Charlton 1, SIPP provider 0: implications for the financial services industry

Mr Charlton invested £24,000 in Sustainable AgroEnergy (SA). The investment was made via a SIPP, which was created for that purpose. SA was an investment scheme involving jatropha tree plantations in Cambodia. It was later revealed to be a fraud and Mr Charlton’s money was lost. He received no advice in respect of the transfer, at least not from a regulated entity, so his complaint to the Financial Ombudsman Service (FOS) was against his SIPP provider, Berkeley Burke SIPP Administration Ltd (BBSAL).

After a tortuous procedural history, including one decision in favour of BBSAL, the complaint was upheld by an Ombudsman. He did so on the grounds of a breach of the FCA’s core Principles for Business 2 (skill, care and diligence) and 6 (paying due regard to customers’ interests, and treating customers fairly). The Ombudsman concluded that those Principles obliged BBSAL to carry out due diligence on SA, which it had not done.

BBSAL brought judicial review proceedings, alleging two mistakes of law by the Ombudsman. First, that the Ombudsman’s decision conflicted with and misinterpreted Conduct of Business Sourcebook(COBS) rule 11.2.19, which BBSAL argued obliged it to execute specific instructions given to it by its client. Second, that the Ombudsman failed to follow decisions of the Pensions Ombudsman, thus producing inconsistencies between jurisdictions. The FCA intervened, in order to give its views on the correct interpretation of the rules.

Neither argument succeeded. The judge ruled that COBS 11.2.19 only relates to the manner of execution, not the decision to execute itself, so the Ombudsman’s decision contained no mistake. Further, the Pensions Ombudsman is a different statutory scheme which does not bind the FOS. This decision raises a number of significant points for the SIPP industry and beyond.

Execution only

COBS 11.2.19(1) reads: “Whenever there is a specific instruction from the client, the firm must execute the order following the specific instruction.” On the face of it, it seems plain that, if a client gives an instruction, it must be carried out without question. That is how it has been viewed in parts of the SIPP industry and beyond. The judge – who made copious references to the originating legislation and surrounding provisions – disagreed. The rule addresses how an instruction is executed, not whether the instruction was executed at all.

That decision was helpful for the FCA. Initially they agreed that rule 11.2.19 applied – they only contested its interpretation – but on day two they changed to say that it could not apply to these types of investment. The court did not have to consider that point, but its actual decision in any event could have wide implications. Arguably there is no direction from a client that can be accepted at face value and which should not be scrutinised and, if appropriate, rejected. The extent of the scrutiny required is uncertain, and the distinction between whether to execute and how to execute will not be clear in all circumstances. It also potentially opens a provider (or adviser) to a claim if an aborted investment or delayed action turned out to have been inappropriate.

Due diligence

This decision clarifies that, whilst a SIPP provider is not obliged to give advice, it must conduct due diligence on the assets to be held in the SIPP. That obligation goes far beyond checking that they attract the tax benefits of a SIPP. In Mr Charlton’s case, the Ombudsman stated that there were seven steps BBSAL, as a minimum, should have undertaken. They included, for example, ensuring "that the investment was genuine and not a scam, or linked to fraudulent activity", and independently checking that the investment operated as claimed.

This raises some questions.

• The Ombudsman’s decision arguably comes close to saying that BBSAL should have uncovered the scam. Not all frauds are obvious.
• The steps required were onerous and expensive, particularly as SA was based overseas. For a group of investors, such checks might be feasible: for an individual, they are likely to be uneconomic. Therefore due diligence requirements could, in effect, be banning schemes. Few would mourn that result for scams like SA, but what about legitimate investments? Obviously, not all high-risk schemes are frauds.
• Mr Charlton received no regulated advice. What would happen if he did, and BBSAL had refused to proceed?

The breadth of the FOS’s powers

The court rejected the argument that the Ombudsman’s use of the Principles was, in effect, creating new, previously unknown, rules from general requirements. This judge relied heavily on the 2011 decision in R (British Bankers Association) v Financial Services Authority to support his reasoning. BBA made clear that the Principles are overarching requirements that apply at all times, and can supplement specific rules to cover new areas. All attempts to distinguish the BBA case were rejected.

This decision emphasises – and reinforces – the breadth of the discretion Parliament granted the FOS. The Principles are stated in very wide terms, and are relevant to all aspects of a SIPP provider’s actions. They can be used to supplement the more detailed rules in any specific situation. Therefore the FOS can penalise behaviour that otherwise complies with, say, COBS on the grounds that it infringes the Principles. Provided the FOS is fair and reasonable in its approach, and the result is not perverse, its conclusions are likely to be unassailable. 

This creates uncertainty. Financial professionals base their work practices on the relevant rules. The Charlton decision emphasises that, even if they comply with the specific rules, they might still fall foul of the Principles. Nor will they know that until the FOS gives its view.

The SIPP industry

That there may be financial ramifications for parts of the SIPP industry is illustrated by the publishing of a "Dear CEO" letter by the FCA the same day the Charlton judgment was handed down. It states:

“If the outcome… calls into question your firm’s ability both now and in the future to meet its financial commitments as they fall due, you must notify the FCA immediately.”

The letter goes on to identify issues around the sale of SIPP businesses. It also refers to “pending civil claims in the High Court”, which refers to the Carey Pensions case, where a decision is expected imminently.

It is known that a number of FOS complaints await resolution following Charlton. The Charlton decision should not mean that all will be upheld – it will depend on the nature of the underlying investments, and the checks undertaken by the SIPP provider. Nevertheless, we can expect similar FOS decisions in favour of complainants in the next 18 months or so. That inevitably means financial stress for SIPP providers and their insurers.

The end is nigh?

Not yet, on two fronts. First, an appeal, or at least, an application for permission to appeal, may yet be lodged – the FCA’s letter anticipates such. That is hardly surprising in the circumstances. Second, the civil claims against various SIPP providers await determination, which is likely to be some way off in many cases.