Non-financial misconduct in financial services firms

00:00:05 David Lee, Host

Hello and welcome to ‘Podcasts by Brodies’. My name is David Lee and in this episode we're looking at changes relating to the handling of non-financial misconduct in the financial services sector.

In the wake of the MeToo movement and a number of high profile cases in regulated financial services firms, the Financial Conduct Authority is taking steps to increase scrutiny of non-financial misconduct in the sector, so I'm delighted to welcome today Brodies employment lawyers, Tony Hadden and Chris Boyle, to discuss the context of these changes and what regulated businesses in the financial services sector need to be aware of when dealing with non-financial misconduct allegations. Welcome to you Chris and Tony.

And coming to you, first of all Chris, I'd like to get a few definitions out the way at the start of these podcasts. When we're talking about the Financial Conduct Authority, what is it and what is its relevance to this podcast?

00:01:08 Chris Boyle, Senior Associate, Brodies LLP

Hi David, so the Financial Conduct Authority or the FCA as it's known is one of the financial regulators in the UK and it regulates the conduct of financial services firms.

Now, the reason we're discussing the FCA today is that over the last few years, they've placed an ever-increasing emphasis on non-financial misconduct. They have made it clear that they treat it very much as a risk and regulatory issue, whereas previously instances of non-financial misconduct may have fallen squarely within the realms of employment law.

Now this is culminated in proposals by the FCA for incorporating non-financial misconduct into the regulatory rules, which we'll go on to talk about.

00:01:53 David Lee, Host

OK, and when you're talking there, Chris, about non-financial misconduct, what does that encompass? What is the breadth of the definition of non-financial misconduct?

00:02:04 Chris Boyle, Senior Associate, Brodies LLP

That's a very good question, so the FCA has on numerous occasions repeated the mantra that non-financial misconduct is misconduct and have looked to enforce this through their fit and proper tests, which requires individuals to satisfy criteria in relation to honesty, integrity and reputation.

However to date, there's been limited guidance on what this actually means in practice, because the rules primarily focus on financial misconduct - for example, fraud or dishonesty.

Now that being the case, we can take from various public statements of the FCA and also the FCA's use of its enforcement powers that, broadly speaking, they regard non-financial misconduct as being any sort of criminal behaviour or bullying, harassment or discrimination. And this very much tracks through to their proposed rules.

00:03:03 David Lee, Host

So why now then Chris? What is the specific background here? Why have these changes been proposed at this particular point in time?

00:03:15 Chris Boyle, Senior Associate, Brodies LLP

So David, just to echo what you said at the outset of the podcast, the impetus for change and approach can be traced back to the MeToo movement in 2018. And with that, the shift in society’s expectations and how this sort of behaviour should be treated. And regulators are very much at the forefront of that.

So although there's nothing specifically touched upon in the rules, the FCA have been more assertive in tackling this in recent years.

00:03:45 Tony Hadden, Partner, Brodies LLP

Just to echo what Chris is saying, we've seen across the whole of employment law in the UK a much more significant emphasis placed on what HR practitioners would call culture. New recruits and existing employees and customers - and even suppliers - are examining the way that organisations regulate behavior between their employees as a marker of whether that organisation is one they want to join, one they want to do business with or one they want to buy products from. So I think this emphasis from the FCA is broadly echoing a general trend in society where the examination of how we talk to each other and how we behave towards each other is increasingly important.

00:04:34 David Lee, Host

Ok thanks very much Tony, very interesting and Chris, just coming back to the nuts and bolts again, what timelines are we talking about here? When are we expecting to see these changes come into force?

00:04:46 Chris Boyle, Senior Associate, Brodies LLP

So the proposed rules were published towards the end of last year, with the consultation paper closing in December. On publication of the final rules, which we expect at some point this year, the new rules will come into force 12 months from the publication. So we expect at some point in 2025.

00:05:09 David Lee, Host

Ok, and we've talked in general terms there about the sort of societal changes in the culture of workplaces, we've talked about the MeToo movement, but are there any specific cases, Chris, that have really, you know, turned the dial up and led to an increased push for changes like this?

