UK FCA looks to crack down on non-financial misconduct

The regulator’s recently published consultation paper (131 pages / 1.59MB PDF) seeks to better integrate NFM considerations into fitness and propriety (F&P) assessments, conduct rules and the suitability criteria for firms to operate in the financial sector, known as ‘threshold conditions’. The proposals build on various public pronouncements and published correspondence from the regulator which highlight its increased focus on this issue.

The current regulatory framework

When it comes to NFM, the current framework has some limitations and challenges for firms and the FCA. For example, in the context of assessing a relevant employee’s fitness, that assessment requires consideration by reference to honesty, integrity and reputation; competence and capability; and financial soundness.

NFM is usually regarded as potentially relevant to integrity and reputation. However, whilst the FCA has noted that misconduct both within and outside the workplace can be relevant to F&P, the FCA Handbook’s guidance focuses primarily on financial misconduct; there is no express reference to NFM.

Similarly, where a firm may be investigating allegations of NFM such that the Individual Conduct rules may fall to be considered, a determination may need to be made as to whether NFM amounts to a breach of the Conduct Rules, particularly with regard to Rule 1 – the obligation to act with integrity. However, the Conduct Rules also have particular limitations depending on the type of regulated firm and the activities being carrying out.

The FCA and firms can therefore face challenges in drawing a sufficient link between NFM, particularly outside a professional setting, and the relevant regulatory provisions that could warrant regulatory action.

Matters of integrity

That is particularly acute in the context of assessing matters of integrity – a concept with which many professional conduct regulators have had to grapple over the years, generating much case-law on the subject, including the leading case of Wingate, in which the court defined integrity as “a useful shorthand to express the higher standards which society expects from professional persons and which the professions expect from their own members”.

In an FCA context, the NFM-integrity issue came under particular scrutiny in the Upper Tribunal case of Frensham, which challenged an FCA Decision Notice withdrawing Jon Frensham’s approval and which prohibited him from undertaking any function in relation to a regulated activity, following convictions for sexual grooming offences, committed whilst on bail and about which he had failed to notify relevant professional bodies.

The Upper Tribunal, applying the principles outlined in Wingate, agreed that, given his criminal conviction, Frensham’s personal reputation had clearly been damaged. However, to justify regulatory action in circumstances where the relevant behaviour occurred in his private rather than professional life, Frensham’s actions must have engaged the standards of behaviour required of the individual concerned by the applicable regulatory provisions.

The Upper Tribunal considered that, in relation to the FCA’s regulatory framework, the starting point must be its statutory objectives, including the consumer protection objective and the integrity objective. Therefore, it said, “in deciding whether to make a prohibition order a key consideration is the severity of the risk which the individual poses to consumers and to confidence in the financial system, thus providing a direct link to the statutory objectives”.

In upholding the FCA’s decision, the Upper Tribunal was satisfied that it was reasonably open for the regulator to establish a link between Frensham’s offences and the integrity objective; albeit the Upper Tribunal did not consider that the FCA would have been able to make this decision based solely on the fact of Frensham’s conviction – relying, in addition, on the fact the offences were committed whilst on bail and his subsequent non-disclosure of the same.

The FCA’s non-financial misconduct proposals

Fit and Proper assessments

The consultation paper proposes to explain that bullying and similar misconduct within the workplace is relevant to F&P and that similarly serious behaviour in a person’s personal and private life is also relevant. It proposes giving examples of NFM such as sexual or racially motivated offences.

The FCA also notes that, where individuals have committed serious NFM, whether inside or outside the workplace, such as sexual or racially motivated offences, there is a risk to public confidence; this is unlikely to be compatible with FCA statutory objectives and is likely to mean that the person is not fit and proper.

Conduct rules

The FCA proposes to expand the conduct rules to make it clear that they cover serious instances of bullying, harassment, and similar behaviour towards fellow employees and employees of group companies and contractors. Guidance is to be added that sets out the types of behaviour that will fall within the expanded scope and what conduct is out of scope because it relates to an employee’s personal or private life.

The FCA also proposes to include guidance that not every instance of misconduct towards a fellow member of the workforce will amount to a breach; only serious misconduct will amount to a breach.

Suitability guidance on the threshold conditions

The FCA proposes to extend the guidance on the suitability threshold condition to include, for example, offences relating to a person or group’s demographic characteristics – such as sexual or racially motivated offences – and tribunal or court findings that the firm or someone connected with the firm, such as a director, has engaged in discriminatory practices.

Implications for firms

Emphasis on public confidence and statutory objectives

It is perhaps not surprising that the proposals make particular reference to public confidence and the statutory objectives, given that the Frensham case emphasised the need to establish a clear link between NFM and risk to consumer protection and confidence in the financial system.

That is also consistent with the approach of other professional conduct regulators such as the SRA, BSB and health regulators; and so future FCA disciplinary actions in this area will continue to put public confidence and protection at the forefront of any proceedings.

Greater clarification to come

The proposals promise to provide further clarification for firms in identifying cases of NFM including more explicit examples and broadening of scope. But whilst this is to be welcomed there remains the perennial challenge of striking a balance between providing sufficient examples to assist decision-making whilst not being unduly prescriptive given that cases may be highly fact sensitive.

Given that sensitivity, there will remain areas of real challenge when assessing whether NFM has sufficiently engaged the regulatory framework to warrant regulatory action, such as enforcement. This may be particularly acute in respect of conduct in an individual’s personal life and the extent to which the FCA can take this into account when assessing F&P.

It may be that the final guidance will be sufficiently clear and comprehensive. But, ultimately, firms and the FCA will need to remain focused on what the Upper Tribunal in the Frensham case described as a “qualitative distinction” between conduct that undermines public confidence, such that regulatory interventions are justified, and “conduct that would be generally regarded as wrong, inappropriate or even for the person concerned, disgraceful”, but would not necessarily warrant such intervention.

Rigorous investigation needed

In making these important value-judgements, real care will need to be taken by firms to investigate cases of NFM properly. Whilst the temptation may be to take shortcuts, this tends to be a false economy and can lead to greater challenges further down the line; not least in being able to demonstrate to regulators that proper enquires have been made and regulatory references have been carefully considered.

Legal and compliance functions will need to ensure that there are properly maintained protocols for investigating such cases and, where appropriate, seek external support to safeguard the integrity and independence of any investigations process, given the potential regulatory, litigation and reputational risks that may arise.

Broader cultural improvements

The FCA has made it clear that these NFM proposals form part of a bigger picture around healthy cultures within regulated environments, with the aim of allowing diversity of thought to flourish. In short, NFM should not be looked at in a vacuum but as part of a wider programme of improving good culture. Positive workplaces, where people feel comfortable to challenge and speak up, tend to be more productive and cohesive workplaces.

In contrast, when issues such as NFM are not properly addressed this can create staff cultures which are passive in respect of further wrongdoing and which can lead to other forms of financial regulatory non-compliance; and, with it, customer harm and potentially significant remediation costs and regulator fines. That can not only mean serious regulatory consequences for the perpetrators of NFM but for those firms and senior managers who fail to take steps to address it.

Written by Anthony Harrison of Pinsent Masons.