Joint Committee on Financial Services and Markets Second Report


APPENDIX 6

Further Memorandum from Clifford Chance

THE ROLE OF FSA GUIDANCE IN THE NEW REGIME

SUMMARY

  The draft Bill empowers the Financial Services Authority (FSA) to issue guidance on the operation of the Act and of any rules made under it as well as certain related matters. However, that guidance has no special status on which market participants can rely.

  The FSA will not be the only prosecutor of offences under the new Act. Contraventions may also render contracts unenforceable and give rise to other civil liabilities.

  The Bill should treat compliance with FSA guidance on the statutory offences as rebuttable evidence that an accused has established prescribed defences to a prosecution or claims to set aside contracts. For example, it should tend to establish that a person exercised reasonable care to avoid the contravention or that a person reasonably believed that he was not contravening the requirements of the Act.

  

  In contrast, a market participant should be able to place clear reliance on the FSA's guidance on its own rules, codes of conduct, etc., and on the operation of the market abuse provisions. However "unlikely" in practice, the FSA should not be able to give guidance on how to comply with its own rules or the market abuse regime and then take enforcement action against someone who complies with that guidance. In addition, firms that have complied with FSA guidance should not be exposed to claims by private investors that they have contravened conduct of business rules.

  The Bill should, however, only give the proposed special status to published guidance. This minimises the risk of any distortion of competition and the disappointment of legitimate third party expectations.

  The FSA should not be compelled to issue guidance on request. However, the FSA should be willing to issue published guidance in individual cases as a means of developing policy and responding to particular situations.

  We propose specific statutory drafting to implement this proposal.

1. FSA guidance under the draft Bill

  1.1 The draft Bill empowers the FSA to issue guidance on the operation of the Act and of any rules made under it as well as certain related matters.[3] However, that guidance has no special status on which market participants can rely.

  1.2 The Government has stated that it is unnecessary to give a particular status to FSA guidance "because it is unlikely that the FSA would wish to or could properly discipline firms who have been following its guidance".[4]

  1.3 However, the FSA is likely to find it necessary to give guidance on the perimeter and other offences prescribed in the new Act. For example, the Government has stated that it expects that "the role of FSA guidance [on the scope of the authorisation offence] will play a significant part in reducing the number of unnecessary authorisations."[5] But the FSA will not be the only prosecutor of offences under the new Act.[6] Contravention of prohibitions in the new Act may also render contracts unenforceable and give rise to other civil liabilities.[7] In addition, contraventions of the FSA's own rules may in some circumstances give rise to civil liability to third parties.[8] It is unjust that the draft Bill provides no recognition of a market participant's compliance with the guidance of the regulator responsible for the administration of the statutory regime.

  1.4 Even where the FSA is responsible for enforcement, market participants may take little comfort from the assertion that it is "unlikely" that the FSA would take enforcement action against a firm that has complied with its guidance. Many of the requirements that will be imposed by the new Act and that are likely to be imposed by the rules, codes of conduct, etc., will be very broadly drawn.[9] Firms and individuals face unlimited fines and other significant sanctions for non-compliance. The Bill should explicitly state that, at least in some circumstances, market participants can place reliance on what the FSA has said as to how they can comply with these requirements.

  1.5 In addition to securing fair treatment for market participants, giving the FSA's guidance special status under the new Act would enhance the role of guidance as a flexible means of developing the regulatory regime. In its present form, the draft Bill encourages market participants to call for amendments to statutory provisions, secondary legislation and the FSA's rules, codes, etc., to deal with grey areas. If guidance had some special status, it could be used to provide some level of comfort in difficult cases. More comprehensive amendments could then be made at a later stage through statutory instruments or changes to rules, etc. in the light of more complete practical experience.

  1.6 However, there are clear policy distinctions between the role that guidance could play in relation to the perimeter and other offences prescribed by the legislation and the role that guidance can play in relation to the FSA's own rules, codes of conduct, etc., and the other matters on which the FSA is empowered to take enforcement action. We discuss these separately below.

