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18/07/2024
On 9 July 2024, Hugh Sims KC and Jay Jagasia were successful in Court of Appeal.
The Court of Appeal handed down judgment in KVB Consultants Ltd and others v Jacob Hopkins McKenzie Ltd and others[1]. The decision is only the second appellate authority on the scope of a principal’s responsibility for the acts and omissions of its appointed representative (AR) under s.39(3) of FSMA and, along with the first instance decision[2]. The first case to consider whether a principal can cut down such responsibility by reference to restrictions in the underlying appointed representative agreement (ARA) restricting the AR from carrying out investment business directed at a class of clients. The Court of Appeal’s authoritative analysis provides clarity on the scope of s.39(3) responsibility and reinforces the importance of consumer protection in this area of law.
This was an appeal against Mr Paul Stanley KC’s decision (sitting as Deputy High Court Judge) in the London CCC. In which he found in favour of the 26 respondents. All investors in failed property investment schemes, entered summary judgment against the appellant and twelfth defendant (KCL) for about £1.4m.
At the material time the investments were promoted, advised upon and arranged by or on behalf of the first (JHM) and tenth defendants (Mr Callen). JHM was the appointed representative of KCL, an authorised person under FSMA. And consequently exempt (by 39(1) of FSMA) from the general prohibition in relation to any regulated activity comprised in the carrying on of business for which KCL had accepted responsibility, in whole or in part, in the ARA. Although various claims were advanced against KCL (and the other defendants), the only claims that the judge was prepared to enter summary judgment concerned those directed at s.39(3), which imposes responsibility on a principal of an AR but not liability, which must be found elsewhere (usually contraventions by the AR of conduct of business standards or other prohibitions).
It was common ground in the action that the schemes in issue were unregulated collective investment schemes (CISs), and that they therefore fell within the regulatory perimeter. It was also common ground that the schemes were unlawful in that neither JHM or Mr Callen were lawfully entitled to operate or market the schemes. Notwithstanding that KCL knew of the schemes and their structure, and that they were the very reason for the ARA as it was the business specifically contemplated by KCL and JHM to be undertaken further to the ARA, KCL sought to defend the s.39(3) claims on two bases (both of which were rejected at first instance), namely that:
(1) Even though the schemes in issue were the very reason for the ARA, the ARA allegedly did not permit JHM to undertake investment business in relation to CISs (Ground 1); and
(2) Even if it did, JHM was not permitted under the ARA to carry out such business with retail clients and many of the respondents were retail clients and had been incorrectly classified by JHM as either ‘elected/elective professional’, ‘high net worth’, ‘professional’ or ‘sophisticated’ investors (Ground 2).
Ground 1 is effectively a point of construction of the terms of the ARA and the judge at first instance and the Court of Appeal had little difficulty rejecting it given that the whole purpose of the ARA, and the relationship thereby formed, was to enable JHM to market (and advise and arrange) the very schemes in issue, even though KCL and JHM both wrongly thought at the time that those schemes would not be CISs. Consequently, when balanced against that admissible background and other relevant provisions in the ARA, the statement “[KCL] acknowledges that [JHM] will offer advisory and arranging services to third party investors with regard to residential property investment. There is no pooling of capital and no CIS”, was a statement of the parties’ (mis)understanding of the position, and not a limitation on the permission granted.
Ground 2, on the other hand, required consideration of not only the restrictions in the ARA which prevented JHM from undertaking investment business with retail clients but also whether such restrictions were capable of cutting down the scope of KCL’s responsibility under s.39(3).
This in turn required consideration of the earlier decision of the Court of Appeal in Anderson v Sense Networks Ltd[3]. In addition to other first instance decisions which have considered s.39(3) (or its predecessor), where the Court of Appeal concluded that a principal could legitimately cut down responsibility by only accepting responsibility under the ARA for part of the business of a prescribed description for which the principal is authorised by the FCA (in that case by limiting such business to business conducted through ‘company agencies’). As explained in Anderson, an AR’s exemption under s.39(1) and the principal’s responsibility under s.39(3) are co-extensive, and whilst a principal cannot cut down responsibility by limiting its permission by reference to ‘how’ the permitted business is to be carried out, it could legitimately do so by limiting its permission to ‘what’ activity may be carried out.
Lord Justice Males, with whom the Master of the Rolls agreed, held that the restrictions in the ARA which sought to restrict JHM from carrying out investment business with retail investors, could not be relied upon by KCL to cut down the scope of its responsibility under s.39(3).
Put another way, they were restrictions which operated inter se between KCL and JHM but were directed at ‘how’ the business permitted under the ARA was to be carried out rather than ‘what’ activity may be carried out. In reaching this outcome, the majority relied on the statutory language in issue which it did not consider supported an acceptance of responsibility in relation to business undertaken in relation to a designated class of clients only.
The majority also considered that matters of client classification shared a great deal in common with matters which arise from a suitability assessment (a classical ‘how’ scenario), and it would make little sense to attribute responsibility for errors made in relation to the latter but not the former. They also considered that there were strong investor protection arguments in support of a construction of s.39(3) which did not enable a principal to cut down responsibility based on client classification. Ground 2 was accordingly dismissed.
Lord Justice Lewison, in his short dissenting judgment, did not consider that he could confidently enter summary judgment on Ground 2 because of the limited argument possible on an application of such nature and the complexity of the statutory scheme: he considered that it was at least arguable that a person is not an authorised person except to the extent that his carrying on of activities is authorised by the FCA and that as KCL did not appear to be permitted by the FCA to engage in advising activities with retail clients, a restriction in the ARA directed at such a matter could fall on the ‘what’ rather than the ‘how’ side of the line.
The appeal was consequently dismissed. KVB, along with the other leading cases on the topic (particularly Anderson), establish that s.39(3) has limits, but that its scope cannot be cut down by restrictions which go beyond restrictions directed at ‘what’ business may be carried out under the ARA.
They are a reminder that if a principal wishes to cut down responsibility for whole or part of a category of business, it needs to do so in clear terms, and will be unable to avoid responsibility by relying on restrictions in the ARA which are directed at ‘how’ business for which it has accepted responsibility is undertaken, whether those restrictions are concerned with the quality of business so undertaken or the type of investor that such business can be undertaken with. It should also be noted that given that exemption and responsibility are co-extensive, KVB should come as welcome relief to the great many ARs that operate throughout this jurisdiction as it means a simple mistake as to client classification will not result in the AR losing the benefit of any exemption and having contravened the general prohibition and thereby committed a criminal offence.
Hugh Sims KC and Jay Jagasia, instructed by Acuity Law, acted for the successful respondents.
A copy of the judgment can be found here
[1] [2024] EWCA Civ 765.
[2] [2023] EWHC 1686 (Comm).
[3] [2019] EWCA Civ 1395, [2019] Bus LR 1.
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