This decision makes it clear that personal culpability cannot be avoided through delegation or collective decision-making structures, such as the board, even where other directors have been allocated particular responsibility for specific areas including compliance.  Where responsibility is delegated, directors are not absolved from acquiring a sufficient understanding of the business to enable them to effectively challenge their fellow directors.

Overview

The Upper Tribunal has upheld the FCA’s decision to prohibit Alistair Burns from performing any significant influence or senior management function, as a result of his lack of competence and capability in his position as former director at TailorMade Independent Limited (TMI). It also directed the FCA to impose a fine on Mr Burns of £60,000 following the finding that he was in breach of Statement of Principle 7 by failing to ensure that TMI complied with its obligations under the regulatory regime, specifically in relation to: (i) ensuring that TMI’s business model, advice processes and systems and controls around that model were compliant (Advice failings); and (ii) in respect of disclosing and managing a conflict of interest (Conflicts failing).

Background

Between January 2010 and January 2013, TMI provided advice to customers who were considering switching their existing pension funds into a self-invested personal pension (SIPP) through which customers invested in unregulated alternative investments such as biofuel oil, farmland and overseas property.  These investments were described by the Upper Tribunal as “typically illiquid” and “esoteric”.  At the relevant time, Mr Burns was approved by the FCA to carry out the director (CF1) controlled function at TMI and, from April 2013 onwards, also held the chief executive (CF3) controlled function.

TMI was one of a number of businesses operating under the “TailorMade” brand, including an unregulated introducer called TailorMade Alternative Investments Limited (TMAI), which promoted alternative investments to customers.  Once the customers had decided to invest in one or more alternative investment, agents of TMAI would introduce customers to TMI for advice on whether a SIPP was suitable for the customer.

The business model was based on the premise that TMAI did not advise on the suitability of the alternative investments and TMI would advise on the suitability of the pension transfer to a SIPP, but not on the underlying alternative investments acquired by the SIPP.  TMAI was remunerated by commission provided that the customer invested in the alternative investment product concerned following a pension transfer.  Mr Burns had a substantial direct or indirect shareholding or other financial interest in each TailorMade entity.  Typically, the customer was not informed by TMI or TMAI of the payment of commission or its amount.

The FCA asserted that the business model was inherently flawed and failed to ensure that TMI’s customers were treated fairly or received suitable advice including by failing to take into account customer’s individual circumstances, demands and needs and that Mr Burns was personally culpable for these failings. The FCA also believed that Mr Burns had received significant financial benefit both in his capacity as a director and shareholder of TMAI and TMI, in that TMAI would only benefit financially if TMI advised the customer to transfer their pension into a SIPP and, accordingly, Mr Burns had an interest which was not disclosed or managed.

Upper Tribunal Decision

The Upper Tribunal considered:

• whether regulated advice had been given;
• the extent to which Mr Burns was responsible for the Advice failings;
• whether there was a conflict of interest between Mr Burns’ roles as director and shareholder of both TMI and TMAI and the extent to which Mr Burns was responsible for the Conflicts failing;
• whether the FCA was time barred from imposing a financial penalty for the Conflicts failing; and
• whether the sanction sought by the FCA was appropriate.

(a)        Was regulated advice given?

The Upper Tribunal found that, despite TMI’s advice model, there was clear evidence that advice had been given by TMI to customers on the merits of the unregulated alternative investments. The Upper Tribunal acknowledged that the relevant FCA guidance was unclear concerning whether advice on the merits of acquiring particular investments to be held within a SIPP is a regulated activity.

However, in the Upper Tribunal’s view, where a firm advising on the merits of establishing a particular SIPP knows that the customer’s intention is for the SIPP to invest in unregulated investments, then advice on the merits of those underlying investments is a component of the advice on the merits of establishing the SIPP and is therefore a regulated activity.  The Upper Tribunal found that because the customer was being advised on rights he will acquire upon establishment of the SIPP, including the right to receive benefits from the capital value or income derived from the particular investments held in the SIPP, the customer was being advised on an “indivisible package of rights”. 

An analogy was made to collective investment schemes, which may effectively constitute a wrapper around particular investments.  The Upper Tribunal noted that Parliament has “effectively decided” that such assets become regulated by reason of the fact that an investor acquires rights in specified investments through the collective investment scheme.

(b)        Advice

In relation to the Advice failings, the Upper Tribunal considered that it would be readily apparent either to any competent financial advisor or a non-specialist director who had properly informed himself about the relevant issues that it was “wholly unsuitable” to advise an unsophisticated retail investor with a relatively small pension pot to switch his pension benefits into a SIPP which would be invested in one or a small number of “inherently risky” overseas property investments.  In addition, the systems and controls in place around TMI’s advice processes were deemed to be “wholly inadequate.”

