1

FINAL NOTICE

To:


Interactive Brokers (UK) Limited

1.
ACTION

1.1
For the reasons given in this Notice, the Authority hereby imposes on IBUK a
financial penalty of £1,049,412, pursuant to section 206 of the Act.

2.
SUMMARY OF REASONS

2.1
The Authority has decided to take this action because IBUK breached Principle 3
by failing to take reasonable care to organise and control its affairs responsibly
and effectively with adequate risk management systems in relation to the
detection and reporting of potential instances of market abuse from 6 February
2014 to 28 February 2015 (inclusive).

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2.2
This heightened the risk of IBUK failing to submit suspicious transaction reports
(“STRs”) to the Authority in accordance with the rules in SUP 15.10. During the
Relevant Period, prior to being notified of the Authority’s concerns, IBUK failed to
submit any STRs in relation to insider dealing and the Authority has identified
three occasions on which IBUK breached SUP 15.10.2R by failing to report
suspicious trading by IBUK clients in advance of three separate RNS
announcements.

2.3
Market abuse is serious and undermines confidence in the integrity of the UK
financial services sector and, as such, detecting it is a high priority of the
Authority. Firms must establish appropriate systems and controls to identify and
manage the particular market abuse risks to which they are exposed.

2.4
A cornerstone of the regime in place to protect markets from abuse is the
requirement on firms to identify where there are reasonable grounds to suspect
market abuse has occurred and to submit STRs to the Authority. STRs are a
critical source of intelligence for the Authority in identifying possible market
abuse. To conduct effective monitoring for suspected market abuse, firms need
appropriately designed trade monitoring systems, staff with sufficient training and
guidance to make appropriate judgements about the use of those systems, and
robust oversight of the process.

2.5
IBUK is an online broker which arranges and executes transactions in certain
instruments directly for its UK clients, including CFDs, index futures and index
options. It also executes transactions in other products, including UK stocks,
stock options, bonds and warrants, on behalf of other entities in the Interactive
Brokers Group.

2.6
During the Relevant Period, IBUK failed to maintain an adequate control
environment in respect of market abuse. IBUK did not take reasonable care to
ensure that the post-trade surveillance systems on which it relied were effective
in identifying potentially suspicious transactions by its clients in that it failed to:

(1)
have adequate policies and procedures in place during the Relevant Period;

(2)
provide adequate input into the design and calibration of those systems;

(3)
test the operation of those systems;

(4)
provide effective oversight of the review of the Post-Trade Surveillance
Reports, which were generated by those systems; and

(5)
provide adequate guidance or training to those carrying out that review.

2.7
IBUK relied entirely on post-trade surveillance systems which were designed for
the whole Interactive Brokers Group and which operated on a global basis, across
multiple jurisdictions, for all Group entities. Although IBUK was entitled to use the
Group systems, IBUK failed to take adequate steps to satisfy itself that potential
market abuse by its clients was effectively captured by the Post-Trade
Surveillance Reports, which were not tailored in any way for the specific business
of IBUK.

2.8
IBUK delegated the conduct of its initial post-trade surveillance to IBLLC
Compliance, a team from a US-based affiliate company. IBUK’s oversight of that

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team’s conduct of the reviews of the Post-Trade Surveillance Reports was
inadequate, and in particular it failed to monitor the quality of the reviews that
were conducted. It also failed to ensure that members of the team had adequate
guidance or effective training. All these failures increased the risk that potentially
suspicious trading would go undetected.

2.9
As a result, IBUK was unable to identify some potentially suspicious transactions
by its clients that ought to have been identifiable, had it been in compliance with
its regulatory obligations.

2.10
IBUK’s failure to ensure that it had appropriate systems and controls to identify
and manage the particular market abuse risks to which it was exposed had direct
and serious consequences, in that it failed to alert the Authority to suspicious
transactions by its clients in breach of SUP 15.10.2R, on three occasions, as
follows:

(1)
on two occasions, the Post-Trade Surveillance Reports failed completely to
identify highly profitable trading by an IBUK client in close proximity to RNS
announcements, as a result of which no investigation was carried out; and

(2)
on a third occasion, even though highly profitable trading in close proximity
to an RNS announcement was picked up by a Post-Trade Surveillance
Report, it was not investigated by IBLLC in any detail and therefore was not
escalated to IBUK.

2.11
All of these occasions of crystallised risk related to possible insider dealing in one
particular type of instrument: CFDs. However, IBUK’s failure to oversee
effectively the outsourcing of its post-trade monitoring to IBLLC undermined its
ability to manage any of its market abuse risks effectively.

2.12
The Authority views IBUK’s failings as serious. The Authority therefore imposes a
financial penalty on IBUK in the amount of £1,049,412, pursuant to section 206 of
the Act.

3.
DEFINITIONS

3.1
The definitions below are used in this Notice:

“the Act” means the Financial Services and Markets Act 2000;

“the Authority” means the body corporate previously known as the Financial
Services Authority and renamed on 1 April 2013 as the Financial Conduct
Authority;

“CFD” means contract for difference, an agreement between a customer and a
broker, where the difference in the value of a specified asset at the beginning and
end of the contract is exchanged. To trade in these products a customer need
only deposit a small percentage of the value of the contract. In the case of
equities, these products allow customers to speculate on share price movement
without the need to purchase the underlying shares;

“Daily Stats Reports” means the Interactive Brokers Group Daily Retail Account
Statistics Reports, a subset of the Post-Trade Surveillance Reports;

“DEPP” means the Decision Procedure and Penalties Manual, part of the
Handbook;

“EG” means the Authority’s Enforcement Guide;

“GBP” means Pounds Sterling;

“Handbook” means the Authority’s Handbook of Rules and Guidance;

“IBUK” means Interactive Brokers (UK) Limited;

“IBLLC” means Interactive Brokers LLC, a subsidiary of IBG LLC based in the
United States;

“IBLLC Compliance” means the team within IBLLC responsible for compliance;

“IBLLC Reviewer” means a member of IBLLC Compliance who reviewed the Post-
Trade Surveillance Reports;

“Insider Trading Report” means the Interactive Brokers Group’s daily Insider
Trading Report, one of the Post-Trade Surveillance Reports;

“Interactive Brokers Group” or “Group” means the group of companies
headquartered in Greenwich, Connecticut which conducts broker/dealer and
proprietary business, which contains IBUK, its parent company IBG LLC, and
other subsidiaries in the United States and other countries;

“MS&F” means the Authority’s Market Surveillance and Forensics team;

“MS&F Review” means the review carried out by MS&F in late 2014 into CFD and
spread bet providers and their provision of STRs, as further described in
paragraph 4.5;

“Policy” means IBUK’s internal document entitled “Market Abuse Directive and
Market Conduct Procedures”;

“Post-Trade Surveillance Reports” means
the Interactive Brokers Group
automatically-generated suite of reports which are intended to detect market
abuse including insider dealing;

“Principle” means one of the Authority’s Principles for Businesses;

“the Relevant Period” means the period from 6 February 2014 to 28 February
2015 inclusive;

“RNS” means Regulatory News Service;

“STR” means a suspicious transaction report through which (pursuant to SUP
15.10.2R) a firm, which arranges or executes a transaction for a client, and which
has reasonable grounds to suspect that the transaction might constitute market
abuse, must notify the Authority;

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“SUP” means the Supervision Manual, part of the Handbook;

“Transaction One” means the transaction described at paragraphs 4.28 to 4.30;

“Transaction Two” means the transaction described at paragraphs 4.31 to 4.33;

“Transaction Three” means the transaction described at paragraphs 4.34 to 4.36;

“the Tribunal” means the Upper Tribunal (Tax and Chancery Chamber); and

“USD” means United States Dollars.

4.
FACTS AND MATTERS

Background to IBUK

4.1
IBUK is, and was during the Relevant Period, an online brokerage firm authorised
by the Authority that provides its clients with a trading platform allowing them to
trade on various worldwide exchanges. As an online-only brokerage firm, IBUK
does not have a front office function. IBUK has approximately 31,000 retail and
institutional clients.

