Shortly before Christmas 2014, judgment was handed down in a case brought by SPL Guernsey ICC Limited (SPL) against the investment manager, Arch Financial Products LLP (AFP), and its director, Robin Farrell. SPL succeeded in its claims against both defendants and was awarded damages of approximately £24.2 million plus interest and costs.

Facts

1. AFP was the investment manager of SPL, a close-ended investment company, and its cells between 2007 and 2009. Mr Farrell was the Chief Executive Officer of AFP.

2. AFP invested the monies raised by each cell and managed the investments. AFP and each cell entered into an investment management agreement (IMA) that governed the scope of duties owed by AFP to the cells.

3. In December 2006, AFP and Foundations Capital Limited incorporated a joint venture, Foundations Holdings Limited (FHL).

4. FHL was interested in purchasing a student accommodation business, Clubeasy Group (CEG). Lonscale Limited (Lonscale) was incorporated as the corporate vehicle for the acquisition of CEG.

5. To finance the cost of the acquisition, AFP arranged for asset-backed notes to be issued to six cells (the Lonscale Cells). The Lonscale Cells invested £20.2 million in these asset-backed notes.

6. AFP and Lee Barkman (a director of FHL) received a payment of £3 million each, which SPL alleged was funded by the Lonscale Cells without their prior knowledge. Ultimately, CEG did not perform as well as hoped so, in early 2010, the Lonscale Cells sold their interests in the notes and made substantial losses.

Decision

SPL’s claim against AFP and Mr Farrell concerned four principal allegations:

1. AFP breached its tortious duty to exercise the reasonable care and skill expected of an investment manager

SPL alleged that AFP:

• failed to conduct adequate due diligence;
• failed to obtain an enforceable funding commitment from a third party prior to committing the Lonscale Cells to the investment; and
• caused the Lonscale Cells to invest when AFP knew or should have known that the investments were uneconomic and/ or that they involved risks disproportionate to the likely returns.

Mr Justice Walker found that, in October 2007, leading up to completion of the acquisition:

– AFP was negligent in the reliance it placed on valuations that did not provide a market value of what the properties.

– An accountants’ report stated that CEG was highly geared and needed a capital injection. Immediate steps were required to ensure that this capital was provided otherwise the Lonscale Cells would be exposed to an obviously unacceptable risk. These steps were not taken.

– The evidence pointed “overwhelmingly” to a lack of any risk/reward analysis on behalf of the Lonscale Cells.

– No reasonable investment manager could possibly have considered that the investments were in the best interests of the Lonscale Cells, and Mr Farrell knew that they were unjustifiable.

2. AFP breached its fiduciary duty not to make a secret profit

The court considered the following clauses in the IMAs:

– Clause 13 – AFP could effect transaction where there was a potential conflict provided that conflict was resolved fairly; and

– Clause 18 – fiduciary or equitable obligations were excluded “which would prevent or hinder the Investment Manager in transactions with or for the Company [i.e. cell] from acting as principal or agent, dealing with other clients and generally effecting transactions as provided above.”

Walker J noted that AFP’s fiduciary duties encompassed a duty to avoid conflicts and not to profit from the cell’s position. He said that “consideration of what to do in the best interests of the cells lay at the heart of the IMAs”.

Walker J agreed with SPL that AFP had a huge financial interest in causing the Lonscale Cells to invest, and the £3 million fee paid to AFP was funded almost entirely by the Lonscale Cells. The £3 million payment to AFP was not for assistance negotiating and structuring the transaction, as the defendants contended; the work that AFP did in that regard was to enable it to extract money from investors.

AFP’s conflict was not viewed as having been resolved fairly in accordance with clause 13 of the IMAs. The court found that disclosure to the Lonscale Cells’ directors was inadequate. Further, there was no documented rationale for the transactions and AFP did not comply with expert advice it had received on managing conflicts.

3. Mr Farrell dishonestly assisted AFP to breach its fiduciary duties and induced its breaches of contract.

The evidence against Mr Farrell was found to be “so strong and cogent” that the court had “no doubt” that Mr Farrell dishonestly assisted AFP to breach its fiduciary duty in committing the Lonscale Cells to the investments in October 2007; he was in charge of the extraction venture on behalf of AFP and ensured it went ahead. At the very least, Mr Farrell clearly suspected that relevant elements of the transaction could be wrong and did not make enquiries. He induced AFP to breach the IMAs and this primarily caused AFP’s breaches of fiduciary duty.

