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Australia – Suspicious Activity Reporting Market Participants.

29 July, 2012

 

Legal News & Analysis – Asia Pacific – Australia – Regulatory & Compliance

 

New market integrity rule – wolf in sheep's clothing? 

 

In brief
 
  • A new ASIC market integrity rule, which will come into effect on 20 January 2013, will require Market Participants of ASX and Chi-X to report suspicious trading activity.
  • The new rule introduces a standard which is materially different to that which applies to other self-reporting obligations. As drafted the new rule appears to allow ASIC to take enforcement action against a Market Participant where it ought reasonably have suspected inappropriate activity, even though the Market Participant did not in fact suspect anything at the time.
 
The Australian Securities and Investments Commission ("ASIC") has issued a new market integrity rule which will require Market Participants of ASX and Chi-X to report suspicious trading activity. The new rule (rule 5.11.1) comes into effect on 20 January 2013 and represents a significant change to the reporting requirements for Market Participants.
 
In conjunction with the new rule, ASIC has issued Regulatory Guide 238: Suspicious Activity Reporting ("RG238") which provides guidance on the rule. What activity must be reported? The new rule requires a Market Participant to notify ASIC in writing as soon as practicable if it has reasonable grounds to suspect that a person has placed an order or entered into a transaction:
 
  • while in possession of inside information; or
  • which has the effect of creating or maintaining an artificial price or a false or misleading appearance in the market or price for trading in financial products.
 
Such matters are referred to as "reportable matters".
 
In RG238 ASIC provides guidance on indicators which may alone or together give rise to reasonable grounds to suspect a reportable matter including, for example:
 
Insider dealing 
 
  • orders or transactions inconsistent with a client's or trader's recent prior history or risk profile
  • an order or transaction occurs immediately before a price sensitive announcement
  • an order is placed or a transaction entered into immediately after a client opens a new account
  • a client or trader opens simultaneous positions in related derivatives (eg CFDs, options or warrants)
  • a trading account receives a large transfer of money before an order is placed or a transaction entered into
  • a trader is an employee of the Market Participant and an order is placed, or transaction entered into, ahead of house of client orders in the same security
  • trading takes place prior to the release of a research report that has been prepared by the market participant.

 

Market manipulation/misleading appearance 

 

  • an order is placed near the close of the trading day or the last day of the month, quarter, half year or financial year 
  • an order is placed near the expiry date of related derivatives (eg options) 
  • a client or trader places matched orders-prearranged trades
  • a client or trader places multiple orders on the same side of the market at different price levels, which are just behind the best bid or ask (ie layering)
  • an order is for significant volume (possibly close to priority) and is then cancelled shortly thereafter
  • an order is for a significant volume close to priority, is followed by the execution of an order on the opposite side of the market, and the initial order is then cancelled.

 

When does the reporting obligation arise?

 

The obligation arises when the Market Participant has "reasonable grounds to suspect" that a reportable matter exists. In RG238, ASIC expresses the view that the test requires both a suspicion and a just cause for the suspicion (we discuss this below).

 

Whether there are reasonable grounds to suspect a reportable matter is a question of fact in each case. A reporting obligation may arise even without the Market Participant conducting exhaustive and conclusive investigations and if a suspicion is honest and reasonable, and based on facts that would create the suspicion. ASIC adds that it is not the role of the Market Participant to form a view as to whether there has been a breach of the Corporations Act 2001 (Cth) or the Market Integrity Rules. A Market Participant is expected to notify ASIC of reportable matters as soon as they occur and also matters identified during subsequent compliance reviews.

 

Other reporting obligations

 

The reporting obligation under Market Integrity Rule 5.11.1 is a separate obligation to other reporting obligations which exist under other regulatory requirements including, for example:

 

  • the obligation to report to AUSTRAC where the Market Participant suspects on reasonable grounds that an indictable offence may have been committed (noting that insider dealing and market manipulation and misconduct offences are indictable offences under the Corporations Act): section 41 of the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth) ("AML-CTF Act")
  • the obligation to report to ASIC significant contraventions by the Market Participant of financial services laws of which the participant becomes aware: section 912D of the Corporations Act
  • the obligation to report to ASX and Chi-X significant contraventions by the Market Participant of their operating rules of which the participant becomes aware: ASX rule 5000 and Chi-X rule 3.4.

 

In the past, where Market Participants have suspected clients have engaged in conduct which constitutes insider dealing or market misconduct, Market Participants have commonly taken the view that if the suspicion has a reasonable basis, the matter should be reported to AUSTRAC, but not necessarily ASIC.

 

The higher standard

 

The new reporting obligation would seem to set a standard which is higher than the similar reporting obligations referred to above.

 

Under the AML-CTF Act, the reporting obligation only arises where the Market Participant actually forms the relevant suspicion, subject to that suspicion having a reasonable basis. In relation to significant contravention reporting under the Corporations Act and the ASX and Chi-X rules, the obligation to report only arises when the participant becomes aware of the contravention.

 

As noted above, ASIC has expressed the view that the test requires both a suspicion and a just cause for the suspicion. If ASIC is right, then in practical terms the test under the Market Integrity Rules is the same standard as under the AML-CTF Act. However, we consider that ASIC's guidance is inconsistent with the wording of the new rule.

 

This new test is purely objective – the reporting obligation arises regardless of whether the Market Participant actually forms the relevant suspicion. If there were reasonable grounds for the Market Participant to form the suspicion, and the suspicion is not formed and no report is made, the Market Participant will have contravened the rule. In other words, if with the benefit of hindsight, the circumstances were such that a Market Participant would have, acting reasonably, suspected a reportable matter, the Market Participant concerned will have contravened the rule by not reporting the matter previously.

 

So the bottom line is that if, after the event, it becomes apparent that a client of a Market Participant has engaged in insider dealing or market misconduct, and the Market Participant did not report it, ASIC may commence proceedings against the Market Participant under rule 5.11.1 if it considers that there were reasonable grounds upon which the Market Participant should have suspected it, and failed to report. That so even if the Market Participant did not in fact suspect anything at the time.

 

It would be preferable for the rule to be amended that there is only a reporting obligation where a Market Participant "suspects on reasonable grounds" such wording would bring the rule into line with ASIC's guidance and the apparent intention, and clearly the test on the same footing as under the AML-CTF Act. It would be also be fairer, by not exposing Market Participants where they quite innocently did not form the relevant suspicion.

 

Accordingly, Market Participants will need to ensure they have compliance arrangements in place to facilitate the detection of reportable matters, so as enable them to actually form the relevant suspicion relation to matters which might be found to be reportable matters. It will be interesting to see how ASIC seeks to enforce rule 5.11.1 in light of its guidance in RG 238.

 
 
For further information, please contact:
 
Jonathan Gordon, Partner, Ashurst
jonathan.gordon@ashurst.com
 
Don Maloney, Partner, Ashurst
don.maloney@ashurst.com
 
Andrew Carter, Partner, Ashurst
andrew.carter@ashurst.com
 
Sonia Tame, Partner, Ashurst
sonia.tame@ashurst.com

 

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