1 The Kingman Review and the Memorandum of Understanding between the FRC and the FCA
2 Variations to contracts: Key change in the law
3 When do you know? A reminder of the trigger for knowledge under the Limitation Act
4 No assumption of responsibility for financial consequences of investment decisions
5 New enhanced powers for the pensions regulator
6 Reconsidered: Integrity and dishonesty in disciplinary proceedings
The Kingman Review and the Memorandum of Understanding between the FRC and the FCA
Following fierce public and Parliamentary criticism of the Financial Reporting Council for its handling of investigations into audit firms, in particular following the financial crisis and high-profile corporate collapses, the Government announced that Sir John Kingman would conduct a review of the FRC ("The Review").
The Review has recently issued a call for evidence and in particular is considering whether the regulator is as effective as it needs to be and whether any of its functions should move to other regulators, in particular the Financial Conduct Authority ("FCA"). Under the current arrangements often the FRC will investigate whether there has been any breach of a relevant requirement or misconduct by the auditor and the FCA will separately investigate the non-accountant directors.
On 20 December 2017 the FCA and the FRC entered into a revised memorandum of understanding (MoU), which sets out how the two regulators will share information each has obtained in the course of their oversight and how they will co-operate and co-ordinate where they have overlapping jurisdiction in disciplinary investigations.
This was intended to be a further step by the FRC to overhaul the way it investigates suspected accountancy and audit misconduct and to more closely align itself with the FCA's model of misconduct investigation and enforcement.
The 2017 MoU replaces the MoU agreed between the two regulators in 2013. While the principles for co-operation and co-ordination between the FCA and the FRC are broadly unchanged, the 2017 MoU provides more detailed mechanisms for information requests and concurrent investigations.
With respect to information requests, the 2017 MoU provides that the requesting party shall identify the information sought, the intended use of the information, and treat any disclosed information confidentially. The receiving party shall then confirm receipt and reply with the documentation in the agreed time period, notifying of any delays. It remains the case that the regulators cannot share privileged information received from a third party (unless privilege has been waived). A further important feature of the MoU is that the regulators will actively consider whether any information they obtain in the course of their investigations may be of interest to each other (so they may share information without having received a request).
Where both regulators have jurisdiction to investigate:
- they will seek to agree which regulator will carry out the investigation, or whether both regulators will investigate.
- If they agree that both regulators will investigate, they may agree that the investigations will run in parallel, or that one will proceed before the other, depending on the circumstances.
- If one investigates after the other, the first will keep the other updated regularly on material aspects of the investigation.
- If the investigations are run in parallel, the regulators will seek to co-ordinate e.g. by conducting joint interviews of witnesses.
- The regulators will also seek to coordinate publication of their respective enforcement decisions: they will provide 24 hours' notification before any press release or public statement, and may agree to simultaneously publish the outcome of their respective investigations.
The 2017 MoU also provides clarification of the FCA's and FRC's respective roles. Broadly, the FRC's role is to promote transparency and integrity in business, and high quality corporate governance and reporting to foster investment. In addition, the FRC has a role under the Transparency Directive, to examine whether information referred to under the Directive is drawn up in accordance with the relevant reporting framework and to take measures where there has been an infringement. The FCA's role is to maintain the integrity of financial services providers by adopting a market-based approach to supervising firms, investigating individuals and firms, and bringing criminal prosecutions.
The Kingman Review has recently published a call for evidence across a range of areas including (1) the FRC's purpose and function; (2) its impact and effectiveness; (3) its role in setting audit regulation; (4) the speed and effectiveness of investigations, enforcement and compliance; (5) the powers and sanctions regime; and (6) staffing and resourcing.
In circumstances where directors may have misled a company's auditors or been actively involved in fraudulent activity or have failed to make proper and adequate disclosure of known issues, it is understandable that there are increased calls for the FRC's investigation function to be incorporated into the FCA so as to ensure that the same body is investigating both the directors and auditors. The current regime (set out above) where-by different regulators investigate different parts to the same story is far from ideal. To that end the report of Kingman Review will be keenly awaited.
