UK Upper Tribunal decision on obligations of those in investment management distribution chains

Background

The FCA’s Conduct of Business Sourcebook (COBS) imposes suitability obligations on firms that manage investments, including to take reasonable steps to ensure that a decision to trade is suitable for its client, and to obtain necessary information regarding the client’s knowledge and experience, financial situation, and investment objectives. 

Statement of Principle 1 of the Statements of Principle and Code of Practice for Approved Persons (APER) requires an approved person to act with integrity in carrying out his accountable functions. (The SMCR’s Individual Conduct Rule 1 is similar.) A lack of integrity may be established by demonstrating recklessness, which has both subjective and objective elements: the individual must be aware of a risk that a result will occur, and it must be unreasonable to take that risk having regard to the circumstances as the individual knows or believes them to be. To "turn a blind eye" is a lack of integrity. 

In this case, First Review Pension Services Limited (the Introducer) introduced retail pension holders to Synergy Wealth Ltd (the Adviser) who advised them to invest in SIPPs managed by Westbury Private Clients LLP (the Manager). Goodchild was chief investment officer of the Manager. Burdett was a director and 50% shareholder of the Adviser. 

Each pension holder was invested in three model portfolios “Global Cautious”, “Global Balanced” and “Global Growth”, yet all three were allocated 40% to high-risk offshore property development projects which failed, resulting in compensation from the FSCS (Failed Investments). 

The FCA fined Burdett and Goodchild and prohibited them from working in financial services. They referred these decisions to the Upper Tribunal. Goodchild argued that the Manager dealt only with the Adviser so owed no regulatory duty directly to the underlying pension holders, and that he undertook extensive due diligence on the Failed Investments. Burdett argued that the Manager, as discretionary investment manager, was solely responsible for suitability. 

Decision

The Upper Tribunal dismissed the references. 

Under COBS the Manager had suitability obligations to the pension holders. They were the Manager’s clients under COBS 3.2.1R because the Manager made decisions to trade for them and was remunerated via fees deducted from their funds. The Manager could not contract out of its regulatory responsibilities via its agreement with the Adviser (which purported to characterise the Adviser as the Manager’s sole—and professional—client).

The Failed Investments were unsuitable even for high-risk investors because they offered limited upside despite high unsystematic risk. The Manager’s due diligence was superficial. The 40% allocation of all three model portfolios to the Failed Investments rendered all three model portfolios high risk, and therefore the names names “Global Cautious” and “Global Balanced” were misleading—something Goodchild should have known. 

Goodchild recklessly acted without integrity: he had sufficient training and experience that he must have subjectively understood the risks of concentration and undiversified portfolios—a risk he ignored.

Burdett recklessly acted without integrity by acting as director of the Adviser knowing that he did not have the FCA CF1 (Director) approval, and because he actively brought about the 40% allocation to the Failed Investments despite subjectively knowing of their high risk, the concentration risk, and that reports to pension holders misrepresented the target asset mix.

The Tribunal determined that a financial penalty of GBP265,071 (reduced from the FCA’s Decision Notice figure of GBP311,762, primarily to reflect tax already paid on disgorged dividends) plus continuing interest was appropriate for Burdett, and that the FCA’s Decision Notice figure of GBP47,600 was appropriate for Goodchild. The Tribunal upheld the prohibition orders against both individuals.

Comment

The risk of "turning a blind eye" recklessness is greater for individuals who are more senior or have more training or experience. The Tribunal will infer a person’s actual knowledge from inherent probabilities and how a reasonable professional would respond in a given situation. Experience and qualifications can be powerful circumstantial evidence of an individual’s state of mind. The Upper Tribunal will even review the detailed content of the training an individual received, to determine what they should have known. Here, Goodchild studied for the Investment Management Certificate (IMC); its syllabus addressed property investment concentration risk and liquidity risk.

Careful review of relevant regulation is necessary to determine whether and to what extent contemplated contractual allocation of regulatory risk will be effective or constrained by regulation (here, between the SIPPs’ Manager and the Adviser, both in respect of suitability obligations to the pension holders). This includes allocations of risk between financial advisers and discretionary managers—both of whom may owe overlapping yet distinct and unavoidable suitability duties (here, in the context of recommendations and decisions to trade respectively).

Investors may be misled if a fund or portfolio’s name is inconsistent with its underlying risk. Firms should conform their naming conventions to actual asset composition and risk profile, remaining alert to the potential for misleading impressions including where strategy drifts or allocations become more concentrated.