(Blue)crest of a wave – case law on the need for a legal liability under a single firm redress scheme

In a decision that will cause consternation for FCA regulated entities and their insurers alike, the Court of Appeal (COA) has overturned the Upper Tribunal (UT's) decision in The Financial Conduct Authority v Bluecrest Capital Management (UK) LLP. The UT's decision had reinforced the need for a legal liability to be established before redress was payable under a single-firm redress scheme. The COA has comprehensively overturned the UT's ruling, casting the position into doubt. Given the increased need for firms to consider whether foreseeable harm has been suffered (and to look to rectify things if it has) following the introduction of the Consumer Duty, this could have far reaching consequences.

The background is fairly complex and I shamelessly refer to my previous blog for a full discussion of the UT's decision. 

The appeal to the COA raised two issues:

1. The statutory powers of the FCA to order redress – specifically the scope of the power at 4A of FSMA and to what extent these are constrained by the requirements of s.404 of FSMA.
2. The jurisdiction of the upper Tribunal when an FCA decision / notice is referred to it.

In very brief terms, in the underlying matter the FCA alleged that Bluecrest Capital Management (UK) LLP (Bluecrest) had failed to manage a conflict of interest. Bluecrest operated two investment funds: the External Fund, which was open to investors, and the Internal Fund, which was only available to employees and directors of Bluecrest. During the period under investigation, some portfolio managers were transferred between the two funds. The US Securities and Exchange Commission ("SEC") announced in 2020 that the parent company (Bluecrest Capital Management Limited) had agreed to settle charges concerning disclosure, misstatements and omissions in relation to the transfer of managers between the Funds. The SEC issued a plan for US based investors to be compensated for management fees paid in connection with the affected investments.

The FCA issued a first supervisory notice (FSN) under s.55L of FSMA that required Bluecrest to pay redress to non US investors. This was based solely on alleged breaches of Principle 8, which relates to managing conflicts of interest. Bluecrest was required to compensate these investors as a condition to their retaining permissions to carry out regulated activities.

A financial penalty of £40,806,700 was also imposed for breaches of Principle 8 (which requires a firm to manage conflicts of interest fairly) via a second decision (DN). Both the FSN and DN effectively concerned Bluecrest having favoured the Internal over the External Fund, allegations denied by Bluecrest.

The UT decision concerned three applications. For the purposes of this blog, the first and second applications are key and summarised briefly below.

Firstly:

• Bluecrest sought to strike out elements of the FCA's statement of case on the basis that s.55L of FSMA only allowed the FCA to implement a single firm redress scheme where it had the power to do so on an industry wide basis under s.404 of FSMA. In order to do this, 4 conditions needed to be met – breach of duty, actionability, causation and loss (the components of a legal lability). Bluecrest argued that the FSN and the FCA's statement of case did not show any real prospect of meeting these conditions. The UT accepted that 55L required fulfilment of the 4 conditions. It also held that the FCA's statement of case was capable of fulfilling the conditions of breach, causation and loss. However, they also held that this did not fulfil the actionability requirement (noting that a breach of the Principles is not actionable) and therefore the FCA did not have the power to impose the redress requirement

• The FCA's appeal contended that s.55L is not circumscribed by s.404F(7) and is not subject to the 4 conditions and, even if it were there is no actionability condition.

Secondly:

• The FCA had sought to amend its statement of case. The UT broke the amendments down into 4 categories, of which 2 were rejected and subsequently appealed. These concerned alleged breaches of PRIN 7 and Rule 4.2.1 of COBS. These amendments were refused by UT on the basis they did not fall within the matter referred. In particular, if the alleged breaches of COBS 4.2.1 were allowed into the amended statement of case, this would have meant that there was an alleged breach of a COBS rule (rather than just breaches of the Principles), which is directly actionable.  

The first application

To give some context, s.55L of FSMA provides that the FCA may impose a requirement on an authorised person if it appears to the FCA that it is desirable to do so in order to advance one or more of its operational objectives – these being the consumer protection, integrity and competition objectives. S.55N in turn identifies requirements which may be imposed by 55L – these include that the FCA may require an authorised person to take or refrain from taking specified action.  S. 55N(5) provides as follows:

"A requirement may refer to the past conduct of the person concerned (for example, by requiring the person concerned to review or take remedial action in respect of past conduct)."

