The English Court of Appeal has overturned a High Court decision which held that the FSA had acted improperly in requiring a firm of London based accountants to produce documents requested by the SEC and which the SEC claimed were relevant to a civil action which the SEC was conducting in New York. The High Court had decided that the FSA should not have required the accountants to provide the wide variety of documents requested by the SEC - it was wrong of the FSA to go beyond what was necessary or proportionate to assist the SEC with the allegations made in the New York litigation. The Court of Appeal disagreed and found that the High Court had taken too narrow a view of the FSA’s power to assist a foreign regulator.

Background

In July 2009, the SEC sought the assistance of the FSA in obtaining the production of documents in connection with ongoing proceedings against a Mr Badain, against whom (along with others) the SEC had instituted proceedings in New York for fraudulent and manipulative trading in the shares of a US company. The SEC’s request for documents was not limited to the parties to the New York litigation and asked for documents relevant to other companies not named in the proceedings. The request also asked for documents created within a wide timeframe starting many years before the events which were the subject of the litigation.

Upon receiving the request, the FSA contacted the SEC to discuss the scope of the request and sought an explanation of why the other companies were relevant and why the timeframe was so wide. The FSA explained that it would need to show that the request was reasonable and necessary in the circumstances. The SEC explained that the other companies identified were thought to be involved in the same manipulative transactions. The reason for the wide timeframe was because under US law, “pattern and practice” evidence could be used to prove motive or intent to engage in the conduct complained of in the litigation.

In the light of this explanation, the FSA determined that the SEC’s request for assistance should be met and appointed investigators to assist the SEC by requiring the accountants to produce the documents specified in the SEC request.

Court of Appeal’s reasoning

The Court of Appeal found that there was no error of law or principle in the FSA’s decision to appoint investigators. While it was right for the FSA to consider the request and seek clarification when deciding to exercise its discretion, it had received “sensible” answers sufficient to justify its decision to accede to the request in full. Having received those answers, it was not for the FSA to second guess the SEC as to its own laws or procedures or as to the relevance of the documents sought. Further, the FSA was not required to satisfy itself of the correctness of what they were being asked to investigate or the basis on which the investigation was asked for.

The first instance judge had erred in finding that it was wrong for the FSA to agree to go beyond what was relevant to the allegations made in the New York litigation. The SEC and the FSA were exercising investigatory powers, not engaging in a discovery or disclosure exercise. It was not for the FSA or the court to limit an investigation to matters currently pleaded in litigation or to consider whether the scope of the proceedings or allegations made may or may not be expanded following disclosure of the documents sought. Having found that the FSA had been given a sensible and sufficient explanation of why the documents were required, the Court of Appeal held that it was appropriate for the FSA to appoint investigators to assist the SEC. The correct test for those investigators to apply when deciding whether to exercise their power to require the accountants to produce documents was whether those documents were “relevant” to the purposes of their investigation – which was to assist the SEC with its on going civil action in New York. The Court of Appeal accepted that this was “a relatively low hurdle”.

The FSA Investigators were concerned to satisfy themselves that the exercise of their powers to require production of documents in this case was necessary and proportionate. The Court of Appeal found that the investigators had applied a more stringent test than was required. However, they did acknowledge that Article 8 of the Human Rights Act may be engaged to introduce a requirement of proportionality – albeit that such a requirement is easily satisfied where the documents sought are relevant to allegations of financial malpractice or crime.

Implications and conclusions

It is disappointing news for accountants faced with wide ranging SEC requests that the FSA need only get a “sensible” answer to questions as to relevance before engaging its own statutory powers to require production of documents. That, coupled with the finding that the FSA investigators’ own test of “necessary and proportionate” was more stringent than required, seems to encourage even less of a check and balance on SEC requests than the FSA has previously applied.

As the Court of Appeal said, it is undoubtedly important that national financial regulators co-operate. However, it is equally important that UK accountants are not subject to unduly onerous requests for production the potential benefit of which is outweighed by the prejudice suffered by the firm in question.