FCA and Employment Issues Guide
- The new regulators
- The FCA’s Approved Persons regime
- What is a controlled function?
- When is the Approved Persons regime relevant?
- What are the standards of conduct expected of Approved Persons?
- Statements of Principle for Approved Persons
- FCA training and competence requirements
- Employment status and FCA Regulation
- How does an individual obtain approval and how is the FCA notified of changes?
- Disciplinary action by the FCA
- FCA investigation
- Suspension of employees who are Approved Persons
- Employer’s investigation and internal disciplinary process
- Risks arising from internal disciplinary procedures
- Legal representation & Legal privilege
- Employee (Approved Person’s) resignation during an investigation
The Financial Conduct Authority (FCA) is an independent organisation responsible for regulating financial services in the UK. The FCA has statutory powers given under the Financial Services and Markets Act 2000 (FSMA) which came into force in December 2001. Under Section 19 of FSMA, any person who carries on a regulated activity in the UK must be authorised by the FCA or exempt (an appointed representative or some other exemption). Secondary legislation under FSMA sets out the particular activities and investment types which are regulated and for which FCA authorisation is necessary. Breach of section 19 may be a criminal offence and punishable on indictment by a maximum term of two years imprisonment and/or a fine.
The FCA regulates most financial services markets, exchanges and firms, setting the standards that they must meet and the FCA can take action against firms if they fail to meet the required standards. It has a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives:
- maintaining confidence in the UK financial system
- contributing to the protection and enhancement of stability of the UK financial system
- securing the appropriate degree of protection for consumers and
- reducing the extent to which it is possible for a regulated business to be used for a purpose connected with financial crime
These objectives are supported by principles of good regulation. The FCA Handbook sets out the FCA’s legislative and other provisions made under powers given to it by FSMA.
The new regulators
The FSA was replaced by new regulators, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) earlier this year.
The FSA Handbook was split between the FCA and the PRA to form two new Handbooks, one for the PRA and one for the FCA. Most provisions in the FSA Handbook were incorporated into the PRA’s Handbook, the FCA’s Handbook, or both, in line with each new regulator’s set of responsibilities and objectives.
The new Handbooks reflects the new regulatory regime (for example, references to the FSA are replaced with the appropriate regulator), and in some areas more substantive changes reflect the existence of the two regulators, their roles and powers. This includes such aspects as the processes for permissions, passporting, controlled functions, threshold conditions and enforcement powers.
The PRA will, over time, replace the Handbook with a PRA rulebook.
The FCA’s Approved Persons regime
Section 59 of FSMA provides that an authorised firm must take reasonable care to ensure that no person (which includes employees and contractors) performs a controlled function in relation to any regulated activity unless the FCA has approved that person to perform that controlled function. The general rule is that almost every authorised firm is required to apply to the FCA for the approval of one or more individuals to perform controlled functions on its behalf. There are specific rules relating to non-UK registered firms.
What is a controlled function?
Approved Persons performing controlled functions are generally:
- Those exerting significant influence on the conduct of the authorised firm’s regulatory activities, eg directors, senior managers, finance, audit, compliance staff and may include proprietary traders likely to exert significant influence on a firm
- Those who deal with customers, eg financial advisers, sales traders, investment managers
When is the Approved Persons regime relevant?
- When a firm submits an application for an employee or other person to become an Approved Person (where a firm is applying for authorisation first time -this is called applying for Part IV permission as set out in FSMA- or where it is already fully authorised and is recruiting more personnel)
- For the purposes of assessing the continuing fitness and propriety of Approved Persons (where disciplinary issues have arisen)
- Where Approved Persons are leaving the firm (particularly in circumstances of misconduct)
Approved Person status depends on the individual’s position within an authorised firm and is not transferable. So, when that person moves jobs, the new employers must apply again to get the individual approved to perform controlled functions. The individual is not “authorised” in his/her own right.
What are the standards of conduct expected of Approved Persons?
The (7) Statements of Principle and Code of Practice for Approved Persons set out the standards of behaviour and guidelines that the FCA expects of approved persons. Additionally, the Fit and Proper test for Approved Persons sets out the FCA’s minimum standards for becoming and remaining an Approved Person.
- Honesty, integrity and reputation
- Competence and capability
- Financial soundness
When applying for Approved Person status for the first time an individual must disclose information including whether they have any criminal convictions, county court judgements, have been the subject of an investigation into allegations of misconduct, etc. It is important that individuals applying for an Approved Person status have an open and frank dialogue with the regulator and if in doubt seek independent advice.
