On 26 July 2017, the FCA published its consultation paper on the extension of theSenior Managers and Certification Regime (“SM&CR“). The paper envisages a widening of the SM&CR from the banking sector to all firms (big or small) authorised to provide financial services under the Financial Services and Markets Act 2000 (“FSMA“). This ‘new’ regime is predicted to come into force in late 2018 and its aim is to reduce harm to consumers and strengthen market integrity.What will it mean, however, for the future of the FCA’s enforcement actions and investigations?
Overview of the regime
In its proposals, the FCA recognises that any new regime needs to be flexible so that it can adapt to the different sizes and types of firms which exist. For this reason, what is introduced with the extended regime is a gradation of obligations. The “core regime” will apply to most firms.Smaller ‘limited scope’ firms (i.e. those currently subject to a limited application of the approved persons regime) will be subject to fewer requirements.Larger, complex ‘enhanced’ firms will be subject to additional requirements. The regime is made up of the following three core elements:
1. Senior Managers Regime
The new proposals extend the Senior Management Functions (“SMF“) for key responsibilities. The FCA refers to the individuals holding these SMFs as “Senior Managers“.
The “core” SMFswill apply to all firms except limited scope firms. These include ‘governing functions’ such as a chief executive or executive director, and ‘required functions’ such as compliance oversight and a money laundering reporting officer.
Limited scope firms will be prescribed different SMFs depending upon their nature under the draft SYSC 23. For example, sole traders will only need compliance oversight, whereas consumer credit firms and insurance intermediaries must have the “limited scope function” of apportioning responsibilities under the FCA Handbook; and the establishment and maintenance of controls.
‘Enhanced’ firms will need to fill additional SMFs including chief finance, chief risk, and head of internal audit.
In addition to the responsibilities inherent in each SMF, the FCA also stipulates a set of ‘prescribed responsibilities’ such as “responsibility for ensuring the governing body is informed of its legal and regulatory responsibilities” which firms must distribute between Senior Managers. Under the new proposals, these will be extended to all “core” firms, with “enhanced” firms being required to allocate these and additional responsibilities.
Likewise, Senior Managers under the extended regime will have a”duty of responsibility“under section 66A FSMA. This means that, where there has been or continues to be a breach of an FCA requirement, the Senior Manager responsible could be held accountable if they did not take “reasonable steps” to prevent or stop the breach.EachSenior Manager under the extended regime will still need to be approved by the FCA before starting the role. Senior Managers will be required to submit a “statement of responsibilities“to the FCA, setting out their role and responsibilities. Significantly, the firm must keep these documents up-to-date and notify the FCA of any changes, ensuring the FCA has immediate knowledge of the individuals who have, or should have, responsibility for each SMF.
2. Certification regime
The proposals will also extend the current ‘certification regime’. Where individuals are not Senior Managers but the functions of their role allow them to potentially cause significant harm to the firm or consumers (as defined under s. 63E(5) FSMA), the firm will now need to certify to the FCA that the individual is “fit and proper” to perform their role at least annually. In its consultation, the FCA envisages that this process would take place as part of the individual’s annual review. It should also be noted, that there will therefore be no FCA register of individuals under the certification regime, and that if a role is not filled, there is no requirement for the firm to certify someone for it. One corollary of this is that in very small firms, there may be no one within the certification regime.
The new proposals also extend “regulatory references” whereby the firm must receive references from the individual’s previous 6 employers to ensure they are fit for the role and unfit individuals are not recycled through new employment.These increased verification steps place a greater burden on firms to ensure fit and proper checks are consistently conducted.
3. Conduct rules
The proposals extend the conduct rules stemming from ss. 64A and 64B FSMA and are set out in COCON, the FCA Handbook. They will apply to all Senior Managers, certified functions, non-executive directors who are not senior managers, and all other employees except ancillary staff. For the avoidance of doubt, these “baseline rules” will apply to all firms, including “limited scope” firms.
There will be two tiers of “Enforceable” Conduct Rules.
