Accepting responsibility and liability for appointed representatives explored by UK court
Published on 18th Jul 2023
A High Court decision has considered the limits on a principal's exclusions of liability for representative's misconduct
At the end of last year, the Financial Conduct Authority published PS22/11 on improvements to the appointed representatives' misconduct regime – strengthening reporting requirements, principals' responsibilities, and expectations for supervision.
A recent High Court decision in the case of KVB Consultants Limited provides a timely reminder of why those improvements were necessary and the significant risk of direct liability which principal's face if they do not clearly define, and supervise, the scope of their appointed representative's activities.
The claimants were a collection of companies and individuals who had invested around £1.7 million in various investment schemes run by Andrew Callen, through his company Jacob Hopkins Maternity Limited (JHM). All of those ventures failed and Mr Callen was made bankrupt.
Neither Mr Callen nor JHM were authorised to carry out regulated activities, but were acting as the "appointed representative" of Kession Capital Limited (KCL), which was so authorised, under an appointed representative (AR) agreement. Under the AR agreement, JHM was allowed to carry out certain regulated activities, subject to KCL's regulatory permissions, and KCL became responsible for supervising JHM and accepted regulatory responsibility for those activities it had authorised.
The investors, as claimants, were seeking to recover their losses from KCL as principal and had made an application for summary judgment arguing that KCL's liability for their losses was so clear that KCL could have no realistic prospect of defending the claims.
KCL argued that Mr Callen had acted outside the scope of the AR agreement such that it had not "accepted responsibility" for those activities and therefore should not be held liable.
The scope of the AR agreement
Under the AR agreement, it was expressly agreed that JHM would only market and provide its services to professional and sophisticated clients and would not be permitted to conduct business with retail clients. All of the claimants alleged they were, in fact, non-sophisticated retail clients.
The AR agreement also expressly provided that JHM's services would be advisory only and there would be "no pooling of capital and no CIS [collective investment scheme]". These schemes have been subject to significant regulatory scrutiny in recent years and require specific regulatory authorisation. KCL did not have that authorisation.
The court held that all of the schemes were, in fact, CIS and at least seven of the schemes were "plainly unlawful": nobody involved had any authorisation to operate them and there was no lawful route by which they could be promoted or marketed.
In 2016, Mr Callen told KCL that he would put a pause on all marketing activity out of a concern that the schemes might be held to be CIS, and he would seek to restructure his activities so that they would be compliant if they were CIS. There is no evidence that KCL took any steps to verify of enforce these assurances. In fact, Mr Callen continued to accept investments and only restructured one scheme.
The claimants made three specific claims against KCL:
- First, that KCL had accepted responsibility for JHM's conduct and was therefore liable, under section 39 of the Financial Services Act (FSMA) as principle, for any losses caused by JHM's conduct in relation to CIS's under section 241 FSMA.
- Second, that KCL had approved the financial promotions for the purposes of section 21 FSMA and was therefore liable under section 214 FSMA.
- Third, KCL's failure to properly supervise its appointed representative was otherwise a breach of the FCA SUP rules.
KCL broadly denied these allegations. It placed specific reliance on the AR agreement and the assurances it had received from Mr Callen that he would not market a CIS nor conduct business with retail clients.
Did KCL 'accept responsibility' for JHM actions?
Section 39(3) provides that: "The principal of an appointed representative is responsible, to the same extent as if he had expressly permitted it, for anything done or omitted by the representative in carrying on the business for which he has accepted responsibility."
KCL argued that, by the terms of the AR agreement and the assurances provided by Mr Callen, it had expressly excluded responsibility for marketing to retail clients and for the marketing of CIS. As it had not accepted responsibility for them, it was not liable under section 39.
The court considered in detail the extent to which a principal can limit its liability in respect of section 39. In broad terms, the court took the view that principals can limit their liability in respect of the "what" (that is, the activity for which it accepts responsibility) but not the "how" (that is, the manner in which that activity is carried out).
For example, a principal cannot limit its liability by only accepting responsibility for "suitable" advice. In Anderson v Sense Networks Ltd, the court held "liability cannot be excluded by reference to a failure to properly conduct the business". Nor can a principal exclude "incidental advice" outside the strict scope of the authority which was "inherently bound up with and incidental to" the specified area.
However, the court was willing to accept that "Section 39 permits and requires lines to be drawn, based both on the prescribed categories of business for which exemption can be claimed, and the business for which the representative is appointed by the terms of the relevant agreement" but "it is equally necessary not to dissect an appointment in a spirit of pedantry, divorced from commercial reality". Or put another way, the court should not take an artificially narrow view with the result that responsibility is avoided when, in commercial reality, it was accepted in the appointment.
Therefore, the court held it could not attribute responsibility to KCL for the operation of the CIS. KCL itself was not authorised to conduct such activities and could not have accepted responsibility for them if it had wished to (which, the AR agreement made clear, it did not).
However, JHM also promoted and marketed those activities which were expressly contemplated under the AR agreement. These were activities for which KCL was authorised. The fact that JHM breached the scope of the AR agreement by marketing to retail clients was not relevant: "what matters is the commercial activity ('marketing'), and its substance. The fact that that activity was carried out improperly was not relevant." The activity was to market the investment schemes – the fact that they were only identified as CIS after the event did not change the fact that marketing the schemes was the very activity contemplated by the AR agreement.
The court therefore concluded that KCL had no reasonable prospect of denying responsibility for the promotional and advisory activities (or, on the facts, liability to the claimants). Even at a summary judgment stage, the court was willing to find that the investors had relied on the promotional materials provided to them and therefore there was no reasonable prospect of KCL defending those claims.
The claimants also argued that KCL had failed to supervise JHM properly as required by SUP 12.4.2R (by establishing "on reasonable grounds" that the representative's activities would not result in an "undue risk of harm" to consumers and that it had "adequate control" over the appointee's activities. This is a continuing duty. The claimants argued that KCL knew (or should have known) the CIS could not be lawfully promoted and was not entitled to rely on the representations of Mr Callen alone that they were not CISs.
The court was not willing to grant summary judgment on this point and did not need to give their findings on section 39. Nonetheless, the judge expressed the view (obiter) that KCL faced an "uphill struggle" in explaining why it was reasonable to rely on Mr Callen's views without taking independent legal advice or to accept Mr Callen's assertions that he had suspended marketing activities without taking steps to check and subsequently enforce that suspension – but he accepted there was a "long shot" that KCL might persuade a judge it had done enough
Again, in light of his views on section 39, the judge did not need to determine this point. However, KCL had made the argument that – to the extent that it had reviewed and commented on any promotional material, it had not done so "for the purpose of" section 21 FSMA approval. The judge was not impressed by this argument finding it "unrealistic to imagine" that any approval was for any purpose other than section 21 which would have been the "obvious context and purpose".
Osborne Clarke comment:
The court expressed a wide range of views which should come as warnings to principals who take responsibility for appointed representatives.
It is unlikely that claimants will face significant difficulties in establishing a principal's liability for their representatives misconduct (the decision here was at summary judgment), and the court's comments are a timely reminder of the approach that will be taken to apparent limitations on the accepted responsibility.
Any principals who believe they are protected against potential liability from the terms of their agreements with representatives may be well served by a periodic review of those terms, alongside regular and true supervision of their representatives to ensure they are doing only what the principal believes they are supposed to be doing and for which the principal is prepared to accept regulatory responsibility.
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