4.2
IBUK is based in London and is part of the Interactive Brokers Group, which also
includes IBLLC, a sister company incorporated in the United States which is the
largest and longest-established of the trading entities within the Interactive
Brokers Group.

4.3
IBUK arranges and executes transactions in certain instruments directly for its UK
clients, including CFDs, exchange traded index futures and options, and certain
commodities that are not exchange listed. IBUK also executes transactions in
other products, for example UK stocks, stock options, bonds and warrants, on
behalf of other entities in the Interactive Brokers Group.

4.4
IBUK’s Compliance team during the Relevant Period comprised five individuals.

MS&F visit

4.5
In late 2014 the MS&F Review was carried out into CFD and spread bet providers
and their submission of STRs. The aim of the MS&F Review was to assess firms’
systems and controls for identifying market abuse and to highlight the importance
of STR reporting to the Authority.

4.6
As a part of this review, on 11 December 2014, MS&F visited IBUK.

Market abuse control framework

4.7
IBUK delegated the conduct of its initial post-trade surveillance to IBLLC
Compliance, so IBUK had no role in the monitoring unless a trade was specifically
referred to IBUK for consideration by IBLLC Compliance. However, IBUK was
responsible for ensuring that the surveillance systems operated on a global basis
by IBLLC were effective in addressing the market abuse risks that IBUK was
subject to, in particular in identifying potentially suspicious transactions by its
clients.

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Policies and procedures

4.8
IBUK’s policies and procedures in relation to market abuse were set out in the
Policy, drafted by IBUK. There were three versions of the Policy in place at
different times during the Relevant Period, dated 10 September 2009, 27
February 2014 and 10 November 2014.

4.9
The Policy was made available to IBLLC on the Interactive Brokers Group intranet,
but IBUK failed to draw it to the attention of all members of IBLLC Compliance
(who were responsible for reviewing Post-Trade Surveillance Reports on IBUK’s
behalf). IBUK relied upon occasional emails and undocumented, ad hoc telephone
conversations to follow up on the Policy and its implementation. IBUK Compliance
did not carry out training or other checks to ensure IBLLC Reviewers had read
and understood the Policy.

4.10
All three versions of the Policy contained sections which covered: (1) the law
relating to market abuse and the seven types of market abuse behaviour as
defined by section 118 of the Act; (2) IBUK’s systems and operational controls;
and (3) the Legal & Compliance personnel within the Interactive Brokers Group
responsible for market abuse regulation. In respect of each of these three
sections it is relevant to state the following:

(1)
The law relating to market abuse

a) The Policy restated the law without any consideration of IBUK’s own
market abuse risks;

b) The Policy did not provide any IBUK-specific guidance on how to apply
SUP 15.10.2R.

(2)
IBUK’s systems and operational controls

a) The Policy made it clear that IBLLC Compliance generated Post-Trade
Surveillance Reports and would review their contents;

b) The Policy included systems and procedures that IBLLC Compliance
would use for identifying potentially suspicious transactions. All three
versions listed two of the Post-Trade Surveillance Reports that were to
be reviewed: a “Cross Trading Report”, and a daily “Insider Trading
Report”;

c) Additionally, for the majority of the Relevant Period, the Policy included
details of “Pre-Execution Compliance Checks” that IBLLC would use,
and included details of additional post-trade “Daily Stats Reports” that
IBLLC would review. These reports are described in paragraph 4.16(1)
below. However it was only in the version of the Policy dated 10
November 2014 that any guidance was given on how these reports
should be reviewed. In particular, it provided that the IBLLC Reviewer
must take into consideration the facts and circumstances of the
account and trading activity involved, which might include whether the
profit and loss was out of line with the account’s regular pattern of
trading;

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d) The Policy did not describe the circumstances in which IBLLC Reviewers
should escalate potentially suspicious transactions to IBUK for further
consideration;

e) The Policy reflected that IBLLC Reviewers were not required to consult
with IBUK, including for any “close calls”;

f) The Policy reflected that IBLLC Reviewers were not required to
document reviews;

g) The Policy did not include a process whereby IBUK would check the
quality of the reviews and/or obtain assurances from IBLLC Compliance
to ensure that effective reviews were being carried out by the IBLLC
Reviewers.

(3)
Legal & Compliance personnel

a) The Policy stated that IBUK personnel were responsible for “Reporting
to FSA/SOCA [later “FCA and/or NCA”] or other European regulator or
legal body or authority”.

b) The Policies dated 10 September 2009 and 27 February 2014 stated
that IBLLC was responsible for reporting to IBUK “…any IBUK client
issues.” The Policy dated 10 November 2014 specified members of the
IBUK Compliance staff who were “responsible for Reviewing [sic]
individual
suspicious
transaction
[sic]
as
reported
by
IBLLC
Compliance”.

4.11
There is no evidence of consideration or challenge by IBUK’s Board or senior
management as to the extent to which the Policy met UK legal and regulatory
requirements.

Training provided to IBLLC’s Compliance Team

4.12
IBUK did not provide training to all members of IBLLC Compliance, based in the
US, who were responsible for reviewing the Post-Trade Surveillance Reports, on
the relevant laws of the United Kingdom and their application, or on how to
conduct reviews of transactions by UK clients. A member of IBUK Compliance sent
regulatory updates to an individual within IBLLC Compliance on an ad hoc basis,
and then discussed the material on the phone; however, IBUK carried out no
checks to ensure the regulatory updates had been passed on to, or discussed
with, those reviewing the Post-Trade Surveillance Reports. IBUK thus delegated
the training of the IBLLC staff involved in reviewing Post-Trade Surveillance
Reports to IBLLC, without maintaining any oversight.

4.13
Nor did IBUK’s Compliance team undertake any testing or checking of the training
conducted by IBLLC. In fact, IBUK’s Compliance team never checked whether
any training had been provided to IBLLC Compliance in relation to how to carry
out a review of the Post-Trade Surveillance Reports. Accordingly, IBUK
Compliance was not in a position to assess whether the training, if provided, was
adequate to enable them effectively to review the Post-Trade Surveillance Reports
and identify and escalate trades which contained indicators of potential market
abuse. IBUK relied upon the IBLLC Reviewers being experts in the work they
carried out.

Post-trade surveillance systems

4.14
IBUK’s lack of a front office function meant it was solely reliant on automated
systems in order to identify possible market abuse. These surveillance systems
were operated at Group level in the US by IBLLC Compliance. The post-trade
surveillance systems were based on the automatic generation of approximately
50 Post-Trade Surveillance Reports. The Post-Trade Surveillance Reports were
run globally for all entities in the Interactive Brokers Group. IBLLC was
responsible for the design and calibration of these reports. IBUK did not provide
adequate input in relation to their design and calibration, and did not test their
operation to ensure they were effective in identifying potentially suspicious
transactions by its clients. IBUK did not generate or request any specific or
tailored reports in respect of its own clients.

4.15
Where transactions did not meet the criteria to be captured on the Post-Trade
Surveillance Reports, there was no mechanism for them to be reviewed, and it
was therefore important that the criteria were effective in identifying potentially
suspicious transactions by IBUK’s clients.

4.16
In the Relevant Period the Post-Trade Surveillance Reports which IBUK considered
capable of capturing potential insider dealing were the Daily Stats Reports and
the daily Insider Trading Report:

(1)
There were 12 Daily Stats Reports, entitled as follows:

a) Customers With 40 Highest Equity

b) Customers With 40 Highest P&L [Profit and loss]

d) Top 100 Customer Holdings

i) Top 40 Highest Percentage Gains

k) Customers who Made or Lost 45% of their Total Balance

l) Customers with New Negative Balances.

(2)
These reports were generated at a global level from clients' trading carried
out by all entities in the Interactive Brokers Group. As such, during the
Relevant Period, no Daily Stats Reports were generated for IBUK clients

specifically; nor were they in any way tailored for the IBUK business.
Indeed, depending on the levels of activity in other jurisdictions, it was
possible for the Daily Stats Reports a) to j) in sub-paragraph (1) above to
highlight no transactions relating to IBUK clients, even where substantially
large, profitable and timely trading by IBUK clients occurred.

