Clifford Chance

On 11 October the FCA published a Final Notice imposing a fine of £15.4m on Tullet Prebon for breaches of Principles, 2, 3 and 11.

We highlight key lessons from the case:

• The importance of the first line understanding and properly performing conduct oversight.
• The importance of the relationship between first and second lines and compliance monitoring.
• The importance of complying fully with FCA information requirements.

Background

The case concerned interdealer brokers in Tullet Prebon's name-passing broking business of its Rates Division entering into inappropriate wash trades and multiparty-switch trades with clients, intended to generate brokerage payments for Tullet Prebon, in some cases in connection with attempts to manipulate LIBOR. It also concerned inappropriate use of gifts and entertainment by Tullet Prebon brokers more broadly.

Failure in the First Line of Defence

The FCA found that senior managers in the first line failed to act with due skill care and diligence because they ignored clear red flags of inappropriate conduct.

For example, one senior manager, when told that a broker had agreed to cover the costs of a client trader's trip to California in return for the client trader entering a trade at an off-market price in order to assist Tullet Prebon in avoiding a loss, responded "It's f**king great news but I don't want to know about it either".

The FCA also found failures in systems and controls for first line monitoring. It was intended that the first line directors take on compliance responsibilities in overseeing broker conduct on the desks for which they had responsibility, but no explanations or training was given as to how they were expected to carry out this responsibility in practice, there were no policies or procedures in place for them to follow and there was an extremely limited relationship between the compliance department and the business.

There were no systems in place to check that attention was being paid to compliance issues and risk, or to check how risk was being managed within the business. As such there was ignorance on the part of the first line directors as to what was expected of them and the intended 'First Line of Defence' failed.

Failures in Compliance Monitoring

The Final Notice places great emphasis on failures in compliance monitoring.

The compliance department was the central function with responsibility for ensuring adequate controls around broker conduct were in place.

The FCA found that the compliance department failed to act with due skill are and diligence because it assumed for three years that the first line was using an electronic brokerage reporting systems to monitor brokerage from a risk perspective, but this assumption was wrong. There was nothing in place to embed the use of the system for this purpose or to check it was being used for this purpose.

Compliance did not take sufficient care to communicate with the business on compliance issues or establish an effective working relationship with senior managers.

There was no procedure or system in place for compliance to check that monitoring was being effectively carried out.

The compliance department had no involvement in monitoring entertainment expenditure at all and, to the extent this was monitored elsewhere, the monitoring focussed on cost control and paid no attention to compliance or risk of abuse.

Delay in disclosing key evidence

The FCA issued a statutory information requirement to Tullett Prebon requiring certain broker audio to be produced.

Tullet Prebon responded that the materials requested had been deleted in accordance with the firm's 12-month audio deletion policy. On the same day, a senior manager within the legal department was informed by the voice communications department that at least some of the recordings requested were available. However, this senior manager did not do anything following receipt of the information.

The FCA later expressly asked Tullett Prebon to check whether historic recordings were available despite the deletion policy. No such checks were carried out.

Two years after the FCA information requirement, the same senior manager within the legal department and a senior manager within the compliance department were informed by the voice communications department that broker audio from 2006 was retained.

It took a further six months for Tullet Prebon to inform the FCA of the availability of the data, in a notice which incorrectly implied that no one within the firm had known about the existence of the recordings previously, and that the discovery of the materials happened "by chance".

Conclusions

The FCA has long emphasised the importance of first line oversight in its disciplinary actions. The renewed emphasis placed on compliance responsibility for ensuring that oversight is, however, noteworthy, albeit not surprising. In light of the case second line functions will wish to reflect on whether they have sufficient comfort that the first line has sufficient awareness of its responsibilities and that systems are being used appropriately for conduct risk oversight.

As to Principle 11, the cases reemphasises the importance of diligence in responding to FCA enforcement investigations. The resulting fine for breach of Principle 11 was £4.9m after discount, meaning that nearly 30% of the overall penalty flowed from the conduct of the investigation itself rather than the underlying facts.