In this decision report, we consider the FCA’s decision notices issued to the former chief executive, sales director and compliance officer of Keydata Investment Services Ltd in connection with the sale of structured products. The FCA is proposing to impose significant financial penalties and prohibition orders on these individuals on the basis that they acted without integrity in breach of Principle 1 of the FSA’s Statements of Principle and Code of Practice for Approved Persons (APER) and failed to be open and co-operative with the FSA and FCA during the course of its investigation in breach of Principle 4 of APER. The FCA’s proposed findings against these individuals are subject to challenge and have been referred to the Upper Tribunal (Tax and Chancery Chamber).
Background
Keydata
Keydata Investment Services Ltd was a firm that designed, launched and, via independent financial advisers (IFAs), distributed structured investment products to retail customers. Keydata went into administration on 8 June 2009 and was dissolved on 2 July 2014. Prior to its administration, Keydata had GBP700 million of its own and GBP2.1 billion of other institutions’ investment products under administration.
The products
During the period 26 July 2005 to 8 June 2009 (the relevant period), Keydata designed, launched and distributed four investment products. The products offered retail customers an income or growth investment, by way of an Individual Savings Account (ISA), personal equity plan or direct investment. The products were underpinned by investments in certain bonds issued by special purpose vehicles (SPVs), which Keydata purchased on behalf of retail investors. The funds raised through the issue of the bonds were invested in portfolios containing US senior life settlement policies and cash to fund the payment of fees, income and insurance premiums. The performance of the portfolios (and therefore the returns to investors) depended on the date of death of the individuals insured under the US senior life settlement policies broadly matching their forecast life expectancies. The FCA has publicly stated that it considers that the products were high risk in nature and that the returns offered to investors (both in terms of income and return of capital) were subject to a high level of risk.
In or around 2010, customers who had invested in the products stopped receiving their income payments. It was also alleged that assets of one of the issuers of the bonds may have been misappropriated. As a result, many customers who invested in the products appear to have lost significant sums of money, not all of which may be covered by the Financial Services Compensation Scheme (FSCS).
Related investigations
The FCA (and the FSA before it) has taken enforcement action against a number of independent financial advisory firms in connection with the advice that they gave to retail customers who invested in the products.
In addition, in July 2009 the Serious Fraud Office (SFO) commenced an investigation into Keydata. In April 2011, the SFO announced that it had concluded that there was insufficient evidence to secure a conviction in this case. Efforts made by the SFO to trace the assets of one of the issuers of the bonds whose assets were alleged to have been misrepresented were also unsuccessful.
FCA findings in respect of former members of Keydata's senior management
In May 2015, the FCA published decision notices in respect of the following three former members of Keydata’s senior management in connection with the sale of the products:
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Stewart Ford, the former chief executive of Keydata.
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Mark Owen, the former sales director of Keydata.
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Peter Johnson, the former compliance officer of Keydata.
The FCA has found that each of these individuals breached APER Principle 1 (which during the relevant period required approved persons to act with integrity) and APER Principle 4 (which during the relevant period required approved persons to deal with the FSA and other regulators in an open and co-operative way and to disclose appropriately any information of which the FSA would reasonably expect notice).
The FCA is proposing to impose financial penalties of varying amounts on each of Mr Ford, Mr Owen and Mr Johnson, in addition to prohibition orders preventing them from performing any function in relation to any regulated activity in the future.
Further details about the FCA’s findings in respect of each of these three former members of Keydata’s senior management are set out below. Each of Mr Ford, Mr Owen and Mr Johnson dispute the FCA’s findings and have referred the FCA’s findings and sanctions against them to the Upper Tribunal.
Stewart Ford: Former chief executive
Role and responsibilities
Mr Ford held the CF3 (chief executive) controlled function throughout the relavant period. Mr Ford had sought to resign as chief executive of Keydata in 2007 and instead become a non-executive director of Keydata. However, Mr Ford did not notify the FSA of his resignation, retained his CF3 (chief executive) approval, was not replaced as chief executive and continued to be regarded internally as the chief executive of Keydata. As a result, the FCA considered that Mr Ford was Keydata’s chief executive during the relevant period. As Keydata’s chief executive, the FCA found that Mr Ford was primarily responsible for managing and controlling Keydata’s business in relation to the products.
