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Regulators around the world are keen to prevent market abuse from creating distrust in the financial system. This endeavour has led to various pieces of legislation within different territories that place obligations on market participants. As well as financial services organisations needing to be alert to misconduct carried out by clients, there are also considerable risks relating to personal account dealing (PAD) by employees.
In the United Kingdom, the Financial Conduct Authority (FCA) expressed concerns in 2019 about “how often we are seeing apparent breaches of PAD policies and the issues which have come to light as a result.” Following this statement, the authority has conducted reviews and investigations into the PAD processes at a range of financial firms and issued guidance on best practices for businesses that fall within the scope of the various pieces of relevant legislation currently enacted in the UK.
This article explores the obligations of UK investment firms, stock brokers and other financial institutions with regard to monitoring employees’ personal account dealing.
1. FCA’s definition of Personal Account Dealing (PAD)
Personal Account Dealing, or employee personal trading, is defined by the FCA as “where employees of an authorised firm trade for themselves rather than for clients.” This includes anyone who works for “the designated investment business of a firm in relation to activities carried on from an establishment in the United Kingdom.”
The reason for highlighting the risks posed by anyone working at an investment firm, or at the investment arm of another business or group, is that they are in a unique position to commit certain types of market abuse or misconduct when carrying out their duties.
PAD refers to the actions taken around the employee’s personal portfolio and ensuring that they do not infringe on their professional duties.
2. Why is FCA oversight becoming stricter?
As financial markets are becoming more complex, with digital communication leading to ever-faster distribution of information, the potential for conflicts of interest and unethical behaviour increases.
The FCA has been increasing its oversight on PAD to ensure that financial professionals don’t engage in actions that could negatively impact market integrity or consumer trust. The authority says that its rules on employee trade monitoring “create a control framework for firms to minimise the risk that such trading:
- conflicts with the interest of their clients
- results in market abuse including front-running client orders
- or creates a conflict between employees’ personal interest and their regulatory obligations to report suspicious transactions or orders.”
For example, if an employee was providing advice to a client about investments, without adequate controls, they could provide suboptimal information if the best investment for the client might negatively impact the employee’s own investments.
In addition, the knowledge that a client was going to make a large investment could lead an employee to buy stock in the target issuer, anticipating that its value would increase after the client’s investment. This and other forms of insider dealing, once exposed, can lead to a loss of trust in the markets and that is why the FCA is keen to prevent it.
3. Legislation that relates to PAD
| Legislation | Explanation |
| COBS 11.7 and COBS 11.7A | The FCA’s Conduct of Business Sourcebook collates the relevant compliance information required by companies that sell activities relating to long-term insurance or that are designated investment businesses. The sections COBS 11.7 and COBS 11.7A outline obligations relating to personal account dealing. |
| FCA Principles for Business | A number of the FCA’s Principles of Business apply to investment firms and Personal Account Dealing. These include the requirements that “a firm must conduct its business with integrity,” “a firm must pay due regard to the interests of its customers and treat them fairly” and “a firm must manage conflicts of interest fairly.” |
| APER 4.1 Statement of Principle 1 | The first statement of principle for approved persons – those who meet the FCA requirements to carry out what are called ‘controlled activities’ – states that “an approved person must act with integrity in carrying out his accountable functions.” This includes not misleading clients, falsifying documents, “deliberately recommending an investment to a customer, or carrying out a discretionary transaction for a customer where the approved person knows that they are unable to justify its suitability for that customer” and other examples of misconduct. |
| APER 4.2 Statement of Principle 2 | The second statement of principle is concerned with the requirement that “an approved person must act with due skill, care and diligence in carrying out his accountable functions.” This forbids approved persons from failing to inform clients of material information in circumstances where they did or should have known about that information. It also encompasses failing to disclose a conflict of interest among other clauses. |
|
Market Abuse |
The European Union introduced the Market Abuse Regulation in 2016 and the UK onshored the legislation following its exit from the EU. UK MAR prohibits insider dealing and the misuse of inside information, which employees might be party to in their role. |
| Markets in Financial Instruments Directive (MiFID II) | The Markets in Financial Instruments Directive II was also onshored from the EU after Brexit. It states that investment firms must ensure employees do not make personal transactions that use inside information or form a conflict of interest with the firm’s obligations. |
4. FCA’s latest updates
Market Watch is the FCA’s newsletter on market conduct and transaction reporting issues. It communicates details of investigations and reviews, providing outcomes and guidance for firms on such matters.
