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16 Aug 2023

When may an individual be liable to make restitution for regulatory breaches by their firm? The meaning of "knowingly concerned" revisited

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The Financial Conduct Authority (the "FCA") has the power to seek court-ordered restitution orders against firms, and individual "knowingly concerned" defendants in respect of regulatory contraventions by the relevant firm. 

Under s. 382 of the Financial Services and Markets Act 2000 ("FSMA"), the court may make a restitution order if it is satisfied that a person has contravened a relevant requirement, or been knowingly concerned in the contravention of such a requirement, and:

(a) that profits have accrued to him as a result of the contravention; or
(b) that one or more persons have suffered loss or been otherwise adversely affected as a result of the contravention.

"Relevant requirements"' for these purposes include any requirement imposed under FSMA and s. 89 and 90 of the Financial Services Act 2012 ("FSA").

In the recent decision of FCA v Forster & Others [2023] EWHC 1973 (Ch) (28 July 2023), Mr. Simon Gleeson sitting as a Deputy High Court Judge considered a claim by the FCA seeking restitution under s.382 FSMA. The judge concluded that the relevant firms involved had committed contraventions of s. 19 FSMA, the "General Prohibition", by operating an unauthorised collective investment scheme, as well as other "Relevant requirements", including s.21 FSMA concerning financial promotions being neither approved or published by an authorised firm.

The Judge next considered:

(i) whether Mr. Forster ("F"), a defendant who was an individual involved in the operations of the relevant firms, was "knowingly concerned" in the contraventions by those firms; and
(ii) whether F had been personally enriched as a result of any such contraventions.

The judge found that F was the guiding mind of the relevant firms. The critical issue then was whether he satisfied the test of being "knowingly" concerned in those contraventions.

The judge referred to "a useful summary" of the requirements of knowing concern is set out by HHJ McCahill QC in FCA v Capital Alternatives [2018] 3 WLUK 623, which was later endorsed and adopted by Mr Johnson QC in FCA v Avacade [2020] EWHC 1673 (Ch). This included:

"The relevant knowledge is knowledge of the facts on which the contravention depends. It is immaterial whether or not the individual knows that such facts constitute a relevant contravention. The individual is presumed to know what the law is and ignorance of the law is no defence: see SIB v Scandex Capital Management A/S [1998] 1 WLR 712 at 720F-H..." [the judge's own paraphrasing].

The Court of Appeal had also considered the meaning of "knowingly concerned" in the FCA v Ferreira [2022] EWCA Civ 397 and applied the same two-limb approach to the question of "knowingly concerned":

(i) the person must have been involved in the contravention; and
(ii) that the person must have had knowledge of the facts on which the contravention depended.

The Court of Appeal noted that the second limb of this approach reflected the principles cited above in Scandex. In Scandex, the Court of Appeal had held the person concerned must have known the relevant firm was not authorised, but did not need to know that the firm's conduct therefore involved a contravention, since that was a matter of law.

The judge found that F was not only the guiding mind of the relevant firms, but also was therefore fully involved in their activities, and was the force behind the establishment of the scheme which was clearly knowingly concerned with the relevant activities which constituted the relevant contraventions.

Legal advice obtained by F and "knowing concern"

This led to "the thorniest of the questions which arise from this case – to what extent, if at all, is the legal opinion received by [F] a defence to the charge of knowing involvement?"

The core of F's case was that he was not knowingly concerned in the sale of regulated investments, or in deceit as regards the sale of such investments, because he had obtained a legal opinion in which he was advised by counsel that the transactions concerned did not involve regulated investments. The FCA argued that the counsel's opinion should be disregarded, relying on the common law position that ignorance of the law is no defence. The FCA argued there was significant authority for this position. The Court of Appeal in Scandex had held that whether a person knows that the facts constitute a contravention (i.e., the legal conclusion as opposed to the facts themselves) is irrelevant.

In Avacade, it was held that legal advice is irrelevant to the question of knowing concern, though it might be relevant to the later inquiry as to the proper quantum of a restitution order.

The judge summarised submissions made on behalf of F that, where a lay client seeks and obtains legal advice from an appropriately qualified professional, he cannot reasonably be expected to form a view on the correctness or otherwise of the legal advice which he has received, and that F, having obtained counsel's opinion, was entitled to rely on it thereafter.

The judge accepted that this was:

 "...in principle, a good argument. To describe a person as "knowingly concerned" in a contravention of the law in circumstances where he has obtained independent advice that the activity concerned is not in contravention of the law is to strain the meaning of the word "knowingly" beyond any reasonable compass. Clearly, a person who acts without giving any thought to the legality of his actions takes a risk, and in this context ignorance of the law is no defence. This is simply recklessness. A person who has carefully considered the legality of an action, obtained external advice from an appropriate professional, and then acts on that advice, simply cannot be described as reckless in this way – still less can he be described as having intended to break the law."

