The SEC’s Powers to Enforce the Production of Documents and Information, in the UK at Least, Hit a Stumbling Block

October 19, 2009

On 25 August 2009 (albeit the relevant decision has only recently been published), the Securities and Exchange Commission (the SEC) hit a stumbling block in its efforts to extend its jurisdiction to obtain documents and information from outside its territory, from the UK at least.  Over recent years, international co-operation between regulators has increased, and has been reported to have increased, and a near assumption has arisen in the UK that, if the SEC asks for assistance from the UK’s financial services regulator, the Financial Services Authority (the FSA), that assistance will be provided by the FSA and complied with by the relevant UK entity, irrespective of the time and cost involved in doing so.

What appears to have been the first real challenge to that near assumption has now occurred.  And occurred successfully.  In particular, in Amro International SA and Creon Management SA v FSA & ors[i], the UK entities from which the SEC was seeking information successfully challenged, by way of judicial review in the English Court, the FSA’s powers to require the production of the documents so sought.

The FSA’s powers in respect of and obligations to the SEC

The FSA’s statutory powers enabling it to assist the SEC are set out in Part 11 of the Financial Services and Markets Act 2000 (the FSMA).  In particular, the pertinent parts of section 169 of the FSMA provide:

"(1)   At the request of an overseas regulator, the Authority may–

(a)   exercise the power conferred by section 165; or

(b)   appoint one or more competent persons to investigate any matter.

(2)  An investigator has the same powers as an investigator appointed under section 168(3) (as a result of subsection (1) of that section).

[…]

(4)  In deciding whether or not to exercise its investigative power, the Authority may take into account in particular–

(a)   whether in the country or territory of the overseas regulator concerned, corresponding assistance would be given to a United Kingdom regulatory authority;

(b)   whether the case concerns the breach of a law, or other requirement, which has no close parallel in the United Kingdom or involves the assertion of a jurisdiction not recognised by the United Kingdom;

(c)   the seriousness of the case and its importance to persons in the United Kingdom;

(d)   whether it is otherwise appropriate in the public interest to give the assistance sought".

Section 165(1) of the FSMA then provides:

"The Authority may, by notice in writing given to an authorised person, require him–

(a) to provide specified information or information of a specified description; or

(b) to produce specified documents or documents of a specified description",

where an "authorised person" is, put simply, an entity that has been specifically authorised by the FSA to conduct certain financial services activities, as a result of which its activities are regulated by the FSA.

By sections 171 and 172 of the FSMA, a person appointed to investigate a matter under sections 169(1)(b) and (2) has the following powers:

171  "(1)      An investigator may require the person who is the subject of the investigation (“the person under investigation”) or any person connected with the person under investigation–

(a)   to attend before the investigator at a specified time and place and answer questions; or

(b)   otherwise to provide such information as the investigator may require.

(2)   An investigator may also require any person to produce at a specified time and place any specified documents or documents of a specified description.

(3)   A requirement under subsection (1) or (2) may be imposed only so far as the investigator concerned reasonably considers the question, provision of information or production of the document to be relevant to the purposes of the investigation"; and

172   "(2)   An investigator may also require a person who is neither the subject of the investigation (“the person under investigation”) nor a person connected with the person under investigation–

(a)   to attend before the investigator at a specified time and place and answer questions; or

(b)   otherwise to provide such information as the investigator may require for the purposes of the investigation.

(3)   A requirement may only be imposed under subsection (2) if the investigator is satisfied that the requirement is necessary or expedient for the purposes of the investigation".

The powers given to the FSA by sections 169(1)(b), 169(2), 171 and 172 of the FSMA are, therefore, far wider than those given to the FSA by sections 169(1)(a) and 165 because they are not limited to regulated entities.  Further, the powers given to the FSA in sections 171(2) and 172 of the FSMA are wider than those given to the FSA in section 171(1) because they are not limited to a person subject to the investigation (or connected with a person subject to the investigation) but to any third parties within the UK.

In addition to the FSA’s statutory powers, the FSA has committed to certain obligations vis-à-vis the SEC in respect of providing assistance to the SEC when requested to do so.  In particular, there are various memoranda of understanding between the FSA and foreign regulators, including the SEC, in connection with cooperation and mutual exchange of information for the purposes of proceedings and regulatory investigations in their respective countries. 

