Professional Conduct: Regulation of Financial Services

Question 1

What are ‘financial services’ in the context of FSMA?

Answer 1

Financial services include advising on the merits of investments, dealing in investments, arranging deals in investments, and managing investments, where investments include shares, bonds, pensions, insurance policies, unit trusts, and regulated mortgage contracts

Question 2

Why are financial services regulated in the UK?

Answer 2

To ensure providers are approved and authorised, and to protect consumers from negligent or unqualified advisers

Question 3

Who are the two main regulators of financial services in the UK and what are their roles?

Answer 3

The Prudential Regulation Authority (PRA) supervises the prudential safety of banks, insurers, and certain investment firms; the Financial Conduct Authority (FCA) oversees conduct of business, supervises firms not regulated by the PRA, and enforces market integrity

Question 4

What is the primary statute governing financial services regulation?

Answer 4

The Financial Services and Markets Act 2000 (FSMA) and the FSMA (Regulated Activities) Order 2001 (RAO)

Question 5

What is the ‘general prohibition’ under section 19 FSMA?

Answer 5

No person may carry on a regulated activity in the UK unless they are an authorised person or an exempt person; breaching s 19 is a criminal offence

Question 6

How is a ‘regulated activity’ defined under FSMA?

Answer 6

A regulated activity is one of a specified kind carried on by way of business in relation to a specified investment, where ‘specified’ is defined by the RAO

Question 7

What constitutes a ‘specified investment’ under FSMA/RAO?

Answer 7

Specified investments include rights under contracts of insurance, shares, bonds, government/public securities, rights under pension schemes, and regulated mortgage contracts, as listed in Part III of the RAO

Question 8

What constitutes a ‘specified activity’ under FSMA/RAO?

Answer 8

Specified activities include dealing in investments as principal or agent, arranging deals in investments, managing investments, and advising on the merits of investments, as listed in Part II of the RAO

Question 9

What are the four steps of the FSMA decision tree?

Answer 9

Step 1: Is there a specified investment? Step 2: Is there a specified activity? Step 3: Is there an exclusion? Step 4: Can the conditions for exempt regulated activities (s 327 and SRA Scope Rule 2) be satisfied?

Question 10

In the FSMA decision tree, what happens if there is no ‘specified investment’?

Answer 10

FSMA does not apply and no authorisation is required for that activity

Question 11

In the FSMA decision tree, what happens if there is a specified investment but no ‘specified activity’?

Answer 11

FSMA does not apply and no authorisation is required

Question 12

In the FSMA decision tree, what happens if there is a specified investment and a specified activity but an exclusion applies?

Answer 12

The activity is an exempt regulated activity and may be carried out without FCA authorisation if the firm complies with any SRA Scope Rules restrictions

Question 13

In the FSMA decision tree, what happens if there is a specified investment and specified activity but no exclusion?

Answer 13

Proceed to Step 4: determine whether s 327 FSMA and SRA Scope Rule 2 conditions for exempt regulated activities are satisfied, otherwise FCA authorisation is required

Question 14

What is the Article 67 ‘necessary part’ exclusion?

Answer 14

An activity is excluded if it is carried out in the course of a profession or business that does not consist of regulated activities and is reasonably regarded as a necessary part of other services provided, provided it is not separately remunerated

Question 15

Give an example where Article 67 ‘necessary part’ exclusion commonly applies for solicitors.

Answer 15

When a property solicitor arranges the sale of a leasehold flat and must also arrange transfer of shares in the management company as part of that conveyancing work

Question 16

What is the Article 70 ‘sale of a body corporate’ exclusion?

Answer 16

Activities in connection with sale or acquisition of 50% or more of voting shares (or day-to-day control) between bodies corporate, partnerships, individuals, or connected groups are excluded from regulated activity

Question 17

What conditions must be met for Article 70 exclusion to apply?

Answer 17

The shares must constitute 50%+ voting shares or convey day-to-day control, and the transaction must be between bodies corporate, partnerships, individuals, or connected groups

Question 18

What is the Article 22 ‘authorised person’ exclusion for dealing as agent?

Answer 18

A solicitor is not ‘dealing in investments as agent’ if the transaction is entered into on the advice of an authorised person or the client is not seeking advice from the solicitor regarding merits of the transaction

Question 19

What is the Article 29 ‘authorised person’ exclusion for arranging deals?

Answer 19

A solicitor is not ‘arranging deals in investments’ if the transaction is arranged on the advice of an authorised person or if it is clear the client is not seeking advice from the solicitor as to the merits of the transaction

Question 20

Can a solicitor rely on Article 22/29 exclusions when the transaction relates to a contract of insurance?

