Linear Investments Ltd v Financial Conduct Authority [2019] UKUT 115

Linear Investments Limited v Financial Conduct Authority [2019] UKUT 115 (TCC) concerned a reference under section 208 of the Financial Services and Markets Act 2000 in which Linear Investments Limited appealed the quantum of a financial penalty imposed by the FCA for breach of Principle 3 of the Principles for Businesses. The Upper Tribunal (Tax and Chancery Chamber), comprising Judge Andrew Bartlett QC and lay members Martin Fraenkel and John Woodman, dismissed the appeal and confirmed that the appropriate penalty was £409,300.

This was the first reference arising from a Focused Resolution Agreement, a contract by which the parties agreed not to dispute the matters of fact and liability set out in sections 2 to 5 of the Authority’s draft Warning Notice. Under DEPP 6.7.3A, the FRA attracted a 30 per cent reduction to the penalty at step 5 of the five‑step penalty policy, so that the penalty before discount was £584,700. Linear, an FCA‑authorised brokerage firm offering trade execution and direct market access services, had failed during the period from 14 January 2013 to 9 August 2015 to take reasonable care to organise and control its affairs responsibly and effectively with adequate risk management systems for the detection and reporting of potential market abuse. The breach was serious: during much of the Relevant Period Linear had no post‑trade surveillance system of its own and relied instead on limited manual oversight and on surveillance conducted by its underlying brokers. When Linear’s business model changed and the volume of trades increased substantially to tens of thousands per month from mid‑January 2013, it failed to appreciate that the risks to which it was exposed had been elevated and that an automated post‑trade surveillance system was necessary. Linear mistakenly believed that its co‑operation with underlying brokers was sufficient to discharge its regulatory obligations. Only in November 2014 did it become aware of the need to conduct its own surveillance. It then sourced and deployed an automated post‑trade surveillance system in May 2015, but further time elapsed before the system was appropriately calibrated and tested. During that period Linear was obliged to disable certain alerts (relating to spoofing and insider dealing) and did not put suitable alternative surveillance in place. The system was not operating effectively with all alerts active until 9 August 2015.

Linear advanced five grounds of appeal. Ground 5 contended that the penalty was fundamentally inconsistent with the approach taken by the Authority in the IB UK Final Notice of 25 January 2018. The Tribunal examined that notice and concluded that there were too many material differences in the facts for it to be a useful comparator, in particular the fact that IB UK had post‑trade surveillance systems in place (albeit insufficiently focused on the nature of its UK business). Ground 1 challenged the use of gross revenue as the foundation for the step 2 calculation. Linear argued that revenue was not proportional to the risk, and alternatively that net revenue rather than gross revenue should be used. The Tribunal rejected both arguments. It held that revenue reflects both the number of transactions and their size and that as a broad starting point the level of risk is likely to be proportional to the volume of business. The Tribunal was not persuaded that net revenue is a better reflection of the relevant risks than gross revenue, emphasised that an overly nuanced approach to “relevant revenue” would diminish the transparency of the step 2 process, and noted that the use of gross revenue must remain subject to the overall judgment of proportionality in the circumstances of the particular case. The Tribunal was satisfied that there was no particular feature which in this case made the use of gross revenue inherently objectionable or led in itself to a disproportionate result.

Ground 2 contended that the Decision Notice substantially overstated the seriousness of the case and that it should have been assessed as level 2 rather than level 3. The Tribunal noted that the Decision Notice identified as a level 4 or 5 factor the fact that the breach revealed serious or systemic weaknesses in Linear’s procedures relating to a key part of its business, and fully agreed with that assessment. Market abuse is a serious matter; Linear’s core business involved obtaining access to the market on behalf of clients, and it needed a proper system of surveillance. Multiple reminders of the importance of such a system had been issued by the Authority. Linear failed to implement such a system from January 2013 to May 2015, during which there were tens of thousands of trades per month. The limited manual oversight was wholly inadequate. Linear had no system of its own and instead left it to others to monitor the transactions. The Decision Notice also identified three level 1, 2 or 3 factors: that no profits were made or losses avoided; that there was limited risk of loss caused to individual consumers, investors or other market users (though the breach could have had an adverse effect on the market by increasing the risk that market abuse would go undetected); and that the breach was committed negligently. The Tribunal took into account that the Authority had pleaded that Linear was in a significantly better position than the underlying brokers to carry out post‑trade monitoring. Linear denied this, pointing to the broker’s effective automated surveillance system, the broker’s awareness of the identity of Linear’s major client and the nature of its business, and the fact that only a modest number of alerts were generated and were followed up appropriately. The Tribunal accepted that there was some justification for these points but only to a quite limited extent. The broker’s automated surveillance system was calibrated to the nature of the broker’s business, not Linear’s business, which was significantly different. While it was an important feature that there was no contention that suspicious transactions were not reported or that abuse in fact occurred, the Tribunal considered that the surveillance carried out by the broker had limited significance in the assessment of Linear’s breach. The Tribunal weighed all the relevant factors and agreed with the Authority that level 3 was the appropriate level of seriousness. The negligence was of a serious kind in relation to a serious matter and was a key failing in the Applicant’s business model. The Tribunal saw no sufficient reason to adjust the figure of £649,713 reached by mechanical application of the 10 per cent rate appropriate to level 3.

Ground 3 contended that insufficient allowance was made for mitigating factors. The Authority had allowed a 10 per cent reduction at step 3, recognising that the delay in remediation was partly caused by unforeseen issues arising with the new automated monitoring system. Linear had not advanced any real argument for increasing this allowance for that factor. Linear relied on several other factors: its belief that its broker was carrying out sufficient surveillance; its prompt steps to secure compliance; its provision of significant time and resources to address the issues with the third‑party system; and more recent improvements. The Tribunal found no merit in any of these arguments. In so far as the first two referred to facts taken into account at step 2 or to the negligent belief (also reflected at step 2) or to the timing of remedial actions (reflected in the period of revenue considered), they were not additional mitigating factors. The provision of time and resources simply reflected the cost of compliance with regulatory obligations, and more recent improvements could not count as a mitigating factor in relation to the breach. Ground 4 contended that the penalty was disproportionate. Linear raised two points: first, that the size of the penalty equated its conduct with more serious conduct by others (relying on the comparison with IB UK, which the Tribunal had rejected); and secondly, that the penalty amounted to 30 per cent of net profit. The Tribunal was not persuaded. Market abuse and the implementation of effective monitoring measures to prevent or detect it are serious matters. The Tribunal did not consider the size of the penalty to be inappropriate in the circumstances of the case. Applying the 10 per cent mitigation reduction to the step 2 figure resulted in £584,741. The Tribunal did not consider that an increase for deterrence was required. Application of the agreed 30 per cent early settlement discount at step 5 resulted in the Authority’s final figure of £409,300 (rounded down).

In short, the Tribunal confirmed the penalty of £409,300 imposed by the FCA for a serious breach of Principle 3 arising from the absence of adequate post‑trade surveillance systems over a period of more than two years during which Linear executed substantial volumes of trades without monitoring for market abuse, and rejected all five grounds of appeal.

Carrimjee v FCA [2015] UKUT 0079