FSA roars as SFO reveals itself to be a paper tiger

In the same week that the SFO was criticised for its failure to act in two high profile cases and its failure to conduct a single raid in the last financial year, the FSA meted out its largest ever fine for an individual in a non market abuse case.

The turn of events neatly encapsulates the contrasting fortunes of the two agencies and serves as a stark warning to those suspected of committing regulatory and/or criminal offences – if the SFO doesn’t get you others just might.

The FSA flexed its muscles in the case of Alberto Micalizzi, CEO and a director of Dynamic Decisions Capital Management Limited (DDCM) – a hedge fund management company based in London.  Mr Micalizzi was fined £3m and banned from performing any role in regulated financial services as a result of concealing losses, lying to investors and eliciting funds through the use of financial instruments that the FSA held were not genuine.

Between 1 October 2008 and 31 December 2008 DDCM managed a hedge fund that suffered “catastrophic losses” of over $390m.  The FSA found that Mr Micalizzi lied to investors about the true position of those losses and entered into a number of contracts for the purchase and re-sale of a bond. The bond contracts were, held the FSA, deliberately undertaken by Mr Micalizzi to create artificial gains for the fund. Units of the bond were sold to the fund at a deep discount to their face value and then valued by the fund at approximately their face value when reporting to investors. This mechanism, so the FSA found, was used by Mr Micalizzi to book purported profits of over $400m.

Whilst the fine of £3m is a significant scalp for the FSA it is particularly embarrassing for the SFO.  The case was originally referred to the SFO by the FSA but the SFO decided not to prosecute – citing a lack of evidence.  By contrast, in its Decision Notice the FSA is at pains to highlight the strength of its case and the morally opprobrious behaviour of Mr Micalizzi – stating “it is amongst the most serious that the FSA has encountered“.  Mr Micalizzi’s actions were “dishonest” and, said the FSA’s acting director of Enforcement and Financial Crime: “fell woefully short of the standards that investors should expect“.

A couple of days later another case that the SFO failed to prosecute hit the headlines as liquidators for Weavering Capital (UK) Limited successfully sued its founder Magnus Peterson (and others) for $450m. Funds were held to have been misappropriated by Mr Peterson after he entered into “sham” agreements and manipulated figures to give the impression to investors that the Macro Fixed Income fund he managed was successful.   As with Mr Micalizzi, the actions of Mr Peterson were held by the Court to be characterised by moral wrongdoing. He had made numerous “misrepresentations” and “misleading statements” and had provided “thoroughly misleading” impressions as to the financial health of the fund.

Viewed in this light it is unsurprising that the SFO has now come under acute criticism for its decision in September 2011 to drop a two-year investigation into Weavering Capital and Mr Peterson.  The SFO stated at the time that there was no reasonable chance of convicting Mr Peterson – a decision that not only surprised legal commentators but angered former investors in the failed hedge fund. Indeed such is the level of feeling regarding the SFO’s perceived impotency that a legal challenge in the shape of judicial review proceedings cannot be ruled out.  A prospect which is sure to fill the agency with dread.

These cases follow on from the SFO conceding, in response to a Freedom of Information Request, that it did not raid a single property in the 2011-12 financial year.  The news is yet another blow to the agency and has served to raise serious question marks as to the organisation’s appetite for investigation and prosecution.

Whilst it may have been yet another tumultuous week in the already chequered history of the SFO, the Micalizzi and Peterson cases both demonstrate that even if the SFO does not have the appetite for a fight, the FSA and aggrieved investors do.