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Court of Appeal decision on Code of Market Conduct

10 May 2010

The Court of Appeal decision in the case of Winterflood Securities Limited and ors v Financial Services Authority on 22 April 2010 marks not only a success for the FSA but also demonstrates today's harsher regulatory environment.


Winterflood was a market maker in the shares of an AIM-listed company called Fundamental-E Investments (FEI).  In its role as market maker, Winterflood entered into a large number of trades in FEI shares during 2003 and 2004.  These transactions were part of a share ramping scheme operated by a third party.  Winterflood was not a knowing participant in the share ramping scheme, although its involvement as market maker was critical to its success.

Winterflood accepted that its activities fell within the statutory definition of market abuse under section 118 of the Financial Services and Markets Act 2000 (FSMA) as it was then drafted.  However, it argued that the Code of Market Conduct (the Code) published by the FSA in effect created a further requirement on the FSA to show that Winterflood had intended (or had an "actuating purpose", ie a purpose which motivates or incites a person to act) to mislead or distort the market. Winterflood referred the matter to the Financial Services and Markets Tribunal (now part of the Upper Tribunal) on this issue, but was unsuccessful.  It then appealed to the Court of Appeal.


The first provision of the Code on which Winterflood relied stated that a transaction which creates a false or misleading impression will not normally be considered to have a legitimate commercial rationale if the purpose of the transaction was to induce others to trade or move the price of the security.  This purpose need not be the sole purpose for entering into the transaction, but must be an actuating purpose.  Winterflood also relied on a second provision of the Code which stated that behaviour will be market abuse if, among other things, it has the purpose of positioning prices at a distorted level. Again this purpose need not be the sole purpose, but must be an actuating purpose. 

In both cases, Winterflood argued that the Code was exclusive and that if Winterflood did not have an actuating purpose, which the FSA accepted it did not, it could not have committed market abuse.

The Court of Appeal focused on the distinction in the provisions of the Code between those provisions which describe behaviour that will not constitute market abuse (marked with a "C" in the Code), which are conclusive, and those provisions which are merely indicative of whether behaviour may be taken to amount to market abuse and are not conclusive (marked with an "E" in the Code).  Both provisions of the Code upon which Winterflood relied fell into the latter category.  The Court held that the provisions on which Winterflood relied should not be read as meaning that behaviour which either misleads or distorts the market would be market abuse only in cases where the transaction is motivated by an intention to achieve either of those results. 

The Court therefore dismissed the appeal and upheld the fines issued by the FSA: £4m in respect of Winterflood, and £200,000 and £50,000 respectively in respect of the two Winterflood traders involved. 


This case has a number of interesting aspects to it.  As we observed at the time of the Financial Services and Markets Tribunal decision, the Code has been interpreted narrowly in this case.  This means that a cautious and conservative view should be taken when attempting to construe its provisions.  Other than the specific safe harbours the Code identifies (marked "C"), it seems that if behaviour falls within the scope of the statutory test under FSMA, the other provisions of the Code may have some persuasive value but ultimately reliance on such provisions will not guarantee that a defence will be successful.

This is important, given the potential consequences of being found to have committed market abuse.  The penalty levied against Winterflood is high compared to its profit of approximately £900,000 from the relevant trades.  This fine was set in 2008 and is an early marker of the FSA's more aggressive approach in recent years.  Looking to the future, the FSA will now be setting penalties by reference to a new framework, which was introduced in March 2010.  This is anticipated to increase penalties and reserves the most serious of all fines for cases of market abuse.  In light of other Court of Appeal decisions in Fox Hayes v FSA, where the Court substantially increased the FSA's proposed fine, and in R v McQuoid, where the Court held that prosecution was to be expected in cases of insider dealing, it is clear that the courts are willing to support the FSA in this approach.   

Finally, the case highlights the importance of monitoring transactions for any warning signs.  The implication of the FSA's case was that Winterflood ought to have realised that the price of the shares was being manipulated.  In a further development, in September 2009, the FSA fined a trader £20,000 for his failure to observe proper standards of market conduct in that he had failed to observe that a transaction was being conducted on the basis of inside information, even though the trader had clear warning signals.  In such cases, the FSA clearly expects firms and approved persons to take action. 

Further information
For more information please contact Arnondo Chakrabarti, or tel + 44 (0)20 3088 4424, Davina Given, or tel +44 (0)20 3088 3768 or Vanessa Vegoda, or tel +44 (0)20 3088 2068).

This article first appeared on PLC Dispute Resolution.