KVB Consultants v. Jacob Hopkins McKenzie: A warning shot for principal firms
The Court of Appeal in KVB Consultants Ltd and others v Jacob Hopkins McKenzie Ltd and others has upheld a High Court decision that principal firms cannot exclude liability for their appointed representatives through drafting contracts which are detached from factual reality.
Appointed representative (AR) arrangements arise where firms authorised to carry out regulated activities (principals) under s19 of the Financial Services and Markets Act (FSMA) 2000 contractually agree to allow unauthorised individuals or firms (ARs) to carry out these activities on their behalf.
AR arrangements are commonplace and enable smaller firms to offer regulated services at more economic rates. You might have had dealings with an appointed representative without initially knowing that they are authorised via a principal business. However, the bone of contention is; who is responsible when the AR’s activities cause consumers to suffer losses?
The Financial Services Compensation Scheme (“FSCS”) foots the bill when regulated businesses are unable to meet their liabilities to consumers. Faced with high volumes of AR-related FSCS claims, which accounted for 61% of the value of claims between 2018 and the first half of 2019, the FCA introduced new reporting obligations for principals in 2022 to enforce proper supervision of ARs. But what happens when prevention fails and losses occur?
Who is responsible for the activities of ARs?
FSMA only holds the principal responsible in relation to business for which it has accepted responsibility in its agreement with the AR. Most consumers will be unaware that principals can limit the scope of their responsibility using the AR agreement. Further, consumers are unlikely to be aware of what the AR has agreed with its principal ahead of doing business with the AR. In our experience, the nature of the arrangements only become known to consumers after something has gone wrong and a dispute has arisen.
When will principal firms be responsible for the activities of their ARs?
The first step when a claim is made against a principal is to examine the AR contract to see what the principal had permitted and accepted responsibility for. Anderson v Sense Networks Ltd.’s “what/how?” distinction specifies that principals can exclude liability for specific activities (the “what?”) but not the way in which activities are undertaken (the “how”?). An example noted in Anderson is that principals cannot only accept responsibility for ‘suitable’ advice, as suitability is an example of how the regulated activity (i.e., giving advice) is carried out.
KVB Consultants High Court decision
26 investors were trying to pursue KCL (the principal firm) after having lost money investing in residential property schemes promoted and operated by, its now insolvent AR, JHM.
Under the AR agreement, JHM was only permitted to carry out certain activities in respect of certain kinds of clients. Amongst other things, the agreement prohibited JHM from handling retail clients, managing collective investment schemes (CIS), or any other scheme involving pooled money. Yet the clients were, in fact, unsophisticated retail clients, and JHM’s property schemes were CISs under s235 FSMA, seven of which were unlawful.
The High court awarded summary judgment in favour of the claimants. The judge, Paul Stanley KC, highlighted that the limitation against dealing with retail clients described how a regulated activity should be carried out following Anderson. He also identified that KCL should take responsibility for the claimants’ losses, as the AR agreement allowed JHM to advertise and advise on investment schemes, even though KCL was prohibited from granting permission to JHM to operate a CIS (FSMA 2000 (Appointed Representatives) Regulations 2001, SI 2001/1217).
KCL appealed this decision.
The Court of Appeal decision
The Court of Appeal dismissed the appeal.
In his leading judgment, Lord Justice Males agreed that the clause prohibiting JHM from operating a CIS was at odds with other sections of the agreement which permitted them to advise and arrange deals on CISs. He indicated that differentiating between operating and advising on CISs was unnecessary and disclosed nothing important about the scope of permissions since these differences were already recognised in law (FSMA 2000 ss 235 and 237(2)). As KCL had at least accepted responsibility for advice in relation to CISs, and that both parties should have had enough regulatory knowledge to draft a more concise agreement, Lord Justice Males found that only a “blanket ban” prohibiting JHM from engaging in any activities involving a CIS would have successfully discharged KCL’s overall liability.
Even though KCL was not authorised to deal with retail clients itself, never mind permit its AR to do so, Lord Justice Males identified that it would be inconceivable to deny retail clients the same opportunities as professional investors to pursue principal firms, given that they are afforded higher levels of protection than other investor classes.
Conclusion
Although we understand that KCL has now sought permission to appeal to the Supreme Court, the Court of Appeal’s decision is a welcome one for consumers in that it creates a high threshold for principals seeking to discharge liability for their appointed representatives’ activities. We anticipate a wave of revisions to existing AR agreements to ensure that liability disclaimers are clearly drafted and consistent with the overall nature of the permissions being granted.
Contact a disputes specialist
If you are affected by issues relating to an investment or pension, please get in touch with our team of Financial Services Litigation experts by calling 0345 209 1046 or get in touch online for a free initial consultation.
Posted:
