Most practitioners in the Financial Services industry are familiar with the concept of “boiler rooms” located offshore to avoid regulatory reach. The FSA has consistently warned consumers about the tactics used by such unauthorised firms in widely publicised press releases inMay 2000, May 2002 and April 2003. Those tactics include an offer by post or email for a free research report into a company in which the recipient held shares (originally described as “the Hook”, but now commonly referred to as “teaser” promotions). Requesting the report involved a signature and contact details, and small print overcoming the cold calling prohibition. What would follow was the classic flood of high pressure calls…

Names of firms who potentially fell into the category of boiler rooms were included in the latter two press releases and the list was expanded in February 2004. Naturally the FSA could not say any given firm was a boiler room without a full investigation which, given such firms are outside the FSA jurisdiction, would be both expensive and probably ineffective. On a risk based approach, the press releases could be seen to be an appropriate regulatory response to the risks posed by unauthorised firms.

To avoid immediate illegality, themailshot requires approval by an authorised person as a financial promotion to ensure it is clear, fair and notmisleading. In this context the financial promotion regime provides another bulwark against unfair practices and protects consumers. Fox Hayes, a ten partner firmof solicitors based in Leeds, acted for five unauthorised overseas companies offering shares quoted on the OTC Bulletin Board1 in the USA and, between February 2003 and June 2004, approved 20 financial promotions issued by their clients to investors in the UK. Three of those companies were named on the FSA’s list at various stages.

The business model was typically for Fox Hayes’ overseas clients to write to UK shareholders of UK quoted companies (obtaining their details from the shareholders register) and offer a free report on that company. They would also seek consent to contact the shareholder about other investments services. In due course the UK shareholder would be contacted by phone about buying shares in companies quoted on the OTC Bulletin Board. On receiving instructions from one of the overseas companies for the first time, Fox Hayes made enquiries into it and its business as is required by the financial promotion rules. If these enquiries did not reveal any problems, Fox Hayes approved the initial letters to UK investors and the research reports into the UK quoted company. The overseas company then communicated directly with the investors via telephone about the OTC Bulletin Board shares.

If an investor agreed to buy shares then the overseas company informed Fox Hayes, who wrote to the investor with details about the payment of the purchase price into an escrow account which Fox Hayes operated on behalf of the overseas companies. The UK investors sent their money to Fox Hayes, who held it in their client account until the share certificates were issued. Some 670 investors paid over in excess of $20million in 1,920 share transactions. In the long term almost all of the shares lost most of their value.

Fox Hayes’ gross fees for the work done totalled £178,424 (of which approximately £29,975 was the profit made). It also received interest on the escrow arrangements of £15,073.22. In addition, the senior partner received a commission, unbeknown to his partners, of 4% on the monies passing through the escrow account: some $518,149.

The FSA took enforcement action against Fox Hayes for breaches of the financial promotion rules and Principle 2 of the Principles for Businesses (due skill, care and diligence). In September 2006 it decided to impose a penalty of £150,000 in relation to the former. The firm referred the decision to the Tribunal.


The Tribunal considered four substantive questions and whether the penalty imposed was excessive. Those substantive questions were whether Fox Hayes had: 

  • taken reasonable steps to ensure that the promotions were clear, fair and notmisleading within themeaning of COB rule 3.8.4(1)? 
  • no reason to doubt that the overseas persons would deal with customers in the United Kingdomin an honest and reliable way within themeaning of COB rule 3.12.6(2)? 
  • arranged for the confirmation exercises (that the promotions complied with the rules) to be carried out by an individual with appropriate expertise within the meaning of COB rule 3.6.1(2)? 
  • conducted its business with due skill, care and diligence within themeaning of Principle 2?

Reasonable steps were taken to ensure promotions were clear, fair and not misleading

The whole purpose of the offer of free research reports was to obtain the consent of investors to be contacted by the overseas companies who would then try to sell the OTC Bulletin Board Shares to the investors. Fox Hayes knew that this was so. Nonetheless the initial letters were not, in the Tribunal’s view, inducements to engage in the purchase of the OTC Bulletin Board shares, but were an invitation to send for a research report into a UK company in which the investors already held shares. The Tribunal also held that the research reports themselves were not inducements to purchase OTC Bulletin Board shares, but could have been inducements to sell or buymore of the UK company’s shares.

On this basis, the Tribunal concluded that Fox Hayes did take reasonable steps to ensure that the financial promotions it approved were clear, fair and not misleading. They did not have to ensure that the reports were of high quality.

Initially no reason to doubt the overseas persons would deal with customers in the United Kingdomin an honest and reliable way, but bymid-November 2003 reason to doubt had arisen

The Tribunal interpreted the phrase “no reason to doubt” in rule 3.12.6(2) to mean that there was no obligation on the authorised firm to make enquiries (noting that it did not say “must ensure”). The Tribunal stated that the firm was under an obligation to consider all the information in its possession when deciding whether the overseas person will seal with its customers in an honest and reliable way.

The Tribunal examined all the information held by Fox Hayes at different times. Doubt was held not to have arisen by virtue of the FSA’s press releases on the subject of overseas unauthorised firms. The Tribunal commented that in the absence of a direct statement that the firms listed were unreliable, “it is difficult to criticise readers of the statement for failing to appreciate that that was what the FSA meant”.

The Tribunal also found it to be relevant that at no time during the FSA’s themed visit to Fox Hayes in July 2003, or in the subsequent correspondence between the firmand the FSA, was Fox Hayes told that it should cease doing business with any company on the FSA’s list of unauthorised firms. In September 2003, Fox Hayes specifically asked the FSA if there were any grounds on which it should not act and were told that this was a “commercial decision” for Fox Hayes, but also that responsibility lay with the firm to comply with both the letter and the spirit of the rules.

