The trend for cooperation between international financial regulators has become a feature of the regulatory environment over recent years. On 24 February 2010, in a boost for the UK Financial Services Authority (“FSA”) in its approach to dealing with requests for assistance from overseas regulators, the Court of Appeal allowed an appeal and found in favour of the FSA in connection with the exercise of its powers in aid of United States Securities and Exchange Commission ("SEC") proceedings.[1] Businesses operating in the financial sector, particular on an international basis, should pay close attention to this decision.

Background Facts

In 2002, the SEC initiated an investigation into a New York-based investment adviser (the “Investment Adviser”) which acted on behalf of two offshore companies (the “Respondents” in the present appeal). Four years later, the SEC commenced an action against an employee of the Investment Adviser and six other individuals in connection with alleged illegal short-selling practices. In 2009, as part of these proceedings the SEC contacted the FSA seeking its assistance in obtaining documents from Goodman Jones, a London-based accountancy firm that the SEC contended had acted for the Respondents and held documents relating to deals with the Investment Adviser. In a broadly drafted request, the SEC sought to obtain all documents from Goodman Jones relating to the Respondents and the Investment Adviser between 2000 and 2009. The FSA, which is subject to a statutory duty under the Financial Services and Markets Act 2000 (“FSMA”) to “take appropriate steps to co-operate with overseas regulators”[2], followed up on the SEC’s request by exercising its discretion and appointing investigators.[3] In August 2009, the FSA sent a formal notice to Goodman Jones requiring the production of the documents sought by the SEC.

High Court

In what is believed to have been the first legal case of its kind brought by a third party, the Respondents challenged the FSA’s appointment of investigators in relation to Goodman Jones as unlawful and claimed that, in any event, the SEC’s request for documents from Goodman Jones (and therefore the FSA’s notice) was unreasonably broad. While the High Court held that the appointment of investigators did not fall outside the scope of the FSA’s powers, it found that the SEC’s request for documents was too broad. The High Court considered that the request went beyond the scope of the litigation in the US (proceedings to which, the High Court noted, the Respondents were not a party and in respect of which the Respondents had no opportunity to defend themselves). The High Court held that in the circumstances, the “FSA could not have done other than decided that it was not necessary or indeed proportionate for the wide scope of discovery that was sought to be agreed to.” The High Court was also critical of the SEC’s approach and the delay in requesting the FSA’s assistance, finding that “what is happening here is that at the very last minute the SEC are trying to bolster their case in relation to the claims made.”[4]

Court of Appeal

In a positive outcome for transnational regulatory cooperation, the Court of Appeal allowed the appeal, finding in favour of the FSA based on the following five issues:

The Duty of the FSA to Verify Information Provided by an Overseas Regulator

The Court of Appeal held that it was not for the FSA to analyse or make further enquiry of the request made by a foreign regulator. The Court of Appeal could find “no good reason why Parliament should have required the FSA to second-guess a foreign regulator as to its own laws and procedures, or as to the genuineness or validity of its requirement for information or documents.”

The Court of Appeal acknowledged that the FSA is not bound to comply with the request of an overseas regulator, and observed that FSMA sets out four factors[5] which the FSA may take into account when deciding whether to exercise its investigative power at the request of a foreign regulator: (1) whether the overseas regulator would give corresponding assistance to the FSA; (2) whether the case concerns the breach of a law that has no close parallel in the UK or involves the assertion of a jurisdiction not recognised by the UK; (3) the seriousness of the case and its importance to persons in the UK; and (4) whether it is otherwise appropriate in the public interest for the FSA to give the assistance sought. The Court of Appeal found that none of these factors suggested that the FSA should also “form a judgment as to the necessity or desirability, from the point of view of the foreign regulator, of its obtaining the information or documents it seeks.” The Court of Appeal held that, by asking “pertinent questions” of the SEC and receiving “sensible answers”, the FSA had decided appropriately to exercise its investigative power to assist the SEC.

In response to the High Court’s criticism of the SEC's approach to the request, the Court of Appeal considered that “it was not incumbent on the FSA to examine the SEC’s request critically, and it was all the more wrong for the court to do so.” The Court of Appeal noted that had the SEC’s request been considered extravagant under New York law, it would have been raised in the context of the New York proceedings and it was therefore not a matter for the UK courts to determine.

Compliance with International Memoranda of Understanding

The High Court considered a Memorandum of Understanding between the SEC and the UK Securities Investment Board (the forerunner of the FSA) signed in 1991, and the IOSCO Multinational Memorandum of Understanding Concerning Cooperation and the Exchange of Information introduced in May 2002 to which both the FSA and SEC are signatories. The High Court noted that the 1991 Memorandum of Understanding includes a requirement that the requesting body’s application is not to be disclosed to any party unless such disclosure is essential in order to achieve the result of the request or the requesting body agrees that such disclosure can be made. In the High Court’s view, this was material in the present case as the Respondents had claimed that the FSA had failed to inform or consult with them concerning the request for documents, that the FSA could and should have asked the Respondents whether they consented to any disclosure by Goodman Jones, and that in any event the Respondents ought to have been informed about the request without such delay. The High Court understood why information was not passed on to the Respondents given the terms of the Memoranda, but queried whether there was any danger in this case in notifying the Respondents. The High Court considered that “no-one could conceivably suggest” that Goodman Jones would have done anything untoward (such as destroying documents) and would not have passed on any documents until the matter was resolved. That said, the High Court found that this was not a basis “in itself” for finding against the FSA in the circumstances of this case.

