UK Upper Tribunal restricts the FCA's interpretation of consumer redress schemes

The Upper Tribunal, in an important decision in BlueCrest Capital Management (UK) v Financial Conduct Authority (FCA), has resoundly rejected the UK financial regulator's attempt to impose a single-firm consumer redress scheme on the basis of its operational objective of consumer protection, without first establishing a breach of duty, loss, causation and actionability by way of legal proceedings. A finding of a breach of one of the FCA's Principles for Business was not enough. 

In doing so, the tribunal has made it clear that the standards required to impose a statutory consumer redress scheme on a single firm are no less high than the standards required to impose a consumer redress scheme across multiple firms as a result of an industry-wide failure. 

Compensation mechanisms

There are a number of mechanisms by which financial services consumers can obtain redress from firms if something goes wrong. They can make a complaint to the firm and, if unsatisfied with the response, proceed to make a complaint to the Financial Ombudsman Service. They can also – in addition or as an alternative – seek compensation through the courts. 

The FCA, by statute, has the power to impose redress schemes on the firms it regulates. There are three statutory mechanisms by which it can do that. First, under section 404 of the Financial Services and Markets Act 2000 (FSMA), the FCA can require firms to establish and operate a compensation scheme if there has been an industry-wide failure by firms to comply with regulatory requirements, which has caused consumers loss for which they could obtain a remedy if they brought legal proceedings against the firm. This mechanism has been used in relation to the Arch Cru funds and unsuitable defined pension transfer advice in respect of the British Steel Pension Scheme. 

Second, it can require firms to make restitution under section 384 of FSMA if they have breached a regulatory requirement (or been knowingly concerned in one) and profits have accrued or others have suffered loss. This power was used to require the credit card provider, Vanquis, to pay compensation to customers for failing to disclose the full price of an add-on product called Repayment Option Plan. 

Third, under sections 404F(7) and (8) of FSMA, it can vary a particular firm's permission or authorisation under section 55J or impose an own-initiative requirement on a particular firm under section 55L, requiring the firm to establish and operate a consumer redress scheme.

Finally, albeit non-statutory, it can seek to use firms' obligations to be open and cooperative with the FCA to compel firms to agree to undertake a redress scheme, either with or without the appointment of a section 166 "skilled person". This has been done in the context of unaffordable lending by high-cost short-term credit lenders and the mis-sale of interest rate hedging products by a number of the major banks. 

Appeals from the FCA's exercise of its statutory powers are determined by the Upper Tribunal. In BlueCrest v FCA , the Upper Tribunal has significantly restricted the FCA's interpretation of its powers to impose a single-firm consumer redress scheme under sections 55L, 404F(7) and (8) of FSMA.

The facts

In September 2021, the FCA issued a First Supervisory Notice (FSN) to BlueCrest Capital Management notifying BlueCrest of its decision to impose upon it a requirement to pay redress under section 55L. The context to the FSN was the FCA's determination that BlueCrest had failed to manage fairly and disclose conflicts of interest in breach of Principle 8 when it reallocated portfolio managers from funds open to external investors to funds, which were only open to partners and employees, thereby favouring those internal investors. The FSN sought to require BlueCrest to pay redress to the external investors because of the sub-standard investment management service being provided to the external fund as a result. The FCA proposed also to fine BlueCrest £40.8 million. 

The arguments before the Upper Tribunal

BlueCrest challenged the FCA's imposition of the requirement to pay redress under section 55L of FSMA to the Upper Tribunal. Its argument was that the section 55L power was subject to sections 404F(7) and 404F(8) of FSMA.

Under sections 404F(7) and 404F(8) of FSMA, the FCA has the power to impose an own-initiative requirement on a particular firm under section 55L requiring the firm to establish and operate a consumer redress "scheme which corresponds to, or is similar to, a consumer redress scheme …[which] includes (a) provision imposing requirements on the person corresponding to those that could be included in rules made under section 404". 

Under section 404(1), the power of the FCA to make rules requiring the establishment and operation of an industry-wide or multi-firm consumer redress scheme is expressly subject to three pre-conditions: (a) it appears to the FCA that there may have been a widespread or regular failure by relevant firms to comply with requirements applicable to the carrying on by them of any activity; (b) it appears to it that, as a result, consumers have suffered (or may suffer) loss or damage in respect of which, if they brought legal proceedings, a remedy or relief would be available in the proceedings; and (c) it considers that it is desirable to make rules for the purpose of securing that redress is made to the consumers in respect of the failure (having regard to other ways in which consumers may obtain redress). 

Section 404A then provides further detail of the scope of the rules that can be made under section 404, including matters to be taken into account for the purpose of determining whether a failure to comply with a regulatory requirement has caused (or may cause) loss or damage to consumers, with those matters being restricted to those that would be taken into account by a court or tribunal for that purpose.

