ADMINISTRATIVE PENALTIES: A DETERRENT TO MARKET ABUSE?
The Securities Services Act, 2004 (SSA) has as its object the increase of confidence in the South African financial markets, the promotion of protection of regulated persons and clients, the reduction of systemic risk and the promotion of the international competitiveness of securities services in South Africa. One of the ways the SSA seeks to achieve this object is through the provisions of chapter VIII which deal with market abuse. The chapter’s provisions, in effect, replaced those of the Insider Trading Act, 1999.
In one of the first cases of its kind, the enforcement committee (a committee established in terms of section 97 of the SSA) (Enforcement Committee) adjudicated a matter between the Financial Services Board (FSB), Michael Berman and Neil Stacey. Berman and Stacey were charged with having used manipulative, false or deceptive trading practices in relation to securities listed on the JSE; practices that contravened the provisions of section 75 of the SSA. Section 75 of the SSA deals with prohibited trading practices and states, inter alia, that no person may:
• either for his own account or on behalf of another person, directly or indirectly use or knowingly participate in the use of any manipulative, improper, false or deceptive practice of trading in a security listed on a regulated market, which practice creates or might create a false or deceptive appearance of the trading activity in connection with, or an artificial price for, that security; and
• place an order to buy or sell listed securities which to his or her knowledge will, if executed, have the effect contemplated above. During the hearing, Berman admitted contravening section 75 of the SSA by intentionally manipulating the prices of two listed securities. The Enforcement Committee imposed an administrative penalty of R2 million on Berman and stated that the overriding consideration in determining this penalty was its deterrent effect.
An administrative penalty of R2 million was also imposed on Stacey. Here the Enforcement Committee found that Stacey, as a registered securities trader, had disregarded the obligations imposed on him by the JSE as an aggravating factor.
Berman alone appealed the decision of the Enforcement Committee in respect of the value of the administrative penalty imposed on him. Berman argued before the appeal board (a board of appeal established in terms of section 26A of the Financial Services Board Act, 1990) (Appeal Board) that in imposing an administrative penalty of R2 million, the Enforcement Committee had overemphasised the importance of deterrence as a factor and failed to give adequate consideration to the factors which it was obliged, in terms of section 104(9) of the SSA, to consider.
Subsequent to the decision, the SSA has been amended, with the sections (97 – 106) dealing with the Enforcement Committee having been moved to the Financial Institutions [Protection of Funds] Act, 2001 (FIPF). At the time of the decision, section 104(9) of the SSA set out various factors to be considered when determining a penalty for market abuse:
• The nature, duration, seriousness and extent of the contravention or failure;
• The extent to which the contravention or failure was deliberate or reckless;
• The loss or damage suffered as a result of the contravention or failure;
• The level of profit derived from the contravention or failure;
• Whether the respondent had previously been found in contravention of the SSA; and
• Any other factor that the panel considers relevant.
Although the section did not expressly state that the deterrent effect of the administrative penalty should be considered, the Enforcement Committee as well as the Appeal Board held that the SSA must have intended the deterrence factor to fall within ‘any other factor’ that the panel considers relevant. They also noted that the element of proportionality always requires that the circumstances of the contravention and those of the offender be taken into account.
Furthermore, the Enforcement Committee referred to section 115 of the SSA which enabled it to impose a fine not exceeding R50 million or to sentence a guilty party to a period of imprisonment for a period not exceeding 10 years, or to both a fine and imprisonment. It follows that the Enforcement Committee was well within its powers when it penalised Berman R2 million for his acts of market abuse.
The Appeal Board noted that it did not have ‘an unfettered discretion to interfere with the penalty imposed by the Enforcement Committee’ and that their role was only to interfere where they believed the penalty imposed was excessive or startlingly inappropriate. In making this assessment, the Appeal Board measured the importance of deterrence against any other relevant factor in order to arrive at a penalty that met the requirements of proportionality.
The Appeal Board stated that the affordability of the penalty was not relevant as this could defeat the important consideration of deterrence. If affordability were to be a deciding factor and the accused was only charged a small, affordable amount the penalty would not have the effect of deterring people from committing prohibited trading practices. Small, affordable penalties defeat the object of the SSA as they do not increase confidence in the South African financial markets.
In reaching its decision, the Appeal Board relied on an article written by Karen Yeung (published in the Melbourne University Law Review  18) entitled “Quantifying Regulatory Penalties: Australian Competition Law Penalties in Perspective”.
According to Yeung, “penalties should be set at a level which are sufficiently high to deter future contraventions of the law, provided that any given penalty is not disproportionate to the seriousness of the offence”. The Appeal Board noted that this view was equally applicable in South Africa. It therefore weighed up the fact that a witness had suggested that the monetary gain by Berman was only an amount between R4 000 and R16 000, that it was Berman’s first offence and that he showed remorse, which was exemplified by his pleading guilty. The Appeal Board therefore ruled that the penalty imposed on Berman be reduced from R2 million to R1 million. This, they felt, would still serve as a significant deterrent.
As mentioned, subsequent to this decision, the FIPF has been amended so as to incorporate, inter alia, the factors used to determine the sanctions to be imposed for market abuse contraventions. Section 6D(3)(g) of the FIPF now has ‘the deterrent effect of the administrative sanction’ as a factor. Although deterrence was used prior to the amendment, it was controversial and, in the Berman case, to a large extent, the basis on which Berman appealed the decision.
The amendment and the case is likely to clarify that:
• deterrence is the most important factor used in determining the penalty to be imposed for acts of market abuse; and
• ‘affordability’ is not a relevant factor in deciding whether a penalty imposed is appropriate in the context of the proportionality principle.