Variations to contractual terms: Key change in the law
In Rock Advertising Limited v MWB Business Exchange Centres Limited  UKSC 24 the Supreme Court considered the effect of a "no oral modification" clause ("NOM" clause) in a contract, changing the existing law in this area.
Rock Advertising licenced office space in premises managed by MWB Business Exchange Centres Ltd. Rock Advertising incurred arrears of licence fees and other charges, following which MWB exercised its right under the licence agreement to lock Rock Advertising out of the premises, claiming for arrears and damages.
Rock Advertising, in its counterclaim, argued that an oral agreement had been made with MWB to re-schedule the licence fee payments to clear the arrears. MWB denied this, arguing that such an agreement would be unenforceable as it lacked consideration and that an oral variation to the licence was expressly prohibited by inclusion of a NOM clause within the written agreement that stated, amongst other things, that: "all variations to this licence must be agreed, set out in writing and signed on behalf of both parties before they take effect."
Issues in dispute
At trial, and on appeal, the Court examined the following two issues:
- Whether a NOM clause was legally effective; and
- Whether an agreement whose sole effect is to vary a contract to pay money by substituting an obligation to pay less money or the same money later, is supported by consideration.
The Court of Appeal held that the variation agreed orally amounted to an agreement to dispense with the NOM clause, and that there was consideration for the variation.
The Supreme Court, by a 4:1 majority (Lord Sumption, giving the leading judgment) disagreed with the Court of Appeal and held that the variation was invalid because of the requirement under the NOM clause for writing and signatures.
The argument against NOM clauses is as follows. Despite the existence of the NOM clause in a contract, there is nothing to stop parties orally agreeing a variation of that contract, including an express or implied term dispensing with the NOM clause (as there are no formalities imposed by law on making or varying a contract). Indeed, it might be considered artificial in circumstances where both parties have acted in accordance with an orally agreed change to the contract, to later not recognise such a variation because the parties have failed to abide by the NOM. However, Lord Sumption held that the common law should give effect to a NOM provision, recognising that these clauses are common in written agreements and have a legitimate commercial rationale: (i) preventing attempts to undermine written agreements by informal means; (ii) where oral discussion can give rise to misunderstanding, thereby avoiding disputes not only about whether variation was intended but also about its terms and (iii) making it easier for corporations to police internal rules restricting the authority to agree them. Contract law does not normally obstruct the legitimate intentions of businessmen. Lord Sumption indicated that if a party were to act on a contract as varied, and is unable to enforce it due to a NOM clause, then the remedy would lie in the various doctrines of estoppel.
The Supreme Court declined to deal with the issue of consideration, as it was not necessary due to the findings in relation to the NOM clause.
The Supreme Court's decision is likely to be welcomed in many quarters, as it brings clarity to the issue of whether NOM clauses, which are included as standard in a wide variety of contracts, will be upheld. No doubt however, there will still be scope for arguments, where the detail of NOM clauses are not respected (perhaps because the clause has been overlooked by the parties in making an oral agreement, or where a NOM clause is partially complied with eg. a modification is set out in writing but not signed as required) over whether an estoppel can be founded.
For professional firms, who may include NOM clauses in terms and conditions of engagements, this is likely to be good news, bringing as it does, greater certainty to the issue of what the contractual terms with the client are, and making it more difficult for individual professionals to vary them informally. However, should a firm wish to make a variation, it will be important to comply with the terms of the NOM clause.
When do you know? A reminder of the trigger for knowledge under the Limitation Act
The Court of Appeal has recently given a reminder of the test for whether a Claimant has knowledge under s14A of the Limitation Act 1980 in Su v Clarksons Platou Futures Ltd  EWCA Civ 1115.
