UK: FSA ups the ante for listed companies with £2.4m fine for LDTR breaches involving inside information

The Financial Services Authority (FSA) has published a final notice setting out its decision to fine Lamprell plc (Lamprell) £2,428,300 for significant failings in its systems and controls which resulted in breaches of the Listing Principles, the Disclosure and Transparency Rules (LDTR) and of the Model Code on directors’ dealings in securities.  This is the first penalty  against an issuer for a breach of the LDTRs, involving delayed release of inside information, to be imposed pursuant to the FSA’s new (March 2010) penalty policy.  The  regulator expects its new approach - which uses a percentage of the issuer's market capitalisation to calculate the penalty for LDTR breaches involving inside information - will yield significantly higher penalties going forward - larger listed companies, in particular, could face very substantial penalties, akin to US penalty levels.

Background

Lamprell is a company based in the United Arab Emirates which provides diversified engineering and contracting services to the oil, gas and renewable energy industries.  It has a Premium Listing on the London Stock Exchange.  In July 2011, Lamprell acquired Maritime Industrial Services Co Ltd Inc, which effectively doubled its operational size.  At about that time, Lamprell also received a letter from the UKLA highlighting concerns around the Company’s systems and controls for dealing with the release of inside information.

Lamprell’s budget for 2012 was the basis on which the market was given guidance as to the Company’s financial expectations for the year; it provided expected revenue of USD $1.4bn, and expected gross profit of USD $171m, for the year.  Analyst reports on Lamprell in the early part of the year largely reflected the Company’s budget.  However, in the first quarter of 2012, Lamprell's monthly Board and financial reports were produced late; this also delayed the production of a scheduled quarterly re-forecast.  When this information became available (by 29 April 2012), it was apparent that Lamprell's financial position and performance would be significantly below the budgeted financial position and performance.

On 16 May 2012, Lamprell issued a profit warning (“the May Trading Update”), stating that expected revenue and profit for the year would be substantially lower than the Board’s original expectations for the year.  Lamprell’s share price dropped by 57% after the May Trading Update.

The breaches

1. Inadequate systems and controls

The deterioration in Lamprell’s financial performance in early 2012 was the result of various operational issues.  Because of systems and controls failings, Lamprell was unable to monitor the full impact of these operational issues on the Company’s  financial performance for the year, or to assess its financial performance against budget and against market expectations, as accurately as it should have been able to do.  Lamprell's systems and controls were inadequate and outdated for a company of its size and complexity, in that:

• Project reporting did not include an assessment of project performance against Lamprell’s budget for the financial year. Project reporting only considered the financial performance of a project against that individual project’s budget, not against Lamprell’s budget for the financial year;
• Lamprell did not properly track the award of new business against budget, as a result of which, if an expected award of new business by a certain date was delayed, the impact of this delay was not automatically  assessed for its impact on Lamprell’s budget; and
• Lamprell did not have sufficient visibility of the utilisation of its staff.  Under-utilisation of staff was a key reason for the revised revenue and profit figures released in the May Trading Update, but this had not been appreciated by Lamprell until this time.

As a result Lamprell did not inform the market of its deteriorating financial position in a timely manner, and there was a risk of investors making decisions based on incomplete information.  The FSA found that Lamprell had breached Listing Principle 2 by failing to take reasonable steps to establish and maintain adequate procedures, systems and controls to enable it to comply with its obligations as a listed company.

2. Incomplete (misleading) information published

Prior to the May Trading Update, Lamprell issued a number of announcements to the market including its financial results for 2012 and announcements regarding certain contract awards. In failing to inform the market of the correct financial position due to its systems and controls failings, Lamprell was in breach DTR 1.3.4R as it had failed to take all reasonable care to ensure that information notified to a RIS did not omit anything which was likely to affect the import of the information being published.

3. Failure to disclose inside information as soon as possible

By 29 April 2012, Lamprell’s senior management had information about material changes to Lamprell’s expected financial performance for the year which the FSA found was inside information.  When the figures were produced, senior management questioned their accuracy and asked for verification work to be undertaken.  The FSA considers that the company should have released a holding announcement when the original figures were produced.  By delaying the release of any information to the market until 16 May 2012, Lamprell breached DTR 2.2.1R as it failed to notify a RIS as soon as possible of inside information which directly concerned it.

4. Giving clearance to deal in a prohibited period

Because there was inside information within Lamprell by 29 April 2012, Lamprell was in a prohibited period for the purposes of the Model Code on directors’ dealings in securities (“the Model Code”), and should not have given persons discharging managerial responsibility (“PDMRs”) clearance to deal in Lamprell’s shares after this date.  However, clearances to deal were given on 1 May 2012 and PDMRs continued to deal in the Company’s shares, including on  2 May 2012.  Accordingly, Lamprell was in breach of Listing Rule 9 Annex 1 (R) and specifically paragraph 8 of the Model Code.

There is no finding that the PDMRs dealt on the basis of inside information and the FSA does not attribute any culpability to those PDMRs who dealt in Lamprell’s shares during this period.