The Tribunal held that reason to doubt did arise by mid-November 2003 because of the cumulative weight of correspondence with the press, a notice from the Spanish regulator about one of the overseas companies, and complaints received from investors about the pressure they were subjected to over the telephone. In fact, although the partner with day-to-day responsibility for the matter raised his concerns with the senior partner at that time, Fox Hayes did not cease to act until June 2004 when the Authority commenced its investigation into the firm.

Confirmation exercises were carried out by an individual with appropriate expertise

The Tribunal held that the financial promotions were approved by a solicitor of 20 years standing with relevant experience who had thoroughly researched the regulatory position. Therefore Fox Hayes did arrange for the confirmation exercise to be carried out by an individual with appropriate expertise.

Conducted business with due skill, care and diligence

The FSA had confirmed by telephone on 13 January 2003 that the steps Fox Hayes proposed to take in conducting checks on its clients and the promotions would be in compliance with the rules. The Tribunal accepted that if Fox Hayes had been told that something was clearly wrong then they would not have done it. Notwithstanding this, the FSA alleged a breach of Principle 2.

Whilst the Tribunal agreed that the enquiriesmade by Fox Hayes could have been improved, for example in following up requests for the details of the qualifications of staff and ensuring references were supplied, it found that, on balance Fox Hayes did conduct its business with due skill care and diligence: it was entitled to rely on the fact that the overseas companies had been recommended by someone who in turn had been recommended by a reputable New York law firm, and the operation of the escrow account also represented a substantial safeguard for investors. In addition, the Tribunal found it relevant that there was no FSA guidance to assist Fox Hayes in this area.

The Tribunal also declined to find that Fox Hayes should have advised their overseas clients as to the legality of the telephone calls to potential investors in the UK (obviously, as real time promotions, the content of the calls was not capable of being approved). The Tribunal stated that the FSA had not persuaded themthat the Regulated Activities Order was relevant in this regard (indeed, the FSA specifically asked the Tribunal not to rule on that issue) and found that failure to give advice about an irrelevant provision did notmean a failure to conduct business with due skill care and diligence.

Penalty – reduced subject to further submissions

The Tribunal reduced the fine proposed by the FSA from £150,000 to £70,000. In doing so the Tribunal noted that it did not agree with the FSA that Fox Hayes acted negligently or recklessly and also stated that Fox Hayes had not received the advice and help that could have been given by the FSA. However, one of the key factors in setting the appropriate penalty was the profit Fox Hayes made from the work done for the overseas companies. The full facts surrounding the secret commissions received by the senior partner only came to light during the hearing before the Tribunal. Accordingly, the final decision on penalty was postponed pending further submissions on whether those commissions should be included in the calculation of profit to be taken into account when fixing the financial penalty.


Apparently as early as December 2003 internal deliberations at the FSA about potential action against Fox Hayes noted that “given the weakness in the rules it will be a difficult case to take forward andmay not succeed”; but that “it is important to demonstrate that the FSA is prepared to take action in this area”. While aspects of its handling of thematter do provide lessons to be learnt, nonetheless, the FSA has reason to be disappointed with the Tribunal’s black letter approach to the various provisions of COB and unwillingness to give a purposive interpretation to the rules in the context of the statutory objective of protecting consumers.

1) Given the primary purpose of the initial letter was to obtain consent to be contacted, it appears to follow that the financial promotion was an inducement – the free research report – to engage – by agreeing to be contacted about other services – in investment activity – the selling of securities. The focus of the letter on the UK company in which the recipient already owned shares and the offer of a free research report wasmisleading as to the true purpose of the financial promotion. The Tribunal’s focus on the form– offer of a research report – lost sight of the substance of the regulatory context.

2) That primary purpose should also have informed the firm’s consideration of whether it had no reason to doubt that consumers would be dealt with “in an honest and reliable way”. The Tribunal’s efforts to distinguish the mode of operation of Fox Hayes’ clients fromthose described in the press releases ofMay 2000 andMay 2002 are admirable, but ignore the essence of the boiler roomoperation: high pressure sales tactics to persuade UK investors to buy shares whichmay not be suitable for them.While the press releasesmay not have amounted to warnings not to deal with all overseas authorised firms, the Authority’s concerns ought to put any authorised firmon notice that such operations could not be automatically relied on to deal with consumers in an honest and reliable way. Further due diligence should have been required. The finding that the requirement that the firmhad no reason to doubt did not oblige the firmto make enquiries in that regulatory context sets the threshold for compliance too low.

3) The Tribunal’s willingness to find Fox Hayes had not been negligent in this regard conversely sets the barrier for proving a breach of Principle 2 worryingly high fromthe Authority’s perspective.

4) Equally worrying for the regulatormust also be the escape route afforded to Fox Hayes by the absence of any guidance fromthe FSA to assist the firmgenerally, or in response to specific questions raised in correspondence. Again, such analysis pays little regard to the regulatory context and the responsibility on firms to make their own judgements on thesematters. Instead, the failure to provide specific guidance was treated as tacit approval to continue with approving the financial promotions. This provides a stark illustration of the difficulties posed for enforcement action by themove to more principles-based regulation.

Despite the fact that ultimately the Tribunal upheld the imposition of a penalty against Fox Hayes, themanner in which the FSA’s arguments were rejected raises points of potentially significant jurisprudential precedent.We will have to wait until after the further penalty hearing (fixed for February 2008) to learn whether the FSA thinks these to be sufficiently important to justify its first outing to the Court of Appeal.