Regulatory focus on non-financial misconduct

Why is it controversial?

There are undoubtedly a number of oddities and challenges concerning the FCA’s work in this area so far (at least insofar as this is public). For many years, there was a troublesome lack of certainty on what the regulatory position was in respect of the relevance of non-financial misconduct to the FCA’s regulatory framework and in particular the individual accountability regime under SMCR. This resulted from the mismatch between, on one hand, the FCA’s numerous hints and suggestions in informal speeches that it considered non-financial misconduct incidents to be capable of amounting to breaches of its Conduct Rules (e.g. “non-financial misconduct is misconduct, plain and simple” – 2018) and on the other hand, its refusal until 2023 to commit to a formal policy position by updating its Handbook guidance to reflect that position. The rules in question were specifically Individual Conduct Rule 1, “You must act with integrity”, and Individual Conduct Rule 2, “You must act with due skill, care and diligence”, as well as the definition of “fitness and propriety” within the Senior Managers and Certification Regime. That problem was, to some extent, fixed by the publication in September 2023 of draft Handbook guidance clarifying the FCA’s position (although at the time of publication, that guidance had still not been finalised).

Less easily fixed, perhaps, is the problem of the mismatch between the FCA’s view and that of the Upper Tribunal on the relevance of misconduct in an individual’s personal life to their fitness and propriety to work in financial services. The Upper Tribunal held, in the case of Frensham v FCA, that in order for misconduct in an individual’s person life to be relevant to an assessment of their fitness and propriety, it must be “qualitatively relevant” to their financial services work. The FCA has since stated publicly that it disagrees with the decision in Frensham and has attempted, via its draft guidance published in September 2023, to circumvent it by stating that:

This formulation places upon HR and Compliance professionals the unenviable task of being arbiters of what is “disgraceful or morally reprehensible” for the purposes of applying the fitness and propriety test – this cannot be the intended outcome.

An even more pressing practical issue for firms seeking to do what the FCA wants them to do on non-financial misconduct is the lack of cases on non-extreme facts that would usefully serve as precedents – the cases to date have involved child sex offences and other serious sexual offences, and violent assault using a dangerous weapon (in the case of the FCA’s prohibition orders against Ashkan Zahedian and Ari Harris).

Why is it helpful?

To us, the regulatory focus on non-financial misconduct seems well-intentioned and progressive. Financial services firms are a collection of individual humans no less than any other corporate, and so the risks arising from poor interpersonal behaviour must form part of the wider risk profile and broader picture.

As a regulatory focus area, it also happens to be aligned with legislative change such as the introduction of the new positive duty on all employers to take reasonable steps to prevent sexual harassment at work. In practice, particularly given the Labour government’s planned extension of the regime alongside the re-introduction of third-party harassment provisions, many employers are considering compliance frameworks that go beyond sexual harassment and address discriminatory behaviours more generally.

The FCA’s non-financial misconduct agenda should be viewed in the context of its wider commitment to drive improvements in diversity and inclusion in the financial services sector. The FCA reasons that improving diversity in firm’s leadership teams will bring a broader perspective which, when coupled with an inclusive and positive culture, ought to deliver real improvements in the effectiveness of their risk management. This in itself was the entry-level “Why” behind the FCA’s focus on non-financial misconduct in the FCA’s earlier policy materials on the topic.

However, the thinking now appears to have become more nuanced, driven perhaps by concern about the legal risks that the FCA would face in attempting to tackle via its regulatory framework behaviours that, in more serious cases, may be more suitable for the criminal justice system. As Nikhil Rathi explained in his letter to the Treasury Select Committee on 3 July 2023:

Where is it headed?

Our reading of the position, from recent matters we have seen, is that the FCA has now moved to a position where its non-financial misconduct agenda is fundamentally about governance: the ability of an organisation to identify and manage the non-financial misconduct risks in its business.

Where we see the FCA‘s focus in this area going, recognising the significant legal difficulties they will face in investigating the underlying personal misbehaviour (especially where it borders on the criminal), is to focus on a particular sub-category of cases. That sub-category is where the misbehaviour of one or more senior individuals adversely impacts the ability of a firm to manage risks and/or govern itself properly thus meet its regulatory obligations.

This version of the non-financial misconduct agenda fits well within the FCA’s regulatory remit and thus makes more sense as a way to frame the FCA’s mission statement, rather than focusing their cases upon the underlying behaviours themselves. It also aligns well with the FCA and PRA’s longstanding focus upon governance and culture within firms, which has been a leading focus of their Section 166 Skilled Person review work in recent years.

The flagship case in this area looks likely to be the FCA’s case against Crispin Odey, formerly of Odey Asset Management, which according to an FCA Warning Notice Statement published on 1 November 2024 appears to be framed around the steps taken by Mr Odey to frustrate the disciplinary process by appointing himself as the sole member of the Executive Committee, rather than around the underlying non-financial misconduct itself. The FCA’s Decision Notice against James Staley, which is framed in terms of his failures to disclose to his firm and to the FCA information about his relationship with Geoffrey Epstein, also falls within the sub-category we have outlined above. (This Decision Notice has been referred by Mr Staley to the Upper Tribunal.)

We believe that this is a sensible direction of travel for the FCA’s non-financial misconduct agenda. In our view, it will have the added regulatory benefit that members of boards and board committees, recognising the impact on their personal regulatory exposure if non-financial misconduct is allowed to happen unchecked at tables they are sitting at, will become more effective at policing the behaviours of senior colleagues themselves – we are already seeing this in practice.