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Comment: Coppicing the hedge - the FSA's update on anti-market abuse systems and controls

Steven Francis (photo) and Richard Burger, former FSA enforcement lawyers now with City law firm Reynolds Porter Chamberlain, say the UK regulator's latest report on anti-market abuse systems at hedge funds should help ward off some criticism of the industry, but highlights areas in which managers still need to improve practices.

Following on from visits conducted last year, the Financial Services Authority has again reported on anti-market abuse systems and controls in hedge funds. The FSA took the view that hedge funds 'appeared to have given reasonable consideration to market abuse issues' but nevertheless identified areas of concern.

The FSA expects to see a compliance function that is independent of the core business of the fund. That does not mean that a small boutique fund manager will need to acquire a large in-house compliance function. Much can be achieved through external consultants, though the firm must not be over-reliant on them - ultimately it is the firm's responsibility to ensure that its controls are sufficiently stringent and are being followed.

The FSA identified clear desk practices as a concern - a policy is not enough. Compliance with it must be monitored and disciplinary action taken against offenders.

External IT consultants should not have access to price-sensitive information. Departures from this rule can be justified in exceptional circumstances and only if the consultant is made subject to the same restrictions on dealing as apply to the fund's employees.

The FSA was surprised at the low level of reporting of accidental disclosures of inside information, for example when funds communicate with industry analysts or customers prior to dealing. The regulator commented: 'In our view, firms cannot simply presume few [accidental disclosures] have occurred because few are reported.'

Care should be taken with restricted lists, the circulation of which present an obvious risk. They should be sent only to those who need to see them.

The FSA thought monitoring procedures could be improved. It makes obvious sense to focus monitoring effort on trades done around announcements and valuation dates. For monitoring an active day-trading fund, end of day positions may be insufficient.

While the FSA was generally pleased with the articulated commitment to training, it highlighted some important points. It is not acceptable to rely on the fact that an employee has (or says he has) received training from a previous employer. Training in market abuse avoidance should be conducted regularly, not just once. And funds need to be sure that the key training messages have been communicated. Reliance cannot be placed on employees' signed undertakings that they understand the firm's procedures.

The FSA noted that few funds had mobile phone policies. Unhelpfully, though, it didn't say what a policy should contain. At the very least funds should require individuals to receive and make important calls on taped lines and should draw negative inferences from employees who receive or make work-related calls on their mobile phones when they are at the workplace.

The FSA's report will certainly play its part in warding off some of the criticism that has been directed at the industry. That said, as standard practice develops, there are real risks to those who are off the pace or who allow their controls to slip.

Steven Francis and Richard Burger are former FSA enforcement lawyers and now a partner and a solicitor respectively in the commercial and regulatory group of City of London law firm Reynolds Porter Chamberlain

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