Regulators across the globe are intensifying their focus on enforcing the regulation of the asset management industry. Over the last twelve months, the global Financial Stability Board, the International Monetary Fund, the US Financial Stability Oversight Council and the Bank of England have repeatedly expressed their concerns over the risk the industry poses to the stability of the broader financial system.1
The UK Financial Conduct Authority (FCA) is also increasingly focused on its regulation of asset managers. For example, it was reported in January 2015 that the FCA’s enforcement team had 67 ongoing investigations into alternative investment fund managers in relation to a series of allegations, including financial crime and market abuse.2
Clearly, asset managers operating in the UK should be aware of this increased regulatory scrutiny. Set out below are some of the key areas of interest for the FCA and a guide to its various investigatory powers.
The FCA’s Review of Asset Managers
In its Business Plan and Risk Outlook for 2014/2015, the FCA stated that it would undertake thematic reviews of three areas of the asset management industry: the inherent conflicts of interest within asset management firms; firms’ agency responsibilities; and firms’ controls and procedures in respect of market abuse.
The FCA has recently published a report in February 2015 (Report) detailing the findings from its review of how effectively asset management firms control the risk of market abuse.3 The FCA’s review covered 19 asset management firms, including long-only asset managers, hedge fund managers and an occupational pension plan. The firms reviewed ranged in size, with global assets under management ranging from £200 million to over £100 billion.
The Report stated that only a small number of firms had put in place comprehensive practices and procedures to control the risk of market abuse. In particular, the FCA indicated that firms need to pay more attention to the possibility of receiving inside information through all aspects of the investment process, and ensure that this information is identified and dealt with correctly. The FCA highlighted that most firms did not have effective policies in the event that inside information is unintentionally received from a conversation about a proposed wall crossing (referred to as a “sounding”) when that wall crossing is not used. The Report also stated that only two of the 19 firms reviewed had a post-trade surveillance programme that was effective in identifying market abuse.
The FCA stated in its Report that it expects all firms reviewed which did not effectively manage the risks of market abuse to make improvements to their policies and procedures. In light of this statement, it would be prudent for all firms to review and update their policies.
Next Steps for the FCA and Asset Managers
The FCA has recently announced its plans to launch a market study (i.e., an in-depth look) into investment and corporate banking, to assess whether competition in this sector is working properly. The FCA has further indicated that it expects to undertake a market study into asset management and related services in the future, in order to consider whether competition is working effectively in this sector. The FCA has expressed its view that there are areas in the procurement and supply of asset management and related services where competition might not be working effectively, such as: (i) the difficulty some institutional investors have in negotiating fees and monitoring asset managers; and (ii) the incentives and ability of asset managers to control costs incurred on behalf of investors along the asset management value chain. This market study will also examine the role of investment consultants (who assist large institutional investors, such as pension funds, in making investment decisions) and potential conflicts of interest arising from the provision of advice and asset management services.
It is clear that the FCA is sharpening its focus on the asset management industry, and it is widely speculated that the FCA will take enforcement action on these issues in the near future.
The number of investigations conducted by the FCA is currently on the rise, with the total number of inquiries opened by the FCA in regard to the financial services sector as a whole increasing by 20% to 109 in 2014, up from 90 in 2013.4 Given the disruption that investigations can cause for both individuals and businesses – with the associated risks of reputational damage and loss of clients – it is important for both businesses and individuals to be aware of their own regulatory requirements and the extensive powers of the FCA investigation team.
Given the heightened level of risk that asset managers may be subject to increased FCA scrutiny, it appears timely to summarise the powers available to the FCA.
The FCA’s information-gathering and investigatory powers are primarily contained in Part XI of the Financial Services and Markets Act 2000 (FSMA). Broadly, these powers extend to:
- obtaining warrants to search and enter business premises;
- requesting the voluntary production of information; and
- compelling the provision of information and attendance of individuals to answer questions.
These powers are not exhaustive. The FCA is granted additional powers under the Proceeds of Crime Act 2002 (POCA), the Regulation of Investigatory Powers Act 2000 (RIPA) and the Money Laundering Regulations 2007 (MLR).
From 1 April 2015, the FCA will gain additional powers to regulate competition – it will have the authority to enforce the prohibitions on anti-competitive behaviour in the Competition Act 1998 and the Treaty on the Functioning of the European Union in relation to the provision of financial services. It will also have powers to carry out market studies and refer market investigations in respect of financial services to the Competition and Markets Authority (CMA) under the Enterprise Act 2002. The FCA is currently requesting comments on draft guidance regarding the implementation of these new powers, as part of its Consultation Paper on Competition Concurrency Guidance and Handbook amendments [January 2015].
