Financial Services and Markets Dispute Resolution Quarterly Update: Autumn 2018
In this edition, we consider the Court of Appeal’s keenly awaited decision on legal privilege in the criminal investigation context, together with judgments concerning the scope of the SFO’s powers of compulsion and the position of banks in relation to statements relied upon by undisclosed principals.
We also address the FCA’s annual enforcement and performance report, the increased focus on Unexplained Wealth Orders as an anti-corruption tool, and an unprecedented analysis of behavioural patterns in market abuse cases over a period of more than two centuries.
- Court of Appeal (CoA) affirms the availability of legal privilege in the context of potential criminal prosecution
- Supreme Court confirms banks are not liable to undisclosed principals for negligent misstatement
Regulatory developments and updates
- FCA’s annual enforcement and performance report
- FMSB analysis of misconduct patterns in financial markets
In the latest decision in Eurasian Natural Resources Corporation Limited v Director of the Serious Fraud Office  EWHC 1017 (QB), the CoA has provided reassurance in regard to a company’s right to claim privilege over documents created in the context of an internal investigation into potential criminal wrongdoing.
These issues arose in the context of a Serious Fraud Office (SFO) investigation into allegations that Eurasian Natural Resources Corporation Limited (ENRC) (and its subsidiaries, officers and employees) had committed various acts of fraud, bribery and corruption in Kazakhstan and an unnamed African country. Using its powers to compel the production of documents, the SFO had sought to require ENRC to provide documents created during ENRC’s own internal investigation into these issues. ENRC had refused to do so, on the basis that the documents were covered by legal advice privilege and / or litigation privilege.
The disputed documents included: (i) notes made by ENRC's external solicitors of interviews with individuals (including current and former employees); and (ii) a review of ENRC’s accounting records by forensic accountants.
The SFO had successfully applied to the High Court for a declaration that the documents were not privileged. The High Court held that criminal litigation had not been "in reasonable prospect" when the documents were created, because the SFO had not yet decided to bring criminal proceedings, nor had evidence been uncovered which rendered a prosecution likely. Further, ENRC had repeatedly stated its intention to cooperate with the SFO and to share the findings from its internal investigations with the SFO. On that basis, the High Court considered that the "dominant purpose" behind the creation of the documents had been to avoid litigation (by persuading the SFO not to prosecute) rather than to conduct litigation.
On ENRC’s appeal, however, the CoA took a different view on the key elements of the test for the application of litigation privilege:
- On whether litigation is reasonably in prospect, the CoA was clear that where (as in this case) a prosecuting authority writes to a potential defendant and specifically draws attention to the “prospect” that it could be prosecuted, and legal advisers are instructed to deal with the situation, there is a “clear ground for contending that criminal prosecution is in reasonable contemplation”.
- On whether litigation is the sole or dominant purpose of particular communications, the CoA held that documents created for the purpose of heading off, avoiding or settling litigation are as much protected by litigation privilege as documents created for the purpose of resisting litigation. (Whether or not there is a subsequent waiver of privilege is a separate issue.)
As to legal advice privilege, the CoA declined to challenge the existing case law (per the longstanding decision in Three Rivers (No5)  EWCA Civ 474) that communications between an employee of a corporate entity and the lawyers of that corporate entity will only be privileged if the relevant employee is within the group of employees specifically authorised to seek legal advice. The CoA did state that it would have decided the point differently today, given the rise of the large national and multinational corporation, in which knowledge of the relevant facts is likely to be widely distributed. However, any development of the law on this point will be for the Supreme Court to determine in an appropriate case in due course; the SFO has confirmed that it will not appeal the current CoA judgment.
This latest decision means that, where a potential criminal offence has occurred, there is greater scope for a company to investigate the relevant events and to claim litigation privilege over the product of that investigation. However, given that the scope of legal advice privilege remains narrow, it is even more important that businesses maximise any claims they may have to litigation privilege. Where litigation is not in reasonable prospect, care should be taken to ensure (wherever possible) that sensitive communications with a company’s lawyers are made by the individuals who have been tasked with instructing those lawyers. Communications from other employees should be made in the knowledge that they are likely to be disclosable in any future proceedings.
In R (on the application of KBR Inc) v The Director of the Serious Fraud Office  EWHC 2368 (Admin), the High Court has recently considered the extra-territorial ambit of a Notice compelling the production of documents and data under Section 2(3) CJA 1987.
On 17 February 2017, the SFO commenced a criminal investigation into, among others, KBR Ltd, a UK subsidiary of the US company KBR Inc, concerning suspected offences of bribery and corruption. The SFO claimed to have identified a large number of suspected corrupt payments totalling US$23m, to Unaoil, a company engaged at various times by KBR's UK subsidiaries, ostensibly to provide consultancy services in the oil and gas industry.
