High Court clarifies extent of SIPP administrator's due diligence duties

Out-Law News | 23 Nov 2018 | 11:10 am | 5 min. read

Regulatory rules require administrators of self-invested personal pensions (SIPPs) to carry out due diligence on their customers' prospective investments, although the High Court has confirmed that they are not providing financial advice.

SIPP administrator Berkeley Burke had claimed that its 'execution-only' contract with customer Wayne Charlton meant that it was not required to check whether an overseas investment was legitimate. It sought a judicial review of the Financial Ombudsman Service’s (FOS) decision requiring it to compensate Charlton for his losses when the scheme failed.

Mr Justice Jacobs rejected Berkeley Burke's argument that the FOS had imposed a new 'duty of inquiry' on the administrator, which went further than the regulatory requirement to treat customers fairly. He ruled that the FOS instead applied the existing regulatory principles to the specific circumstances of the case, and found that Berkeley Burke fell short of what was expected of it.

"There is nothing in the ombudsman's decision that indicates he thought he was articulating a new rule, as distinct from applying the established rules to the circumstances of the case," the judge said. "The concept of 'due diligence' in [the regulatory principles] inevitably brings to mind the concept of enquiry or investigation. They are not such distinct concepts that an ombudsman's conclusion - that the exercise of due diligence involved enquiry or investigation - involves the creation of a new rule."

The judge also rejected Berkeley Burke's argument that the FOS was bound by the conclusions of the Pensions Ombudsman Service (POS) in similar cases. The FOS and POS operate under different statutory regimes, while it is for the FOS to decide what the fair and reasonable outcome of a complaint should be, he said.

Financial services and SIPP disputes expert Ravi Nayer of Pinsent Masons, the law firm behind Out-Law.com, said that the ruling "has the potential to erase some of the benefits of SIPPs" - a type of personal pension plan which allows individuals to choose how their savings are invested from a range approved by the government and tax authorities.

"Requiring SIPP providers to perform due diligence on all investments, albeit without rules to that effect, will inevitably limit the types of investments clients will be able to choose from and consequently remove the investment autonomy that clients have previously enjoyed and which is fundamental to SIPP operators' businesses," he said.

"The industry will have understandable concerns about the actual differences between what was  expressed by the FOS, and accepted by the High Court, to be a distinction between, on the one hand, a duty to advise on the suitability of an investment and, on the other hand, a duty to assess that investment's suitability for a pension. Indeed, other execution-only investment providers, such as asset managers, might look on with concern at the latest step in an incremental blurring of the lines between an adviser and a SIPP operator’s duties," he said.

"Nevertheless, the High Court’s decision must be placed in its legal context - that it merely upheld a FOS decision, made not on strict legal grounds, and it therefore remains to be seen whether the High Court would make the same decision when not encumbered by a FOS finding of fact," he said. "Where, however, the implications of this decision increases the costs to SIPP operators by way of compensation payments, efforts will no doubt be re-doubled to look to PI Insurers of IFAs, where they are involved."

"Whilst SIPP providers have historically offered low fees, the added cost of performing due diligence on investments will unsurprisingly lead to increased fees for clients. The potentially onerous requirements that the judgment imposes on SIPP providers may compel the industry to alter the nature of SIPPs and diminish the benefits that SIPPs originally offered," said Nayer.

Charlton became a customer of Berkeley Burke's in 2011. He transferred his existing personal pension, worth around £29,000, to a SIPP, in order to invest the money in a 'green oil' scheme in Cambodia run by a company called Sustainable AgroEnergy plc. It later emerged that the scheme was a scam and that Sustainable AgroEnergy did not own the land on which the project was purportedly run. The company was placed into receivership following an investigation by the Serious Fraud Office, and three of its directors imprisoned for fraud.

SIPP administrators are regulated by the Financial Conduct Authority (FCA) and bound by the regulatory principles set out in the FCA Handbook. Principles 2 and 6, requiring firms to conduct their business "with due skill, care and diligence", and to "pay due regard to the interests of [their] customers and treat them fairly", were particularly relevant in this case, and could be relied on by the ombudsman, according to the judge.

The FCA Handbook also contains guidance and specific rules governing the conduct of a firm, set out in the Conduct of Business Sourcebook (COBS). In a separate argument, Berkeley Burke claimed that there was a conflict between the principles relied on by the ombudsman and the COBS rule requiring the firm to execute orders from the client "following the specific instruction". The judge, however, disagreed. He agreed with the FCA and the FOS that there could be no conflict, as the principles are "the ever present sub-strata or overarching framework" which 'stand over' the COBS rules.

"Any suggestion that a SIPP provider must, as a result of [the COBS rules], execute a transaction, regardless of the duties contained in the principles, produces surprising results and in my view cannot be right," the judge said.

The judge went on to list examples of scenarios in which the SIPP administrator "would or might think it inappropriate to proceed, or at the very least query the transaction with his client". These included where the investment was not eligible for the SIPP tax benefits, or would imminently no longer be eligible; and where the SIPP administrator had learned of problems, such as a possible insolvency, which affected the proposed investment.

The FCA subsequently wrote to SIPP administrators in response to the judgment (2-page / 187KB PDF), and to similar cases currently proceeding through the courts. It used the letter to remind firms of their existing regulatory obligations, and to urge them to consider the potential implications for their own business models.

"If the outcome of any of these cases 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 regulator said. "Where relevant, firms should also notify claims to their professional indemnity insurers in accordance with their policies."

The FCA followed this letter with a "Dear CEO" letter to SIPP providers, explaining its expectations of firms. The letter recommends that firms should consider whether the High Court's decision, and subsequent related decisions, will impact its business and customers. The FCA expects firms who feel that the decision may affect their capacity to meet their financial commitments to their customers should notify the FCA immediately. Firms should additionally inform their insurers of any claims under professional indemnity policies.

In circumstances where SIPP providers are unable to meet its financial commitments, the FCA recognises that "it may be in the interests of some of its customers for part or all of its business to be sold to another firm". Should this situation arise, firms will still be required to consider their customers' interests and treat them fairly, including where customers may have a possible claim for compensation. Firms will continue to be required to deal with the FCA in an open and cooperative way. Open communication with the FCA will include informing the FCA if the firm is intending to wind the business up, or sell all or a substantial part of the business to another firm.

"Considering the content of the 'Dear CEO' letter, the FCA evidently considers that the High Court's decision may have a significant impact on complaints against SIPP providers and consequently their ability to meet their financial commitments," said pensions expert Simon Laight of Pinsent Masons.  

Berkley Burke may still appeal the High Court's decision. A spokesperson stated that it intended to "take all reasonable steps to pursue this case and to defend its position through the appeal process".