FCA and PRA Publish Consultation on New Rules Relating to Non-Financial Misconduct

Key Points

• Following a joint Discussion Paper in 2021 issued by the FCA and the PRA, both regulators have now issued Consultation Papers proposing new rules and guidance in relation to diversity and inclusion in the financial services sector.
• As well as dealing formally with diversity and inclusion matters (which are discussed in more detail in our parallel alert here, the FCA’s Consultation Paper also proposes new rules and guidance in relation to non-financial misconduct.
• Non-financial misconduct has been a significant matter of concern for firms in recent years when having to make assessments as to individuals’ fitness and propriety and assessing whether the FCA’s Conduct Rules have been breached. In part the issues have arisen because there has been limited guidance on how these matters should be taken into account.
• The newly proposed rules and guidance set out a fairly expansive role for considering non-financial misconduct in assessing fitness and propriety, and in relation to the Conduct Rules would make it clear that non-financial misconduct would primarily only be relevant if it occurred in a workplace/business context.

Introduction

Following on from its earlier Discussion Paper¹  on diversity and inclusion (D&I) in the financial sector, the FCA and the UK Prudential Regulation Authority (PRA) have now issued consultation papers² proposing new rules in relation to D&I. Following receipt and consideration of the consultation feedback, final rules are expected to be promulgated in 2024, with the rules coming into effect one year later.

The new rules include specific D&I measures, including (for example) new reporting obligations and requirements on larger firms to set and report on D&I targets. We discuss these in more detail in our parallel article here.

As relevant to this alert, the proposed rules would amend the UK Financial Conduct Authority’s (FCA) Conduct Rules and the FCA’s rules and guidance on making fitness and propriety assessments, with consequential changes to how firms must prepare and provide regulatory references.

Background

Back in 2018, Christopher Woolard, who was then the FCA’s Executive Director of Strategy and Competition, stated in a speech that “non-financial misconduct is misconduct, plain and simple”.³

Despite this, in the years following, the FCA has struggled to act on non-financial misconduct, and guidance to firms has been subject to criticism.

Perhaps most memorably, the FCA brought enforcement action against Jon Frensham seeking to prohibit him from working in the financial services sector following Mr. Frensham’s conviction for certain sexual offences involving a child. Mr. Frensham took his case to the Upper Tribunal⁴, which found that the FCA had not made out its case sufficiently to show that Mr. Frensham relevantly lacked integrity given that the criminal conviction had nothing to do with his professional life. In particular, the Tribunal noted that:⁵

“It is not simply a question of assessing whether the behaviour concerned demonstrates a lack of integrity at large, but whether the behaviour engages the specific standards laid down by the relevant regulator.”

Ultimately the Tribunal agreed with the FCA that Mr. Frensham should be prohibited on an alternative ground, but the criminal conviction alone which was unrelated to Mr. Frensham’s professional activity—even for such a serious offence—was not sufficient under the FCA’s rules to establish a lack of integrity.

Since then, there have been several other non-financial misconduct cases which have arisen or are still progressing through the regulatory process. There have been some notable recent regulatory actions in this space, where the outcome of ongoing investigations is expected to further strengthen the FCA’s position on non-financial misconduct being a material risk consideration to authorised firms.

Other regulators in the UK have faced similar difficult questions in relation to their assessment and treatment of misconduct which is not directly related to an individual’s professional competence, including the Solicitor’s Regulation Authority (for example in the Beckwith case which went before the High Court⁶) and proceedings before the Enforcement Board of Lloyd’s of London involving Atrium Underwriters Limited.

Conduct Rules

Under the Senior Managers and Certification Regime (SMCR), the Code of Conduct Rules (COCON) apply to all employees of regulated firms, except for people performing certain enumerated functions such as receptionists, security guards, cleaners and catering staff.⁷ 
For most firms, except for banks, COCON’s scope is restricted to regulated activities, certain other specified financial activities, and certain kinds of misconduct which could have a negative effect on the integrity of the UK financial system, the ability of the relevant firm to meet the ‘fit and proper’ test, or the ability of the firm to meet the applicable requirements and standards under the regulatory system relating to the the firm’s financial resources.

