Previous Section Back to Table of Contents Lords Hansard Home Page

Lord McIntosh of Haringey moved Amendment No. 152:

The noble Lord said: My Lords, Amendment No. 152 makes a minor yet necessary consequential change to Clause 140. As the House will recall, subsection (3) was inserted in Committee to enable the authority to exercise its powers under Part IV (permission to carry on regulated activities) or Clause 65 (disciplinary powers with regard to approved persons) at the request of the take-over panel. That will specifically enable the panel to invoke the authority's disciplinary powers with regard to approved persons in addition to its powers referred to in subsection (4); namely, Parts XIII, XIV and XXV. This further amendment is consequential on the introduction of subsection (3) and I commend it to the House. I beg to move.

Lord Kingsland: My Lords, the clause refers to the power of the authority to endorse rules made by the take-overs and mergers panel. The amendment is to subsection (6) and makes clear that subsection (3) applies to the rules, as amended from time to time by the panel, as well as subsection (4). Both allow the authority to take enforcement action at the request of the panel and we are happy with the amendment.

On Question, amendment agreed to.

9 May 2000 : Column 1403

Clause 142 [Financial promotion rules]:

Lord McIntosh of Haringey moved Amendment No. 153:

    Page 69, line 33, leave out from ("communication") to end of line 34 and insert ("by them, or their approval of the communication by others, of invitations or inducements--

(a) to engage in investment activity; or
(b) to participate in a collective investment scheme.").

The noble Lord said: My Lords, in moving Amendment No. 153, I shall speak also to Amendments Nos. 154, 155 and 167. Clause 142 confers the power on the authority to make rules applying to authorised persons in relation to the regulation of financial promotions under Clauses 19(1) and 234(1). Clause 263, to which Amendment No. 167 applies, empowers the authority to suspend the promotion of an EEA scheme to the public where it appears that the operator has contravened the authority's financial promotion rules.

Amendments Nos. 153, 154 and 155 are technical amendments to Clause 142 restricting the application of the rule-making power set out in this clause. Amendment No. 153 to subsection (1) and Amendment No. 154 to subsection (2) are drafting changes which pave the way for the substantive Amendment No. 155.

Amendment No. 155 inserts a new subsection after subsection (2), ensuring that the authority may only regulate communications made by authorised persons which, if they were made by unauthorised persons without the approval of an authorised person, would contravene Clause 19(1), and communications which may be made by authorised persons without convening Clause 234(1).

The effect of this is that an authorised person will not be subject to rules made under the clause when he makes a communication which falls outside the scope of the controls applying to unauthorised persons imposed by Clauses 19 and 234. The Government are also proposing that a technical amendment--Amendment No. 167--be made to Clause 263(1) in order to delete the express reference to invitations and inducements,

    "of a kind mentioned in Section 234(1)",

in that subsection. Given that authorised persons cannot make the kind of invitations or inducements referred to, the deleted words are unnecessary and have therefore been removed. I commend all the amendments to the House. I beg to move.

Lord Kingsland: My Lords, our understanding is that Amendments Nos. 153 to 155, which affect Clause 142, relate to the authority's power to impose financial promotion rules on FISMA-authorised firms and are technical only. Therefore, they are quite acceptable.

So far as concerns Amendment No. 167, as the Minister explained, Clause 263 relates to the power of the authority to give a direction under that clause. Even though the fund is recognised, and so for

9 May 2000 : Column 1404

marketing purposes is treated as an authorised unit trust and therefore outside the marketing restrictions in Clause 234(1), that power enables the authority to require that the restrictions none the less apply. The authority can do that only if the operator of the recognised scheme--typically the manager of a non-UK open-ended investment company--has failed to comply with the FSA's financial promotion rules.

We have only one query relating to this issue. The amendment seems to provide that the invitation or inducement covers the redemption of shares as well as their promotion. The Government may like to consider that point before Third Reading.

Lord McIntosh of Haringey: My Lords, I shall be very glad to do that.

On Question, amendment agreed to.

