Clifford Chance

On 25 September 2023, the FCA and PRA (the "Regulators") published their much anticipated consultation papers (PRA CP 18/23 and FCA CP23/20, together the "Consultation Papers") on a package of measures to promote diversity and inclusion in the financial services sector, including proposed amendments to clarify where the Regulators' rules apply to non-financial misconduct.

In recent years, the Regulators have made clear that, in certain circumstances, non-financial conduct can amount to misconduct within their regulatory remit. However, in the absence of explicit guidance as to the extent to which the Regulators' rules apply to non-financial misconduct, there has been a degree of uncertainty in terms of the expectations on firms and individuals. This uncertainty has been exacerbated by apparent inconsistencies in regulatory decisions concerning non-financial conduct, in particular regarding the extent to which behaviour in an individual's private life and their personal integrity could amount to a breach of the Conduct Rules or be relevant to assessment of fitness and propriety. For example in relation to fitness and propriety, whilst the Upper Tribunal in Frensham expressed the importance of establishing a link between an individual's personal lack of integrity and their professional integrity, the FCA's decision in Zahedian indicated that serious personal misconduct, in that case a conviction for grievous bodily harm, may in itself be evidence of serious lack of integrity and reputation such that the individual is not fit and proper to perform regulated activities. Therefore, clarification in this area has been sought for some time.

The FCA is now proposing to make amendments to its Handbook to address non-financial misconduct within the Conduct Rules, Fit and Proper assessments, and Suitability guidance on the Threshold Conditions. Similarly, the PRA proposes to update SS35/15 (Strengthening individual accountability in insurance) and SS28/15 (Strengthening individual accountability in banking) to clarify that the PRA may take into consideration established patterns of behaviour of an individual that would, or would be likely to, affect the firm’s safety and soundness, when considering whether the individual meets the PRA’s standards of fitness and propriety.

Fitness and Propriety

In accordance with the Fit and Proper test for Employees and Senior Personnel (FIT) section of the FCA Handbook, firms must ensure that individuals performing a senior management function or a certification function are fit and proper to carry out their role, and FIT provides guidance on how firms should make that assessment. The FCA proposes to amend FIT to explain that an assessment of fitness and propriety should not be limited to conduct in the course of a firm's activities, by specifying that bullying and similar misconduct within the workplace are relevant to an individual's fitness and propriety assessment, and that misconduct in a person’s personal or private life may also be relevant. Similarly, the PRA's proposed amendments set out that non-financial behaviours, including bullying, discrimination, and harassment, may be relevant to its assessment of whether an individual's behaviour may affect their firm's safety and soundness.

The proposals regarding fitness and propriety are intended to clarify that conduct which could damage public confidence in the UK's financial system is not compatible with the FCA's statutory objectives and, is likely to mean that the relevant individual is not fit and proper. The FCA considers that providing this guidance will reduce the risk of inconsistency in how FIT is interpreted and applied in firms and within judicial settings.

Of particular note, the amendments explicitly confirm that misconduct in a person’s personal or private life may be relevant to an assessment of fitness and propriety, even where it does not involve a breach of standards that are equivalent to those required under the regulatory system and/or there is little or no risk of that behaviour being repeated in their work for their firm. The FCA indicates that this will be the case if the individual's behaviour is "disgraceful or morally reprehensible or otherwise sufficiently serious". This directly addresses the apparent inconsistency between the positions expressed in Frensham and Zahedian, and provides clarity that the FCA does not consider that it needs to draw a direct link between personal and professional integrity in order to take action in relation to non-financial misconduct.

Notwithstanding the Regulators' efforts to provide clarity through the introduction of greater guidance on non-financial misconduct, the proposed amendments may raise questions and leave room for interpretation. For example, firms may query the extent to which they will be required to actively explore individual conduct outside the workplace in respect of fit and proper assessments and, if it is assumed that firms will not be expected to proactively investigate employees' private lives unless on notice of an issue, the question arises as to what amounts to being "on notice".

Conduct Rules

The FCA proposes to make changes to its Code of Conduct rules ("COCON") to clarify that these rules cover serious instances of bullying, harassment and similar behaviour towards fellow employees and employees of group companies and contractors. For regulated firms that are not banks, the proposals mean an expansion of scope as, currently, COCON applies to regulated activities, other SMCR financial activities, and certain kinds of misconduct only.

The proposed amendments to the drafting of COCON include examples of non-financial conduct that may breach COCON. Some of these examples, such as "seriously offensive, malicious, or insulting conduct" and "unreasonable and oppressive conduct causing serious alarm or distress to a fellow member of the workforce" are relatively general in nature and, noting that such behaviour may be in breach of COCON if it is committed recklessly (as well as deliberately), the proposals potentially bring a wide range of behaviours into the scope of these rules.

