Non-financial misconduct under the Senior Managers and Certification Regime

April 25, 2023lawfirm_adminNo CommentsCategories: Employment Law

Non-financial misconduct has been an area of increasing regulatory focus for the Financial Conduct Authority (FCA) over the last five years. To date, published regulatory outcomes have focused on the most egregious end of the spectrum, with the FCA handing out bans and fines for those already convicted in the criminal courts of serious sexual offences. However, these cases provide little guidance for FCA-regulated firms grappling with allegations of more nuanced conduct, such as the inappropriate use of social media on a personal account or allegations of bullying or sexual harassment in the workplace.

Whilst not criminal in nature, such personal behaviour inside or outside of work may be relevant to the integrity and reputation elements of a regulated individual’s fitness and propriety.  They may also be vehemently disputed by the employee concerned.
How does the FCA expect firms to deal with allegations of non-financial misconduct?  And how does such misconduct in its various guises fit within the regulatory framework which governs the vast majority of financial services employees?
In tandem with potential disciplinary considerations, there are two principal regulatory components of the Senior Managers and Certification Regime (SMCR) to be worked through by firms dealing with such allegations: fitness and propriety and the conduct rules.

Fitness & Propriety

The fit and proper test is the standard the FCA expects firms to apply to its senior managers, certification staff and non-executive directors (NEDs). Firms are required to assess the fitness and propriety of these individuals for their roles on an on-going basis and to certify them as such at least once a year. The FCA sets out guidance in its handbook (FIT) as to what it expects firms to consider in assessing those individuals’ fitness and propriety. This includes honesty, integrity and reputation, competence and capability and financial soundness.
It is clear from the FIT guidance that this is a broad-reaching assessment which includes personal matters insofar as these relate to the individual’s suitability to perform their function and that non-financial misconduct is relevant to the assessment of fitness and propriety.
Although the question of whether a person’s non-financial misconduct – particularly if it relates to conduct outside work – affects their ability to perform their role in a regulatory context is very fact-specific, the FCA’s enforcement action in this area provides some guidance to firms.
A few examples of cases in which the FCA issued a prohibition order (prohibiting an individual from performing a specified/regulated function) include the following:
  1. Conduct in litigation: The FCA concluded that an individual’s conduct in litigation and the findings and observations of the Court of Appeal during those civil proceedings (regarding his management of a team move from his previous employer) cast doubt over his honesty and integrity. The comments made by the Court of Appeal were such that the FCA felt it was necessary to issue a prohibition order in order to ensure confidence was maintained in the honesty, integrity and reputation of persons in senior positions within the management of UK authorised financial institutions.
  2. Dishonesty outside of work: A managing director at an asset management firm who was caught without a valid train ticket and who admitted evading his rail fair on a number of occasions (knowing that he was breaking the law when doing so) was deemed not fit and proper and subject to prohibition order on the grounds that he lacked honesty and integrity. The FCA held that individuals approved to work in the financial services industry should conduct themselves with honesty and integrity in both their professional and personal capacity, which this individual had failed to do.
  3. Sexual offences outside of work: In 2021, an independent financial adviser was issued with a prohibition order following his conviction for sexual grooming whilst he was an approved person. The FCA decided that the individual was not a fit and proper person to perform any function in relation to any regulated activity because he lacked the necessary integrity and reputation. Similarly, the FCA announced in late 2020 that it had issued prohibition orders against three individuals who had been convicted of serious sexual offences (including sexual assault and the making, possession and distribution of indecent images of children) while working in the financial services industry.
  4. Violence outside of work: In November 2022, the FCA issued a prohibition notice against an individual (senior manager) who was sentenced to three years’ imprisonment having been convicted of wounding with intent to do grievous bodily harm and for being in possession of a machete (the individual had attacked a security guard at a bar). Unsurprisingly, the FCA held that the nature of the offences and the associated publicity following the individual’s conviction, were such that he did not have the requisite reputation to perform functions in relation to regulated activities and was likely to damage the reputation of any regulated firm at which he was required to perform such functions.  It was also held that he posed a serious risk of damage to the reputation of, and public confidence in, the financial services sector.
Although the above examples are extreme, they illustrate how the FCA approaches the question of fitness and propriety in the context of non-financial misconduct. Firms are expected to apply similar principles when carrying out their own fitness and propriety assessments of their staff.

Conduct Rules

The FCA’s conduct rules, on the other hand, apply to a wider population of employees: all of the above categories of staff member plus all other employees except for ancillary staff (such as post-room and reception staff).

