UT-2022-00097 - [2024] UKUT 00352 (TCC)

As DEPP 6.5.2 makes clear, there are three distinct principles which underlie the penalty regime namely:

Whilst there is an overlap between the discipline and deterrence principles, the disgorgement principle is of a different character. It is not designed to penalise the firm or deter the firm or others from committing the same behaviour. Its purpose is confined to ensuring that the firm does not benefit from its misconduct. Consequently, as the policy makes clear, the amount arrived at by the application of Step 1 is not to be increased or decreased by reference to any aggravating or mitigating factors. Nor is any discount for settlement applied to the disgorgement figure. It is solely a question of deciding on a case-by-case basis what, realistically, has been the financial benefit that has accrued to the firm as a result of its misconduct.

The phrase “financial benefit” should not be construed in an overly legalistic fashion. The policy should not be construed in the same way as a statutory provision and should be capable of being applied flexibly, depending on the facts. Therefore, for instance, in a case where the firm is legally entitled to receive the full amount of the income it derives from the misconduct in question in circumstances where it is obliged to meet certain expenses out of the amount received, the fact that it had a legal entitlement to the whole amount should not be decisive as to the amount of the financial benefit. Whether the “financial benefit” is the gross amount, or a lesser amount to take account of expenses, needs to be considered on a case-by-case basis.

This was recognised by Snowden J in Da Vinci. That case was concerned with the provisions of s129 FSMA which gives the High Court the power to impose a penalty for market abuse. The DEPP framework also applies to such penalties. Traders had traded shares on the London Stock Exchange under an arrangement with Da Vinci, a company which used direct market access facilities provided by Goldman Sachs as a broker for share trading on the exchange. Da Vinci supplied financial resources and market access in return for half the profits of their trading. Market manipulation was carried out under this arrangement.

Snowden J held at [219] to [221] that, for the purposes of a financial penalty, Da Vinci should be given credit for the costs it incurred in committing the market abuse as follows:

“219.

Mr. Beauchamp's evidence was that at step 1 (disgorgement) when applying DEPP 6.5A.1 the FSA would have regarded it as inappropriate that those who have committed market abuse should be given any credit for any costs incurred in committing that market abuse. On that basis, Mr. Beauchamp gave evidence that the FSA would have considered it appropriate to require DVI to disgorge its gross profits from trading during 2010, which the FCA had calculated were £688,730.

220.

I disagree with this approach – or at least I disagree with it as broadly as it was stated by Mr. Beauchamp. On the basis that step 1 – disgorgement – is designed to ensure “the removal of any financial benefit derived directly from the breach”. I do not accept that a person who has engaged in market abuse should be required to disgorge benefits that they have not received. That would amount to a penalty, which is dealt with at steps 2–3.

221.

The point can most readily be illustrated in relation to the dealing costs and commissions which were directly referable to the trading in question and which were payable by DVI to Goldman Sachs. As might be expected, those costs and commissions were simply deducted by Goldman Sachs from DVI's account, and DVI therefore never received or became entitled to them I can see that there might be more merit in an argument that a defendant who has committed serious market abuse should not be able to claim credit for his general business overheads, but that issue does not arise on the facts of this case, and so I express no view upon it.”

In Ford and others v FCA [2018] UKUT 358 (TCC), the Tribunal made the following statement of principle in relation to disgorgement at [684]:

“We accept that the principle of disgorgement is to deprive the wrongdoer of the benefit of their wrongdoing. That principle does not look to the source of the benefit (in particular if that source is also the product of misconduct) nor is it concerned with whether or how the sums in question have been disbursed or otherwise applied.”

The Authority has taken disciplinary action against a number of other brokers who carried on similar activities to the Applicant with the Solo Group. One such broker was Sapien Capital Limited (“Sapien”), who challenged the Authority’s findings before the RDC but did not refer its decision to the Tribunal.

In the Authority’s Final Notice given to Sapien on 6 May 2021, at paragraph 4.24 the Authority found that in 2014 Sapien took on a new trading desk. The individuals working on the desk reported directly to Sapien management. The new trading desk was taken on to conduct futures derivatives trades for Sapien. While at prior firms, these individuals had acted as brokers for the Solo Group. Upon joining Sapien, they were keen to continue their prior relationship with the Solo Group.