The FCA will not normally require the candidate to supply a statement of assets or liabilities. The fact that a person may be of limited financial means will not, in itself, affect his suitability to perform a controlled function.
Matters taken into account by the FCA when assessing “honesty, integrity and reputation” include:
- criminal offences
- adverse findings or any settlement in civil proceedings
- involvement in investigations or disciplinary proceedings
- contraventions of FCA rules
- concern in the management, of a business that has gone into insolvency, liquidation or administration
- justified complaints against the person
- dismissals, including agreed resignations
- disqualification from acting as a director or disqualification from acting in any managerial capacity
- truthfulness and frankness in dealings with any regulators
Statements of Principle for Approved Persons
Statement of Principle 1: An Approved Person must act with integrity in carrying out his controlled function.
Statement of Principle 2: An Approved Person must act with due skill, care and diligence in carrying out his controlled function.
Statement of Principle 3: An approved Person must observe proper standards of market conduct in carrying out his controlled function.
Statement of Principle 4: An Approved Person must deal with the FCA and with other regulators in an open and cooperative way and must disclose appropriately any information of which the FCA would reasonably expect notice.
Statement of Principle 5: An Approved Person performing a significant influence function must take reasonable steps to ensure that the business of the firm for which he is responsible in his controlled function is organised so that it can be controlled effectively.
Statement of Principle 6: An Approved Person performing a significant influence function must exercise due skill, care and diligence in managing the business of the firm for which he is responsible in his controlled function.
Statement of Principle 7: An Approved Person performing a significant influence function must take reasonable steps to ensure that the business of the firm for which he is responsible in his controlled function complies with the relevant requirements and standards of the regulatory system.
FCA training and competence requirements
The FCA has an overarching requirement for training and competence in the Senior Management Arrangements, Systems and Controls sourcebook (SYSC). Known as the “competent employees rule”, it requires firms to employ personnel with the skills, knowledge and expertise necessary for the discharge of the responsibilities allocated to them.
Employment status and FCA Regulation
Self-employed or employee?
FCA regulation may have an impact on the employment status of individuals such that those who are ostensibly self-employed could be considered employees. This was the finding of an Employment Tribunal in the case ofJohnson-Caswell v MJB (Partnership) Ltd (Oct 2011) where an IFA was subject to the directions, instructions and training requirements of his FCA-regulated principal. This degree of control was a relevant factor in determining that the individual had employee status. This could have wide-reaching implications for businesses which rely on the self-employed model, such as a number of hedge funds.
How does an individual obtain approval and how is the FCA notified of changes?
The firm must complete Form A (Application to perform controlled functions under the Approved Persons regime) and submit it to the appropriate FCA department (Individuals, Mutuals and Policy Department).
To notify the FCA of certain other events, it is necessary to complete and submit a number of different forms:
- Form B: withdrawal of an application for approval before obtaining the FCA’s decision;
- Form C*: notification that an approved person has ceased to perform a controlled function – the employer has seven business days in which to file a Form C;
- Form D: notification of changes in personal information of Approved Persons or application details;
- Form E: notification of an internal transfer of an approved person.
The FCA may take disciplinary action against a firm if a person undertakes a controlled function without first being granted Approved Person status. The FCA may also take disciplinary action against the individual. This is dealt with in more detail in the section on Disciplinary.
*“Qualified” Form C: where an Approved Person has been suspended or removed from normal duties, this form needs to be filed “as soon as practicable” (also commonly referred to as a “dirty withdrawal”).
Disciplinary action by the FCA
Once a person has become an Approved Person, he/she is individually regulated by the FCA and is therefore personally accountable to it. This has implications for the standards of conduct – Statements of Principle and Code of Practice for Approved Persons (APER) and fit and proper test – the person is expected to maintain and the disciplinary action that the FCA can take against him/her for failure to maintain standards.
If the FCA considers at any time that an Approved Person is no longer fit and proper to perform their controlled functions, it can make an order prohibiting that individual from performing one or more of those functions. This is known as a prohibition order. This is likely to prevent the individual from working in the financial services sector again.
The FCA can take action against an Approved Person if:
- It appears to it that the person is guilty of misconduct;
- It is satisfied that it is appropriate in all the circumstances to take action against the person.