The FCA and the CMA will have concurrent powers in respect of the regulation of competition in the financial services industry.
Duty to Cooperate
Firms are subject to a broad duty to cooperate with the FCA. In this regard, they must disclose to the FCA any firm-related information of which the regulator would reasonably expect notice in accordance with Principle 11 of the FCA’s Principles for Businesses. A breach of Principle 11 can subject a firm to regulatory sanctions. For further information regarding Principle 11, please refer to “Informal Request for Information” below.
Approved persons (i.e., individuals who have been approved by the FCA to perform one or more controlled functions on behalf of an FCA-authorised firm, such as directors, partners and those responsible for compliance oversight) are also subject to a duty to cooperate with the regulator under Principle 4 of the FCA’s Principles for Approved Persons.
Informal Request for Information
The FCA can make an informal request for information, which can be used both to support its supervisory role and in the context of an investigation. Failure to comply with this request may lead to the FCA invoking its statutory powers in relation to information-gathering. The FCA Handbook’s Supervision Manual provides that, in order to comply with Principle 11, a firm should:
- make itself readily available for meetings with the appropriate regulator as reasonably requested;
- give the appropriate regulator reasonable access to any records, files, tapes or computer systems within the firm’s possession and control;
- produce specified documents, files, tapes, computer data or other material in the firm’s possession or control as reasonably requested;
- print information in the firm’s possession or control held on a computer or otherwise and convert it into a legible format;
- permit the regulator to copy documents at the premises and expense of the firm; and answer truthfully, fully and promptly all questions that are reasonably put to it by the regulator.
Firms should take reasonable steps to ensure that their employees, agents and appointed representatives also comply with these obligations. Firms are required to grant the regulator access to their business premises during reasonable business hours, and must take reasonable steps to ensure that their agents, suppliers under material outsourcing arrangements and appointed representatives do the same.
Firms may consider whether to seek a formal request for information from the FCA where the firm wishes to avoid any risk of breaching data protection legislation or its duty of confidentiality to its clients.
Formal Request for Information
The FCA has the power to compel an authorised person (i.e., an individual or legal entity authorised by the FCA to carry out regulated activities) to provide specified information or documents that are reasonably required in connection with the regulator’s statutory powers. This power extends both to current and former authorised persons. A person cannot generally be compelled to disclose information or produce a document in which such person owes an obligation of confidence by virtue of carrying on the business of banking, although there are a number of broad exceptions to this rule. Similarly, communications protected by legal professional privilege (referred to as “protected items”) are not required to be produced. The FCA can require a report to be prepared by an independent person appointed by the firm or by the FCA itself (referred to as a “skilled person’s report”) regarding any matter as to which the regulator can compel the provision of specified information or documents.
Investigation by the FCA
Appointment of Investigators
The FCA may appoint investigators where it believes that there is a good reason for doing so in relation to the ownership or control, nature, conduct or state of a firm’s business. It may also open an investigation into specific regulatory offences, such as where it appears that a person may have breached the Alternative Investment Fund Managers Regulations 2013, and in circumstances suggesting that a criminal offence has been committed. The FCA can also compel information and appoint an investigator at the request of an overseas regulator.
The FCA must generally provide written notice of the appointment of investigators to the person under investigation, and will also provide notice where there is a change in the scope of the investigation. However, the FCA is not under an obligation to do so if service of such notice is likely to result in the investigation being frustrated or where the investigation relates to certain offences (such as insider dealing or market abuse).
Firms will need to consider carefully whether it is appropriate to carry out their own internal investigation into the facts being reviewed by the FCA. If a firm does elect to conduct its own investigation, it will then need to decide at what stage to appoint external counsel to assist with this process. Important factors to bear in mind in making this decision include: the need to maintain the independence and credibility of the investigation; the resources at the firm’s disposal; whether individuals within the firm have the skills required to conduct a thorough investigation; whether it will be necessary to conduct a review of the firm’s electronic data; and how to determine the scope of the investigation.
Perhaps the most important issue to consider in relation to appointing external legal counsel to assist with internal investigations is legal professional privilege. Privilege applies to advice given by solicitors, barristers, foreign lawyers and in-house lawyers5 (acting in their capacity as lawyers, not in an executive or compliance capacity). Privilege does not apply to advice given by other professionals, such as accountants. Firms should therefore consider engaging lawyers (external or internal) from the outset of an investigation for the purpose of directing the process of collecting information required to provide advice/deal with the investigation – maximising the application of privilege.