Section 14A provides an additional time limit of three years for negligence actions, where facts relevant to the cause of action were not known at the date of accrual. The three years runs from the earliest date on which the claimant has both the knowledge required for bringing an action for damages and a right to bring the action. The Act provides that 'knowledge' means knowledge of both the material facts about the damage, and that the damage was attributable in whole or in part due to the act or omission alleged to constitute negligence. It includes knowledge that the claimant might reasonably have been expected to acquire from facts observable or ascertainable by him, or from facts ascertainable with the help of appropriate expert advice that it is reasonable for him to seek.
The House of Lords gave guidance on what s14A requires in terms of knowledge in Haward v Fawcetts  UKHL 9, clarifying that it does not mean knowing for certain but with sufficient confidence to justify the preliminaries to the issue of a claim such as taking advice and collecting evidence. Vague and unsupported suspicion will not be enough to trigger knowledge, but reasonable belief will suffice. (These principles were also discussed in another recent case, Halsall v Champion ).
In this case the Claimant's companies had entered into a forward freight agreement (FFA) with third parties, which the Claimant's companies breached. A freezing order was obtained against the companies and against the Claimant personally (in August 2011), and an appeal on the issue as to whether there was a good arguable case that the Claimant was personally liable under the FFA was dismissed (in July 2012). In October 2014, the trial of the substantive action took place, and the Claimant was found, in November 2014, personally liable to pay the judgment sum to the third parties. The Claimant subsequently claimed that the Defendant broker had negligently bound him personally to the FFA.
The issue before the Court of Appeal was whether the first instance judge had been correct to grant summary judgment on the negligence claim on the basis that the limitation period had expired, and the specific point being considered in this judgment was when the Claimant had acquired s14A knowledge. The Claimant argued that he did not have that knowledge until November 2014, for reasons including: (1) that the documents did not indicate that the Claimant was personally a party to the FFA and witnesses for the third party waivered on this point;(2) the brokers intimated that they had not foreseen the conclusion of the Court on this point, and (3) his solicitors had advised they were confident that he would not be found personally liable under the FFA despite the Court of Appeal judgment in relation to the freezing order. The Court rejected these arguments, finding that (1) by the end of July 2012 the Claimant knew enough for it to be reasonable to investigate further and to start asking questions; and (2) the potential liability was clear from the outset of proceedings against him. The appeal against summary judgment was therefore dismissed by the Court.
Arguments around when section 14A knowledge was triggered are common in relation to professional negligence claims. This case reiterates that the relevant date is not when the claimant knows it might have a claim for damages but an earlier date when there is sufficient knowledge to justify investigating the possibility. We have seen the courts taking a robust approach towards claimants' arguments for delaying the date of knowledge, in recent cases.
No assumption of responsibility for financial consequences of investment decisions
The recent case of Manchester Building Society v Grant Thornton UK LLP  EWHC 963 illustrates the Court's approach to causation issues in professional liability cases, and the potential difficulties of predicting whether an accountant will be found by the courts to be responsible for a claimant's losses on a given set of facts. Positively for accountants, the Court was unwilling to find that the defendant accountant had assumed responsibility for the financial consequences of entering into swaps, by advising on how they should be treated in the accounts.
Grant Thornton UK LLP (the Defendant) provided advice to, and audited the accounts of, Manchester Building Society (the Claimant), which provided lifetime mortgages to borrowers who wanted to release equity. In order to manage the overall risk of its lending portfolio, the Claimant hedged the risk that the variable interest rate on the funds it borrowed in order to lend monies would exceed the fixed rate interest rates it received from its borrowers by purchasing interest rate swaps ("the Swaps"). From 2006 to 2012, the Claimant had entered into Swaps with a value of £74.2 million in the UK and EUR 57 million in Spain.