First tier – Individual conduct rules which will apply to most employees in a firm:
- Rule 1: You must act with integrity
- Rule 2: You must act with due skill, care and diligence
- Rule 3: You must be open and cooperative with the FCA, the PRA and other regulators
- Rule 4: You must pay due regard to the interests of customers and treat them fairly
- Rule 5: You must observe proper standards of market conduct
Second Tier – Senior Manager Conduct Rules, applying to Senior Managers only:
- SM1: You must take reasonable steps to ensure that the business of the firm for which you are responsible is controlled effectively
- SM2: You must take reasonable steps to ensure that the business of the firm for which you are responsible complies with relevant requirements and standards of the regulatory system
- SM3: You must take reasonable steps to ensure that any delegation of your responsibilities is to an appropriate person and that you oversee the discharge of the delegated responsibility effectively
- SM4: You must disclose appropriately any information of which the FCA or PRA would reasonably expect notice
Statements of responsibilities (a statement produced by a firm which accompanies an application for the approval of the Senior Manager by the FCA) and, for enhanced firms, management responsibilities maps outlining how governance and responsibility structures work.There is already considerable scope for the FCA to investigate individual responsibility for breaches at all levels, directly and indirectly through various matrices. The FCA’s proposals at least attempt to clarify what it will have regard to in determining whether a Senior Manager is responsible. The focus will be on:
- The reality of the Senior Manager’s role and interaction with other Senior Managers’ roles. This could be evidenced by documents such as minutes, telephone conversations, and email exchanges.
However,what is meant by “reasonable steps” has not yet been defined.The FCAstates that it will need to be defined on a case-by-case basis. It has, however, released guidance on factors it will be looking to take into account (PS17/9 and Ch. 6.2 of the FCA’s Decision Procedure and Penalties manual). The FCA will for example, have regard to:
- The nature and size of the firm;
- The roles and responsibilities of the Senior Manager and whether they exercised reasonable care when considering the information available to them, and reached reasonable conclusions;
- The Senior Manager’s awareness of the breach, or whether they should have been aware of actual or suspected issues;
- Whether the Senior Manager properly understood the firm’s activities for which they were responsible. For example, failing to get expert opinion where appropriate, inadequately monitoring transactions, practices, and individuals, and failing to ensure adequate reporting;
- If the Senior Manager had delegated authority, whether that was reasonable and overseen appropriately;
- What steps were taken by the Senior Manager to satisfy themselves the firm had adequate systems and controls for the areas they were responsible for and following those procedures, as well as implementing them to comply with regulatory requirements and standards; and
- Whether orderly transitions and handovers took place.
From an enforcement perspective, this, along with the fact that the list of factors is neither exhaustive nor prescriptive, means the FCA has a considerable range of factors to determine whether reasonable steps have been taken. The burden of proof in demonstrating that reasonable steps were not taken lies with the FCA. Firms will be expected to keep good records of minutes of board and committee meetings as well as internal meetings, statements of responsibilities and management maps, organisation charts and reporting lines, and any relevant internal materials. Deficiencies in record keeping will not play out well in any investigation process.
In addition, the conduct rules require firms to demonstrate they apply the spirit, as well as the letter of the rules, and will have to train employees as to the content of the applicable rules. It will be critical, therefore, where there has been a breach, for firms to be able to demonstrate that the relevant individuals have undergone the necessary training programmes. The FCA expects firms to notify it within 7 days of a breach for Senior Managers, and annually in the case of other individuals. This emphasises the focus on senior management.
The expansion and additional clarification of the SM&CR is welcome. The new proposals, however, still lack an element of precision and various areas remain open to interpretation.
As of April 2017, the FCA has started investigations into 2 senior managers, and 11 individuals who are certified persons under the SM&CR regime since it came into force in May 2016. Although this may seem a small number, it is limited to the banking sector.The indications are that the level of investigation in this area is picking up in intensity.When the FCA’s proposals come into force late next year, the increased level of detail provided by firms to the FCA under the new regime and the new framework for measuring the actions of senior management in particular will likely feed further investigation activity.
nt to that other party. However, if the bank does give an explanation or tender advice, then it owes a duty to give that explanation or tender that advice fully, accurately and properly. How far that duty goes must once again depend on the precise nature of the circumstances”. On the facts of the case, the court held there was no corresponding broader duty to explain. In reaching its decision the court highlighted some relevant factors to consider, including the parties’ respective skill and knowledge, the commerciality of the relationship, whether the parties were entitled to expect the bank to act as their advisers generally and any written statements setting out the bank’s role.