In that case, after representations from Sapien, the RDC decided that the figure for financial benefit that should be disgorged was £178,000, a figure which was arrived at after deducting custody and consultant fees from the gross revenue received by Sapien from the Solo Group. In its Warning Notice, the Authority had sought disgorgement in the sum of £297,000, that figure being what the Authority said were the financial benefits derived directly from Sapien’s breaches. In its representations to the RDC, as recorded in Annex D to the Final Notice Sapien said:

“While £297,000 of revenue technically came into Sapien from the Solo business by way of commissions, most was instantly paid out, under pre-agreed contractual terms, in fees of £94,000 to the team of individuals working on the trading desk, and custodian and consultant fees of €40,000 to Solo.”

Referring to DaVinci for support, Sapien contended that the sum should not be required to be disgorged because it could not be said that Sapien received a benefit from the funds that were paid out straightaway.

This argument was accepted by the RDC. It said in its response to the representations:

“The Authority considers that while the gross commission from the Solo business is the starting point for the appropriate figure for disgorgement, in all the circumstances of this case, Sapien’s financial benefit ought to be calculated as that amount minus the sums paid out in respect of fees to the brokers and the custodian and consultant fees to Solo. The Authority is satisfied that the net figure is appropriate in this case because of Sapien’s particular business structure, notably its contracts with independent, self-employed brokers which were specifically introduced on this business model, which predated the Solo clients, under which they were entitled to recoup their commission share. The Authority accepts Sapien’s argument that it did not receive a benefit from those funds, notwithstanding the fact they were technically received by Solo before being paid on. It considers a similar approach should be taken in this case to the custodian and consultant fees….”

In our view, this Decision illustrates how the concept of “financial benefit derived directly from the breach” which is the test to be applied under DEPP in considering the amount to be disgorged, must be considered on a case-by-case basis. In Da Vinci, Snowden J accepted that fees which were deducted from the revenue earned before it was passed on to the recipient should not be regarded as being part of the financial benefit because they were never received by the person concerned, but left open the question as to whether other costs and expenses might also in an appropriate case be deducted. In the case of Sapien, the RDC did accept that deductions could be made in respect of sums that, although technically received were subject to a pre-existing contractual obligation to pass them on straightaway. Correctly, in our view, the RDC was not seeking to construe the words of the relevant provision in DEPP strictly and was able to conclude that the firm concerned should not be regarded as having received a benefit “directly” in circumstances where it was under an obligation to pass the sums concerned on to another person straightaway.

In our view, the RDC’s decision offers support for the proposition that it is, in appropriate cases, correct to deduct expenses which are directly referable to the generation of the revenue concerned. That, in our view, was the basis on which Snowden J was able to agree that custody and brokerage fees should be deducted in Da Vinci. It is true that Snowden J put some emphasis on the fact that the sums representing the deductions concerned had not been received by Da Vinci.

Consequently, we do not consider that Snowden J was intending to limit the meaning of the word “received” in this context. Likewise, we do not consider that the passage in Ford quoted above should be construed as meaning that one should always take into account as a financial benefit received, sums which were “disbursed” immediately on receipt. It does not appear to us that that point was in issue in that case.

It is common ground that the Authority’s decisions which relate to matters which have not been referred to the Tribunal are not judicial decisions; they are administrative decisions and do not create a legal precedent. However, in the case of a Final Notice which has been through the Authority’s contested decision-making process before the RDC, we should pay due regard to the decision of the RDC, particularly where it is applying the Authority’s policy on financial penalties. The Decision should be regarded as an expression of the policy of the Authority in relation to the point of concern, and therefore, as the case law shows, in relation to the setting of financial penalties, we should not depart from the Authority’s policy unless there is a good reason to do so.

Furthermore, there is great merit in consistency of decision-making when it comes to the setting of financial penalties, both as between decisions made through the Authority’s administrative decision-making process as well as between such decisions and those of the Tribunal.

In this case, the Applicant contends that the Authority has applied the disgorgement principle incorrectly by not deducting from the gross revenue received the amount of commission paid to Hopa. Mr Mansell submitted that where commission was paid to Hopa there was no proper basis for treating money received by Hopa as the Applicant’s benefit. The monies paid to Hopa were an expense of the Applicant and the Decision Notice has already acknowledged that expenses should, as a matter of principle, be deducted from the Firm’s disgorgement figure in respect of custodian or clearing fees.