Amro International SA and Creon Management SA v FSA & ors

The facts

In brief, the SEC commenced an investigation into a New York corporation (Inc.) that it suspected to have conducted market manipulation as long ago as 1999.  The suspected market manipulation was allegedly committed by Inc. short selling stock in certain companies to which, on Inc.’s advice, the Claimants (A and C) were proposing to provide financing in return for stock.  The SEC subsequently launched proceedings against Inc. and certain of its employees for breaches of section 17(a) of the Securities Act of 1933 and section 10(b) of the Securities Exchange Act of 1934 in respect of certain specific instances in 2001 of alleged short selling in one company to which A ultimately provided financing.  No allegations of misconduct or involvement in the alleged illegality were made against A or C in those proceedings; indeed, C was not even mentioned in those proceedings.  Those proceedings remain pending in the United States District Court for the Southern District of New York (the New York Court). 

On 24 July 2009, the SEC wrote to the FSA, asking for assistance in obtaining documents from a London firm of accountants (the Accountants), which had acted for A and C and which was said to have documents relevant to the SEC’s claim.  The document request was exceedingly wide and, in effect, covered all documents related to A or C or Inc. that may have been in the possession of the Accountants for a period of some nine and a half years.  The SEC explained to the FSA that the reason for requesting such documents was to show the identity of the owners of A and C because, the SEC believed, A and C were knowingly involved in the illegal activity because they were ultimately owned by the relevant individuals who had engaged in the alleged short selling.  The requested time frame for production of such documents was also exceedingly short because of a discovery deadline imposed by the New York Court.

Following the SEC’s request, there was some communication between the FSA and the SEC because the FSA was not originally satisfied that the documents the SEC was requesting fell within the scope of the claim that was being made by the SEC, not least because there was no mention at all of C in the SEC’s claim in the New York Court.  The FSA, therefore, wondered whether it would be appropriate for it to agree to obtain them or to ensure that they were obtained.  The SEC explained that it believed that, in addition to allegations made in its claim in the New York Court related to alleged short selling in the company to which A ultimately provided financing, the defendants to its claim in the New York Court had been involved in repeated fraudulent and manipulative practices in multiple companies, including companies to which C as well as A had provided financing, and in which, it suspected, A and C had therefore been involved.  By obtaining the documents requested, the SEC wanted to show a "pattern of practice" or a "course of conduct" on the part of the defendants to the proceedings before the New York Court. 

Ultimately, the SEC’s responses satisfied the FSA and, following an obvious refusal by the Accountants to produce the documents voluntarily (given that they owed duties of confidentiality to their clients, A and C), the FSA invoked its legislative compulsory powers and, on 3 August 2009, appointed inspectors pursuant to section 169(1)(b) of the FSMA (section 169(1)(a) not being applicable, given that the Accountants were not an "authorised person").  Those inspectors sent a notice to the Accountants demanding production of the documents as requested by the SEC (presumably either in accordance with sections 171(2) and 172, section 171(1) not being applicable as neither the Accountants, nor A and C were, themselves, subject to the SEC’s investigation). 

A and C, as the Accountants’ clients, launched these proceedings against the FSA and the inspectors appointed by the FSA alleging:

(i)     that the FSA was acting unlawfully in agreeing to appoint inspectors in order to obtain the documents through their compulsory powers in the FSMA; and

(ii)    that the document request in the notice was too wide and unspecific, such that it went beyond the powers granted to the FSA by the FSMA.

The English Court’s decision

The English Court upheld A and C’s challenge to the FSA’s request for documents on the first ground, namely that the FSA should not have appointed inspectors in order to obtain the documents through their compulsory powers.  (The Court also thought it likely that the second ground was valid as well, given that the document request was very broad and covered such an extended period of time, although in the light of its decision on the first ground, it did not consider it necessary to go into much detail on this point). 

The first question the Court had to determine was whether the FSA’s powers in section 169 of the FSMA applied equally to providing assistance for a civil claim being brought by a foreign regulator as to an investigation being conducted by the foreign regulator, thus allowing the foreign regulator to avoid the requirement that a lay claimant to foreign proceedings would have to satisfy in order to obtain documents from the UK, namely to go through the Hague Convention (and the protections that that process provides).  The Court had little hesitation in deciding that there was nothing in the FSMA that prevented the powers being used for such purposes, although it thought that the fact that the documents were required for a civil claim, rather than a regulatory investigation, was a relevant matter to be considered by the FSA in determining whether or not to exercise its powers. 