In the more recent decision in Crestsign v National Westminster Bank plc and Royal Bank of Scotland plc  EWHC 3043 (Ch), in the context of a swap transaction, the bank had again chosen to volunteer information to the customer. It was found there was no duty to explain the whole range of products that might be available. The duty was to explain fully only those products which the bank had wished to sell to the customer. As to the content of the duty, the judge observed that it would require the bank to explain the effect of swaps accurately, without misleading, but did not extend as far as a “duty to educate” in the sense of giving a comprehensive “tutorial”. There was no duty to ensure that the information provided was properly understood, and it was sufficient for the bank to provide short summaries of the essential attributes of each of the four products it had described, provided the descriptions were not factually wrong or misleading. The duty, it said, would extend to correcting any obvious misunderstandings and answering reasonable questions. In relation to break costs specifically, in the context of structured interest rate derivatives, the judge found that the duty had been satisfied where the bank had described them as “substantial”. However, the judge acknowledged that “in this respect the bank came closest to breaching the duty it owed in respect of the provision of information”. Crestsign appealed the first instance decision (the appeal was due to be heard in April 2016), but the case settled on a confidential basis in February 2016.
Crestsign seems to suggest that there can be a positive duty to explain even in the absence of an advisory duty. Nonetheless, that duty is fact sensitive and there is some onus on the customer to make further enquiries, in circumstances where the information provided is brief and generic (albeit not factually inaccurate and misleading).
In the first instance decision of Thornbridge v Barclays  EWHC 3430 (QB) (an appeal is outstanding), the court found that there is a sharp distinction between advised and non-advised sales. In the absence of an advisory relationship, it was unwilling to recognise a broad duty to provide information. It noted that if Crestsign did intend the existence of a more general duty to explain products fully, then it had erred in doing so. Each case must depend on its facts. The court also observed there was no obligation on banks to warn of unexpected risks, such as movements in interest rates.
On 21 December 2016, Asplin J handed down judgment in Property Alliance Group (“PAG“) v Royal Bank of Scotland (“RBS“)  EWHC 3342 (Ch). PAG was claiming against RBS for amongst other things, the misselling of interest rate swaps. The Court was reluctant to recognise a wider duty to “explain fully” outside an advisory relationship. However, it recognised a potential “broader duty of care”, which is “fact dependent” and “contemplated as a duty falling on the advisory spectrum.” On the facts, it was found that no duty existed, given that PAG (i) was not an unsophisticated party, (ii) had a series of banking advisers who were aware of the potential costs, (iii) never sought the relevant information complained of and (iv) was under no time pressure (unlike the claimant in Crestsign). It was also not considered market practice to give information about potential break costs at the outset and in any event the Court observed that the explanations given were more extensive than in Bankers Trust.
At present the issue remains open for argument. The starting point is that banks owe no duty to explain the nature and effect of a proposed transaction. However, if they choose to volunteer information, then that may give rise to a duty to explain – a question of fact in each case. The scope of any duty to explain will be highly fact sensitive and depend on the context and on enquiries made by the customer.
Given the importance of relevant factual circumstances, and the outstanding appeal in Thornbridge, the scope of a bank’s explanation duty is likely to be explored further, with significant consequences for future misselling claims.
Abdul and Henry’s article has been published in the October 2017 issue of FX-MM.
In a recent case concerning allegations of abusive FX trading by a customer, the English courts gave an important clarification on when an online brokerage would be subject to a duty of good faith.
The claimant, an FX retail customer, sought recovery of trading profits from her online brokerage, FXCM, after it revoked profitable Gold and USD CFD trades that it deemed were placed in an “abusive” manner. The Judge comprehensively dismissed the breach of contract claim, finding that FXCM’s Terms of Business (“TOB“) were not subject to an implied duty of good faith. However, the decision is significant as it considers the circumstances in which the courts will imply a term into a contract that, when exercising a contractual discretion affecting both parties, a party must exercise that discretion reasonably.
This duty was first implied in Braganza v BP Shipping Ltd  UKSC 17, a Supreme Court decision which was a significant development in English contract law. The existence of the duty (the “Braganza Duty“) raises the spectre of the court delving into whether a party’s decision-making process was reasonable, that it considered all relevant issues and to ensure it was not acting in an “arbitrary, capricious or irrational” manner.