Answer 20

No, the authorised person exclusions do not apply to contracts of insurance or investment services/activities

Question 21

What are the key s 327 FSMA conditions for exempt regulated activities?

Answer 21

The person must be a member of a profession (e.g., a solicitor), must not receive any commission or pecuniary reward from a third party unless accounted to the client, the activity must be incidental to professional services, and must be permitted by s 332(3) via compliance with SRA Scope Rules

Question 22

What must a solicitor do if they receive commission for carrying out a regulated activity?

Answer 22

They must hold the commission to the client’s order and account to the client, retaining any only with the client’s informed consent

Question 23

How does the FCA interpret ‘incidental’ under s 327(4)?

Answer 23

Regulated activities cannot be a major part of the firm’s practice; they must form a small proportion of overall work, not held out as separate services, and not be heavily promoted on their own

Question 24

What are the SRA Scope Rule 2 basic conditions for exempt regulated activities?

Answer 24

(a) satisfy s 327(2)–(5) FSMA; (b) activities arise out of or are complementary to provision of a particular professional service to a particular client; (c) no FCA order under s 328/329 preventing activities; (d) activities are not otherwise prohibited by SRA rules

Question 25

How do you determine if a regulated activity 'arises out of' or is 'complementary to' a professional service under SRA Scope Rule 2?

Answer 25

The activity must arise naturally from the non-regulated work the solicitor is doing for the client, such that it is necessary or closely connected to that work (e.g., arranging a mortgage as part of a conveyancing transaction)

Question 26

What additional obligations do firms carrying out exempt regulated activities have under SRA COB Rules?

Answer 26

They must disclose solicitor’s status, keep records of transactions and commissions, safeguard client investments, and comply with rules specific to insurance activities when relevant

Question 27

What is the restriction on financial promotions under s 21 FSMA?

Answer 27

No person may, in the course of business, communicate an invitation or inducement to engage in investment activity unless they are an authorised person or the content is approved by an authorised person, or an exemption applies

Question 28

What are three common exemptions to the s 21 FSMA restriction on financial promotions?

Answer 28

Sale of a body corporate exemption (Art 62 FPO), distribution to investment professionals, and distribution to certified high net worth individuals

Question 29

What is the requirement for an approved prospectus under s 85 FSMA?

Answer 29

It is unlawful to offer shares to the public in the UK without making an approved prospectus available to the public before the offer is made

Question 30

What are two common exemptions to the s 85 FSMA prospectus requirement?

Answer 30

Offers made to fewer than 150 persons or offers sent only to qualified investors (e.g., banks, investment institutions, governments)

Question 31

In the example where a client asks a solicitor for advice on investing sale proceeds in shares, why would FCA authorisation be required?

Answer 31

Shares are a specified investment, advising on merits is a specified activity, no exclusion applies (Art 67 is not satisfied), and although the activity is incidental, it is not complementary to the sale of the business, so s 327/SRA Scope Rule 2 conditions fail

Question 32

How should a firm respond if a solicitor cannot meet s 327 and SRA Scope Rule 2 conditions?

Answer 32

The firm should refuse to carry out the regulated activity and refer the client to an authorised person (e.g., an independent financial adviser)

Question 33

What must a law firm do to carry out exempt regulated activities under SRA oversight?

Answer 33

Obtain SRA authorisation for the specified activities and comply with all relevant SRA Scope Rules and SRA Conduct of Business Rules

Question 34

Under SRA Scope Rule 2, can a solicitor provide regulated advice if the regulated activity is promoted separately from legal services?

Answer 34

No; if regulated activities are held out as separate services or form a major part of the practice, they fail the incidental/complementary test and require FCA authorisation

Question 35

What must a solicitor always remember when considering FSMA implications, even if exempt?

Answer 35

They must still satisfy SRA Standards and Regulations, including having the necessary skill and competence (e.g., CCS 3.2) to provide the requested advice

Question 36

How does the FSMA decision tree help solicitors?

Answer 36

It provides a structured process to determine if an activity is regulated, if an exclusion applies, and if exempt regulated activity conditions are met, thus indicating whether FCA authorisation is required

Question 37

Why might a law firm refer clients to an independent financial adviser rather than give financial advice itself?

Answer 37

Most law firms cannot meet s 327 and SRA Scope Rule 2 conditions because the advice is not incidental or complementary, and obtaining FCA authorisation imposes burdensome compliance requirements