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5 March 2018

Battle over Conflicts of Interest

Categories: Blog, Financial Crime,

Peter Bowles Oct 2018 web

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

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Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

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Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

By Sangeeta Bedi

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

Categories: Blog, Financial Crime,

One product of an adversarial legal system is that, whilst someone always has to lose, someone else always has to win. The Court of Appeal’s judgment in Burns v FCA Angela Burns v The Financial Conduct Authority rather gives the impression that their lordships regretted this inescapable fact and would have preferred that neither party could claim victory. Whilst the appeal failed, the court severely criticised the FCA’s conduct in several respects – the case will therefore be of interest to many lawyers in the regulatory field.

Like many dramas, this particular piece of theatre unfolded in three acts – two grounds of appeal and a cross-appeal on costs by the FCA. In brief, Ms Burns – “an experienced investment professional” of 25 years standing – was appointed a non-executive director (‘NED’) of two mutual societies in the United Kingdom. Whilst still a holder of those posts she failed to declare to the societies that she was seeking a NED with an asset management company (‘V’) when V was itself applying to become a fund manager for both the mutual societies. It later became clear that, in the course of her job applications for the non-exec roles, Ms Burns had also failed to disclose to the two mutual societies or the FCA, a previous employment at Pearl (‘the Pearl Employment’) which had resulted in her bringing an unsuccessful employment tribunal claim.

As a NED, Ms Burns was under duties both to avoid a situation in which she faced a conflict of interest (section 175 of the Companies Act 2006) and to disclose any interest she had in the company’s proposed transactions or arrangements (section 177 of the same Act).

Having discovered Ms Burns’ apparent conflict of interest, the FCA imposed a financial penalty of £154,000 after finding that she had breached Principle 1 (the duty to act with integrity). Those familiar with FCA regulation will immediately recognise the significance of the Principle engaged. The regulator was not accusing Ms Burns of inadvertent failures or carelessness but a deliberate act evidencing a lack of honesty. This may be partly explained by the fact that the FCA are particularly exercised about actual and perceived conflicts of interest which makes them a live issue for the industry.

At the request of Ms Burns, the matter was re-heard in the Upper Tribunal (Tax and Chancery Chamber).Here, the FCA dropped the ball – twice. First, despite it having been considered and rejected by the authority’s own Regulatory Decisions Committee (‘RDC’), the FCA decided to make an allegation of soliciting a corrupt payment. The Tribunal rejected this allegation and ordered the FCA to pay Ms Burns £100,000 plus VAT for bringing it.

Second, in the course of closing submissions (and only then) the FCA sought to introduce her failure to disclose the Pearl Employment as a substantive allegation. As is plain from paragraphs 120-130 of the Court of Appeal judgment, the FCA had long been aware of the Pearl Employment issue and chosen not to make it part of their case.

Despite the FCA’s conduct Ms Burns’ lost her case and appealed on two grounds. First, that the Tribunal had applied the wrong standard of conduct to her in finding that she had breached the fiduciary duty she owed to the mutual society; and second, that the Tribunal should not have taken into account her failure to disclose her previous employment in determining as it had been introduced at such a late stage by the FCA. The FCA’s response was to bring across appeal against the Tribunal’s Costs Order.

Ground 1 – Disclosure of Conflicts of Interest

The first ground of appeal was, perhaps, the easiest to decide. Their Lordships swept aside Ms Burns’ arguments relating to the supposed tenuous nature of the risk of a conflict of interest. Relying on previous case law, the Court emphasised that companies are entitled to the “undivided” loyalty of their directors[1] and that only a real possibility of a conflict of interest is required to trigger the duty to disclose. Whilst this may not be news to many in the financial sector (and it certainly isn’t new law), it serves as a timely reminder of the strong stance that the Court’s take of such matters.

The Court dismissed the “various ways”[2] in which Ms Burns sought to heighten the threshold for disclosure. Her arguments that the asset manager’s application to become a fund manager was at an early stage was rejected, as was evidence supposedly showing that she was not fully cognisant of the need for disclosure.

Such an interpretation of this principle will affect many individuals in the financial sector, particularly NEDs who routinely hold various positions at any one time – thereby significantly heightening the risk of conflict between them. Whilst such a situation was not specifically addressed by the Court, the judgment does cite (without apparent criticism) the Tribunals comment that the very fact of holding multiple business positions “requires rigorous adherence to the proper standards concerning avoidance of conflicts and the making of disclosures”. Thus, far from being an excuse for failing to disclose conflicts of interest, holding various posts should be a spur to greater vigilance.

Their Lordships were also clearly keen to snuff out any route by which future appellants might seek to raise the bar triggering disclosure. For example, a submission by Ms Burns that a conflict needed to be a “racing certainty” before it triggered disclosure (based on the off-hand use of that phrase by Knox J) was roundly rejected.[3]

However clear it may be that a risk of future conflict of interest is enough to trigger the requirement to disclose, the application of that rule is far from easy. It may not always be clear to those in the financial sector how likely a future conflict may be. Equally, it may not be easy to judge when a merely fanciful possibility of conflict morphs into a risk requiring disclosure.

The difficulty of assessment under section 177 of the 2006 Act is compounded by the fact that the Court specifically declined to define the scope of the duty to avoid (as opposed to disclose) conflicts of interest (section 175 of the 2006 Act)[4]. The lack of such definition could result in a director declaring an interest (pursuant to section 177) which he should in fact have avoided in the first place (pursuant to section 175). Such a situation might put such an individual in an impossible position and certainly does nothing for the efficiency of regulation.

