Fox Hayes approved a mailing for overseas clients to send to UK recipients. No investment opportunities were mentioned, but respondents would receive such inducements in due course. Was this first mailing itself a “financial promotion”? Zoe Hare reports on the Court of Appeal’s emphatic answer.
Topic: Financial services
Who: Financial Services Authority v Fox Hayes (a firm of solicitors)
Where: Court of Appeal, UK
When: 17 February 2009
Law stated as at: 16 March 2009
The Court of Appeal recently overturned a decision of the Financial Services and Markets Tribunal ("FSMT") relating to the approval of financial promotions.
The FSA had claimed that Fox Hayes, a firm of solicitors, had abused its status as an FSA- authorised firm by approving multiple financial promotions for unauthorised overseas companies. Having lost at the tribunal, the FSA appealed to the Court of Appeal.
The Respondent Fox Hayes had approved financial promotions for overseas companies which were unauthorised and unregulated in the UK market. The promotional material was then used for the purposes of inviting UK-based investors to invest.
The approved promotional material was sent by the overseas companies to potential investors in the UK. The targeted investors were selected on the basis of shares already held in various companies. The overseas companies contacted the Investors offering a free research report into those companies in which they held the shares.
Investors which had agreed to be contacted regarding other investment opportunities were then invited to purchase shares in various other companies. However the shares to be purchased were in Over the Counter Bulletin Board companies, which are high-risk and illiquid shares. This process resulted in the overseas companies, described as boiler room fraudsters, illegally selling shares to 670 UK investors for the total sum of approximately US $21 million.
The FSA believed that the firm had not taken the necessary reasonable steps under the FSA's Conduct of Business rules to ensure that the materials were clear, fair and not misleading. It claimed that Fox Hayes did not have sufficient reason to believe that the overseas companies would deal with the potential investors in an honest and reliable manner. There was reason to doubt this. Accordingly, the FSA imposed a penalty on Fox Hayes, which the firm referred to the FSMT.
The FSMT reduced the FSA penalty. It held that Fox Hayes had taken reasonable steps to ensure that the promotions were clear, fair and not misleading and the law firm initially had no reason to doubt that the overseas companies would deal with UK customers in an honest and reliable way.
The FSMT held that the initial letters offering research reports on the companies in which the mailing recipients held shares were not themselves inducements to engage in the purchase of shares. Accordingly it was not fair to penalise Fox Hayes for failing to require that before it approved the letters, they were amended so as to be more transparent about the real, underlying reason behind the sending of the letter.
The FSA appeals
The FSA appealed this finding, submitting that the whole purpose of the promotional material was for the overseas companies to encourage UK investors to purchase what it considered to be high-risk illiquid shares.
It followed, the FSA argued, that the promotional activity should be looked at as a whole. Adopting this approach, the initial letter was clearly an integral part of the promotional activity and was therefore itself caught by the Conduct of Business Rules as an inducement to engage in the purchase of investments. As such, the initial letter had to be clear, fair and not misleading as to its real purpose and this was not clearly communicated.
The Court of Appeal agreed with the FSA. The FSMT had already found that the purpose was not clear and thus it should follow that Fox Hayes did not take reasonable steps to make the promotion clear, fair and not misleading.
If the firm knew what the purpose of the material was, it was therefore the case the firm had reason to doubt that the overseas companies would deal with their UK investors in an honest and reliable way.
It was held that the firm's conduct was "serious and reckless". The penalty imposed was £750,000 but reduced to £500,000 as it was a test case. Furthermore the managing partner of Fox Hayes had received £454,770 in secret commissions from the overseas companies and these were to be added on to the penalty.
The case has been referred back to the FSMT in order to determine which partners of the firm would be liable to contribute to the remedy.
Why this matters:
This case acts as a warning to firms which deal in the financial services sector and particularly with overseas companies. It illustrates the necessity for careful due diligence into clients' identities.
Margaret Cole, the FSA's director of enforcement, stated that "this decision supports out view that firms that assist boiler room operators should be brought to task for their role in perpetrating boiler room fraud and share scams. We hope this will send a strong message of deterrence to other firms and individuals that may turn a blind eye to the legitimacy of their clients in exchange for fees or commission".
This case also demonstrates the hard line which the FSA will take for breach of any of its rules. The FSA maintains a list of unauthorised overseas companies which are known to target UK investors for using dubious sales tactics. This case shows that the FSA is being highly vigilant in its monitoring of both authorised companies and unauthorised companies. It is not afraid of bringing costly enforcement action in order to protect investors. Therefore any authorised or regulated company should be careful to follow to rules imposed by the FSA.
A final message of the verdict is that all individual communications that are part of an overall strategy to "reel in" potential investors are likely to be regarded as inducements to engage in the purchase of investments and therefore caught by the "clear, fair and not misleading" requirement as well as the Conduct of Business rules generally.