Failure to meet the required standards for FCA authorisation

A recent case serves as a useful reminder to firms seeking FCA authorisation of the paramount importance of positive and timely engagement with the FCA.

On 12 September 2022 the Upper Tribunal (Tax and Chancery Chamber) decided that the FCA was entitled to conclude that an application by Przemyslaw Soszynski, a claims management company business trading as “Phenix”, to carry on regulated activities under section 55A of Financial Services and Markets Act 2000 (“FSMA”) should be refused on the basis that Phenix had not been able to demonstrate that it met the conditions required for authorisation. The decision is notable in its discussions concerning the satisfaction of the FCA’s Threshold Conditions and serves as a reminder of the importance of positive and timely engagement with the FCA.

Background

Soszynski T/A Phenix Consultancy v The Financial Conduct Authority [2022] UKUT 247 (TCC) concerned an application made by Phenix, a sole trader operating a claims management business, to carry on various regulated activities in respect of claims management activity under section 55A of FSMA. The FCA issued a decision notice on 28 May 2021 refusing Phenix’s application which Phenix then referred to the Upper Tribunal. The reasons given by the FCA for refusing Phenix’s application were based on the failure of Phenix to satisfy the “Threshold Conditions” under FSMA.

Among the various questions the Tribunal considered in its decision, our focus here will be on what those Threshold Conditions are and the facts that the Tribunal looked at in deciding that, in agreement with the FCA, Phenix had indeed failed to meet them.

The legal framework and the Threshold Conditions

The regulation of claims management activities has undergone relatively recent change and it was only from 1 April 2019 that the regulation of such activities was transferred from the (now defunct) Claims Management Regulator to the FCA. In connection with the regulatory transition, claims management firms operating prior to April 2019 were required to apply for a full Part 4A permission (i.e., permission to carry on regulated activities) under FSMA to continue operating.

In granting such permission the FCA must ensure that an applicant satisfies and will continue to satisfy – in relation to all of the regulated activities for which the person has or will have permission (so claims management in this case) – the Threshold Conditions, which comprise the following:

Location of offices – broadly, this requires the head office of a firm and, in particular, its base of management and control to be in the UK if it is incorporated in the UK.

Effective supervision – this requires that firms must be able to be effectively supervised by the FCA.

Appropriate resources – this requires that the resources of a firm (both financial and non-financial) must be appropriate to the activities which that firm is carrying on.

Suitability – this requires that the firm must be “fit and proper”. Generally, the FCA will consider factors such as the integrity of the firm and the competence of its management when making its assessments as to whether a firm has satisfied this condition.

Business model – this condition relates to the ability of the FCA to assess whether a firm’s business model is suitable, appropriate and sustainable for the regulated activities it undertakes.

In its May 2021 decision the FCA found that, on the balance of probabilities, it could not ensure that Phenix had satisfied and would continue to satisfy the Threshold Conditions relating to effective supervision, appropriate resources and suitability. We consider the Tribunal’s assessment of each of these Threshold Conditions below.

Effective supervision

The first Threshold Condition considered in the context of the Phenix decision is “effective supervision”. As noted above, this requires that firms must be able to be effectively supervised by the FCA. In making its decision on whether a firm has satisfied this condition, the FCA will look at whether the firm is communicative with the FCA, including whether the firm is good at providing the FCA with the information requested of them in a manner which enables the FCA to judge that firm’s compliance with the applicable regulations. The FCA will also consider whether the firm is structured in a way which might hinder the provision of information (e.g. if the firm operates in various territories with different standards) and whether it is possible to assess the financial position of the firm from time to time (e.g. by reference to a single set of accounts).

In its May 2021 decision, the FCA found that Phenix failed to satisfy this condition and the Tribunal agreed, saying that, on the balance of probabilities, Phenix failed to provide information to the FCA in a timely manner. Some of the key facts considered by the Upper Tribunal when making this decision are summarised below:

Phenix submitted its application for Part 4A permission on 31 July 2019, which was the deadline day for such application under the transitional provisions. The application was largely incomplete, the majority of required supporting documents were omitted and the accompanying business plan was insufficiently detailed.

The FCA sent Phenix numerous requests for additional information which was frequently provided after the deadlines set by the FCA had passed and the documents which were required to accompany the application were not provided until around 19 weeks after the application was submitted. In total, Phenix failed to comply with deadlines on 12 separate occasions during the application process.

Phenix provided a variety of reasons for the delays, including illnesses without providing supporting medical evidence, the “current political and social situation” (referencing the George Floyd protests) and a “No Deal Brexit”. Although the Tribunal noted that some level of delay may be validly impacted by circumstances beyond the control of Phenix, taken as a whole they did not accept the explanations given as reasonable, particularly given the lack of supporting evidence.

Phenix repeatedly disputed the need to comply with certain rules rather than provide requested information demonstrating its compliance.

