Compliance code cracker – dishonesty and financial markets in criminal, civil law

In a startling development, proceedings related to "cum-ex" tax evasion/market abuse in the Financial Conduct Authority's (FCA) Regulatory Decisions Committee (RDC) have been stayed. This is pending a decision in a case due to be heard in the Commercial Court, which is based on the same facts. It is rare for a judge to question the competence of the RDC. The case also raises difficult issues related to the definition of dishonesty in complex financial crime cases that deal with evidence of market practice.

The RDC case concerns conduct claimed to have been to be dishonest and lacking in integrity in breach of Principle 1 of the FCA's Statements of Principle for Approved Persons. In T & Anor, R (On Application of) v Financial Conduct Authority, Mr Justice Swift said aspects of the defence to the Commercial Court claims asserted the strategy had been operated consistent with established market practice.

He also said, however, with regards to the RDC: "In the same way that it is important to recognise that members of the RDC bring with them experience of working in the financial services sector, it would be foolhardy to pretend that they are as well-equipped as judges of the Commercial Court to deal with matters such as the issues to be determined in the Validity Trial." These matters related to Danish Law and the application of the Denmark-U.S. Double Taxation Treaty.

In the leading Supreme Court judgment on the criminal law relating to dishonesty, Ivey v Genting, Lord Hughes said there was no reason why the law should excuse those who made a mistake about what contemporary standards of honesty were, whether in the context of insurance claims, high finance, market manipulation or tax evasion.

RDC and FCA enforcement

In the case of Arif Hussein, a UBS derivatives trader, however, Judge Tim Herrington said the RDC had rejected the contention — put forward by the FCA's enforcement division — that Hussein had acted dishonestly in attempting to influence UBS's Libor submissions for the benefit of the profitability of his trading book, knowing that to be improper. The RDC had found that Hussein had closed his mind to the risk that his preferences would be used to influence Libor submissions with the aim of benefiting his trading positions.

In so doing, he had acted recklessly and therefore without integrity. Judge Herrington also said that FCA enforcement had refused to accept the RDC's finding that Hussein had not acted dishonestly.

The vexed issue of dishonesty in financial markets transactions was addressed by the Supreme Court in Ivey v Genting Casinos. In this case of criminal cheating at cards under s 42 of the Gambling Act 2005, Lord Hughes applied the civil standard of dishonesty as stated in Royal Brunei Airlines v Tan, which was a case of dishonest assistance in a breach of trust. Lord Nicholls said in that case that, when dishonesty was in question, the fact-finding tribunal must first ascertain (subjectively) the actual state of the individual's knowledge or belief as to the facts.

The reasonableness or otherwise of his belief was a matter of evidence (often in practice determinative) going to whether he held the belief. It was not, however, an additional requirement that his belief must be reasonable; the question was whether it was genuinely held.

When his actual state of mind as to knowledge or belief concerning facts was established, the question whether his conduct was honest or dishonest was to be determined by the fact-finder by applying the (objective) standards of ordinary decent people. There is no requirement that the defendant must appreciate that what he had done was, by those standards, dishonest. This requirement diverged from the standard of dishonesty in the leading criminal case of R v Ghosh.

Ghosh test

The Ghosh test provided that — in determining whether the prosecution had proved that the defendant had been acting dishonestly — a jury was required to decide whether, according to the ordinary standards of reasonable and honest people, what had been done was dishonest.

If it was not dishonest by those standards, the prosecution would fail. If it was dishonest by those standards, the jury would then have to consider whether the defendant himself must have realised that what he was doing was, by those standards, dishonest.

The Ghosh test had featured in the appeal case of case of fellow UBS trader, Tom Hayes, who has recently been released from jail and has a live case at the Criminal Cases Review Commission. Hayes had argued, unsuccessfully, that the judge in his criminal trial had been wrong to conclude the evidence relating to the views and conduct of participants in the market was not relevant to the first limb of the Ghosh test of dishonesty.

Hayes had argued that, in determining that standard, a necessary contextual factor had been the standards of the relevant market at the time, and how participants in that market had operated. The judge should have directed the jury that it should have regard to all the evidence of market activity in deciding whether the conduct in context was dishonest by the standards of ordinary men.

He also argued that the judge had wrongly identified and ruled, as a question of law, that the defence could not refer the jury to matters of fact which the appellant relied upon in defence as relevant to the first "objective" limb of the test. This was the case even though the evidence was relevant to the second subjective limb and could be taken into account in relation to that.

The court found, however, there was no authority that objective standards of honesty were to be set by a market, as markets sometimes adopted patterns of behaviour which were dishonest by the standards of honest and reasonable people. To depart from the view that standards of honesty were determined by the standards of ordinary, reasonable and honest people was not only unsupported by authority, but would also undermine the maintenance of ordinary standards of honesty and integrity that were essential to the conduct of business and markets.