The claimant, Mrs Shurbanova, sought recovery of c.£460k in trading profits revoked by her online broker, FXCM, on the basis that FXCM believed the “Trades” constituted abusive trading as defined by its TOB.
Shurbanova had earned the profits by employing an algorithmic trading strategy based on US Non-Farm Payroll Data (NFPD) where, upon strong results, she simultaneously entered CFD positions to buy USD while selling Gold. This scheme relied on “a very fast news feed” (Forex Trading Gun) to place trades and close them out at the height of any price discrepancy between FXCM’s ‘slow’ retail price feeds (its “DD Platform“) and ‘fast’ price feeds, which reflected the prevailing market. FXCM alleged this trading strategy constituted a form of Latency Trading and so the Trades were placed in an abusive manner.
In answer to Shurbanova’s allegations that the revocation of the Trades was in breach of contract, FXCM contended, inter alia, that:
- The Trades, which opened at significantly “off market prices”, constituted a “manifest error” within the meaning of its TOB, which it was entitled to correct, amend or revoke altogether; and
- Further or alternatively, the Trades were abusive and so FXCM was entitled to revoke them without notice.
Shurbanova disputed these contentions and further argued that FXCM owed and breached a duty of good faith when handling the Trades.
Despite finding that the quoting of significantly off market prices did not constitute a “manifest error” the court found that the Trades were abusive and so amenable to revocation. The court found that Shurbanova’s trades constituted a form a Latency Trading – which relied on the discrepancy in price between FXCM’s platforms and “were placed with the knowledge of the outcome” and so a form of “classic abusive trading.” It also agreed with FXCM’s assessment that Shurbonova’s accounts were a front for her husband and son, both highly sophisticated FX traders known to have operated schemes exploiting latency issues to generate near guaranteed income.
On the question of whether Shurbanova’s trading techniques were abusive, the court rejected the suggestion that a very large profit was, in itself, indicative of abusive trading. Instead, the court found that it was the context in which such profits were made that was important for deciding whether abusive trading had occurred. From looking at FXCM’s global blotter the court identified the following characteristics of the Trades as “red flags” for abusive trading:
- The Trades were, with a gross value of c.USD$130m, unusually substantial in nature for a non-sophisticated customer.
- The Trades, which were opened 1-2 seconds after the release of the NFPD and were closed out 34 seconds later, suggested a deliberate trading practice.
- The Trades were executed using numerous very small orders.
- Shurbanova sought to withdraw the trading profit entirely, exceeding FXCM’s trigger point of USD $75,000.
The court considered whether FXCM was subject to a Braganza Duty to Shurbanova in relation to the manifest error and abusive trading clauses.
First addressing the manifest error provisions, the court found that it was for FXCM to determine whether there had been a manifest error. This discretion gave rise to an inherent conflict of interest given that it would be in FXCM’s financial interests to find that a manifest error existed (and so revoke the Trades). In light of this conflict, the court found that (but for the express requirements of good faith present in the TOB) the manifest error provisions would have been subject to the Braganza Duty.
Conversely, the court found that the abusive trading clause was not a contractual discretion attracting the Braganza Duty but a pure contractual power. This meant that it was for FXCM to determine whether the Trades were abusive as a matter of fact.
As one would expect, the decision confirmed that it is possible for a Braganza type duty to be implied in to FX Terms of Business. For customers, the possible existence of the Braganza Duty provides an opportunity to have courts review adverse decisions involving the exercise of discretion.
The decision is significant for brokers in that, in some cases, they will be expected to show that they have used “a proper process for the decision in question.” More positively for brokers was the court’s decision that a Braganza Duty could not be implied in relation to the abusive trading provisions.
Also of positive news for online brokers will be the finding that the Trades were deemed abusive. The decision provides helpful clarification as to how it would approach such questions going forward. The court will look to the nature of the trades, how they were made and the context in which they were made when assessing whether such trades are abusive.
One point that was not considered was the question of whether FXCM was subject to a wider obligation to act reasonably and/or in good faith in respect of the Trades (because the trades were deemed abusive). It is anticipated that this point will be raised in future cases and a finding in favour of a claimant on this point could have far reaching consequences for the industry and the general treatment of customer orders.