It was under this power that the FCA sought to impose the single firm redress scheme on Bluecrest by way of a change to their permissions. In considering the matter, the UT identified 4 mechanisms under FSMA and supporting legislation which could be used to compensate clients where breaches of regulatory rules had been established:

1. A civil claim under what is now s.138D(1) (2) of Financial Services Act 2012 (originally under s.150(1) of FSMA).
2. Restitution orders from the court or FCA under 382 – 384 FSMA
3. The imposition of a redress scheme under 404 of FSMA
4. VIA the FOS

The UT held that all of these required the establishment of loss, causation and duty conditions and that both s.404 and s.150 (now 138D) required the actionability condition to be fulfilled. The UT drew attention to the restrictions on the FCA's power to use 404, noting that this could only be used to implement a redress scheme where the conditions at 404(1) were met – these being a widespread, regular failure by firms to comply with regulatory requirements and that consumers had suffered or may suffer loss or damage which if they brought legal proceedings a remedy or relief would be available, and that it is desirable to impose such a scheme.  The imposition of a s.404 redress scheme therefore required 'actionability' and the FSN was based solely on a breach of the Principles and was therefore not actionable.

Again, the FCA's view was that they were able to impose a redress scheme under their s.4A FSMA powers without the constraints of s.404(1). The UT had said that the FCA's interpretation would lead to a surprising result, as it could require 'redress' to be paid (which would have been in the region of $700 million dollars in the Bluecrest case) without the 4 elements of a legal liability, or that regulatory requirements had been breached at all, or even that the redress related to regulated activities. The UT felt that the s.55L power must therefore be restrained to avoid absurd results. They held it was therefore constrained by 404(f) 7 and 404A – again, the 4 conditions needed to be established. The UT noted that it was unlikely that Parliament wanted to also grant a restriction-less power to impose redress without any statutory hurdles when the 4 mechanisms for redress required such hurdles to be cleared. It would also be striking if no hurdles had to be cleared for a single firm redress scheme when clear conditions were set out for an industry wide scheme.

The UT concluded that on proper construction, s.404F(7) is the provision enabling the FCA to impose a single firm redress requirement under 55L(3) which corresponds to or is similar to a consumer redress scheme. This section ensures that the statutory criteria are aligned. The UT held that there was no freestanding power under s.55L(2)(C) and (3) for the FCA to impose a redress requirement simply because they are satisfied that the consumer protection objective is met.  The requirements the FCA may impose when ordering such a redress scheme are only those that may be imposed by way of rules made under s.404 – provided at 404A. In brief, it was concluded that loss, causation, duty and actionability must be established.

In brief terms, the FCA's counter argument was that 55L was constrained by the provisions of subsection 2, which included the requirement that the exercise of the power must appear desirable to advance one of the FCA's operational objectives, along with the public law requirement of rationality. They also stressed that 55N(5) sets out that a firm may be required to take remedial action (which Bluecrest had argued was conceptually different from 'redress'). Their view was therefore that a single firm redress scheme under 55L did not need to satisfy the 4 conditions before redress was payable.

The appeal

In its judgment the COA reached the 'clear conclusion' that the FCA was correct in its interpretation; the power at 55L could impose requirements as a variation of an existing permission provided there was a rational decision to exercise the power which the FCA considered was necessary to advance the objective of consumer protection. The COA stated that, if it was the intention to impose restraint on this power, it was expected that it would be expressly found at Part 4A.

The COA also found that there was nothing in Part 4A which limited the imposition of permission requirements to those for which FCA/FOS had powers to impose compensation through other areas of FSMA. The COA found that there was a 'false premise' underlying the UT decision – being that the power to impose conditions on permissions are linked to and constrained by powers to impose compensation or redress. The COA stated that there was nothing in the wording which so limited the powers, that sanctions form a different function from permission requirements and that sanctions must relate to a regulated activity, whereas permission requirements did not (for example, these could be linked to the general integrity of the authorised person). On this last point, the Court noted that the FCA could rationally impose an 'own initiative' requirement that a judgment debt be satisfied as a condition of continuing permission, regardless of whether the debt related to a regulated activity. They also made the point that two of the routes for redress (FOS and a s.384 restitution order) did not require the 4 conditions to be met (and anyone who has dealt with FOS will agree that causation doesn’t seem to be a necessary requirement for upholding complaints).

In rejecting the argument that s.55L was constrained by s.404F(7), the Court noted that this provision merely governed what may happen if the FCA exercised its power under s.55L. This provision states that, if the FCA varies a permission or authorisation so as to establish a scheme similar to a consumer redress scheme, "the provision that may be included in the permission or authorisation as varied includes provision imposing requirements on the person corresponding to those that could be included in rules made under section 404; and provision corresponding to section 404B." The COA noted that this provision did not state that the s.404A powers defined the scope of a single firm redress scheme, nor did the language impose threshold conditions for this.

