Non-Financial Misconduct – FCA and PRA Consultation: Clarifying Revisions or Further Confusion?

The range of behaviour that could be said to amount to non-financial misconduct is broad. It will include conduct such as bullying, sexual harassment, and discrimination.

Examples from enforcement action include serious physical violence ^1, repeatedly evading train fares,² and using work emails to send inappropriate messages.³

It is perhaps unsurprising, given the breadth of potentially relevant conduct, that a degree of inconsistency and resulting lack of clarity has developed, particularly in respect to the division between the personal and professional lives of relevant employees.

In the next section we discuss some general trends, contrast two recent FCA enforcement outcomes which illustrate the need for reform, before considering the proposed revisions themselves.

Of the handful of individuals prohibited by the FCA for non-financial misconduct, three points stand out.

First, in terms of the nature of the conduct that the FCA has pursued, it is notable that all but one example given by the FCA in a recent letter to a Treasury Select Committee involved a criminal conviction or a caution:

“We have publicly prohibited seven individuals for non-financial misconduct of various kinds, including sexual assault, possession of indecent images of children, voyeurism, serious assault, non-payment of railway tickets and use of work email to send inappropriate images. All but one of these cases involved a criminal conviction or a caution.”

Second, the number of reports received by the FCA from firms is, despite the justified attention this important and difficult issue receives, surprisingly small:

“We receive around six reports per quarter from firms regarding non-financial matters of concern. In addition to these reports we also consider criminal and civil cases, press reporting and vitally, information provided by whistleblowers. We receive around 1,000 whistleblowing disclosures a year. Of these, around three per quarter relate to allegations of sexual misconduct.”

Third, and as referred to in the introduction, how firms are required to assess behaviour which arises within an individual’s personal life is not free from doubt. This is demonstrated by two recent and contrasting enforcement outcomes, namely Frensham v FCA [2021] UKUT 0222 and the Final Decision Notice issued to Mr Ashkhan Zahedian dated 14 November 2022. We expand on both below.

Frensham

In Frensham v FCA, the Upper Tribunal determined that a conviction related to child sexual grooming was insufficient by itself to justify the FCA’s imposition of a prohibition order⁴:

“[I]n deciding whether to make a prohibition order a key consideration is the severity of the risk which the individual poses to consumers and to the confidence of the financial system, thus providing a direct link to the statutory objectives. Therefore, in our view, when considering the relevance of behaviour that takes place in a person’s private life, the key issue is whether the behaviour concerned realistically engages the question as to whether the individual poses a risk to consumers and to confidence in the financial system.”

While accepting that the FCA is “fully entitled to take into account non-financial misconduct which occurs outside the work setting”⁵ the Upper Tribunal held that “…the basis on which the Authority seeks to link Mr Frensham’s lack of personal integrity to his professional role [primarily advising on mortgages and pensions] on the basis of the nature of the offence alone is speculative and unconvincing”. Having made that observation, the Upper Tribunal concluded that the FCA was entitled to make a prohibition order, but not because of Mr Frensham’s offending. Rather, the Upper Tribunal concluded that a prohibition order should be imposed because of the way Mr Frensham behaved after, namely by failing to inform the FCA of his conviction and his expulsion from his professional body, the Chartered Insurance Institute.⁶

In approaching the matter in this way, the Upper Tribunal effectively warned the FCA away from its broad and expansive approach to incidents which occur within individuals’ private lives, instead requiring clear evidence linking the impugned conduct and the FCA’s statutory objectives, here a risk to consumers and confidence in the financial system. As we observe below, however, the FCA sees matters differently.

Zahedian

Notwithstanding the criticism of its approach by the Upper Tribunal in Frensham, the FCA maintained its pre-Frensham enforcement position in Zahedian.

Like Mr Frensham, Mr Zahedian was convicted of a serious offence, namely wounding with intent to do grievous bodily harm and of possession of a machete. He committed these offences whilst he was an approved person. Without identifying evidence to link Mr Zahedian’s conduct to the FCA’s statutory objectives, the FCA concluded that:

“…the nature and circumstances of Mr Zahedian’s violent offences … demonstrates a clear and serious lack of integrity…the nature of Mr Zahedian’s offences and, separately, of the associated publicity following his conviction, is such that he does not have the requisite reputation to perform functions in relation to regulated activities and is likely to damage the reputation of any regulated firm at which he is required to perform such functions. Further, he poses a serious risk of damage to the reputation of, and public confidence in, the financial services sector.”

The FCA therefore relied on the nature of Mr Zahedian’s offending and the extent of its coverage by the media to justify its decision to impose a prohibition order. While clearly many may agree with the practical consequence of the FCA’s decision in this case given the violent offending in issue, it is difficult to reconcile the regulatory outcome here with the reasoned approach of the Upper Tribunal in Frensham.

