Financial Services and Markets Dispute Resolution Quarterly Update: June 2020

Judicial highlights include: the Court of Appeal’s decision that the dominant purpose test extends to legal advice privilege; the High Court’s finding that where there has been judgment against a party, particularly in cases concerning serious fraud, there is a strong public interest in allowing the collateral use of documents for the purpose of enforcing that judgment; and the rejection of an unprecedented attempt to obtain disclosure of the identities of anonymous traders in securities on the AIM market.

Meanwhile, the FCA has published its business plan for the 2020/2021 financial year. Unsurprisingly, dealing with the impact of Covid-19 is top of the agenda, with a clear message for firms that a pandemic is no excuse for poor conduct or culture. As we heard from one FCA director, a firm’s culture for compliance matters most when risks are highest, as they are today in times of market and operational turbulence. More recently the FCA has levied a significant fine for AML failings in the London branch of a German bank.

Finally, in the realm of financial crime, the Court of Appeal has confirmed that the Ghosh test for criminal dishonesty no longer applies. The new test removes the subjective element, thereby significantly reducing the evidential and legal burden for prosecutors.

Quick links

Financial litigation

• Privilege update
• “Dominant Purpose Test” applies to legal advice privilege
• Attachments to privileged emails are not necessarily privileged
• Collateral use of documents obtained under freezing order: National Bank Trust v Yurov [2020]
• Disclosure of identity of anonymous traders - Burford v London Stock Exchange [2020]

Regulatory developments

• FCA Business Plan: FCA sets out its priorities for the next financial year
• AML Enforcement: the FCA impose a significant fine on Commerzbank for AML failings

Financial crime

• Court of Appeal confirms change to the test for criminal dishonesty

Litigation developments

Privilege update

There have been two noteworthy privilege cases in recent months. The first and most important case (Civil Aviation Authority v R. (on the application of Jet2.com Ltd) [2020] EWCA Civ 35) relates to legal advice privilege and has potentially significant practical implications for in-house lawyers. The second (Sports Direct International PLC v The Financial Reporting Council [2020] EWCA Civ 177) serves as a reminder that an attachment to an email should be considered separately from the email itself for the purposes of assessing whether that attachment attracts privilege.

“Dominant Purpose Test” applies to legal advice privilege

In Civil Aviation Authority v R. (on the application of Jet2.com Ltd), the Court of Appeal settled the debate as to whether the dominant purpose test applies to legal advice privilege, holding that it does.

This means that simply “involving” lawyers in communications will not, in itself, be sufficient to ensure that those communications are protected by legal advice privilege.

This ruling has potentially significant consequences for in-house lawyers:

• Lawyer-client communications: Where a lawyer is performing the types of duty which typically fall within a lawyer’s role, the addition of a dominant purpose test will not, in most cases, reduce the protection afforded by legal advice privilege to communications passing (only) between lawyer and client. This is because the Court of Appeal made it clear that “legal advice” has a very wide meaning. However, the Court held that where a lawyer is acting in a commercial rather than a legal role, only advice given “specifically in a legal context” will be privileged. Other advice will be discloseable. Whilst much will depend on the facts, in-house lawyers who provide both legal and non-legal advice (as most will), may take the view that the safest course of action is to keep the different types of communication separate.
• Multi-addressee communications: The Court of Appeal indicated that multi-addressee communications (i.e. lawyer-client communications, which are also simultaneously sent to third parties) should be treated as bilateral communications between the sender and each individual recipient. While the judgment is not entirely conclusive on this point, it appears that the question will then be whether the communication was sent to each of those recipients for the dominant purpose of giving or receiving legal advice.

Where the sender is a lawyer, the communication(s) will “almost certainly” be privileged if they contain legal advice, even if they are copied to more than one addressee. However, where clients send emails to both lawyers and non-lawyers, it will be necessary to consider whether the email could be said to be for the dominant purpose of legal advice if it had only been sent to the non-lawyer. The Court of Appeal stated that such emails would be privileged in the following situations:

1. where a communication “might realistically disclose” legal advice; and
2. where internal communications are sent for the dominant purpose of “settling instructions to lawyers”. This exception is likely to be limited in scope.

Although these categories do not appear to be closed, it may be difficult to show that other types of communications to third parties are for the dominant purpose of giving or receiving legal advice. For example, an email from a client requesting advice from both a lawyer and another professional adviser, which could have been sent in two separate communications, is unlikely to satisfy the test of the communication being for the dominant purpose of seeking legal advice. In that situation, privilege in the communication with the lawyer will also be lost.

