On 17 February 2009 the Financial Services Appeal Board (the “Appeal Board”), in the case of Michael Berman vs the Financial Services Board, confirmed that deliberate manipulation of securities prices will be harshly penalised.
Mr Berman was a director and chief executive officer of Velocity Trading (Pty) Limited (“Velocity Trading”). Velocity Trading was a hedge fund management company that managed two funds. The two funds were: Velocity Capital Real Estate Hedge Fund (“Velocity Capital”) and Mayibentsha Fund.
Velocity Capital and the Mayibentsha Fund paid Velocity Trading a management fee and a performance fees. The Velocity Capital 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 of such securities on the day of the valuation was used. In the case of the Mayibentsha Fund the fees were based on the valuation of funds under management.
The events leading to the case against Mr Berman happened on 31 March 2005. The events can be summarized as follows:
• At 16h20 Mr Berman instructed a securities trader (the “Trader”) to purchase 4000 Ifour Properties Limited (Ifour) share in the Johannesburg Securities Exchange at 940 cents per share (“cps”). At 16h31:06 the Trader entered the bid in the market. At that stage the last recorded transaction in Ifour shares had been placed at 870 cps. By placing the bid Mr Berman purchased all the shares on offer at 870 cps and 885 cps. In addition, Mr Berman purchased 212 shares at 940 cps. Consequently, the new recorded price for Ifour shares moved to 940 cps.
• At 16h31:40 another dealer entered an offer to sell 88 Ifour shares at 840 cps. There was at that stage already a bid in the market to buy 1000 Ifour shares at 840 cps. The bid and the offer matched and brought the last trading price of Ifour shares back to 840 cps.
• At 16h41:53 Mr Berman talked to the Trader about the movement of the Ifour shares. Following the conversation Mr Berman decided to wait until closer to the end of the trading day (i.e. 17h00) before issuing a further instruction to the Trader. At 16h57:59 (approximately two minutes before the close of the market) the Trader, on the instruction of Mr Berman, entered a bid to buy 100 Ifour shares at 940 cps. The bid matched an offer to sell 19721 Ifour shares at 940 cps. The trading price of the Ifour shares was therefore increased to 940 cps.
• On the same day, Mr Berman instructed the Trader to sell 500 shares in SA Retail properties Limited (SA Retail) on behalf of Velocity Trading at 875 cps. At the same time he instructed the Trader to buy the same shares for the Mayibentsha Fund at 875 cps. 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 875 cps. The transaction effected by Mr Berman increased the last recorded price of SA Retail shares from 800 cps to 875 cps.
The transactions were investigated by the Financial Services Board (“FSB”). The investigation was conducted on behalf of the FSB by the Directorate of Market Abuse. Following the investigation the Directorate of Market Abuse found that the transactions constituted, among others, a manipulation of trade in securities. The recommendation of the Directorate of Market Abuse was that an appropriate penalty would be no less than R10 million. The FSB then referred the matter to the Enforcement Committee of the FSB.
On 30 August 2005 the Registrar of Securities Services (the “Registrar”) suspended the license of Velocity Trading. The Registrar subsequently withdrew Velocity Trading’s license and ordered that Velocity Trading and Mr Berman were debarred for a period of four years form re-applying for a license. Mr Berman admitted that he had intentionally manipulated the price of shares Ifour and SA Retail. Mr Berman 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 Enforcement Committee’s view was that the contravention was deliberate and very serious. Not only was there a great potential of harm but Mr Berman’s conduct could prompt investors in the market to question the trustworthiness and credibility of the market. In fixing the amount of the penalty to be imposed, the Enforcement Committee considered the fact that the Securities Services Act provides, among others, for a fine not exceeding R50 million for a criminal offence such as the manipulation of securities prices. The Enforcement Committee found that deterrence is an overriding factor when considering an appropriate sentence. Consequently the Enforcement Committee imposed an administrative penalty of R2 million on Mr Berman.
Mr Berman appealed the decision of the Enforcement Committee. Mr Berman challenged the imposition of an administrative penalty of R2million. Mr Berman’s argument was that the Enforcement Committee had overemphasized the importance of deterrence and failed to give adequate consideration to the factors which 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 stated that when one has regard to the Securities Services Act, deterrence is undoubtedly of paramount importance when a penalty is imposed for a contravention of the type committed by Mr Berman. Market manipulation of the kind committed by Mr Berman conflicts directly with the integrity of the market. Mr. Berman’s conduct was not only fraudulent towards his clients who had invested in the hedge funds operated by him, but caused other players in the market to believe that SA Retail and Ifour shares were worth more than they actually were. According to the Appeal Board, Mr Berman’s conduct called for a penalty that sends a message to the public that practices that deflect from the objects of the Securities Services Control Act are taken seriously and that anyone who might consider embarking on that type of conduct will be harshly treated. However, the element of proportionality always requires that the circumstances of the contravention and those of the offender be given due consideration.
The Appeal Board agreed with the Enforcement Committee on the importance of deterrence. A large penalty was called for. The Appeal Board also mentioned that affordability on the part of the offender is not a relevant factor in deciding whether the penalty imposed was appropriate in the context of the proportionality principle.
In determining whether to interfere with the penalty of R2 million imposed by the Enforcement Committee, the Appeal Board stated that, it had to measure the importance of deterrence against other relevant factors involved in arriving at a penalty that meets the requirements of proportionality. Applying that test, the Appeal Board came to the conclusion that, having regards to the need for proportionality, the penalty imposed was in the circumstances excessive and inappropriate. The Appeal Board considered that: the offence was committed on a single afternoon and did not involve a vast number of shares; although the effect of these transaction was to falsely increase the value of the funds managed by Mr Berman, his monetary gain was a relatively modest amount between R4000 and R16000; this was Mr Berman’s first offence and his plea of guilt was supportive of the contrition he had shown.
The Appeal Board’s view was that a penalty of R1 million would have been sufficiently appropriate to send the correct message to the public that the manipulation of securities prices will not be tolerated and at the same time impress upon would-be offenders that it would not be worth their while to embark on this type of conduct. Therefore, Mr Berman’s administrative penalty was reduced from R2 million to R1 million.
The decision of the Appeal Board confirms that any act which undermines confidence in the South African financial markets will be harshly dealt with. This is an important message to convey in the context of the current global financial crisis and major scandals relating to investment funds (e.g. the Bernard Madoff and Allen Stanford matters in the United States). 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.