Phenix failed to apply for all the permissions necessary for it to conduct its business and failed to amend its application in relation to permissions no longer being sought.

The fact that Phenix was a small firm increased the Tribunal’s level of scrutiny with respect to effective supervision, as smaller firms are generally not subject to supervision by dedicated FCA supervisors.

Taken as a whole, the repeated breaches across a variety of areas led the Tribunal to agree with the FCA and be satisfied that the effective supervision condition was not met, concluding that Phenix was not ready, willing or sufficiently able or organised to comply with this condition.

Appropriate resources

As to the “appropriate resources” Threshold Condition, this requires that firms must have appropriate resources, in the context of their nature and scale, to carry on their regulated activities.

The FCA considers both “financial” resources and “non-financial” resources when assessing this condition, with financial resources comprising matters such as prudential resources requirements, and non-financial resources covering a firm’s internal systems, controls and policies and, more generally, whether the firm is ready, willing and organised to comply with the FCA’s requirements.

As with the “effective supervision” condition, the FCA found that Phenix had failed to satisfy the “appropriate resources” condition and the Tribunal agreed. Some of the key facts considered by the Tribunal in making this decision are summarised below:

The professional indemnity insurance (“PII”) that Phenix was obliged by the FCA’s rules to maintain and produce as part of its application did not cover any regulated activities under FSMA, including claims management services. Moreover, the Tribunal was of the view that Phenix had conducted regulated activity without the requisite PII for over a year, which was a material breach of the FCA rules.

Phenix held client money and was therefore required to comply with the FCA’s Client Assets Sourcebook (“CASS”) rules. However, Phenix was unable to provide the FCA with the required acknowledgment letter from its bank (as required under CASS) claiming that the bank was unwilling to sign it. Phenix further failed to notify the FCA of this breach. The FCA noted that “This was but one example of many where he blamed others for his failings.” The Tribunal commented on this breach notwithstanding the fact that it accepted that Phenix no longer intended to hold client money: no changes had been made to relevant client documentation which still explicitly referred to Phenix holding client monies.

Under the Claims Management: Conduct of Business sourcebook (“CMCOB”), Phenix was subject to a prudential resources requirement of £25,000 which it had failed to maintain and which it had further failed to notify to the FCA. On this point, the Tribunal said that “It is important to note that … [Phenix] disputed the proportionality and appropriateness of these rules, stating he intended to challenge them, rather than providing evidence of how he meets them”.

Phenix argued that it was unable to conduct telephone calls with customers (a requirement under the Dispute Resolution (“DISP”) section of the FCA Handbook) due to the recording requirements, despite accepting that it could do this on its smartphone.

The above list does not cover all the issues noted by the Tribunal – for example, the Tribunal also noted that Phenix did not have rights of audience for certain court processes nor did it have business continuity arrangements in place – but they do serve to illustrate the ways in which Phenix’s general systems, controls, procedures and resources were deemed to be inadequate and, further, showed a clear unwillingness to be supervised and regulated by the FCA.

Suitability

Finally, with respect to the “suitability” condition, as noted above this requires that firms must be “fit and proper” and the FCA will consider general factors such as whether the firm conducts its business in accordance with proper standards, whether a firm’s management is competent and whether a firm can demonstrate that it conducts its affairs with due skill, care and diligence. In making its decision in deciding whether a firm satisfies this condition, some specific factors that the FCA may consider include:

if the firm is responsive and forthright in its dealings with the FCA

if the firm is ready and willing to comply with the FCA’s requirements

if the firm has appropriate human resources procedures in place

if the firm is governed by people with appropriate skill and experience to understand and manage the firm’s regulated activities

The factual findings considered by the Tribunal with respect to the suitability condition in relation to Phenix are the same as those it considered for the effective supervision and appropriate resources conditions, summarised above. The Tribunal considered these factual findings holistically to form the view that Phenix “demonstrated an attitude of active frustration of the [FCA]… He has sought to justify his non-compliance based on blaming others rather than taking responsibility for his own failures. In essence, he believes that the [FCA’s] requirements are unjustified and he should not be required to comply. This attitude is long held, persistent and unlikely to change.” As a result, the Tribunal agreed with the FCA that it was right to conclude that Phenix failed to satisfy this condition.

Conclusion

The Tribunal’s decision is a helpful illustration of how satisfaction of the Threshold Conditions is assessed in practice and the expectations on regulated firms as to how they should cooperate with the FCA and demonstrate compliance. It is worth noting that the Tribunal did make the point that their assessment was formed by viewing the various breaches as a whole and that individual breaches of the Threshold Condition requirements might be deemed to be insignificant if they occurred in isolation. However, it is clear from the facts that Phenix breached a number of these requirements repeatedly over a material period of time and it is because of the cumulative nature of these breaches that the Tribunal formed their view that Phenix’s general approach and attitude was not suitable for FCA regulation.