By Stephen Gilchrist
The UK financial regulator, the Financial Services Authority (FSA) and its proposed successor, the Financial Conduct Authority (FCA) is a powerful enforcement body which may not only sanction and punish authorized persons within its own regulatory framework, but also has the authority to criminally prosecute those who commit financial offences under the Financial Services and Markets Act 2000 (FSMA). This article is a brief overview of some of the more serious types of cases which may be brought before the criminal courts.
By the end of 2012 the Financial Services Authority (FSA) will have transferred its responsibility for conduct and enforcement within the financial services sector to the Financial Conduct Authority with a single strategic objective: to protect and enhance confidence in the UK financial system. It will also have new powers, specifically in relation to product intervention: to direct firms to withdraw or amend misleading financial promotions with immediate effect and, to publish the fact that a warning notice in relation to a disciplinary matter has been issued. In 2011, the FSA stepped up their proactive approach to deal with insider dealing, closing down so-called ‘land banking’ businesses and prosecuting boiler room fraud. Under the Financial Services and Markets Act 2000 (FSMA), one of the statutory objectives of the FSA (and presumably the new FCA) is “the reduction of financial crime ‑ reducing the extent to which it is possible for a regulated business to be used for a purpose connected with financial crime”.
The FSA has the power to prosecute several specific offences relating to regulated activities. Some of these are ‘summary’ and can only be dealt with by the magistrates’ courts. Others are ‘indictable’ and can only be heard in the crown court, where a jury decides on guilt. Yet others are ‘either way’, and so can be tried either in a magistrates’ or crown court. Punishments include fines at various levels and imprisonment for up to seven years. The Serious Fraud Office (SFO) concentrates on investigating and prosecuting fraud; that is, acts of deception intended for personal gain or to cause loss to another. The FSA and the SFO often work together. Sometimes the FSA will refer blatant fraud to the SFO to prosecute, and both are empowered to take civil proceedings to secure the proceeds of crime, including funds believed to have been salted away abroad. Memoranda of Understanding or guidelines for the exchange of information have been agreed between the SFO and many other several regulatory and prosecuting bodies including the FSA.
Significantly, however, in the 2010 Supreme Court case of R v Rollins (Neil) and R v McInerney (Michael) – a money laundering case – it was decided that the FSA’s powers to prosecute criminal offences were not limited to the offences set out in FSMA. The Court held that the FSA had always been able to bring any prosecution subject to statutory restrictions and conditions, and provided that it was permitted to do so by its memorandum and articles of association. After a criminal conviction for an offence (or offences) resulting in financial benefit, the court will invariably be asked to consider making a confiscation order under the Proceeds of Crime Act 2002 (POCA) to deprive a defendant of the benefits he haws accrued as a result of his offending. A default prison sentence of up to ten years consecutive may be imposed if the order is not satisfied and so in FSMA cases this penalty may exceed the sentence for the crime itself. A restraint order may also be granted to the prosecutor even at the investigative stage to prevent dissipation of assets.
Arguably the most serious offences under the FSMA are those of carrying on a regulated activity without authorization and making misleading statements to induce investments. Doing so can have very serious consequences for the victim or consumer, who will typically have ‘invested’ large amounts of money in unauthorised schemes, which often take the form of collective investment schemes (CIS), and will be unable to recover their money from the unauthorised operators of the scheme. Dealing with unauthorised firms will deprive a victim of malfeasance from access to the Financial Ombudsman Service and the Financial Services Compensation Scheme. Increasingly the FSA will obtain civil freezing orders against these operators, but in practice it is often too little too late, despite the fact that under section 26 of the FSMA “an agreement made by a person in the course of carrying on a regulated activity in contravention of the general prohibition is unenforceable against the other party”. Such activities may have generic characteristics – they may be pyramid or ‘easy money’ schemes – that make any recovery all but impossible. ‘Boiler rooms’, which sell often worthless investments and target UK-based consumers though they are operated from abroad, may also fall into this category since communicating an inducement or invitation to engage in investment activity (in the absence of authorisation) is also prohibited under section 21 of the FSMA – if it is “capable of having an effect in the United Kingdom”.
