FSA fines company secretary for market abuse

On 10 February 2004 the Financial Services Authority (FSA) announced that it had fined Robert Middlemiss, a chartered accountant and the company secretary of AIM-quoted Profile Media Group (PMG), £15,000 for market abuse based on his dealings in the company's shares. The FSA acquired the power to impose financial penalties for market abuse on 1 December 2001 - N2. This is one of the first cases in which it has imposed a fine for this type of market abuse.

The fine related to "misuse of information": dealings by Mr Middlemiss in the company's shares while he was in possession of information that was not generally available to those using the market. In April 2002 he became aware that the group's revenues were likely to be significantly below expectations. Before this news was announced to the market he sold some of his own shares in PMG, breaching PMG's own rules requiring senior employees to seek prior approval for dealing in its shares. Following the announcement the share price dropped from 14.5p to 4.75p. He avoided a loss of £6,825.

Statutory Provisions

Section 118 of the Financial Services and Markets Act 2000 empowers the FSA to impose a financial penalty of such amount as it considers appropriate if the FSA is satisfied that a person has engaged in market abuse.

Market abuse is behaviour which:

1. occurs in relation to qualifying investments traded on a prescribed market;
2. satisfies any one or more of the conditions set out in section 118(2); and
3. is likely to be regarded by a regular user of the market who is aware of the behaviour as a failure on the part of the person concerned to observe the standards of behaviour reasonably expected of a person in his position in relation to the market.

AIM is one of the prescribed markets and PMG shares, which are traded on AIM, are qualifying investments. The relevant condition in section 118(2) in this case is that 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. A "regular user" in relation to a particular market means a reasonable person who regularly deals on that market in investments of the kind in question.

The FSA has issued a Code of Market Conduct giving guidance as to whether or not behaviour amounts to market abuse. The Code may be relied on so far as it indicates whether or not particular behaviour should be taken to amount to market abuse.

Facts found by the FSA

PMG had two divisions and a number of subsidiaries. At the time of the share-dealing its US division was the most significant subsidiary.

On 15 April 2002 PMG's Chief Executive Officer and Financial Director attended a board meeting of the US subsidiary, where they learned that it was unable to meet its sales targets and that it was projected to make US$9 million rather than the budgeted US$14-15 million for the year to 30 June 2002. For the rest of that week the Financial Director reviewed the projections and decided that, in order to assess their impact on PMG's performance overall, it would be necessary to re-forecast the other PMG subsidiaries. During that week no information about the US subsidiary's fall in revenue projections was communicated to other members of PMG management.

On Monday 22 April 2002 the CEO and Financial Director returned to PMG's head office and the Financial Controller was instructed to co-ordinate an urgent re-forecast of the other PMG subsidiaries. In order to maintain confidentiality a cover story was devised to explain the reason for the urgent re-forecasting. PMG's Board was convened to consider the matter on Friday 26 April 2002. Its bankers were informed that there was a likelihood that there would be a substantial revenue shortfall and that banking covenants were likely to be breached.

Although not formally briefed, Mr Middlemiss was made aware of the significant fall in the US subsidiary's revenues and the need for urgent re-forecasting of other subsidiaries. The FSA decided that Mr Middlemiss was aware of the material problems in relation to the US subsidiary's business performance and finances, knew the true reason for re-forecasting the other subsidiaries' performance and understood the significance of the US subsidiary in terms of PMG as a whole. He also knew that three months earlier PMG had issued a trading statement which had followed similar circumstances and that that had resulted in a significant fall in the price of PMG shares.

On 26 April 2002 he sold 70,000 PMG shares at 14.5p each. He did not seek permission from the CEO or the Financial Director, as he was required to do by PMG's internal rules and as he had done on a number of occasions in the past when dealing in PMG securities. On 2 May PMG issued a trading statement to the effect that in the light of recent trading developments the financial results of the group for the year to 30 June 2002 were likely to be materially below expectations and that this was mainly due to deterioration in the trading performance of the group's publishing businesses. The share price fell from 14.5p to 4.75p. Mr Middlemiss avoided a potential loss of £6,825 on the shares that he sold.

The FSA decided that his behaviour amounted to market abuse, because he was in possession of information concerning the US subsidiary's fall in revenues, which was relevant information concerning PMG. The FSA decided that this information had a material influence on his decision to sell the shares because he knew of the strong possibility that PMG would need to make a trading announcement. Mr Middlemiss accepted that he had sought permission to deal in the past and that if he had sought permission on this occasion it would have been refused.

The FSA considered that a reasonable person who regularly deals on AIM would regard Mr Middlemiss' behaviour as a failure to observe the standards of behaviour reasonably to be expected of any investor and certainly that of a chartered accountant employed as company secretary of an AIM-quoted company. The FSA concluded that someone in his position was well aware of the sensitivity of the information and the impropriety of exploiting it to his own advantage before it was made available to investors by an announcement in accordance with the AIM rules.

The fine

In deciding on the financial penalty the FSA took into account certain considerations. The first of these was that he avoided a potential loss of £6,825. The FSA would normally seek to impose a penalty that, at a minimum, deprived him of the benefits gained from his abusive behaviour. Other factors taken into account included:

• The need for investors on AIM to have confidence in the integrity of share- trading on the market and that misuse of such information obtained in the course of employment is likely to undermine investor confidence seriously.
• The fact that Mr Middlemiss was the company secretary and that his behaviour was deliberate or reckless.
• That during the investigation Mr Middlemiss was experiencing some personal difficulties and that the impact on him, as a professionally qualified individual, is likely to be significant.

Account was taken of the fact that he had no previous history of market misconduct and did not regularly deal on the markets. The FSA concluded that his behaviour merited not just the publication of a statement that he had engaged in market abuse, but the imposition of a financial penalty of £20,000, which was reduced to £15,000 on account of his financial resources and other personal circumstances. The fine is required to be paid in three instalments by 30 June 2004.

Comment

A person in possession of unpublished price-sensitive information who deals on the market in order to avoid a loss could be subject to prosecution for insider dealing under the Criminal Justice Act 1993. Conviction requires satisfaction of the criminal burden of proof (that there is no reasonable doubt of guilt) rather than the less exacting civil burden (that the accused is more likely than not to be guilty), which applies in cases of market abuse. The difficulties of securing a conviction have meant that the insider dealing regime has not been perceived to be an effective means of maintaining confidence in the workings of the market. The market abuse regime is intended to make the job of rooting out abusive practices quicker, easier and more effective.

The fine imposed on Mr Middlemiss was partly designed to deprive him of the benefit of his action. The FSA is also entitled to apply to court for a restitution order under which a person who has committed market abuse may be required to account to the FSA for any profit made as a result, or to pay the FSA an amount equal to any loss or other adverse effect suffered by anyone, for distribution as the court directs (for example, to the person from whom the profit was made or who suffered a loss).

It is clear that the FSA will not invariably resort to the market abuse regime in preference to the courts. On 11 February 2004 the Financial Times reported that the FSA had started its first criminal prosecution based on market abuse-type behaviour. This relates to three former directors of a listed company who issued a statement on the Regulatory News Service which is alleged to have been "misleading, false and deceptive" and designed to induce others to buy or sell shares. The statement was to the effect that turnover and profits were in line with market expectations. Subsequently the company issued a surprise profits warning which resulted in a fall of 80 per cent. in the company's share price. While these facts appear to fall within the scope of section 118 of FSMA, the FSA has chosen to proceed under criminal provisions which could lead to imprisonment or a fine, or both. There is also the possibility of restitution orders.

For further information, please contact Peter Smith on +44 (0) 20 7367 2816 or at [email protected]