The FCA is proposing to expand the scope of COCON so that it explicitly covers “serious”⁸ non-financial misconduct performed in the broad context of the firm’s regulated activities. This would include bullying, harassment (including sexual harassment) and similar behaviour towards other employees and employees in group companies. In the terms of the proposed rules, non-financial misconduct which would be covered includes behaviour which:⁹

• Has the purpose or effect of violating another employee’s dignity or creating an intimidating, hostile, degrading, humiliating or offensive environment for them.
• Is offensive, intimidating or violent to another employee.
• Is unreasonable and oppressive to another employee.
• Humiliates, degrades or injures another employee.

The proposed rules make clear that “conduct relating to the conduct rules staff member’s private or personal life is outside the scope” of COCON,¹⁰  with guidance given on how firms should assess whether something is in a staff member’s private or personal life, including whether:¹¹

• The conduct occurred on or off the firm’s premises.
• The conduct occurred whilst the staff member was working on firm business.
• The conduct involved clients or someone the person had dealt with on behalf of their firm.
• The conduct was committed using work equipment or by involving the firm’s staff.
• The position of the staff member as an employee helped them carry out the conduct.
• The purpose (misguided or not) of the conduct was to benefit the firm.

Whilst firms may still have to make multifactor assessments of whether or not COCON has been breached in particular cases, this additional guidance and framework should be helpful in assessing whether there has been a formal breach of COCON.

Fitness and Propriety Assessments

Fitness and propriety assessments need to be made annually by firms for certification staff and senior managers, and the FCA performs its own fitness and propriety assessment for senior managers when they are first approved. The FCA also considers fitness and propriety when considering whether or not a firm meets the “Threshold Conditions” to be a regulated firm.

As explained above, whilst COCON breaches will continue to be restricted to an individual’s behaviour associated with the firm, the same cannot be said for assessments of an individual’s fitness and propriety. Under proposed COCON 1.3.7G, the FCA is explicit that conduct which may be excluded from the scope of COCON on the grounds of it being “private or personal life” conduct “can still be relevant to fitness and propriety”.¹²

Consequently, the FCA is proposing to amend the “Fit and Proper Test for Employees and Senior Personnel Sourcebook” of the FCA Handbook (FIT) and the Threshold Conditions Sourcebook (COND). The rules and guidance proposed are fairly complicated, and the following is a high-level summary only.

Criminal Convictions

The FCA is proposing to make clear that “any conviction for a criminal offence is potentially relevant to an assessment of fitness and propriety”, though it does not “automatically” mean that the member of staff is unfit.¹³

Perhaps in direct response to the Upper Tribunal’s criticism of the FCA in the Frensham case, the FCA is now explicitly making a link in its Handbook that “[m]isconduct in [a] person’s private or personal life may run a significant risk that the person would commit misconduct in their work activities”,¹⁴  and “it may show that the person lacks moral soundness, rectitude and steady adherence to an ethical code”.¹⁵

It is also proposed that the list of offences in the FIT 2 “Main Assessment Criteria” will be amended to include not just financial crimes, but also “violence, sexual offences and offences related to a person’s or a group’s demographic characteristics such as racially motivated or aggravated offences”.¹⁶

Relevance of Upholding Confidence in the Financial System

Following the Upper Tribunal’s judgment in Frensham, one avenue the FCA pursued in seeking to prohibit individuals was that their activities had (or had the potential to) damage public confidence in financial services. A good example of this was the FCA’s Final Notice in the case of Ashkan Zahedian,¹⁷  who had been convicted of wounding with intent and possession of a machete, and where the FCA found that there was a “severe risk of an erosion of public confidence if those who are convicted of violent offences are permitted to continue working in the financial services industry”.¹⁸

The newly proposed rules go quite far beyond this assessment, however. In particular, the FCA is proposing guidance that misconduct might lead to a person being found not to be fit and proper “even if it cannot be shown that the misconduct will by itself cause direct and discernible damage to public confidence in the financial system … or to confidence in their firm”.¹⁹

Suitability Threshold Condition

The FCA notes that a person may be assessed as unfit if their behaviour would result in the firm being assessed as unfit under the “Suitability” Threshold Condition, which itself is proposed to be amended to explicitly note that the FCA would look to not just financial crimes or misconduct committed by the firm or its personnel, but also violent, sexual or discriminatory offences or practices.²⁰

Comment

As noted above, the proposed rules and guidance on the assessment of fitness and propriety are fairly intricate, which may be of assistance to firms in making the necessary determinations.

