Laven Partners Regulatory News Alert – January 2012

Greenlight Case – Detecting Market Abuse

Alexander Edward Ten-Holter, a trader and compliance officer at Greenlight Capital (UK) LLP was fined and banned by the FSA on 26 January 2012 for failing to question an order for sale where signs of market abuse were present.

Mr Ten-Holter was acting on the instructions of the portfolio management team at Greenlight Capital Inc, (“Greenlight”) in executing orders to sell shares in Punch Taverns Plc. The FSA stated that “under the circumstances, Mr Ten-Holter had failed to recognise the risk of market abuse in how the instruction was communicated to him and the information he was given.

The FSA stated several factors which should have alerted the compliance officer to question Greenlight’s reason for sale. These include:

  • the instruction from Greenlight for the sudden disposal of its entire holding of a major stake in Punch Taverns;
  • the instruction followed immediately after a call with the management of Punch Taverns;
  • management of Punch Taverns had told Greenlight that there were “secret bad things” that they would tell Greenlight if Greenlight signed a non-disclosure agreement;
  • following the call with management, Greenlight had formed a view that the share price would plummet and this was thereason for the instruction;
  • that there was no other reason for the instruction known or anticipated by Mr Ten-Holter; and
  • that the sale took place immediately prior to Punch’s unscheduled announcement on 15 June 2009, which caused the share price to fall significantly.

The FSA fined Mr Ten-Holter GBP130,000 and banned him from performing Compliance Oversight and Money Laundering Reporting functions.

EU Short Selling and CDS Restrictions Update 

In the midst of the current regulatory turmoil, market players have to pay closer attention to the upcoming EU restrictions on short selling and use of credit default swaps (CDS). These restrictions – which are still subject to change – will affect hedge funds and other investors who short shares that are traded in EU markets and exchanges or who use CDSs to hedge against sovereign debt risks. The main restriction will be on naked short selling, requiring sellers to own a part of the stock they are selling.

The fund managers whose investment strategies involve a use of these instruments will have to align their operations with the new rules, as hedge funds will be instantly bound by these rules when they become effective on 1 November 2012.

In particular, the draft transparency rules described in European Securities and Markets Authority’s (ESMA) latest discussion paper would require investors holding net short positions in the share capital of a publicly traded company to disclose information to regulators and the public. Under these draft rules, investors would have to disclose net short positions that have reached 0.2% of the publicly traded company’s share capital, and every 0.1% increase to this number would require further disclosure. If the investor’s short position reaches 0.5% of the company’s share capital, the investor would have to disclose his position to the public as well as to the regulator, including any 0.1% increase to that position.

Further information of the upcoming short selling rules will be published when ESMA produces its final report by the end of March 2012.

Amendments to the Client Assets Sourcebook 

On 20 January 2012 the FSA published its Policy Statement PS12/2 on Client assets sourcebook: Custody liens.

The most important changes introduced by the Policy Statement are the amended rules on liens held overseas and on the liens taken over omnibus client accounts. The FSA has for example relaxed its rules on general liens being granted over client assets where they are held overseas. If a professional client, for example a fund, instructs that its assets should be held in a specific jurisdiction, regardless of the existence of the lien, the custodian does not need to take reasonable steps to ensure this is in the best interest of the client.

Although this relaxes the current rules, the FSA stated that the professional client must be aware of the existence of the lien so that it can appreciate the risks of having a lien over the assets. Possible ways of making sure the client has appreciated the risks could be, according to the FSA, providing disclosure and obtaining informed consent as part of the terms of business.

The Policy Statement has a broad application and is relevant to all firms that custody assets with a third party custodian. Firms whose custody agreements with custodians and sub-custodians include liens and the use of omnibus accounts should review their contracts with these service providers to ensure these are in line with the amended regulations. When reviewing a custody agreement, firms should be particularly careful with any references to affiliates and their potential rights over client assets.

The rules will come into force on 1 April 2012. Although the FSA introduced a transition period until 30 September 2012 for custody agreements entered into before 1 April 2012, the FSA stressed the importance for firms to amend such custody agreements according to the new rules as soon as possible.

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