For the reasons set out above, it may be prudent for a firm to engage the services of external legal counsel to assist in complying with its obligations under a formal FCA investigation, as well as part of its own internal review.6
Powers to Compel Production of Information and Attendance at Interviews
The FCA has statutory powers to compel a person who is the subject of an investigation or any person connected with this person (such as partners, managers, employees, agents, appointed representatives, bankers, auditors, actuaries or solicitors of the firm) to provide information and to attend interviews. Similarly, an investigator may also require any person to produce specified documents at a particular time and place. In respect of certain criminal and regulatory investigations, the FCA has additional powers to compel unconnected third parties to attend interviews and to provide information, where the investigator is satisfied that this is necessary or expedient for the purposes of the investigation.
Evidence obtained during compulsory interviews is not generally admissible in criminal or market abuse proceedings (with the exception of perjury-related offences), unless evidence relating to the statement is brought forward or a question relating to it is asked, by or on behalf of the maker of the statement.7
Alternatively, the FCA can invite a person holding relevant information to attend an interview on a purely voluntary basis – the regulator has indicated in its Enforcement Guide (dated April 2014) that a person is not obliged to attend a voluntary interview, or to answer questions put to such person at that time. However, there may be circumstances in which an adverse inference may be drawn from the reluctance of a person to participate in a voluntary interview.8 This means that, in subsequent FCA disciplinary proceedings, a negative conclusion could be drawn from the individual’s failure to answer questions.
The FCA’s Enforcement Guide states that the regulator may prefer to question suspects in criminal or market abuse investigations on a voluntary basis (possibly “under caution”), rather than under compulsion. In such circumstances, where the interview is “under caution”, the interviewee is not required to answer, but any answers given may be used against the individual in subsequent proceedings.9 Interviews in respect of criminal investigations will be subject to all relevant safeguards contained in the Police and Criminal Evidence Act (PACE) Codes. FCA investigators do not have powers of arrest, but may request that the police arrest an individual for questioning where the police have such powers.
Additional Powers in Investigations Involving Criminal Offences
The FCA is granted additional powers of surveillance and information-gathering under RIPA for the purpose of preventing and detecting crime. These powers permit it to:
- acquire data relating to communications; carry out covert surveillance;
- make use of covert human intelligence sources; and
- access electronic data protected by encryption or passwords.
However, the FCA is not permitted to obtain a warrant to intercept communications during the course of transmission (i.e., it is not permitted to wiretap telephones). It must receive authorisation from a head of department in its Enforcement Division to exercise these powers, which can only be granted if the proposed action is considered to be necessary and proportionate in the specific circumstances.
In relation to proceeds of crime, the FCA can apply to the Crown Court for a restraint order in its investigation or prosecution of criminal cases under POCA, where there is reasonable cause to believe that an individual has benefited from criminal conduct – the effect of such an order is that the person named therein will be prevented from dealing with the assets it covers for the duration of the order.
The FCA may also obtain a warrant to conduct an unannounced “dawn raid” in order to seize materials where the investigation meets certain specified conditions (for example, in respect of insider dealing offences).10 The warrant will normally authorise the police (and the FCA enforcement team accompanying them) to do the following:
- enter and search the premises specified in the warrant;
- take possession of copies of, or extracts from, any documents or information appearing to be relevant under the warrant;
- require any person on the premises to provide an explanation regarding any such document or information, or to state where such documents or information may be found; and
- use such force as may be reasonably necessary.
The FCA also has powers of entry and inspection of premises, with or without a warrant, in respect of investigations relating to allegations of money laundering under the MLR. “Premises” means any property other than that used solely as a dwelling.
Understanding the limits of the FCA’s powers in relation to dawn raids is essential in ensuring that a company preserves its legal rights. For this reason, firms should be prepared, and should consider compiling a dawn raid manual so that staff know what to do in the event a raid is conducted. External lawyers will be able to help develop and test a company raid response plan, as well as to assist with raid training for company employees. Such a policy will need to cover:
- what documents the FCA can take or copy;
- how the company records what is taken or copied; what should be done with potentially privileged material;
- how employees should respond if inspectors begin to interview staff; how external and in-house counsel can assist during a raid; and
- how the company should prepare to deal with the publicity surrounding a raid.
It is not just senior management who need to know how to deal with a raid. Investigators may ask questions of any staff and request that they provide factual replies. However, any questions that go beyond seeking factual clarification are not permitted. It is therefore imperative that all staff be made aware that they should limit their answers to specific and factual replies. In addition, receptionists and security staff must know how to greet FCA inspectors and who to inform (e.g., senior employees and the firm’s external legal counsel) in the event of the production of a search warrant. Staff should also be trained in how to inspect a warrant to check its validity and the premises to which it relates.
