Full Circle Asset Management Ltd v Financial Ombudsman Service Ltd & Ors

Full Circle Asset Management Ltd (‘FCAM’), the Claimant in this matter, carries on business as an investment manager. Between October 2009 and May 2011 one of its clients was Mrs Joanna King and it provided her with a model portfolio discretionary investment service. She became dissatisfied with FCAM’s service and complained, first to the Claimant itself, and then, on 19^th July 2011, to the Financial Ombudsman Service (‘FOS’), the Defendant.

The FOS is established by the Financial Services and Markets Act 2000 (‘FSMA’) s.225 and, in circumstances such as this, the FOS has compulsory jurisdiction to consider complaints against investment managers such as the Claimant. The FOS made a determination on 14^th June 2013 (‘the first Ombudsman decision’) upholding Mrs King’s complaint. The Claimant challenged the first Ombudsman’s decision in an application for judicial review (CO/13079/2016). On 14^th March 2014 Lewis J. granted permission to apply for judicial review. There never was a substantive hearing of the application because, by a consent order of 13^th June 2014, the parties agreed that the first Ombudsman’s decision should be quashed and Mrs King’s complaint should be considered again by a different Ombudsman.

Raj Varadarajan was appointed to carry out this task. On 18^th February 2016 he again upheld Mrs King’s complaint. He also made directions as to how the Claimant should compensate her (‘the second Ombudsman’s decision’). By the present proceedings the Claimant seeks to quash the second Ombudsman’s decision. Permission to apply for judicial review was granted by Martin Chamberlain QC, sitting as a Deputy High Court Judge on 4^th August 2016.

Mrs King was named as the 1^st Interested Party. She has taken no part in these proceedings. At the time when she was the Claimant’s client, the relevant regulator of those providing such services was the Financial Services Authority (‘FSA’). Since 2013 the Financial Conduct Authority (‘FCA’) has taken over the role of the FSA. The parties are agreed that nothing turns on that transfer of responsibility. The FCA is the 2^nd Interested Party, but, with one qualification to which I will come, it, too, has taken no part in these proceedings.

One of the powers available to the FSA was to require a person or company which it regulated to commission a report into its business or a part of it by a ‘skilled person’ whom the FSA approved – see FSMA s.166. It seems that the FSA visited the Claimant and wrote a report dated 3^rd October 2011. Following this visit and report and by a requirement notice dated 18^th November 2011, the FSA required the Claimant to commission such a ‘skilled person review’ (‘SPR’). The FSA spelt out in Annex A of the notice that the Claimant had been required to commission this review because of concerns that its main model portfolio was likely to be unsuitable for a significant proportion of its retail customers with balanced or medium risk appetite. The skilled person was to be required to review the main model portfolios over the period 31st July 2008 - 31st July 2011 to see whether the portfolios matched the firm's risk categorisation. In particular the review was to include (a) reviewing any financial promotions describing the nature and risk profile of the model portfolios; (b) reviewing the firm’s definition of risk and risk categories as used within the firm’s processes for assessing a customer’s risk preferences; (c) reviewing the underlying products/investments included in the model portfolio to determine whether the firm had made an adequate and appropriate risk assessment of the risk profile of the investments contained in the model portfolios and of the overall model portfolio; (d) identifying and reviewing the impact of any conflicts of interest (including, but not limited to, any investments made within customers’ portfolios where the firm has or had an actual or potential interest).

If the SPR showed that the contents of any of the model portfolios’ risk profiles did not match the firm’s risk categorisation of the model(s) then the skilled person was also (e) to identify all the customers whose portfolios were invested in line with the model portfolio, devise a methodology for determining any loss caused by the firm, calculate the amount of redress such customers would require to compensate them for being provided with an unsuitable discretionary service and (f) recommend how it would supervise the redress exercise. All this was described as ‘Stage 1’ of the SPR. Stage 2 of the SPR would only be triggered if Stage 1 concluded that the risk profile of the contents of the model portfolios matched the firm’s risk categorisation of the models. If Stage 2 was triggered, then the SPR would involve a review of a representative sample of at least 10% of the Claimant’s discretionary retail customers to confirm whether the portfolios were suitable for those customers. Other details of the SPR were set out in the requirement notice. An interim report was required by 25^th January 2012 and the final report had to be sent to the FSA by 28^th February 2012.