Perhaps even more worryingly, the Court made clear that the actions of a director can themselves result in the creation of a conflict of interest even where none existed previously. In the case of Ms Burns, her very attempt to solicit work from the asset manager created a conflict of interest for the purposes of the 2006 Act.[5] The possibility of such a situation should be considered by all regulated persons holding multiple business positions.

Of course, such difficulties exist in applying any general rule to particular facts, but the increasingly aggressive line taken by the FCA and other regulators coupled with the court’s re-statement of the low threshold required for disclosure should prompt those potentially affected to ensure they have proper systems in place. As with any risk management exercise, early consideration of conflicts of interest and ensuring that all relevant information can be quickly and easily accessed by those who need it are crucial. As this case shows, the consequences of non-disclosure are severe.

Overall, the Court of Appeal’s reasoning on the first ground serves to emphasise the heavy burden of loyalty on directors and that their duty to disclose potential conflicts of interest is easily triggered.

Ground 2 – Late Addition of a Substantive Matter (her non-disclosure of the previous employment)

Sweeping though the FCA’s triumph on ground may have been on ground 1, its victory on ground 2 was pyrrhic. The Court, were clearly extremely unhappy with the fact that the FCA introduced the non-disclosure of a previous employment as a substantive ground at such a late stage (so much so that paragraphs 120-127 of the judgment are devoted solely to demonstrating that the FCA had ample time to make this allegation part of their case and chose not to).

Nor did their Lordships hold back in their criticism of the authority’s handling of the issue. Having declared that handling “unsatisfactory”, paragraph 157 of the judgment makes the point that the onus is on the FCA to ensure the matter was made a substantive part of the pleaded case so that it could be properly argued. More caustically, the Court commented that  the FCA’s submission that its policy is to plead all those allegations on which it relies was “no more than the law requires”.[6]

Yet, however clear the criticism, the fact remains that the FCA’s misconduct in introducing a substantive ground at a very late stage resulted in no repercussions for the agency. With the best will in the world, it is difficult to envisage the Court’s justified criticism having any serious impact on the FCA in future cases. Their Lordships are doubtless aware of this but the logic of their decision is unassailable.

The judgment itself gives two reasons for the failure of this ground of appeal – first that Ms Burns and her legal team did not challenge the late introduction of the new substantive ground and second that she was in fact able to submit further evidence on the issue of her previous employment. Whilst the first of these reasons seems rather harsh (after all, decisions of this type are necessarily taken with no notice and almost no consideration) it is in line with the established principles of an adversarial justice system. Equally, the fact that Ms Burns was entitled to submit material must go a long way to ameliorating the procedural failure by the FCA.

It is possible that the Court wished to support the Tribunal’s use of case management powers to remedy procedural errors ex-post facto and it is only to be hoped that similarly reasonable solutions can be found in future cases.

Ultimately, the Court may simply have been unwilling to allow Ms Burns to succeed on a procedural point when even the new material she submitted failed to demonstrate any defence to the allegation in question.[7]

Ultimately, the Court had no sympathy for either party on this issue and all but said as much.

The Cross-Appeal – The FCA’s Challenge to the Costs Order

Individuals who lose at all stages of proceedings and on all grounds don’t tend to receive substantial costs orders. Not so in this case. After careful consideration, the Court ruled that the Tribunal had been correct to award Ms Burns £100,000 plus VAT in respect of the failed corrupt payments allegation. The FCA had argued that the Tribunal had misdirected itself by stating that “cogent” evidence was required for the FCA to reintroduce an allegation rejected by its own RDC committee. Given the seriousness of the allegation in question (and its mishandling of the previous employment matter decided above) the FCA might have been expected to let this one lie (as they almost did with the Pearl Employment issue). Perhaps budgetary considerations were in play here?

Unsurprisingly, the Court found in favour of Ms Burns. Their Lordships held that the Tribunal had only been using the word “cogent” to underline that the more serious an allegation the more convincing the evidence of it will have to be to prove that it occurred. As with Ground 2, it is clear that the Court wanted to support the Tribunal’s use of initiative in relation to a party failing to fulfil its duties properly.

Conclusion

Whilst the Court’s approach to costs and tardy allegations are interesting, the true importance of this case is its clarification of the threshold required for disclosure of conflicts of interest. Over the five years since Ms Burns failure to disclose, the FCA’s interest in this issue has only grown. Moreover, as this case shows, conflicts of interest very easily give rise to allegations of breach of integrity rather than of lesser failings. Those involved in business would do well to remember the Court’s message – any real risk of a conflict of interest requires disclosure and failures to disclose will be treated severely.

[1] See para 73, where Upjohn LJ (as he then was) in the case of Boulting v Association of Cinematograph, Television and Allied Technicians [1963] 2QB 606.

[2] Paragraph 77 of the judgment.

[3] See Paragraph 77 of the judgment and Re Dominion International Group Plc (No.2) [1996] 1

BCLC 572

[4] Paragraph 68 of the Judgment.

[5] Paragraph 84 of the Judgment.

[6] Paragraph 158 of the Judgment.

[7] Paragraph 154, Re: the inadequacy of the material Ms Burns submitted post-decision.

This article was also published in The Law Society Gazette and Compliance Monitor (behind a paywall). 

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