Do we need a new duty of care in financial services?

On 17 July 2018, the FCA published a paper on its Approach to Consumers (the Approach), accompanied by a discussion paper DP18/5 (the DP) on the possible introduction of a new duty of care and other alternative approaches (a New Duty).

The Approach sets the FCA’s vision for well-functioning markets that work for consumers, and builds on the November 2017 consultation on its Future Approach to Consumers. The aim is to provide greater transparency on when and how the FCA will act to protect consumers, its policy positions on key issues, and its strategy for ensuring that it advances its consumer protection objective with the greatest impact.

The key question raised by the November 2017 consultation, one of immediate interest to firms and other stakeholders, was whether there was a need to introduce a New Duty.

Some stakeholders suggested that the current regulatory framework was insufficient, was not applied effectively to prevent harm to consumers and did not provide appropriate levels of protection. Some thought the introduction of a New Duty could foster long term cultural change within firms and avoid conflicts of interest. Others by contrast felt that existing FCA rules and common and statute law, complemented by the Senior Managers & Certification Regime collectively represent in practice the same requirements on firms as a duty of care.

The FCA’s objective is therefore to open broader discussion on the merits of a New Duty and understand what outcomes a New Duty may achieve to enhance behaviours in the financial services sector.

To that end, the FCA seeks views on:

• whether there is a gap in the existing legal and regulatory framework, or the way the FCA regulates, that could be addressed by introducing a New Duty;

• whether change is desirable and if so, the form it should take;

• what a New Duty for financial services firms might do to enhance positive behaviour and conduct from firms in the financial services market, and incentivise good consumer outcomes;

• how the New Duty might increase the FCA’s effectiveness in preventing and tackling harm and achieving good outcomes for consumers;

• whether breaches of a New Duty or of the FCA’s Principles for Businesses should give rise to a private right of action for damages in court; and

• whether a New Duty would be more effective in preventing harm (by, for example, enhancing good conduct and culture within firms) and therefore lead to less reliance on redress.

The DP deliberately leaves open for discussion the nature of any duty, i.e. whether it would be more akin to a ‘duty of care’ or to a fiduciary duty, the former being more of a positive obligation than the latter which is, largely, a prohibition (e.g. a firm must not put its own interests above those of the client).

Assessment of the current legal and regulatory framework

The DP reviews the current legal and regulatory framework and notes that it could be said that the current Principles for Businesses (Principles), amplified by detailed rules, address many of the issues cited for introducing the New Duty.

The FCA identifies the following as the most relevant Principles:

• Principle 2 - a firm must conduct its business with due skill, care and diligence
• Principle 6 - a firm must pay due regard to the interests of its customers and treat them fairly
• Principle 7 - a firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading
• Principle 8 - a firm must manage conflicts of interest fairly, both between itself and its customers and between a customer and another client, and
• Principle 9 - a firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment.

The FCA also points to the client’s ‘best interests’ rule, whilst highlighting that there is no equivalent rule applicable to accepting of deposits and carrying out contracts of insurance, and obligations on firms to take reasonable care in undertaking certain activities.

These are supplemented by the Consumer Rights Act 2015 (the CRA), which implies a term requiring those providing services to consumers to act with reasonable care and skill, and the FCA’s power to enforce breaches of certain consumer protection laws (including the CRA).

The FCA has also concurrent competition powers to investigate and intervene in respect of markets where competition may not be working well, and to enforce against breaches of the competition law prohibitions.

Finally, the FCA is extending its Senior Managers and Certification Regime (SM&CR) to all FSMA authorised firms: this will impose on most employees of financial services firms five conduct rules, including in particular the requirement to act with due care, skill and diligence, and to pay due regard to the interests of customers and treat them fairly. The FCA believes these additional obligations on individuals could help address some of the key cultural and governance concerns which underlie calls for a New Duty.

Proposals for the New Duty

As well as seeking views on the merits, practicalities and consequences of introducing a New Duty, the FCA will consider a range of possible alternatives to address stakeholders’ concerns:

1. making a rule introducing a New Duty, through the use of FSMA rule-making powers. This approach would require clarification through the issue of guidance and consideration as to how it would sit within the regime, and in particular its relationship to the Principles.
2. by the introduction of a statutory duty (through a change in primary legislation in Parliament) and supplemented by FCA rules and guidance. A statutory duty would have greater status than the Principles, going further than the requirements of s1C(2)(e) FSMA¹.
3. the extension of the client’s best interest rule. This would only apply to regulated activities and may require some amendment to some of the Principles.
4. enhancements to the Principles through the introduction of detailed new rules or guidance, for example through the guidance expected to be published next year on the identification and treatment of vulnerable customers.

Consumer outcomes and redress

While being clear that the best consumer outcome is to prevent harm from occurring in the first place, the FCA addresses the mechanisms available to a consumer when seeking redress when things go wrong.

It is in that regard, the FCA raises what will no doubt be a controversial question as to whether a breach of a New Duty or of the Principles should give rise to private right of damages. The latter reopening a debate had in the context of a 1998 consultation that originally introduced the Principles.

Any extension of private rights of action in respect of breach of the Principles would need to be considered in conjunction with the FCA’s recent discussion of a proposed extension of Principle 5 to unregulated activities, which the FCA may revisit in the future. Such an extension of Principle 5, together with the recognition of a range of industry codes relating to unregulated activities, would assume a wholly different complexion if private rights of action were also added to the mix.

Reflection

The call for duty of care in financial services regulation is not a new one and, as well as having been a priority for the Financial Services Consumer Panel for some time, was considered by the Parliamentary Commission on Banking Standards as well as the Law Commission.

It is not clear from the DP that there is in fact an obvious gap in the existing legal and regulatory framework to be filled – that itself being an open question in the DP. That is, rationally, the fundamental starting point – proceeding to discuss the nature or form of a New Duty, including the potential for the Principles to be actionable, is premature before the underlying problem or gap is properly identified. Clearly there continue to be conduct issues in the market that need to be addressed but rushing to introduce new rules or guidance is not necessarily the best answer.

¹ In meeting its objective of securing appropriate degree of protection for consumers the FCA is currently required by s1C(2)(e) FSMA to have regard to “the general principle that those providing regulated financial services should be expected to provide consumers with a level of care that is appropriate having regard to the degree of risk involved in relation to the investment or other transaction and the capabilities of the consumers in question”