(3)
The Daily Stats Reports identified clients of Interactive Brokers Group
entities whose trading fell within certain criteria, pre-set by IBLLC
programmers, with no input from IBUK. IBUK took no steps to test the
operation of the Daily Stats Reports to ensure they were effective in
identifying potentially suspicious transactions by its clients.

(4)
As set out in paragraphs 4.28 - 4.33 below, the Authority has identified
that, during the Relevant Period, the Daily Stats Reports failed to identify
two highly profitable CFD transactions by an IBUK client which took place
in close proximity to RNS announcements.

The Insider Trading Report

(5)
The Insider Trading Report was also generated on a daily basis for all
Interactive Brokers Group client trading carried out globally. It was used
to identify trades by clients who traded in relation to stocks for which they
had a confirmed connection. A trade would appear on the Insider Trading
Report only if:

a) the client had confirmed at account opening that it held 10% or more
of the available shares, or that it was a director or officer, of the traded
stock; or

b) if this had been determined as a result of open source checks carried
out by IBUK at account opening.

The Insider Trading Report therefore relied on the fullness of the
information provided by the client at account opening, the client’s honesty,
what was in the public domain and IBUK and/or IBLLC identifying publicly
available information.

(6)
IBUK took no steps to test the operation of the Insider Trading Report to
ensure it was effective in identifying potentially suspicious transactions by
its clients.

Review of the Daily Stats and Insider Trading Reports by IBLLC

4.17
IBUK relied on IBLLC’s Compliance team to: (1) maintain the post-trade
surveillance systems; (2) review the Post-Trade Surveillance Reports to identify
possible market abuse; and (3) inform IBUK of instances indicating possible
market abuse by an IBUK client.

4.18
After the Post-Trade Surveillance Reports were generated, they were reviewed by
the IBLLC Reviewers. Where the IBLLC Reviewer decided that a transaction was
suspicious, it would be referred to IBUK for consideration. However, IBLLC
Reviewers were not required to document their review unless they considered
further action was warranted.

4.19
The Policy did not state until late in the Relevant Period (10 November 2014 - see
paragraph 4.10(2)(c) above) that IBLLC Reviewers should take into account all
relevant circumstances. Even after it did so, as set out at paragraph 4.9 above,
the Policy was poorly communicated to IBLLC Compliance.

Monitoring by IBUK

4.20
IBUK was not involved in the process for the review of the Post-Trade
Surveillance Reports by IBLLC Compliance staff as IBUK considered them to be
the experts. No arrangements were in place to allow IBUK to undertake quality
assurance checks to ensure reviewing was consistent and appropriate escalations
were being made.

4.21
IBUK chose not to carry out any checks of the reviews carried out by IBLLC or the
IBLLC Reviewer’s determinations, on the basis that it would be duplicative of the
work done by IBLLC Compliance. IBUK’s checks were limited to occasionally
confirming on Interactive Brokers Group’s internal system whether or not a trade
had been reviewed by IBLLC.

4.22
IBUK relied on occasional, informal, and undocumented phone calls between IBUK
Compliance and IBLLC Compliance to keep informed of the approach IBLLC was
taking to the reviews.

Submission of STRs to the Authority

4.23
Once the transactions captured on the reports were reviewed by IBLLC
Compliance, any transactions which the IBLLC Reviewer considered to be
potentially suspicious were escalated to IBUK. IBUK was at that stage required to
review the transactions and decide whether or not to report these transactions to
the Authority. In the Relevant Period, prior to the MS&F visit to IBUK, IBLLC only
escalated one transaction considered to be potential insider dealing to IBUK. In
the event, the transaction escalated was outside the scope of the market abuse
regime. IBUK did not consider whether the extent of IBLLC’s escalation of
potentially suspicious trades to IBUK for consideration and reporting to the
Authority was appropriate.

4.24
IBUK maintained a log of the decisions made in relation to all suspicious
transactions escalated to it by IBLLC. The log was also used to record the
number of STRs submitted by IBUK to the Authority. Given the lack of
transactions escalated to IBUK relating to potential insider dealing, no STRs
regarding potential insider dealing were submitted to the Authority by IBUK in the
Relevant Period prior to MS&F’s visit. This can be contrasted with the significant
increase in the number of STRs submitted to the Authority by IBUK regarding
potential insider dealing in the months after the visit by MS&F. The precise figures
are included in the table below. During the Relevant Period, IBLLC also escalated
to IBUK six transactions considered to be market manipulation, and IBUK made
two STRs to the Authority.

Year
Total number of

potentially
suspicious
transactions
escalated for
review from IBLLC

The number of

transactions identified
by IBUK as being
potentially suspicious for
insider dealing

Number of STRs
submitted to the
Authority for
insider dealing

2013
5
1
0

2014
6
1
0

Jan – May

Jun –

Dec 2015

Data not available
Data not available
10

Specific transactions

4.25
The Authority has identified three occasions during the Relevant Period on which
IBUK did not submit STRs to the Authority, despite having reasonable grounds to
suspect the transactions constituted market abuse in the form of insider dealing.
In each case IBUK executed highly profitable transactions for its clients in close
proximity to an announcement of price sensitive information. None of these
transactions were escalated to IBUK by IBLLC, and therefore they were not
reported by IBUK to the Authority.

4.26
The three relevant transactions involved trading in CFDs. In equity trading, a
client has to pay the full value of the shares; in CFD trading, while IBUK will
purchase the underlying shares in the market in order to hedge its customer
transaction, the customer only has to deposit a small percentage of the total
value of the shares (the ‘margin’) to achieve the same level of exposure to price
movements in the shares as if they owned the shares outright. The customer will
make the same absolute profit or loss from share price movements whether they
purchase the shares outright or gain the same level of exposure through a CFD;
but a customer who buys a CFD will have a much higher percentage return (or
loss) in relation to their initial margin payment than the percentage increase (or
decrease) in the underlying share price.

4.27
None of the transactions detailed below were included in the daily Insider Trading
Report. Further, two of these transactions did not appear on any Post-Trade
Surveillance Reports and therefore they were not reviewed by the IBLLC
Reviewers. The other transaction was reviewed by IBLLC Reviewers but was not
escalated to IBUK.

4.28
Client A bought CFDs equivalent to approximately 1.3 million shares in Stock X on
two consecutive days in November 2014. Three days later a positive RNS
announcement was published, after the market closed that day, which resulted in
the share price of Stock X closing nearly 6% higher on the next trading day.

Client A closed the position on the day of the share price increase, realising a
profit of over £440,000. As regards this trading compared with Client A’s previous
trading through Interactive Brokers Group, it is relevant to note that:

(1)
the absolute profit was 83%1 higher than the profit made by Client A from
the next most profitable CFD trading, and more than twice as profitable as
the third most profitable CFD trading by Client A related to any other
single stock in the previous 12 months; and

(2)
Client A’s highest exposure to this stock was 20% greater than Client A’s
next highest exposure to any single stock in the previous 12 months, and
also more than four times greater than the average highest exposure to
any single stock in all of Client A’s CFD trading over the previous 12
months.

4.29
As set out, Client A’s trading in Stock X was unusual in that it was significantly
out of line with Client A’s previous investment behaviour, and was in close
proximity to a positive RNS announcement relating to Stock X.

4.30
This transaction did not meet the criteria to appear on any of the Post-Trade
Surveillance Reports. Accordingly it was not reviewed by IBLLC Compliance, nor
escalated to IBUK. Accordingly, IBUK did not consider whether to submit an STR
in respect of this trading. In its response to MS&F’s request for information
related to IBUK’s non-submission of an STR in relation to this transaction, IBUK
said that the trading was not highlighted to IBUK by IBLLC as, among other
things, the client had “informed IB that none of its officers, directors or any 10%
shareholder was affiliated with any publically [sic] traded company”.

