Enforcement watch: what are the key learnings from the recent FCA fine of Macquarie Bank’s London branch for fictitious trading?

The FCA has fined the London branch of Macquarie Bank Limited ("MBL") £13,031,400 for systems and controls failures relating to the oversight and control of trading positions in breach of Principle 3.  As a result, a trader on MBL's London Metals and Bulk Trading desk was able to conceal trading losses by recording over 400 fictitious trades for 20 months (the "Fictitious Trades").  The trader in question has also been banned.

The Fictitious Trades were recorded on MBL's internal systems as exchange traded but were not, in fact, entered into on the relevant exchange. As a result, there were no counterparties or other third parties impacted by the Fictitious Trades.  The trader's loss-making positions were unwound, giving rise to a loss to MBL of approximately USD 57.8 million.

Whilst certain aspects of this case are fact specific, there are some important takeaways for firms and senior managers in terms of supervision and oversight of controls around trading and junior traders.

Background

An external review of MBL's systems and controls to prevent and detect unauthorised trading was undertaken in December 2019, followed by a Skilled Person review in January 2020. An internal project was commenced to implement the recommended enhancements to systems and controls (referred to internally as Project Papa).

In June 2020, the trader was asked to de-risk his Freight book due to an escalation of losses and step back from taking on new risks for a two-week period. Instead, the trader started to book the Fictitious Trades which gave the appearance that his position had been de-risked as requested.

Various strategies were adopted by the trader to avoid detection, including leaving trades open for a number of days (trades left open at the end of the day being referred to as "breaks") and then cancelling, amending or backdating them. The trader ensured trades did not breach the threshold of USD50,000 above which they would have been investigated. Another strategy was to book trades with a future clearing date in order to avoid appearing in the End of Day ("EOD") futures reconciliation process and amending trades on an ongoing basis to another future date. The trader relied on a good working relationship with the operations team to avoid close scrutiny around the reason for the breaks. Falsified broker quotes were also provided by the trader in order to make his positions appear more profitable than they were, further conceal his loss-making positions and avoid detection of the Fictitious Trades.

Due to a range of governance and resourcing issues in relation to Project Papa, actions were not completed in time to mitigate the risk of unauthorised trading or the detection of the Fictitious Trades.

The Fictitious Trades were identified as a result of an internal routine risk control report. A meeting was arranged with the trader for the following day at which he admitted to the Fictitious Trades and taking steps to avoid their detection, resigning with immediate effect.

Explanations offered for the conduct included: a lack of liquidity (although accepting it would have been possible to de-risk in a matter of weeks); a desire not to disappoint the trader's supervisors; and an initial mistake made in response to the de-risk request which spiralled out of control. The trader was working from home at the time as a result of the Covid-19 pandemic.

Following an internal investigation, steps were taken to enhance systems and controls and the reductions were made to senior staff members' profit share.

Findings

In breach of Principle 3, the FCA found a number of trading systems and control failings by MBL including:

• Ineffective monitoring and investigation of discrepancies as part of the daily Profit & Loss reporting process.

• Inadequate design of the EOD reconciliation process which excluded trades with future clearing dates.

• Deficient Cancelled, Amended and Backdated ("CAB") reporting control which failed to report on exchange cleared future trades, together with a poor functioning CAB Committee.

• The process for the independent verification of broker quotes did not prevent unverified or falsified quotes from being submitted.

The trader was a Certified Person and his conduct was found to breach Individual Conduct Rule 1 (Integrity) and to lack fitness and propriety due to his dishonesty and lack of integrity. He was banned from the industry and would have been fined £103,700 (reduced to £72,600 for early settlement) had verifiable evidence of financial hardship not been submitted.

Mitigating factors taken into account in setting the level of penalty included the fact MBL immediately notified the FCA upon discovery of the Fictitious Trades, the high level of cooperation demonstrated by MBL with the FCA's investigation, including disclosing internal investigation reports into root causes of the Fictitious Trades and waiving any right to assert privilege over any material, which the FCA said gave rise to significant time and resource savings. Equally, a high degree of cooperation was shown by the trader who made full admissions without delay and engaged with subsequent requests in a frank and timely manner, which again the FCA said gave rise to significant time and resource savings.

Comments

Whilst the FCA makes no overt connection between the working from home arrangement in the early stages of the pandemic and the misconduct, the decision notice in respect of MBL refers to a lack of challenge or supervision in broad terms.

Commentary both from the regulator and observers during the pandemic (although predominantly specific to market abuse) highlighted the potential risks around the supervision of employees whilst working from home. Given the controls environment shortcomings summarised above, it is arguable that the Fictitious Trades could have arisen whether the trader was working from home or in the office. However, there remain potential learning points around the supervision of junior members of the team, together with broader trading controls takeaways.

Key learnings include:

• Where firms continue to have hybrid working arrangements in place, consideration should be given to whether risk assessments need to be revisited to reflect existing working arrangements.
• Consider how to supplement formal controls in place, particularly in relation to the supervision of junior members of the team. For example, consider whether there are frequent check-in conversations with supervisors, a number of routes to raise issues and seek guidance and the allocation of buddies and other peer support.
• Where de minimis thresholds for compliance checks are in place, consider whether other controls would identify unauthorised trading below the threshold or whether periodic random spot checks are required.
• Avoid reviewing trading anomalies in isolation and consider whether additional controls can be introduced that seek to identify emerging patterns (such as frequent cancellation of trades or threshold breaches by particular individuals).
• Consider whether management information is sufficient to enable senior managers to review the effectiveness of the trading controls.