The Upper Tribunal found that Mr Burns was personally culpable for the Advice failings and did not accept that such processes, governance and systems and controls were the responsibility of one of his co-directors. The Upper Tribunal noted that the directors of TMI had operated within silos according to their expertise but held that it was not open to Mr Burns to delegate his individual responsibility as a director for matters such as compliance to a more expert Board member.  This did not absolve Mr Burns or the other members of the board from responsibility for obtaining a sufficient understanding of the business, and that each director had a clear obligation to provide a challenge to the actions of other individual directors.  It was made clear that those who consider themselves unequal to acquiring the necessary expertise should not accept the board appointment.  It was also noted that it was open to TMI to seek legal advice on whether its advice model was compliant.

The Upper Tribunal concluded that Mr Burns had not taken reasonable steps to put in place the necessary systems and controls or ensure such systems were reasonably robust in breach of Statement of Principle 7.  Despite the fact that Mr Burns no longer acted as an investment adviser, the Upper Tribunal considered that he had sufficient knowledge and experience of the industry to make an assessment about whether there was an issue in relation to treating customers fairly.

(c)        Conflicts of interest

In relation to the Conflicts failing, the Upper Tribunal considered that as a director and shareholder of TMAI Mr Burns would benefit financially if the customer was advised to transfer their pension into a SIPP in which an alternative investment would be held.   Mr Burns therefore had an interest in the outcome of the advice TMI was giving customers referred to it by TMAI, which was separate and distinct from the customer’s interest in the same advice. Mr Burns’ position that TMI advisers were remunerated regardless of their advice, that he disclosed potential conflicts to customers verbally, and that his co-director was responsible for the advice model, failed to convince the Upper Tribunal that conflicts of interests were managed and disclosed appropriately.  The conflict of interest concerned Mr Burns personally, was not a matter for which responsibility could be delegated and, in the Upper Tribunal’s view, was an “obvious conflict that any reasonably competent director of a regulated firm should have identified, even if he was not an expert in compliance.”

Accordingly, the Upper Tribunal found Mr Burns was personally culpable for the failure to identify that conflict of interest or manage it in breach of Statement of Principle 7.

(d)       Limitation

Prior to the Upper Tribunal hearing, the FCA conceded during the course of case management proceedings that its case for fining Mr Burns in relation to the Advice failings was time-barred pursuant to the provisions of s 66 (4) of the Financial Services and Markets Act 2000 under which the FCA must take action by issuing a Warning Notice within three years(at the relevant time). Time runs from the first day on which the FCA knew of the misconduct or had information from which the misconduct can reasonably be inferred.

As a result of its change of position in relation to limitation during the case management stage, the FCA invited the Upper Tribunal to consider imposing a reduced penalty of £116,830 (as opposed to £233,600 sought in its Decision Notice). The Upper Tribunal severely reprimanded the FCA in relation to its “inexplicable failure” to recognise the legitimate limitation issues relating to the Advice failings but agreed with the FCA in finding that the limitation period had not expired in relation to the Conflicts failing since the FCA did not have the required level of knowledge at the relevant time.

(e)        Sanction

Whilst the Upper Tribunal found that the imposition of a financial penalty on Mr Burns was appropriate because the failure to identify and manage the conflict of interest contributed significantly to customer detriment, it considered these failings to be less serious than those related to the advice issue and, as a result, reduced the penalty by more than 50% to £60,000.

Finally, it upheld the FCA’s decision to issue an order prohibiting Mr Burns from performing senior management and significant influence functions on the basis that his failure to ensure compliance with the relevant regulatory requirements demonstrated a “fundamental lack of competence and capability”.

To date compensation totalling over £55.6 million has been paid by the Financial Services Compensation Scheme (FSCS) in relation to claims upheld against TMI. This is just over half of the losses suffered by investors which FSCS estimate to be £106.5 million.

Comment

This case is the first to deal with issues surrounding the widespread “shocking…mis-selling of pensions transfers” in the financial services industry. The Upper Tribunal’s decision serves to emphasise that directors will personally be held to account where they have failed to identify and manage conflicts or take reasonable steps to discharge their responsibility for the adequacy of a firm’s systems and controls, including acquiring sufficient understanding of the business or seeking advice where appropriate and, and that such responsibility cannot be entirely devolved to others.   The case also illustrates the circumstances in which unregulated investments might fall within the scope of a firm’s regulated activities.