BlueCrest argued that the power in section 55L, therefore, by virtue of sections 404F(7) and 404F(8), was also subject to the same pre-conditions in sections 404 and 404A, specifically that (i) persons must have suffered loss or damage; (ii) that loss or damage must have been caused by a wrong on the part of the firm; (iii) the loss or damage must have been suffered by a person or persons to whom the relevant regulatory duty was owed; and (iv) the wrong that caused the loss or damage must be an actionable wrong (being a wrong in respect of which a remedy or relief would be available in legal proceedings). 

In respect of the need for the wrong to be actionable, consumers have a private right of action for damages under section 138D of FSMA if they suffer loss as a result of a firm's breach of a regulatory rule. However, consumers do not have a private right of action for damages under section 138D of FSMA in respect of an alleged breach of one of the FCA's Principles for Business, such as Principle 8 (see the FCA's Principles for Business PRIN 3.4.4R and section 138D(3)). This is on the basis that the principles are a statement of regulatory expectations, not a set of legal rights at large. 

By contrast, the FCA argued that its imposition of the requirement to pay redress was purely under section 55L of FSMA, which expressly allowed the FCA to "require the person concerned to take specified action" (section 55N(1)) and "refer to the past conduct of the person concerned (for example, by requiring the person concerned to review or take remedial action in respect of past conduct)" (section 55N(5)).

By section 55L(2), the FCA's use of its section 55L own-initiative requirement power was only subject to the pre-condition that it "appears to the FCA that […] it is desirable to exercise the power in order to advance one or more of the FCA's operational objectives", the relevant operational objective being to secure an appropriate degree of protection for consumers under section 1C(1) of FSMA. 

Section 55L, so the FCA said, was a freestanding, broad and flexible power, meaning that the requirements of sections 404F(7), 404 and 404A do not apply before it can impose a single-firm consumer redress scheme. It was not, therefore, necessary for any breach to be actionable by customers or customers to have suffered any loss as a result before the FCA can require the provision of redress.

The Upper Tribunal's decision

The tribunal resoundly rejected the FCA's interpretation of its powers. 

In an extremely robust and fully reasoned decision, and having gone through the history and development of the relevant statutory provisions, the tribunal considered that the FCA's interpretation would create a "surprising result", in that it would allow the FCA to compel a firm to pay a significant amount of redress (in this case over US$700 million) without there being any statutory requirement on the FCA to establish that the firm owed the customers any duty, those customers have suffered loss, the loss was caused by a breach of that duty by the firm, and the breach which caused the loss or damage was an actionable wrong, being a wrong for which legal proceedings could be brought. 

In the tribunal's view, it was clear that the power in section 55L is constrained by the terms of section 404F(7) and the rules under 404, namely section 404A, and the FCA is required to establish causation, loss, duty and actionability before a redress requirement may be imposed upon a single firm, just like before a redress requirement may be imposed on multiple firms. In respect of actionability, any failure to comply with a principle, such as Principle 8, cannot be taken into account for the purposes of a single firm redress scheme imposed under sections 55L and 404F(7), even if it has caused loss to a consumer. 

Osborne Clarke comment

The Upper Tribunal's decision is clearly right. As it said, on the FCA's interpretation, the regulator could impose a redress scheme on a firm without needing to show that the firm had even breached a regulatory requirement at all or that the redress proposed even related to regulated activities. That would produce "unreasonable or absurd results". 

As the tribunal aptly (but politely) noted it cannot reasonably have been the intention of Parliament to impose restrictions on the FCA implementing a multi-firm consumer redress scheme, if the regulator could at the same time bypass those restrictions by simply imposing unfettered consumer redress schemes on as many firms as it liked on a firm-by-firm basis. Further, if section 55L gave the FCA the autonomous unfettered power to impose a redress scheme on a firm if desirable for operational objectives without more, then the additional power to impose a redress scheme on an individual firm under section 404F(7) that was granted to the regulator subsequently would not have been needed at all. 

The tribunal clearly considered the FCA's arguments wholly devoid of merit and spent some time going through the regulator's own published guidance and handbook chapter on how it would use its power to impose a single-firm consumer redress scheme in section 404F(7) as supporting the tribunal's construction, noting the lack of any suggestion that the FCA also had a separate, parallel and standalone power under section 55L to impose a consumer redress scheme on a firm.

We have seen, in practice, the FCA using the threat of an own-initiative variation of permission as a "stick" to persuade firms voluntarily to agree to consumer redress schemes. While the "stick" of Principle 11 remains, of course, this decision will give some support to firms who, in appropriate circumstances, want to push back on compensating customers where, for example, they do not consider customers would have a legal claim for compensation against them if legal proceedings were brought.