00:05:30 Chris Boyle, Senior Associate, Brodies LLP

Yes, so the proposals appear to be an attempt to address some limitations in enforcement, which are highlighted in, for example, a case called the Frensham case and the possible lack of clarity and the relevance of an individual's conduct in their private life on their regulatory status.

So just looking at the Frensham case, first of all. John Frensham had a criminal conviction for child grooming offences. And although the individual was found by the upper tribunal not to be a fit and proper person due to lack of integrity for other reasons, on the criminal offence element, it was held that the FCA had not made out the case that his criminal conviction had anything to do with his actual professional life and carrying on his regulated activities. So although he was held not to be fit and proper, as I said for other reasons, the FCA had failed to establish the link between the actual offence and their statutory objectives.

00:06:32 David Lee, Host

Tony, do you want to come in on that?

00:06:34 Tony Hadden, Partner, Brodies LLP

Thanks David. It's a theme we see across the regulatory sphere, so if you look at some of the most powerful regulators in the UK, the Solicitors Regulatory Authority and the FCA being two of those, the extent to which a regulator of a profession or in the finance sector's case, a regulator of the most senior people in that industry, can reach into somebody's private life and say, because of this, we don't think you should be allowed to do your job. The way that the law regulates that interface is something that's been developing for a number of years. And previously, most regulatory and employment lawyers took the view that it was for an employer to establish the boundary between interference with what someone does in their private life and the impact it might have on their job. HR practitioners in banks and financial services businesses as well as others, are super familiar with trying to articulate the reputational impact that, for example, a criminal offence which is publicised in the local newspaper, might have on their business. But regulators struggled to properly define that boundary line and I think one thing that's happened both with the SRA and with the FCA is that they see certain private life matters as now being directly relevant to concepts which they have jurisdiction over. Chris mentioned the fit and proper test for senior individuals in the finance sector. There's a broad principle in the FCA's regulatory approach, which is that you have to act with integrity. And most people understand that integrity is a very broad word, so some of these changes, which the FCA will say are not changes, but probably clarifications of where that boundary line sits. They rest on the extent to which a lack of integrity in your private life can potentially influence both how that organisation operates, but also how people might perceive that organisation. So there is still some link to the workplace, but I think these changes push the boundary much further into our private lives than was previously the case.

00:09:00 David Lee, Host

Ok, thanks very much. Tony touched a little bit there, Chris, on senior executives within companies. Can you tell us a little bit about these different levels of firms that might be impacted on by these changes? So senior executive level, organisational level more generally, but also at an individual level within a firm? There's quite a lot to think about.

00:09:27 Chris Boyle, Senior Associate, Brodies LLP

Yeah, so this probably goes back to the nuts and bolts of the actual changes. So the rules seek to integrate non-financial misconduct considerations in three ways:

- looking at fitness and propriety tests

- the conduct rules, and also

- the threshold conditions.

In terms of the fitness and propriety tests, for senior managers and certified staff, that’s staff who could present significant harm to the business, they're required to satisfy fitness and propriety assessments.

So what the rules do for those individuals, those senior managers and certified staff, is they confirm that misconduct in a person's personal or private life may be relevant to assessment of fitness and propriety. And this is where, for example, if repeated in work, it would breach regulatory standards; so, for example, violence or sexual misconduct.

If the conduct shows a person lacks - and this is said in the proposals - moral soundness, rectitude, and steady adherence to an ethical code or behaviour, again this is taken from the guidance, that is disgraceful or morally reprehensible, or otherwise sufficiently serious. So we see here that the FCA are trying to capture some of the gaps potentially that they weren't able to do so from the Frensham case, but it doesn't stop there. The FCA says misconduct can also be relevant where it doesn't otherwise involve a breach of regulatory standards or there's little or no risk that behaviour can be repeated and is being repeated in work. So that's the fitness and propriety test.

In terms of conduct rules, which is the second level of changes which the FCA are proposing to introduce, those apply to a wider spectrum of employee population. So those apply to all employees carrying out financial services activities, so wouldn't apply for example to receptionist or facility staff but would apply to most other individuals and to echo what Tony was saying, there's a high level set of rules for individuals to comply with, one of which involves the requirement to act with integrity.