In addition, Mr Ford set up, was a director of and beneficially owned one of the SPVs that issued the bonds purchased by Keydata as part of the products. This underlay more than GBP 373 million of the products purchased by 30,000 retail customers. Mr Ford and/or his family (through trusts he set up on behalf of his family) were also the beneficial owners of companies which took over GBP 72.4 million in fees from arrangements relating to the same products. The FCA considered that the companies performed no meaningful services in return for these fees and that taking such a high level of fees increased the risk of investors not receiving promised returns in relation to the products. In the light of Mr Ford’s roles in relation to Keydata and these other companies that were connected with the products or the bonds, the FCA found that Mr Ford had a clear and acute conflict of interest in relation to the sale of the products.
The FCA’s findings in respect of Mr Ford
The FCA stated in the decision notice issued to Mr Ford that Mr Ford breached the following rules during the relevant period:
APER Principle 1 – failure to act with integrity
Due diligence and financial promotions. The FCA found that Mr Ford was aware that Keydata’s due diligence regarding the products was inadequate. Further, the FCA found that Mr Ford received professional advice that Keydata’s financial promotions for the products contained unclear, incorrect and misleading statements and that Keydata’s due diligence relating to the products was inadequate. The professional advice also identified the risk that the products may not perform as expected. However, the FCA found that Mr Ford recklessly failed either to ensure that Keydata addressed these issues or to stop Keydata from marketing and selling the products. In addition, the FCA found that Mr Ford then recklessly failed to ensure that Keydata took steps to explain or mitigate the risks associated with the products to existing and potential investors.
Concealment of issues relating to the performance of the products. The FCA also found that Mr Ford was aware of issues relating to the performance of the products, but deliberately concealed (or caused Keydata to conceal) these problems from Keydata’s compliance officer (Mr Johnson, see further below), the FSA, investors and IFAs who were advising clients in relation to the products.
The FCA also concluded that Mr Ford deliberately provided factually incorrect and misleading answers about the performance of the products during an FSA compelled interview, despite being aware of issues in relation to the performance of the products. The FCA also found that Mr Ford deliberately failed to instruct Keydata’s compliance officer not to misrepresent the position regarding the products at a meeting with the FSA, despite being aware that Keydata’s compliance officer was intending to mislead the FSA.
Failure to manage a conflict of interest. The FCA established that Mr Ford’s roles relating to Keydata as well as other companies that were connected with the products and/or bonds constituted a conflict of interest, meaning that Mr Ford had a substantial financial interest in the products continuing to be promoted and sold. The FCA found that no arrangements were put in place in order to manage adequately this conflict of interest and that Keydata’s other directors, as well as Keydata’s compliance officer, were not aware of Mr Ford’s conflict of interest.
APER Principle 4 – failure to be open and co-operative with the FSA/FCA
In addition to the matters outlined above, the FCA found that Mr Ford knew that information provided by Keydata’s solicitors to the FSA about the performance of the products was misleading but failed to correct it. He also failed to ensure that the FSA was made aware of the issues with the products and the underlying portfolios, as described above. Further, the FCA found that Mr Ford failed to ensure that the FSA was made aware of the Luxembourg financial regulator’s concerns about the products.
The FCA found that Mr Ford did not disclose to it his true involvement as the director and beneficial owner of one of the SPVs that issued the bonds and that he and/or his family were the beneficial owners of companies being paid fees in relation to the products. This was despite Mr Ford being aware that the FSA had concerns about his role as a director of Keydata and the SPV.
Mr Ford’s response to the FCA’s findings
Mr Ford rejected the FCA’s findings. He argued that he was not the chief executive of Keydata throughout the relevant period. Further, Mr Ford claimed that he had relied on Keydata’s management team and professional advisers. Mr Ford claimed that the products were not high risk, highly illiquid or expensive to maintain. He believed that the products had been performing well and that the financial promotions for the products were the responsibility of Keydata’s compliance officer and his team, In addition, in the light of Keydata’s role as a product distributor (as opposed to a product provider), Mr Ford argued that the due diligence undertaken by Keydata in relation to the products was appropriate.