In coming to its decision as to whether or not the FSA’s powers should, nevertheless, have been exercised in the current circumstances, the Court decided that, whilst the qualifications to the section 171 and section 172 powers were framed in slightly different terms (in section 171(3) that a person may be required to produce specified documents or documents of a specified description "only so far as the investigator concerned reasonably considers the question, provision of information or production of the document to be relevant to the purposes of the investigation" and, in section 172(3), that a person may be required to produce such information as the investigator may require for the purposes of the investigation "only […] if the investigator is satisfied that the requirement is necessary or expedient for the purposes of the investigation"), the more restrictive requirement in section 172(3) that the information be "necessary or expedient for the purposes of the investigation" applied equally (if necessary, implicitly) to the power to require the production of documents in section 171 of the FSMA.  This was particularly the case where, as here, the relevant documents were confidential documents (confidential to persons not the subject of the investigation, here A and C).  However, in coming to this decision, the Court was clearly swayed by the fact that the FSA, itself, had considered that it needed to "be able to prove request is reasonable and necessary in the circumstances", which the Court considered akin to the requirement in section 172(3). 

Against that background, so the Court said, where, as here, the request for assistance by a foreign regulator is based on the need to assist in a civil claim, then the nature of that claim is of fundamental importance.  The Court said that it might be all very well for the SEC to say that it was now alleging that A and C were implicated in the pleaded misconduct.  However, those allegations were not contained within the complaint filed in the civil claim before the New York Court; nor was there anything in the complaint filed that suggested that A or C were involved in any type of illegality.  It was, therefore, wrong for the FSA to agree to go beyond what was actually included in the complaint because it could not be said that it was "necessary or indeed proportionate" to require the production of documents not relevant to the SEC’s pleaded case.  That was particularly so where, as here, the document request was so broad[ii].

Conclusion

This is a welcome decision for entities or individuals in the UK faced with a request for the production of documents from the FSA to assist with an SEC investigation or claim, particularly those who are non-regulated and, therefore, do not owe any independent regulatory obligations of co-operation with the FSA.  It provides such entities or individuals, when faced with a requirement from the FSA to produce documents or information to assist an SEC investigation or claim, with judicial support for the possibility of challenging the document request if it appears to the relevant entity or individual that the documents requested are not relevant to the case or investigation being brought by the SEC.  This decision may equally be of help in providing ammunition for affected parties to argue that the SEC should not be allowed to seek wide-ranging, speculative information at early stages of an investigation, when the SEC’s allegations have yet to be made out or where the facts are yet to be completed or properly understood.  We would note, however, that the English Court was clearly more resolved in its decision to uphold the Claimants’ challenge by the fact that the SEC had taken so long to ask the FSA for its assistance and had taken no steps or even shown any intention to amend its claim in the New York Court, despite having the information concerning the existence of A and C as long ago as 2003.  To quote the English Court, the SEC was "at the very last moment […] trying to bolster [its] case" and asking the FSA "to help to pick up the pieces". 

This should also be a welcome decision for the FSA.  The English Court specifically acknowledged that it was not necessary for the FSA in all cases to engage in a lengthy debate with the SEC as to whether in fact the documentation requested was relevant to the case or investigation being brought by the SEC, but was entitled to rely on what it was told or provided by the SEC, in this case the complaint in the New York Court.  However, in circumstances where it appears from the information provided by the SEC that the document request is unnecessarily wide and does not appear to relate to the claim or investigation being brought by the SEC, the FSA has the legal support and backing of the English Court to resist (and thereby reduce) the hugely wide-ranging requests for documents and information for an SEC investigation, which would never be permitted were the FSA to be conducting its own investigation in the UK.  This decision, however, does mean that it is not open to the FSA (if it did in the past) merely to act as a transmitter of international requests from foreign regulators, but requires it to devote resources to at least understanding the case being made, or the allegations being investigated, in order to check whether the material sought would have a bearing on that case. 

One final word: the English Court gave the FSA and its inspectors permission to appeal its decision, so, as ever, we all need to watch this space.