Transaction Two

4.31
A few weeks later Client A bought CFDs equivalent to approximately 1 million
shares in Stock Y over a period of ten days in December 2014. On the last of
these days a positive RNS announcement resulted in the share price of Stock Y
closing 11% higher than the closing price of the previous day. Client A closed the
position over the three weeks following the share price increase, realising a profit
of over £870,000. As regards this trading compared with Client A’s previous
trading through Interactive Brokers Group, it is relevant to note that:

(1)
there had been no trading in relation to the stock by Client A over the
previous 12 months;

(2)
(with the exception of Transaction One) the absolute profit was more than
three times the profit made by Client A from the next most profitable CFD
trading, and more than four times as profitable as the third most profitable
CFD trading by Client A related to any other single stock in the previous 12
months; and

1 In relation to the transactions described in paragraphs 4.28 to 4.36, the relative exposures and profits quoted

are calculated converting transactions in non-GBP currencies into GBP on the day of the transaction.

(3)
(with the exception of Transaction One) Client A’s highest exposure to this
stock was greater than Client A’s highest exposure to any single stock in
the previous 12 months, and also more than five times greater than the
average highest exposure to any single stock in all of Client A’s CFD
trading over the previous 12 months.

4.32
As set out, Client A’s trading in Stock Y was unusual in that it was significantly out
of line with Client A’s previous investment behaviour, and was in close proximity
to a positive RNS announcement relating to Stock Y. It also followed shortly after
Transaction One.

4.33
This transaction did not meet the criteria to appear on any of the Post-Trade
Surveillance Reports. Accordingly it was not reviewed by IBLLC Compliance, nor
escalated to IBUK, and IBUK did not consider whether to submit an STR in
respect of this trading.

Transaction Three

4.34
Client B bought CFDs equivalent to approximately 500,000 shares in Stock Z on
two consecutive days in November 2014. In the period between market close
eight days later and market opening on the following day, positive news was
published which resulted in the share price of Stock Z closing nearly 22% higher
than its closing price on the day before the share price increase. While Client B
sold a small amount a few days before the announcement after a 33% increase in
the share price, 80% of the position was retained until after the positive news
was published, with the sale realising a total profit of over £1,000,000. As
regards this trading compared with Client B’s previous trading through Interactive
Brokers Group, it is relevant to note that:

(1)
there had been no trading by Client B in relation to the stock over the
previous 12 months;

(2)
the absolute profit was 50% more than the profit made by Client B from
the next most profitable CFD trading, and more than six times as
profitable as the third most profitable CFD trading by Client B related to
any other single stock in the previous 12 months; and

(3)
Client B’s highest exposure to this stock was in the top 15% of Client B’s
highest exposure to any single stock in the previous 12 months, and also
almost three times greater than the average highest exposure to any
single stock in all of Client B’s CFD trading over the previous 12 months.

4.35
As set out, Client B’s trading in Stock Z was unusual in that it was significantly
out of line with Client B’s previous investment behaviour, and was in close
proximity to a positive RNS announcement relating to Stock Z.

4.36
This transaction was flagged on a Daily Stats Report and was therefore reviewed
by IBLLC. However, the transaction was not escalated to IBUK. The IBLLC
Reviewer recorded that the increase in share price explained the profitability of
the client’s trading; no consideration of the pattern of trading by this client or the
timeliness of this trading is recorded.

5.
FAILINGS

5.1
The regulatory provisions relevant to this Final Notice are referred to in Annex A.

5.2
Principle 3 requires a firm to take reasonable care to organise and control its
affairs responsibly and effectively, with adequate risk management systems.

5.3
IBUK breached Principle 3 because it failed to take reasonable care to organise
and control its affairs responsibly and effectively with adequate risk management
systems in relation to the identification and reporting of possible market abuse.

5.4
On the basis of the facts and matters set out above, IBUK failed to maintain an
appropriate control environment in order effectively to detect and report potential
instances of market abuse. This increased the risk that market abuse would
occur. The control environment was inadequate because:

(1)
IBUK failed to have adequate policies and procedures in place during the
Relevant Period as throughout the Relevant Period the Policy in place did
not:

a) provide sufficient guidance to IBLLC Reviewers detailing how to carry
out a review of the Post-Trade Surveillance Reports, which created a
risk that reviews would be inadequate and suspicious transactions
would not be identified;

b) require IBLLC Reviewers to document their reviews of the Post-Trade
Surveillance Reports which created a risk that reviews would not be
carried out consistently;

c) provide for specific circumstances in which IBLLC Reviewers should
escalate potentially suspicious transactions to IBUK Compliance for
further consideration or consultation;

d) require IBUK Compliance to monitor IBLLC Compliance and/or IBLLC
Reviewers to ensure the reviews being carried out for IBUK were done
effectively; or

e) state, until late in the Relevant Period (10 November 2014 - see
paragraph 4.10(2)(c) above), that IBLLC Reviewers should take into
account all relevant circumstances. Even after it did so, as set out at
paragraph 4.9 above, it was poorly communicated to IB Compliance.

(2)
IBUK delegated the training of the IBLLC staff involved in reviewing
surveillance reports to IBLLC, without maintaining any oversight. IBUK
thereby failed adequately to supervise and monitor the training given to
IBLLC Reviewers of the Post-Trade Surveillance Reports.

(3)
IBUK failed to have adequate input into the design and calibration, or test
the operation, of the post-trade surveillance systems, to ensure they were
effective in identifying potentially suspicious transactions by its clients and
enabling it to comply with its obligations to report to the Authority. The

Insider Trading Report relied upon the client diligently and honestly
providing full information at account opening, and what was in the public
domain. As such this report was not a robust control which could be relied
upon by IBUK to identify insider dealing; this increased the need for the
Daily Stats Reports to be calibrated effectively to identify potential insider
dealing.

(4)
The Post-Trade Surveillance Reports, which were intended to identify
suspicious transactions, were generated for all clients’ trading carried out
globally by entities in the Interactive Brokers Group. This global approach
and insufficient focus on the UK market abuse regime created the risk that
too few IBUK clients would be identified in the Post-Trade Surveillance
Reports, and potentially suspicious trading could therefore be missed and
not escalated by IBLLC to IBUK. The crystallisation of this risk is shown by
the fact that two of the three suspicious transactions referred to above
were not picked up by the Post-Trade Surveillance Reports.

(5)
IBUK failed to consider whether the extent of IBLLC’s escalation of
potentially suspicious trades to IBUK for consideration and reporting to the
Authority was appropriate.

(6)
IBUK did not supervise or effectively monitor the reviews conducted, or the
decisions made, by IBLLC Reviewers to ensure the reviews being carried
out were effective in identifying and escalating potentially suspicious
transactions. IBUK placed undue reliance on the IBLLC Reviewers being
experts in the work they carried out. The crystallisation of this risk is
shown by the fact that although one transaction was identified by the Post-
Trade Surveillance Reports, it was not escalated to IBUK and the record
made by the IBLLC Reviewer merely states that the profit made was due
to the increase in share price, without considering other factors.

5.5
SUP 15.10.1R and 15.10.2R in force during the Relevant Period provided that a
firm (carrying out activities from an establishment in the UK) which arranged or
executed transactions with or for a client, and which had reasonable grounds to
suspect that the transaction might constitute market abuse, must notify the
Authority without delay i.e. submit an STR. As stated above, IBUK remained
responsible for the submission of STRs even where the post trade review and
surveillance had been delegated to IBLLC.

5.6
Further guidance was provided in SUP 15 Annex 5G of the Handbook, which gave
examples of indications of possibly suspicious transactions. These included “a
transaction significantly out of line with the client’s previous investment
behaviour” and “unusual trading in the shares of a company before the
announcement of price sensitive information”. IBUK included this guidance in the
versions of its Policy of 27 February 2014 and 10 November 2014.

5.7
The Authority takes the view that the obligation under SUP 15.10.2R to notify the
Authority arises once the firm possesses the information giving rise to reasonable
grounds to suspect market abuse, even if no actual suspicion has in fact been
formed.

5.8
STRs are a crucial asset in the detection of market abuse and are key to the
Authority’s ability to protect and enhance the integrity of the UK financial system.