2. Guidance on the perimeter and other offences

  2.1 A number of the proposed statutory prohibitions will provide the accused with a defence to a prosecution where he can show that he has taken reasonable care to avoid committing the offence or that he believed on reasonable grounds that he was not contravening the relevant prohibition.[10] Similarly, the court will, in some cases, be given the discretion to allow the enforcement of an otherwise unenforceable agreement where it is satisfied that the person in question reasonably believed that the transaction was lawful[11].

  2.2 The Bill should treat compliance with FSA guidance on the statutory provisions as rebuttable evidence that these defences have been established. The court would not be bound by the FSA guidance. It would be free to reach its own decision on the facts. However, the court should be required to give special weight to the fact that a person has complied with the FSA's guidance. Otherwise, that guidance may be of no more value than the opinion of any other commentator.

3. Guidance on FSA rules, etc.

  3.1 In contrast, a market participant should be able to place clear reliance on the FSA's guidance on its own rules, codes of conduct, etc. However "unlikely" in practice, the FSA should not be able to give guidance on how to comply with its own rules and then take enforcement action against someone who complies with that guidance. Also, a firm that has complied with FSA guidance should not be exposed to claims by private investors alleging non-compliance with conduct of business rules or other similar requirements under the new Act.

  3.2 Similarly, the FSA should not be able to give guidance on the operation of the vague and unbounded provisions of the market abuse regime and then take enforcement action against a market participant who complies with that guidance.

4. Unpublished guidance

  The Bill should, however, only give the proposed special status to published guidance.[12] There would be a danger of distortion of competitive conditions if one firm were able to rely on unpublished guidance when other firms cannot. In addition, giving special status to unpublished guidance could unjustifiably affect third party rights by prejudicing legitimate expectations.[13] The Government has already stated that the FSA should be required to publish for consultation any standing guidance that it proposes to issue.[14]

5. Requirements to issue guidance

  We do not advocate that the FSA should be compelled to issue guidance on request. As the Government has stated, this could place a considerable burden on the regulator.[15] However, powers to issue guidance are of no value unless they are used. In particular, the FSA should be willing to issue published guidance in individual cases as a means of developing policy and responding to particular situations.

6. Proposed amendments

  6.1 We propose that the draft Bill should be amended by the addition of the following provisions:

    (1)  A person is taken to act in conformity with any rule or any statement of principles prepared or issued under this Act or any other requirement which is imposed by or under this Act and whose contravention does not constitute an offenc

e[16], where the Authority has published guidance on compliance with that rule, statement or requirement and, in reliance on the standards set out in that guidance, that person believes on reasonable grounds that he is acting in conformity with that rule, statement or requirement.

    (2)  A person is taken not to have engaged in market abus

e[17] or other conduct for which a fine may be imposed under section 58 of this Act[18] where the Authority has published guidance to the effect that certain conduct does not constitute market abuse or such other conduct and, in reliance on the standards set out in that guidance, that person believes on reasonable grounds that his conduct does not constitute market abuse or such other conduct.

    (3)  Where the Authority has published guidance on compliance with any requirement which is imposed by or under this Act and whose contravention constitutes an offence, compliance with that guidance may be relied on as tending to establish that:

  (a)  in relation to any offence where this would be a defence, a person took all reasonable precautions and exercised all due diligence to avoid committing the offence;

  (b)  in relation to any contravention of such a requirement where this is relevant for the purposes of this Act, a person reasonably believed that he or another relevant person was not contravening that prohibition;[19] and

  (c)  in relation to an offence under section 212(3), a person reasonably believed that his act or conduct would not create an impression that was false or misleading as to the matters mentioned in that section.

  6.2 The provision in (1) above is modelled on existing provisions in the FSA's own rulebook and the rulebooks of the self-regulating organisations.

  6.3 Failure to comply with guidance should not, however, tend to establish that defences are not available or tend to establish non-compliance with applicable rules, etc. The FSA should not have the power, in effect, to extend the criminal law or its own rules without compliance with the appropriate statutory procedures.