The FCA makes clear, however, that the proposed expansion does not cover non-financial misconduct in a person's private or personal life (although this may still be relevant to an assessment of fitness and propriety under FIT), and has made efforts to provide guidance on assessing whether behaviour is within the scope of COCON. For example, the proposals include the following table setting out examples of when a person's conduct is or is not outside the CONCON rules:

Notwithstanding this guidance, grey areas are likely to remain, particularly in areas where there may be an overlap between an individual's personal and professional life, which could lead to firms applying different thresholds when assessing whether certain behaviours may be within the scope of COCON.

The FCA indicates that only serious non-financial misconduct will amount to a breach of COCON, and that it will only take disciplinary action for serious breaches of COCON, such as particularly serious behaviour or multiple instances of behaviour that are, collectively, particularly serious. However, questions may still arise about the basis on which seriousness should be assessed given the potentially subjective nature of some of the behaviours that may fall within scope. Broadly, the Regulators expect allegations of non-financial misconduct to be assessed objectively and independently by an appropriately qualified person but, nevertheless, it may be challenging in certain circumstances to assess whether there may have been a breach of COCON, for example where the person alleging non-financial misconduct feels that the behaviour in question was seriously offensive or distressing but the alleged did not intend to have a negative impact on that individual. Whilst difficult assessments of this kind have long been grappled with by HR professionals and employment lawyers, the proposed amendments to COCON add an additional layer of consideration.

Historical Conduct

The Regulators have indicated that the new rules will come into force 12 months after the publication of their Policy Statements. This prompts a question as to whether firms would be expected to address and apply the new rules retrospectively to historical misconduct that comes to light after the rules come into effect. Typically, new rules cannot be applied retrospectively but it is noted that the PRA's proposed updates to SS35/15 and SS28/15 state that it may take into consideration established patterns of behaviour of an individual when considering whether the individual meets the PRA’s standards of fitness and propriety. This suggests that historical conduct is relevant, but it is not yet clear whether the Regulators might seek to rely on historic behaviour when taken action on the basis of new rules, or whether this might be very difficult to do in practice. For example it seems unlikely that the Regulators would pursue a breach of COCON if it concerned a conduct rules person at a regulated firm that is not a bank and the alleged breach concerned historic non-financial misconduct.

How might these changes impact the Regulators' appetite for taking enforcement action in relation to non-financial misconduct?

The Regulators are likely to view the introduction of updated rules on non-financial misconduct as a firmer basis on which to enforce standards that they consider are already within their remit. Therefore, given the existing focus on this area and recent enforcement action by the FCA, there may be an increase in the number of investigations relating to non-financial misconduct opened by the Regulators.

Non-financial misconduct cases have, to date, focused on the fitness and propriety of regulated individuals and this is likely to continue to be the main basis on which the Regulators seek to address non-financial misconduct. However, if the proposed amendments are introduced, the Regulators may view the Conduct Rules as a more feasible option in relation to workplace misconduct such as bullying or harassment. In this context, it is noted that a broader range of employees are subject to the Conduct Rules than to FIT although, in practice, the Regulators are likely to focus their regulatory attention on more senior individuals, unless the misconduct in question is particularly serious.

It should be anticipated that, going forward, the Regulators may seek to take action in relation to a broader range of conduct. Whilst previous enforcement action has exclusively related to the conviction of serious offences, the proposed examples indicate that the Regulators can take action in relation to less serious and non-criminal behaviour. Further, consistent with the approach taken by the FCA in Zahedian, the Regulators may not necessarily draw a direct link between an individual's personal conduct and their professional integrity where the underlying behaviour is considered to be very serious or morally reprehensible.

Firms must remain mindful that in investigating workplace-related non-financial conduct the Regulators' may also scrutinise the adequacy of the firm's systems and controls. To manage this risk, firms should implement and maintain adequate measures that set out clear expectations in relation to employees' non-financial conduct (and provide training where needed), and which make sure that issues are effectively investigated, addressed and, where necessary, reported should they arise.

What happens next?

The Regulators have invited firms to respond to the Consultation Papers by 18 December 2023. This includes the question from the FCA: "To what extent do you agree with our proposals to expand the coverage of non-financial misconduct in FIT, COCON and COND?"

The Regulators will subsequently publish Policy Statements, and (as noted above) they have indicated that the new rules will come into force 12 months from that date.