5.9
The Authority has made public statements about the standards that are expected
of firms in relation to market abuse, and their obligation to submit STRs to the
Authority, for example:

(1)
In 2005, Issues 12 and 14 of ‘Market Watch’ (a newsletter published by
the Authority on its website) highlighted:

a) firms’ obligations to submit STRs, with firms being referred to
guidance by the Committee of European Securities Regulators on this
issue;

b) that identifying suspicious transactions is not an easy task and it is not
realistic to expect that every possible case will be picked up, but firms
must have the necessary systems and procedures to meet the
requirement;

c)
that, when deciding what transactions to report, firms should apply
the key test of whether “there are reasonable grounds for suspecting
the transaction involves market abuse”;

d) that firms are required to report transactions of which they
retrospectively become suspicious, although there is no requirement to
go back and retroactively review transactions in the run-up to an
event which had a significant effect on the price of a security;

e)
that the quality of an STR is improved when detailed client information
is provided and when a thorough explanation of why trades are
considered to be suspicious is given; and

f)
that if the Authority identified a trade that it would expect a firm to
have notified it about, then the Authority’s first step would be to ask
what systems and controls the firm had in place to identify suspicious
transactions, then to ask the firm why it did not identify the relevant
trade (the example was given that, if this was due to a lack of staff
training about market abuse and the STR requirements, then the
Authority could take action).

(2)
In December 2006, Issue 18 of Market Watch reminded firms of their
obligations under the STR regime and the obligation on management to
interpret and apply the rules on STRs. Issue 18 of Market Watch also
referred to the need for firms to have in place appropriate and robust
monitoring systems.

(3)
In March 2007, Issue 19 of Market Watch contained further emphasis on
the importance of STRs and included a number of case studies on STRs.
One of the case studies related to a firm trading in CFDs and the factors
that may strike a compliance officer as being suspicious when viewed
together with the timeliness of trading. The factors included: monitoring
the previous day’s trades against regulatory announcements; the change
in share price; the client’s previous trading history; and KYC (‘know your
customer’) documentation.

(4)
In August 2009, Issue 33 of Market Watch reiterated the obligation for
firms who arrange or execute securities transactions and that the test
firms should apply is “reasonable grounds to suspect that the transaction
might constitute market abuse”.

5.10
On three occasions during the Relevant Period, IBUK executed transactions for its
clients but failed to identify that it had reasonable grounds to suspect that these
transactions might constitute market abuse in the form of insider dealing; and
hence failed to submit an STR to the Authority. On two of these occasions, the
Post-Trade Surveillance Reports failed completely to identify the transactions, as
a result of which no investigation was carried out. On the third occasion, even
though the transaction was picked up by a Post-Trade Surveillance Report, it was
not investigated by IBLLC in any detail and therefore was not escalated to IBUK.

5.11
On each occasion, the transaction was:

(1)
highly profitable in absolute terms and in relation to the client’s normal
trading activities; and

(2)
carried out in close proximity to an announcement of information that led
to significant and rapid changes in the share price.

5.12
A comparison of the particular transaction with the client’s trading history should
have led IBUK to conclude that the transaction was unusual for the client
concerned, in terms of both profits made and amount invested, and therefore
suspicious. The timeliness and the profitability of the three suspicious CFD
transactions were factors that should have given rise to suspicion that they might
constitute insider dealing.

5.13
Therefore on each occasion IBUK breached SUP 15.10.2R, by having reasonable
grounds to suspect that the client’s trading might constitute market abuse but
failing to notify the Authority.

5.14
All of these occasions of crystallised risk related to possible insider dealing in one
particular type of instrument: CFDs. However, IBUK’s failure to oversee
effectively the outsourcing of its post-trade monitoring to IBLLC undermined its
ability to manage any of its market abuse risks effectively.

6.
SANCTION

Financial penalty

6.1
The Authority’s policy for imposing a financial penalty is set out in Chapter 6 of
DEPP. DEPP 6.5A sets out the details of the five-step framework that applies in
respect of financial penalties imposed on firms.

6.2
In deciding the penalty, the Authority has had regard to all the circumstances of
the case and the financial resources of IBUK.

6.3
Given that the breaches of SUP 15.10.2R occurred within the period of the
Principle 3 breach and are based on similar facts, the Authority considers it

appropriate to impose a combined financial penalty for the Principle 3 and SUP
15.10.2R breaches.

Step 1: disgorgement

6.4
Pursuant to DEPP 6.5A.1G, at Step 1 the Authority seeks to deprive a firm of the
financial benefit derived directly from the breach where it is practicable to
quantify.

6.5
The Authority has not identified any financial benefit that IBUK derived directly
from its breach.

6.6
Step 1 is therefore £0.

Step 2: the seriousness of the breach

6.7
Pursuant to DEPP 6.5A.2G, at Step 2 the Authority determines a figure that
reflects the seriousness of the breach. Where the amount of revenue generated
by a firm from a particular product line or business area is indicative of the harm
or potential harm that its breach may cause, that figure will be based on a
percentage of the firm’s revenue from the relevant products or business area.

6.8
The nature of IBUK’s business is executing and arranging transactions in certain
instruments directly for its UK clients, and executing transactions in other
products on behalf of other entities in the Interactive Brokers Group. The
Authority considers the revenue generated from this business area is indicative of
the harm or potential harm caused by the firm’s breaches. The Authority
considers that total revenue generated by IBUK in connection with qualifying
investments, or investments which are related investments, is indicative of the
harm or potential harm caused by its breach.

6.9
On this basis, the relevant revenue during the Relevant Period is £20,988,249.

6.10
In deciding on the percentage of the relevant revenue that forms the basis of the
step 2 figure, the Authority considers the seriousness of the breach and chooses a
percentage between 0% and 20%. This range is divided into five fixed levels
which represent, on a sliding scale, the seriousness of the breach; the more
serious the breach, the higher the level. For penalties imposed on firms there are
the following five levels:

Level 1 – 0%

Level 2 – 5%

Level 3 – 10%

Level 5 – 20%

6.11
In assessing the seriousness level, the Authority takes into account various
factors which reflect the impact and nature of the breach, and whether it was
committed deliberately or recklessly. DEPP 6.5A.2G (11) lists factors likely to be

considered ‘level 4 or 5 factors’. Of these, the Authority considers the following
factor to be relevant:

(1)
The breach revealed serious or systemic weaknesses within IBUK’s
procedures.

6.12
DEPP 6.5A.2G (12) lists factors likely to be considered ‘level 1, 2 or 3 factors’. Of
these, the Authority considers the following factors to be relevant:

(1)
There were no profits made or losses avoided as a result of the breach,
either directly or indirectly.

(2)
There was limited risk of loss caused to individual consumers, investors or
other market users.

(3)
The breach was committed negligently.

6.13
The Authority also considers that the breach could have had an adverse effect on
the market, in that it increased the risk that financial crime, in the form of market
abuse, could occur undetected. The submission by firms of STRs is essential to
the detection and prevention of all types of market abuse, including insider
dealing. Market confidence is put at risk if firms have ineffective systems and
controls in place and do not submit STRs, as this reduces the Authority’s ability to
protect the market from potential market abuse.

6.14
The Authority has had regard to the fact that neither the firm’s senior
management, nor any of its other staff, were aware that its systems and controls
fell short of required standards until the visit by MS&F.

6.15
Taking all of these factors into account, the Authority considers the seriousness of
the breach to be level 3 and so the Step 2 figure is 10% of £20,988,249, which is
£2,098,824.

6.16
DEPP 6.5.3G(3) states that the Authority recognises that a penalty must be
proportionate to the breach. The Authority may decrease the level of the penalty
arrived at after applying Step 2 of the framework if it considers that the penalty is
disproportionately high for the breach concerned. In this case the Authority does
consider that the Step 2 figure is disproportionately high and should be adjusted.
In order to achieve a penalty that (at Step 2) is proportionate to the breach, the
Step 2 figure is reduced by 50% to £1,049,412.