• Meetings: the Court of Appeal also stated that these rules apply equally to oral communications. This will be particularly significant in the context of meetings involving lawyers and non-lawyers. Notes of a meeting will not be privileged just because a lawyer happened to be present. Where the purpose of a meeting is commercial or otherwise “non-legal”, any legal advice given will be privileged, but the content of the rest of the meeting will not.

Practical implications

Lawyers (particularly in-house lawyers), who are acting in a commercial or other non-legal role, should be aware that their commercial advice may not be privileged. When they give legal advice, it should be specifically identified as such and, ideally, kept separate from non-legal advice.

When communicating with their lawyers, parties should be wary of including non-lawyers in the distribution list. A safer (albeit more cumbersome) way of keeping third parties informed is to ensure that the original communication is limited to those within the lawyer-client relationship. This should create a privileged communication, which can then be circulated to others who need to see it on a confidential basis and on the basis of a limited waiver of privilege.

More generally, parties should be aware that the court will not look kindly on attempts to cloak communications in privilege by artificially including lawyers in the drafting or decision making process.

Attachments to privileged emails are not necessarily privileged

In Sports Direct International PLC v The Financial Reporting Council, the Court of Appeal considered whether certain documents which had been requested by the Financial Reporting Council (FRC) in the context of a regulatory investigation were privileged and therefore protected from disclosure to the FRC.

The issue arose in the context of the FRC’s investigation into the conduct of Sports Direct’s former auditors, B, and an individual at B, referred to as “Subject A”. In the course of its investigation, the FRC used its regulatory powers to require Sports Direct to produce certain categories of documents that related to its investigation (albeit that Sports Direct itself was not the subject of the FRC’s investigation). Sports Direct provided around 2000 documents in response to the request, but withheld 40 documents, consisting of certain emails and attachments, on the ground that they were privileged.

The FRC challenged Sports Direct’s decision to withhold the 40 documents on two main grounds:

1. The FRC argued that there would be no infringement of Sports Direct’s legal professional privilege (LPP) because Sports Direct itself was not the target of the investigation. The FRC did not dispute that it would not have been able to compel privileged documents from the subjects of its investigation, but argued that the same did not apply for Sports Direct, which was itself a third party to the inquiry. The Court of Appeal rejected this argument, stating that there was no such thing as a “no infringement” exception to LPP.
2. The FRC argued that even if the emails themselves were protected by LPP, some or all of the attachments to the emails were not in themselves privileged documents, and did not become privileged documents simply by being attached to privileged emails. The Court agreed with this analysis – for the purposes of assessing whether a document is privileged, an attachment to an email must be considered separately from the email itself. The Court noted that the ordinary civil procedure process requires the disclosure of all free-standing documents which are relevant to the issues in dispute, regardless of whether they have been attached to emails at any point. The same logic applied in this case.

This case serves as an important reminder that simply attaching a document to a privileged communication with a lawyer will not cloak the relevant document in privilege. The content of an attachment must be assessed separately in order to determine whether there is a valid claim to privilege.

Collateral use of documents obtained under freezing order: National Bank Trust v Yurov [2020]

In National Bank Trust v Yurov [2020] EHWC 757 (Comm) the High Court granted the Claimant’s application for permission to use documents obtained under a worldwide freezing order (WFO) in collateral proceedings.

This hearing was consequential on the High Court’s finding in National Bank Trust v Yurov [2020] EWHC 100 (Comm) that the Defendants, being three former shareholders in the Claimant bank, and their wives, had been involved in fraudulent conduct that had resulted in the bank’s collapse. At the hearing Bryan J held in favour of the Claimant’s application to be released from an undertaking in the WFO (which had been in place since 2016), so that it could use documents obtained under the WFO in civil proceedings in England and Wales, Switzerland and potentially in other jurisdictions. These civil proceedings aim to recoup the damages owed to the bank by the Defendants. Only one Defendant opposed the application.

The Judge stated that in order for such an application to be successful, the applicant must establish that: “(a) there are special circumstances which constitute “cogent and persuasive reasons” for permitting collateral use; and (b) the release or modification will not occasion injustice to the person who has given the disclosure”.

In assessing this test, The Judge had regard to the comments of Hildyard J in ACL Netherlands BV v Michael Richard Lynch & Anor [2019] EWHC 249 (Ch), that the collateral use of documents will ordinarily only be allowed where there is at least some public interest in its favour. An example of such public interest is the investigation or prosecution of serious fraud, which includes civil fraud.