The value of the Swaps (which depended on changes in interest rates) had to be recorded on the Claimant's profit and loss accounts. However, any change to the fair value of the hedged asset (the lifetime mortgages) would not be reflected on the Claimant's balance sheet and would show the Claimant's profits and capital as "volatile" which could negatively impact the Claimant's business. It was alleged that the Defendant advised that the solution to this was "hedge accounting" allowing the volatility caused by including the Swaps to be off-set by adjusting the value of the lifetime mortgages.
In 2013, the Claimant realised that it could not use hedge accounting to off-set the Swaps and should not have been doing so for the previous years. The Claimant's profits became losses and its net assets were significantly reduced. As a result, the Claimant closed out the Swaps, sold its UK lifetime mortgages, and stopped lending at the end of 2013.
The Claimant alleged that the Defendant's advice on its hedge accounting policy was negligent and that it caused the Claimant to enter into Swaps from 2006 onwards. The Claimant claimed its losses of £48.5 million from the time of that advice in 2006 until 2013. Some £32.7 million of the loss was the result of the Claimant's decision to close the Swaps.
However, the Defendant argued that, even assuming that it had been negligent from the end of 2006 until 2011:
- the Claimant would have entered into a different type of hedging in any event and suffered loss;
- the Claimant's loss was a result of its own commercial decision to use Swaps and not how they were treated in the Claimant's accounts;
- the losses were not within its scope of duty in accordance with the principles in SAAMCO;
- the Claimant had been contributorily negligent by its attitude to risk and taking out long-term Swaps, contrary to the Claimant's own stated policy.
Mr Justice Teare concluded that, but for the Defendant's failures alleged by the Claimant, the Claimant would not have incurred the cost of closing out the Swaps in 2013, and therefore factual causation was established. In addition, the negligence that was alleged by the Claimant was one of the effective causes of the loss, as the use of hedge accounting was intended to mitigate the effects of volatility in the fair value of the swaps and it was such volatility that led to the closure of the swaps. However, that did not lead to a finding that the Defendant caused the Claimant's loss.
Teare J considered that, following the Supreme Court's guidance in BPE Solicitors v Hughes Holand  UKSC 21, the correct question was whether the losses sought to be recovered were those for which the accountants had assumed responsibility. The Judge did not consider that an accountant, by advising a business as to how its activities could be reflected in its accounts, assumed responsibility for the financial consequences of those activities. The Claimant's loss flowed from market forces (i.e. the change in interest rates) and not from any negligence on the part of the Defendant and therefore the Claimant's loss from closing out the Swaps was not recoverable. The Defendant would, however, be liable for the "penalty" costs of breaking the Swaps, subject to any discount for the Claimant's own contributory negligence caused by its decision to use hedge accounting and calculated at 25% of the recoverable damages: the Claimant was therefore awarded £315,345 plus interest (being 75% of its recoverable damages).
As the Judge himself noted, it would have been a striking conclusion to find that an accountant who advises a client on the accounting treatment of certain activities assumes responsibility for the financial consequences of those activities. However, the outcome appears to have been finely balanced with the judge finding all of the necessary elements of causation present, except for assumption of responsibility. The judgement makes clear the difficulties of predicting how these issues will be decided in professional liability cases, even post the guidance given by the Supreme Court in this area. It is understood however, that the judgement is under appeal.
New enhanced powers for the Pension Regulator
As a response to the high profile BHS case, in which Dominic Chappell (the BHS director owner) was fined £87,000 for a failure to provide information and documents persuant to a s72 request by the Pensions Regulator, the Government has announced that it intends to give more powers to the Pensions Regulator. The proposals were set out in a White Paper entitled "Protecting Defined Benefit Pension Schemes", published in March. A consultation on some of the proposals was then published by the Department for Work & Pensions on 26 June 2018.
The Government has concluded that there is no systemic problem in the regulatory and legislative framework that governs defined benefit pension schemes; but there are examples of sponsoring employers misusing the flexibility in scheme funding, so the proposed changes are aimed at supporting the Pensions Regulator's ambition to be clearer, quicker and tougher. One of the headline grabbing proposals is the proposed new criminal offence "to punish wilful or grossly reckless behaviour of directors" in relation to a defined benefit pension scheme.