Mr Ford claimed that he had not deliberately misled the FSA and did not have knowledge of all the matters on which the FSA considered he misled it. Further, Mr Ford represented that his involvement in one of the SPVs issuing the bonds did not create a conflict of interest with Keydata as his interest in the SPV was only "theoretical" (in that his interests were subordinated to the holders of bonds issued by the SPV and deferred for at least 20 years). He also claimed that he had no interest in the companies that were paid fees in relation to the products.
In any event, Mr Ford alleged that the limitation period for the FCA to take enforcement action had expired since it had issued him with a warning notice more than two years after it became aware of the facts suggesting that he had engaged in misconduct.
Sanctions
In the decision notice issued to Mr Ford, the FCA proposed to impose a financial penalty of GBP75 million on him. Most of this figure is attributable to Mr Ford having received a personal benefit of over GBP72.4 million from the companies that were paid fees from arrangements relating to the products. The FCA also took into account Mr Ford’s earnings of GBP1.3 million from Keydata over the relavant period, the seriousness of his misconduct, the length of time over which it took place, the risk of loss to consumers and the actual losses that were sustained by investors.
If the FCA’s proposed financial penalty for Mr Ford is upheld by the Upper Tribunal, this will be the largest financial penalty that the FCA or the FSA has imposed on an individual.
The FCA also proposed to impose a prohibition order on Mr Ford, preventing him from performing any function in relation to any regulated activity in the future.
Mark Owen: Former sales director
Role and responsibilities
Mr Owen was Keydata’s sales director and throughout the relavant period was approved to perform controlled function 1 (director). For various parts of the relavant period, Mr Owen was also approved to perform the following controlled functions: CF16 (significant management (designated investment business)) and subsequently CF29 (significant management).
As Keydata’s sales director, Mr Owen’s responsibilities included assessing and researching new product ideas for board approval, overseeing the work and training of Keydata’s sales team that promoted the products and compliance monitoring in respect of this sales team.
The FCA's findings in respect of Mr Owen
The FCA has stated in the decision notice issued to Mr Owen that Mr Owen breached the following rules during the relavant period:
APER Principle 1 – failure to act with integrity
Due diligence and financial promotions. The FCA found that Mr Owen knew that Keydata had received professional advice that its financial promotions contained unclear, incorrect and misleading statements and that its due diligence relating to the products was inadequate. However, the FCA found that Mr Owen failed to ensure that Keydata took the steps recommended by its professional advisers to address these deficiencies, including amending its financial promotions or stopping Keydata from selling or marketing the products.
The FCA also found that Mr Owen knew that the professional advice received by Keydata had highlighted the risk that the products may not perform as expected. The FCA concluded that Mr Owen failed to take effective action to manage the risks associated with the products and did not consider that these risks should be notified to the FSA, investors and IFAs.
In addition, the FCA found that Mr Owen recklessly permitted Keydata to continue marketing and selling some of the products with an ISA wrapper, despite him being aware that it was highly likely that the products did not fulfil certain legal requirements that needed to be met in order for the products to be marketed and sold in this way (as set out in the Individual Savings Account Regulations 1998 (SI 1998/1870)).
Concealment of issues relating to the performance of the products. In or around 2010, customers who had invested in the products stopped receiving their income payments. The FCA found that Mr Owen was aware of issues relating to the performance of the products and that Mr Owen agreed to Keydata funding customers’ income payments from Keydata’s own resources. The FCA concluded that Mr Owen was reckless in doing so given that he was aware that this course of action was likely to mislead investors and IFAs in relation to the performance of the products.
Mr Owen sought to argue that he had relied on repeated assurances from Keydata’s chief executive, Mr Ford (see above) that he would resolve these issues relating to the products and the performance of the SPVs that issued the bonds. However, the FCA found that Mr Owen was reckless in relying on Mr Ford’s assurances as he failed to take any steps to evaluate and mitigate the risk that Mr Ford would not be able to resolve these issues in practice.
