The Court of Appeal has recently ruled about whether a principal was responsible for certain activities carried on by its appointed representative under section 39 of the Financial Services and Markets Act 2000 (FSMA).

Kession Capital Ltd (KCL) was authorised to carry on designated investment business and it entered into an appointed representative agreement with Jacob Hopkins McKenzie Ltd (JHM) to carry on "relevant business" (as defined). KCL was the principal and JHM the representative. They entered into the agreement under section 39.

JHM promoted and operated various property investment Schemes in which the claimants invested around £1.7 million. The Schemes failed, so the claimants tried to recover their lost money from KCL.

The claimants applied for summary judgment and the first instance judge ruled that KCL had accepted responsibility for promoting the Schemes and so the judge awarded liquidated damages and costs.

KCL appealed the judgment because:

• The agreement prohibited JHM from conducting business relating to the Schemes. As a result, KCL did not give permission or accept responsibility for JHM conducting such business under section 39.
• The agreement prohibited promoting the Schemes to retail clients.

The Court of Appeal’s decision

The Court of Appeal dismissed the appeal.

Prohibition of business related to Schemes

It rejected the argument that the agreement prohibited promoting and marketing Schemes. It provided that KCL did not consent to JHM operating a Scheme and did not accept responsibility for JHM operating a Scheme but Schedule 5 to the agreement permitted advising on, and arranging deals in, Schemes.

Prohibition of promotions to retail customers

The Court of Appeal said that the real question was not whether the agreement prohibited promoting schemes to retail clients, but if the limitation on the scope of KCL’s permission to JH was allowed under section 39 of the FSMA. The key point was the meaning of "business of a prescribed description" in section 39(1)(a) and "the whole or part of that business" in section 39(1)(b). 

The 'description' of the business referred to the activity in question, in this case 'advising on investments' and 'arranging deals in investments'. The court said that those generic descriptions were not defined by reference to the classification of the clients to whom advice may be given or for whom deals may be arranged. They do not distinguish, as descriptions of activities, between giving advice to or arranging deals for professional clients and eligible counterparties and retail clients. The Court then considered if, under subsection (1)(b), the business of 'advising on investments' and 'arranging deals in investments' could be divided into two parts: (a) advising and arranging deals for retail clients; and (b) advising and arranging deals for other types of customer, enabling an authorised person to give limited permission for those activities. 

The judge said that this was not a sensible reading of what is meant by 'part of that business' in subsection (1)(b) for several reasons.

The type of business which an appointed representative is permitted to conduct is distinct from the question of for whom that business is undertaken.

Assessing if a client is a professional client or eligible counterparty is like assessing suitability.  It must happen before an investment can be recommended to a client regardless of the client's status. It was common ground that assessing suitability relates to how the business is conducted, so that if an appointed representative recommends an unsuitable investment, the principal is responsible. That responsibility could not be avoided by a contract term aiming to limit the permission given to the appointed representative to recommending investments which are suitable for the investor. 

In addition, how a client should be classified is part of how the business activity in question is carried on. If a client is mistakenly classified as a professional client or eligible counterparty, the principal should be responsible for the representative's error. To limit the appointed representative's authority to dealing with professional clients and eligible counterparties necessarily involves the principal entrusting to the appointed representative the decision about how a prospective client should be classified, just as it entrusts to the representative the decision whether an investment is suitable for an investor. According to the Court of Appeal, it made no legal or commercial sense to say that the principal entrusts that decision to the representative when the representative gets it right, but not when it gets it wrong. 

Section 39 was aimed at protecting investors. Therefore, to interpret 'part of that business' in (1)(b) as enabling a principal to grant permission, and to accept responsibility limited to providing advice to or arranging deals for professional clients and eligible counterparties only, would go against this. It would mean that a professional investor dealing with an appointed representative would have a higher degree of protection than a retail client. In this case it would have meant that the one claimant who was correctly classified as a professional investor would have had a remedy against KCL, but those retail investors wrongly classified as professional investors would not. That would make little sense.

The stipulation in the agreement that JHM should deal only with professional clients and eligible counterparties was a contractual term as between JHM and KCL, but neither affected the scope of the permission KCL had given, nor the responsibility it had accepted under section 39. If KCL's own authorisation did not permit it to deal with retail clients, the responsibility was on KCL to ensure in its own dealings that it dealt only with investors who were correctly classified as professional clients and eligible counterparties, and a retail client investor to whom it gave advice, or for whom it arranged a deal, would be protected. Similarly, when appointing JHM as an appointed representative, the onus was on KCL to supervise JHM’s activities and systems and KCL was responsible as principal if a retail client was wrongly classified as a professional client. The court said that as KCL enabled JHM to promote and market its investment schemes, during which JHM would inevitably have to decide how investors should be classified, this was a fair outcome. Interpreting section 39 as placing responsibility on the principal except where there is a clear demarcation between different parts of its business, and the representative is only appointed for a clearly demarcated part of that business, complies with the statutory objectives.

What does this mean for my business?

We advise principals to document their arrangements with appointed representatives in a carefully drafted agreement. It is also a good idea for you to carefully monitor your representative’s activities.