Step 3: mitigating and aggravating factors

6.17
Pursuant to DEPP 6.5A.3G, at Step 3 the Authority may increase or decrease the
amount of the financial penalty arrived at after Step 2, but not including any
amount to be disgorged as set out in Step 1, to take into account factors which
aggravate or mitigate the breach.

6.18
The Authority considers there are no aggravating or mitigating factors in this
case.

6.19
Step 3 is therefore £1,049,412.

Step 4: adjustment for deterrence

6.20
The Authority considers that the Step 3 figure of £1,049,412 represents a
sufficient deterrent to IBUK and others, and so has not increased the penalty at
Step 4.

6.21
Step 4 is therefore £1,049,412.

Step 5: settlement discount

6.22
The Authority and IBUK have not reached agreement to settle so no discount
applies to the Step 4 figure.

6.23
The total financial penalty is therefore £1,049,412.

7.
REPRESENTATIONS

7.1
Annex B contains a brief summary of the key representations made by:

(1)
IBUK; and

(2)
IBLLC, a third party identified in the reasons set out in the Warning Notice
issued to IBUK on 25 July 2017, and to whom in the opinion of the
Authority the matter is prejudicial;

and how they have been dealt with. In making the decision which gave rise to
the obligation to give this Notice, the Authority has taken into account all of the
representations made by IBUK and IBLLC, whether or not set out in Annex B.

8.
PROCEDURAL MATTERS

8.1
The following paragraphs are important.

Decision maker

8.2
The decision which gave rise to the obligation to give this Final Notice was made
by the Regulatory Decisions Committee.

8.3
This Final Notice is given under, and in accordance with, section 390 of the Act.

Manner of and time for payment

8.4
The financial penalty must be paid in full by IBUK to the Authority by no later
than 8 February 2018, 14 days from the date of the Final Notice.

If the financial penalty is not paid

8.5
If all or any of the financial penalty is outstanding on 9 February 2018, the
Authority may recover the outstanding amount as a debt owed by IBUK and due
to the Authority.

8.6
Sections 391(4), 391(6) and 391(7) of the Act apply to the publication of
information about the matter to which this notice relates. Under these provisions,
the Authority must publish such information about the matter to which this notice
relates as the Authority considers appropriate. The information may be published
in such manner as the Authority considers appropriate. However, the Authority
may not publish information if such publication would, in the opinion of the
Authority, be unfair to IBUK or prejudicial to the interests of consumers or
detrimental to the stability of the UK financial system.

Authority contact

8.7
For more information concerning this matter generally, contact James Pender
(direct line: 0207 066 5114) of the Enforcement and Market Oversight Division of
the Authority.

Financial Conduct Authority, Enforcement and Market Oversight Division

ANNEX A

RELEVANT
STATUTORY
PROVISIONS,
REGULATORY
REQUIREMENTS
AND
AUTHORITY GUIDANCE

1. STATUTORY PROVISIONS

1.1. The relevant section of the Act is section 118, which concerns market abuse,
which during the Relevant Period stated as follows:

(1)
For the purposes of this Act, market abuse is behaviour (whether by one
person alone or by two or more persons jointly or in concert) which—

(a) occurs in relation to—

(i) qualifying investments admitted to trading on a prescribed
market,

(ii) qualifying investments in respect of which a request for
admission to trading on such a market has been made, or

(iii) in the case of subsection (2) or (3) behaviour, investments which
are
related
investments
in
relation
to
such
qualifying
investments, and

(b) falls within any one or more of the types of behaviour set out in
subsections (2) to (8).

(2)
The first type of behaviour is where an insider deals, or attempts to deal,
in a qualifying investment or related investment on the basis of inside
information relating to the investment in question.

(3)
The second is where an insider discloses inside information to another
person otherwise than in the proper course of the exercise of his
employment, profession or duties.

(4)
The third is where the behaviour (not falling within subsection (2) or
(3))—

(a) is based on information which is not generally available to those
using the market but which, if available to a regular user of the
market, would be, or would be likely to be, regarded by him as
relevant when deciding the terms on which transactions in qualifying
investments should be effected, and

(b) is likely to be regarded by a regular user of the market as a failure
on the part of the person concerned to observe the standard of
behaviour reasonably expected of a person in his position in relation
to the market.

(5) The fourth is where the behaviour consists of effecting transactions or
orders to trade (otherwise than for legitimate reasons and in conformity
with accepted market practices on the relevant market) which—

(a) give, or are likely to give, a false or misleading impression as to the
supply of, or demand for, or as to the price of, one or more
qualifying investments, or

(b) secure the price of one or more such investments at an abnormal or
artificial level.

(6) The fifth is where the behaviour consists of effecting transactions or
orders to trade which employ fictitious devices or any other form of
deception or contrivance.

(7) The sixth is where the behaviour consists of the dissemination of
information by any means which gives, or is likely to give, a false or
misleading impression as to a qualifying investment by a person who
knew or could reasonably be expected to have known that the
information was false or misleading.

(8) The seventh is where the behaviour (not falling within subsection (5), (6)
or (7))—

(a) is likely to give a regular user of the market a false or misleading
impression as to the supply of, demand for or price or value of,
qualifying investments, or

(b) would be, or would be likely to be, regarded by a regular user of the
market as behaviour that would distort, or would be likely to distort,
the market in such an investment,

and the behaviour is likely to be regarded by a regular user of the market
as a failure on the part of the person concerned to observe the standard
of behaviour reasonably expected of a person in his position in relation to
the market.

(9) Subsections (4) and (8) and the definition of “regular user” in section
130A(3) cease to have effect on 31 December 2014 and subsection
(1)(b) is then to be read as no longer referring to those subsections.

1.2. With the exception of the subsections mentioned in (9) above (to the extent
set out there), the section as stated above was in force throughout the
Relevant Period.

2. REGULATORY PROVISIONS

2.1. In exercising its power to issue a financial penalty, the Authority must have
regard to the relevant provisions in the Handbook.

2.2. In deciding on the action set out in this Notice, the Authority has had regard to
guidance published in the Handbook and set out in the Regulatory Guides, in
particular the Decision Procedure and Penalties Manual and the Enforcement
Guide.

3. PRINCIPLES FOR BUSINESSES

3.1.
The Principles are a general statement of the fundamental obligations of firms
under the regulatory system and are set out in the Handbook. They derive
their authority from the rule-making powers as set out in the Act and reflect
the Authority’s regulatory objectives.

3.2.
The relevant Principle is as follows:

Principle 3 provides: “A firm must take reasonable care to organise and control
its affairs responsibly and effectively, with adequate risk management
systems”.

4. SUPERVISION MANUAL

4.1.
SUP sets out the relationship between the Authority and authorised persons
(referred to in the Handbook as firms). The provisions of SUP set out in this
Annex are those in force during the Relevant Period.

4.2.
The relevant rule is as follows:

SUP 15.10.1R provides: “This section applies in relation to activities carried on
from an establishment maintained by the firm or its appointed representative
in the United Kingdom.”

SUP 15.10.2R provides: “A firm which arranges or executes a transaction with
or for a client and which has reasonable grounds to suspect that the
transaction might constitute market abuse must notify the [Authority] without
delay.”

4.3.
SUP 15 Annex 5G provides indications to be used as a starting point for
consideration of whether a transaction is suspicious. These include:

“A transaction is significantly out of line with the client's previous investment
behaviour (e.g. type of security; amount invested; size of order; time security
held)”; and

“There is unusual trading in the shares of a company before the announcement
of price sensitive information relating to the company”.

5. ENFORCEMENT GUIDE

5.1. The Authority’s approach to taking disciplinary action is set out in Chapter 2 of
EG. The Authority’s approach to financial penalties and public censures is set
out in Chapter 7 of EG. EG 7.1.1 states: “…the effective and proportionate use
of the Authority’s powers to enforce the requirements of the Act, the rules
…and the Statements of Principles for Approved Persons… will play an
important role in the [Authority’s] pursuit of its statutory objectives. Imposing
disciplinary sanctions shows that the [Authority] is upholding regulatory
standards and helps to maintain market confidence and deter financial crime.
An increased public awareness of regulatory standards also contributes to the
protection of consumers.”