The FCA’s frustration at the Upper Tribunal’s decision is clear not only from its approach in Zahedian, but also from its letter to the Treasury Select Committee sent earlier this year in relation to the FCA’s investigation into Odey Asset Management:

“The Upper Tribunal’s decision [in Frensham] demonstrates the challenge we may face banning people relating to sexual misconduct alone, even when criminal convictions have been secured.

We continue to consider, however, that such misconduct can, of itself, create a sufficient risk to our objectives such that it should result in a prohibition and we continue to pursue cases on that basis. We also recognise that Parliament may choose to legislate if it wished to specify that certain offences should lead to an automatic prohibition from a regulated sector.”

[Bold and underlined emphasis added].

Despite the FCA’s criticism of the Upper Tribunal’s decision in Frensham, it is clear that the FCA’s perspective on this issue has shifted significantly in recent years, primarily it seems in response to changes in public attitudes. This is illustrated by evidence that emerged during the cross examination of an FCA witness in Frensham, the contents of which are recorded at 84 of the decision as follows:

“Ms Couzens [an FCA employee and witness, who also appears to have been responsible for the approach in Zahedian] said that the Authority’s thinking was evolving during this period [i.e. between the FCA becoming aware of Mr Frensham’s conviction in 2016 and it issuing a Warning Notice in May 2020] taking into account the public’s view of such matters. Therefore, although Ms Couzens mentioned in her witness statement that it was always open to the Authority to take into account convictions for non-financial misconduct unrelated to a person’s role, she did not mention that the Authority had not previously taken action in relation to such matters and at the time that Mr Frensham’s offence was notified to the Authority it had not decided to deal with such cases.”

[Bold and underlined emphasis added].

The consultation provides an opportunity for the regulators to clarify some of the confusion that has been permitted to develop in this difficult area, as highlighted by the divergent regulatory outcomes just discussed. They also provide the market with an important opportunity to respond. We discuss the proposals below.

The FCA proposes to include non-financial misconduct considerations into the Conduct Rules, fitness and propriety assessments, and the suitability criteria for firms to operate in the financial sector.

In the FCA’s view, perhaps echoing the regulatory outcome in Zahedian and frustrations with the Upper Tribunal’s approach in Frensham:

“…there is a risk to public confidence where individuals have committed serious non-financial misconduct…but are permitted to continue working in the sector. Such conduct is unlikely to be compatible with our statutory objectives and we can impose a partial or a full prohibition, depending on the level and type of risk posed by the individual in question.”⁷

By providing additional guidance the FCA seeks to “give firms the reassurance needed to take decisive and appropriate action against employees for instances of non-financial misconduct”.

We examine the proposals below, looking first at the proposed changes to the fit and proper assessment followed by the Conduct Rules.

What are the FCA’s proposed reforms to the ‘fit and proper’ test?

Currently firms must be satisfied on an ongoing basis that individuals performing a senior management or certification function are “fit and proper” to do so.

Unlike the Conduct Rules, however, which are in principle limited to conduct in the course of a firm’s activities, the FCA’s proposed revisions to the fitness and propriety rules provide that the fit and proper assessment criteria are more expansive⁸ and misconduct both within and outside the workplace can be relevant to the fit and proper assessment.

The shift in thinking within the FCA which gave rise to the proposed guidance appears to have been driven by two things.

1. First, a desire on the FCA’s part (reflected in its evidence under cross examination in Frensham, as discussed above) to ensure that regulatory outcomes reflect developing public expectations.
2. Second, to reduce the risk of inconsistency in how the FCA’s guidance involving non-financial misconduct is interpreted and applied by firms and (in a thinly disguised criticism of the Upper Tribunal’s decision in Fensham) also in “judicial settings”.⁹

The theoretical foundation for the FCA’s position is its belief that misconduct in an individual’s private or personal life “…may show that the person lacks moral soundness, rectitude and steady adherence to an ethical code”¹⁰ and that there is “a significant risk that the person would commit misconduct in their work activities”¹¹. The draft guidance moves beyond this position however and provides that misconduct in an individual’s personal life can be relevant to the fit and proper assessment “even though there is little or no risk of it being repeated” in a professional context “if it is disgraceful or morally reprehensible or otherwise sufficiently serious”¹².

Further and in direct contrast with the Upper Tribunal’s approach in Frensham, which required the FCA to establish an evidential link between the impugned conduct and a risk to consumers and / or confidence in the financial system, the draft guidance provides that misconduct in a person’s private life will be relevant:

“…even if it cannot be shown that the misconduct will by itself cause direct and discernible damage to public confidence in the financial system and [the] financial services industry in the United Kingdom or to confidence in their firm on the part of customers or those who deal with the firm.”¹³

It is difficult to see how either of the above revisions will “give firms the reassurance needed to take decisive and appropriate action against employees for instances of non-financial misconduct”.