Non-compliance with the FCA’s Powers
Failure to comply with the FCA’s information-gathering powers without a reasonable excuse may be treated as contempt of court. A person who intentionally destroys, conceals, falsifies or disposes of any documents that are suspected of being relevant to the investigation will be guilty of an offence carrying a prison term and/or fines. Similarly, the intentional or reckless provision of false or misleading information in a material respect in connection with a FCA request is also subject to a prison term and/or fines.
Interaction with Other Regulators
Individuals and firms need to be aware of the FCA’s interaction with other regulators, both domestically and overseas, and that information can be exchanged by way of gateway disclosure regimes.
The FCA is required to work closely with the Bank of England (BOE), the UK’s central bank, and the BOE may give a direction to the FCA to provide it with specific information or documents where the BOE considers that information or documents are reasonably required in connection with the BOE’s exercise of its functions pursuant to its objective of protecting and enhancing the stability of the UK financial system.
The FCA also works closely with other UK law enforcement agencies, such as: (i) the National Crime Agency (NCA), the non-ministerial UK Government department responsible for tackling serious and organised crime in the UK; (ii) the Serious Fraud Office (SFO), the UK agency responsible for the investigation and prosecution of serious and complex fraud, bribery and corruption; and (iii) HM Revenue & Customs (HMRC), the UK tax authority.
The UK is a signatory to a number of cross-border cooperation treaties (such as those covering the EU Member States and the United States), leading to the increasing globalisation of regulatory investigations and enforcement action – with the UK regulators, such as the FCA, increasingly exchanging information and coordinating their investigations with overseas regulators, such as the U.S. Securities and Exchange Commission. The FCA has the power to compel the production of information and documents, as well as to require the attendance at interviews at the request of overseas regulators.
Practical Guidance for Dealing with FCA Investigations
There are a number of practical steps that firms subject to an FCA investigation may wish to consider carrying out when dealing with the investigation process:
- Firms and employees should demonstrate clear cooperation with the FCA in its investigation. A firm should take reasonable steps to ensure the compliance of its employees with the FCA’s requests.
- Notification of the FCA’s investigation and/or the firm’s own internal investigation should be restricted to individuals on a “need to know” basis within the firm. It may also be prudent to engage the services of public relations advisers at an early stage and devise a media strategy in case news of the investigation breaks.
- Firms should conduct their own internal review into the facts of the investigation promptly, and consider appointing external legal counsel to assist in scoping and carrying out the investigation.
- In complying with a request for the production of documents or with investigators requesting access to documents as part of a dawn raid, all documents should be reviewed for privilege, relevance and confidential information. It is important that the firm maintain a complete record of what has been provided to the regulator. In the event that documents are held by third parties, if the firm still retains control over a document, the firm will be required to make it available to the regulator.
- Firms should ensure that procedures are put in place to ensure that all relevant documents are preserved, and should work with their internal IT departments and/or external consultants to map all likely sources of information and devise a strategy to collect this data.
- In circumstances where there may be a conflict of interest between the firm and one of its employees that is under investigation, the individual should seek separate legal representation. Where the firm suspects that a director may have breached his/her duties to the firm, it cannot pay for his/her legal representation.
- It is important to establish whether an interview is being conducted under compulsion, under caution, or otherwise, and clarification should be sought as to the statutory powers underlying the interview.
- Firms should ensure that they have a comprehensive manual and employee training programme in respect of dawn raids.
In light of the FCA’s increased scrutiny on the asset management industry, firms should make the necessary enhancements to their policies and procedures, and, in particular, ensure that they control the risk of market abuse effectively. In circumstances where a firm becomes the subject of an FCA investigation, the firm should make itself aware of the FCA’s powers of investigation, and consider seeking the assistance of external legal counsel.
1) Steve Johnson, Liquidity fears loom over fund industry, The Financial Times, 1 February 2015.
2) Sam Dale, 67 Aif managers under FCA investigation, HFM Week, 12 February 2015.
3) FCA Thematic Review: Asset management firms and the risk of market abuse, February 2015.
4) Caroline Binham, Investigations by Financial Conduct Authority rise 20% in a year, The Financial Times, 22 February 2015.
5) However, communications between in-house lawyers and their employer will not be treated as privileged in the context of European Commission competition investigations (Akzo Nobel Chemicals Ltd and Akcros Chemicals Ltd v European Commission (Case C-550/07P) ).
6) Key issues firms need to consider when deciding how to conduct an internal investigation are set out in Dechert’s film, A Price Worth Paying.
7) Section 174, FSMA.
8) FCA Enforcement Guide, paragraph 4.10.
9) FCA Enforcement Guide, paragraph 4.8(1).
10) Section 176, FSMA. 11) Section 2, CJA 1987.