Upper Tribunal turns trader in its latest landmark spoofing case

The Upper Tribunal's recent decision in Gonzalez, Sheth and Urra v FCA has implications for market abuse compliance efforts of all market participants - in some cases reaching directly into the way that individual traders keep records of their trading strategies.

Three bond traders unsuccessfully challenged the FCA's decision in 2022 to fine and ban them for spoofing in the market for Italian bond futures between 1 June 2016 and 29 July 2016.

It's all about intention

Article 12 MAR (and, relevantly for this case, its UK predecessor) in essence prohibits transactions or orders which give or are likely to give false or misleading signals as to supply or demand, other than for legitimate reasons and in conformity with accepted market practices.

The Upper Tribunal considered that this has an objective element: what impression or signal was likely given? But crucially, it also has a subjective element: was the impression or signal false or misleading?  Put another way: did it differ from the trader's actual intention?  Specifically, here, did the trader place an order without actually intending to trade?

In the absence of evidence …

In this case the hearing took place over eight years after the relevant conduct. As a result, in practice, there was no contemporaneous evidence of the traders’ intention, and their recollections were limited.  The Upper Tribunal therefore made its assessment principally on the basis of data – both what they had (such as trading activity data, RFQs and SMARTS market data) and what they didn’t have (any contemporaneous communications evidencing the rationale for the trading strategies argued by the defendants).

Putting on a trader's hat

Mindful of the burden of proof (on the FCA) and the standard of proof (balance of probabilities – as this wasn’t a criminal case), the Upper Tribunal assessed the relative plausibility of the FCA's explanation (spoofing) and the traders' explanations (here, strategies of anticipatory hedging and/or obtaining information on other market participants' intentions).

Importantly, the Upper Tribunal didn't rule such strategies to be illegitimate in principle, which is unsurprising given both are common market practice. However, siding with the FCA, it concluded that they did not provide plausible explanations for the trading activity in question:

• The "information gathering strategy" explanation was implausible for large orders placed after-hours into a thin market, or for large orders with a short duration.
• The "anticipatory hedging strategy" explanation was implausible e.g. for large orders placed when, for this desk, the anticipated opposing order flow was unreliable as to time of day, volume and even direction.
• The explanations were less plausible if their execution involved potential or actual breaches of an applicable desk mandate.

Then, from findings about the traders' relevant industry experience, training and qualifications, the Upper Tribunal concluded not only that their intentions were contrary to the signals given (and therefore there was market abuse) but also that they knew this and therefore were acting dishonesty (upon which their industry bans rested).

Don't get caught short

The decision provides helpful indications of what the Upper Tribunal would have expected to see by way of contemporaneous evidence if the trading activity has been legitimate and in line with the posited strategies:

• Records of discussions with or approval from the Head of the relevant department, Compliance or Risk for the strategies, particularly where this is required by internal policies / procedures.
• Records or monitoring of plans and outcomes of the strategy – to test and evaluate the strategy. If an anticipatory hedge, how successful was it?  If information gathering, what if any information was obtained?

Firms might also revisit the coverage and effectiveness of their order and trade monitoring systems so that patterns of activity that on their face may raise regulatory eyebrows can be put to the desk in question for a prompt and documented explanation.

With market abuse enforcement risks often taking years to fully play out - and the questions they raise being highly subjective and fact-specific - the more contemporaneous paper you generate the better off you'll be.

Some penalty concessions

Whilst all three traders are still banned, two had their penalties reduced:

• Urra's penalty was based on his income in a relevant one-year period, and the Upper Tribunal decided it was appropriate only to include income earned in that period (as distinct from income paid or vested) – a welcome clarification on the calculation methodology.
• Sheth's penalty used £100k as a base (his income coming in under this), yet the Upper Tribunal found this to result in disproportionality between the individuals, and unusually, re-based his penalty on the ratio of his income to Lopez's income.