There's also an additional set of conduct rules applying to senior managers. So in terms of the proposals on the conduct rules, they expand the rules to incorporate non-financial misconduct examples into what would otherwise amount to a breach of acting with integrity. So the examples used include bullying, harassment, discrimination.

But the key thing to note in terms of the conduct rules is it's more limited in scope than the fitness and propriety rules, so it doesn't apply to parts of a firm’s business that do not carry out regulated activities, and it doesn't apply to an individual's private or personal life. And in drawing that distinction, which is sometimes a very difficult line to draw, the FCA provides an example of misconduct where misconduct by an employee occurs against a fellow employee at a social occasion that they attend in a personal capacity. The FCA says that generally will not fall within scope.

However, where there's misconduct at a social occasion organised on behalf of the firm or attending on behalf of the firm, they said that would generally fall within scope.

And the third thing to say is that this conduct is only caught by conduct which is serious.

And in contrast to employment law, where the focus is on effect rather than purpose generally, an individual in terms of breach of contract rules also has a defence here. So where they say there's a good reason for the conduct, provided that the belief is reasonable; they didn't intend that their behaviour would have a negative impact, didn't know that their behaviour was going to have that effect, and they weren't reckless about the effect of their misconduct. Now how that defence could be used in practice, we'll wait and see and that will only be when cases come before courts or tribunals. But it'll be interesting to see how that is used or how seldom that is used when the rules actually come into force.

And just to finish off on the 3rd point in terms of at the company level, the FCA proposes to extend the guidance on what are suitability threshold conditions and these are effectively the minimum standards a firm must satisfy to remain fit and proper.

So the FCA has been clear that included within that assessment is where there's been sexual or racially motivated offences within a firm or there's been discriminatory practices within a firm. So it goes very much to a systems and controls issue as well, in addition to being at a senior level and at an individual level.

00:14:34 David Lee, Host

Ok, thanks very much Chris. So we'll just turn that around, you've outlined there quite a lot of considerations that firms are going to need to take, quite a lot of nuances. If there is a case that a firm believes to be non-financial misconduct, what are their obligations? If they think this looks like a case of non-financial misconduct, what do they have to do in terms of reporting it to the regulator?

00:15:03 Chris Boyle, Senior Associate, Brodies LLP

So in terms of reporting requirements, that varies depending on the regulatory status of the employee and also the type of rule breach. So from a fitness and propriety perspective, if someone falls below the standards and aren't deemed to be fit and proper, in the case of senior managers, the firm must report this to the FCA, and where there's a breach of fitness and propriety, this has to be done within one business day of them becoming aware of this information in relation to a senior manager.

In the case of certification staff, and I explained who certification staff were earlier on, the firm should refuse to renew their certificate for fitness and propriety, and the firm must take reasonable care to ensure that individual ceases to perform the function in question. But there's no requirement to report for certification staff.

In relation to conduct rule breaches, if disciplinary action is taken in relation to any conduct rule breaches, again in relation to senior managers, firms must make a notification to the FCA as soon as practical, but within seven days in any event and in relation to other staff, there's an ongoing reporting obligation so they must do this on an annual basis.

00:16:24 David Lee, Host

Great, ok thanks very much Chris and just coming to you Tony, what about some of the wider implications here for regulated firms where financial misconduct is concerned? What do they need to think about in terms of reputational risk, future recruitment, etc?

00:16:42 Tony Hadden, Partner, Brodies LLP

Yeah, I think it's a great question, and there's quite a few aspects to the answer.

The first thing that regulated businesses should be aware of is that from the FCA's perspective, I don't think this issue is going to go away and we have some clients who operate in the insurance part of the financial services landscape and they've already been served with what the FCA have described as an information request, asking them for information about non-financial misconduct over the past three years. And it's clear that what the FCA is going to do with that type of information is help it to inform its policy in the future. So there is always the possibility that the FCA uses those information-gathering powers with other parts of the financial services industry, or even with specific firms if issues arise.

In terms of reputational risk, I think that's pretty obvious in terms of the finance sector. It is a reputation-based business, so whether it's business to business sales or business to consumer sales, people need to feel as if they can trust their financial services partner or supplier.

And the way that businesses deal with significant issues of, for example, sexual harassment significantly impacts on the public's perception of that organisation. And if you need an example of that, the CBI issues recently are pretty much a case in point.