The civil test of dishonesty should apply

Lord Hughes in Ivey v Genting said the second limb of the Ghosh test wrongly allowed the accused to escape liability where he had made a mistake of fact as to the contemporary standards of honesty. He held that the test of dishonesty adopted in civil proceedings should apply in all circumstances. There was no requirement that the defendant must appreciate that what he had done was, by those standards, dishonest.

"When dishonesty is in question the fact-finding tribunal must first ascertain (subjectively) the actual state of the individual's knowledge or belief as to the facts. The reasonableness or otherwise of his belief is a matter of evidence going to whether he held the belief, but it is not an additional requirement that his belief must be reasonable. The question is whether it is genuinely held. When once his actual state of mind as to knowledge or belief as to facts is established, the question whether his conduct was honest or dishonest is to be determined by the fact-finder by applying the (objective) standards of ordinary decent people. There is no requirement that the defendant must appreciate that what he has done is, by those standards dishonest," he said.

Barclays bankers suffer from retrospective effect of Ivey

Colin Bermingham and Carlo Palombo, both former bankers at Barclays, argued unsuccessfully in their Euribor manipulation criminal appeal that some of the drafters of the Euribor code had expressed views not too dissimilar from their own concerning what was appropriate market practice in accordance with the code. They also argued that they had been disadvantaged by the change in the standard dishonesty directions from Ghosh to Ivey, despite the fact that the Ivey judgment had been decided after the offences with which they had been charged. Criminal law decided by judges is, however, construed to take effect retrospectively, although that principle is not generally applicable to statutory provisions.

The court had found that the first limb of the Ivey test had, however, given a substantial measure of protection from the application of an objective test unrelated to the state of mind of the defendant under consideration. This was because the test of dishonesty in Ivey remained a test of the defendant's state of mind — his or her knowledge or belief — to which the standards of ordinary decent people were then to be applied.

Dishonest assistance and self-invested pensions

The Ivey v Genting finding on dishonesty in a criminal law case — which had followed the civil dishonest assistance decision in Royal Brunei Airlines v Tan — was applied in a recent case of dishonest assistance. The claimant, Nigel Ross Burns, said he had been induced by a broker to transfer of his pension into a qualifying recognised overseas pension scheme (QROPS). The broker had then transferred 80% of the monies to Capitis Fora LLP. Burns' monies had then been loaned to a property developer and lost.

Burns has won an application for summary judgment in a case brought against the partners in Capitis. Claims against the broker and the QROPS manager are continuing. The court found that the Capitis partners had no real prospect of defending a claim that they had dishonestly assisted QROP manager, Gibraltar-based Castle Trust & Management Services Ltd, to invest his pension monies in a property development in breach of trust.

The deal brochure provided to Ross by Capitis had indicated that there was an existing portfolio of UK residential property in place over which security would be provided. That did not permit or contemplate the making of an unsecured and unregulated loan by Castle to Capitis, or the forwarding of pension funds to the property developer with a view to being used to fund property development without security being offered until completion, which was what had actually happened.

Master Teverson found, applying Ivey v Genting, that, judged objectively, the partners in Capitis ought to have known that the investment was improper as it was outside the terms of the brochure. That was sufficient to render them liable to the claimant for dishonest assistance. It was no defence for them to rely on their subjective belief that they were acting honestly, nor was it a defence to say that others known to them had invested their own money in the same way and lost it.

He held that a claim for dishonest assistance required that there had to be a trust or fiduciary relationship; that relationship must have been breached; the breach must have been procured or assisted by the defendant; and the defendant must have acted dishonestly when so acting. He concluded that there had been a trustee/beneficiary relationship between the Castle Trust and Burns following the transfer of his monies to Castle Trust.

Master Teverson also cited the more recent case of Group Seven v Notable Services (discussed further here, here, here and here) at which the Court of Appeal had confirmed: "In the light of Ivey, it must in our view now be treated as settled law that the touchstone of accessory liability for breach of trust or fiduciary duty is indeed dishonesty, as Lord Nicholls so clearly explained in Tan, and that there is no room in the application of that test for the now discredited subjective second limb of the Ghosh test. That is not to say, of course, that the subjective knowledge and state of mind of the defendant are unimportant. On the contrary, the defendant's actual state of knowledge and belief as to the relevant facts forms a crucial part of the first stage of the test of dishonesty set out in Tan. But once the relevant facts have been ascertained, including the defendant's state of knowledge or belief as to the facts, the standard of appraisal which must then be applied to those facts is a purely objective one. The court has to ask itself what is essentially a jury question, namely whether the defendant's conduct was honest or dishonest according to the standards of ordinary decent people."


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Thomson Reuters Regulatory Intelligence and Compliance Learning

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