- Market Watch 62 – The FCA reported on its analysis of suspicious transaction and order reports (STORs) and transaction reports, expressing concern at the breaches of companies’ PAD policies. These were found to result from both ignorance of the policies and, in some cases, wilful misconduct.
The update made it clear to firms that they should ensure their employees understood their employee personal trading policy through training. Some employees, the FCA found, had signed documents that they were familiar with the firm’s policy, yet their actions were not in compliance with it.
- Market Watch 69 – The FCA reported that companies were approaching compliance risk in a range of different ways, and it was concerned that some investment firms were failing to manage potential employee trading concerns effectively because they did not calibrate their risk alert scenarios for each different type of risk, either related to PADs or to clients. They merely calibrated thresholds based on macro rather than micro ricks elements.
The update also reminded companies of the importance of issuing STORs immediately and not informing the subject of the trade that the report had been made. The FCA confirmed that it is appropriate to issue the STOR before the internal investigation takes place and that firms can then communicate additional information once it has been assessed.
5. How to manage Personal Account Dealing
5.1 Create PAD and conflict of interest policies
Help your employees understand what is expected of them and why the company puts in place certain restrictions on their personal trades. You should be clear about your expectations on both PADs and what happens in the event of a conflict of interest.
Add context so that employees understand these are not rules for the sake of having rules, and set out clearly the process they must take when making personal trades or if they find themselves with a conflict of interest.
Upload these documents to a shared workspace so they are always accessible.
5.2 Break down your risks
The FCA found that some firms only assessed the risk level of market abuse as a whole, without considering the many different types of market abuse that carry varying degrees of risk depending on the firm.
Even where there was some differentiation between types of market abuse, many firms failed to look into granular detail. Insider trading and market manipulation are types of market abuse, but within them, there are a variety of offences, such as wash trading, front-running, layering and spoofing, and more. Firms must understand their risk of non-compliance for each type of activity.
5.3 Extend lookback periods
During its research, the FCA discovered that, even if companies had identified potential insider dealing as a major concern, some of them only implemented a ‘lookback period’ of 24 hours before the release of inside information. This meant they only monitored trades that had taken place in that timeframe to assess the likelihood of misconduct. This remained the case, even if the inside information had existed for longer than 24 hours before it was released.
By extending the lookback period, you gain a clearer picture of whether insider dealing is occurring.
5.4 Submit STOR without delay
It is a requirement of UK MAR that companies issue a STOR as soon as they spot a suspicious transaction. They should not delay until they carry out an investigation. STORs are required for potential infringements as stated in Article 16 of UK MAR:
“Where such a person has a reasonable suspicion that an order or transaction in any financial instrument, whether placed or executed on or outside a trading
venue, could constitute insider dealing, market manipulation or attempted insider dealing or market manipulation, the person shall notify the competent authority.”
5.5 Establish a pre-clearance process
Obliging employees to run their prospective personal trades through a pre-clearance process helps the company monitor their trading, as well as helping the individual understand which financial products are and are not eligible.
Using a tool such as TradeLog, you set the parameters to restrict trading in certain products, due to a conflict of interest with the company, a conflict of interest with a client or the potential for insider dealing, for example. When employees try to run the trade through the platform, they find that they are simply not allowed to request a trade for certain securities.
The platform can also provide information on why these trades are restricted, helping employees understand the reasoning.
5.6 Invest in employee training
Most companies have PAD policies, but the FCA found that even getting employees to sign an agreement to say they understand the policy does not mean that they really are aware of their obligations and the reasons behind them.
