Financial Services and Markets Act 2000

Is section 150 Financial Services and Markets Act 2000 incompatible with European Law?

The last few months have seen a number of articles in the press about allegedly mis-sold interest rate swaps by banks and other financial institutions. A number of claims are proceeding with backing from funders such as Norton Accord. Many others remain under consideration by claimant lawyers, involving, as many do, complex questions in respect of contract, agency, misrepresentation, negligence and the application, or otherwise, of the Financial Services Authority’s Conduct of Business rules. Affected businesses have banded together under the umbrella of ‘Bully Banks’  to provide mutual support for such litigation.

So far, some defendant banks have relied upon Section 150 Financial Services and Markets Act 2000 (‘FSMA’) (as amended) against claims by limited companies over interest rate swaps. Section 150 FSMA restricts the application of FSA COB rules to a ‘private person’. Although the term ‘private person’ is not found in the interpretation section of the FSMA, the Financial Services and Markets Act 2000 (Rights of Action) Regulations 2001 defined the term as:

“Private person

3.  – (1) In these Regulations, “private person” means –

(a) any individual, unless he suffers the loss in question in the course of carrying on –

(i) any regulated activity; or

(ii) any activity which would be a regulated activity apart from any exclusion made by article 72 of the Regulated Activities Order (overseas persons); and

(b) any person who is not an individual, unless he suffers the loss in question in the course of carrying on business of any kind;

but does not include a government, a local authority (in the United Kingdom or elsewhere) or an international organisation.”

In Titan Steel Wheels Limited v Royal Bank of Scotland [2010] EWHC 211 (Comm), Mr Justice David Steel considered, as a preliminary issue, whether the Claimant was a ‘private person’ for the purposes of section 3(1)(a) of the Financial Services and Markets Act 2000 (Rights of Action) Regulations 2001 or whether Titan were caught by the exclusion in section 3(1)(b):

46. ‘ The threshold issue for determination at this stage is whether Titan is a “private person”. This raises what should be a short point of construction. It is the Bank’s case that Titan, whilst being an incorporated individual, falls within the proviso or exception to Reg. 3(1)(b). It is submitted by Titan that on the true construction of the regulations the question for the Court is whether currency trading of the sort that occurred in 2007 was an integral part of Titan’s business as opposed to an incidental part of its business. 

The Learned Judge concluded:

75. ‘In any event, even if the purchase of foreign exchange products was merely incidental to Titan’s business, the scale and frequency of the hedging is well sufficient to satisfy any requirement of regularity justifying the categorisation of such activity as being integral with the business:

i) Between 2000 and 2007 Titan purchased 23 structured foreign currency products from the Bank.

ii) In addition Titan purchased 20 similar products from Anglo Irish Bank and Allied Irish Bank.

iii) The overall figures amounted to between €100m and €200m. In 2006 alone (as reported to Mr. Wicks) Titan entered into foreign exchange products worth a total of €25 million.

iv) In addition, Titan also entered into frequent short term swap arrangements.

76.  I reject Titan’s submission that this reflected merely sporadic and intermittent activity fully outside the course of Titan’s business. To the contrary, the trades were sustained, large scale and a necessary concomitant of Titan’s trading. For all the above reason, I hold that Titan was not a “private person” for the purposes of the FSMA.

If the courts follow Titan, they will hold that section 150 FSMA only applies to individuals and not corporate entities.  In Grant Estates v Royal Bank of Scotland, the Pursuer company argues that section 150 FSMA should not apply to the company. Judgment is awaited in the next few weeks.

The Financial Service Authority’s COB rules, upon which many of the present actions on interest rate swap products rely, are based upon EU Directive 2004/39/EC (‘the Directive’).

One of the objectives of the Directive is to protect investors. Article 1 (31) of the Directive says: ‘Measures to protect investors should be adapted to the particularities of each category of  investors (retail, professional and counterparties)’.  

Annex II of the Directive defines a professional client as:

…a client who possesses the experience, knowledge and expertise to make its own investment decisions and properly assess the risks it incurs.’

Annex 1 (1)(a)-(i) lists the following as professional clients:

(a)    Credit institutions, (b) Investment firms,(c)  Other authorised or regulated financial institution,(d)  Insurance companies, (e) Collective investment schemes and management companies  of such schemes, (f) Pension funds and management companies of such schemes,(g)  Commodity and commodity derivative dealers,(h) Locals, (i) Other institutional investors.

Annex II (2) also includes ‘large undertakings’ as professional clients, but only if they meet two of the following requirements on a company basis:

–          Balance sheet total              EUR 20,000,000

–          Net turnover                         EUR 40,000,000

–          Own funds                            EUR 2,000,000

Thus the Directive does not define any company or individual as a professional client if they do not meet the requirements of Annex II(2). It is submitted that such companies must therefore either be retail clients or counterparties who do not possess the relevant ‘experience, knowledge and expertise to make [its] own investment decisions’ for the purposes of the definition of professional clients found in Annex II (1) of the Directive; and who are entitled to a higher level of protection than professional clients.

From the figures referred to (at paragraphs 75-76) by Mr Justice David Steel in Titan, it is almost certain that Titan Steel Wheels Limited exceeded the financial requirements in Annex II(2) of the Directive and thus was a professional client who had the experience, knowledge and expertise to make its own investment decisions and properly assess the risks it incurred.

However, the decision in Titan  did not take account of the Directive relying, as it did, upon the exclusionary provision in  section 3(1)(b)  Financial Services and Markets Act 2000 (Rights of Action) Regulations 2001. So is it still open to Claimant companies who do not meet the financial requirements in Annex II(2) of the Directive to argue that they are ‘private persons’ entitled to protection as retail clients?

By permitting only ‘private persons’ to seek redress, Section 150 FSMA 2000 and the Financial Services and Markets Act 2000 (Rights of Action) Regulations 2001 are arguably incompatible with the aims of the Directive, as those companies who do not     meet at least two of the financial criteria in Annex II (2) are denied the ‘high level of protection’ in Article 1(2) of the Directive addressed by the FSA’s COB rules.

It is therefore submitted that banks cannot rely on section 150 FSMA 2000 and the Financial Services and Markets Act 2000 (Rights of Action) Regulations 2001 to defend claims for mis-selling of interest rate swap products, unless the claimant meets the criteria for a ‘Large undertaking’ in Annex II (2) of the Directive.

However, the banks may well argue that the Directive is not horizontally effective between the contracting parties since Directives are normally only vertically effective between the state and a party. If this argument prevails and the Claimant has no contractual provision incorporating the COB or COBS rules, their only means of redress may be an action against the state for losses incurred by a failure to implement the Directive.

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