An Approved Person is guilty of misconduct if he/she:
- Has failed to comply with the Statements of Principle and Code of Practice for Approved Persons (APER);
- Has been knowingly concerned in a contravention by the authorised firm of a statutory requirement under FSMA or an FCA Handbook provision.
The FCA can take action against individuals relating to historic matters and therefore against those who ceased to be Approved Persons a long time ago. It does not matter if that individual has changed jobs or retired.
The FCA has the power to impose a financial penalty on the Approved Person or issue a public statement of their misconduct. The FCA may also suspend its approval of the performance of a specific controlled function by the Approved Person or impose such limitations or restrictions on the performance of a controlled function as it deems appropriate. However, any such suspension or restrictions (currently) must not exceed two years. Disciplinary action may even result in withdrawal of authorisation.
The FCA expects senior management to take responsibility for ensuring firms identify risks, develop appropriate systems and controls to manage those risks and ensure systems and controls are effective in practice. Personal culpability of an Approved Person arises where, in the exercise of an approved function, behaviour was deliberate or where the Approved Person’s standard of behaviour was below what would be reasonable in all the circumstances. The FCA’s expectation of individuals’ responsibilities under the various controlled functions differs.
The approved persons regime operates alongside the Senior Managers and Certification Regime (SM&CR) and the Senior Insurance Managers Regime (SIMR) (both of which came into force in March 2016).
The FCA may take disciplinary action against individuals within senior management who fail to ensure that their firm complies with requirements, such as having adequate systems of control or an appropriate training and competence programme.
The FCA has the power under section 168 of the Financial Services and Markets Act 2000 (FSMA) to investigate individuals, including Approved Persons, where there are circumstances which suggest that specified offences have been committed or FCA rule breaches have occurred. Section 66 FSMA provides that the FCA may take action against an Approved Person if it appears they are guilty of misconduct. The FCA may also investigate senior management’s conduct in the context of an investigation it is carrying out into a firm and if senior managers are responsible for misconduct, the FCA may bring a case against the individual/s. The FCA mainly confines its investigations into individuals to those who hold significant influence functions these are controlled functions which broadly fall into categories:
- Governing functions (controlled functions 1 – 6)
- Required functions (controlled functions 8 – 12B)
- Systems and controls function (controlled function 28)
- Significant management function (controlled function 29)
Ten of the above controlled functions are also PRA designated controlled functions for dual-regulated firms (specifically CF1, CF2, CF3, CF4, CF5, CF6, CF12, CF12A, Ch22B and CF28).
However, the FCA also investigates and takes disciplinary action against individuals performing the customer controlled function (controlled function 30/CF30).
The standard practice for a regulatory investigation is for the FCA to send the individual(s) under investigation notice that investigators have been appointed, identifying the scope of the investigation and the relevant period, and indicating the basis on which any interview may be conducted. This can be voluntarily or compulsory or under police caution: the FCA has power to compel a person to attend interview, (sections 171, 172 or 173 of FSMA). If suspected of a criminal offence, the individual may be interviewed on a voluntary basis, or under caution where an individual would be provided with a caution under the Police and Criminal Evidence Act 1984 to the effect that he/she is not required to answer any questions but that failure at the interview to provide details of a defence later relied on in court may give rise to adverse inferences being drawn. Individuals who are being investigated may need independent legal representation, particularly if there has been any evidence of misconduct.
Cooperation with the FCA is essential to ensure that an investigation proceeds efficiently.
Cooperation is taken into account by the FCA as a mitigating factor and may reduce the level of any fine or other sanction.
It is a criminal offence knowingly or recklessly to provide false information to the FCA. The obligation not to mislead the FCA extends to documents submitted in connection with authorisations and other applications, as well as those provided during investigations (section 177(4) FSMA).
All interviews are recorded and the interviewee may be asked to review the transcript for typographical errors in the transcribing of the interviewee’s voice. No additional factual information may be added to the transcript, however the interviewee may submit further evidence at any stage.
Suspension of employees who are Approved Persons
The first action that is likely to be taken in respect of an employee suspected of significant wrongdoing is his suspension pending investigation. Check that there is a contractual right to suspend and the terms that will apply during any period of suspension.
The firm’s disciplinary policy may specify the maximum number of days for which an employee can be suspended. If not, and in any event, the suspension should only last for as long as reasonably necessary. Provisions regarding suspension (whether in employment contracts or disciplinary policies), should ideally not contain a maximum length of a suspension as this can be restrictive.