In order to prevent many of the non-compliant trades made on personal accounts unintentionally, companies can require employees to undertake training on market abuse compliance. The practical nature of these sessions means that they are more likely to remember the key requirements of the policy than they are if they simply scroll down a wall of text. Ignorance of the rules was found to be behind a proportion of the contraventions, so finding a way to impart the information more clearly can be an effective tool.
Training and education on how to spot suspicious trades and how to report them is another way that companies can reduce misconduct from personal account dealing.
5.7 Create a speak-up culture
When employees understand that the organisation values compliance and encourages people to report misconduct, it means that you are more likely to find out about infringements early and stop them before they cause too much damage.
You should show buy-in from the top for a speak-up culture, rewarding those who help to maintain compliance with anti-market abuse legislation.
Implement a confidential and user-friendly whistleblowing reporting channel that allows employees to make reports, safe in the knowledge their identity will be protected and the company will investigate the matter fully.
6. FAQs
6.1 What are the penalties for non-compliance with Personal Account Dealing rules?
Non-compliance with Personal Account Dealing rules can result in a range of penalties and other sanctions from the FCA:
- For individuals, this may include fines, suspension or the revocation of licences and, in severe cases, imprisonment.
- For firms, penalties can include hefty fines, reputational damage and increased scrutiny from regulatory bodies. In some instances, firms may also face class action lawsuits if their non-compliance adversely affected clients.
6.2 How often should personal account dealing policies be reviewed and updated?
You should review Personal Account Dealing policies at least annually. However, it’s advisable to review and update them more frequently if there are changes in the regulatory environment, or if the firm undergoes significant changes such as entering new markets, offering new products or altering its business model.
Continuous monitoring and periodic assessments are essential to ensure that PAD policies remain effective and compliant with the latest regulations.
6.3 What is the role of technology in improving Personal Account Dealing compliance?
Technology plays a pivotal role in improving Personal Account Dealing compliance. Modern compliance solutions can automate many of the monitoring and reporting tasks that are essential for PAD compliance.
For instance:
- Log employees’ trading activities to create an audit trail, ensuring that they comply with company policies and regulatory requirements.
- AI and machine learning algorithms can be employed to detect unusual trading patterns, which might indicate insider trading or other non-compliant activities.
- Digital pre-clearance systems, such as TradeLog, can streamline the process of obtaining necessary approvals for personal trades.
- Training and education can be used to ensure employees are up-to-date on PAD policies and regulations.
This type of technology enhances the efficiency and effectiveness of compliance programmes, making it easier for firms to adhere to PAD rules.
7. Conclusion
Personal Account Dealing is a major risk for potential market abuse activity within financial firms and requires mitigation. There are a number of procedures compliance teams can implement to reduce this risk, including requiring employees to run their prospective trades through a pre-clearance process.
TradeLog automates pre-clearance thanks to the parameters you input. Employees can discover which trades are restricted immediately on this user-friendly platform, ensuring they can make authorised trades in good time. And the compliance team benefits from a streamlined pre-clearance and detection process, along with advanced record keeping to show the steps they have taken to reduce PAD abuse. Request a demo of TradeLog for your company today.
8. References and further reading
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Article Summary
- 1. FCA’s definition of personal account dealing (PAD)
- 2. Why is FCA oversight becoming stricter?
- 3. Legislation that relates to PAD
- 4. FCA’s latest updates
- 5. How to manage personal account dealing
- 5.1 Create PAD and conflict of interest policies
- 5.2 Break down your risks
- 5.3 Extend lookback periods
- 5.4 Submit STOR without delay
- 5.5 Establish a pre-clearance process
- 5.6 Invest in employee training
- 5.7 Create a speak-up culture
- 6. FAQs
- 6.1 What are the penalties for non-compliance with personal account dealing rules?
- 6.2 How often should personal account dealing policies be reviewed and updated?
- 6.3 What is the role of technology in improving personal account dealing compliance?
- 7. Conclusion
- 8. References and further reading