The Court noted the difference between the purposes of s.55 and s.404 in general, whilst also noting that the power to require 'remedial action in respect of past conduct' at 55N(5) was broad enough to encompass a single firm redress scheme, rejecting Bluecrest's argument that this was only intended to cover a review of past conduct.

The Court also rejected the argument that the 4 conditions should apply equally to a single firm redress scheme as to a market wide one; they again noted that s.55 concerns regulation of permissions whilst s.404 is solely concerned with redress (brushing over the fact that the practical outcome of the FCA's use of 55L was solely to impose a redress scheme). They also noted the industry wide nature of s.404, which imposed investigatory obligations on firms regardless of whether it was believed that each and every firm was in contravention.

On the different outcomes point, the Court noted that "…where none of the Four Conditions are fulfilled, it will rarely be the case that the FCA would be able to justify the imposition of a redress requirement as rational." Bluecrest argued that the FCA's position gave it unfettered power with no real public law constraints, given the breadth of discretion afforded by a subjective judgment of what the FCA considered appropriate consumer protection. However, the Court held that it was commonplace for complex market activity to be subject to generally expressed rules and high-level objectives and that regulated firms had recourse to the UT.

Amendment

In looking at the UT's decision to reject the amendments to include allegations re PRIN 7 and COBS, the COA noted that the UT had accepted that the new reliance on Principle 7 and COBS relied to a large extent on the same 'body of disclosure' and the same regulated activity as the breaches of Principle 8. However, they held that the new allegations must not only be based on the same factual background but must also be of the same nature.

The COA held that the word 'matter' (in the context of the contents of the FSN and DN) had a wide meaning – secondly, it was the 'matter' itself that was referred to the UT rather than the decision itself (noting that s.133(4) of FSMA permits the UT to consider any evidence relating to the subject matter of the reference- it's power to consider matters were not constrained by the decision reached by the FCA). In looking at what constituted the matter the COA found that Bluecrest's case was too narrow and the FCA's too wide. It was held that the 'matter' must bear some relationship to the decision – there must be a sufficient relationship between the matter referred and the decision which triggers the right to refer. Sufficiency will be satisfied if there is a real and significant connection with the subject matter of the process. It need not be something that the FCA has specifically relied on during the process.  Provided it had a real and substantial connection with the subject matter of the process.  

The COA notes that the proposed amendments 3 & 4 were essentially relabelling the conduct already identified as having allegedly breached different rules and therefore fell within the matter referred. The UT had therefore made an error in respect of this approach and held that these amendments should be allowed.

Conclusion

Regulated firms will no doubt feel equal and opposite emotions on reading this judgment to those felt when reading the UT's decision. The FCA noted that rationality and public law constraints serve to fetter its power to impose single firm redress schemes but whether or not to impose such a scheme is largely down to the FCA's will and perception – the level of protection and oversight afforded by the need to meet the 4 requirements before redress is payable is valuable to the industry as it acts as a check and balance on the proposals of the regulator.  

One would hope that the FCA would adhere to the provisions of s.404F(7) when ordering redress under Part 4A, and there will indeed be a degree of unfairness if redress schemes are imposed which pay no regard to causation or limitation, for example. It does seem strange that a redress scheme can be imposed under s.55 (the primary purpose of which concerns restriction or variation of permissions) without any legal liability requirements when the specific section of FSMA that deals with redress schemes expressly includes a need for these.  That said there were some consoling comments made by the COA that it will be a "rare case" where none of the Four Conditions are satisfied and the FCA's decision to impose a redress scheme by the backdoor under Part 4A by way of a change in permissions is not susceptible to challenge. An area ripe for challenge going forward.  I have some sympathy with Bluecrest's argument here, being that remedial action and redress are conceptually different.

It also does indeed seem strange to conclude that the legislature's intention was to embed the need for a legal liability when imposing an industry wide scheme but to give the FCA largely unfettered discretion when imposing what are basically the same requirements on a single firm. That public law restraints will protect firms here doesn’t really ring true – a challenge can be expensive and time consuming and is far more likely to arise when an industry-wide scheme is looming as a consequence. It is single firms (and particularly smaller firms) who require the clear, set protections offered by the 4 conditions as a consequence.

We await news of any appeal, but in the meantime firms will no doubt be concerned about how the FCA looks to approach redress exercise given the sharp about-turn here.