Therefore, whilst Mr Mansell accepts that fixed business overheads may not be deductible, he submits there is no reason why such a concept should be extended to commission payments contractually owed and calculated by direct reference to the specific underlying business transactions subject to disgorgement. In this instance whilst gross monies were initially paid into the Applicant’s accounts, commission payments to Hopa, like custodian or clearing fees (already deducted), were then paid out pursuant to the Applicant’s contractual obligations. In this way, Mr Mansell submits, the physical receipt of payment does not alter the analysis in Da Vinci where no benefit was in fact physically received by the firm.

Mr Hinks, for the Authority, contends that these submissions should not be accepted. In summary, he submits:

We prefer the submissions of Mr Mansell on this issue for the following reasons.

First, we see no reason in principle to distinguish the custody and consultancy fees from the commission paid to Hopa. In our view, the commissions payable to Hopa are expenses directly referable to the trading in question and, consistent with the reasoning in Da Vinci, to be deducted from gross revenue to which the Applicant was entitled.

Secondly, we agree with the analysis of the RDC in Sapien. In that case, the commissions were paid out pursuant to pre-agreed contractual terms and, as we have said, were commissions that were directly referable to the trading undertaken with Solo. We do not accept that they are of the same character as salary payments. In Sapien, the RDC relied on the firm’s particular business structure, notably its contracts with independent self-employed brokers under which they were entitled to recoup their commission share. As Mr Meadows’s evidence demonstrates, the Applicant followed the same business structure. All of its brokers, in accordance with common industry practice, were self-employed and were remunerated on the basis of commission, payable out of the commissions payable to the firm. Mr Lawrence, through Hopa, was engaged on the same basis.

Thirdly, we do not consider that the fact that there was some delay in the payments being made to Hopa after their receipt by the Applicant makes any difference. As Mr Meadows’s evidence demonstrates, there was no written agreement between the Applicant and Hopa, but there is nothing to suggest that the payment terms were anything other than that the 80% share was payable to Hopa immediately upon the sums out of which it was to be paid were received by the Applicant. That would be an obvious implied term in the circumstances. It may well be the case that as a matter of law it was open to the Applicant to use the sums received for general business purposes, but that would not have affected its pre-existing legal obligation to pass them on immediately upon receipt. The sums received were in essence earmarked funds, 20% payable to the Applicant, and 80% to Hopa.

Fourthly, we do not consider the fact that Mr Lawrence was an equity partner in the Applicant makes any difference. Mr Lawrence has benefitted from the 20% share of the commission payable to the Applicant because of his status as an equity partner in the Applicant. He has received his full entitlement to his share of that sum as an equity partner in the firm. None of the 80% share paid to Hopa was paid to him in his capacity as a partner in the Applicant, but under a separate contractual arrangement. There is no reason therefore to put Mr Lawrence in a different position to any of the other brokers in the firm who were remunerated on the same basis.

Fifthly, to seek to disgorge the full amount of the commissions payable to the Applicant would in our view amount to the imposition of a further penal sanction beyond that arrived at by the application of Steps 2 to 4 of the policy framework. Had the Applicant thought of it, it might have included in the contractual arrangements with Hopa provisions to the effect that it could claw back the commission payments made in the event that the Applicant was obliged to disgorge them as a result of any misconduct caused by the broker concerned to take the view that the failure of the Applicant to include such a provision in the contractual arrangements was a reason for treating the sums concerned as a financial benefit to the Applicant would, in our view, clearly be a sanction of a penal nature which, as discussed above, is not permitted when considering the amount to be disgorged under Step 1, as recognised in Da Vinci. Whilst we make no criticism of the Authority for not having done so, it would have been open to the Authority to take regulatory proceedings against Mr Lawrence if they considered that he was personally culpable for the misconduct that occurred, and sought disgorgement from him of the amounts paid to Hopa.

We therefore conclude that the Step 1 figure should be £140,912.53, that is the 20% share of the net commission retained by the Applicant after making the payments it was obliged to make to Hopa.