The UK Regulatory Approach To Non-Financial Misconduct – Latest Developments And Insights

The UK Regulatory Approach To Non-Financial Misconduct - Latest Developments And Insights

October 12, 2023, Covington Alert

The UK Financial Conduct Authority (FCA) recently published its latest proposals relating to diversity and inclusion in financial services - CP23/20 (the "CP")[1]. Amongst other things, the CP includes a suite of eagerly-anticipated provisions and draft rules relating to the topical (and somewhat controversial) issue of non-financial misconduct. This article focuses specifically on these non-financial misconduct proposals - offering a constructive analysis and critique, framed by a recap of prior regulatory and judicial pronouncements in this sphere.

Introduction

For present purposes, "non-financial misconduct" is defined as 'personal misconduct - whether: (i) in or out of the workplace; and (ii) impacting a work colleague and/or any other person and/or the perpetrator's reputation.'

Non-financial misconduct perpetrated by an employee or director of a UK-regulated entity has long been considered by the UK Financial Conduct Authority (FCA) as potentially relevant in the context of the perpetrator's on-going eligibility to work in the financial services industry.

Burrows

In2014, the FCA famously imposed a prohibition on Jonathan Burrows, a former investment manager, for deliberately and knowingly[2], on numerous occasions, failing to purchase a valid ticket to cover the entirety of his daily commute. The FCA determined that Mr Burrows was not fit and proper to conduct any function in relation to any regulated activity - on the basis that he lacked the requisite honesty and integrity.

The Burrows case generated significant interest (and some consternation), as it represented the first time that the FCA had sanctioned an individual for out-of-work conduct - not least, given that no clients, colleagues or financial markets were directly affected.

Post-Burrows

The FCA has since pursued a series of further cases involving non-financial misconduct. One such case resulted in an appeal to the Upper Tribunal, which was required to opine on the extent to which non-financial misconduct could legitimately be taken into account in the context of an individual's regulatory fitness and propriety.

Jon Frensham (2021)

In March 2017, Jon Frensham, an FCA-approved financial adviser, was convicted of various sexual offences and imprisoned. The FCA consequently withdrew Mr Frensham's regulatory approval and prohibited him from performing any regulated function - reasoning that, in light of his convictions, he was not a fit and proper person.

Appeal

Mr Frensham appealed the FCA's determination to the Upper Tribunal. Mr Frensham argued that the FCA had allowed irrelevant considerations to affect its judgement and did not, for example, have sufficient or any regard to the fact that the conviction was not for an offence of dishonesty and that the offence was not related to his regulated activities.

Upper Tribunal's observations and approach in Frensham

According to the Upper Tribunal, the starting point must be the FCA's statutory objectives - namely, securing an appropriate degree of protection for consumers (the "consumer protection objective") and protecting and enhancing the integrity of the UK financial system (the "integrity objective"):

"… a key consideration is the severity of the risk which the individual poses to consumers and to confidence in the financial system, thus providing a direct link to the [FCA's] statutory objectives. Therefore … when considering the relevance of behaviour that takes place in a person's private life, the key issue is whether the behaviour concerned realistically engages the question as to whether the individual poses a risk to consumers and to confidence in the financial system." {our emphasis}

Why did the Upper Tribunal not consider that Mr Frensham's conviction alone warranted a withdrawal of his approval and a prohibition?

In essence, the FCA had to establish a link between Mr Frensham's behaviour and (i) the consumer protection objective; and/or (ii) the integrity objective.

As regards the consumer protection objective, the FCA relied upon an "abuse of trust" parallel argument - on the basis that Mr Frensham's offence involved an abuse of trust and being a financial adviser requires client trust. Beyond that, the FCA placed reliance upon a general assertion that Mr Frensham displayed a willingness to disregard ethical and legal standards that posed an unacceptable risk to consumers and the integrity of the financial services industry more generally. The FCA further relied upon the need to maintain public confidence - reasoning that the public are entitled to expect that approved persons are individuals of the utmost integrity and reputation.

The Upper Tribunal was unconvinced:

"Those statements appear to be bare assertions and no evidence has been offered to support them ... The assertions … seem to be based only on the awfulness of the offence itself, which we readily accept to be the case. It would have been helpful had the FCA's assertions been backed up by criminological or psychological evidence which could support the view that the serious failure to act with integrity in one's personal life in the manner that Mr Frensham did, by seeking to exploit a young girl, runs a significant risk that he would likewise seek to exploit vulnerable clients (such as the elderly) who seek to rely on him putting his clients' interests before his own when giving them advice …" {our emphasis}

With respect to the integrity objective, the Upper Tribunal accepted that this embraced public confidence in the financial services industry and, in that context, whether there is a significant risk that the confidence of consumers will be impaired if it is known that a person guilty of an offence of this nature is allowed to work as a financial adviser. The Upper Tribunal stated that the FCA was:

"clearly entitled to take into account the nature of the offence in considering the effect it has had on both Mr Frensham's reputation and the reputation of the industry as a whole. Mr Frensham's personal reputation has clearly been severely damaged as a result of the offence. But the question is whether the offence affects the reputation of Mr Frensham as a financial adviser and therefore potentially has an impact on the FCA's integrity objective …"{our emphasis}

According to the Upper Tribunal:

"the FCA has not clearly linked the facts of the case to … the integrity objective. They deal with the public confidence question simply by reference to an assertion that the public are entitled to expect that approved persons are individuals of the utmost integrity and reputation ... That is presumably because public confidence in the industry would be significantly harmed if such a person was allowed to continue to work in the industry. However, the FCA's guidance does not make it clear that particular offences are considered by the FCA to be so serious that without more they would automatically disqualify the person concerned from working in the industry. In those circumstances, the FCA's assertions must be supported by evidence … As with the consumer protection issue, the FCA's case would … benefit from a more independent, analytical justification of the link between the offence and public confidence." {our emphasis}

Conclusion

In summary, in the specific context of Mr Frensham's conviction alone[3], the FCA had failed to establish the requisite degree of relevance of his conduct to his regulatory fitness and propriety by, in turn, failing to establish the necessary links between Mr Frensham's conduct and the relevant regulatory objectives. In the absence of credible and objective supporting evidence, the FCA's bare assertions proved insufficient.

Commentary

In effect, the Upper Tribunal cautioned the FCA against too readily deeming out-of-office misconduct to be relevant to regulatory fitness and propriety. The Frensham judgement represents the current jurisprudence on this topic.

The CP and Non-Financial Misconduct

The CP addresses non-financial misconduct in the context of both the Fitness and Propriety (FIT) and Conduct Rules (COCON) regimes.

Fitness and Propriety (FIT)

The FCA frames its proposals in the following extracts from the CP[4]:

"Bullying and similar misconduct within the workplace is relevant to fitness and propriety and similarly serious behaviour in a person's personal or private life is also relevant ... We consider that articulating our views clearly in FIT would reduce the risk of inconsistency in how our guidance involving non-financial misconduct is interpreted and applied in firms and within judicial settings."

"One of the purposes of FIT is to maintain confidence in the financial system in the UK. In our view, there is a risk to public confidence where individuals have committed serious non-financial misconduct, whether inside or outside the workplace, such as sexual or racially motivated offences, but are permitted to continue working within the sector. Such conduct is unlikely to be compatible with our statutory objectives ... Our proposed changes also clarify that conduct that could damage such public confidence is likely to mean that the person is not fit and proper."

Fitness and Propriety - Specific Rule and Guidance Proposals

The CP clarifies that - in sharp contrast to the (COCON) Conduct Rules (discussed further below) - an assessment of fitness and propriety should not be limited to conduct in the course of a firm's activities. Accordingly[5], conduct relating to a person's private and personal life is potentially relevant to a fitness and propriety assessment.

Non-financial misconduct against individuals

According to the FCA, misconduct outside the regulatory system "may be an indicator" that the [relevant] person does not currently meet applicable regulatory standards and "may not have the qualities and abilities needed for a person performing the role for which they are being assessed."[6]

The following CP extracts outline the FCA's general stance on the relevance of non-financial misconduct:

"Misconduct in a person's private or personal life may run a significant risk that the person would commit misconduct in their work activities that would breach regulatory standards."[7]Examples provided include violence or sexual misconduct, and dishonest out-of-work conduct.[8]

However, in an apparent acknowledgement of the Upper Tribunal's findings in Frensham, the FCA emphasises the importance of the link between the conduct concerned and its statutory objectives:

"One of the key factors in deciding whether something is relevant to fitness and propriety is the FCA's statutory objectives. Conduct that is inconsistent with the FCA's statutory objectives is likely to show that the person concerned is not fit and proper. Maintaining public confidence in the financial system and financial services industry in the UK is part of the FCA's statutory objectives.Therefore, conduct of a type that can damage such public confidence is likely to mean that the person concerned is not fit and proper."[9]{our emphasis}

"Misconduct in a person's private or personal life or in their working life outside the regulatory system may be relevant to their fitness and propriety even though there is little or no risk of it being repeated in their work for their firm. This will be the case if it is disgraceful or morally reprehensible or otherwise sufficiently serious. This is because their working in the role for which they are being assessed may damage public confidence in the financial system and financial services industry in the UK and consequently be inconsistent with the FCA's statutory objectives."