In terms of recruitment, I think in every part of society, but particularly in white collar jobs, the next generation of applicants have high expectations of their firms. They certainly Google check the business they're applying to, not least to get some information for the interview, but much more I think commonly nowadays than perhaps when I started, they want to know about culture so they look at publicly available information. They'll look at the gender pay gap information, they'll Google to see whether employment tribunal claims have been raised and found against the business, and they'll also Google press reports, so sexual harassment claims in particular remain of significant interest to the wider society and the press will pick up on claims that are brought or sometimes even grievances.

So having a robust, fair objective and nowadays transparent system for dealing with these issues is no longer a nice to have, I think it's required.

00:19:31 David Lee, Host

Thanks very much, Tony. Chris, do you want to come in and add something there?

00:19:34 Chris Boyle, Senior Associate, Brodies LLP

Yes, I'd just add, there's also the impact on references. So regulated firms are under an obligation to provide regulatory references. So this expands the scope of considerations that a firm would need to take into account to any prospective employer that comes back to a firm and asks for regulatory reference. So non-financial misconduct should be included in that as well.

00:19:59 David Lee, Host

Ok thank you. And coming back to you, Tony, we've talked there about reputational risk, we've talked about recruitment. What about the nitty-gritty of business, what might be some of the implications for investment and pitching and tendering for new work as well?

00:20:15 Tony Hadden, Partner

Yeah, I mean this has been a growing feature of societal change. And I guess the global phrase for it is contract compliance. So that is large customers requiring suppliers to demonstrate as a condition of receiving the work, so the mandate to manage funds or the opportunity to ensure a risk, as a requirement of being allowed to provide that business, many businesses are required to demonstrate not only that they have effective procedures in place to manage these issues, but also sometimes to list out the number of times that they've received an employment tribunal claim for sexual harassment or for discrimination.

So that level of contract compliance and that increased aspect of transparency is something that's been a feature of business life, but is definitely increasing and particularly with ESG and other standards being available for businesses, particularly in the finance sector, being able to demonstrate that your supply chain adheres to the same cultural values that you do if you're at the top of that tree, is something that's required.

00:21:38 David Lee, Host

Ok, thank you. And we touched on this a little bit with Chris in terms of what specifically needs to be done in the event of a claim of non-financial misconduct, what process does a firm need to follow if it is investigating and then dealing with non-financial misconduct?

00:22:01 Tony Hadden, Partner, Brodies LLP

Well the good news is that it's the same process that they would have followed to deal with financial misconduct. So issues that previously fell squarely within the regulators compass were investigated by finance sector firms and have been for a couple of decades, so there's no change to that process. The need for HR to liaise properly with the compliance team, the need to consider the reporting obligations that Chris talked about, some of which are very prompt, the need sometimes to consider whether the investigation could lead to a professional loss of the ability to practice your profession, in which case the safeguards that are built into the disciplinary process for the alleged perpetrator are significantly more important, and also the stakes will be significantly higher. The challenge with non-financial misconduct, and you alluded to this at the very beginning of our podcast, is sometimes defining what it is. So the new challenge from this increased focus by the regulator is making sure that HR teams - because it usually will be an HR team who ends up with the information about the criminal offence, about the harassment in the private life, about whatever it is - recognise that that is now something that engages all of the compliance arms of the firm, that an insider trading issue would deal with. So it doesn't need a different process, but it does need that more sophisticated process to be applied to a wider range of issues.

00:23:50 David Lee, Host

And Tony you've talked about HR and you've talked about compliance. How important is it in dealing with this, what really is still quite a fast moving and emerging issue in financial services? How important is it for all the parts of the firm to be singing from the same hymn sheet on this and making sure that the governance of looking at non-financial misconduct works effectively?

00:24:20 Tony Hadden, Partner, Brodies LLP

Well, what you've described is the Holy Grail, and if I knew how to make sure that in every case all parts of a business could sing together in harmony, I would be far richer than I am and far more successful. And I don't think anyone has fully solved that conundrum.

I think the big point is making sure that within your business you have a system in place for the right people to be told about the right level of information at the right time. And as I say, this isn't a new process because we've always had to, for example, investigate insider trading or Libor rigging or other things which are very difficult to deal with, which are potentially career ending and which have a significant regulatory overlay.