There are five ‘individual conduct rules’:

  1. acting with integrity;
  2. acting with due skill, care and diligence;
  3. being open and cooperative with regulators;
  4. paying due regard to customers’ interests and treating them fairly; and
  5. observing proper standards of market conduct.
These individual conduct rules apply to the entirety of the wide group described above. In addition, there are a further four ‘senior manager conduct rules’ which essentially apply to senior managers only. These rules require senior managers to:
  1. take reasonable steps to ensure that the business of the firm for which the senior manager is responsible is controlled effectively;
  2. take reasonable steps to ensure that the business of the firm complies with the relevant requirements and standards of the regulatory system;
  3. take reasonable steps to ensure that any delegation of the senior manager’s responsibilities is to an appropriate person and that the senior manager oversees the discharge of the delegated responsibility effectively; and
  4. disclose appropriately any information of which the regulator would reasonably expect notice.
However, unlike the fit and proper test, the conduct rules only apply to the performance of functions relating to the carrying on of regulated activities (or, for banks, the carrying on of regulated or non-regulated activities). This means that behaviour wholly unrelated to the workplace may raise questions as to that individual’s fitness and propriety for their role but is unlikely to constitute a conduct rule breach.
Consider, for example, a banker using their personal social media account, in their own time, to share inappropriate or offensive (non-financial) information; or an individual who finds themselves in trouble for taking drugs with their friends at a non-work-related dinner party; or perhaps the regulated individual who is overheard making racist remarks on the side-lines of a Saturday football match. Misbehaviour at an after-work social event, on the other hand, may engage the conduct rules, depending upon the degree of connection between the event and the firm’s activities. There will often be grey areas, such as where a relevant incident takes place at an event which involves a workplace team but is not sanctioned or organised by the firm, or where an employee moves from a workplace event to a non-official after-party.

Considerations

Firms should therefore consider the following when dealing with allegations of non-financial misconduct against employees:
  1. What is the regulatory status of the individual? This will determine whether he or she is subject to the fit and proper test, the conduct rules, or both.
  2. If the individual is required to be fit and proper, any found misconduct – whether it is related to the workplace or not – must be considered against the FIT guidance and an assessment made as to whether it impacts the firm’s assessment of the individual’s fitness and propriety for the role held. Honesty, integrity and reputation are the factors most likely to be impugned by non-financial misconduct.
  3. If the individual is subject to the conduct rules, the firm must consider whether these are engaged by the misconduct in question. Does the misconduct relate to the performance of the firm’s activities? If so, have any of the conduct rules been breached? It is individual conduct rule 1 – the requirement to act with integrity – which non-financial misconduct is most commonly considered to breach. However, at the moment, the relevant section of the FCA handbook provides little guidance in relation to non-financial misconduct, with all examples relating specifically to financial- and client-related activities.
  4. The relevant policies of the firm such as its Compliance Manual, Staff Handbook and Disciplinary Policies will be key. Insofar as there might sometimes be a line between “compliance issues” and “HR issues”, they very much overlap in this context and firms need to make their decisions following a fair internal process, which will potentially need to stand up to scrutiny in an Employment Tribunal.

Investigation

A firm’s assessment as to fitness and propriety and the conduct rules should be founded on a proper investigation of the facts and consideration of all the evidence. This may be an investigation by someone independent within the firm or conducted by an external investigator such as an independent law firm. The basis for the decisions made must then be carefully documented. This assessment will determine, where applicable: (i) whether the firm is able to continue to certify the individual as fit and proper for their role or whether certification must be withdrawn; (ii) whether the firm has a regulatory notification obligation and, if so, what form this should take; (iii) whether the firm should take disciplinary action; and (iv) what the firm should disclose in any regulatory reference for the individual which it may be obliged to provide in future.

Guidance

Given the weighty consequences of getting it wrong, particularly in finely-balanced cases which amount to one employee’s word against the other, firms have been calling for clearer guidance from the regulator. It is therefore welcome news that the FCA has promised to publish guidance on this topic in the near future. In the meantime, those looking for indications of the form this may take should perhaps review the guidance on sexual misconduct published by the Solicitors Regulation Authority (SRA) in September last year (and also the SRA’s more general guidance on workplace culture). It sets out the SRA’s approach and its expectations of law firms investigating these type of allegations and lists the factors to be considered as well as providing a number of helpful examples. While the new guidance promised for the financial sector will almost certainly extend beyond sexual misconduct, the SRA guide will undoubtedly be considered by those in Stratford tasked with drafting the FCA’s version. It is hoped that, when published, it will provide practical assistance for firms seeking to navigate what can be a fraught and highly sensitive process for all involved.