Supreme Court rules on principal responsibility

The Supreme Court has handed down its judgment in the case of Kession Capital Ltd (in Administration) v KVB Consultants Ltd and others. It overturned the High Court and Court of Appeal’s surprising view that a principal is responsible for the activities of an AR when the AR dealt with retail clients despite the AR agreement prohibiting it from doing so.

Kession had appointed Jacob Hopkins McKenzie Ltd as its appointed representative. The AR agreement prohibited JHM from dealing with retail clients, but JHM set up several investment schemes, which failed causing investors to lose all their money. It transpired that all but one of the investors was a retail client – although JHM had classified them as professional. Since JHM was insolvent, the investors brought a claim against Kession for the £1.7m lost.

Kession said JHM had acted outside the scope of the permission it had under the AR agreement and therefore was not business for which Kession had agreed to take regulatory responsibility.

The Deputy High Court judge rejected Kession’s argument. The judgment focused on the wording in s39 FSMA which says the principal must accept responsibility for the AR “in carrying on the whole or part” of the specified business – meaning that the principal can limit the permission is gives to the AR to part only of a business. The High Court said that dealing with retail clients could not be described as a distinct “part” of a business, and the ban in the AR agreement on dealing with them was just a contractual restriction which did not affect the rights of third parties. The court was also asked to opine on whether the investment schemes were CISs (which was also forbidden by the AR agreement), and it held that they were. This aspect was not appealed, because the appeal focussed on the retail client issue.

The Court of Appeal agreed with the High Court, saying that it would strip s39 of much of its intended effect if a mistake about categorisation deprived the AR of exemption or the client of protection and it considered whether the limitation on scope was permitted by s49. It decided that because the description of the relevant regulated activities did not in themselves distinguish between client types, it was therefore not sensible to divide the business for clients into different client types. It ended up saying that to allow the principal to limit permission to professional clients would be contrary to investor protection and stuck to this view even if it was the case that the principal did not actually have permission to deal with retail clients. There was one dissenting judgment on this point, noting that since Kession’s permission did not include retail clients, it was therefore not an “authorised person” in respect of dealing with them.

The Supreme Court however unanimously allowed Kession’s appeal, saying that dealing with retail clients does constitute “part” of a business and Kession could perfectly well restrict its AR’s permission to dealing only with professional clients and therefore accept responsibility for its actions only when it dealt with professional clients. Part of the reasoning was that, not only was it reasonable to draw a distinction between, say, business and retail customers in any business, but the FCA regime makes an important distinction between retail and professional clients. Given especially that the FCA can grant permission to a firm to deal only with professional clients, this goes to support the argument that dealing with retail clients is a distinct “part” of a business.

The judge went on to say that:

• it would undermine effective regulation if a principal who lacked expertise in dealing with retail clients was required to monitor, supervise and take responsibility for an AR dealing with them – and made the point that if the principal’s permission did not include the ability to deal with retail clients it would not be “sensible” to make it take responsibility for an AR dealing with such clients;
• regardless of whether the principal’s permission allows it to deal with retail clients, the principal is entitled to form the view that the AR is not qualified to do so, and again it would therefore make little sense to require the principal to be responsible for the AR’s dealings with them;
• if dealing with retail clients is not a “part” of the permitted business, then an AR that is not allowed to deal with them would not incur any penalties if it chose to do so regardless, which the judge said would not be a result “calculated to improve consumer protection; and
• it would be unfair and regulatory overkill to make an authorised person responsible for its AR doing something the firm had expressly banned it from doing.