Financial services businesses have always had to deal with that. It is more difficult when you're investigating something that may have happened in a private capacity or at least more removed from the workplace capacity. It's harder to maintain confidentiality if some of the witnesses are not your employees.

It's more difficult to investigate certain things if they happened in very private settings where there aren't other witnesses and there aren't necessarily emails, so all of the challenges that HR professionals are very used to dealing with when they investigate private life issues, those are now layered on top of all of the issues that HR and compliance professionals are used to when dealing with issues which have a regulatory overlay, so you're really almost doubling the layer of complexity there.

00:26:04 David Lee, Host

And you talked earlier on Tony, about the changing culture being right at the heart of this and the change in what we expect in terms of behaviour. We've also heard about trust, we've heard about integrity, these are quite challenging concepts to map against what the regulator can and can't do. Does that make all these changes particularly interesting for employment lawyers to grapple with this? It sounds like it's going to throw up some very interesting challenges for you.

00:26:37 Tony Hadden, Partner, Brodies LLP

Well Chris and I have made a decision to dedicate our lives to employment law because we love it, and one of the reasons why we love it, and Chris will no doubt tell you whether I'm right or not about him but I think I am, is because what we do changes as society develops. So when I started as an employment lawyer it wasn't specifically illegal to discriminate against gay people, and it's now almost unthinkable that an employer would say no, you're not getting that job because you're gay. That's been a societal shift. And I think in terms of this regulatory action, where people breach expected norms in their private life it just reflects a societal trend that says we need to regulate the way that people interact with each other. We're in Scotland, where we've had a lot of debate up here about the Hate Crime and Public Order Act that the SNP Government brought in which came into force at the beginning of April. An attempt to codify all of the statutes in the criminal law that tell us how we should behave towards each other, particularly on social media. We've also got very recently the Worker Protection Amendment of Equality Act which was imposing a positive obligation on employers to take steps to prevent sexual harassment in the workplace, so we can see through that and through the continuing emphasis in all sectors, but particularly the finance sector, on whistle blowing and the FCA's really robust expectations of firms in relation to how they handle people who say something's going wrong here, something's not right. That seems to me to be reflected in the FCA's pushing of that boundary and that seems to me to reflect a societal trend that there is a need for us to agree as a country, as a society, on how we should treat each other. And that's what the FCA is trying to grapple with, and that's what some of those other pieces of legislation are also dealing with.

00:28:54 David Lee, Host

Ok thank you. And maybe just a final word from you both then. There's a lot to unpack here – it's a cliche, I really don't like and I don't know why I used it there, but there's a lot to think about. What do you think the overall impact might be on the financial services industry of everything we've talked about today, Tony and Chris?

00:29:18 Tony Hadden, Partner, Brodies LLP

Ok, for me it emphasises and probably increases the importance of your human resources function cooperating with the other functions in the business. And it means that your senior managers, and Chris talked a bit about the senior manager regime earlier, the senior managers essentially being the bits of your business that control what actually happens. Senior managers have to have confidence that the systems and controls, the processes, and the team that implement those processes are able to deal with all those issues we've talked about. So this will mean that in the regulated financial services sector, the importance of human resources and compliance teams will increase.

00:30:13 Chris Boyle, Senior Associate, Brodies LLP

I would agree with that. The rules seem a natural progression from the FCA's perspective, and it's consistent with the publications they've made over the last couple of years, but in terms of what Tony was saying, ensuring that training senior management are equipped to deal with the oncoming challenges of the next few years when the rules actually come into force will be key.

00:30:37 David Lee, Host

Ok, thank you very much indeed to Chris Boyle and to Tony Hadden for their terrific insights today on what is a very complex and fast-moving subject. You've been listening to ‘Podcasts by Brodies’, where some of the country's leading lawyers and special guests share their Enlightened Thinking about major issues and developments affecting the legal sector and what that might mean for organisations, for businesses and individuals across various sectors of the UK economy and wider society.

If you'd like to hear more, please subscribe to ‘Podcasts by Brodies’ on all the main podcast platforms. And for more information and insights, please visit brodies.com .