If implemented in its present form the FCA’s proposed guidance risks creating further confusion and uncertainty. The FCA should reconsider both (i) its use of ambiguous and subjective concepts to mark the boundary between relevant and irrelevant personal conduct; and (ii) the removal of the requirement in Frensham for there to be an evidential link between the impugned conduct and the FCA’s statutory objectives.

Conduct Rules and Private Life – what would potentially breach the FCA’s proposed Code of Conduct rules?

Unlike the fit and proper assessment, the starting point for non-financial misconduct and the Conduct Rules is that conduct occurring in an individual’s personal life is outside the scope of the rules.

As matters stand, however, determining the boundary between the two can be challenging. To address this, the draft guidance lists categories of conduct the FCA believes fall within Conduct Rules.¹⁴ We set these out in figure 1 below:

The FCA’s proposals then go on to set out examples of conduct it believes fall within the Conduct Rules, and some that do not because they would form part of the individual’s personal life.¹⁵  We set these out in table 2 below:

Table 2:  Examples of Conduct the FCA believes fall within the Conduct Rules

Having set out the above guidance, the FCA’s proposals go on to develop the definitions of non-financial misconduct in relation to both rules 1 and 2 of the Conduct Rules, being the obligations to act with (i) integrity, and with (ii) due skill, care, and diligence. We examine these below.

What does the FCA’s draft guidance say about the obligation to act with integrity?

The starting point when considering many allegations of non-financial misconduct will be the requirement under rule 1 of the Conduct Rules that an individual must act with integrity. The FCA seeks to clarify what this means in relation to conduct directed towards fellow members of the workforce.

The draft guidance begins with an attempt to define a good working environment, described¹⁶ as one in which each employee feels respected, valued and able to give their best, and is more over treated fairly and with dignity and respect. Conduct that is “inconsistent” with a good working environment “may” be a breach of rule 1.¹⁷  However, only a “serious” departure from that standard is likely to be a breach of the obligation to act with integrity.¹⁸

The guidance provides a non-exhaustive list of conduct which the FCA believes will amount to a breach, and factors that it will take into account in determining whether there has been a breach of the obligation to act with integrity.¹⁹  These are set out in tables 3 and 4 below:

It should be noted that the guidance²⁰ expressly provides that sexual harassment is a breach of the Conduct Rules, being conduct which falls within categories (3) and (4) above.

In considering whether the conduct in issue breaches the Conduct Rules, the FCA proposes to take account of the following factors:

The draft guidance²¹ provides defences. We set out the text of the available defences in table 5 below:

What are the FCA’s proposed changes to the obligation to act with due skill, care and diligence?

Further guidance is then given in relation to rule 2 in relation to conduct by managers,²² namely, the obligation to act with due skill, care and diligence.

We set out the non-exhaustive list of examples of conduct the FCA believes would breach rule 2 in table 6 below:-

Generally, the draft proposals are helpful in so far as they clarify the FCA’s perspective on this important issue. Those aspects of the reforms which articulate the FCA’s view on the line between the private and professional lives of relevant employees for the purposes of the Conduct Rules are a useful guide for decision-making. The same is likely to be true of the FCA’s proposed guidance on conduct relevant to the obligations to act with integrity and to exercise due skill, care, and diligence.

Firms and individuals should therefore be reasonably confident in assessing and responding to non-financial misconduct that occurs within the workplace, such as bullying and harassment that takes place during the working day in the office or using firm systems in relation to colleagues.

The same cannot be said about the proposed guidance in relation to isolated incidents which occur within an individual’s personal life. These are likely to be the most difficult cases. The FCA’s guidance is therefore likely to attract considerable scrutiny.

Regrettably, as matters stand, the approach to such incidents in the draft guidance turns on inherently ambiguous and subjective concepts, namely, whether the conduct is considered “disgraceful or morally reprehensible”.

While the FCA’s reasons for selecting this language is reasonably clear in light of Frensham and the FCA’s wish to reflect shifting public attitudes, it is highly doubtful whether this is a sensible reform.

In practical terms, it will require firms to reach a moral view on events which occur within individuals’ private lives. Quite how that should be done in a way that is consistent, fair, and objectively defensible is unclear. The FCA should think again.

While the regulators should be applauded for seeking to clarify the boundaries in this important area, further work is required. Your regulators will be listening to your concerns. At least until 18 December 2023, when responses to the proposed reforms are due.