Regulatory investigations and investigation costs are a signifi cant source of indemnity claims for FI and D&O insurers. Whilst rarely used, there is a mechanism available which allows the subject of an investigation to seek their costs back from the regulator in certain circumstances. In this article we take a look at two cases (both concerning individuals) where a proportion of costs incurred were successfully recovered from the UK fi nancial regulator, the Financial Conduct Authority (FCA).
Upper Tribunal appeals
The Upper Tribunal Tax and Chancery Chamber (the "Tribunal") hears a variety of appeals, including appeals against certain decisions made by the FCA, covering a wide range of disciplinary and regulatory matters, such as authorisation and permissions, penalties for market abuse and disciplinary sanctions. Appeals from Tribunal decisions can be made to the Court of Appeal on a point of law only.
In proceedings before the Tribunal, the normal practice is for parties to bear their own costs on the basis that the Tribunal's power to make costs orders is limited by the Tribunal Procedure (Upper Tribunal) Rules 2008/2698 (the "2008 Rules"), rule 10. This prescribes that the Upper Tribunal may not make an order in respect of costs or expenses except in certain situations. In relation to financial services cases the relevant provisions are rules 10(3)(d)-(f), which provide that a costs order can be made:
(d) if the Upper Tribunal considers that a party or its representative has acted unreasonably in bringing, defending or conducting the proceedings;
(e) if, in a financial services case, the Upper Tribunal considers that the decision in respect of which the reference was made was unreasonable; or
(f) if, in a financial sanctions case, the Upper Tribunal considers that the decision to impose or uphold a monetary penalty in respect of which the appeal was made was unreasonable.
These powers are rarely exercised by the Tribunal in financial services cases (the majority of applications made under rule 10 are against the Revenue and Customs Commissioners). However, in the last few years there have been two cases which provide a valuable insight into the situations where the Tribunal has been willing to make such an award in a financial services case and serve as a warning to the FCA going forward.
Angela Burns v The Financial Conduct Authority  EWCA Civ 2140
Ms Burns was appointed as a non-executive director of two UK mutual societies. Upon investigation, the FSA (as it was then) found that Ms Burns was in breach of her fiduciary position, had failed to disclose conflicts of interest and had acted to further her own commercial interests. The FSA imposed a financial penalty and made an order prohibiting her from performing any function in relation to any regulated activity.
Ms Burns denied the allegations and made a reference to the Tribunal for the case to be reviewed. In December 2014, the Tribunal upheld four misconduct findings and agreed that she was not a fit and proper person to exercise the functions of a non-executive director. In May 2015 Ms Burns made an application for an order against the FCA for the payment of her legal costs which amounted to GBP 1,885,820.90 (GBP 1,494,562.32 was claimed on behalf of insurers who instructed solicitors and counsel on her behalf pursuant to a D&O policy).
Despite the findings against Ms Burns, the Tribunal exercised its discretion under rule 10(3)(d) of the 2008 Rules to order the FCA (as it by then had become) to pay costs of GBP 100,000 plus VAT to Ms Burns on the basis that the FCA had acted unreasonably in pursuing an allegation that she had made a demand for corrupt payments. Ms Burns appealed to the Court of Appeal on the basis of the misconduct findings and the FCA appealed against the costs award.
The Court of Appeal upheld the Tribunal's findings regarding Ms Burns' misconduct. It also upheld the Tribunal's costs order. Upon reviewing the evidence, it was clear that the FCA's Regulatory Decisions Committee (RDC) had accepted Ms Burns' evidence that the email in question, which could have been interpreted as a demand for a corrupt payment, was not a demand for a corrupt payment and was in fact just "poorly worded". After Ms Burns made the reference to the Tribunal, the FCA's statement of case contained no allegation that the email constituted a corrupt payment demand. However, following the receipt of further evidence unconnected to the email in question, the FCA doubted Ms Burns' general credibility and sought to amend its statement of case to reintroduce the allegation. Ms Burns argued that the FCA had been unreasonable in pursuing the allegation on a number of grounds, which the FCA sought to contest in a variety of ways, none to the satisfaction of the Tribunal. The Tribunal stated:
"The Authority needed to consider whether the additional evidence contained something which showed, implied or pointed to any intention to seek corrupt payment in return for misuse of influence as a non-exec director. It did not contain any such material. Even though there were wider concerns in certain other respects about Ms Burns' integrity and the credibility of her evidence, these were not capable of providing a sound basis for rejecting the conclusion reached by the RDC and reading the email in a way that would have flouted common-sense."
The unreasonableness of the FCA therefore, the Tribunal held, "increased the gravity of the proceedings and increased Ms Burns legal costs", thereby justifying the imposition of the costs order.
The Court of Appeal, whilst accepting the FCA's argument that the FCA is entitled to plead any allegation which has a real prospect of success and lies within the scope of the facts and matters considered by the RDC, stated that the FCA must, nonetheless, have a proper basis for making any allegation and have suitable evidence, especially when the allegation was as serious as a demand for corrupt payments.
The FCA had contended that the Tribunal had wrongly applied a gloss to the statutory test and directed itself that the FCA required a cogent basis for differing from the position taken by the FCA's RDC. The Court of Appeal disagreed:
"We do not understand [the Tribunal] to have been purporting to lay down any new rule of general application but merely to have been making a parenthetical observation that, the more serious the allegation, the more cogent the evidence must be to overcome the inherent improbability that it occurred. Where, as here, the allegation is of a particularly serious nature, the FCA must well know that it will require evidence of commensurate cogency to make it good. It should consider with great care whether it is appropriate to advance such an allegation, and particularly so in circumstances where it has been considered and rejected by the RDC."