6. DECISION, PROCEDURE AND PENALTIES MANUAL

6.1. Guidance on the imposition and amount of penalties is set out in Chapter 6 of
DEPP. The Authority has determined the appropriate financial penalty pursuant
to the framework set out in DEPP 6.5A.

ANNEX B

REPRESENTATIONS

Representations of IBUK

1. IBUK’s representations (in italics), and the Authority’s conclusions in respect of
them, are set out below.

2. The obligation under Principle 3 is broad and unspecific. The Authority has
provided only very limited guidance on how it might be interpreted in relation to
STRs and expressly declined to identify the criteria it considers establish
reasonable grounds for suspicion. It has accepted that it is for firms to determine
those criteria and how they might be identified in relation to any given
transaction. Firms have discretion as to how to achieve this and the Authority
should not substitute its own judgement in deciding whether the firm’s
arrangements are acceptable.

3. Principle 3 imposes a duty on firms to take reasonable care to organise their
affairs responsibly and effectively, with adequate risk management systems. The
duty requires firms to design systems appropriate to fulfil this duty in relation to
their own business; it does not confer on them a discretion to adopt a lower
standard.

4. Given the volume of its trading, IBUK adopted a reasonable approach in designing
and operating a system that incorporated pre-trade filters and post-trade
surveillance to narrow down the transactions requiring review. Post-trade
surveillance included the generation of automated reports which identified
transactions of interest by reference to the size (calculated in a variety of ways)
of profits generated. IBUK made sure the reports were built appropriately and
notified IBLLC of any improvements that it thought ought to be made. These were
calibrated by what IBUK reasonably considered the appropriate criteria to identify
transactions of interest without creating large numbers of false positive results.
Although the Authority states that it was possible for no transactions for UK
clients to appear on a number of the reports on any given day, this was in fact
unlikely.

5. The Authority does not criticise the use of post-trade surveillance reports in
themselves, or say that trade size (expressed in different ways) was not a
relevant criterion for review. However, the Post-Trade Surveillance Reports were
operated on a global basis and IBUK did not input adequately into their design
and calibration, or conduct testing, so as to ensure that they were appropriate to
identify potentially suspicious transactions by IBUK’s own clients. There is in fact
no evidence of significant input into the design and calibration of the reports, or

of any requests by IBUK for changes to be made. While contending that it was
unlikely that any of the Post-Trade Surveillance Reports would ever highlight no
transactions by its clients, IBUK provided no evidence to demonstrate this, and
did not dispute that this was possible. In any event, the identification of one or
more transactions each day would not of itself indicate that the filters used in the
reports were adequate.

6. As well as operating its own compliance department in the UK, IBUK also
incorporated into its systems the expertise of a substantial and well-trained team
of compliance officers engaged by its US sister company to identify market abuse
from a US and UK perspective. The IBLLC Reviewers were skilled and familiar
with market abuse, which is not specific to the UK but a generic problem for all
financial markets. Transactions identified in an automated report were further
scrutinised by reference to proximity to an announcement, duration of holding,
previous patterns of trading and known connections.

7. IBLLC Reviewers had their own detailed internal guidance so it was not necessary
for the Policy to set out exhaustive guidance on how the Daily Stats Reports
should be reviewed. Nor was it necessary to set out procedural matters of which
IBLLC Reviewers were well aware, such as the need to escalate potentially
suspicious matters to the UK, to consult IBUK where necessary, and to document
reviews. It did set out the UK legal position, as this would be less familiar to US-
based reviewers.

8. Although the Policy referred to the UK legal position, it restated the law without
any consideration of IBUK’s own market abuse risks, and contained no IBUK-
specific guidance on how to apply SUP 15.10.2R. Only the final version of the
Policy contained any guidance on how to review the reports. While it was not
unacceptable, in itself, for IBUK to outsource the review, this did not discharge
IBUK’s own obligations in relation to the review process. It was inappropriate for
IBUK to rely on IBLLC Reviewers to identify suspicious transactions without
meaningful guidance on the UK legal and regulatory position or how this might
apply to the specifics of IBUK’s business. While market abuse regulatory regimes
in other countries including the US might, to a greater or lesser extent, be similar
to that of the UK, it was not appropriate to proceed on an assumption that there
were no material differences. Nor was it appropriate for the Policy to omit
reference to important procedural steps such as the requirement to report to, or
consult with, IBUK or to document reviews, on the assumption that the reader
would realise they were required.

9. Reviews were not, in fact, adequately documented by IBLLC. IBUK stated that
IBLLC provided only a brief note stating the reason for the profit or loss made, in
relation to transactions that required further review, the purpose being just to
record that a transaction had been reviewed and that it was thought to require
further review. The reason given for this was to maximise the time spent
carrying out reviews, rather than documenting them. To the extent that reviews
were not documented, it is not possible to say whether the review in any given
case was adequate.

10. IBUK accepts that it did not conduct formal quality assurance checks of the IBLLC
reviews, but the Authority wrongly downplays the regular engagement between
IBUK and IBLLC Compliance which enabled an assessment of quality to take
place.

11. The Authority does not accept that there was such regular engagement; there
were only occasional, undocumented telephone conversations between IBUK and
IBLLC Compliance, and there is no evidence of any checks conducted.

12. The Authority inappropriately relies on an increase in submission of STRs by IBUK
after the MS&F visit as demonstrating that its previous approach was in breach of
Principle 3. This does not follow: IBUK enhanced its standards and took a highly
cautious approach to reporting after the visit, in response to the feedback from
the Authority. The Authority has indicated that firms should not submit
“defensive” reports, which suggests that firms should err on the side of not filing
STRs unless the “reasonable grounds for suspicion” test is clearly met.

13. The STR figures before and after the MS&F visit are not determinative in the
Authority’s assessment of the adequacy of the systems and controls in place
during the Relevant Period. However, the Authority has assessed all of IBUK’s
more recent STRs to be “good” (subject only to reservations about timeliness in
certain cases) and this suggests that “defensive” reporting has not been taking
place since the MS&F visit. While it is possible that there were very few suspicious
transactions occurring prior to the MS&F visit and substantially more afterwards,
this proposition is weakened by the existence, during the Relevant Period, of the
three unreported transactions referred to in paragraphs 4.28 to 4.36 of this
Notice, and the Authority considers it a reasonable inference that the material
increase in reporting following the MD&F visit was due to the improvement of
IBUK’s systems and controls.


14. There were not reasonable grounds to suspect insider dealing in relation to any of
the three transactions identified by the Authority. This is the conclusion reached
after applying formal and informal guidance from the Authority on the matters to
be taken into account. In each case the relevant transactions were within the
client’s normal range, albeit at the higher end of that range in terms of size; they
were not of a different kind to the relevant client’s previous trading.

(a) Transaction One:

i.
If the currency variations introduced by the Authority’s
conversion of profits into GBP at different times are removed
(and there is no reason to convert into GBP transactions that
took place in USD), the realised profit was in fact 60% higher
than the next most profitable CFD trading (not 83%), and Client

A’s highest exposure to this stock was 10% greater than its
next highest exposure to any stock (not 20%).

ii.
The highest exposure is a more appropriate measure of a
client’s behaviour than the profit made, as the former is more in
the client’s control. The fact that the highest exposure was 10%
higher than the previous highest exposure does not make this
trade significantly out of line with Client A’s previous investment
behaviour. Client A regularly put on large bets on stocks and
made or lost large amounts doing so. As for the comparison
with the average exposure, where a client places a wide variety
of different trade sizes, the larger trades will inevitably be
larger than the average, and this is not in itself suspicious.

