One of the City of London's larger compliance consultancies, founded by Ben Blackett-Ord (pictured), shares some tips with us about pre-trade and post-trade controls. Once a trade has occurred, only good surveillance can detect any suspicious patterns.

Pre-trade controls

Each of the following pre-trade controls can be listed under one of two headings, but many actually fall under both. Controls that often fall under the heading of 'insider dealing' include:

• a designated person keeping the restricted list;

• hard blocks;

• restrictions being coded into trade order system;

• a process for approving PA (private account) dealing;

• training for staff;

• regular attestations in relation to PA dealing; and

• informal attendance by compliance people at investment meetings.

Controls for 'market manipulation' include:

• a review by a second pair of eyes before a trade occurs;

• the use of a separate dealing desk;

• a clear statement of the trading strategy;

• position limits coded into the trade order system; and

• exception reports based on risks.

One of the things that the FCA's Market Watch 48 came out with recently was an observation to the effect that "firms with less sophisticated controls may be more at risk of not complying with the ESMA [European Securities Markets Authority] guidelines." [NB "more" sophisticated controls include: stock-specific criteria such as percentage of average daily volume; aggregate/exposure controls that are stock-specific; aggregate/exposure limits broken down into separate time segments (e.g. 30-60 minute slots); participation (percentage of traded volume) alerts; automated restrictions on non-priced (market) orders; and market impact controls.] It also noted that when it was reviewing market abuse controls, it found that a lot of people did not go beyond equities. The controls have to cover all asset classes and all parts of the business.

Everybody is required to have PA dealing approval processes and it is to be hoped that everybody has. Staff training is a very standard requirement in both categories as it ensures that people are 'fit and proper' and understand what they are doing in the business. A clear statement of the firm's investment strategy can work for both categories as well.

A lot of people with portfolio management systems use automatic controls, where they 'hard-code in' stops at certain limits or for certain securities. This is a good strategy which might perhaps generate exception reports [i.e. summary reports about events that are outside a normal range]. Some use a second pair of eyes to pre-approve trades and some have committees to oversee a separate dealing desk. All of these can be very useful pre-trade controls.

When a designated person is in charge of a 'stop list' (or restricted list), he often does not record such minutiae as the time the information came in and who was privy to it, who was at the meeting and the time it went off. Whether it went onto the list at 8am or 12 noon on a certain day can make all the difference. The right 'blocks' are essential. [NB Firms often use a 'block' or warning prompt to prevent the trading of securities that have been restricted because of the possession of inside information.]

Post-trade controls

When thinking of post-trade controls, you really ought to ask what you were expecting to see when your firm was dealing. Once again, there is much cross-over between the categories.

The insider-dealing controls include:

• a review of dealing by security and separately by staff, making it easier to see who is doing what;

• double-checking to see whether PA dealings were “as approved” (with confirmation by receiving broker);

• a review of trading that concerns market events (or the other way 'round);

• a review of holding periods of PA and client trades; and

• a review of stated dealing rationales in relation to trading patterns.

The market manipulation controls include:

• trading pattern reviews (volume, sales v purchases, times of cancelled transactions);

• having a separate dealing desk;

• a review of 'outperformance'; and

• a review of exception reports.

As with our list of pre-trade controls, most of these will work under both headings. When bringing them into force, you ought to ask yourself the following questions.

• What was I expecting to see when we were dealing, and what actually came about?

• Did the volume of trades we were putting through come up to expectations? (This is, of course, a question directed mainly at market manipulation, notably the act of “painting the tape” [traders selling a security among themselves to inflate the price] or front-running [dealing on advance information from a broker before their client receives it].

• Is somebody always cancelling, i.e. closing out just before the close of market?

• Is it happening at an effective price?

Outperformance, either transactional or for a portfolio, need not be controversial. If your firm is responsible for consistent outperformance, and you truly understand why because you understand your systems and your life cycle and your investment process, this is nothing but good news and you can pat yourself on the back. If, on the other hand, you come to inspect some recent market events and you realise that somehow you are performing well in a way that you would not necessarily have expected the firm to perform, you should ask yourself whether the firm is getting a bit of inside information that is boosting its performance.

Not for personal gain

People often forget that market abuse and insider trading do not always occur for personal gain, or at least immediate personal gain. They also need not happen through PA deals. The perpetrators sometimes commit these crimes to boost the performance of a fund or a transaction which might lead to someone getting a bonus later. The compliance officer must think more widely than "did this man know something and do a PA deal on it?" The offences are wider than that.

* Beth Cazalet can be reached on +44 (0)20 7620 8440. In the next instalment she looks at the entire control spectrum.