However, it is prudent to indicate the likely length of a suspension period, but that it may be longer if necessary. Usually, the longer the employee is suspended, the more difficult it is for the employee to return to work. Such employees are likely to consider that their reputation has been damaged.
The FCA must be notified where an Approved Person has ceased to perform a controlled function, and this should be done within 7 business days (by filing a Form C. However, where the Approved Person has been suspended or removed from normal duties, it may be necessary to file “as soon as practicable” a “qualified” Form C if the firm reasonably believes that the information it contains may affect the FCA’s assessment of the Approved Person’s fitness and propriety or that person is dismissed or resigns while under investigation by the firm, the FCA or any other regulatory body. The initial notification may be made to the firm’s FCA supervisor by telephone within hours or days, with a commitment to follow up with report shortly thereafter.
There may be employment law benefits to providing the Approved Person with a draft of the qualified Form C for their comments before submission to the FCA, but this is not usual practice. Firms must balance the need to notify issues promptly to the FCA against the need to conduct a reasonable investigation to ascertain whether or not suspicions of misconduct are founded.
Firms will be keen to persuade the FCA that it is not necessary for it to launch its own investigation under section 168(5) of FSMA or to commission a “skilled persons report” into the problem (section 166, FSMA). In most cases the FCA is content with the firm carrying out its own investigation and committing to providing the FCA with a copy of the report prepared at the conclusion of the investigation (the employer’s report).
Employer’s investigation and internal disciplinary process
An employer’s investigation is likely to have several different purposes including:
- To report information to the FCA;
- For use in any internal disciplinary proceedings against employees;
- Establishing litigation risks to the firm;
- Identifying remedial steps such as improvements to systems and controls, compensating customers/ third parties who may have suffered loss.
Risks arising from internal disciplinary procedures
The primary importance of the relationship with the FCA will not excuse the employer from complying with employment law. This and other factors could give rise to a number of conflicts/risks:
- An employer could be tempted to dismiss an employee to demonstrate to the FCA that a matter is being taken seriously; the investigation process must follow fair principles. It should take no longer than reasonably necessary and be kept confidential. An unfair investigation could lead an employee to claim breach of trust and confidence and constructive dismissal
- Media relations internal and investigations conducted by the FCA are subject to the confidentiality provisions under section 348 of FSMA. Therefore very little information can be released to the public. In the absence of the full facts, there is a risk of manipulation by the press so generally all media contact should be suspended
- Those investigating should not be the same persons who conduct the disciplinary hearing. Depending on the nature of the alleged misconduct, the investigation is likely to be conducted by external lawyers but the relevant business team, compliance department, human resources and other parts of the firm may need to be involved
- Where there is also an FCA investigation and the employee’s conduct is part of that, the employer’s disciplinary process and the FCA investigation will need to be run in parallel. Tension may therefore arise between the objectives of the compliance and legal departments as against the requirements of the human resources department to ensure a fair process is applied and a fair sanction given
- Documents created in the course of an investigation led by lawyers (whether in-house or externally) may attract legal professional privilege (see below) and therefore be protected from disclosure to the FCA and/or in any subsequent legal proceedings. Equivalent documents created in the course of an investigation conducted by compliance, HR or internal audit staff would not attract similar protection
- The expectations of FCA enforcement staff may need to be managed; they may expect a firm to take severe disciplinary action and would need to have explained that if the compliance department/outside influence dictate the result of disciplinary action, it could render the action unfair in employment law terms
- FCA investigation can take a long time and if this causes a substantial (and perhaps unfair) period of suspension for the employee, this can lead to breach by the employer of the employee’s rights under employment law
- An unfair dismissal which leads to the employee losing their approved status may justify the award of “career loss” (Credit Agricole Corporate and Investment Bank v Wardle  ICR )
- Whistleblowing – if the regulatory issue has come to light as a result of another employee raising the issue, care needs to be taken when dealing with that employee. Employees are protected from dismissal or suffering detriment (such as bullying or being passed over for promotion) as a result of making a “protected disclosure”. Protected disclosures can be validly made to a variety of people, including the firm and a legal adviser or the regulator. They are disclosures of information that the employee reasonably believes tends to show (among other things) that:
- A criminal offence has been committed, is being committed or is likely to be committed
- A person has failed, is failing or is likely to fail to comply with their legal obligations
- Information demonstrating either of the above, is being or is likely to be deliberately concealed
The employer’s disciplinary panel should determine on the facts, after a reasonable investigation, what the appropriate sanction should be. A dismissed employee is unlikely to give the firm assistance in responding to any FCA investigation, but the employee will be under an obligation to co-operate with the FCA investigation.