4. AFP breached its contractual duties owed under the IMAs

1. During the period January 2008 and August 2009, two of the Lonscale Cells invested additional sums to fund CEG’s operational costs. Walker J found that AFP acted in breach of clause 15 of the IMAs (“the Investment Manager will always take reasonable care in managing the Portfolio”) because there was no material improvement in the viability of the business, AFP did not consider the investments and did not act in the Lonscale Cells’ best interests. Instead, AFP’s focus was entirely on keeping CEG afloat.

Causation, remedies and recoverability

2. The defendants raised a number of causation defences. For example, they asserted that, in the event that AFP had fulfilled its duties, the Lonscale Cells would have made alternative investments giving rise to losses. The court did not find the defendants’ evidence sufficiently sound.

3. The defendants also argued that the sale and purchase agreement in 2010 disposing of the Lonscale Cells’ interest in Lonscale was premature, left the business to fend for itself and the agreement’s contingent terms left the Lonscale Cells exposed to the risks of non-payment and default. Walker J said that these criticisms were “utterly unwarranted”.

Comment

It is understood that the defendants are appealing the decision.

In the meantime, however, the judgment provides useful commentary on the extent of the contractual, tortious and fiduciary duties owed by an investment manager and how careful investment managers (and their directors) need to be in situations that present clear conflicts between their interests and the funds they manage.

Further reading:

SPL Private Finance (PF1) IC Ltd and Others v Arch Financial Products Ltd and Others [2014] EWHC 4268 (Comm)  http://bit.ly/1DG9Qez

View article online http://bit.ly/1w4zr06

On February 2, 2015 the Obama Administration acknowledged the plight of certain US citizens residing abroad and proposed limited relief.

In the “General Explanations of the Administration’s Fiscal Year 2016 Revenue Proposals”¹, known as the “Green Book,” the Administration proposed a change to US law (the “Proposal”) that would allow certain dual citizens to renounce their US citizenship without the fear of delinquent tax filings, penalties, the US exit tax, and the other consequences to being a covered expatriate.

The details of the Proposal, and the chances of being given the effect of law, while interesting, are less so than the Administration’s motive for advancing it.

Could the Proposal play a small part in a more subtle strategy that might involve foreign opposition to FATCA and IGA-partner domestic legislation?

Regardless of the Proposal’s chance of being given the effect of law, the Administration’s motivation for bringing it forward, or the narrow class of individuals to whom it would apply, the Proposal is positive step.

It is evidence that the unenviable predicament faced by dual citizens living abroad has been heard in Washington, DC and there may be the political will to affect change. Change may come quickly or not at all, but it will never come until there is understanding of the issue. The Proposal is an indication that understanding may be taking hold.

Channel Island Businesses still have a lot to consider for the next stages of the Foreign Account Tax Compliance Act (FATCA) implementation, delegates heard at a recent breakfast seminar hosted by EY.

The event, led by Wendy Martin, EY’s Tax Executive Director, highlighted:

1. The recent updates made to the FATCA guidance notes and the imminent arrival of the Common Reporting Standard (CRS) to address what Channel Island businesses should be doing next to meet the 2015 deadlines.

Mrs Martin said:

1. “While it has been reported that the majority of local businesses are prepared for FATCA, a quick survey of the room suggested otherwise.
2. Most are still feeling the burden and there is clearly work to be done to ensure effective identification of accounts and efficient reporting,”
3. “With only a few months until reporting starts, 2015 is going to be a busy year.
4. The recent revisions to guidance notes in Jersey, Guernsey and the Isle of Man are important to note; while the jurisdictions are largely similar and are working together in many respects, there are some subtle but important differences in the notes reflecting legislative differences in each.
5. There is also useful clarification on Employee Benefit Trusts.”

James Guthrie, EY associate partner in the London office who was also speaking at the event, discussed:

1. how the introduction of the CRS means further preparation is needed this year.

James Guthrie said:

1. “It is crucial that businesses have a mechanism in place to report under the CRS, which, although similar in many respects to the existing intergovernmental agreements, will require additional work.
2. The ideal is to have in place a future-proof solution that can be adapted to any upcoming regulatory requirements,”
3. “It is important that businesses understand the sequencing for CRS reporting but also understand that, while preparation is important, not everything needs to be done from day one.’