The Penalty

The FSA considered that each of the breaches set out above were serious.  As a result of systems and controls that were inadequate and outdated for a company of its size and complexity, Lamprell was unable to keep the market properly informed of its financial position on an ongoing basis, which meant that there was a risk of investors making decisions based on incomplete information.  This also led to the release of information that was incomplete, a delay in releasing inside information and the giving of clearance to deal in a prohibited period.

In applying the penalty policy introduced in March 2010, the FSA has used the issuer's market capitalisation as the appropriate indicator to reflect the harm or risk of harm resulting from a failure to provide the market with complete information about financial performance in a timely manner.  The figure used for market capitalisation in this case was an average over the period in which Lamprell was in breach - so before the release of the profit warning which led to the 57% reduction in share price.

Having decided that the issuer's market capitalisation was the appropriate indicator to reflect the harm or risk of harm resulting from a failure to provide the market with complete information about financial performance in a timely manner, the FSA adopted a scale of 0-0.5% of market capitalisation, to be applied according to the seriousness of the breach, so that

• 0% of the market capitalisation would apply in respect of the least serious breaches
• 0.125% would apply to a Level 2 breach
• 0.25% would apply to a Level 3 breach
• 0.375% would apply to a Level 4 breach
• 0.5% would apply to a Level 5 breach.

Although the regulator recognised that Lamprell's failure to keep the market informed was neither deliberate nor reckless, the FSA nevertheless treated the breach as a Level 4 breach, because:

• Lamprell was unable fully to comply with its continuing obligations over a prolonged period;
• the disclosure of the inside information on the market had a significant impact on share price;
• various market announcements made had indicated continued strength in Lamprell's operations.

Despite the very significant degree of pro-active cooperation provided by Lamprell throughout the FSA's investigation (giving FSA full access to internal investigation work by their lawyers, setting up an on-line electronic document database controlled by external consultants, and flying individuals in for interview from abroad), and the significant steps Lamprell had taken to remedy the problems (replacing senior managers, retaining external consultants, and significant improvements to systems, controls and reporting processes), the FSA then chose to adjust the penalty upwards by 10% - to £3,269,125 - to reflect the fact that the UKLA had previously raised with Lamprell concerns about its controls for dealing with the release of inside information.

Lamprell did, however, get the benefit of the full 30% settlement discount for reaching agreement with the FSA at stage 1 (from commencement of the investigation to when the FSA had communicated its assessment of appropriate penalty to Lamprell and allowed a reasonable opportunity to reach agreement as to the amount of the penalty - generally before the issue of a Warning notice).

Additional thoughts

1. Co-operation with the FSA investigation

An early draft of the Financial Services Bill had proposed giving the FSA the power to require issuers and sponsors to appoint skilled persons to produce a report on any matter, although this proposal was ultimately not taken forward.  Even that power, however, would not have allowed the regulator access to privileged material in the hands of the issuer.

Lamprell elected to provide the FSA with the internal investigation work undertaken by its legal advisers (potentially including privileged material), and appointed external consultants to undertake remedial work.  It is not clear to what extent these concessions enabled the FSA to perfect its case, but the credit given by the FSA for this pro-active cooperation was wholly overshadowed by the aggravating factor of the prior UKLA warning.

The suggestion is that without the exceptional cooperation shown by Lamprell, the upward adjustment would have been higher - firms can therefore assume that failing to act on a warning from the regulator about issues that later form the basis of a breach is likely to merit an uplift which is significantly greater than 10%.

2. Effect on shareholders

A somewhat perverse outcome of this approach is that it is the shareholders (of a listed company on the receiving end of a very substantial fine for delayed inside information about financial performance) who are likely to suffer a double blow - the fall in the value of their shares following the release of inside information, and the reduction in funds available for distribution, following payment of a penalty based on the issuer's market capitalisation pre-release.

3. Integration issues

Lamprell appears to have been taking some action which may have been (at least indirectly) responsive to the prior warning issued by UKLA.  The weaknesses in Lamprell’s systems and controls had been recognised by senior management, and steps were being taken to implement an up-to-date ERP system which would integrate all management information across the Company, including financial information.  However, significant delays and problems in implementation of the ERP system - compounded by post-acquisition integration issues - meant that it had not been successfully implemented by the time the Trading Update was issued.

Lessons to be learned

In light of this case, listed companies should ensure that:

• they review their procedures for the flow of management and financial information, with particular focus on reporting systems;
• their systems and procedures keep pace with the company's expansion;
• when acquiring another company, the company should pre-plan the integration, with a particular focus on reporting systems;
• if necessary they should engage extra staff to make sure that the company is able to monitor its financial performance; and
• when asking for verification of unexpected results which are out of line with market expectations, issuers should consider whether a holding announcement should be made.

This enforcement action, together with the recent fines imposed on Nestor Healthcare Group Limited (for clearance to deal failings) and against Exillon Limited (for failing to identify and disclose related party transactions), serve as a clear warning to listed companies that the new FCA will continue to focus on and enforce compliance with the LDTRs.