A £14m FCA insider dealing investigation that culminated in a prison sentence for two defendants is expected to give the watchdog confidence to tackle complex criminal proceedings in the future.
Former investment banker Martyn Dodgson and chartered accountant Andrew Hind were sentenced last week following the conclusion of Operation Tabernula, the regulator’s largest-ever insider dealing investigation spanning more than eight years.
The latest convictions follow three previous Operation Tabernula convictions: Paul Milsom in 2013, and Graeme Shelley and Julian Rifat in 2014.
However, three of the five defendants awaiting a verdict at Southwark Crown last week were acquitted leading to the FCA having to justify the operation’s success.
FCA wholesale enforcement head Therese Chambers says: “The [wealth] of circumstantial evidence which created an enormous patchwork and jigsaw the jury had to digest over a three-month period – much of which was highly technical information – even to secure a single conviction is a tremendous success.”
While these headline-grabbing investigations show the regulator has teeth, internal resourcing constraints and the unpredictable nature of jury trials have led to questions around whether such enforcement activity will have a place in the regulator’s future.
The FCA and its predecessor the FSA have secured 30 insider dealing convictions, including Dodgson and Hind, while there have been 10 acquittals. Criminal prosecution is just one avenue for FCA enforcement, with the regulator also pursuing individuals and firms through its civil or regulatory powers.
Enforcement takes up a relatively modest chunk of the regulator’s annual operating costs with an estimated £8.3m out of a total budget of £502.9m in 2016/17.
“I suspect the FCA will continue to do these sorts of cases because they can show success. Headline-grabbing cases will be trans-mitted to market”
RPC regulatory counsel Marcus Bonnell says previously the regulator was accused of shying away from complex cases but that criticism cannot be levelled over Operation Tabernula.
He adds: “It is significant to decision-making within the FCA what cases to take and the level of attention they will attract because when you are trying to change behaviour it is all about delivering messages effectively.
“I suspect it will continue to do these sorts of cases because they can show success far more than with the smaller cases. If you are allocating resource then the headline-grabbing cases are the ones that will be transmitted to the market.”
Independent regulatory consultant Richard Hobbs says the “deterrent effect” means regulators cannot avoid high-profile, high-risk enforcement action.
However, such proceedings also present significant hurdles for prosecuting authorities, in particular, the unpredictable nature of jury trials.
Hobbs says: “The big problem, and this has dogged the Serious Fraud Office and FCA action particularly with large financial institutions, is the cases presented are very difficult for an average jury to understand.
“The idea that the consequence of trying and failing is that you just give up or try lower risk investigations is poor public policy. [The FCA] has to keep on doing it and it has to take the consequences.”
Law firm Pinsent Masons senior associate Michael Ruck considers the FCA will be disappointed with the Tabernula acquittals but that the regulator should not be put off.
He says: “Any regulator or prosecutor has to be willing to lose. They have got to not be afraid to step forward now and say they did the right thing.”
Indeed, Chambers says the FCA has an appetite to continue large-scale investigations.
“The level of support we got from the National Crime Agency in investigating this case demonstrates the wider appetite of UK law enforcement to assist in this type of enterprise.”
She says Operation Tabernula was running in conjunction with other enforcement proceedings, with staff working across multiple projects.
“I am never going to say don’t give me any more resource. We have significant resource and we resourced this investigation at the same time we were funding multiple other investigations in the realm of insider dealing and more generally in the FCA’s enforcement remit. It is not true that doing a case like this means we cannot do anything else. We have a lot of things going on at the same time.”
Irwin Mitchell partner Sarah Wallace adds it is possible Hind and Dodgson will pay a portion of the £14m spent by the FCA on the investigation but notes that the four-and-a-half-year prison sentence handed to Dodgson was significantly less than those imposed in the US for securities fraud, which have been in double figures.
Drop in skilled persons reports
At the same time, one of the FCA‘s other regulatory tools seems to be falling out of favour. The number of s166 skilled persons reports issued by the FCA has significantly dropped since the regulator was established in 2013. While s166 reports are considered a supervisory rather than an enforcement tool, they can be a precursor to enforcement activity.
In 2012/13 the FCA issued 113 s166 reports, a figure that dropped to 52 the following year. Last year 42 reports were commissioned.
Ruck considers the reduction in reports is a result of the FCA suggesting to firms they should improve their practice before a skilled person review is imposed.
He says: “Now we have firms more inclined to have done internal reviews or have external compliance [officers] come in and do a review before the FCA comes to do a s166.”
Bonnell adds that the expense of a review means the regulator has to be able to justify it as a proportionate response. He explains: “Perhaps more firms are challenging the regulator on this. It may also be indicative of firms being more proactive in undertaking their own pseudo-s166 to dissuade the FCA from imposing [such action].”
Surveillance, phone-tapping and code cracking: How the FCA gathered its evidence
Investigators working on Operation Tabernula used several techniques to gather the evidence required to bring Dodgson, Hind and the three acquitted defendants – Andrew Harrison, Ben Anderson and Iraj Parvizi – to trial.
During the course of the investigation 485 applications were made under the Regulation of Investigatory Powers Act 2000 leading to the seizure of 120 devices. The trial featured nearly 30 pay-as-you-go phones whose data was used to show the suspects were meeting at certain times when cash was traded.
The investigators also used broker data from firms to compare to notes made by Anderson.
FCA associate Richard Littlechild says: “That was a massive task. We had over 120 accounts of more than 30 brokers and it ran on to almost 200,000 lines of data we had to analyse and organise. It took us over a year to really get a grasp on what was going on. The outcome of all of this was we got to what became known as the ‘Anderson/Hind list [which was] Anderson’s record of the trading he did on behalf of Hind.”
The investigation also involved trawling through a significant amount of digital data.
Technical specialist Damien Dewildt explains his team gathered nearly 600 digital items including phones, laptops, tablets, computers and hard drives obtained through search warrants. There was a significant amount of information collected from firms such as emails, Bloomberg chats and trading records amounting to more than 10 million individual files. Throughout its course, 27 members of Dewildt’s team worked on the investigation.
Hind was particularly concerned about the privacy of his data and used apps and encrypted USB sticks called Iron Keys, developed for use by the US military, to protect information.
Dewildt says: “It is clear Hind wanted to stay off the grid to avoid detection by agencies like us. He kept some notes on his iPhone and iPod Touch with his plans on how to do this.”
The investigators gained access to a password-saving app on Hind’s phone called Splash ID as well as an app called Splash Money that stores financial information relating to bank accounts and assets. However, finding the passwords for the five Iron Keys that were seized proved challenging as they were not listed on Splash ID. Furthermore, if a password is entered into an Iron Key incorrectly 10 times the device “self-destructs” and the data is lost. The investigation team managed to access Dodgson’s Iron Key – after discovering in an email his password was Lamborghini55 – but not Hind’s.
The team also used surveillance and phone bugs to identify suspects in the early stages of the investigation.
Littlechild says: “The bug picked up Anderson and Parvizi discussing Hind’s trading and they described that Hind’s man was someone who had worked at Morgan Stanley, then Lehman’s, then Deutsche. Later that day we had pictures of Parvizi and Hind in Hind’s car looking through notes of trading he had just been discussing in Anderson’s office.
“We had identified Hind as the potential middle man so we could obtain Hind’s telephone records and we could do a lot more work on Hind. As a result of that his records led us to Martyn Dodgson and his employment profile fitted the Morgan Stanley, Lehman’s, Deutsche Bank history perfectly.”