Can a firm acting on an execution-only basis still be liable when underlying investments turn out to be unsuitable? Will an authorised firm’s client agreement be unenforceable following the conduct of an unauthorised third-party introducer? These were the questions considered by the High Court in the recent case of Adams v Options SIPP UK LLP. The case concerned execution-only Self-Invested Personal Pensions (SIPPs), but the principles could apply to many other types of authorised firms. In this briefing, Jolyon Connell and Jessica Reed consider the key lessons for financial services firms.
Mr Adams, a retail investor of “modest” means, was persuaded to transfer his entire personal pension plan into a high risk single investment in storage rental units, held by way of a SIPP. Mr Adams alleged that he did so upon the recommendation of an overseas broker known as CLP, which was not authorised by the FCA to advise on or arrange investments. CLP introduced Mr Adams to Carey Pensions UK LLP (now known as Options SIPP UK LLP (Options)), which was authorised by the FCA to establish and operate SIPPs. Options then created a SIPP wrapper to house Mr Adam’s investment. The value of the storage rental investments fell very significantly. Mr Adams brought a claim against Options to recover his funds and his losses. Given the importance of the points in question, the FCA took the unusual step of intervening in the case and made submissions to the Court on a number of key points.
The Court was asked to consider the following two key questions:
1. Does COBS 2.1.1 require firms providing services on an execution-only basis to consider the suitability of the investments they are being instructed to execute?
Mr Adams claimed that, by allowing him to open a SIPP which was wholly invested in a single high risk investment, Options had breached COBS 2.1.1 which requires an authorised firm carrying out designated investment business for a retail client to “act honestly, fairly and professionally in accordance with the best interests of its client”. Contravention by an authorised firm of a regulatory rule (ie COBS 2.1.1) can give rise to a claim for damages.
Crucially, Options’ contractual documentation made it very clear that Options (i) was providing an execution-only service and (ii) would not provide advice upon the suitability of investments held within the SIPP. Notwithstanding that, Mr Adams claimed that, properly construed, COBS 2.1.1 required Options to ensure that unsuitable investments were not posted within a SIPP wrapper and that Options had breached this rule by agreeing to take the unsuitable storage rental unit investment into the SIPP. Mr Adams also argued that COBS 2.1.1 required Options to have in place procedures and controls which would enable it to identify possible “instances of consumer detriment”.
In response, Options asserted that COBS 2.1.1 should be read in the light of the obligations owed under the client agreement, which made it clear that no advice about the underlying investment was being given by Options. Options pointed out that, if COBS 2.1.1 did impose such a duty, it would oblige Options to undertake a regulated activity (ie giving advice) for which it did not have regulatory permission. Options also pointed out that there are separate COBS rules (ie COBS 9.2 and COBS 10.2) which impose duties on particular authorised firms to ensure the suitability or appropriateness of clients’ investments – and that COBS 2.1.1 should not be interpreted so widely as to apply these rules to Options as an execution-only SIPP operator - not least because Options did not have (nor was it required to seek) any information about Mr Adams’ circumstances and risk appetite to determine suitability.
The FCA argued that execution-only SIPP providers still owe some duties regarding the suitability of underlying investments, even though COBS 9 and 10 may not apply directly. The FCA’s view was that COBS 2.1.1 does impose a duty upon firms not to accept into a SIPP an investment that is (i) inappropriate for any SIPP or (ii) a SIPP investment by a retail customer who is not known to have received independent regulated advice about the investment. The FCA did not see this as contradictory to the SIPP’s execution-only (non-advised) status, pointing out that, where it had concerns, a firm could simply refuse to act, without having to give advice to the investor. The FCA also highlighted that firms cannot limit their regulatory obligations by contract (see COBS 2.1.2).
So, what is the correct interpretation of COBS 2.1.1? The Court held that the starting point for ascertaining the scope of the “clients best interest rule” in COBS 2.1.1 was the contractual agreement between the parties. Here, there was a “very plain inconsistency” between the agreement for the execution-only SIPP and the duties which Mr Adams was insisting arose under COBS 2.1.1. The Court held that it was not necessary for Options to consider whether the underlying investment was suitable and doing so was beyond the scope of the agreement: the parties had clearly agreed that Options would provide execution-only services and any regulatory obligations must be interpreted in the light of that fundamental agreement.
