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With great power comes a need to establish legal liability

29 June 2023. Published by David Allinson, Partner

The Upper Tribunal has confirmed the FCA cannot impose a redress scheme on a single firm unless the conditions in s.404 of FSMA (the need to establish breach, actionability, causation and loss) are met; and a redress scheme cannot be imposed solely in reliance on breaches of the Principles.

The judgment of the Upper Tribunal in Bluecrest Capital Management (UK) LLP v the Financial Conduct Authority has confirmed the need for a legal liability to exist before the FCA can impose a single-firm redress scheme under the Financial Services & Markets Act 2000 ("FSMA"). 

The matter referred to the Tribunal was fairly complex, but for our purposes the FCA alleged that Bluecrest Capital Management (UK) LLP (BCMUK) 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. SEC issued a plan for US based investors to be compensated for management fees paid in connection with the affected investments.

The FCA sought to impose a redress scheme paying similar redress to non-US investors; a supervisory notice required BCMUK to pay redress to non US investors. A financial penalty of £40,806,700 was also imposed for breaches of Principle 8 (which you will of course know requires a firm to manage conflicts of interest fairly).

In very brief terms, the Tribunal's decision concerned 2 case management applications:

1. The FCA's application to amend its statement of case and to rely on a draft rejoinder to its case on redress; and
2. BCMUK's application to strike out elements of the FCA's statements of case. 

The strike out and rejoinder applications concerned whether the FCA had pleaded a case as a matter of law that was capable of supporting the redress requirement it sought to impose – specifically, the FCA was looking to impose a redress requirement on the firm pursuant to s.55L of FSMA and the Tribunal was to consider whether it could do so under this provision, or only under s.404F(7) of FSMA (and, if so, whether the FCA's case as pleaded was capable of meeting the relevant requirements). 

The Tribunal noted that the disciplinary notice issued by the FCA demonstrated a considerable amount of 'muddled thinking' and a lack of clarity as to why it believed there had been a breach of Principle 8. However, they summarised that the disciplinary notice alleged that BCMUK breached Principle 8 for two reasons:

1. In respect of the External Fund it failed to manage the conflict that arose from the manner in which it allocated portfolio managers; and
2. It failed to make adequate disclosure of the conflict to investors when marketing the External Fund.

The FCA sought to make four amendments to its statement of case, which we don’t need to dwell on for the purposes of this blog. In brief, the Tribunal allowed two amendments to be made, concerning the adequacy of disclosure to the External Fund's directors (given that they were allegedly subject to the same conflict as BCMUK) and an allegation that BCMUK was obliged to provide services to the External Fund's investors in carrying out regulated activities (both making arrangements with a view to transactions in investments and arranging / bringing about deals in investments) and thus these investors were indeed 'clients' of BCMUK. Crucially however, amendments alleging breach of Principle 8, Principle 7 and COBs 4.2.1(R) in respect of the treatment of investors as clients were not allowed, as these did not fall within the subject matter of the reference and the Tribunal had no jurisdiction to consider them.

The strike out application

 The strike out application concerned two questions:

1. What statutory requirements did the FCA need to satisfy before imposing a redress requirement on BCMUK as a single firm; and
2. Did the FCA have a reasonable prospect of satisfying those conditions based on its pleaded case.

BCMUK argued that there was no freestanding power under s.55L of FSMA to impose a redress requirement. They submitted that, on proper interpretation of s.55L and s.404F(7) (and reading in the requirements of s404 more broadly), a redress scheme could only be imposed if 4 statutory conditions were satisfied:

1. Consumers had suffered loss (loss)
2. The loss had been caused by a wrong on the part of the firm (causation)
3. The loss was suffered by a consumer to whom a regulatory duty was owed (duty)
4. That the loss was caused by an actionable wrong (actionability)

The FCA argued that it did not need to satisfy the requirements of s.404F(7) or the requirements of s.404 more broadly in order to impose a single firm redress scheme, stating that the relevant consideration was contained at 55L of FSMA which required only that "it appears to the FCA that…it is desirable to exercise the power in order to advance one or more of the FCA's operational objectives." The FCA also referred to the consumer protection objective, arguing that considering whether they had the power to impose a redress requirement only required it to conclude that it was desirable to do so in order to advance its operational objective of providing an appropriate degree of protection to consumers. 

The Tribunal noted that FSMA included 4 powers of redress (including s.404 and the use of FOS) and that each of these required loss, for that loss to have been caused by the wrong of the firm, and the existence of a duty. The consumer redress powers also required that the wrong be actionable at law.

The Tribunal went on to note that the FCA interpretation would lead to a 'surprising result', in that it would mean they could compel redress to be paid without a statutory requirement to establish loss, duty, breach or causation. It would also mean that they could do so without needing to show that the firm had breached a regulatory requirement at all or that the redress even related to regulated activities. The Tribunal's view was that the power at 55L(2)(c) must be constrained to an extent greater than that argued for by the FCA so as to avoid unreasonable or absurd results. They concluded that this power was constrained by s.404F(7) and the rules under s.404 and that the FCA was required to establish the 4 conditions of loss, causation, duty and actionability before a redress scheme could be imposed on a single firm. The Tribunal noted that it would not make sense if the FCA could impose a single firm review without establishing the four conditions when a multi-firm redress scheme under s.404 explicitly required these to be established.

The Tribunal concluded that there was no freestanding power under s.55L to impose a redress requirement on a single firm, and that any such power was restricted by the terms of s.404F(7), and that the same statutory conditions (being a need to establish loss, causation, breach and actionability) to be satisfied under s.404 had to be satisfied under 404F(7). Furthermore, breach, causation and loss were to be determined in accordance with the approach of the civil courts.

The Tribunal accepted that the FCA's case had real prospects of success on the first three conditions. However, on actionability, the Tribunal noted that whilst breaches of the FCA's Rules were actionable at law, breaches of the Principles of themselves were not. The FCA's proposed amendment to rely on a breach of COBs 4.2.1R had been rejected (I told you above that this was crucial) and so their pleaded case proceeded solely based on alleged breaches of Principle 8. The Tribunal held that there was no power to impose a single firm redress scheme based on breach of the Principles. The Tribunal did note that the FCA itself chose not to plead (for example) that there had been a breach of COBs in the original statement of case and could, subject to any issues, bring a fresh case. However, the case as pleaded was deemed to have no real prospect of success in establishing any actionable loss as was required by 404F(7). The redress requirement could not therefore be lawfully imposed.

This serves as a useful reminder of the limits on the FCA's power to impose a redress scheme. This could be increasingly relevant with the advent of the Consumer Duty and the FCA's current Thematic Review into later-life income. It seems unlikely that the FCA will seek to impose redress schemes based solely on breaches of the Principles again, but the key takeaway from this case is that there needs to be a legal liability before the FCA can impose a redress requirement on a firm. When faced with the imposition of a redress scheme, it is wholly legitimate for a firm to argue that (for example) no duty was owed to those suffering losses or that limitation has expired. It will also need to be established that any breach of duty was causative of any loss allegedly suffered.