At the same time, firms should note quite how expansive the current proposals are, and how non-financial misconduct, and indeed conduct not related to business, is being explicitly brought within the FCA’s remit.

By potentially sweeping every form of misconduct into being relevant, firms may still be left in a position of not knowing quite how to make the necessary balancing analysis and judgement in individual cases, particularly if the behaviour is minor or very clearly outside the scope of the business’ interests. This is especially true given the FCA’s proposed disavowal of the test that reputational damage to the financial system is what is relevant.

Regulatory References

Firms will be aware that they are required to request and provide regulatory references, and to keep these updated in accordance with the rules and guidance in Chapter 22 of the Senior Management Arrangements, Systems and Controls Sourcebook (SYSC). The FCA is proposing to amend the guidance to ensure that firms are aware that breaches of the broadened COCON may be required to be disclosed, as may non-financial and/or non-business activities which would be relevant to the broadened fitness and propriety assessment rules and guidance.²¹  In particular, firms may be required to disclose misconduct which is not a breach of COCON, but which would be relevant to the assessment of the individual’s fitness and propriety in accordance with the FIT (as proposed to be amended).²²

Next Steps

The deadline for responses to the consultation is 18 December 2023 and the FCA anticipates being able to issue a Policy Statement with final rules some time in 2024. Rules would come into force 12 months later. We will continue to monitor and report on developments in this area. Please reach out to your usual Akin contact or to the authors for further information.

^{1 https://www.fca.org.uk/publication/discussion/dp21-2.pdf.}

^{2 Respectively, FCA: https://www.fca.org.uk/publication/consultation/cp23-20.pdf and PRA: https://www.bankofengland.co.uk/prudential-regulation/publication/2023/september/diversity-and-inclusion-in-pra-regulated-firms.}

^{3 https://www.fca.org.uk/news/speeches/opening-and-speaking-out-diversity-financial-services-and-challenge-to-be-met.}

^{4 Judgment in Frensham v FCA [2021] UKUT 222 (TCC) here: https://assets.publishing.service.gov.uk/media/612e14dfe90e07054107585e/Frensham_v_FCA.pdf, on which, see our client alert here: https://www.akingump.com/en/insights/alerts/upper-tribunal-clarifies-fcas-powers-regarding-non-financial-misconduct-by-regulated-individuals.}

^{5 Frensham, para 38.}

^{6 Beckwith v. SRA [2020] EWHC 3231 (Admin), https://www.judiciary.uk/wp-content/uploads/2020/11/Beckwith-v-SRA-judgment.pdf/.}

^{7 See COCON 1.1 in the FCA Handbook: https://www.handbook.fca.org.uk/handbook/COCON/1/1.html.}

^{8 Proposed COCON 1.1.7G G.}

^{9 Proposed COCON 1.1.7F R (4).}

^{10 Proposed COCON 1.3.3 G.}

^{11 Proposed COCON 1.3.4 G.}

^{12 https://www.fca.org.uk/publication/consultation/cp23-20.pdf, page 116.}

^{13 Proposed Guidance FIT 1.3.7 G.}

^{14 Proposed Guidance FIT 1.3.12 G (3).}

^{15 Proposed Guidance FIT 1.3.12 G (5).}

^{16 Proposed Guidance FIT 2.1.3 G (1).}

^{17 https://www.fca.org.uk/publication/final-notices/ashkan-zahedian.pdf.}

^{18 https://www.fca.org.uk/publication/final-notices/ashkan-zahedian.pdf.}

^{19 Proposed Guidance FIT 1.3.16 G (1).}

^{20 Proposed Guidance COND 2.5.6 G (2).}

^{21 Proposed Guidance SYSC 22.6.6 G.}

^{22 Proposed Guidance SYSC 22.6.6 G.}