The SFO also identified 27 separate categories of material that were potentially outside the jurisdiction in the possession or control of KBR Inc in the US, and outside the control of KBR Ltd. Therefore, during a meeting held at the offices of the SFO on 25 July 2017, a Notice was served on a representative of KBR Inc, EA, who was its Executive Vice President, General Counsel and Corporate Secretary, compelling the production of the relevant material.
Upon KBR Inc's challenge to the validity of the Notice, the High Court found that:
- Section 2(3) CJA 1987 did not require the Notice to be served “on KBR Inc." EA was present at the meeting within the jurisdiction, representing KBR Inc, and not coincidentally or on a personal frolic, and there were no additional formalities to be fulfilled by the SFO in serving the Notice upon her;
- whilst there were some unappealing features of the SFO's decision to hand the Notice to EA in the course of attending a meeting to discuss the investigation, they did not serve to invalidate the Notice;
- the Notice was not, as KBR Inc submitted, ultra vires because it requested material held outside the UK;
- Section 2 Notices must have an element of extra-territorial application and can extend to foreign companies in respect of documents held outside the jurisdiction when there is a sufficient connection between the foreign company and the UK;
- KBR Inc's own actions in approving and making payments relating to KBR Ltd's contracts or arrangements with Unaoil made good a sufficient connection between KBR Inc and the UK, thereby bringing it within the scope of Section 2(3);
- further support for KBR Inc's connection with the UK could be found in one of the company's corporate officers being based in KBR Group's UK office; and
- the availability of Mutual Legal Assistance between the authorities of different countries was simply an alternative route by which the SFO could obtain information in certain cases, and did not preclude the SFO from choosing to exercise its Section 2 powers instead.
This decision illustrates the extent to which the High Court will be supportive of the SFO's work in the public interest.
In Playboy Club London Ltd and others v Banca Nazionale del Lavoro SpA  UKSC 43, the Supreme Court held that banks do not owe a duty of care in tort to undisclosed principals, in circumstances where the bank is unaware of the relevant principal’s involvement.
The First Claimant operated a casino in London, which offered cheque cashing facilities to customers. In October 2010, the First Claimant wished to obtain a credit reference from the Defendant Bank in respect of a customer. In order to preserve the customer’s confidentiality, the reference was requested by the Third Claimant, Burlington Street Services Limited (a company within the same group); the Defendant Bank was not at that stage aware of the First Claimant’s involvement. The Defendant Bank provided a reference, addressed to the Third Claimant, confirming that the customer was “financially healthy and able to meet his business commitments”. In reality, the customer was still in the process of opening an account and had not deposited any funds with the Defendant Bank. In reliance on the Defendant Bank’s reference, the First Claimant cashed counterfeit cheques from the customer totalling approximately €1.25m.
The Claimants brought proceedings against the Defendant Bank for negligent misstatement in respect of the reference. At first instance, the High Court found the Defendant Bank liable. However, the Court of Appeal overturned the decision at first instance, finding that the Defendant Bank had not owed a duty of care to the First Claimant.
In July 2018, the Supreme Court upheld the Court of Appeal’s decision. It was not persuaded by the Claimants’ argument that the relationship between the Third Claimant and the Defendant Bank was akin to a contract in respect of which, as an undisclosed principal, the First Claimant was entitled to declare itself and assume the benefit of the contract. Applying Hedley Byrne & Co Ltd v Heller & Partners Ltd,  AC 465, the Supreme Court emphasised that in order to recover a purely economic loss in negligence, it was fundamental that: (i) the Defendant assumed “responsibility to an identifiable (though not necessarily identified) person…”; and (ii) the Defendant, in giving the statement, was fully aware of the nature of the transaction and knew that part of the statement’s purpose was to be communicated to and relied upon by the First Claimant.
In this case, the Defendant Bank was completely unaware of the involvement of the First Claimant, and therefore could not have known that the reference would be communicated to and relied upon by the First Claimant. Accordingly, no duty of care arose.
This case marks a positive development for banks, limiting liability under credit references to identified or identifiable parties. However, the importance of disclaimers in references should not be overlooked. Under English law, a disclaimer limiting liability to a named or identifiable class of individuals would normally be upheld. Best practice for banks is still therefore to include a narrowly drafted disclaimer in any credit references to avoid the risk of liability to undisclosed principals.
Regulatory developments and updates
The FCA has published its annual enforcement and performance report 2017/18 which provides an insight into the FCA’s enforcement activities during 2017/18.
The highest numbers of open enforcement cases (as at the end of March 2018) appeared under the following categories:
- Financial crime (86)
- Retail conduct (78)
- Unauthorised business (77)
- Insider dealing (75)
- Culture / governance (61)
In addition, the FCA recorded 28 open enforcement cases for market manipulation and 12 for misleading statements.
The FCA received 1,064 requests from over 80 different regulatory and law enforcement authorities in 63 jurisdictions during the reporting period, up from 998 in 2016/17. (The FCA has not disclosed the type of information that is predominantly requested under these mutual assistance arrangements.)
