Financial Services and Markets Dispute Resolution Quarterly Update: December 2020
Judicial highlights include confirmation of the legal test for setting aside a judgment obtained as a result of fraud, and a reminder of the consequences of failing to adhere to corporate compliance procedures.
Despite the extended lockdown, the FCA has continued to remain active, and we draw out some themes from recent enforcement actions as well as significant speeches given by the FCA. We also highlight a recent example of the continued focus on culture within regulated firms.
Finally, in the area of financial crime, we comment on the Serious Fraud Office’s recent guidance on its approach to Deferred Prosecution Agreements, and on the Financial Reporting Council’s proposals for enhancing the role of auditors in detecting fraud.
- How to set aside judgments obtained by fraud: Takhar v Gracefield Developments Ltd et al 
- Judicial reminder for regulated firms and their staff to follow compliance procedures
- Compliance in 2020 – Lessons Learned
- First prohibition on approved persons found guilty of serious non-financial offences
- Fraud detection: an increased role for auditors?
- The Serious Fraud Office publishes new guidance on Deferred Prosecution Agreements
The legal test for determining whether a court’s judgment should be set aside because it has been obtained as a result of fraud has been confirmed and applied in the recent case of Balber Kaur Takhar v Gracefield Developments Ltd and others  EWHC 2791 (Ch).
This case came after more than a decade of related and contested hearings, reaching the Supreme Court in March 2019 ( UKSC 13) (the ‘Original Action’). Then, despite the Defendants alleging abuse of process, the Claimant returned to the High Court to seek to set aside the judgment which had originally been made against her in 2010. The issue to be determined was whether the original judgment should be set aside in light of new expert evidence that confirmed “there was conclusive evidence that the Claimant’s signature […] had been forged.”
In setting aside the original judgment, the Court held that had the Judge in the Original Action known that the agreement had been forged by the Defendants, it would have “entirely changed the way in which the first Court approached and came to its decision” (quoting Aikens LJ in Royal Bank of Scotland plc v Highland Financial Partners  EWCA Civ 328).
The following test for setting aside a judgment obtained by fraud which had been unanimously endorsed by the Supreme Court in March 2019, was applied:
- there must be “conscious and deliberate dishonesty” in relation to the relevant evidence given, or action taken, statement made or matter concealed, which is relevant to the judgment that is being sought to be impugned;
- the relevant evidence, action, statement or concealment must be “material” in the sense that it was an operative cause of the Court’s decision to give judgment in the way it did (i.e. it must be shown that the fresh evidence would have entirely changed the way in which the first court approached and came to its decision); and
- the question of materiality of the fresh evidence is to be assessed by reference to its impact on the evidence supporting the original decision, not by reference to its impact on the decision that might be made if the claim were to be retried on honest evidence.
As well as confirming the correct legal test, this case serves as an important reminder of the requirement of “materiality” in setting aside a judgment. The emphasis on materiality reserves this form of relief for only the most serious cases; in the words of Lord Sumption, there are still “very stringent conditions” that need to be met for fraud to unravel all and trump the finality of litigation.
In Mr Biagino Palmeri and others v Charles Stanley & Co  EWHC 2934 (QB), it was held that compliance-related failings of P, an approved person contracted to Charles Stanley, were sufficient grounds to permit the summary termination of his employment. The Court was critical of how P blurred the lines between professional conduct and personal relationships and in doing so breached various compliance procedures.
Mrs Justice Collins Rice found that loans to clients, which P did not put through Charles Stanley’s books, led to “self-evident” conflicts of interest. P should have reported those potential conflicts to Charles Stanley’s compliance department, but he did not do so. The fact that “no client suffered demonstrable detriment” did not “answer a failure to report.” The reporting requirement ensures that the approved person “is not permitted to be the final arbiter of the appropriate management of potential conflict”; that function is reserved to the firm.
The Court also warned against “the blurring of boundaries between professional conduct and friendship”. In a regulated context these boundaries must be carefully maintained. P had an immediate and unconditional obligation to report any client’s expression of dissatisfaction, including expressions of dissatisfaction from friends, which in one instance he failed to do. Charles Stanley’s complaints handling procedures superseded any personal friendship.
The judgment underlines the importance of adhering to compliance procedures and sends a strong message as to the consequences if they are not complied with.
While the UK has largely remained in lockdown this year, the FCA has remained visibly active. Based on certain recent enforcement actions, as well as commentary by the FCA itself, there are a few obvious themes and lessons for firms and senior managers to consider.
Maintaining Good Records
The FCA has been clear in a couple of recent enforcement cases that firms which fail to keep adequate records are unlikely to be acting with due skill, care and diligence. Not only does a failure in this regard make it harder for firms to identify and mitigate problems as they arise, but a lack of good records can make any subsequent investigation – whether internal or by the FCA – significantly more difficult. This lack of good records could relate, for example, to the nature of a firm’s consideration of the risk of a particular business relationship that was later found to be problematic; or to demonstrating what took place internally in response to a compliance breach.
Internal risk assessments are a key part of any firm’s approach to preventing financial crime and maintaining compliance with its regulatory obligations. Firms should be careful to avoid “off-the-shelf” approaches to risk monitoring and prevention. They should take every opportunity to adapt and customise their risk assessments (and associated policies and procedures) to the specific way their business operates. This approach to scrutinising risk should not stop at a firmwide risk assessment. It is important to be able to show that individual business relationships or transactions have been assessed for risks and any necessary steps to mitigate those risks have been taken.
As working from home remains prevalent, the FCA has made it clear that firms must have updated their policies, refreshed their training programmes and put in place new oversight arrangements to accommodate remote working.
