Regulatory Recall: the case of Brandeis

Regulatory Recall: the case of Brandeis

Those who cannot remember the past are condemned to repeat it

Spanish philosopher George Santayana (1863-1952)

The central premise of thought leader Matthew Syed’s excellent book Black Box Thinking (Syed, 2016) is that learning from failure is the most powerful driver of advancement, be it scientific, entrepreneurial or organisational. We agree. This is why, in our ‘Regulatory Recall’ series (yes, in case you were wondering, the series title is inspired by the 1990 cult classic Total Recall directed by Paul Verhoeven and starring Arnold Schwarzenegger), we will be examining past risk incidents in the financial markets through the lens of the modern conduct focused world. We hope contemporary organisations will find these summaries helpful in navigating today’s regulatory expectations.

We start by taking a look at one of the last disciplinary cases heard by the Securities and Futures Authority (“SFA”) before its complete absorption into the Financial Services Authority (“FSA”) as a part of the Blair-Brown era reforms to financial regulation. If you are a ‘millennial’ or ‘generation Z’ employee of an entity trading on the London Metal Exchange (“LME”), you could be forgiven for having never heard of the SFA vs Brandeis (Brokers) Limited (2001). Accordingly, we provide a short summary of what this case involved and our thoughts on operational lessons for the modern regulatory environment.

The protagonists

  • Brandeis (Brokers) Limited (“BBL”), a former Ring Dealing Member of the LME.
  • Herbert Black and his associated companies, one of BBL’s most significant clients in the 1990s. Mr Black’s companies were major users of the LME .
  • The SFA, then a subsidiary of the Financial Services Authority (“FSA”).

The issue(s)

  • Primarily, the abuse of “dual capacity”. Dual capacity refers to a unique feature of LME trading, whereby a dealer simultaneously handles house and client transactions
  • Specifically, BBL was found by the SFA to have:
  1. ‘front run’ the orders of Mr Black’s entities for the benefit of its own account;
  2. mispriced executions given to Mr Black’s entities. Fills were given at prices much wider than were obtained by BBL in the market;
  3.  allowed confidential information about the pending orders of Mr Black’s entities to flow to its proprietary traders without restriction;
  4. by extension, almost non-existent systems and controls for:
  •  the managing the conflicts of interest inherent in the dual capacity model, particularly around adequate training, information barriers and surveillance; and
  • ensuring clients were given best execution.

The outcomes

  •    BBL ceased operations on the LME and its authorisation was formally withdrawn.
  •   BBL agreed to pay selected customers £1.75 million. Had it not done so, it would have been fined by the SFA.
  •  BBL’s copper dealer was determined not to be fit and proper and required to pay costs.
  •  BBL’s aluminium dealer was suspended from the then equivalent of the FCA Register for two years and required to pay a £25,000 fine and costs.

Operational lessons for senior managers, front offices and compliance professionals in the contemporary LME world

  • Considerations for material risk taker (“MRT”) assessments pursuant to the Senior Managers and Certification Regime (“SMCR”) and the Investment Firms Prudential Regime (“IFPR”):
  1.  there is a difference between dual capacity dealers and matched/riskless principal style futures brokers who only act on client instructions and do not run a ‘book’;
  2. additionally, dual capacity Ring dealers play a unique role in setting official prices – key benchmarks for physical market participants; and
  3. differences in order sizes between venues (floor versus electronic). The frequent handling of large order sizes that could move markets and the conference of wide discretion in how to manage them is likely to be indicative of greater potential conduct risk.
  4.  Have the unique features and inherent risks of ‘dual capacity’ been considered as a part of your firm’s role specific Conduct Rules training? It is possible that many ‘generation Z’ and ‘millennial’ employees have never heard of the Brandeis case. Although not a disciplinary case, dual capacity was also at the root of the matters alleged in the (reportedly) recently settled Red Kite Management Ltd vs Barclays Bank Plc (Farchy, 2017) civil case. This may also prove useful in training exercises.
  5.   Are the firm’s best execution arrangements tailored to meet the operational challenges posed by dual capacity? Have the effectiveness of these been tested by the second and third lines of defence?

A.C.Culley & Co. has substantial experience of implementing compliance programmes at LME firms. Please contact us today on enquiries@acculley.com if you would like any assistance with your LME compliance programme.

References

2001. SFA Expels Brandeis for mispricing and misuse of information [Online]. The Securities and Futures Authority. Available: https://webarchive.nationalarchives.gov.uk/ukgwa/20081112200208mp_/http://www.fsa.gov.uk/pubs/additional/sfa015-01.pdf [Accessed 30th September 2021].

FARCHY, J., BURTON, M. 2017. Barclays sued by £2bn hedge fund over alleged copper market rigging: Red Kite, whose co-founder is Tory peer, Lord Farmer, alleges that Barclays allowed staff to share confidential information about its positions with the bank’s traders. The Independent, 20th October 2017.

SYED, M. 2016. Black Box Thinking: Marginal Gains and the Secrets of High Performance John Murray Press.

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