Clifford Chance

The FCA has censured H2O AM LLP for making highly illiquid investments without appropriate due diligence and falsifying related documents during the investigation.

On 2 August 2024, the Financial Conduct Authority ("FCA") published a Final Notice against H2O AM LLP ("H2O") as authorised fund manager for various funds, including seven French UCITS funds ("H2O Funds"). Between 2015 and 2019, H2O made a series of highly illiquid investments through the H2O Funds into entities controlled or introduced by investment company founder Lars Windhorst (the "Investments").

H2O had not carried out appropriate due diligence on the Investments and lacked proper associated policies and governance, breaching Principles 2 and 3.

More strikingly, in 2019, in breach of Principle 11, individuals at H2O began retrospectively "re-papering" the Investments, either in direct response to the FCA's investigation or to an unfavourable Financial Times article of the same year¹. Led by "Senior Manager A", employees created backdated due diligence materials and minutes of non-existent governance meetings. The use of metadata-altering software to conceal the fabrication was considered, but not pursued.

No public action has (yet) been taken against Senior Manager A or anyone else involved. There would be various bases upon which such action could potentially be taken. For instance, falsifying, concealing, destroying or otherwise disposing of a document which a person knows or suspects is or would be relevant to an FCA investigation is an offence under s177(3) of the Financial Services and Markets Act 2000 ("FSMA"). Similarly, knowingly or recklessly providing information known to be false or misleading to the FCA in response to an information requirement in a material particular is an offence under section s177(4) FSMA.

The FCA found that, intending to conceal certain matters from the FCA, H2O made multiple false and misleading statements and knowingly provided falsified documents to the FCA, taking more than a year to admit that certain materials had been created retrospectively. H2O additionally failed to disclose and provided misleading information to the FCA about the relationship between H2O's CEO Mr Crastes and Mr Windhorst. Some of the untruths told by Senior Manager A are quoted in the Final Notice, including three separate assertions that the due diligence and governance materials in question had been created at the time of the Investments, despite his knowledge of their retrospective creation. It is perhaps surprising in these circumstances that H2O was only censured for its breaches.

However, the FCA's decision to censure rather than to impose a fine recognised that substantial sums had either been paid out or otherwise secured for the benefit of investors and a fine would have adversely affected unitholders. There have been various past examples of the FCA taking this approach.

In this instance, since the suspension of the impacted funds in August 2020, €229 million has already been returned to unitholders in the H2O Funds. The H2O Group has also voluntarily secured the sum of €250 million for investors and waived its rights to investment fees totalling €320 million for the benefit of investors. The FCA expressly recognised that a fine would have reduced the amount available to be paid to investors. Further, H2O had voluntarily agreed to apply to cancel its regulatory permissions and cease to conduct regulated activities in the UK by 31 December 2024.

The number of voluntary requirements agreed with the FCA is a further interesting aspect of the decision. The first in April 2020 prevented further investments into entities linked to Mr Windhorst. The second in October 2020, prevented Mr Crastes dealing in the Investments and required an independent person to advise H2O. In December 2019 the FCA also required H2O to appoint a Skilled Person to conduct an independent review into its due diligence processes and conflicts of interest management. The FCA has plans to increasingly use such early intervention powers to secure swift protection for investors, and this case illustrates how such powers can be put to effect well in advance of the eventual enforcement outcome.

The facts of this case are unusual, to say the least. Firms and their employees generally do their best to be open and cooperative with the FCA (and PRA) and even in those circumstances, it is possible to fall foul of Principle 11/Fundamental Rule 7 (or the equivalent requirements that apply to individuals). Where that happens, regulators can be unforgiving. It is, therefore, necessary to regularly reappraise whether any threshold for disclosure has been met to avoid committing a breach. The backdating of documents and contemplation of metadata-altering software to falsify records, falls at the extreme end of a broad spectrum of possible breaches.

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¹https://www.ft.com/content/51b425fc-94b6-3cc5-a4ea-47d72dca5e75