Legal representation & Legal privilege
Legal representation for an employee under investigation
Employers may consider whether the individual under investigation should be offered separate legal representation and, if so, whether this should be funded by the employer. As the interests of the individual(s) under investigation may have diverged from the interests of the firm, the firm’s legal advisers may be unable to represent the interests of the individuals.
Legal advice on a client’s liabilities under FSMA is privileged, as is legal advice on the presentation of facts to the Financial Conduct Authority (FCA) (section 413 of FSMA sets out the statutory scheme which prevents disclosure of “protected items”).Whether or not legal privilege attaches to particular documents created in the course of an internal investigation is complicated. Consideration should be given to legal privilege issues at the beginning of an investigation, so that appropriate decisions can be made as to what documents should be created and, whether legal privilege will attach to those documents.
Two main types of legal privilege exist:
- Legal advice privilege – attaches to a broad range of communications between a lawyer and his client, where they are created in a relevant legal context (conducting an investigation is included)
- But, who is the lawyer’s “client” for these purposes? The judgment of the Court of Appeal in Three Rivers District Council v Governor and Company of the Bank of England (No. 5) indicates that, in conducting an investigation, the lawyer’s “client” may be limited to the individual(s) by whom the lawyer is instructed. Where the investigation is being carried out by lawyers, but an individual under investigation is receiving separate legal representation, it will almost certainly be the case that communications with that individual will not be covered by legal advice privilege as the individual cannot be said to be the investigation team’s “client”.
- Litigation privilege – attaches to a wider category of communications (including communications with third parties) but to apply, the “dominant purpose” of bringing the relevant document into existence must be for use in the litigation and the litigation to which the firm would be a party must be in “reasonable contemplation”. Internal investigations and FCA investigations themselves do not amount to litigation, as they are investigatory rather than judicial or quasi-judicial in nature.
Employee (Approved Person’s) resignation during an investigation
Individuals facing likely dismissal may resign in the hope that they can avoid having a dismissal on their employment record. They may attempt to resign with immediate effect, which would be in breach of their contract unless the employer agrees to accept it. The relevant business unit may be happy to allow the individual to resign immediately, in which case it can accept the early termination date. However, where the employee has committed misconduct, the organisation may wish to proceed with the dismissal proceedings during the employee’s notice period. The employee can be dismissed during their notice period for misconduct.
An employee who resigns whilst under investigation can cause potential problems and conflicting interests can arise between the business, legal/compliance departments and HR. Some parts of the business may be prepared to support the resignation (particularly if the individual is moving to the client side) but the compliance department may wish to demonstrate that appropriate disciplinary action has been taken against the individual. Considerations for HR and legal departments will be to ensure the firm is protected against employment claims by the individual. Therefore, a negotiated departure following without prejudice discussions with the intent to reach an agreed exit is often the solution.
This will often be in the form of a Compromise Agreement (soon to be renamed Settlement Agreement) which should cover key issues such as:
- Waiver of employment law (and any other) claims: basically, to be valid this needs to comply with the requirements of section 203 Employment Rights Act 1996
- Reference: any reference agreed with the employee must not contradict the reference the firm would give in accordance with its FCA obligations. The FCA takes a pragmatic view but will be keen to ensure that the individual is not treated as if he were a good leaver if that is not the case, and may take action against the firm if an agreed reference does not properly reflect the circumstances in which the individual resigned
- The employee’s exit may have an impact on his entitlements, such as share options under an incentives plan, as many such schemes contain good leaver/bad leaver provisions. Negotiation regarding the firm’s discretion to decide that the employee is in fact a good leaver may be a primary motivation for the employee wanting to agree terms on exit
- Confidentiality of the existence and terms of the agreement
- Agreement that the employee will not to make detrimental statements about the firm
- The employee confirming that there is no other action of the employee which would affect the firm’s decision to enter into the compromise agreement
- Reconfirmation of restrictive covenants (if appropriate)
- Employee to provide assistance to the firm in any future regulatory proceedings or litigation
This publication is intended for general summary guidance. It is not and should not be considered legal advice. Specific advice should be sought for specific cases; we cannot be held responsible for any action (or decision not to take action) made in reliance upon the content of this publication.