The Claimant chose Kinetic Partners LLP to be the Skilled Person for the purpose of this exercise and its choice was approved by the FSA.

Apparently, the SPR was sent to the FSA on 20^th March 2012 (‘the March 2012 SPR report’). I say ‘apparently’. A full copy of the March 2012 SPR report has not been produced either to the Ombudsman or to the Court. Mr Constance, the Claimant’s solicitor, says that this is ‘for confidentiality reasons’. However, the Claimant asked Kinetic to produce another report. This is dated 25^th July 2012. It is entitled ‘Extract from Skilled Person’s Report on Suitability, Systems and Controls dated 20 March 2012’ (‘the July 2012 SPR report’). It includes what is described as an ‘Executive Summary’. It records, in passages on which Mr Phillips QC, on behalf of the Claimant particularly relies,

The March 2012 SPR report was sent to the FSA. In October 2012, the Claimant wrote to the FSA and asked whether it accepted Kinetic’s conclusions. On 17^th October 2012 the FSA responded to say

A complaint to the FOS is considered first by an adjudicator. His or her task is to see whether the complaint can be resolved without the need for a full determination. That was not possible in the case of Mrs King’s complaint. The parties made written submissions and the Claimant provided the Ombudsman with the July 2012 SPR report.

I have said that the first Ombudsman’s determination (which found in favour of Mrs King) was quashed by consent on 18^th June 2014. A ‘Statement of Reasons’ was attached to the Consent Order. These said,

Following the quashing of the first Ombudsman’s decision and the appointment of Mr Varadarajan as the fresh Ombudsman, he received written submissions from the Claimant and from Mrs King and her representative. Oral hearings are possible, but not obligatory, and none were held in this case. The next stage is that the Ombudsman can produce a provisional determination. Mr Varadarajan did so on 23^rd March 2015. The Claimant and Mrs King had the opportunity to make further submissions in response to this, an opportunity which they both took. Mr Varadarajan then issued his final determination, as I have said, on 18^th February 2016.

The legal framework within which the Ombudsman operates, begins with FSMA 2000 s.228(2) which provides,

The legislation refers to the provider of the ombudsman system as the ‘scheme operator’. The Defendant is the, and the only, ‘scheme operator’. By FSMA 2000 Schedule 17 paragraph 3A, the FCA and the scheme operator must take such steps as each considers appropriate to co-operate with each other. The scheme operator has also to make rules which, among other things, must specify matters which are to be taken into account in determining whether an act or omission was fair and reasonable – see FSMA 2000 Schedule 17 paragraph 14. The Rules have to be approved by the FCA – ibid paragraph 14(7). The Defendant has made Rules which have been approved by the FCA and which are published in the FCA’s Handbook. DISP 3.6.4R (Footnote: ¹) says,

Mr Varadarajan’s final determination is 27 pages of single space typing long. That is not a complaint, but to underline that what follows is necessarily no more than a summary. Paragraph numbers have helpfully been added to the determination and I include reference to these where appropriate.

He said that her complaint ‘in summary’ is that FCAM provided Mrs King

He noted that she was in her early 60s and retired. She had previously had some money on deposit with Firm A. She required an income of £1,200 per month. It was recorded that she was an ‘average’ risk taker. [3]

After meeting with Mrs King, the Claimant had made a formal recommendation to her in a suitability letter, proposing that she should open an investment account which it would manage along the lines of its model portfolio. It said her long term aim was capital growth and that investments would be set with that aim. It said the recommended plan matched her risk. [4]

She had been asked to complete documents which included an ‘attitude to risk and loss’ document. This recorded that she was a ‘medium risk investor’ [5]. In total Mrs King had transferred about £450,000 to the Claimant.

By April 2011 her accounts with the Claimant were valued at about £360,000 and so she had lost some £90,000 over 15 months [8]. She complained, first to the firm and then to the Ombudsman. The Ombudsman recorded at [14] that the Claimant had provided him with an independent assessment of the model portfolio (what I have called the ‘July 2012 SPR report’) which the FCA had accepted. In brief, the Claimant’s response to Mrs King’s complaint was that she had been prepared to accept a ‘medium’ risk; the portfolio was ‘medium’ risk; and the complaint should therefore be dismissed [16]. The Claimant had argued that it had not made a ‘personal recommendation’ to invest in a product, rather it had provided a discretionary investment management service. [17]

I can pass over the summary of the submissions which both parties had made in response to the provisional determination, an argument relating to jurisdiction (not relevant to the present challenge) and an argument that the complaint should be dismissed in view of the Claimant’s offer to settle (again, irrelevant to the present proceedings).