In establishing that there were indeed “cogent and persuasive reasons” for permitting collateral use of the documents, The Judge found, citing Bank of Crete SA v Koskotas (No 2) [1992] 1 WLR 919, that “civil proceedings are not an end in themselves” and ultimately damages should be paid to the Claimant. There are compelling reasons for ensuring that those who have perpetrated fraudulent acts are not able to retain the proceeds of those acts. He also noted that there is a need for international co-operation between courts in order to deal with multi-national frauds. The risk of injustice to the Defendant in this instance was considered to be highly theoretical and unlikely, not least given the disclosure of much of the relevant documentation pursuant to the original judgment and the absence of any objection to the application from the other Defendants.

This case serves as useful guidance to the matters that a court will take into account when assessing whether or not to allow the collateral use of documents. In particular, where there has been judgment against a party, there is a clear interest in allowing the collateral use of documents for the purpose of enforcing that judgment. Furthermore, where such a judgment relates to serious fraud there appears to be a strong public interest in allowing collateral use of documents.

Disclosure of identity of anonymous traders - Burford v London Stock Exchange [2020]

In Burford v London Stock Exchange [2020] EWHC 1183 (Comm), the Court rejected an attempt to obtain disclosure of the identity of anonymous traders in the Applicant’s securities. 

In early August 2019, the shares in Burford, which are quoted on the AIM market, were the subject of lawful short-selling by a US investment advisory business, causing the share price to collapse. However, Burford considered that the share price had also collapsed because it had been artificially depressed by unlawful market manipulation, even though analysis of the trading in the relevant two-day period, conducted by both the London Stock Exchange and the FCA, had shown that there was no evidence of market manipulation.

Since market participants trade anonymously on AIM, Burford sought Norwich Pharmacal relief against the London Stock Exchange (the LSE), requiring it (an innocent third party) to disclose the (confidential) identities of all those who had traded in the relevant period, so that Burford could pursue any wrongdoers. The LSE argued that such an order would be unprecedented, and potentially harm the legitimate interests of innocent market participants.

The Court dismissed the application. First, there did not appear to have been any market manipulation. Secondly, as a matter of discretion, even if Burford had shown a good arguable case of market manipulation, the application would have failed for a number of reasons, including the fact that Burford (unlike its shareholders) did not have a right of action under the Market Abuse Regulation, as well as the potential damage to innocent market participants.

Regulatory developments

FCA Business Plan: FCA sets out its priorities for the next financial year

On 7 April 2020, the FCA published its Business Plan for the 2020/2021 financial year. Highlights include the following:

Covid-19

Unsurprisingly, the FCA’s highest priority is to deal with the hugely significant implications of Covid-19. Unlike regulators in some jurisdictions, the FCA confirmed that it would not impose a ban on short selling during the pandemic. However, the regulatory message underpinning the FCA’s Business Plan is uncompromising: the FCA recognises the challenges facing firms, but expects firms to continue to comply with their regulatory obligations and to maintain proper standards of conduct. The FCA remains vigilant in regard to market misconduct and will bring enforcement action against firms/individuals where appropriate:

“There may be some who see these times as an opportunity for poor behaviour – including market abuse, capitalising on investors’ concerns or reneging on commitments to consumers.

Where we find poor practice, we will clamp down with all relevant force.”

Priority areas

The Business Plan sets out four external priority areas where the FCA will address continuing harm: (i) enabling effective consumer investment decisions; (ii) ensuring consumer credit markets work well; (iii) making payments safe and accessible; and (iv) delivering fair value in a digital age.

In addition, the FCA has identified its own transformation as a fifth priority. It has highlighted the need to:

• make faster, more effective decisions;
• focus on outcomes rather than narrow compliance; and
• act in an integrated way across the organisation.

This is a new and welcome development given the delays many clients experience on account of the manner in which investigations are managed.

Enforcement

In the area of enforcement, the FCA confirms that financial crime and culture continue to be priority areas. The Business Plan states that in assessing firms, the FCA will continue to focus on the four key culture drivers within firms (purpose, leadership, approach to rewarding and managing people and governance) and their effectiveness.

AML Enforcement: the FCA impose a significant fine on Commerzbank for AML failings

Commerzbank has been fined £37,805,400 by the FCA for anti-money laundering failings.

