In this issue of Signature’s Financial and Regulatory Disputes update, we review the FCA’s approach to enforcement action for breach of its Principles of Business and consider the fundamental changes to this regime due in the spring 2016. We also consider the recent High Court decision to refuse permission to judicially review the Serious Fraud Office’s decision to prevent three senior employees from being accompanied by the external legal representative of their employer. Finally, we look at recent case law and ask whether the definition of “client” needs to be widened for privilege purposes.
By Abdulali Jiwaji and Johnny Shearman
This article has also been published by CDR News.
By Abdulali Jiwaji and Rory Spillman
By Abdulali Jiwaji and Daniel Hayward-Hughes
The Financial Conduct Authority’s (the “FCA“) eleven Principles for Business (the “Principles“) (Table.1) form part of the main regulatory obligations that apply to every authorised firm. The Principles underpin the market abuse regime and set out, in simple terms, the standards that all firms must meet. If a firm contravenes one or more of the Principles the FCA can bring enforcement action. However, this regime is under review and fundamental changes are to be implemented in March 2016.
A recent review of fines resulting from FCA enforcement action brought under the Principles, shows that the vast majority were imposed for breaches of Principle 3 (management and control) (Fig. 1) which can be explained as Principle 3 has the widest scope. Where a relevant activity is carried out in a prudential context, Principle 3 applies to both regulated and unregulated activities. Fines for breaches of Principle 3 are often brought in conjunction with breaches of one or more of the other Principles, as failings in relation to management and control are likely to be present in significant cases of enforcement action.
Breaches of Principles 6 (customers’ interests) and 7 (communications with clients) have also resulted in a high number of fines since 2013. This aligns with the FCA’s overall approach to encourage firms to put customers and clients at the core of their businesses. This approach was reiterated in the FCA’s Business Plan and Risk Outlook for 2015/16 (the “Business Plan“) (for more information on what the Business Plan says about enforcement see our April Update).
The Business Plan also states that firms’ behaviour should support market integrity. However, our research shows that since its inception the FCA has found only one firm in breach of Principle 1, the central principle dealing with integrity.
The FCA’s only fine for a breach of Principle 1 occurred in 2014 when it penalised City & Provincial (“C&P“). C&P, a mortgage broker, and effectively one-man-band, offered non-advised mortgage broking servers to retail clients. The FCA found that C&P failed to conduct its business with integrity. Specifically, its sole trader and principal was found to have failed recklessly to prevent numerous client mortgage applications, which contained false and misleading information, from being submitted to lenders for approval. The FCA noted that C&P’s conduct was particularly serious because it posed a risk to both consumers and to lenders and therefore to the integrity of the UK financial system. C&P’s principal was ultimately banned from carrying on any regulated activities in the future.
Although C&P provides one example of where the FCA has found a lack of integrity in a firm’s activities, it is noteworthy that it is the only example when put in context with other recent enforcement action. Contrast this to the fines imposed on the five banks in late 2014 for FX manipulation. The banks (Citibank N.A, HSBC Bank Plc, JPMorgan Chase Bank N.A, the Royal Bank of Scotland Plc and UBS AG) were all found to have manipulated the foreign exchange market. The FCA’s findings in relation to these banks were similar in many ways to those relating to C&P. For example, the FCA noted that these banks behaved in a manner that put their interests ahead of the interest of their clients, other market participants and the wider UK financial systems. Even though the FCA commented that the failings of these banks undermined the confidence in the UK financial system and put its integrity at risk, no specific penalty was imposed for a breach of Principle 1. Instead all five banks were fined for breaching Principle 3. This was also the case in May of this year in relation to the fines imposed on Barclays Bank Plc for its involvement in the FX manipulation.
Principle 1 applies only to regulated activity and Spot Forex contracts are not in themselves qualifying investments under the Financial Services and Markets Act 2000 so constitute an unregulated activity. This means the FCA was limited to bringing enforcement action against the banks solely based on breaches of Principle 3.
Another point to consider is that, unlike C&P were the actions of its principal were effectively the actions of the firm itself, these banks are large institutions, so more difficult to show a lack of integrity for the bank as a whole for the actions of only a minority of employees.
The new regime that the FCA is implementing is made up of three categories:
- the Senior Managers Regime;
- the Certification Regime; and
- the Conduct Rules.
The Senior Managers and Certification regimes wil apply to regulated activities only. However, the new Conduct Rules, which will replace the existing Principles, will apply to both regulated and unregulated activity, and will allow the FCA to penalise a firm where its employees have acted without integrity.