2. Did the actions of an unregulated introducer render the agreement between Mr Adams and Options unenforceable?
Section 27 of the Financial Services and Markets Act 2000 (FSMA) is an often-overlooked provision which aims to hold authorised persons accountable where they obtain business through unregulated third parties who are acting in breach of the general prohibition under section 19 of FSMA. In summary, it provides that where an agreement to perform a regulated activity (other than deposit taking) is entered into by an authorised person and a client as a consequence of something said or done by another person (or firm) who is carrying out a regulated activity without authorisation to do so:
- the agreement between the authorised person and its client is unenforceable against the client;
- the client is entitled to recover from the authorised person any sums paid under the agreement;
- the authorised person is liable to pay the client compensation for any losses suffered as a result of the client being a party to the agreement.
Mr Adams claimed that CLP had unlawfully conducted the regulated activity of advising upon investments and/or arranging deals in investments without authorisation, and that, as a consequence of this, Mr Adams had entered into the SIPP agreement with Options. The Court therefore had to consider what actions by an unregulated third party (ie CLP) would suffice to mean that an agreement was “in consequence” of the unregulated third party’s conduct. The Court also considered whether the actions of CLP amounted to the regulated activities of “advising on investments” and/or “arranging deals in investments”. If so, Options’ agreement with Mr Adams would be subject to challenge pursuant to section 27 of FSMA.
Mr Adams submitted that CLP was “arranging deals in investments” because the SIPP would not have been established “but for” CLP’s conduct. Interestingly, the FCA agreed with this point, and went further in its submissions: emphasising that ongoing arrangements to provide introductions could, in their view, constitute arranging deals in investments. However, the Court held that, in order to constitute the regulated activity of “arranging”, the arrangements must have been a “direct and substantial” cause of the ultimate transaction. Here, CLP had not been “arranging” the SIPP as additional steps were required to conclude the transaction and these were beyond the control of CLP. Therefore, Mr Adams’ claim under section 27 failed.
Key issues and lessons for authorised firms
Each case will turn on its facts, but this case contains some very useful lessons for financial services firms, particularly those providing services on an execution-only basis and/or those dealing with unauthorised third-party introducers:
1. Clearly drafted terms of business are essential. Options’ documentation made it very clear that it was not providing advice to Mr Adams or taking any responsibility for the suitability of the investments in the SIPP. It also specified clearly and prominently that Mr Adams should take independent advice and doing so was his responsibility. The documentation also contained clear risk warnings so that Mr Adams was aware that the underlying investments were high risk and speculative. These clearly drafted documents were crucial to the Judge’s decision not to extend liability to Options in the way Mr Adams claimed. Other firms should ensure their terms are similarly clear.
2. However, a firm’s documentation must also reflect the reality of its relationship with its clients. Documents stating that a firm’s role is execution-only will not assist the firm if, in fact, it is providing advice. As seen in the recent Parmar v Barclays decision, the Courts will look at the substance of a relationship (rather than the contractual labels only) and will apply COBS 2.1.2 to disqualify any clauses which are divorced from reality.
3. Ensure that all parties to introduced business have clearly understood and documented roles. Options’ documentation clearly defined the separate roles to be played by CLP (introducer), Options (execution-only SIPP provider) and Mr Adams (decision maker). This clear delineation strengthened Options’ position concerning both the COBS 2.1.1 allegation and the claim under section 27 of FSMA, as well as allowing Options to defeat a separate claim for negligence based on Options and CLP allegedly acting in concert. Firms should ensure their own documents make the separate roles of different parties sufficiently clear.
4. Robust internal compliance processes and good record keeping procedures are crucial. The evidence at trial was that Options had strong internal processes. It carried out sufficient due diligence into the underlying investment to discharge its obligations to ensure that the investments into the SIPP were eligible, (ie compliant with the relevant HMRC criteria). It clearly documented its relationship with unregulated introducers. Had their processes been less thorough, it is more likely that Options would have been found liable to Mr Adams for breach of COBS 2.1.1.
5. Firms should take note of the FCA’s position in this case. While the Court did not accept all of its submissions, it is interesting nonetheless that the FCA argued for a wide interpretation of the duties owed under COBS 2.1.1 and also emphasised its view that ongoing introducer arrangements could be considered to be “arranging” investments.
6. Firms should keep their unauthorised introducers under review. There was no evidence at trial to suggest that Options been on notice that CLP was providing unauthorised regulated advice to Mr Adams. Had there been, the outcome may have been different. Therefore, if firms fail to take reasonable steps to consider an introducer’s role and authorisation (or, worse still, turn a blind eye to unauthorised activity by an introducer) they should expect repercussions.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, June 2020