Analysis and commentary

• The proposed new FIT guidance would appear to address (in large part, at least) the Upper Tribunal's observation (in Frensham) that: "However, the FCA's guidance does not make it clear that particular offences are considered by the FCA to be so serious that without more they would automatically disqualify the person concerned from working in the industry."
• The new guidance expressly clarifies and confirms the FCA's previously articulated stance on the (likely high) significance of non-financial misconduct (wherever and against whomsoever perpetrated) in the context of an individual's regulatory fitness and propriety.
• On one (literal) interpretation, the draft guidance, as it currently stands, can be seen as effectively establishing a 'default' rebuttable presumption that serious non-financial misconduct will be considered to compromise or undermine the perpetrator's fitness and propriety.
  • In particular, the underlined extract from the proposed new guidance above sets a low bar: any conduct that "can" damage public confidence will "likely mean" that the person concerned is not fit and proper. "Can" is susceptible to a very broad interpretation - for instance, it might be translated in practice as "could conceivably", a threshold which would likely be met in the vast majority of cases.
    
    We suggest that an alternative formulation, such as "could reasonably be regarded (taking into account any available supporting evidence/analysis) as detrimental to public confidence" (or similar), might represent a more appropriate threshold - one which is more readily reconcilable with the essence of the Frensham judgement and, specifically, the Upper Tribunal's emphasis on an "independent, analytical justification of the link between the misconduct and public confidence".

Conduct Rules (COCON)

The 'fit and proper' regime is technically distinct from the Conduct Rules contained in the COCON Handbook, albeit that they do cover some similar ground[10]. A breach of a Conduct Rule might (but will not necessarily) serve to compromise the perpetrator's fitness and propriety - this will always be a circumstance-specific question. For example, a one-off and relatively inconsequential Conduct Rule breach will typically not, without more, be regarded as undermining fitness and propriety. Conversely, a breach of Conduct Rule 1 {integrity}, such as falsification of records, may well be considered to render the culprit no longer fit and proper.

While only 'certified persons' and Senior Management Function holders (SMFs) are required to be assessed as fit and proper, virtually all financial institution employees will be subject to the COCON regime.

The FCA has previously indicated that non-financial misconduct may (depending on the circumstances) constitute a breach of Conduct Rule 1 {integrity}. However, the scope of COCON is considerably narrower than that of FIT. The Conduct Rules are, broadly, restricted to conduct in the course of a firm's activities.

Conduct Rules - CP Proposals (General)

The CP reiterates[11]that conduct occurring in relation to a person's personal or private life remains out of scope of COCON. Relevant factors in deciding whether conduct is within the scope of COCON include[12]whether: (i) the conduct occurred on the firm's premises; (ii) the conduct occurred when the employee was working on the firm's business; (iii) the conduct involved any clients; (iv) the conduct was committed using work equipment or by involving the firm's staff; (v) the position of the person as an employee of the firm helped them to carry out the conduct; and (vi) the purpose (misguided or not) of the conduct was to benefit the firm. The CP includes a helpful table of illustrative examples[13].

In a significant new development, the FCA proposes to "expand the scope of COCON to make clear that it covers serious instances of bullying, harassment and similar behaviour towards fellow employees and employees of group companies and contractors."[14]There will be a carve-out from this expansion "where the misconduct clearly relates to a part of the firm's business that does not carry on any financial services activities …".[15]

However, not all misconduct towards a work colleague will amount to a breach of COCON. The FCA "will only take action for serious breaches of COCON ... for particularly serious instances of bullying, harassment or similar behaviour, or multiple instances that are collectively particularly serious."[16]

Commentary

Some may argue that any instances of bullying, harassment or similar behaviour are, by definition, serious. It would be helpful to understand, by way of specific illustrative examples, what species of 'non-serious' bullying or harassment the FCA is minded to exclude from COCON? The factors to be taken into account when determining "seriousness" (outlined immediately below) do not properly address this point.

Conduct Rules - CP Proposals (Specific)

COCON 4.1.1CG confirms that "Only a serious departure from [Conduct Rule 1 {integrity: misconduct in relation to fellow members of the workforce}] is likely to be a breach [of COCON]."

Factors to be taken into account when assessing whether the misconduct is sufficiently "serious" to amount to a breach of COCON include (amongst others): (i) whether the conduct is repeated or part of a pattern; (ii) the duration of the conduct; (iii) the size of the impact on the subject of the conduct and on those who witnessed or heard about or may hear about the conduct; (iv) the likelihood of damage to the firm's culture; (v) the seniority of the person whose conduct is in question; (vi) the difference in seniority between the person whose conduct is in question and the subject of the conduct; (vii) whether the conduct is related to a protected characteristic under the Equality Act 2010; (viii) whether the person concerned has been warned or disciplined for similar conduct; and (ix) whether the conduct is criminal or would justify dismissal.[17]

The CP (in COCON 4.1.1FG) provides a non-exhaustive list of examples of conduct in relation to a fellow member of the workforce that "will" breach Conduct Rule 1 {integrity}:

