IFA PI: s.39 FSMA and the scope of a Principal’s liability when ARs act outside of their authority

The Court of Appeal has upheld the decision that the Principal was not liable for the acts of an AR for which the Principal had not accepted responsibility. The claims against the Principal firm arose from the investment advice of one of the Principal’s Appointed Representatives (“AR”) and were brought under s.39 of the Financial Services and Markets Act 2000 (“FSMA”), a provision previously untested at appeal level.

Background

FSMA establishes a framework for the regulation of financial services. AR activities are governed by s.39 of FSMA which sets out the basis upon which an AR, by entering into a contract with a Principal, can carry out regulated activities, such as advising or arranging investments. The AR had been appointed by the Principal under an AR agreement. The AR agreement provided that the AR was permitted by the Principal to advise on Authorised Products only, through particular agencies. The AR agreement also contained a disclaimer providing that the Principal’s liability to third parties was no greater than that required by s.39 of FSMA assuming the AR was carrying out regulated activities on the terms of the AR agreement.

Unknown to the Principal, the AR advised on and operated what it called a short-term deposit investment scheme but which was actually a dishonest Ponzi scheme (“the Scheme”). The claims related to payments made by the claimants under the Scheme. The AR took steps to conceal the Scheme from the Principal – for example, no documents in relation to the Scheme were uploaded by the AR to the system operated by the Principal, which it monitored, and the Scheme payments were made from a separate bank account to the one audited by the Principal.

Ninety-five claimants issued proceedings against the Principal, and twelve proceeded to trial as lead cases. In October 2018, the Commercial Court handed down its Judgment dismissing all of the claims on the basis that, even though the Scheme was an unregulated collective investment scheme (UCIS), as defined by s.235 of FSMA; and the Principal was not responsible for losses arising from acts of the AR for which the Principal had not accepted responsibility. Permission to appeal was granted in respect of only two claims – those made under s.39(3) of FSMA and those made on the basis of vicarious liability at common law.

Appeal

The issues before the Court of Appeal were (i) the application of s.39(3) of FSMA, on the assumption the Scheme was a UCIS; (ii) the extent that the Principal was responsible for the tortious acts of the AR at common law; and (iii) whether the Scheme was in fact a UCIS as defined by FSMA.

Issue (i): In respect of the application of s.39(3) of FSMA, the claimants argued that a broad approach should be taken to the identification of the business for which a Principal accepts responsibility, in light of the public policy basis of the provision. The AR was authorised to give advice on and arrange deals in investments, and so the Principal’s responsibility extended to advice given on, and deals arranged in, investments. Advising upon units in UCIS would amount to advising on investments.

Richards LJ started his analysis from the statutory wording and s.39(3), which imposes liability on the authorised person (here the Principal) for the acts or omissions of the AR “in carrying on the business for which he (i.e. the authorised person) has accepted responsibility”. This defines the extent of the Principal’s liability. He then considered s.39(1) which he summarised as meaning that an AR is an exempt person only to the extent that an authorised person has accepted responsibility for the business to be carried on by the AR – “acceptance of responsibility is the equivalence of authorisation”. He did not accept the claimants’ submission that the Principal necessarily must accept responsibility for the whole of a generic description of business, it is open for a Principal to restrict the permission it gives to an AR. There was a distinction to be drawn between the AR's scope of authority and how the AR was to conduct business (i.e. in accordance with COBS). The Judge noted the case of Martin v Britannia Life where the High Court considered that a Principal could be liable for an AR’s activities which were incidental to those for which it was authorised – but implicitly suggested this case was not analogous as the unregulated business was not tied up with the regulated business.

Issue (ii): The claimants’ second argument was that the Principal, in entering into the AR agreement with the AR, had created the risk of tortious acts and was therefore liable for the acts of the AR at common law. Richards LJ considered there was no substance in the appeal on vicarious liability. He reiterated the decision of the judge below that the AR was carrying on its own business, independent of the Principal – the AR was not carrying out activities assigned to them by the Principal as part of the Principal’s business and for its benefit. There was no basis to challenge the findings of fact and so the Court of Appeal did not go on to consider the application of common law principles, leaving such issues open for future case law.

Issue (iii): It was common ground that, to succeed in their s.39 claims, the claimants had to establish that the Scheme was a UCIS, as defined by FSMA. Given the findings on the first two points, the Court of Appeal did not have to comment upon whether the Scheme was a UCIS. However, and although not determinative, the Court confirmed previous interpretations that investments offering fixed returns could be UCIS.

Ultimately, Richards, LJ concluded, in agreement with the Judge below, that whilst the claimants had undoubtedly been the victims of a “callous fraud” by the AR, participated in a UCIS, and suffered severe losses as a result, such losses were not recoverable from the Principal because the Scheme fell outside the business for which the Principal had accepted responsibility.

Comment

This commercially rational decision harmonises existing industry commentary and sheds light on two very important aspects of FSMA. Firstly, as this is the first case in which the Court of Appeal has been asked to interpret s.39 of FSMA, it provided welcome assurance to IFA firms that a Principal is open to restrict the permission it gives to an AR, and accordingly restrict its liability under s.39. This decision provides clarity on the difference between an AR who acts in breach of an AR agreement by the manner in which it conducts business, e.g. negligently, for which a Principal cannot escape liability, and an AR who acts in breach of an AR agreement by carrying out business which was not permitted by the agreement, for which a Principal can. The decision highlights the need for express agreement between ARs & Principals, explaining what the AR is authorised to do, and what it is not. Such agreements will in turn provide comfort to PI Insurers of IFA Principals in an otherwise difficult & highly regulated environment.

A point of caution, however, in reaching its decision, the Court of Appeal had in mind that the Principal was found to have properly carried out its supervisory functions, and the AR had taken steps to hide the Scheme from the Principal. It could be seen that this is a fact specific judgment and that Claimants may still try to argue that the advice/activity provided by an AR is incidental to those activities for which an AR is authorised by the Principal.

Secondly, it shows that the definition of CIS (and, it follows, a UCIS) will be interpreted broadly and can therefore include many different investments, not just those most commonly seen when dealing with UCIS matters, such as carbon credits or pooled investment in agricultural land.

Further Reading

Adam Anderson and others v Sense Network Limited [2019] EWCA Civ 1395.

Martin v Britannia Life Ltd [2000] Lloyd's Rep PN 412.