Proceeds of Crime Act 2002: Progress, but in Which Direction?’ (2005) 04 JIBFL 127. For further criticism of the new provision, see ‘Solicitors in “double bind” over crime Act’, LS Gaz, 30 June 2005.

30  This number is referred to in a report issued in 2004 by the Inspector of Constabulary, and quoted in Delahunty, ‘Three is one is too many’ LS Gaz, 16 June 2005. Higher numbers were quoted at a Financial Times conference, reported on 8 June 2005. As one delegate (the head of financial crime prevention at Lloyds TSB) remarked: ‘There is little point in turning on the tap and providing a torrent of information if there isn’t a big enough bucket to deal with it.’ According to LS Gaz, 14 July 2005, solicitors in England and Wales made 12,740 disclosures to the authorities under POCA 2002 in 2004. The corresponding number under comparable laws in Germany was 15 (and similarly low numbers were recorded in other EU jurisdictions).

31  Banks and Financial Crime (Oxford University Press, 2008) at 1.52.

32  According to the Home Office, banks and solicitors are the highest contributors of SARs (about 33 per cent each). See 2007 Consultation Document on the ‘consent regime.’

33  Regulation (EU) No 596/2014 of the European Parliament and of the Council of 16 April 2014, which, together with its implementing legislation, came into effect from 3 July 2016. This latest market abuse law has been expanded to align more closely with revised legislation under ‘Market in Financial Instruments Directive II’ (such as on transaction reporting) that will take effect from January 2018. There is a broader definition of ‘inside information’ capturing a wide range of financial products (such as benchmarks), a prescribed process for ‘market soundings’ and, most notably in the context of this book (and section), a requirement for suspicious orders in any financial instrument to be reported, whether or not placed or executed on a trading venue; and not merely the reporting of suspicious transactions.

34  Pursuant to Article 16(5) of the Market Abuse Regulation. (See ‘Commission Delegated Regulation (EU) of 1.3.2016 supplementing Regulation (EU) No 596/2014 of the European Parliament and of the Council with regard to regulatory technical standards for the content of notifications to be submitted to competent authorities and the compilation, publication and maintenance of the list of notifications’ and ESMA Table 2 (OJ 2016/909).

35  This should be distinguished from a ‘suspicious activity report’ filed with the National Crime Agency under the above-referred POCA regime.

36  See FCA Handbook, Supervision Manual, SUP15 Annex 5.

37  Market abuse itself is not a criminal offence but insider dealing is a criminal offence under the Criminal Justice Act 1993, s 52. Because it can attract fines from the FCA, market abuse is often referred to as an offence. It should be noted that the FCA can also impose fines if it is satisfied that a person (A) ‘by taking or refraining from taking any action has required or encouraged another person or persons to engage in behaviour which, if engaged in by A, would amount to market abuse’ (see FSMA 2000, s 123(1)(b)).

38  Formerly s 118(2) of Financial Services and Markets Act 2000. See Article 8 of the Market Abuse Regulation and the FCA’s Code of Market Conduct sourcebook, para MAR1.3

39  Formerly s 118(3) of Financial Services and Markets Act 2000. See Article 10 of the Market Abuse Regulation and the FCA’s Code of Market Conduct sourcebook, para MAR1.4

40  Formerly s 118(5) of Financial Services and Markets Act 2000. See Article 12 and Annex I of the Market Abuse Regulation, and the FCA’s Code of Market Conduct sourcebook, para MAR1.6.

41  There is some overlap between the provisions of Article 12(1)(b) above, Annex I (B) of the Regulations, and the FCA’s guidance at MAR1.7 (these provisions essentially replaced s 188(6) FSMA).

42  Article 12(1)(c) (and Recital 47) of the Regulations covers the behaviour associated with the former ss 118(7) and (8) FSMA in relation to dissemination, misleading behaviours, and distortion. The FCA’s guidance can be found at MAR1.8 and 1.9.

43  See Article 12 (1) of the Market Abuse Regulation. Further examples of behaviour that will be considered as market manipulation are detailed in Article 12(2).

44  See FSMA 2000, s 123 and the FCA’s policy statement in its Decisions, Penalties and Procedures Manual, part 6.

45  As well as under the provisions of s 139A FSMA 2000.

46  See Blair et al, Banking and Financial Services Regulation (3ed edn, Butterworths, 2002) para 9.52: ‘the novelty of the new regime, as regards both its structure, its conceptual framework and the language in which its requirements are couched, has given rise to a significant amount of apprehension among market participants’.

47  See Chs 29 and 30 below.

48  The behaviour described in Annex I,A(c) is clarified by the FCA’s guidance at MAR1.6.3 G that states that ‘[e]ntering into a stock lending/borrowing or repo/reverse repo transaction, or another transaction involving the provision of collateral, does not of itself indicate behaviour described in Annex I,A(c) of the Market Abuse Regulation’.

49  See para 24.51 et seq. above.

50  In the ‘Full Handbook’, SUP/15/Annex 5.

51  Financial Times (C. Binham), ‘FCA inundated with claims of possible market abuse’ (22 March 2015).