The judge did then say, however, that it was equally important to emphasise that "an independent legal opinion was "not a get-out-of-jail-free card". The term "legal opinion" covers a "bewildering array of different forms of advice: some absolute; some conditional; some tentative; and all based on a series of factual assumptions whose accuracy is generally outside the scope of knowledge of the legal advisor. There can be no hard rule as to the legal effect of "a legal opinion" – everything depends on the circumstances."

The judge accepted that a lay client could not be expected to interrogate the accuracy or otherwise of the legal analysis which forms the basis of the advice which he has received, and if he acted on the basis of defective legal analysis legitimately obtained, he was entitled to the forbearance of the court. The judge said "it is absurd to suggest that a lay client should not rely on the advice which he has received as regards the legal analysis which it contains. Provided that he has sought the advice of an appropriate professional, he cannot be criticised for relying on the advice which he has received."

However, on the facts of the case itself, the judge found that the factual assumptions recited in the advice were wrong and F would have known that was the case – "Where he knows (or should know) that the factual matrix on which the advice given to him is based is incorrect, it is simply not open to him to say that he relied upon that advice."

The judge added that in this sort of case, "the benefit of the doubt should clearly be with the recipient of the opinion – if it is genuinely unclear as to whether the assumed facts of the opinion cover his particular situation, then he is entitled to proceed on the basis that the opinion is correct."

F had also relied on the observations of Snowden LJ in the Court of Appeal in Ferreira that to interpret s. 382 FSMA in a way that suggested the legislature intended to impose personal liability on directors (or others) simply on the basis that they knew of the actions that the company was taking in the course of its business (note this case concerned s.21 FSMA alone):

"…would be a far-reaching step indeed. Business is normally conducted, and investment opportunities are routinely offered, by companies with limited liability. The interpretation adopted by the Judge would result in limited liability being disregarded irrespective of whether the company was in fact rendered insolvent by the contravention of FSMA, and in a much wider set of circumstances than those in which the courts have conventionally thought it appropriate to pierce the corporate veil. Such grounds conventionally require some finding that the directors or corporators have established the company as a sham or facade for the purposes of some fraud. The corporate veil has never been disregarded simply because the directors were aware of the actions that their company was taking in the course of its business. In my judgment, the intention to introduce such a radical departure from the principles of limited liability in the financial services field should not be attributed to the legislature in the absence of some very clear indication of which there is none."

The judge said Snowden LJ's observations were clear – a director of a firm who has the ordinary knowledge of the firm's activities which a director is expected to have should not automatically be liable under s.382 FSMA in respect of a breach by their firm of a regulatory requirement. Directors of financial firms were entitled to the same company law protections as directors of any other type of company – " … the proposition as articulated by Snowden LJ seems clearly correct. The ordinary rules of director's liability are not dispensed with simply because the firm concerned engages in unauthorised financial business. The FSMA does provide the FCA with the ability to pursue directors personally, but an essential threshold condition for such pursuit is, as Snowden LJ put it, "some fraud"."

The judge therefore concluded that in order for s.382 FSMA to apply, there must be some involvement by a director in the contravention of a regulatory rule by his company "which goes some way beyond the normal involvement of a director in the affairs of the company".

Commentary

The judge set out the principles established in cases such the Court of Appeal in Scandex in which it had held that whether a person knows that the facts constitute a contravention (i.e., the legal conclusion as opposed to the facts themselves) is irrelevant. Ignorance of the law is no defence.

However, and albeit arguably obiter, the judge held that an apparent qualification applies where the individual has received a legal opinion (provided it is based in factual assumptions which the individual does not know to be inaccurate nor is reckless as to their accuracy) indicating the activity in question does not contravene a particular relevant requirement. That is apparently the case even if the legal analysis itself is wrong.  

In contrast, in Scandex, it was held that the relevant knowledge is knowledge of the facts on which the contravention depends. It is immaterial whether or not the individual knows that such facts constitute a relevant contravention. The individual is presumed to know what the law is and ignorance of the law is no defence. It seems difficult to reconcile this with the judge's conclusion immediately above concerning legal advice.

The judge went on to suggest that, based on Snowden LJ's comments in Ferreira, there must be proof of "some fraud" or some other aspect going "some way beyond the normal involvement of a director in the affairs of the company".

In Scandex, it was recognised that knowledge that the firm was not authorised was one of the necessary factual elements known to the individual – a factual point.  However, that does not involve some proof of a "sham or façade for the purposes of some fraud" as Snowden LJ suggested, nor requires, as the judge himself held, "some fraud" or other aspect "which goes some way beyond the normal involvement of a director in the affairs of the company".

The decision may well give additional comfort to individuals such as directors who seek and rely upon legal advice as to the legitimacy of their firm's conduct, and in effect introduces a "legal due diligence" defence, or even the need to prove some element of fraud.

These materials are for general information purposes only and are not intended to provide specific legal advice nor to be a comprehensive review of all developments in the law and practice, nor to cover all aspects of those referred to. Please take legal advice before applying anything contained in these materials to specific issues and transactions.

Author: David Capps

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