FCA Merrill Lynch fine—pour encourager les autres?

To what extent is the Financial Conduct Authority’s (FCA’s) recent penalty against Merrill Lynch a warning to other firms about the consequences of transaction reporting failures? Rosali Pretorius, partner at Dentons, tells us why firms should be particularly concerned about this outcome.

Original news

Merrill Lynch fined £13.2m for reporting failures, LNB News 22/04/2015 113

The FCA has fined Merrill Lynch International £13,285,900 for incorrectly reporting transactions and failing to report other transactions between November 2007 and November 2014. It is the highest fine ever imposed for transaction reporting failures, reflecting the severity of Merrill Lynch’s misconduct.

What is the background to the enforcement action?

Several firms have failed to report transactions to the FCA since the introduction of transaction reporting under the Markets in Financial Instruments Directive 2004/39/EC (MiFID).

Between November 2007 and November 2014, Merrill Lynch committed 11 breaches. These can be categorised as:

• failure to report
• missing information
• providing incorrect information, such as incorrectly reflecting the booking vehicle
• providing information in the wrong fields

What did the FCA say about the breaches?

Despite taking actions to rectify the breaches the FCA said that Merrill Lynch had the resources to undertake correct reporting. Even the working group it established and the third-party specialist it brought in to assist made mistakes and did not identify nor rectify all the problems. The breaches were considered serious given the period over which they occurred and the number of breaches.

In terms of the penalty, part of it was set under the old regime which had a number of considerations but limited science in terms of calculating the fine. That part was set at circa £5.9m including a 30% reduction for reaching an early settlement.

The FCA has now put in place a five-step process for setting fines which was used for the period from 6 March 2010:

Disgorgement

How much did Merrill Lynch benefit from the breach?

Severity of the breach

Levels have been set from 1–5 with a percentage applied to the £1.50 per transaction—Merrill Lynch’s breaches were considered a high Level 4.

Mitigating versus aggravating factors

Aggravating factors included the number of times the FCA has warned Merrill Lynch, the other transaction reporting fines and the amount of guidance issued. These were weighed against mitigating factors such as the high level of resource Merrill Lynch devoted to rectifying the problems and its cooperation. Ultimately, the FCA uplifted the fine by 50% to c£10.5m.

Deterrence

The FCA did not consider it needed to increase the fine further for deterrence.

Settlement discount

As Merrill Lynch reached an early settlement, the fine for the later period was reduced by 30% to circa £7.4m.

The total fine therefore reached circa £13.3m.

Why is this enforcement particularly noteworthy?

The size of the fine is the highest for non-reporting or misreporting transactions, particularly in comparison with the previous transaction reporting fines. Previously they were in the region of £100,000–£2.5m and they have generally been increasing over time. In October 2014, the Royal Bank of Scotland received a fine of circa £5.6m (after a 30% reduction for settling early)—the then highest transaction reporting fine.

This circa £13.3m fine amount on Merrill Lynch reflects not only the severity of the breaches but also the need for a stronger deterrent. The basis of the fine was increased from £1 per failed report to £1.50 per failed report for the first time. This amount will now apply to all future transaction reporting fines.

The FCA made it clear that it is increasing the level fines because the previous levels did not act as an effective deterrent.

Should firms be concerned about the outcome in this case? What should lawyers advise their clients?

Firms that are required to report transactions should be concerned about the outcome of this case as the level of fines is likely to ratchet upwards (proportionately).

Where applicable, firms should also be reporting transactions under the European Markets Infrastructure Regulation (EU) 648/2012 (EMIR) separately to MiFID. EMIR catches a much broader range of derivative transactions under MiFID, which is currently limited to equity derivatives.

Head of the FCA’s over-the-counter (OTC) derivatives and post-trade policy, Tom Springbett, recently commented that not all firms were complying with EMIR transaction reporting and that a thematic review from the FCA is likely.

We predict that the next wave of fines will be linked to EMIR.

EMIR

EMIR is particularly problematic in two ways:

It has extra-territorial reach

Where EEA counterparties trade with non-EEA counterparties, transactions must be reported by the EEA counterparty. The problem here is that the EEA counterparty may have confidentiality obligations towards the non-EEA counterparty and it cannot rely on the blanket confidentiality waiver in EMIR as it can generally do when trading with other EEA counterparties. Therefore, some firms may have chosen to breach EMIR rather than breach confidentiality obligations by masking the data reported to trade repositories.

Under EMIR transactions reports are sent to trade repositories and not to the FCA

The FCA can obtain information from those repositories but this method of collecting data is too fragmented. There is a move to aggregate the data (see: Two major data projects launched by ESMA, LNB News 01/04/2015 130) but until then, it appears difficult for the FCA to police the reporting of transactions.

MiFID II

Under MiFID II (2014/65/EU), transaction reporting will apply to many more financial instruments transactions than under MiFID I. These provisions will come into force on 3 January 2017.

As firms have struggled to meet MiFID I requirements, it is likely that they will also struggle with MiFID II as it is much broader. Some firms may learn their lessons from the MiFID I fines and apply equity standards to other types of transactions. However, many firms view MiFID II requirements (such as the fields they are required to report) as too heavily based on equity transactions and many fields are unsuitable for other types of transactions, such as commodity derivatives.

In an unsympathetic approach to calls for guidance the message from the FCA is that, as firms did not provide input when drawing up the rules and those rules are now set, it is too late to amend them and firms will have to take appropriate steps to observe them.

Interviewed by Stephanie Boyer.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.