The FCA also found that Mr Owen deliberately misled the FSA during a compelled interview by representing that the products were on target to meet their obligations, despite being aware of issues in relation to the performance of the products. Mr Owen was also found to have deliberately consented to Keydata’s compliance officer, Mr Johnson (see further below) misleading the FSA in relation to this matter at a meeting.
Undisclosed commission arrangement. During the investigation into Keydata, it came to light that Mr Owen had received just over GBP 2.5 million through three commission payments pursuant to an undisclosed commission arrangement between Mr Owen and Mr Ford, which related to some of the products. The commission received by Mr Owen was dependent on the amount of investment in these products being raised by Keydata. However, Mr Owen failed to disclose the commission arrangement between him and Mr Ford to Keydata’s compliance officer or finance director. In addition, when Mr Owen was specifically asked by the FSA to provide details of any commissions received by him in connection with the products, he failed to inform the FSA of the undisclosed commission arrangement that existed between him and Mr Ford.
APER Principle 4 – failure to be open and co-operative with the FSA/FCA
The FCA also found that Mr Owen had failed to deal with it in an open and co-operative way. The reasons given by the FCA for this finding include that Mr Owen made false representations to the FSA during a compelled interview, consented to Keydata’s compliance officer misleading the FSA during a meeting relating to this matter, failed to correct information provided to the FSA by Keydata’s solicitors, despite knowing that the information was incorrect, and failed to ensure that that the FSA was made aware of the fact that income payments in respect of some of the products had stopped and that Keydata was funding these income payments from its own resources. In addition, the FCA relied on its finding that Mr Owen had failed to provide information about his undisclosed commission arrangement that had been agreed with Mr Ford when he had been asked by the FSA to provide details of any commissions received by him in connection with the products.
Mr Owen’s response to FCA’s proposed findings
Mr Owen rejected the FCA’s findings. In his representations to the FCA, Mr Owen emphasised the advice that Keydata had received from professional advisers in relation to the products and the assurances that had been made by the chief executive, Mr Ford, and sought to argue that he had reasonably relied on the advice and assurances given to him. In particular, Mr Owen did not think that the FCA had paid sufficient regard to the role of Keydata’s finance director who was more senior than him and, along with Mr Ford, was the only person who at all times knew Keydata’s financial position.
Mr Owen also disputed the FCA’s finding that the products were high risk, arguing that the products had not been considered high risk at the time they were launched or sold. In support of this argument, Mr Owen noted that the FCA had only stated since the end of the relavant period that it considered life settlement backed products to be high risk. Likewise, Mr Owen also disputed the FCA’s finding that Keydata’s financial promotions relating to the products were misleading.
Mr Owen sought to describe Keydata’s due diligence relating to the products as "extensive and adequate". In his representations, Mr Owen also sought to distinguish Keydata’s role as a product distributor from that of a product provider, arguing that Keydata’s role as a product distributor meant that its due diligence obligations relating to the products were more limited.
As regards the undisclosed commission arrangement that had been agreed between Mr Owen and Mr Ford, Mr Owen attempted to describe the payments he received from Mr Ford as long-term loans as opposed to commission payments that depended on the sale of certain of the products.
Mr Owen also denied having deliberately misled the FSA himself or having consented to Keydata’s compliance officer misleading the FSA. To the extent that there was any failure on his or Keydata’s part to provide relevant information to the FCA or the FSA, Mr Owen argued that this was due to the information in question being subject to legal professional privilege. In any event, Mr Owen alleged that the limitation period for the FCA to take enforcement action had expired since it had issued him with a warning notice more than two years after it became aware of the facts suggesting that he had been engaged in misconduct.
Sanctions
In the decision notice issued to Mr Owen, the FCA proposed to impose a financial penalty of GBP4 million on him. Over half of this proposed financial penalty (approximately GBP2.5 million) reflected the commission that the FCA found that Mr Owen had received from Mr Ford pursuant to their undisclosed commission arrangement.
The FCA also proposed to impose a prohibition order on Mr Owen, preventing him from performing any function in relation to any regulated activity in the future.