Mrs Martin said that 90 jurisdictions had committed to implement CRS with more than 50 having signed an agreement to bring it into force from 1 January 2016.

• “There is an ever-increasing requirement for automatic exchange of information and all of the actions businesses take now will help reduce the burden at later stages.
• There is time, but we would strongly advise

1. creating road maps for both the next stages of FATCA and
2. implementation of CRS to establish each of the important deadlines and allocate the appropriate resources, including time to ensure you have a robust reporting system in place.

Following the exchange of letters between the FCA Practitioner Panel and the FCA (see Daily News on 27 August 2014), the FCA has published on its website data on the use of attestations in 2014 broken down by quarter, sector and conduct classification of firm.

In total, 59 attestations were obtained from senior managers of firms in 2014.

The data shows a marked increase in the use of attestations in the second half of 2014, being 43 in the second half compared with 16 in the first half of 2014.

Also, 21 attestations were obtained from senior managers in the wholesale and investment management sector, which was more than in any other sector.

The FCA explains the four principal situations for requesting attestations as:

• Notification: For emerging risks at firms that are unlikely to result in material harm to consumers or a negative impact on market integrity the FCA may ask an appropriate individual at a firm to attest that they will notify the FCA if the risk changes in its nature, magnitude or extent;
• Undertaking: Where the FCA wants a firm to take specific action within a particular timescale, but the risk is unlikely to result in material harm to consumers or a negative impact on market integrity, the FCA may ask for an attestation undertaking that the action will be taken;
• Self-certification: For more significant issues, but where the FCA is confident that the firm can resolve the issue itself, the FCA may ask for an attestation that the risks have been mitigated or resolved; and
• Verification: Where the FCA wants a firm to resolve issues or mitigate risks and verification of completion, the FCA may ask for an attestation confirming that the action and verification (for example by internal audit) has been completed.

In future, the FCA will publish data on the use of attestations every quarter.

This FCA webpage is available. http://bit.ly/1veGKl9

The ultimate owners of companies will have to be listed in central registers in EU countries, open both to the authorities and to people with a “legitimate interest”, such as journalists, under a Parliament/Council deal endorsed by the Economic and Monetary Affairs and Civil Liberties committees on Tuesday. The new anti-money laundering directive aims to help to fight money laundering, tax crimes and terrorist financing. New rules to make it easier to trace transfers of funds were also approved.

The fourth anti-money laundering directive (AMLD) will for the first time oblige EU member states to keep central registers of information on the ultimate “beneficial” owners of corporate and other legal entities, as well as trusts. (A “beneficial” owner actually owns or controls a company and its activities and ultimately authorises transactions, whether such ownership is exercised directly or by a proxy).

These central registers were not envisaged in the European Commission’s initial proposal, but were included by MEPs in negotiations. The text also requires banks, auditors, lawyers, real estate agents and casinos, among others, to be more vigilant about suspicious transactions made by their clients.

“Legitimate interest” access

The central registers will be accessible to the authorities and their financial intelligence units (without any restriction), to “obliged entities” (such as banks conducting their “customer due diligence” duties), and also to the public (although public access may be subject to online registration of the person requesting it and to a fee to cover administrative costs).

To access a register, a person will in any event have to demonstrate a “legitimate interest” in suspected money laundering, terrorist financing and in “predicate” offences that may help to finance them, such as corruption, tax crimes and fraud.

These persons (e.g. investigative journalists) could access information such as the beneficial owner’s name, month and year of birth, nationality, country of residence and details of ownership. Any exemption to the access provided by member states will be possible only “on a case-by-case basis, in exceptional circumstances”.

Central register information on trusts will be accessible only to the authorities and “obliged entities”.

MEPs also inserted several provisions in the amended AMLD text to protect personal data.

Special measures for “politically-exposed” persons

The deal also clarifies the rules on “politically-exposed” persons”, i.e. people at a higher than usual risk of corruption due to the political positions they hold, such as heads of state, members of government, supreme court judges, and members of parliaments, as well as their family members.

Where there are high-risk business relationships with such persons, additional measures should be put in place, e.g. to establish the source of wealth and source of funds involved, says the text.

Tracing transfers of funds

MEPs also approved a deal on a draft “transfers of funds” regulation, which aims to improve the traceability of payers and payees and their assets.