The FCA noted a series of specific failures by Commerzbank that constituted breaches of Principle 3 (Management and Control), despite FCA visits to the bank in 2012, 2015 and 2017 to discuss its AML framework and identify weaknesses. In particular, the FCA found that:

• A significant backlog had developed, during 2012-2017, of clients that were overdue a refreshing of their KYC information. This was partly due to understaffing within the first and second lines of defence tasked with carrying out key AML controls. Specifically, the compliance team was expanded from three full-time employees in mid-2016, to forty-two full-time employees in mid-2018 after the understaffing issue in this area had been acknowledged. By February 2017, over 2,220 existing clients were overdue refreshed KYC checks. Steps taken to reduce the backlog were taken too late and were effected too slowly.
• An exceptions process was misused in order to allow the bank to continue engaging with clients even though KYC checks were overdue. One example involved a high-risk client who was nearly five years overdue a KYC refresher, but who nevertheless entered into 16 transactions with the bank.
• Commerzbank's automated tool for monitoring money laundering risk was not fit for purpose. It was found that at one stage 40 high-risk countries and 1,100 high-risk clients were not included in the automated monitoring system. Certain business areas did not always adhere to the bank's policy of verifying the beneficial ownership of clients, including high-risk clients, from a reliable and independent source.

Further failings of Commerzbank identified by the FCA included: (i) inadequate due diligence on intermediaries; (ii) inadequate checks on politically exposed persons; (iii) inadequacies in the procedure for terminating client relationships; and (iv) a lack of clarity around responsibility for AML.

The examples provided illustrate how important it is to address promptly AML failings within an organisation, in order to prevent serious issues from compounding and becoming unmanageable.

Interestingly, the FCA was clear that there was no evidence of financial crime having been committed or facilitated by these failings, and the fine was imposed for the failure to maintain adequate policies and procedures. Firms subject to the Money Laundering Regulations are required to take reasonable care to organise their affairs responsibly and effectively, with adequate risk management systems. They must have policies and procedures in place that are comprehensive and proportionate to their business activities, to enable them to identify, assess, monitor and manage the risk of money laundering.

It is also important to note that another European bank has since been fined 1.6m krona (approximately £140,000) for failures in its money-laundering and terrorist-financing controls. Despite the different scale of the monetary fines imposed in these two cases, it appears that AML enforcement remains an active and high priority area both in the UK and Europe. Firms would be well advised to ensure that high standards of AML compliance are maintained at all times, even in the difficult conditions presented by Covid-19 and the associated restrictions.

Financial crime

Court of Appeal confirms change to the test for criminal dishonesty

In R v Barton and Another, the Court of Appeal recently confirmed that the criminal test for dishonesty is no longer that set out in R v Ghosh, thereby aligning the civil and criminal tests for dishonesty.

This does not come as any great surprise. Last year the Supreme Court proposed (albeit strictly obiter) in Ivey that the test in Ghosh should no longer be followed in establishing criminal dishonesty. Ivey was a civil case and dishonesty was not in issue. Nevertheless, Lord Hughes took the opportunity to propose that the Ghosh test should no longer apply.

The Court of Appeal considered that Lord Hughes’ opinion in Ivey amounted to a direction from the Supreme Court that the test which he had proposed in Ivey should be adopted.

The test in Ghosh included both an objective and a subjective element. However, the Ivey test dispenses with Ghosh’s subjective limb. The test is now an objective one:

1. First, the actual state of the individual’s knowledge or belief as to the facts must be ascertained. This is a subjective analysis of a defendant’s state of mind.
2. Once the actual state of the defendant’s mind has been established, the question of honest conduct is to be determined “by applying the (objective) standards of ordinary people”.

Importantly, Lord Hughes emphasised in Ivey that “there is no requirement that the defendant must appreciate that what he has done is, by those standards, dishonest.” The subjective analysis in step one will not excuse a defendant who claims that s/he did not understand her/his behaviour to be dishonest.

This confirms that the criminal test for dishonesty is now the same as that in a civil context, as provided in Barlow Clowes International Ltd v Eurotrust International Ltd.

The removal of the subjective element of the Ghosh test constitutes the removal of a significant evidential and legal burden for prosecutors. Accordingly, it is possible that the new test for dishonesty could precipitate an increased number of prosecutions for criminal offences of dishonesty, such as fraud.

The removal of the subjective protection afforded by Ghosh will also apply in a corporate context and could have an impact on corporate prosecutions for fraud and other dishonesty offences. Prosecutors will no longer need to prove that senior management actually understood their actions to be objectively dishonest in relation to such offences, removing at least one hurdle for the prosecution. However, whilst this may be of some assistance, the “identification principle” applicable to corporate prosecutions continues to pose significant challenges in securing corporate convictions. Confirming the objective test for criminal dishonesty will not provide an immediate solution to those challenges.