Peter Johnson: Former compliance officer
Role and responsibilities
Mr Johnson was the compliance officer at Keydata until 1 December 2008. He was approved to perform the following FSA controlled functions: CF30 (customer) and CF10 (compliance oversight). After 1 December 2008, Mr Johnson became Keydata’s operations director. He was not approved to perform a significant influence function (SIF) for this role but retained his CF30 (customer) approval.
As Keydata’s compliance officer, Mr Johnson was responsible for carrying out the due diligence in relation to the products, as well as for overseeing the verification and approval of the financial promotions in relation to the products. Mr Johnson was also responsible for ensuring Keydata’s compliance with regulatory standards. As Keydata’s operations director, Mr Johnson remained responsible for Keydata’s dealings with the FSA in relation to the products and, in the FCA’s view, continued to have some responsibility for Keydata’s compliance with regulatory requirements in relation to the products.
The FCA’s findings in respect of Mr Johnson
The FCA has stated in the decision notice issued to Mr Johnson that Mr Johnson breached the following rules during the relevant period:
APER Principle 1 – failure to act with integrity
Due diligence and financial promotions. The FCA found that Mr Johnson was aware that Keydata had received professional advice that its financial promotions relating to the products contained unclear, incorrect and misleading statements and that Keydata’s due diligence relating to the products was inadequate. The FCA also found that Mr Johnson was aware that there was a risk that the bonds underpinning the products may not perform as expected. The FCA alleged that Mr Johnson had recklessly failed either to take adequate steps to ensure that Keydata addressed these issues and risks or to take adequate steps to stop Keydata from marketing and selling the products until appropriate remedial steps were taken. The FCA also alleged that Mr Johnson recklessly failed to take adequate steps to ensure that Keydata explained or mitigated the risk to investors who had invested in the products and that material circulated to investors gave an inaccurate impression of the risks associated with the bonds underlying the products, despite becoming increasingly aware of the risks and issues affecting the bonds.
In the decision notice issued to Mr Johnson, the FCA stated that steps Mr Johnson could have taken to ensure that Keydata’s board committed to addressing the issues outlined above included refusing to sign-off financial promotions relating to the products, and/or making it clear that, if Keydata’s board did not commit to Keydata taking these actions, he would have no alternative to resign from his position and/or notify the FSA/FCA of these issues.
In addition, the FCA found that Mr Johnson had deliberately misled it by representing to the FSA during a compelled interview that there had never been a problem with the income payments relating to the products and that the products were on target to meet their obligations when he knew that this was not the case.
The FCA also concluded that Mr Johnson had recklessly failed to take adequate steps to prevent Keydata from continuing to market and sell the products as fulfilling the conditions set out in the Individual Savings Account Regulations 1998, despite being aware that it was highly unlikely that the products fulfilled these conditions.
APER Principle 4 – failure to be open and co-operative with the FSA/FCA
The FCA found that Mr Johnson had failed to deal with it in an open and co-operative way due to Mr Johnson having made misleading statements to the FSA during compelled interviews and having withheld information from the FSA about the issues relating to the performance of the products or the professional advice received by Keydata in relation to the products. In addition, the FCA found that Mr Johnson was aware that information provided by Keydata’s solicitors to the FSA in connection with this matter was likely to mislead the FSA as it misrepresented the projected income for the products but that Mr Johnson took no steps to correct this information.
Sanctions
In the decision notice issued to Mr Johnson, the FCA proposed to impose a financial penalty of GBP200,000 on him. It appears that a substantial portion of this proposed financial penalty is attributable to the FCA’s view as to the seriousness of Mr Johnson’s alleged misconduct, the losses that have been suffered by customers who invested in the products, as well as the allegation that Mr Johnson recklessly misled the FCA and the FSA.
The FCA also proposed to impose a prohibition order on Mr Johnson, preventing him from performing any function in relation to any regulated activity in the future.
References to the Upper Tribunal
Mr Ford, Mr Owen and Mr Johnson have referred the FCA’s proposed findings and sanctions against them to the Upper Tribunal.