The Ombudsman reminded himself of the FCA’s Principles for Businesses which included as Principle 9,

In addition, the FCA had adopted Conduct of Business Sourcebook Rules (‘COBS’). The Ombudsman recalled that COBS 9.2.1R said,

COBS 9.2.2R said,

COBS 9.3.1G (Footnote: ²) said,

If a firm had a ‘suitability report’ COBS 9.4.7R provided that it must at least,

The Ombudsman recognised that it was the Claimant’s case that it made no personal recommendation to Mrs King, but only provided a discretionary management service. The Ombudsman explained why he did not accept the Claimant’s argument [81]–[90]. On the contrary, he found that,

In response to the Ombudsman’s provisional determination the Claimant had again argued that it had made no personal recommendation. The Ombudsman responded by saying,

The Ombudsman then noted that the Claimant had complained that he had re-characterised the complaint of Mrs King and turned it from a challenge to the riskiness of the Model Portfolio into one into the suitability of its offer to provide a discretionary investment service [94]. The Ombudsman denied that he had re-characterised her complaint, but went on to say that the Claimant would have seen from his provisional determination the approach he intended to take. He added

The Ombudsman then turned to the argument from the Claimant that he had failed to give proper weight to the SPR’s conclusions and the FCA’s acceptance of the fact that the model portfolio was in fact medium risk. [100]

The Ombudsman responded by saying that he had given due regard to the review, but it was just one of the factors he had to take into account [103]-[104]. Mrs King’s complaint was that the portfolio recommended for her by the Claimant had been unsuitable for her [105]. That meant the Ombudsman had to consider what her specific circumstances were so far as they were known to the Claimant [106]. He noted that risk assessment was not a precise science [107] – [115]. He noted as well that the July 2012 SPR report, with which he had been provided, said expressly,

At [120] he turned to the FCA’s endorsement of the SPR and said,

The Ombudsman concluded this section of his determination by saying,

The Ombudsman then reviewed what the Claimant knew of Mrs King’s personal circumstances. He noted that she had complained to the Claimant that her previous financial adviser had left a large proportion of her capital in cash. From this the Ombudsman concluded that she preferred her portfolio to be more fully invested and did not prefer sizeable cash holdings. [130]-[135]

He noted that she said she was in her sixties and recently retired. She was not in a position to replace any capital that was lost. The sums she wished to invest were evidently a considerable proportion of her investible assets. FCAM should have taken these factors into account in deciding what was suitable for her. [136]-[139]

After the first meeting with Mrs King, the Claimant had recorded her as an ‘average risk investor’, but there was no definition of what this term meant and the Claimant should have given a more detailed explanation of its understanding of her risk attitude and how the portfolio which it was recommending was suitable for her. The firm’s suitability letter had been accompanied by an ‘Attitude to Risk and Loss’ form. This described Mrs King as a ‘medium risk investor’ but that expression, too, was undefined and not further explained. [140]-[144]

Following further submissions made by the Claimant in response to the provisional determination which the Ombudsman summarised, he added at [159],

The Ombudsman then looked at the contemporary documentation for evidence as to Mrs King’s need for an income from her investments [160]-[164]. Responding to his provisional decision, the Claimant had said that Mrs King had sufficient cash balance to meet her income needs [165]. The Ombudsman then said,

In [167] he summarised Mrs King’s requirements as:

The Ombudsman then turned to consider whether the portfolio which was provided for Mrs King was suitable for these requirements. He recognised that the Claimant had submitted that its strategy was to invest across a range of asset classes with no restriction on the amount in any particular class. Nonetheless, the Ombudsman said, the ‘key consideration however is that FCAM needed to make sure that the portfolio was suitable at all times to Mrs K.’ [170]

He looked at the composition of the portfolio as at 31^st March 2010. He noted that nearly 42% was then in cash, about 45% of the holdings were high risk and 60% were, in the Claimant’s risk score, of 8 or 9. 35% of the portfolio were in short term investments. About 20% of the investments were in just 2 markets (UK and China). Any hedging was inadequate. The portfolio was not geared to produce adequate natural income to meet Mrs King’s requirement. The proportion of high risk investments was excessive. In conclusion, he said, the portfolio contained an excessive proportion of higher risk investments given the circumstances. [171]-[189]

The Ombudsman concluded that:

The portfolio provided to Mrs King was not suitable to her circumstances.

