Market Abuse by Market Maker

UK FSA has won its market abuse case at the Financial Services and Markets Tribunal (the Tribunal) against Winterflood and two of its traders, Mr Sotiriou and Mr Robins.

Winterflood is an FSA authorised firm and the largest market maker in AIM securities. In June 2008, FSA found that Winterflood and its traders had played a pivotal role in an illegal share ramping scheme relating to Fundamental-E Investments Plc (FEI), an AIM listed company. In particular, the market maker had misused rollovers and delayed rollovers thereby creating a distortion in the market for FEI shares and misleading the market for about six months in 2004.

In May 2003, Mr Eagle was seeking to secure control of an AIM shell company as an investment vehicle to acquire electronic technology companies, and he identified FEI as suitable for this purpose. He agreed with the two shareholders of 85% of the shares in FEI to arrange for their shares to be sold and then he arranged with Winterflood for executing the deal. Mr Eagle thereafter instituted a share ramping scheme in FEI shares, the effect of which was to inflate the share price of FEI shares.

The key elements of the share ramping scheme were as follows:

1. Acquisition of SP Bell: Mr Eagle proposed to buy a 10% stake in FEI himself but had to find buyers for the remaining 75%. To do so, he needed to generate significant demand for its shares. On 27 May 2003, Mr Eagle acquired SP Bell Limited, an agency-only stockbroking firm, using an investment vehicle. He intended to find buyers for the remaining 75% of FEI shares and to maintain demand thereafter by, for the most part, selling to clients of SP Bell. By acting as middleman, Winterflood helped Mr Eagle to conceal the full extent of his role and in particular the significant commission he stood to gain from the original shareholders.
2. Rollover trades and delayed rollover trades: In order to procure sufficient purchasers for the 85% interest of the original shareholders, and to continue to buy FEI shares in the market following the initial sale, Mr Eagle introduced 50 new clients to SP Bell in the period from 18 July 2003 to 13 May 2004. However, a number of the Eagle clients did not have sufficient funds to pay for the shares, so in order to avoid those clients being required to make payment, Mr Eagle instituted a scheme whereby their FEI positions were purportedly rolled from one SP Bell client to another. From 5 January 2004, Mr Eagle refined the rollover scheme by the use of delayed rollover trades, whereby the size and price of the buy and sell legs of the rollover trade were agreed at the outset, but the two legs of the transaction were then executed at different times of day. The effect of the rollover scheme was to defer settlement, potentially indefinitely. However, it required a rising share price in order to operate successfully.
3. Consistent purchasing of FEI shares by SP Bell: In order to support and increase the FEI share price, SP Bell consistently purchased FEI shares (in particular, from Winterflood), regardless of market conditions. In many cases, this trading was not authorised by the underlying clients, and shares bought were not paid for but were simply added into the rollover scheme. The trading did not represent genuine market demand for the shares.
4. Involvement of Winterflood: The involvement of Winterflood, Mr Sotiriou and Mr Robins was critical to the success of the share ramping scheme. In addition to executing the trades referred to above, there were many untaped conversations between Mr Eagle and Winterflood, particularly Mr Sotiriou. On a number of occasions there was obvious pre-arrangement of trades where details were agreed on untaped lines before they were executed on taped lines.

The FEI share ramping scheme had the effect of misleading the market as to the supply, price or value of and demand for FEI shares and of distorting the market in FEI shares. It caused the positioning of the FEI share price at an artificially high level, and resulted in an almost five-fold increase in the share price of FEI between May 2003 and July 2004.

On 15 July 2004, the share price of FEI fell sharply from 11.75p to 7.5p as a result of sustained selling. The London Stock Exchange also received information that substantial unsettled positions in FEI shares had accumulated within SP Bell. At 10:35am, the Exchange temporarily suspended trading in FEI shares because it was of the view that the market was disorderly. The suspension of trading caused the unsettled positions in FEI shares at SP Bell to crystallise. Neither the clients of SP Bell nor SP Bell itself had sufficient funds to settle the resulting debt of over £9 million. On 23 July 2004, SP Bell ceased trading and was placed into administration.

FEI was the single most profitable stock for each of Winterflood, Mr Sotiriou and Mr Robins. Winterflood received £204,403 from the sale of the interest of the original shareholders and approximately £941,133 from its trading in FEI shares between January and July 2004. The profitability of trading in FEI also had a direct impact on the level of bonus awarded to Mr Sotiriou and Mr Robins. As a result of their conduct, FSA decided to impose fines of £4 million, £200,000 and £50,000 on Winterflood, Mr Sotiriou and Mr Robins respectively.