The two deals still need to be endorsed by the full Parliament (March or April) and by the EU Council of Ministers. Member states will then have two years to transpose the anti-money laundering directive into their national laws.

The following provides an overview of

(a) yesterday’s addition of new names to the list of persons and entities subject to the asset freeze and travel ban;

(b) clarification on the grandfathering of pre-existing contracts in relation to restricted tourism activities in Crimea and Sevastopol; and

(c) some points of interest arising from the recent judgment in Rosneft’s judicial review of aspects of the UK’s implementation of the sanctions.

Extension of asset freeze and travel ban

On 16 February the EU published in the Official Journal Council Implementing Regulation (EU) 2015/240 of 9 February 2015 (amending Regulation (EU) No 269/2014) and Council Decision (CFSP) 2015/241 of 9 February 2015 (amending Decision 2014/145/CFSP).

The new legislation extends restrictive measures in respect of actions allegedly undermining or threatening the territorial integrity, sovereignty and independence of Ukraine by adding 14 additional persons and 9 additional entities to the list of persons, entities and bodies subject to an asset freeze and travel ban.

As well as 14 Ukrainians (military or political figures in the self-declared republics of Donetsk and Lugansk) the list includes two Russian deputy defence ministers, Arkady Bakhin and Anatoly Antonov, and Andrei Kartapolov, deputy chief of the general staff of armed forces of the Russian Federation.  Two members of the Russian parliament are also listed – Valery Rashkin and Joseph Kobzon.  All but one of the listed entities are armed separatist groups, the exception being the Public Movement “Novorossiya”.

The asset freezes in respect of these persons operate in the usual way, and HM Treasury has also issued an advisory notice confirming the measures.

Following an extraordinary meeting of the EU’s Foreign Affairs Council on 29 January the Council also agreed to extend the asset freeze and travel ban (due to expire this March) until September 2015.

http://bit.ly/1ziatYZ

No legislation has yet been published to effect this decision.

Tourism restrictions relating to Crimea and Sevastopol: grandfathering of pre-existing contracts

On 13 February the EU published a corrigendum to Council Regulation (EU) No 1351/2014 of 18 December 2014 amending Regulation (EU) No 692/2014 relating to the restrictive measures focused on Crimea and Sevastopol.

http://bit.ly/1JrcWZ5

The corrigendum clarifies the scope of the carve-out of pre-existing contracts from the ban on tourism activities in Crimea and Sevastopol. Specifically it amends Article 2d(4) as follows:

• “4. The prohibitions in paragraphs 1 and 2 shall be without prejudice to the execution until 21 March 2015 of an obligation arising from a contract or an ancillary contract concluded before 20 December 2014…”.

Accordingly, there is now a long-stop date after which this exception cannot be relied upon.

Separately, the UK legislation which will criminalise breach of the extended Crimea-focused sanctions (the Export Control (Various Amendments) Order 2015) was passed on 3 February and will come into force on 24 February 2015.

Judgment in Rosneft’s judicial review application

The UK High Court has handed down judgment in a judicial review application brought by Rosneft (an entity subject to the sectoral/capital markets sanctions) against HM Treasury, the Secretary of State for Business, Innovation and Skills, and the Financial Conduct Authority.

http://bit.ly/1vJogUF

The Court has referred a number of questions to the EU Court of Justice (CJEU). These are listed in the Schedule to the Judgment and include questions relating to:

• the validity of certain elements of the sanctions (relating to the oil sector and the capital markets restrictions);
• whether it is contrary to principles of legal certainty for breach of these provisions (if they are valid) to be criminalised;
• whether the term “financing or financial assistance” includes payment processing;
• whether the capital markets restrictions prevent the issuance of GDRs in relation to “old” transferable securities; and
• the proper interpretation of “shale” and “waters deeper than 150 metres”.

The UK proceedings will now remain stayed, pending the outcome of the proceedings before the CJEU.

Rosneft is separately pursuing an annulment challenge before the General Court, as are a number of other entities who are subject to the sectoral sanctions.

The Court also expressed its preliminary views (subject to the outcome of the CJEU reference) on a number of issues (see section C of the judgment), including:

• that the measures should be capable of challenge;
• that the measures were not sufficiently ambiguous to offend the principle of legal certainty; and
• that GDRs on “old” shares are not permitted.