If the inherent risks had been clear to her she would not have proceeded with the investment.

He accepted that Mrs King was aware that the business could invest in different asset classes at its discretion and there was no pre-agreed asset model as such, but the Newsletter and other material which the Claimant provided to her was too technical and she did not have the investment expertise to understand it fully. Nor had she understood the risks inherent in the various complex investments that were included in the portfolio.

The portfolio was not suitable for Mrs King. [190]-[196]

The Ombudsman considered that Mrs King was entitled to be compensated by the Claimant. He proposed that the Claimant should calculate how her assets would have performed by reference to the FTSE WMA Stock Market income Total Return Index compared with the actual performance of the funds managed by the Claimant. The FSMA 2000 capped the award which he could make to £100,000 and he said that if the calculation that he proposed should lead to a sum up to £100,000 then the Claimant should pay that amount. Above that amount he could recommend that the Claimant pay the balance, and he did so.

At the heart of Mr Phillips’ challenge to the Ombudsman’s decision is this reasoning:

The problems with this chain of reasoning begin with stage (i). Part of the Ombudsman’s findings, as I have shown, was that the term ‘medium risk investor’ was too vague. It was, the Ombudsman found, incumbent on the Claimant to investigate more closely what Mrs King’s requirements were. It was necessary for the Ombudsman to do that, but it had also been necessary for the Claimant to do that if it was to discharge its responsibilities to her before making a personal recommendation to her. There had been an issue between the Claimant and Mrs King as to whether the Claimant had made a personal recommendation to her. The Ombudsman made a finding of fact that the Claimant had made a personal recommendation to her. The present proceedings are not an appeal on the facts. The Claimant could only impugn that finding if it was infected with legal error. The Claimant does not suggest it was. That being so, the claim for judicial review must proceed on the premise that the Ombudsman was entitled to make that finding.

What Mrs King wanted would only be of relevance if the Claimant knew or ought to have known of her requirements. The Ombudsman appreciated this and he supported each of his findings as to what her requirements had been by reference to contemporaneous documentation. There is, and can be, no complaint that the Ombudsman was entitled to find that the Claimant had these requirements and that they either had been known to the Claimant or ought to have been known to it. Once again, these are unchallenged findings of fact by the Ombudsman.

The SPR review concluded that overall the portfolio was medium risk. The Ombudsman did not disagree. But that was not dispositive of Mrs King’s complaint. Having analysed her requirements, his conclusions were that the portfolio was not suitable for her. Since the Ombudsman was not departing from what Mr Phillips called the standard approved by the FCA, there was no obligation on the Ombudsman to explain why he differed from the standard which the FCA had approved. That simply did not arise.

The Ombudsman had said in his provisional determination and repeated in the final determination at [98] ‘My aim is not to risk rate FCAM’s Model Portfolio, but to consider the suitability of the Portfolio for Mrs King’s individual circumstances’. It is right that he referred to the disclaimer by Kinetic at [116] of his Final Report, although it is hard to see why that was improper. He acknowledged the endorsement of Kinetic’s views by the FCA at [120] but, at [124] reminded himself that he was investigating whether the portfolio which the Claimant had recommended for Mrs King was suitable for her.

Mr Phillips stressed the importance of the regulatory regime under which firms, such as the Claimant had to operate being coherent and not inconsistent. I agree. He showed me a Memorandum of Understanding dated 18^th December 2015 between the FCA and the Defendant. This said at paragraph 6(c),

It follows that I do not accept that this central chain of reasoning is sustainable.

