Under the Microscope: Organized Crime's Growing Influence in Financial Markets

Market abuse and insider trading may often be associated with nefarious TV hedge funds, slick-haired Hollywood characters or, simply, bad actors making opportunistic decisions. However, recent publications and notices from the UK Financial Conduct Authority (FCA) may point to the increasingly treacherous and shrouded world of criminal enterprises targeting the UK financial services sector, meaning market surveillance must, in turn, become more sophisticated and consider a far broader range of information.

In its recent Market Watch 77 newsletter, the FCA warns of indicators that so-called “Organized Crime Groups” (OCGs) may form a significant proportion of those committing market abuse, and in particular, insider trading through UK-regulated firms. As defined in the Serious Crime Act 2015, “an OCG is a group consisting of three or more persons, who act or agree to act together, to further the purpose of carrying out criminal activities.”

As the FCA ramps up its supervisory and enforcement efforts to take assertive action against market abuse, it should be no surprise then to see the FCA issue various press releases regarding multiple arrests of OCG members, successful court cases and sentencing linked to market abuse.

While market abuse and the wider aspects of financial crime have long been a foundational area of concern for the FCA, this flurry of activity appears to indicate an uptick in scrutiny by the UK regulator. Regulated firms are being put on notice to review not only how effective their market surveillance and financial crime controls are but also to ensure that these often-disparate areas are working together to pool data and create an accurate picture of connected clients, potentially suspicious behaviors and trading anomalies. Failure to do so may result in an institution becoming the broker of choice for an entirely unwanted clientele.

With the issuance of Market Watch 77, the FCA is clearly demonstrating that it expects firms to adopt a more integrated and holistic approach to the oversight and monitoring of potential market abuse indicators, including working proactively with front-office staff and financial crime teams. While market surveillance systems may flag up specific trades or behaviors based on certain triggers, escalation of such activities to the level of a Suspicious Transaction or Order Report (STOR) or a Suspicious Activity Report (SAR) will require a more holistic view and assessment to determine whether the often subjective “suspicious” threshold is met. As OCGs and other bad actors continue to find new, smarter ways to abuse the financial market through UK-regulated firms, it is incumbent on these firms to deploy smarter ways to detect and investigate potential market abuse to avoid becoming a weak link that can be exploited.

For example, the FCA expects firms to tie together not only patterns of STORs from individual clients but also to recognize patterns and connections between current or former clients and other connected ties. This will require close interactions between the market surveillance and financial crime teams who perform know-your-customer (KYC) and anti-money laundering (AML) checks on clients at the onboarding stage, as well as ongoing monitoring and review of clients, their transactions and payments.

The other aspect of a firm’s holistic review of market abuse risks and controls is to identify those within the firm that may be at risk of being approached by the aforementioned OCGs. Firms should consider those individuals who are regularly exposed to inside information and those who publicize having access to inside information on their social media profiles. As the FCA warned, junior members of staff in these roles are often the key targets for OCGs to extract information. Therefore, appropriate and targeted measures for these individuals may be required, including specific training, policy on social media content and social media monitoring.

The question of subjectivity when assessing and reporting STORs and SARs is also exacerbated should a firm maintain a “5 STORs and you’re out” rule or variant upon this. At what point does the risk become too big for a firm to continue having relations with a client? Firms will need to navigate the balance and conflicts of interest very carefully and conservatively between terminating clients based on thresholds of suspicion and commerciality. The FCA makes it very clear in Market Watch 77, this should be based on “very low thresholds of suspicion.”

The FCA has acknowledged concerns regarding the risk of “tipping off” and interactions between compliance and market surveillance teams and front-office professionals. Although the risk of “tipping off" will always need to be managed, the FCA expects the business to take ownership of the market abuse risks to which they are exposed and to have a proactive and open engagement with compliance teams to prevent and detect market abuse. By way of further educating front-office staff through robust training, the FCA has suggested in the past that real-life examples be used to clearly demonstrate an individual’s obligation as an employee of a regulated firm.

What Should Firms Do?

Firms need to ensure that their market surveillance and financial crime controls work together to pool critical data and due diligence processes in a way that enables them to identify suspicious behaviors, patterns and connections across a broader range of data points than just trading activities.

Notwithstanding well-known indicators of potential market abuse, there are additional red flags that require better cooperation between market surveillance and financial crime teams to identify, investigate and respond to, including but not limited to:

• Connections between current and/or former clients who trade in the same security under unusual and unexpected circumstances
• Links between current and / or former clients, including those with familial or connected ties, and where the firm has concerns, or whose trades have resulted in STORs or a pattern of STORs
• Connections between clients who have generated STORs and employees or related brokers who may regularly have access to inside information
• Connections between current or former clients or overseas brokers from higher risk jurisdictions who regularly trigger market surveillance alerts and further investigations
• Other patterns such as the use of the same brokers, potentially in jurisdictions that do not display equivalent standards of safeguards to UK firms
• Identical / connected entities within a complex ownership structure
• Links between current clients and former clients who have been offboarded due to concerns around trading patterns, preventing further abuse of the financial system through the simple opening of accounts in various names.

It should be noted that while some financial institutions may view their exposure to market abuse as limited, perhaps operating exclusively across the private markets, the levels of inside information that these firms have access to does open the door to potential abuse. Provision of robust training and reminders of obligations around the risks of market abuse, both to employees and clients, should be provided ensuring individuals are aware of the risks and implications of engaging with OCGs.

Those with good memories may remember Project Tabernula, which was the last successful joint crackdown by the FCA and National Crime Agency (NCA) of a criminal insider dealing ring in 2016. This investigation led to the convictions of six individuals and spanned over eight years with 46 binders of evidence and over 320 hours of surveillance audios. This demonstrates just how difficult and resource-intensive market abuse and collusive trading committed by these OCGs can be to investigate. With the recent market abuse investigations and convictions, it is clear that the regulators have not let up on their monitoring and therefore, why regulated firms should demonstrate similar tenacity and endurance in their own efforts to combat financial crime. While it has always been arguable if greed really was “good,” it is clear that the authorities are striving to ensure that financial crime will not pay in the long run. The market may just have been put on notice once again.

How Can Kroll Help

Speak to our market surveillance and financial crime experts to learn more about how we advise and support firms in their design, implementation and remediation of market surveillance and financial crime frameworks and arrangements across all financial sectors.