An interesting (for those who are interested in such matters) summary of Rosneft’s and the Defendants’ arguments is included in the Schedule to the judgment.

Next steps

Whilst the European Council and Commission, together with the leaders of the G7 (UK, France, Germany, Italy, Canada, USA, Japan) have welcomed the agreement reached in Minsk on 12 February, the situation remains fragile and the G7 has stated that it remains ready to adopt “appropriate measures” against persons who violate the “Minsk package” and, in particular, those who do not observe the agreed ceasefire and withdrawal of heavy weapons.

http://bit.ly/1JavXPj

Prosecutors in Geneva have raided the offices of HSBC’s scandal-hit private bank as pressure increases on Britain’s biggest lender over allegations of money laundering and tax evasion.

The raid forms part of a criminal inquiry amid accusations that the bank helped customers, including arms dealers and blood diamond traders, move money around the world.

It has been reported today @ noon on 18 feb 2015

• Prosecutors in Geneva have raided the offices of HSBC’s scandal-hit private bank as pressure increases on Britain’s biggest lender over allegations of money laundering and tax evasion.

• Officers began searching HSBC’s premises in the Swiss city as part of a criminal inquiry amid accusations that the bank had helped customers, including arms dealers and blood diamond traders, move money around the world.

• In a statement, the Geneva prosecutor’s office said it was investigating claims of “aggravated money laundering” by HSBC Private Bank (Suisse), the arm of the lender already hit by allegations that it was at the centre of a network that helped thousands of clients dodge billions of pounds in taxes.

“A search is currently under way in the premises of the bank, led by attorney general Olivier Jornot and the prosecutor Yves Bertossa,” said the prosecutors.

Two former employees of Smith & Ouzman Ltd (“SO”) were sentenced at Southwark Crown Court yesterday for foreign bribery offences.

Key facts

1.       SO is an Eastbourne-based printing company that specialises in security documents, such as ballot papers.

2.       A jury found that between 1 November 2006 and 31 December 2010, corrupt payments totalling £395,074 were made to public officials in Kenya and Mauritania in return for contracts.

3.       Mr Christopher Smith, chairman of SO was found guilty of

1. Two counts of corruptly agreeing to make payments contrary to s. 1(1) of the Prevention of Corruption Act 1906.
2. He was sentenced to 18 months’ imprisonment, suspended for two years,
3. as well as 250 hours unpaid work and a three-month curfew.

4.       Mr Nicholas Smith, sales and marketing director of SO was found guilty of

1. three counts of corruptly agreeing to make payments and
2. was sentenced to three years’ imprisonment.

5.       Both were disqualified from acting as company directors for six years.

6.       SO has also been found guilty of offences and will be sentenced at a later date.

Comment

1.       This prosecution represents the SFO’s first successful contested conviction of a corporate for overseas bribery.

2.       While the court has yet to sentence SO, the fact that the jury was able to deliver a guilty verdict for the corporate is significant in itself.

3.       As the wrongdoing occurred prior to the Bribery Act 2010 coming into force, the jury had to find that those individuals committing bribery within the business were the “directing mind and will” of the corporate for the purpose of those acts.

4.       This so-called identification doctrine has come under much criticism for being a difficult threshold to meet and was one of the reasons for the introduction of the strict liability corporate offence under the Bribery Act 2010.

5.       This case has demonstrated

1. That it is possible to secure convictions of corporates under the pre-Bribery Act regime.
2. The increased international co-operation between prosecuting authorities, as the SFO was keen to thank the Kenyan, Ghanaian and Swiss authorities for their assistance in securing these convictions.

6.       The prosecution is also indicative of

1. The increased ferocity with which the SFO is seeking to prosecute and convict corporates of overseas bribery and a salient message to those corporates doing business overseas who might assume that wrongful acts committed overseas will not be punished in the UK.

7.       Behaviour overseas will also come into sharper focus as a result of the changes to the director disqualification regime set out in the Small Business, Enterprise and Employment Bill, which is expected to receive royal assent in March.

1. Disqualification will be available for an offence committed outside Great Britain corresponding to an indictable offence under the law of England and Wales (or Scotland) in connection with the promotion, formation, management, liquidation or striking off of a company (or any similar procedure).
2. Also, the court will be able to take a director’s conduct in relation to overseas companies into account when considering certain disqualification applications.