The proposed Conduct Rules are nine high level rules (Table 2) which will be applied by the FCA to all employees of relevant firms. Under the new regime the FCA will continue to be able to impose penalties for breaches.
Not only do the Conduct Rules have a wider scope but the new regime seeks to align a firm’s actions more closely with those of its employees and senior managers. Therefore, the new regime certainly gives more scope for the FCA to pursue employees and senior managers, in the event of LIBOR or FX type misconduct recurring.
If one looks back at the FCA’s findings in relation to the benchmark manipulation episodes and applies the wider scope of the new Conduct Rules, it is arguable that we may have seen the FCA itself take an even stronger stance. Going forward, the likelihood is that the new regime will lead to more Principle 1 based enforcement actions against key participants in misconduct for demonstrating a lack of integrity.
 FCA fines from 1 April 2013 to 31 June 2015. Fines brought by the Financial Services Authority in 2013 have not been included.
 CP15/22 Strengthening accountability in banking: Final rules (including feedback on CP14/31 and CP15/5) and consultation on extending the Certification Regime to wholesale market activities dated 7 July 2015.
 There will be some limited exceptions for ancillary staff whose role is not specific to the financial services business of the firm.
The High Court has refused permission to judicially review the decision of the Serious Fraud Office (“SFO“) to refuse to permit three senior employees to be accompanied by the external legal representative of their employer at a s.2 compelled interview. Whether the SFO is willing to permit a legal representative to attend a compelled interview is dependent on whether the proposed legal representative’s presence may be considered to be potentially prejudicial to the SFO’s investigation.
Facts and outcome of proceedings
GlaxoSmithKline plc (“GSK“) has been and is the subject of a number of investigations in multiple jurisdictions with respect to alleged bribery and corruption. On 27 May 2014 the SFO announced that it had opened a criminal investigation into the commercial practices of GSK and its subsidiaries. As part of its investigation the SFO served notices on three senior individuals within GSK to attend compelled interviews pursuant to s. 2 Criminal Justice Act 1987. Section 2 provides the Director of the SFO with certain investigatory powers, including the power to compel an individual to attend an interview and answer questions.
There was no suggestion that these individuals were suspects: they were being interviewed as witnesses in order to further the SFO’s investigation. The three individuals in question confirmed their attendance and advised the SFO that they wished to be accompanied by a legal representative. Each individual had retained the same law firm representing GSK with respect to the investigation. The SFO initially opposed the three individuals being accompanied by any legal representative. However, during the course of correspondence the SFO agreed to allow the individuals to be accompanied by legal representatives, but refused to allow this to be the legal representatives of GSK.
The three individuals brought an application for permission to judicially review the decision of the SFO on the following grounds: (1) the SFO had breached the common law right of an individual to be accompanied by a legal representative of his/her choice; (2) the SFO had acted contrary too its own policy; and (3) the decision was irrational.
In refusing permission the High Court found that the grounds were unarguable:
- Although there is a general right at common law to consult privately with a solicitor when detained in custody, there is no common law right to be accompanied by a solicitor at a s.2 interview. Nothing in the Act conferred any such right upon an interviewee and it would be for Parliament to create such a right.
- The SFO’s policy, as evidenced in its “Operational Handbook”, is to permit the attendance of legal representatives at s. 2 interviews on the condition that their attendance does not unduly delay or in any way prejudice the investigation and the legal representative understands their role, which is different to that of a PACE interview. The written policy of the SFO goes further and indicates that it is not always appropriate to allow solicitors acting for companies to be present when an employee is being interviewed as there may be a conflict of interests between the employer and the employee. The SFO was entitled to take the view that there was a real risk of its investigation being prejudiced by the presence of the legal representative. Such prejudice included the risk that the legal representative would be under a professional obligation to report back to the employer and, as a result, may interfere with the candour in which the interviews are normally conducted, hindering the SFO’s chances of obtaining relevant information. The SFO did not have to prove that an actual conflict existed.
- However, there was no restriction on the interviewees seeking the advice of GSK’s legal representatives before the interviews and reporting back to GSK and its legal representatives after the interview. Further the individuals were free to retain and instruct any other solicitors to act for them with respect to the interview.
The Court also confirmed that arguments invoking the European Convention of Human Rights did not take the matter further in circumstances where the interviewee being interviewed pursuant to s. 2 has not been arrested or detained.
The Court was careful to indicate that its findings were only with respect to the circumstances of this particular case. The SFO’s objection to the presence of a legal representative will, at least according to its own written policy, need to be considered on a case by case basis. The SFO’s “Operational Handbook” is currently under revision, and it will be interesting to see how the SFO, and indeed other investigators, approach this area going forward.