Mr Phillips submitted that the Ombudsman’s characterisation of Mrs King’s complaint differed from:

I am not persuaded by these arguments. Paragraph 1 of the consent order quashed the first determination. Paragraph 2 of the Consent Order provided that ‘The complaint of the First Interested Party [i.e. Mrs King] be remitted to the Defendant to be determined afresh by a different Ombudsman.’ That is precisely what has happened by Mr. Varadarajan. Mr Phillips did not argue that the Statement of Reasons operated to estop Mr Varadarajan from analysing her complaint in any different way. I agree with Mr Phillips that the Statement of Reasons did not have that effect. He did argue that if Mrs King’s complaint was truly as Mr Varadarajan interpreted it, then there was no reason why the first Ombudsman’s decision had to be quashed. That’s as may be. It is not my task to investigate whether the consent order was necessary or not. Indeed, while passing mention has been made of the first Ombudsman's determination, it has not been necessary for me to examine it and certainly not with the care which I must pay to the second determination.

It was, in my view, a necessary part of Mr Varadarajan’s function to determine the nature of Mrs King’s complaint. After all, as the Court of Appeal said in R (Heather Moor and Edgecomb Ltd) v Financial Ombudsman Service [2008] EWCA Civ 642 at [80] the Ombudsman ‘is dealing with complaints, and not legal causes of action’ and, as Irwin J. said in R (Keith Williams) v Financial Ombudsman Service [2008] EWHC 2142 (Admin) at [26] ‘His jurisdiction is inquisitorial not adversarial.’

Mr Phillips referred me to the beginning of the box on the complaint form answering the question, ‘Please tell us what your complaint is about’, but after the passage which I have quoted above, it continued,

Paragraph 1 of the determination was no more than a summary and introduction to the determination; it set no limits on what the Ombudsman could properly do.

I have looked at the substance of Mr Phillips’ arguments on the question of how the Ombudsman characterised Mrs King’s complaint. However, Mr Strachan QC, on the Defendant’s behalf, noted that the Claimant’s grounds for seeking judicial review did not allege legal error in the Ombudsman's characterisation of Mrs King's complaint.

Of course, the Ombudsman was obliged to treat the Claimant and Mrs King fairly. The inquisitorial character of his function did not absolve him of that duty. However, so far as the Claimant’s complaint is of unfairness, it has no force. If not earlier, the Claimant was alerted to the approach which Mr Varadarajan was minded to take to Mrs King’s complaint by his provisional determination. As the Ombudsman recorded in his final determination, both parties took the opportunity to make further submissions as a result. He took those into account. The Claimant has not therefore been taken by surprise by the manner in which the Ombudsman characterises Mrs King’s complaint. There has been no unfairness.

Mr Phillips invited me to ask myself ‘So what?’ in response to the Ombudsman’s criticisms of the Claimant. By this I understood him to mean that Mrs King had been a medium risk investor and the Model Portfolio was a medium risk investment (see Kinetic’s conclusion). Those two propositions were and should have been sufficient to dispose of her complaint and lead to its dismissal. But I reject this approach. The Ombudsman found that the Claimant had personally recommended the Model Portfolio to Mrs King. Before doing so, it should have assessed whether it was suitable for her. That required a more sophisticated investigation than crudely determining she was a ‘medium risk investor’. The Claimant had not done that. The Ombudsman looked at what her requirements in fact were and then decided that the Model Portfolio was not suitable for those requirements. The answer to Mr Phillips’ ‘So what?’ question was given in [191] where the Ombudsman said ‘I am not persuaded, on balance, that had the inherent risks as seen above been made clear to Mrs K, she would have accepted to proceed with the investment.’

In the course of his oral submissions, Mr Phillips appeared to accept that the Claimant’s case turned on ground 1 of his challenge (which I have sought to put into my own words above). He recognised that the other grounds were, in a sense, parasitic on ground 1. I agree. In view of this, I can deal with them briefly.

Ground 2 alleged that the Ombudsman had failed to account for wider implications. By this I understood Mr Phillips to be referring to what I have summarised in [44] (ix) above. However, for the reasons which I have given, I do not accept that there is a conflict between the Ombudsman’s determination of Mrs King’s complaint and the wider regulatory role or standards of the FCA. The wider implications to which ground 2 refers do not therefore arise.

Ground 3 alleged procedural and substantive unfairness. This is another way of expressing the same complaint as grounds 1 and 2. The unfairness is said to arise because the Claimant, having had its Model Portfolios approved as medium risk by the FCA, is confronted with an Ombudsman’s decision which criticises it for using one of those Portfolios for a medium risk investor. It is said that the Ombudsman has departed from the industry standard set by the FCA, but given no reasons for doing so. It is sufficient for me to say that I do not accept that this is a proper characterisation of the Ombudsman’s decision. There is no unfairness and there is no breach of the European Convention on Human Rights.