(1) intimidating or violent conduct;

(2) seriously offensive, malicious or insulting conduct;

(3) unwanted conduct that has the purpose or effect of violating the

dignity of the fellow member of the workforce;

(4) unwanted conduct that has the purpose or effect of creating an

intimidating, hostile, degrading, humiliating or offensive

environment for the fellow member of the workforce;

(5) bullying;

(6) unreasonable and oppressive conduct causing serious alarm or

distress to a fellow member of the workforce;

(7) subjecting a fellow member of the workforce to detriment for

complying with rule 3 in COCON 2.1 or rule SC4 in COCON 2.2 or

for using the firm's whistleblowing procedures;

(8) abusing or misusing their power or position in a way that:

(a) humiliates;

(b) seriously undermines or denigrates; or

(c) significantly injures;

the subject of that conduct; and

(9) victimisation as defined in the Equality Act 2010.

Under COCON 4.1.1HG, an example of conduct by a manager in relation to members of the workforce whom they manage that would breach Conduct Rule 1 is abusing or misusing their position as a manager in a way that undermines, humiliates, denigrates or injures the subject of the misconduct.

However (and significantly), both COCON 4.1.1FG and COCON 4.1.1HG are expressly subject to the following proviso (the "Proviso")[18]:

(1) Misconduct in relation to a fellow member of the workforce

described in COCON 4.1.1FG and COCON 4.1.1HG may fall

outside the scope of Conduct Rule 1 if the conduct rules staff member:

(a) thought that there was a good and proper reason for the

conduct; or

(b) did not intend to have a negative impact on the subject of the

misconduct, did not know that they were doing so and was

not reckless about the effect of their conduct.

(2) A belief of the kind referred to in (1)(a) should be reasonable. An

unreasonable belief that conduct is justified may itself show a lack of

integrity. For example, bullying, sexual harassment or violence

cannot be justified.

Commentary and analysis

• Notably, several of the types of conduct listed in COCON 4.1.1FG above reference the effect on the colleague. Such focus on the impact on the recipient, as opposed to the intent or mind-set of the perpetrator, is broadly consistent with elements of the approaches adopted in employment law cases of bullying and harassment; and serves as a warning to those who lack self-awareness and/or are generally oblivious or unconcerned as to how their conduct is perceived by others.
• In essence, therefore, in order to fall within the scope of COCON, misconduct in relation to a fellow member of the workforce must be:
  • of a kind characterised in COCON 4.1.1FG (and COCON 4.1.1HG); and
  • sufficiently serious - having regard to the above factors;
• However, even if these two pre-conditions are met, the conduct concerned may nevertheless ultimately fall outside of COCON if either of limbs 1(a) or 1(b) of the Proviso are satisfied.
  • In the interests of certainty, we suggest that the word "may" within the Proviso ought to be replaced with "will".
• Limb 1(a) requires thought on the part of the perpetrator.
• Sub-section (2) of the Proviso effectively renders bullying, sexual harassment and violence as unjustifiable under limb 1(a).
• However, what if the perpetrator gave (or simply claimed that (s)he gave) no thought to the appropriateness of their conduct? For example, a senior manager whose particularly assertive style and demeanour gave rise to a finding of bullying; but who in fact never once considered that his behaviour was inappropriate? Indeed, he may honestly have believed that his conduct was perfectly appropriate - one person's bullying is another's strong management.
  • Instinctively, it would be tempting to view such an example as potentially constituting "reckless" behaviour as per limb 1(b). However, as confirmed in a recent Upper Tribunal case[19], a person can only be said to recklessly ignore a risk of which they are actually aware:

"A person acts recklessly with respect to a result if he is aware of the risk that it will occur and it is unreasonable to take that risk having regard to the circumstances as he knows or believes them to be."[20]

In other words, subjective awareness of a risk is a pre-requisite of recklessness.

On this basis, the bullying senior manager in the above example may be able to successfully argue that he had not been reckless, on the ground that he lacked the requisite awareness; and consequently that he had not breached Conduct Rule 1. He could, though, still face a challenge under the 'lesser' Conduct Rule 2 {due skill, care and diligence}[21].

• The FCA may therefore wish to reflect on the terms of the Proviso - to ensure that it does not afford an effective 'get-out' to the ignorant (or those pleading ignorance).

Conclusion

In the context of non-financial misconduct, the CP aims to achieve the key objectives of: (i) offering clarity; (ii) introducing specific provisions for the treatment of work colleagues; and (iii) achieving better alignment with legal jurisprudence.

The CP goes a significant way to meeting these objectives. However, as outlined above, the draft rules and guidance would benefit from some further refinements and clarifications - if the new provisions are to serve their intended purpose and operate to maximum effect.

If you have any questions concerning the material discussed in this client alert, please contact the members of our Financial Services practice.

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