The Queen on the Application of Jason Lord, Paul Reynolds, Justin Mayger v Director of the Serious Fraud Office  EWHC 865 (Admin)
June 2015 proved a fertile month for developments relating to privilege. First, the High Court in England and Wales held in Property Alliance Group Limited v The Royal Bank of Scotland Plc that a bank seeking to rely on certain documents deployed in its defence to a live action had necessarily waived privilege in related without prejudice documents. Second, the Hong Kong Court of Appeal in Citic Pacific Ltd v Secretary of State for Justice and Commissioner of Police widened the definition of “client” as laid down by the English case law in Three Rivers District Council v Governor and Company of the Bank of England (No 5) and held that Legal Advice Privilege is subject to a “dominant purpose test”.
Of the two cases the decision in Citic is of particular interest because it highlights the practical difficulties with the definition of the “client” in current English jurisprudence and the need for a more sensible and commercial approach.
Three Rivers No. 5
In Three Rivers No. 5 the Bank of England sought to assert Legal Advice Privilege (“LAP“) over documents created in response to the independent Bingham Inquiry into the collapse of Bank of Credit and Commerce International. The Bank of England had established an internal investigations team called the Bingham Inquiry Unit (“BIU“) to deal specifically with the Bingham Inquiry and to be the conduit for related legal advice.
In Three Rivers No. 5 it was accepted that litigation privilege did not apply because the Bingham Inquiry was non adversarial. The Court of Appeal in Three Rivers No. 5 held that LAP did not apply to documents provided to a client or its solicitor simply for advice to be taken in relation to them; rather the privilege attached only to the communications between the client and its solicitor (or documents evidencing such communications).The Court of Appeal viewed the BIU as the “client” of the Bank of England’s lawyers, rather than any other employee or officer of the Bank. The effect was that communications between the employees of the Bank and the BIU were to be regarded as if they were internal memoranda or communications with third parties and accordingly were not protected by LAP.
The decision in Three Rivers No. 5 caused a great deal of concern as it placed limitations on the protection afforded to companies through LAP.
In Citic a large number of documents and computer hard drives were seized pursuant to search warrants as part of a fraud investigation following Citic Pacific Limited’s entry into forex contracts, making of market announcements, and suspicions of insider dealing. Citic made a blanket claim to legal professional privilege in respect of all the seized material. As a result, the documents were sealed pending the determination of privilege by the court.
The Court of First Instance decided to follow Three Rivers No. 5. The Judge determined that the “client” in this case was the group legal department (comprising two in-house lawyers) and the Board of Directors and other employees of Citic were (as in Three Rivers No. 5) to be regarded as “third parties” for the purposes of LAP. The effect being that communications with or by such employees would not be privileged, even if intended for provision to in-house or external lawyers.
On 29 July 2015, the Hong Kong Court of Appeal held that LAP in Hong Kong applies more widely to communications between company employees and external lawyers where those communications “form part of the necessary exchange of information of which the object is the giving of legal advice as and when appropriate“, and its application is therefore subject to a “dominant purpose test”.
The “dominant purpose test” which the Hong Kong Court of Appeal chose to follow was the test formulated by Tomlinson J (as he was then) in the first instance decision in Three Rivers No. 5, being “an internal confidential document, not being a communication with a third party, which was produced or brought into existence with the dominant purpose that it or its contents be used to obtain legal advice is privileged from production“.
The broader test for LAP was adopted on the basis that legal professional privilege is a fundamental right (protected by Article 35 of the Basic Law) and a restrictive, narrow definition of the “client” would likely frustrate that policy. The Court stated that it was meaningless to have a right to confidential legal advice if the protection did not extend beyond the communications providing that advice. It was acknowledged that lawyers needed to be provided with certain background or relevant information before they could form a view and distil this into legal advice, and such provision of information must be protected by privilege or the whole process would breakdown.
This is a sensible decision by the Hong Kong Court of Appeal and has brought much needed clarity to the position in Hong Kong: both communications between the company (through its employees or in-house counsel) and external lawyers and documents created for the dominant purpose of obtaining or receiving legal advice will be privileged. This brings the law in line with other major jurisdictions such as Singapore, Australia, and the US.
The decision in Citic is not, of course, binding on the English courts, but it does serve as a timely reminder that the decision in Three Rivers No. 5 is far from satisfactory and that the law in this area is open to question. Over the next 12 months we are likely to see the English courts grapple with this issue, although a decision of the Court of Appeal is needed to put things right.
  EWHC 1557 (Ch).
 CACV 7/2012.
  QB 1556.
Feb 26, 2021
Feb 26, 2021