In keeping with our experience in dealing with the regulator in the last 12 months, the average case length for regulatory and civil cases has generally increased. For example, the average length of cases concluded as a result of settlement in 2017/18 was 32.3 months, up from 23.2 months in 2016/17 and 25.2 months in 2015/16.
It is not surprising then that the feedback from those subject to FCA investigations included comments about: the proportionality of investigations; the rigour applied by the FCA in analysing issues before deciding to proceed with an investigation; and the quality of information provided by the FCA at the start of the investigation.
In addition, the feedback suggested that communication could be improved in cases where the regulator ultimately decided to take no further action. In fact, in the reporting period, the average length of cases including no further action decreased slightly: from 17.6 months in 2016/17 to 19.1 months in 2017/18.
It will come as no surprise that the feedback also highlighted the significant financial impact of investigations, for example in complying with information requirements. However, the FCA observed, in turn, that the experience of an investigation had some positive effects, such as providing useful lessons and increasing staff awareness and performance.
To the extent it provides reassurance, the FCA concluded that it has “considered the key themes that were raised and [we] are working to implement the lessons we have learned."
The FICC Market Standards Board (FMSB) has recently published an important research document which analyses the behavioural patterns in financial misconduct cases over a period of 225 years. The Behavioural Cluster Analysis (BCA) is the first time that these patterns of behaviour have been collated, analysed and published as a single reference point for market participants.
The FMSB addresses the finding of the Fair and Effective Markets Review that:
“One of the Review’s most striking findings has been that, although the specific aspects of individual misconduct may have varied substantially across traders, firms and markets, the underlying behaviours were remarkably similar in many cases and relatively straightforward to describe.”
The BCA’s key finding is that the behavioural patterns evident in misconduct cases are not unique to each case - the same behavioural patterns consistently recur over time. The review also identifies that these same behavioural patterns occur in different jurisdictions and across different asset classes. This demonstrates the importance of focusing on the underlying behavioural patterns rather than the individual circumstances of each case.
A team at Macfarlanes worked with the FMSB on this project. Mark Carney (Governor, Bank of England) described the BCA as an “innovative and evidence based methodology, of great value to market participants as well as regulators”. It is a practical document which will assist market participants working on the design and enhancement of systems for oversight and control. We hope it will become a useful reference point for financial services firms and their advisors.
In our April 2018 Quarterly Update, we covered the recent introduction of Unexplained Wealth Orders (UWOs) in the UK and the relevant legal mechanics. We had anticipated that the UK Enforcement Authorities – the NCA, HMRC, FCA, SFO and DPP – would place a significant emphasis on UWOs. This has now proven to be the case: there has been repeated reference to UWOs by both politicians and the Enforcement Authorities in recent months, and the NCA is in the process of bringing test cases to trial.
In summary, UWOs are an important new power for the UK Enforcement Authorities, which enable them to require that individuals and companies in specified categories explain how they acquired and hold property (including real estate or other assets) in the UK. If they do not provide an explanation, the normal burden of proof is reversed and the assets in question will be presumed to be the proceeds of crime and subject to the POCA civil recovery regime.
Recent developments in relation to UWOs include:
- A judgment in the High Court on 3 October 2018 in relation to a challenge made to three UWOs obtained by the NCA (being the only UWOs obtained to date), in confidential proceedings brought against the NCA by Mrs A (Zamira Hajiyeva). Mrs A’s husband (Jahangir Hajiyeva) was a state banker from a former Soviet Union country outside the EEA (who was jailed overseas for a major fraud). Mrs A argued that the fraud conviction was unjust, that the wealth was not unexplained, and that her husband’s role did not relate to public functions (such that the family was not politically exposed), but could instead be explained by his legitimate overseas enterprises and commercial banking. The family’s assets in the UK include property worth £22m and £15m of shares. The High Court found in favour of the NCA and upheld the UWOs. As a result, Mrs A also lost her right to anonymity on 10 October 2018, subject to any appeal, which she has indicated that she will be making.
- Responding to the judgment, the NCA stated that it “will continue with this case and seek to quickly move others to the High Court. We are determined to use the powers available to us to their fullest extent where we have concerns that we cannot determine legitimate sources of wealth.”
- The NCA has indicated that it will seek to increase the total number of UWOs obtained to double figures within the next year, and target politically exposed persons. The director of the NCA’s economic crime unit has stated that Russia, former Soviet Union republics, Africa and Asia are a current focus for UWO activity. The Security and Economic Crime Minister, Ben Wallace, has suggested that preparations for a significant number of further UWOs are already underway.
- The SFO has recently published a speech by its general counsel titled “Unexplained wealth – whose business?” in relation to the forfeiture of criminal wealth in the UK, addressing a two-pronged attack which comprises separate investigations into crime and its proceeds.
We expect that UWO developments will continue over the coming months, as the courts make important decisions on their validity, and politicians continue to rely on the regime to demonstrate progress being made on a prominent political topic.