Ground 4 alleged a failure to give adequate reasons for ignoring or giving no weight to the regulatory standard approved by the FCA and by improperly relying on the provisional determination which itself was flawed. I reject this criticism. I have already addressed its first aspect. I have looked closely at the final determination. Far from this ground of challenge having merit, I would pay tribute to the Ombudsman for dealing comprehensively with the evidence and arguments which had been addressed to him. He explains his reasons fully.

Ground 5 alleged that the determination had been re-interpreted by the Defendant in pre-action correspondence and made the decision unsupportable. Mr Phillips accepted that the Claimant had to mount its challenge to the final determination itself. If that was legally flawed, the Claimant would succeed whatever the subsequent correspondence said. If the final determination was not legally flawed, it could not become so because of something the Defendant had written later. Both propositions may, in some circumstances, need to be qualified, but there was nothing in Mr Phillips’ oral or written submissions which suggested that any such qualification arguably applied in the present circumstances.

The Claim Form in the present proceedings was accompanied by the 1^st witness statement of Robert Constance, a partner in the Claimant’s solicitors and dated 18^th May 2016. Mr Constance referred to the notice from the FSA under FSMA 2000 s.166 requiring the Claimant to commission a Skilled Person’s Report. He said that the report was produced by Kinetic Partners LLP dated 20^th March 2012. As I have already mentioned, he said that this was not disclosed for ‘confidentiality reasons’. Mr Constance’s statement continued,

As I have already noted, the FCA (as the successor regulator to the FSA) was served with the proceedings as an Interested Party. On 7^th September 2016 it wrote to Mr Constance and the Defendant to draw attention to a factual inaccuracy in Mr Constance’s 1^st witness statement. It said,

The Executive Summary of the First Report (what I have referred to elsewhere as the March 2012 SPR report) is not to be confused with the Executive Summary included in the July 2012 SPR report (what the FCA and Mr Constance called the ‘Second Kinetic Report’ and Kinetic called ‘the supplementary report’).

The Executive Summary of March 2012 SPR included the following:

On 20^th September 2016 Mr Constance made his 2^nd witness statement. He said,

It is noteworthy that Mr Constance did not exhibit the letter from the FCA of 7^th September 2016, nor did he exhibit the Executive Summary of the March 2012 SPR report which was attached to that letter. A reader of Mr Constance’s 1^st and 2^nd witness statements would not have been aware that the March 2012 SPR report included the criticisms in the Executive Summary which I have quoted above.

On 25^th October 2016 Georgina Surry, a solicitor employed by the Defendant made a witness statement which did exhibit the FCA’s letter of 7^th September 2016 and the Executive Summary of the March 2012 SPR report.

At about the same time, the Defendant applied to amend its Detailed Grounds of Resistance to the Claim to rely on the March 2012 SPR report Executive Summary. It argued that the criticisms made by Kinetic were consistent with the findings of the Ombudsman and that there was no conflict between the Ombudsman’s final determination and the views of Kinetic as adopted by the FCA.

On 2^nd February 2017 Mr Constance made his 3^rd witness statement. He gave some further information about the work which Kinetic had done. He said that Stage 2 of the SPR was a review of a sample of case files. 17 had been chosen, but they were all files of people who were still clients of the Claimant at the time, so that did not include Mrs King’s file.

As the Executive Summary of the March 2012 SPR report had shown, Kinetic could not reach a conclusion on suitability because the Claimant’s documentation had been inadequate. That had led Kinetic to conduct what Mr Constance referred to as a ‘re-papering exercise’. Mr Constance said that had been completed in late July 2012. Kinetic had issued a follow-up report dated 7^th August 2012 which was provided to the FSA. He said in summary, Kinetic had concluded:

I have set out this aspect of the evidence before me, although I have borne well in mind that the Executive Summary to the March 2012 SPR report was not before the Ombudsman and neither, so far as I am aware, was Mr Constance’s account of the ‘re-papering’ exercise. However, it seems to me that there is force in the observations of Mr Strachan that:

For all of the reasons I have given, this application for judicial review is dismissed.