The FCA has identified recent examples where firms have failed to respond appropriately to warning signs. This can be seen as evidence that firms are not taking seriously enough their responsibility to prevent financial crime. There are a wide range of ways to improve on this front. Education and training of staff is key, as is creating a culture in which reporting possible issues and escalating them to appropriate senior management is a normal and encouraged part of the way a firm operates. Staff who work “at the coalface” in a business, but who have either not been trained to spot possible issues or do not feel compelled to respond to them, even if this is just by escalating the issue to more senior staff, represent a potentially significant weakness in a firm’s anti-financial crime armoury.
Senior managers need to appreciate the value of regulatory compliance and, to the extent possible, prioritise this in the way that they approach business targets. A failure to put in place governance and reporting structures that involve senior managers and, more importantly, a failure of senior managers to respond adequately where the alarm is raised or a serious risk identified, will reflect poorly on a firm under subsequent scrutiny.
The FCA has for the first time prohibited three individuals from working in the financial services industry following convictions for sexual offences (committed separately).
The individuals concerned undertook different roles in their regulated firms:
- a financial adviser at an authorised firm, approved by the FCA to hold various significant influence and customer facing functions at the firm;
- a sole director and shareholder of an authorised financial advice firm with permission to conduct designated investment business (including advising on and arranging deals in investments) and insurance distribution; and
- a director and shareholder of an authorised financial advice firm with permission to advise on pensions, mortgages and investments.
The sexual offences committed by the individuals while approved persons varied in nature, but all constituted serious crimes. They included voyeurism; sexual assault, engaging in controlling and coercive behaviour; and offences involving the making, possession and distribution of indecent images of children. Sentences of between nine months to seven years’ imprisonment were levied; and all three individuals have been required to sign the sex offenders register (one indefinitely, whilst also being included in the list of individuals barred from working with children or vulnerable adults).
The Regulatory Decisions Committee (RDC) concluded that, because of these criminal convictions, the individuals are not fit and proper persons, and lack “the necessary integrity and reputation to work in the regulated financial services sector”.
Back in 2018, Megan Butler (Executive Director of Supervision – Investment, Wholesale and Specialists Division) had indicated to Parliament’s Women and Equalities Committee that the FCA considered sexual harassment to constitute misconduct:
[a] culture where sexual harassment is tolerated is not one which would encourage people to speak up and be heard, or to challenge decisions. Tolerance of this sort of misconduct would be a clear example of a driver of poor culture. It would be an obstacle to creating an environment where the best talent is retained, the best business choices are made and the best risk decisions are taken.
The RDC’s decisions provide clear examples of the FCA’s requirement for high standards of behaviour extending beyond conduct in relation to financial services. In a post #MeToo world, financial institutions and senior managers will want to think carefully about managing conduct risks: through comprehensive training, whistle-blowing policies and review processes, to ensure that the firm and its staff and affiliates understand, and meet, the standards required both inside and outside the office.
On 23 October 2020, the Serious Fraud Office (SFO) published comprehensive guidance on its approach to Deferred Prosecution Agreements (DPAs) and how it engages with companies where a DPA is a prospective outcome (the Guidance). The Guidance does not represent a significant change from existing practice, but provides a helpful steer on the SFO’s policy in respect of DPAs.
In determining whether a DPA is appropriate, the SFO must satisfy itself that it would be in the public interest to enter into a DPA, rather than pursuing a criminal prosecution. The Guidance lists a number of public interest factors militating against prosecution and in favour of a DPA. These include:
- co-operation (see further below);
- a lack of history of similar conduct;
- the existence of a proactive corporate compliance programme, both at the time of the offending and at the time of the reporting, but which failed to be effective in this instance; and
- the offending is not recent and the company in its current form is effectively a different entity from that which committed the offence(s) (for example, the company’s management team may have been completely changed or disciplinary action may have been taken against the culpable individuals).
The Guidance outlines co-operation requirements which should ordinarily be included in a DPA, such as requiring the company to:
- retain material gathered during an internal investigation;
- co-operate with the SFO;
- make relevant individuals available for interview where possible; and
- self-disclose any relevant new conduct.
The SFO has concluded nine DPAs since their introduction in 2014. Although the SFO has lauded the use of DPAs as a success, their use has raised separate questions about the failure successfully to prosecute any individuals. Therefore, the jury is out on whether the SFO will one day be able both to negotiate a DPA with a company, and then prosecute culpable employees of that company.
The Financial Reporting Council (FRC), the UK’s accounting regulator, wants to enhance and formalise the role of auditors in identifying fraud in company accounts. It has launched a consultation on revisions to the accounting standard which would represent the first substantive reform in 16 years. The FRC states that there is “ongoing concern that auditors are not doing enough to detect material fraud”.
The consultation comes in the wake of a number of high-profile corporate failures due to fraud which left many questioning why the company’s auditors did not identify fraud in the relevant accounts. This concern was expressed by Sir Donald Brydon, the former Chairman of the London Stock Exchange, who was commissioned by the Government in 2019 to review the audit profession. In light of more recent failures in 2020, Brydon warned that the industry “must not wait until there is a market failure” before reforming the rules around auditors’ responsibilities in respect of fraud.
The FRC’s proposals would clarify that auditors are required to undertake work to detect material fraud, and would enhance existing obligations for the identification and assessment of risk of material misstatement due to fraud. The proposals include: an emphasis on the importance of staying alert to records or documents that may not be authentic; a requirement to consider whether a forensic expert is required should a misstatement due to fraud be identified; and an obligation for auditors to conclude whether financial statements are materially misstated as a result of fraud. The FRC has also separately stated that it expects whistleblower reports to be prioritised during company audits as a “potential route [by which] an auditor can identify potential risks of fraud”.
The consultation closes on 29 January 2021 and, when finalised, it is proposed that the revised standard should become effective for audits of accounting periods commencing on or after 15 December 2021.