Investigative Powers of the FSA
The FSA has a number of distinct investigative powers as a regulator. Under FSMA the FSA has powers of search and seizure (under a warrant) and to compel those under investigation to answer questions and produce documents, other than those which are subject to legal privilege. If an individual fails to answer questions, they may be held in contempt of Court which can result in up to 2 years in prison, a fine or both. Investigations conducted under compulsory powers are not criminal proceedings but if it is concluded there is evidence of criminal conduct, then the FSA may decide to instigate criminal proceedings. If the FSA believe there is evidence of criminal conduct, they can conduct interviews under caution.
Offences under the FSMA
The most serious criminal offences and incidents of misconduct in the financial services sector that fraud practitioners are likely to encounter are:
- Carrying on a regulated activity without authorisation. This is described in FSMA as a breach of the ‘general prohibition’;
- Communicating an invitation or inducement to engage in investment activity;
- Making misleading statements to induce investments.
Additionally the FSA often conducts insider dealing prosecutions under section 52 of the Criminal Justice Act 1993. The FSA has so far secured 10 convictions in relation to insider dealing and is currently prosecuting 13 other individuals for insider dealing.
A. Carrying on a regulated activity without authorisation
Section 19 of the FSMA provides that no person may carry on a regulated activity in the United Kingdom, or purport to do so, unless he is an authorised person or an exempt person. The prohibition is referred to in this Act as the general prohibition.
Under section 23 of the FSMA, it is a criminal offence to contravene the general prohibition and punishable in the magistrates’ court with six months’ imprisonment and/or a fine of £5,000; in the Crown Court it is punishable with two years’ imprisonment and/or an unlimited fine. For example in R v Powell and Hinkson(2009), the appellants were convicted of offences contrary to section 21 of the 2000 Act. On appeal, their sentences of 15 months’ imprisonment were upheld. Although there was no finding of dishonesty, the sentences were held to be justified. The offence is committed through breach of the prohibition and no specific intent is required, although it is a defence under section 23 for “the accused to show that he took all reasonable precautions and exercised all due diligence to avoid committing the offence”.
The issues are:
- Is the accused carrying out a regulated activity? A regulated activity is one of a specified kind that is carried on by way of business and (a) relates to an investment of a specified kind; or (b) is carried on in relation to property of any kind (section 22). Schedule 2 of the FSMA (and amending orders) sets out the parameters of such activities which includes offering investment advice, deposit taking, managing investments and establishing a collective investment scheme. (see, for example FSA-v-Fradely, The Times, 1 December 2005 referring to provision of a betting service that involved collecting money from the public and placing bets on their behalf on horse races).
- Is the regulated activity being carried out in the UK?
- If so, is the accused an authorised or exempt person’?
- Even if the accused is not actually carrying out a regulated activity, is he purporting to do so?
- Has the accused taken all reasonable precautions and exercised all due diligence to avoid committing the offence?
Collective investment schemes (CIS)
Establishing, operating or winding-up a collective investment scheme is a regulated activity. Such schemes are described in section 235 of the FSMA, the essential criteria being:
- Participation or receipt of profits or income from the acquisition;
- No day-to-day control by the participants;
- And either: (a) pooled contributions or (b) management by or on behalf of the operator of the scheme.
Very often an investigation into a breach of the prohibition will reveal, or arise from, the operation of a CIS. Of course not all these schemes are illegal; a classic CIS is a unit trust, which is generally operated under appropriate FSA authorisation by a reputable body. However, other types of unauthorised scheme, which have either been prosecuted or are currently under criminal investigation, include (as in Fradeley). Recently, there have also been a number of so-called land banking schemes, which involve persuading people to invest in plots in the green belt, on the improbable basis that the land will rocket in value when planning permission is secured for building houses; the profits (to the unauthorised land bankers) from buying land at agricultural prices and selling for development have been phenomenal.