From the point of view of professional advisers, one of the key changes set out will be the increase in the Regulator's information gathering powers.
The changes are:
- The introduction of powers to compel a relevant person to attend an interview with the Pensions Regulator and explain any facts, events or circumstances that are relevant to the investigation or the Regulator's function or to answer questions about information, records or documents held. This is an extension and enhancement of an existing power under s72(1A) of the Pensions Act 2004 which is limited in scope and applies only in respect of automatic enrolment and Defined Contribution Master Trusts. The White Paper indicates that based on its casework experience the Regulator provisionally assesses that the use of this power will be considered in every future avoidance case, in particular with regard to undertaking initial discussions with trustees and receiving factual accounts directly from professional advisers. The interview process is expected to significantly reduce the current timeframe of a section 72 notice process which can be three to six months;
- Civil penalties for a failure to respond to section 72 notices for information. This is as an alternative to the existing criminal sanctions. The White Paper notes that criminal prosecution is expensive and time-consuming and may be a disproportionate reaction in the case of a lower level breach and;
- An extension of the Regulator's existing inspection powers. The Regulator will be given the power to inspect records, documents and electronic devices of parties at premises for purposes relevant to the Regulator's function.
The Government has decided against legislating for a "duty to co-operate" at this stage, as it considers that the introduction of civil sanctions will assist in diffusing the "combative approach" that often results from the use of s72 powers, and drive cooperation. However, this will be given further consideration as part of the wider discussions on a more proactive Regulator.
There will be further consultation to be carried out, and as ever with pensions the devil will be in the detail, but the changes proposed in the White Paper are unlikely to come into force before 2020.
Reconsidered: Integrity and dishonesty in disciplinary proceedings
In Wingate and Evans v SRA and SRA v Malins (2018) the Court of Appeal gave guidance on the concept of "integrity". Whilst the cases concerned the behaviour of solicitors and were decided in the context of the SRA Code of Conduct 2011, the Court of Appeal's decision is applicable to the regulation of all professionals including accountants. It goes without saying that the principles of honesty and integrity are, of course, fundamental to the work of a chartered accountant, and included within the various codes of conduct.
In the High Court, the judge in Malins reached the conclusion that lack of integrity and dishonesty were synonymous. However, as was widely predicted, the Court of Appeal concluded that Malins was wrongly decided: honesty and integrity are not the same.
Jackson LJ held that honesty is a basic moral quality which is expected of all members of society. Integrity, on the other hand, is a broader concept and, although hard to define, is very much distinct and linked closely with the ethical standards expected of professional people:
"In professional codes of conduct, the term "integrity" is a useful shorthand to express the higher standards which society expects from professional persons and which the professions expect from their own members... the underlying rationale is that the professions have a privileged and trusted role in society. In return they are expected to live up to their own professional standards".
Jackson LJ cautioned that neither the courts nor professional tribunals must set unrealistically high standards; the duty of integrity does not require professionals to be paragons of virtue. However, in connecting integrity with the manner in which a particular profession professes to serve the public, he emphasised that in each case it is a concept which the relevant professional disciplinary tribunal, with its specialist knowledge of the profession concerned and its particular ethical standards, is best placed to identify. The tribunal's decisions must, therefore, be respected unless it has erred in law.
Had the Court of Appeal reached a different conclusion, this would have been problematic for professional regulators, who may frame charges on the basis of a lack of integrity in serious cases of unethical conduct which may fall short of dishonesty.
Despite the Court of Appeal's guidance, the concept of integrity still remains something that is relatively fluid. Given Jackson LJ's comments that tribunals are best placed to apply their own particular ethical standards, it is also likely that decisions in this area will be even harder to challenge.
1 South Australia Asset Management Corpn. v York Montague Ltd  AC 191.
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