High Court ruling on Principals' liability
A High Court judgement, on an application for Judicial Review, has upheld a decision of the Financial Ombudsman Service (“FOS”) that a Principal, as…
R (on the application of TenetConnect Services Ltd) v Financial Ombudsman  EWHC 459 (Admin)
A High Court judgement, on an application for Judicial Review, has upheld a decision of the Financial Ombudsman Service (“FOS”) that a Principal, as defined by s.39(1)(a) of the Financial Services and Markets Act 2000 (“FSMA”), can be liable for the actions of its Appointed Representative (“AR”), even though the loss arose from unregulated activity for which the Principal had not accepted responsibility.
In the case under review, an AR of the claimant (“Tenet”) had advised his clients to sell existing regulated investments to fund a new unregulated investment in off-plan property in Goa. Rather than reinvesting his clients’ money, the AR gambled it away. The clients complained to Tenet as the AR’s Principal. Tenet refused to offer redress, so the clients complained to the Ombudsman who issued a Final Decision in their favour.
Tenet contended that the Ombudsman did not have jurisdiction to consider the complaint because the proposed investment in Goan property was unregulated and any losses arising from the disposal of the regulated assets fell outside the scope of the clients’ complaint, which focused on the proposed investment rather than the preceding sale. Tenet also argued that it was not responsible for any unregulated activity undertaken by its AR because it had not accepted responsibility for such business pursuant to s.39(3) of FSMA.
Rejecting Tenet’s application, Mr Justice Ouseley agreed with the Ombudsman that the sale of regulated investments was “intrinsically linked” with the advice to invest in an unregulated product because the specific purpose of the regulated sale was to finance that purchase. He also found that the scope of the complaint was not limited to the terms appearing on the complaint form and that it was up to the Ombudsman to determine the issue as a matter of fact.
The Judge rejected the argument that there was an impenetrable “bright line” between the regulated and unregulated activity as wholly artificial and contrary to “the purpose of the FSMA, and the language of the [FSMA] Order [2001 S.I. No. 544], the very nature of the Ombudsman Scheme, and the Financial Conduct Authority’s Handbook”. In particular, the Judge referenced DISP 2.3.1R and 21.4.1G as extending jurisdiction to the FOS in relation to “offering or providing or failing to provide a service in relation to an activity”, blurring any distinction between the sale of regulated products on one hand to fund the purchase of unregulated products on the other.
The decision of Parker J in Martin & Anor v Britannia Life Ltd  EWHC 852 (Ch) was also referenced as authority for the conclusion that Tenet’s responsibility for the sale of regulated products by its AR extended to any “associated or ancillary transactions”. Since the advice on the unregulated investment was the justification for disposal of the regulated investment, the Judge found that the two elements were “part and parcel of the same advice” such that “the whole advice was regulated activity, and … the Ombudsman had jurisdiction.”
While the Judge accepted that the AR’s authority under its agreement with Tenet did not extend to recommending Goan property investments, he also determined this issue by the finding that the regulated sale was inextricably linked with the unregulated investment recommendation. Tenet was therefore fixed with liability for the fraudulent unregulated investment advice, pursuant to s.39(3) of FSMA, merely because it had authorised the AR to deal with the sale of regulated investments.
The issue of fraud was also found to be of no assistance to Tenet, following the decision of HHJ Waksman QC in Ovcharenko v InvestUK Ltd  EWHC 2114 (QB). The nature of the AR’s default does not affect the Principal’s potential liability; if the Principal would be liable for the default of a negligent AR, the same would apply to a fraudulent AR. The default merely provides the Principal with a cause of action against the AR.
Since the AR in fact stole the clients’ money rather than reinvesting it, the Judge noted that the Ombudsman could simply have treated the matter as a case of fraudulent misrepresentation. On that basis, consideration of advice about “unregulated” investments was a red herring: “The effect of advice to sell a specified investment, based on a fraudulent misrepresentation that the money would be placed in an unregulated investment, when the intention was that it would instead be stolen, cannot be different from the effect of a fraudulent misrepresentation that the money would be placed in a specified investment, when the intention was that it would be stolen.”
This is an important decision for the Principals of ARs and their professional indemnity insurers since it diminishes the protection that Principals might expect from well-defined member agreements. Close connection between regulated and unregulated activities could present a risk of liability for unregulated activity regardless of the scope of the responsibility adopted by the Principal. As ever, Principals should be rigorous in their assessment and monitoring of ARs in an effort to prevent issues arising in the first place. Moreover, in the case of fraudulent activity, the distinction between regulated and unregulated activity may be rendered entirely irrelevant.