7. Related matters

  7.1 The Bill should give the court power to allow the enforcement of a contract resulting from unlawful financial promotion where the person seeking to enforce the contract reasonably believed that he had not contravened the prohibition on financial promotion.[20]

  7.2 The provisions on financial promotion and the provisions relating to the authorisation offence should allow a person to enforce a contract entered into as a result of unlawful activity by a third party at least where the person seeking to enforce did not know of the contravention by the third party or reasonably believed that the third party was not contravening the relevant prohibition.[21] It would in fact be more consistent to specify that a person should be entitled to enforce his contract where he was not knowingly concerned in the contravention of the Act by a third party.[22]

  7.3 The Bill should be reviewed to ensure that all relevant offences have either a "due diligence defence" or a "reasonable belief" defence.[23]

  7.4 The FSA's powers to give guidance should be extended to cover guidance on related statutory provisions such as the insider dealing legislation, public offers of securities regulations and money laundering regulations and FSA guidance should be given similar status in relation to those provisions as well.

28 April 1999


3   Clause 87 of the draft Bill. References to clauses are to clauses of the draft Bill. Back

4   Paragraph 5.8 of HM Treasury Progress Report on the Financial Services and Markets Bill (March 1999). Back

5   Paragraph 1.3 of HM Treasury Consultation Document on Regulated Activities under the Financial Services and Markets Bill (February 1999). Back

6   See clause 215. The other principal prosecutors are the Secretary of State and the Director of Public Prosecutions. Back

7   See e.g., clauses 14 and 15 (in relation to the authorisation offence), clause 19 (in relation to financial promotion) and also clause 55 (in relation to the employment of prohibited persons and employment of persons without approval). Back

8   See e.g., clause 80 (in relation to suits by private persons). Back

9   The obvious examples are the market abuse regime (clause 56) and the proposed FSA Principles for Business (see FSA Consultation Paper 13). Back

10   See e.g., clauses 12(3) and 13(3) in relation to the authorisation and holding out offence and paragraph 6(2) of Schedule 4 in relation to the exercise of Treaty rights by EU firms (defence if accused shows that he took all reasonable precautions and exercised all due diligence to avoid the contravention); clause 17(4) in relation to financial promotion (defence if accused shows that he believed on reasonable grounds that the communication was lawful or that he exercised all due diligence to avoid the contravention); clause 212(4)(a) in relation to the market manipulation offence (defence if accused shows that he believed on reasonable grounds that conduct would not create false market). Back

11   See clause 16(4)(b) and (c) in relation to the agreements made where the authorisation offence has been committed. No similar power is currently granted in relation to agreements rendered unenforceable as a result of a contravention of the financial promotion regime (see clause 19), although our submission to HM Treasury on the draft Bill argues that there ought to be such a provision. Back

12   Clause 87(3)(a) contemplates that the FSA may, but is not required to, publish its guidance. Back

13   Compare for example the treatment of unpublished guidance under the Competition Act 1998.  Back

14   Paragraph 5.4 of HM Treasury Progress Report. Back

15   Paragraph 5.8 of HM Treasury Progress Report. Back

16   See e.g., clause 43 (need for approval), paragraph 18 of Schedule 3 (exercise of passport rights by UK firms), newly published clause A3 (restrictions on promotion of collective investment schemes). Back

17   Market abuse does not fall within (1) above as the draft Bill does not propose to impose a "requirement" not to engage in market abuse. Back

18   Our submission to HM Treasury suggested that the provisions of section 58(b) were in fact unduly broad. It would give the FSA power to fine anyone for "taking action or refraining from taking action that has induced another person or persons to engage in market abuse". This might be used to fine someone who gives advice on the market abuse regime (even where that advice is not negligent) or someone who is not under any duty to take any action to dissuade someone else from engaging in market abuse. Back

19   See below. Back

20   Compare clause 19 with clause 16(4)(b). Back

21   Compare clause 16(4)(c) and section 5(3)(b) of the Financial Services Act 1986. Back

22   Compare Part XVIII of the draft Bill and in particular clauses 202(2) and (3), 204(1) and 206(1).) Back

23   See e.g., clause 120(8). Back


 
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