Application to the Upper Tribunal restricting publication of the decision notices
Prior to the publication of the decision notices, Mr Ford, Mr Owen and Mr Johnson applied to the Upper Tribunal for:
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A direction that the effect of the decision notices be suspended, meaning that the financial penalties and prohibition orders proposed by the FCA would not take effect until the Upper Tribunal had dealt with the references made by Mr Ford, Mr Owen and Mr Johnson.
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A direction that the public register of cases to be heard by the Upper Tribunal does not include particulars relating to the FCA’s cases against them and an order pursuant to Rule 14(1) of the Tribunal Procedure (Upper Tribunal) Rules 2008 that the decision notices should not be published by the FCA. Mr Ford, Mr Owen and Mr Johnson argued in favour of keeping the details of the FCA’s case against them and their references to the Upper Tribunal private due to:
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the reputational damage that they would suffer if this information was released into the public domain (including personal threats that may be made to them and their families); and
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the prejudice that this information may cause to them in relation to other claims made or to be made against them by the FCA and other parties.
The Upper Tribunal rejected each of these applications, giving the following reasons for doing so:
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The effect of section 133A(4)(b) of the Financial Services and Markets Act 2000 (FSMA) is that, where a decision notice is referred to the Upper Tribunal, the action specified in the decision notice must not be taken until the reference to the Upper Tribunal and any appeal against the Upper Tribunal’s determination has been dealt with. As a result, the Upper Tribunal held that there was effectively already a statutory suspension of the decision notices and no direction given by the Upper Tribunal can affect this.
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The Upper Tribunal was not satisfied that including references to the Upper Tribunal made by Mr Ford, Mr Owen and Mr Johnson on the public register or publishing the decision notices would cause any of them "irreparable reputational damage" or that there would be a "substantial likelihood of disproportionate damage" to them.
Comment
Each of Mr Ford, Mr Owen and Mr Johnson has referred the FCA’s findings and proposed sanctions to the Upper Tribunal. Based on the summary of each individual’s representations as set out in the decision notices, it is likely that the Upper Tribunal will be required to consider several interesting issues which may be of broader application to members of senior management in financial institutions, including:
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Reliance on others. Mr Ford and Mr Owen indicate in their representations that they relied on others in order to discharge their responsibilities. For example, Mr Ford appears to have argued that he relied on Keydata’s management team and professional advisers in relation to the products and Mr Owen appears to have argued that he relied on repeated assurances made by Mr Ford that issues relating to the products and the bonds would be rectified. The FCA does not seem to have been satisfied that the reliance that Mr Ford and Mr Owen placed on others in relation to the products was reasonable in the circumstances. As a result, the Upper Tribunal may be required to consider in more detail what it considers is the appropriate level of reliance for a SIF holder to place on colleagues or on professional advisers, as well as what steps should be taken to monitor and evaluate the effectiveness of any such reliance.
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The role of a product distributor versus the role of a product provider. The FCA’s expectations of product distributors and product providers, especially in relation to product due diligence, has been the subject of considerable debate over the past few years. Each of Mr Ford, Mr Owen and Mr Johnson all point to the fact that Keydata was a product distributor in order to support their arguments that the due diligence that Keydata undertook in relation to the products was appropriate. As a result, the Upper Tribunal is likely to need to consider the roles of product distributors and product providers, as well what level of due diligence it is appropriate for the FCA to expect product distributors to undertake in relation to their products.
In the decision notice issued to Mr Johnson, Keydata’s former compliance officer, the FCA took the unusual step of setting out what it would have expected Mr Johnson to do in order to help ensure that the various issues identified in relation to the products were rectified. One of the FCA’s suggestions as to what Mr Johnson should have done was to make it clear to Keydata’s board that, if it did not commit to rectifying these issues, he would have no alternative but to resign from his position as compliance officer and/or notify the FSA/FCA of the issues. Although it is likely that the FCA would only expect a compliance officer to take such steps in extreme cases, this guidance nonetheless demonstrates the tough stance that the FCA expects compliance officers to take where regulatory breaches are identified but are not being handled appropriately, as well as the FCA’s eagerness for whistleblowers to make disclosures directly to the FCA as opposed to via their firms’ internal procedures.
Decisions
This article first appeared on Practical Law and is published with the permission of the publishers.