Significantly, the Court of Appeal held that the requirements applicable to the FSA and its investigators are solely those contained in the applicable UK statute. In the Court of Appeal’s view, “it is immaterial” whether the SEC’s request complied with a Memorandum of Understanding entered into by the regulators.

The Provision of Notice of the Appointment of Investigators to the Subject of the FSA Investigation

In connection with the FSA’s general powers to appoint investigators,[6] FSMA imposes a duty on the FSA, save in specified circumstances, to give written notice of an investigator’s appointment to the person who is the subject of the investigation.[7] The High Court noted that “section 170, 171 and 172 are material in considering the conduct of investigations generally and they are applicable to an investigation resulting from an agreement to support an overseas regulator just as for domestic investigations”. However, the Court of Appeal held that the lack of notice of the appointment of investigators in this case was “immaterial”. The FSMA requirement concerning the provision of notice of an investigator’s appointment to the person who is the subject of the investigation did not apply to investigations commenced by the FSA to assist a foreign regulator.

The Scope of the Investigators’ Appointment

The Court of Appeal decided that the High Court had adopted a “fundamentally incorrect approach” by considering the scope of disclosure sought by the FSA on behalf of the SEC “as if the FSA had sought disclosure of documents in domestic litigation,” instead of by reference to the FSA’s investigatory powers. The FSA investigation had been initiated to assist the SEC, not to obtain documents admissible in New York proceedings. It was not for the UK courts to examine “whether the scope of the New York action or the facts pleaded in it may or may not be enlarged following disclosure of the documents now sought.”

The Powers of Investigators to Require the Production of Confidential Documents

The Court of Appeal held that the High Court had been wrong to find that the power of the investigators to require production of confidential documents could be exercised “only if it was necessary or expedient” for the purposes of their investigation. That test is applicable in the context of a demand that a person who is not under investigation or who is not connected with that person attend an interview or produce documents.[8] The Court of Appeal confirmed that where information or documents are sought from a person who is the person under investigation or is connected with that person, the applicable test is whether the questions to be answered or the provision of the information or documents sought are “relevant to the purposes of the investigation.”[9]

“Specified Documents” or “Documents of a Specified Description”

The FSA’s investigators have the power to require the production of “any specified documents or documents of a specified description.”[10] The Court of Appeal held that while the SEC and the FSA in the present case were unable to specify precisely the documents they wanted to be produced, the FSA investigators had made a lawful requirement for “documents of a specified description.” Significantly, there had been no suggestion that Goodman Jones had been unable to identify the documents to which the investigators’ requirement related.

Comment

The Court of Appeal recognised that “Financial enterprises and financial transactions are increasingly international, as the banking crisis has only too clearly demonstrated. It is therefore of the greatest importance that national financial regulators cooperate, particularly where there are suspicions or allegations of financial fraud or other misconduct.” With that in mind, the Court of Appeal has provided robust support for the FSA’s approach to transnational financial regulatory investigations. The judgment also provides further support for the SEC’s ability to obtain evidence from beyond the borders of the United States.

In light of the judgment, financial firms can expect to continue to face potentially broad document requests originating from overseas regulators. Overseas regulators, and the SEC in particular, may seek to rely on the Court of Appeal’s support for the FSA’s existing approach and the finding that it is not for the FSA to scrutinise the extent to which the request is lawful under the relevant overseas laws.

Against this background, businesses in the financial sector and their advisers should pay close attention to the guidance set out in the judgment in relation to how the FSA ought to exercise its discretion in assisting overseas regulators. Businesses should consider the extent to which co-operation with the regulator is appropriate, bearing in mind that the regulator in one jurisdiction is likely to be sharing information with relevant overseas counterparts. Businesses operating on an international scale should also be aware that a reluctance to cooperate with regulators in the US, for example, may simply be putting off the inevitable. The SEC may call on foreign regulators, such as the FSA, to assist in obtaining evidence that a business may be otherwise unwilling to provide. Financial firms should also formulate compliance and training programmes to ensure preparedness among staff when faced with regulatory requests for information and documents. As the trend for international regulatory cooperation shows no sign of slowing, the message is to "be prepared."

Lista Cannon (lcannon@fulbright.com or +44 207 832 3601) is Partner-in-Charge (and a former acting Head of Enforcement at the UK Securities Investment Board, now Financial Services Authority), Antony Corsi (acorsi@fulbright.com or +44 207 832 3659) a partner, and Ian Pegram (ipegram@fulbright.com or +44 207 832 3645) a Professional Support Lawyer at Fulbright & Jaworski International LLP in London.

Richard C. Smith (rcsmith@fulbright.com or +1 202 662 4795) is a partner and chair of Fulbright’s White Collar Crime Practice Group and Government Investigations and Enforcement Practice Group and is based in Washington, DC. Richard is a former Acting Chief and Principal Deputy Chief for Litigation of the Fraud Section of the U.S. Department of Justice, Criminal Division. Kimberly S. Walker (kwalker@fulbright.com or + 1 202 662 0434) is a senior associate in the White Collar Crime Practice Group and Government Investigations and Enforcement Practice Group in Washington, D.C.

Fulbright’s White Collar Crime Practice Group
Fulbright’s White Collar Crime Practice Group is experienced in the management of complex civil and criminal litigation on behalf of U.S. and international companies, including Fortune 500 corporations and other large commercial organizations, their officers and directors, international corporations and entities, and individuals. Fulbright’s White Collar Crime Practice Group also is experienced in the practice of preventative counseling and compliance programs. From a strategic perspective, this is important for reducing the risk of civil and criminal litigation. Our representation includes all phases of governmental investigations and criminal and civil litigation.