FMA extracts significant settlement from leading asset management firm

Monday 22 June 2015

Authors: Sophie East, James Cooney and Tom Pasley

​Following an investigation which has received considerable media coverage (yet with many of the details kept confidential), a leading asset management firm has made a significant settlement payment to the Financial Markets Authority (FMA). In a settlement agreement signed last week,1 Milford Asset Management (Milford) agreed to pay NZ$1.5 million to the FMA for alleged market manipulation. This is significant in two respects.  First, because it is a significant amount of money. Secondly, because Milford took responsibility for the inadequacy of oversight and controls of the relevant trading conduct by the portfolio manager in question and its failure to identify and adequately monitor that trading activity.

The investigation and settlement serves as a reminder to firms dealing in securities to ensure adequate oversight and control of trading conduct, and to continue to review systems and processes to ensure compliance is ongoing. This is particularly important given that the FMA has stated that “probing allegations of secondary market violations” is currently one its key areas of focus.2

What happened?

The settlement followed an investigation by the FMA of certain trading conduct undertaken by an unnamed portfolio manager at Milford between December 2013 and August 2014. The FMA’s investigation concluded that Milford, as the portfolio manager’s employer, engaged in market manipulation in breach of section 11B of the Securities Markets Act 1988 (SMA). Applying section 11B, the FMA alleged that Milford ought reasonably to have known that the actions of its portfolio manager would have, or would have been likely to have, “the effect of creating, or causing the creation of, a false or misleading appearance with respect to the extent of active trading in the securities, or with respect to the supply of, demand for, price for trading in or value of those securities”. The details of what exactly occurred are not available in any of the public statements.

The FMA also asserted, and Milford accepted, that there was a failure to adequately monitor Milford’s trading activity so as to identify and intervene in the sort of trading activity under investigation. Milford undertook to pay the FMA:

  • NZ$1,100,000 in lieu of a pecuniary penalty under section 46A of the Financial Markets Authority Act 2011; and

  • NZ$400,000 as a contribution to the FMA’s investigation costs.

As a result of the investigation Milford also reviewed its systems and processes and undertook a programme of improvement. It appointed PwC to review its governance, risk and compliance capability and to make recommendations. This review was provided to the FMA.

The FMA has agreed to take no further action against Milford. However, the settlement agreement does not apply to the Milford portfolio manager, who is still the subject of a FMA enforcement process.3

How does this compare to other cases?

The only other recent comparable reported case is the FMA’s investigation of Brian Henry, the founder of Diligent Board Member Services (Diligent). That investigation, which was launched in 2013, resulted in Henry admitting market manipulation and being ordered by the High Court to pay a $130,000 penalty following settlement with the FMA.4

The High Court judgment in the Henry case provides detail of the sort of conduct considered to amount to market manipulation. Mr Henry was a party on several occasions to trading of Diligent shares from which no beneficial ownership resulted. Specifically, Henry purchased shares on the NZX that his family trust (of which he was trustee and beneficiary) already owned. Henry had also made “wash sales” by placing a number of buy and sell orders in Diligent shares and trading in Diligent shares on the same day, artificially inflating the Diligent share price through layering bids and offers to the market, and creating an artificial impression of the level of trading interest in Diligent shares. This was said to force other buyers and sellers to bid at higher prices and to set the market closing price.

The introduction of the Financial Markets Conduct Act 2013

On 1 December 2014, the SMA was repealed and replaced by the Financial Markets Conduct Act 2013 (the FMCA),5 but with no substantive change to the market manipulation test. The new market manipulation provisions are contained in section 262 (which prohibits making statements or disseminating information that is false or misleading and which may induce persons to trade in financial products or which may affect the price of financial products), and section 265 (which prohibit acts or omissions that have the effect of creating a false appearance with respect to the extent of trading in financial products or the supply, demand for, price or value of those products).6 The FMCA includes examples of the sort of conduct these sections are directed at. For example, it is a breach of section 265 if a person (A) is directly or indirectly a party to trading in the quoted financial products of a listed issuer from which no change in beneficial ownership results (i.e., buying from and selling to themselves). However, there are also exceptions carved out, for example if A was acting on behalf of another (section 267(2)(a)), did not know that no change in beneficial ownership would result (section 267(2)(b)), or if the trading was made in conformity with accepted market practices and for a proper purpose (section 268). An example of permitted conduct is where a family trust holds financial products and those products are transferred to newly appointed trustees in connection with their appointment. In this situation there is no change in beneficial ownership, but yet the actions are in conformity with accepted market practices and for a proper purpose.

As well as bringing civil claims for breach of the market manipulation provisions of the FMCA, the FMA also has the power to bring criminal proceedings. The key requirement for a criminal offence is knowledge. A breach of sections 262 and 265 is a criminal offence if a person knows that the information is false or materially misleading or knows that the act or omission might create a false or misleading appearance in relation to the extent of trading in a financial product or the supply, demand, price or value of those financial products (sections 264 and 269). The criminal penalties have increased under the FMCA to a maximum of $500,000 and/or five years imprisonment for an individual, or $2.5 million for a body corporate.7 The maximum civil pecuniary penalties are the greatest of either: (i) the consideration for the relevant transaction; (ii) three times the amount of the gain made or the loss avoided; or (iii) $1 million in the case of an individual or $5 million in any other case.8

It is also worth noting that the FMA is not the only regulator interested in the sort of activity at issue in the Milford investigation. The NZX is also focussed on detection and prevention of similar conduct for listed companies. Under NZX Participant Rule 10.2, each Trading Participant, NZX Advising Firm and Advisor must ensure that orders they are placing do not, and are not likely to, manipulate the market.

Comment

The Milford investigation and settlement illustrates the FMA’s continued focus on preventing and penalising market manipulation. Indeed, in its 2014 Annual Report, the FMA noted that one of its “key areas of focus” was “proving allegations of secondary markets violations, including insider trading or market manipulation.”9 As such, all firms dealing in financial products (whether they be debt securities, equity securities, management investment products or derivatives) should have robust systems and processes in place to ensure that there is adequate oversight and control of trading conduct, and should continue to review those systems and processes to ensure that they are being complied with and remain appropriate.

Finally, this is not just an issue to be left to management. The Milford settlement agreement specifically notes that “the Milford Board failed to ensure that there was the requisite degree of monitoring of the Trader and his trading activity.”10 Failure to ensure the requisite degree of oversight can result in civil and criminal liability, as well as significant fines or pecuniary penalties (both for an individual and for the company).


1 Available to view here.

2 Financial Markets Authority, Annual Report 2014 at p. 39.

3 Milford issued an amended prospectus for the firm’s fundraising arm, Milford Funds Limited, on the same day the FMA settlement was announced.

4 Financial Markets Authority v Henry [2014] NZHC 1853 (Venning J).

5 The conduct at issue in the Milford case was before this law change.

6 “Financial products” are defined in s 7 of the FMCA as debt securities, equity securities, managed investment products or derivatives.

7 Sections 264 and 269 of the FMCA. The penalties under the SMA were a maximum of 5 years imprisonment and/or a $300,000 fine for an individual, and a maximum $1,000,000 fine for a body corporate (s 11D  of the SMA).

8 Section 385(2) of the FMCA.

9 Financial Markets Authority, Annual Report 2014 at p. 39.

10 Settlement agreement at E.


Disclaimer

This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

For more information
  • Sophie East

    Partner Auckland
  • James Cooney

    Partner Auckland
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