Deliberate manipulation of securities prices will invariably and inevitably be harshly penalised

Deliberate manipulation of securities prices will be harshly penalised.

That’s the clear message to emerge from the 17 February 2009 Financial Services Appeal Board case of Michael Berman vs the Financial Services Board.

Mr Berman was a director and chief executive officer of Velocity Trading, a hedge fund management company that managed two funds – Velocity Capital Real Estate Hedge Fund and Mayibentsha Fund.

Velocity Capital and the Mayibentsha Fund paid Velocity Trading management and performance fees. The former’s fees were based on the performance of the fund’s investments. In order to establish the value of the securities of the fund, the closing price on the day of the valuation was used. In Mayibentsha’s case the fees were based on the valuation of funds under management.

The following events, which took place on 31 March 2005, led to the case against Mr Berman:

• At 16h20 Mr Berman instructed a securities trader to purchase 4 000 JSE-listed Ifour Properties shares at 940c a share. At 16h31:06 the trader entered the bid in the market, at which stage the last recorded transaction in Ifour shares had taken place at 870c. Mr Berman bought all the shares on offer at 870c and 885c, along with an additional 212 shares at 940c, which figure thereby became the new ruling price for Ifour shares.

• At 16h31:40 another dealer entered an offer to sell 88 Ifour shares at 840c – a time when there was a bid in the market to buy 1 000 shares at 840c. The bid and the offer matched, hence lowering the ruling price to 840c.

• At 16h57:59, some two minutes before the close of the market, the trader, on Mr Berman’s instruction, entered a bid to buy 100 Ifour shares at 940c. The bid matched an offer to sell 19 721 Ifour shares at 940c. Again the ruling price rose to 940c.

• On the same day, Mr Berman instructed the trader to sell 500 shares in SA Retail Properties on behalf of Velocity Trading at 875c. He simultaneously instructed the trader to buy the same shares for Mayibentsha at the same price. The trader entered the two orders in the market and as they matched the result was a purchase and sale of 500 SA Retail shares at 875c. The transaction boosted the ruling price of SA Retail from 800c to 875c.

The transactions were investigated on behalf of the Financial Services Board (FSB)by the Directorate of Market Abuse, which found that the transactions constituted a manipulation of trade in securities. The Directorate of Market Abuse recommended R10 million as an appropriate penalty. The FSB then referred the matter to its Enforcement Committee.

On 30 August 2005 the Registrar of Securities Services suspended, and subsequently withdrew, Velocity Trading’s licence and debarred Velocity Trading and Mr Berman from re-applying for a license for four years.

Mr Berman admitted that he had intentionally manipulated the Ifour and SA Retail share prices. He also expressed his regret, made a commitment not to repeat the offences and offered to pay an administrative penalty of R250 000.

Following the admission of guilt, the Enforcement Committee considered the penalty to be imposed. The Committee’s view was that the contravention had been deliberate and serious. Not only had there been a great potential of harm but Mr Berman’s conduct could prompt investors in the market to question its trustworthiness and credibility.

In determining the penalty, the Committee considered the Securities Services Act’s provision of a fine not exceeding R50 million for a criminal offence such as the manipulation of securities prices. Believing that deterrence was an overriding factor when considering an appropriate sentence,it imposed an administrative penalty of R2 million on Mr Berman.

Mr Berman appealed the decision, challenging the R2 million penalty on the ground that the Enforcement Committee had overemphasised the importance of deterrence and had failed to give adequate consideration to the factors it was required to consider under the Securities Services Control Act.

While conceding that deterrence was a relevant factor, Mr Berman argued that in determining a suitable administrative penalty what was required was a degree of proportionality between the benefit to society and the hardship imposed upon the offender. However, the FSB argued that, subject to the circumstances of the contravention and those of the offender, general deterrence was the primary consideration.

The Appeal Board insisted that the Securities Services Act regarded deterrence as of paramount importance when imposing a penalty for a contravention of the nature in question.

It said that market manipulation of the kind committed by Mr Berman conflicted directly with the integrity of the market. His conduct had not only been fraudulent towards his clients, who had invested in the hedge funds he had operated, but had caused other players in the market to believe that SA Retail and Ifour shares were worth more than they actually were.

The Board maintained that Mr Berman’s conduct called for a penalty that sent a message to the public that practices which deflected from the objects of the Securities Services Control Act were taken seriously; that such conduct would be harshly punished.

However, the element of proportionality always required that the circumstances of the contravention and those of the offender be given due consideration.

The Board agreed on the importance of deterrence and that a large penalty was called for. Affordability was not relevant.

Even so, the Appeal Board said it had to measure the importance of deterrence against other relevant factors involved in arriving at a penalty; factors that metthe requirements of proportionality. Applying that test, it concluded that the penalty imposed was in the circumstances excessive and inappropriate.

It considered that:

· The offence was committed on a single afternoon and did not involve a vast number of shares;

· Although the effect of the transaction was to falsely increase the value of the funds managed, his monetary gain was a relatively modest R4 000 and R16000;

· It was Mr Berman’s first offence; and

· His plea of guilt reflected contrition.

The Board considered that a penalty of R1 million would have been sufficiently appropriate to send the correct message to the public and accordingly reduced the penalty from R2 million to R1 million.

The decision confirms that any act which undermines confidence in the South African financial markets will be harshly dealt with – an important message in the context of the current global financial crisis and major investment fund scandals.

While observing the principle of proportionality when deciding on a penalty, deterrence is the objective. The decision also confirms that affordability on the part of the offender is irrelevant.

Francisco Khoza is a partner in the investment management practice area at commercial law firm Bowman Gilfillan