Shareholder dispute triggers disclosure obligations to the FCA

Two things are true: first, dealing with shareholder disputes can be complicated, time-consuming, and exhausting; and second, companies authorised by the Financial Conduct Authority (“FCA”) have additional disclosure obligations.

Less straightforward is whether such a company is required to disclose or notify the FCA of a dispute between its shareholders and when such notification should be made.

We recently assisted the shareholders of a London-based financial services company, that had been acting as an appointed representative (“AR”) of a principal regulated by the FCA. We helped the company’s majority shareholders navigate their dispute with an exiting minority shareholder, ensuring the company complied with its disclosure obligations.

Nature of the shareholder dispute

Our client company undertook insurance underwriting activities and, as AR, carried on insurance distribution activities on behalf of a third party. At the time of the disputes, the company was also applying for its own FCA authorisation.

The dispute arose when two shareholder-directors discovered issues regarding A, their fellow shareholder-director’s performance of his duties, prompting the company to temporarily suspend A and undertake a disciplinary investigation into his activities. The allegations of misconduct related to breaches of duties of confidentiality and the company’s expenses policy as well as failures to comply with internal policy and procedures. Although the parties attempted to resolve the dispute by negotiating A’s orderly exit, the dispute escalated when A raised unsubstantiated grievances against the company, made serious but unfounded allegations against his fellow shareholder-directors and made multiple disparaging remarks against his fellow shareholder-directors to the company’s business contacts.

The company, which had been in difficult negotiations with A regarding his exit for some time, had reasonably focused on the commercial and internal nature of the dispute. Indeed, its previous solicitors had dealt with the matter as a straightforward employment claim, ensuring the company instructed third party experts to handle the disciplinary investigation and A’s grievance. A’s grievance was found to be unsubstantiated and made in retaliation to the disciplinary investigation against him whilst the allegations against him were upheld. Whilst helpful, these steps were incomplete and failed to consider the overall picture and the precarious situation of the company. It also failed to consider the company’s reporting obligations to the FCA.

Notifying the FCA and the AR’s principal

Upon instruction, we were alive to the company’s disclosure obligations to its principal and the FCA, as well as the shareholder-directors’ own disclosure obligations to the FCA as individuals who are Approved Persons and therefore subject to the FCA’s Senior Managers and Certification Regime.

Whilst an AR’s principal is the entity authorised by the FCA to carry out regulated activities and is therefore typically responsible for the AR’s actions, most agreements oblige an AR to notify the principal of anything that could expose it to regulatory risk or liability. This will include any breaches of (or failure to comply with) regulatory requirements, which generally includes the rules, codes of conduct, codes of practice and practice requirements of the FCA, the Financial Services and Markets Act 2000, and any other relevant laws and industry codes of practice. It’s crucial that companies are aware of the existence and the extent of such contractual obligations. This is particularly so where indemnities in favour of a principal are commonplace in AR agreements.

Obligations for businesses

In this case, as the AR’s principal was subject to the FCA’s regulatory regime, the principal is obliged to notify the FCA of events which involve its AR and has an impact on the principal’s regulated activities. We ensured that the company complied with its contractual obligation to notify its AR about the allegations against A, as well as his allegations against his fellow shareholder-directors and the outcome of the investigations carried out by the company.

As the client company was going through direct FCA authorisation, we also ensured that the company complied with its disclosure and notification obligations to the FCA. As part of its application process, the company had previously made declarations and had certified A, among others, as passing the FCA’s Fit and Proper test. It was therefore crucial that our client notified the FCA immediately concerning A’s lack of fitness and propriety following the outcome of his disciplinary investigation. The company also clarified with the FCA the measures it had implemented, following A’s failures, to ensure its internal regulatory compliance procedure remained robust.

Mindful that the allegations, including those made by A against his fellow shareholder-directors, our client engaged the principles prescribed and the outcomes set out in the FCA’s Principles for Businesses sourcebook and Chapter 15 of the FCA’s Supervision Manual, we also ensured the company made proper disclosures to the FCA in respect of the fitness and propriety of individuals who would be performing Senior Management Functions and Certified Functions for the company once it obtains its own authorisation. Although the company’s investigators found that A’s allegations were meritless, the company demonstrated to the FCA the extent to which it had already investigated the same.

Principle 11 and the Supervision Manual

The Principles for Business sourcebook is the FCA’s statement of the fundamental obligations of firms and individuals subject to the FCA’s regulatory regime. Principle 11 obliges all firms and relevant individuals to deal with the regulator in an open and cooperative way, and to disclose to the FCA anything relating to the firm that the FCA would reasonably expect notice. This is a deliberately open ended and subjective obligation undefined by Principle 11.

The Supervision Manual expands on what is meant by “dealing in an open and cooperative way”. This includes events that trigger notifications to the FCA and when a firm should notify the FCA of matters concerning non-regulated activities and other members of its corporate group. These include rules on the events and changes in condition that a firm must notify the FCA about, such as rule breaches, fraud and other matters having a serious regulatory or reputational impact, or both.

Regulated firms should note that this does not just relate to issues relating to financial misconduct. Indeed, the FCA has made it clear in September 2023 that it expects authorised firms to have effective systems in place to identify and mitigate risks of all kinds, whether this relates to toxic corporate cultures where people do not feel able to speak up or cultures that tolerate non-financial misconduct like sexual harassment.

Principle 11 therefore operates as a catch-all principle and could become relevant to the question of mitigation or aggravation when the FCA considers whether or not a firm or relevant individual has complied with the Principles.

Don’t cut corners in a shareholder dispute

In the context of a shareholder dispute, which is complicated by regulatory requirements applying to the shareholders, failing to take the appropriate steps at the right time can escalate the time and costs required to deal with the dispute. This is particularly so where the consequences for failing to comply with such requirements can be extensive including, but not limited to, hefty fines or removal of authorisation.