The CIS issue here is an alleged promise by the operators to apply for planning permission on behalf of the plot buyers, or otherwise mange the plots for them after purchase. The FSA takes the position that this amounts to the pooling of assets and depriving the plot holders of day-to-day management. Although trading in land is not in itself a regulated activity under the FSMA, the property concerned in a CIS can be any property, including land. In some of these cases, the offences of fraud by misrepresentation and money laundering are also engaged. A number of these cases are currently being investigated by the police and at least two cases have resulted in persons being charged with conspiracy to defraud.
B. Communicating an invitation or inducement to engage in investment activity
Section 23 of the FSMA provides that a person must not, “in the course of business, communicate an invitation or inducement to engage in investment activity” except where the person is an authorized person or where “the content of the communication is approved for the purposes of this section by an authorized person”. An offender is liable on summary conviction to imprisonment for up to six months and/or a fine not exceeding £5,000, and on indictment up to two years’ imprisonment and/or an unlimited fine.
Issues that may arise are:
(i) Is the communication in the course of business?
(ii) Is there a communication? In Fradely unsolicited mail had been sent to individuals inviting them to become participants in the scheme.
(iii) Is there an invitation or inducement?
(iv) Is there engagement in an investment activity?
(v) Is there a defence? It is a defence (section 25 FSMA) for the accused to show that he believed on reasonable grounds that the content of the communication was prepared or approved by an authorised person, or that he took all reasonable precautions and exercised all due diligence to avoid committing the offence. Under section 21, in the case of a communication originating outside the UK, the restriction applies only if the communication is capable of having an effect in the UK.
C. Misleading statements and practices
Section 397 of the FSMA creates criminal offences concerning misleading statements and practices, punishable by up to seven years’ imprisonment and/or an unlimited fine. An offence is committed where a person deliberately makes a misleading statement, promise or forecast, or dishonestly conceals facts from someone with the intention of inducing another to do, or refrain from doing, something in relation to an investment.
A person is guilty of an offence if he:
1. Makes a statement, promise or forecast that he knows to be misleading, false or deceptive in a material particular;
2. Dishonestly conceals any material facts whether in connection with a statement, promise or forecast made by him or otherwise; or
3. Recklessly makes (dishonestly or otherwise) a statement, promise or forecast which is misleading, false or deceptive in a material particular, for the purpose of inducing, or is reckless as to whether it may induce, another person to enter, or refrain from entering, a relevant agreement, or to exercise, or refrain from exercising, any rights conferred by a relevant investment.
A further offence is committed, under section 397, by a person who engages in any course of conduct that creates a false or misleading impression as to the market in, or the price or value of, any relevant investments if he does so for the purpose of creating that impression and of thereby inducing another person to acquire, dispose of, subscribe for or underwrite those investments, or to refrain from doing so, or to exercise, or refrain from exercising, any rights conferred by those investments.
There is a statutory defence under section 397 if the accused can show:
(i) That he reasonably believed his actions or conduct would not create an impression that was false or misleading;
(ii) That he acted, or engaged in the conduct, for the purpose of stabilizing the price of investments, and in conformity with price-stabilising rules;
(iii) That he acted in conformity with control-of-information rules;
(iv) That he acted in conformity with the relevant provisions of Commission Regulation (EC) 2273/2003.
Section 397 does not apply unless the act is carried out, or the course of conduct is engaged in, in the UK, or the false or misleading impression is created there. It is important to note that these offences may be committed by unauthorized persons, such as those who are in breach of the general prohibition, by, for example, running an unauthorised CIS.
Other offences that may arise in fraud investigations are:
- It is an offence under section 24 to falsely claim to be authorised by the FSA or to be an exempt person, or to behave as such although the due diligence defence is available.
This is a summary offence for which the sanction is six months’ imprisonment and/or a £5,000 fine. The fine may be increased if there is a public display of any misleading material.
- It is an offence under section 398 to knowingly or recklessly give the FSA information that is false or misleading in a material particular in purported compliance with any requirement under the FSMA.
In either a magistrates’ court or a crown court, this is punishable by a fine.
This article was originally published in Credit Control Journal, January 2012