Bad company corrupts good character. While that wisdom from 1 Corinthians is hardly a new idea, it is one reinforced very recently – and with potentially far-reaching consequences for financial services firms – by the Court of Appeal. FCA authorised execution-only firms who accept introductions from unregulated third parties now appear more likely to be held liable for losses suffered by retail clients. In this briefing note, Jolyon Connell and Jessica Reed consider the Court of Appeal’s judgment in Adams v Options UK Personal Pensions LLP  and explain the significant implications for authorised firms.
Mr Adams transferred his pension fund into a self-invested personal pension plan (SIPP) operated by an FCA authorised firm called Options, with Mr Adams having been referred to Options by an overseas and unauthorised firm called CLP. Options is a SIPP operator which operates on an execution-only basis and provides no advice to clients. Mr Adams’ SIPP was invested (upon his instructions) in storage units. The investment proved very unsuccessful and Mr Adams lost significant sums.
Mr Adams brought a claim against Options in the High Court, asserting (among other things) that his SIPP investment was brought about as a consequence of a firm (CLP) carrying out a regulated activity without authorisation to do so, which would render the agreement between Options and Mr Adams void and leave Options, as an authorised entity, liable to compensate Mr Adams for his losses under s27 of the Financial Services and Markets Act 2000 (FSMA).
The High Court dismissed Mr Adams’ claim – see our earlier briefing note on that judgment here. Mr Adams appealed against the High Court’s judgment and the Court of Appeal upheld Mr Adams’ appeal, with the consequence that Options is liable to make good Mr Adams’ losses.
Court of Appeal judgment
Mr Adams contended that, contrary to the general prohibition imposed by FSMA (s19), CLP carried out the regulated activities of arranging deals in investments (Article 25 of the FSMA Regulated Activities Order 2001 (RAO)) and advising on investments (Article 53 RAO). Mr Adams therefore argued that, pursuant to s27 FSMA, Options should be liable for his investment losses. Options disputed this and asserted that, even if liable in theory, the Court should exercise its discretion under s28 FSMA which permits an agreement (otherwise in breach of s27 FSMA) to be enforced if it is “just and equitable in the circumstances”.
The Court of Appeal considered the following:
- What counts as “arranging deals in investments”? The Court held that it is necessary to consider what constitutes ‘bringing about’ the investment; there must be what the Court described as “sufficient causal potency”. There is no hard and fast rule, but the more a party did to bring about the investment, the more likely it was ‘arranging deals in investments’ per Article 25 RAO. In this case, CLP procured letters of authority for Mr Adams, completed anti-money-laundering paperwork for him and completed his Options application form for him. The Court of Appeal held that these activities (among others) were sufficient to constitute “arranging deals in investments”.
- Was the unregulated introducer “advising upon investments” notwithstanding the fact that the underlying investment was unregulated? The Court held that, while advice to invest in the storage units was not itself investment advice under Article 53 – as storage units were not a class of security constituting a regulated ‘investment’ – the recommendation that Mr Adams transfer his pension funds from his current provider to an Options SIPP (which then invested in the storage units) did constitute “advising on investments” for the purposes of Article 53 RAO. As such, CLP was providing regulated investment advice without the authorisation to do so.
- What if the authorised firm didn’t know that the third party was contravening the general prohibition? Options did not know that CLP was providing investment advice in breach of the s19 prohibition. Nor did Options itself commit any breach of duty. Options had proper systems and controls in place; and Mr Adam’s losses were caused by him (or by CLP), not by Options. In addition, Mr Adams misled Options by failing to disclose that he received a financial inducement to invest in the storage units. Options argued that these factors militated in favour of the Court exercising its discretion under s28 FSMA and allowing the agreement with Mr Adams to stand. The Court of Appeal disagreed. It stressed that: (i) the key aim of FSMA is consumer protection; (ii) regulation is there to “safeguard consumers from their own folly”; and (iii) s27 FSMA is “designed to throw the risks associated [with accepting introductions from unregulated third parties] onto the providers”.
Key issues for authorised firms
- This particular case was about SIPPs. However, the lessons could be equally relevant to any authorised firm accepting introductions from unregulated third parties and offering execution-only services to those clients.
- Firms can accept execution-only business recommended by an unregulated person. However, authorised firms must be increasingly careful about from whom that business is being accepted. As the Court of Appeal put it in this case, if authorised firms “accept business from the likes of CLP, they run the risk of being exposed to liability under…FSMA”.
- Your terms and conditions will not protect you. Options’ terms and client-facing documentation could not have been clearer: Options was acting in an execution-only capacity and not giving any investment advice; Mr Adams’ was responsible for the investment decisions; Options was not obliged to review any aspects of CLP’s proposed investment strategies; and Mr Adams was strongly recommended to seek professional advice from an independent financial adviser (and confirmed in his Options on-boarding documents that he had done so). Notwithstanding that, Options was still held liable because of the introduction by CLP and CLP’s breach of the general prohibition on unauthorised firms carrying out regulated activities.
- Be extremely diligent in arrangements with unauthorised firms who are introducing unregulated investments. Even if the underlying investment is unregulated, the ancillary activities undertaken by such introducers could still constitute regulated investment advice. If an inherent adjunct to the unregulated investment is a regulated activity – such as selling a regulated investment to realise cash for the unregulated investment – the Court appears likely to consider the entire series of transactions as a single (regulated) transaction.
- The s28 message is stark. Even if authorised firms have done nothing wrong, accepting introductions from an unauthorised third-party firm which has (unbeknownst to authorised firms) been carrying out regulated activities contrary to the general prohibition will leave the authorised firm liable for the losses caused by the third party. It is also clear that (when considering what is just and equitable), the Court can be expected to lean heavily towards the consumer, not the firm.
- Overall, this case highlights the risks of accepting introductions from unauthorised firms. Authorised firms should therefore choose their introducer friends very carefully indeed.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, April 2021