As such, the Court of Appeal was entirely satisfied that the Tribunal had made no error in arriving at its conclusion.
Alistair Rae Burns v The Financial Conduct Authority  UKUT 19 (TCC)
Mr Burns was a director of a financial advice company, TMI, which specialised in the giving of advice to retail customers on transfers into Self Invested Personal Pension Schemes ("SIPPs"). Upon establishing himself as a SIPP operator in 2012, Mr Burns told the FCA that TMI did not provide advice on the underlying investments. In 2015, the RDC issued a warning notice to Mr Burns regarding the lack of advice given on underlying investments and also in relation to undisclosed conflicts of interest and Mr Burns argued to the RDC that the FCA was aware of the issue regarding advice in 2012 and that, in any event, it was time-barred in relation to that issue under section 66(4) of the Financial Services and Markets Act 2000, which provides that the FCA may not take action after 3 years from when they become aware of the misconduct (the "Advice Limitation Issue"). The RDC's Decision Notice was ultimately made on a slightly different basis: that Mr Burns' personal recommendation process did not in practice comply with the FCA's regulatory requirements and that Mr Burns had failed to ensure that TMI fairly managed and clearly disclosed Mr Burns' personal conflicts of interest and the conflicts of interest relating to other individuals at TMI i.e. side-stepping the Advice Limitation Issue. The RDC fined him GBP 233,600 and prohibited him from performing any senior management or significant influence function in relation to any regulated activity.
Mr Burns made a reference to the Tribunal in 2016 in which he repeated his submissions and Statements of Case were issued by both sides. Following an internal investigation in 2017, the FCA conceded that the Advice Limitation Issue was time-barred and therefore sought to amend its Statement of Case to reflect that it was now only pursuing the conflict of interest point and sought a reduced financial penalty of GBP 116,830.
The Tribunal, in its decision of 31 July 2018, upheld the RDC's finding in relation to the conflict of interest point but considered a penalty of GBP 60,000 appropriate. It further upheld the prohibitions on Mr Burns' activities.
In August 2018, Mr Burns applied for a costs order. His original application was for costs in excess of GBP 130,000 but he later submitted a revised costs order for GBP 58,283.30. He based his application on:
- Rule 10(3)(e), on the basis that the RDC's Decision Notice was unreasonable. Mr Burns contended that the FCA had information in its possession in July 2015 which should have led to it concluding that it was time-barred from bringing an action in relation to failing to give advice. He said that this information was withheld from him and when settlement talks were in progress he would have settled the case, rendering the RDC and Tribunal hearings unnecessary. Further, that the RDC and FCA colluded to side-step the Advice Limitation Issue and reformulate the Decision Notice
- Rule 10(3)(d), on the basis that the FCA conceded the Advice Limitation Issue unreasonably late
In relation to the application under rule 10(3)(e), the Tribunal found that there was no collusion between the FCA and the RDC but that the RDC had "failed to consider why, if the Authority did have knowledge that TMI did not advise on the underlying investments, that knowledge was not in itself sufficient for the Authority to be regarded as having knowledge of the "particular misconduct" that the Authority was relying on, namely the failure to take reasonable steps to ensure that the Personal Recommendations Process was compliant." This resulted in a "significant gap in the RDC's reasoning" and its reason for not addressing the Advice Limitation Issue was therefore unreasonable and Mr Burns was entitled to costs.
In relation to the application under rule 10(3)(d), the Tribunal held that the FCA acted unreasonably in the conduct of the proceedings by not addressing the Advice Limitation Issue in its Statement of Case. The FCA had many opportunities to fully examine the point at various stages of its investigation and the proceedings and, when they eventually did, they concluded that the point should be conceded. If they had taken one of the earlier opportunities, the point would have been conceded far earlier. Mr Burns was, therefore, entitled to costs.
However, despite these successes for Mr Burns, the amount of costs actually awarded (GBP 4,400) was a fraction of what Mr Burns had sought as the Tribunal found that Mr Burns wanted to contest other points that had been found against him in order not to receive any financial penalty and so it was not the case that he would definitely have settled at an earlier stage or that the FCA's late concession was the reason the hearings went ahead. The costs awarded therefore reflected the period between the Statement of Case in September 2016 and the FCA's concession in July 2017 and related only to the findings of unreasonableness regarding the Advice Limitation Issue.
These two cases will serve as a reminder to the FCA that care must be taken in meeting the appropriate evidential standards of each and every aspect of an enforcement case and the reasonableness of its approach may be open to consideration from a costs perspective should the matter be referred to the Tribunal. Indeed, the Tribunal in the Alistair Burns case concluded that it was appropriate for it to order a limited costs order in the circumstance as "To do so will send out an important message to the Authority that, even in circumstances of what is found to be serious misconduct on the part of the applicant, which I accept is the position here, it is imperative that all subjects of investigation and enforcement proceedings should be treated fairly and reasonably. There have been a number of significant instances in this case where I have found that the Authority has fallen below the standards that should reasonably be expected of it."
Further, and as a consequence of the FCA having appealed the costs order made by the Tribunal in the Angela Burns case, the Tribunal now has a Court of Appeal authority for an adverse costs award against the FCA, even in situations where there is clear misconduct on the part of the regulated person in question and where the FCA has in fact won on its substantive points. We may, as a result, see the Tribunal becoming more willing to exercise its discretion under rule 10(3) to make costs orders against the FCA. This will, of course, depend on the specific circumstances of the case.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.