(b) Transaction Two:

i.
Removing currency variations, Client A’s highest exposure to
Stock Y was between four and five times greater than the
average highest exposure (not more than five times greater).

ii.
The fact that there had been no trading by Client A in Stock Y
over the previous 12 months is not significant. Like many
clients who use online brokers such as IBUK, Client A traded in
a large number of stocks. In the previous 12 months, it had
traded in 37 different underlying stocks, of which it had never
traded 35 (95%) before. (Stock X in Transaction One was
notable in being a stock it had traded before.)

iii.
The same points apply regarding highest and average
exposures as set out in relation to Transaction One.

(c) Transaction Three:

i.
Removing currency variations, Client B’s absolute profit was
approximately 41% more (not 50% more) than for its next
most profitable CFD trading on its IBUK account, and 4.9 times
(not six times) as profitable as the third most profitable CFD
trading. The IBLLC reviewers also had access to Client B’s
trading on its IBLLC account, and its trading in other instrument
types, and would rightly have considered its trading on a global
basis. Client B’s profit in Stock Z was only 11% more than its
profit from the next most profitable trading.

ii.
The fact that there had been no trading by Client B in Stock Z
over the previous 12 months is not significant. In the previous
12 months, it had traded in 293 different underlying stocks, of
which it had never traded 234 (almost 80%) before.

30

iii.
In terms of trade size, there were other exposures of similar or
greater size. The same point applies regarding average
exposure as set out in relation to Transaction One.

15. The Authority should be wary of relying on its own detailed forensic analysis ex
post facto, as it would have been completely unrealistic for a reviewer to carry
out this level of analysis in real time.

16. The Authority converted all transactions into one currency in order to carry out a
comparison, and chose GBP because this was the currency of most of the
transactions compared. However, the figures relied on by IBUK in USD are not
materially different for the purposes of the conclusions which the Authority draws
from the comparison, as set out in this Notice.

17. IBUK’s analysis of Transaction One, Transaction Two and Transaction Three,
summarised above, is unduly narrow in focusing on whether the transactions
were different in kind from previous trading by the client concerned, in
considering whether they were suspicious. The analysis fails to engage with the
full range of applicable factors and, so far as it suggests that particular factors
identified by the Authority are to be given no weight, is wrong. Nevertheless, in
each case the trading involved a very significantly greater exposure, and
generated very substantially higher profits, than was usual for the client.

18. The Authority’s analysis of the relevant trading used information available to
IBLLC Reviewers and was the kind of analysis that could have been carried out by
them in order to determine whether or not there were reasonable grounds to
suspect that transactions might constitute market abuse.

Enforcement action not appropriate

19. Even if IBUK was in breach of Principle 3 or SUP 15.10.2R, enforcement action
was not appropriate. The Authority’s work on STRs was primarily intended to be
collaborative with industry and educational in nature, with enforcement action
reserved for the most egregious cases. The alleged misconduct could have been
much worse (eg complete ignorance of the relevant requirements) and IBUK co-
operated with the Authority and adopted a proactive approach when provided
with feedback by the Authority.

20. This Notice is concerned only with the position of IBUK and not with that of any
other firm. The Authority acknowledges that the misconduct could have been
worse but does not agree that IBUK’s misconduct was insufficiently significant to
merit enforcement action in this case; indeed, it considers the misconduct was
serious. While co-operation by a firm is a relevant factor for the Authority in
deciding whether or not to take action against it, it does not consider that the co-
operation shown by IBUK in this case was exceptional, or otherwise such as to
justify not taking action.

Financial penalty

21. If there were a breach of Principle 3 and/or SUP 15.10.2R, and a financial penalty
were considered appropriate, the calculation of the financial penalty should take
account of the following matters:

(a) The relevant revenue taken at Step 2 should not include any revenue
attributable to index options and futures, which are by nature not
susceptible to insider dealing. Accordingly, revenue from these products is
not “indicative of the harm or potential harm” that the breach may cause
(as set out in the guidance at DEPP 6.5A.2). This accounts for the
majority of IBUK’s trading income.

(b) The relevant revenue figure should also exclude a substantial sum
attributable to “other income”, which is income from sources other than
client trading and inter-company brokerage, execution and clearing fees ie
interest income and foreign exchange gains.

(c) The breach in this case should be assessed as, at most, level 2 in
seriousness rather than level 3, in view of the preponderance of “level 1, 2
or 3 factors” in this case (set out at paragraph 6.12 of this Notice).

(d) In light of IBUK’s profit figures, the Authority should make a substantial
proportionality reduction, in line with DEPP 6.5.3(3), to a penalty of no
more than £250,000.

(e) A 20% discount is appropriate at Step 3 in recognition of the following
mitigating factors:

i. IBUK reacted quickly and proactively when it first received
feedback in the approach the Authority wished it to take in
reporting and conduct surveillance for insider dealing;

ii. IBUK’s senior management were not aware of the issues until the
MS&F visit;

iii. IBUK co-operated with the Authority’s investigation; and

iv. IBUK has a clean disciplinary record.

22. As to these matters:

(a)

i. These proceedings relate to failures in IBUK’s systems and controls
for detecting market abuse of all kinds, not only insider dealing.
The Authority has not made any specific findings as to the
adequacy of those Post-Trade Surveillance Reports which were
intended to capture types of market abuse other than insider

dealing. However, the Authority’s findings in all other respects as
to the adequacy of IBUK’s systems and controls in relation to the
detection of market abuse – notably the design of its outsourcing of
post-trade surveillance to IBLLC and the failure in its oversight of
those outsourcing arrangements – apply to all types of market
abuse. It is also the case that the Authority has only identified
occasions of crystallised risk in relation to possible insider dealing in
relation to CFDs, but that does not mean that the risk did not exist
in relation to trading in other instruments, or other types of market
abuse.

ii. IBUK’s argument that index options and futures were not
susceptible to insider dealing was based on evidence which, in fact,
went no further than to support an argument that insider dealing in
relation to such instruments was, putting it at its highest, very
unlikely rather than impossible. Further, IBUK did not argue that
index options and futures were less susceptible than CFDs to other
types of market abuse. Accordingly, the Authority considers that
revenue from index options and futures forms part of the relevant
revenue at Step 2.

(b) The Authority considers that the “other income” should be included in the
penalty calculation because it is income that would not have accrued to
IBUK but for its main business of executing and arranging transactions for
clients.

(c) The assessment of a level of seriousness on the level 1 to 5 scale is not a
question of adding up the number of factors that are likely to be
considered “level 1, 2 or 3 factors” on the one hand (which in any event
point only towards a seriousness of level 1, 2 or 3, not to any particular
level within that range) and those that are likely to be considered “level 4
or 5 factors” on the other hand; rather, it is necessary to weigh all the
relevant factors in terms of their significance in the particular case.
Paragraphs 6.7 to 6.15 of this Notice explain how the Authority has
reached its assessment that the breach in this case is level 3.

(d) The Authority considers that the figure reached at Step 2 of the financial
penalty calculation was, without adjustment, disproportionately high for
the breach concerned; accordingly, it has made an appropriate reduction,
but it does not agree that a reduction of the amount suggested by IBUK is
appropriate.

(e) The Authority has taken the matters listed by IBUK into account in
concluding that there are no mitigating factors such as to justify a
reduction of the penalty in this case (nor any aggravating factors such as
to justify its increase).

23. The Authority should not describe the breach as having been committed
“negligently”, because that term has a specific legal meaning which is not
supported by the evidence in this case.

24. The Authority is using the term “negligently” in the sense in which that term is
used in DEPP 6.5A.2(12).

Representations of IBLLC

25. IBLLC’s representations (in italics), and the Authority’s conclusions in respect of
them, are set out below.

26. IBLLC adopts the representations of IBUK.

27. Additionally, the conclusion should not be drawn that IBLLC has objectively poor
systems and controls or is non-compliant with US regulatory rules. On the
contrary, IBLLC Compliance staff have been instrumental in notifying US
authorities and assisting various exchanges and regulators in relation to
suspicious trading activity, in particular insider dealing.

28. The Authority repeats its comments in relation to the representations of IBUK.

29. The Authority has not investigated IBLLC’s processes and systems for detecting
market abuse, other than to the extent it was acting as an outsource provider to
IBUK, and makes no finding as to whether they are compliant with US law.