Lord McIntosh of Haringey moved Amendments Nos. 154 and 155:

    Page 69, line 37, leave out paragraph (b).

    Page 69, line 38, at end insert--

("( ) Subsection (1) applies only to communications which--
(a) if made by a person other than an authorised person, without the approval of an authorised person, would contravene section 19(1);
(b) may be made by an authorised person without contravening section 234(1).
( ) "Engage in investment activity" has the same meaning as in section 19.").

On Question, amendments agreed to.

5.15 p.m.

Lord McIntosh of Haringey moved Amendment No. 156:

    After Clause 143, insert the following new clause--


(".--(1) The Authority may make rules ("control of information rules") requiring an authorised person ("A") to withhold information from a person ("B") for or with whom he does business in the course of carrying on any regulated or other activity.
(2) Control of information rules may--
(a) require the withholding of information which A would otherwise have a legal obligation to disclose to B;
(b) require A to restrict or prevent the passing of information within his business.
(3) Subsection (1) applies only in relation to information obtained from a person other than B in the course of the carrying on by A of any activity, whether it was obtained by A, by an approved person or by any other person.
(4) "Approved person" has the same meaning as in section 63.").

The noble Lord said: My Lords, in moving Amendment No. 156, I shall speak also to government Amendments Nos. 157 and 218. I shall respond to anything that is said about opposition Amendment No. 157VA in due course when the amendment has been spoken to.

Amendment No. 156 inserts a new clause after Clause 143 giving the FSA the power to make rules which require an authorised firm to operate Chinese

9 May 2000 : Column 1405

walls restricting or preventing the flow of information within a firm and dealing with the disclosure of certain information. These are called the "Chinese walls rules", which is not the easiest thing to say!

Chinese walls are simply established arrangements in the form of procedures, systems, management and physical location which act as barriers within a firm to ensure that information which is generated within one part of the firm or obtained from a client in one part of the firm does not penetrate another part of the firm. They are important for a number of reasons. They provide a mechanism for authorised firms to function as multi-disciplinary operations. Of course, a major point of the Bill is that it responds to the fact that much financial service activity is now multi-disciplinary.

As the Law Commission indicated in its 1995 paper, Fiduciary Duties and Regulatory Rules:

    "Chinese walls are widely used in organisations which provide financial services ... they are essential if the industry is to operate in its present form with multi-functional investment houses performing a wide range of services".

Those rules will continue to protect the interests of the clients of such a firm by ensuring that information which relates to a particular person in relation to a particular activity does not reach another part of the firm. They also protect the firms themselves, establishing a firm regulatory framework within which the firm must control the flows of information, both internally and externally.

The other two amendments in the group are consequential changes. Amendment No. 157 allows the authority to modify or waive control of information rules provided that the procedure set out in Clause 144 is followed; that is, rules made under the proposed new clause are treated in the same way as other rules referred to in Clause 144(1). Amendment No. 218 simply provides a definition in Clause 407 of control of information rules.

I should add that, in response to concerns raised by the City Liaison Group, the Government are currently reviewing whether adjustments to this clause would be desirable. We aim to report back on this issue at Third Reading if, indeed, it is considered that they would be desirable. I beg to move.

Lord Kingsland: My Lords, I may take a little while both in responding to the government amendment and in speaking to my own, for which I apologise in advance.

Amendment No. 156 is headed "Control of information" but, as the Minister said, should really be headed "Chinese walls". Chinese walls are of great help to investment firms because, on the one hand they give the advantages of being in a single corporate entity but, on the other, allow the separate parts of that entity to be treated as different in law. As your Lordships are well aware, the purpose of that is to ensure that knowledge in one part of the firm, behind the Chinese wall, should not infect the other part of the firm in front of the Chinese wall.

That is crucial; because the walls protect the firm from having to use information that it receives confidentially from one client for the benefit of

9 May 2000 : Column 1406

another. They help firms to deal with conflicts of interest and the strict application of fiduciary duties by which all advisers, brokers and investment managers are bound. They also protect the firm against charges of insider dealing and, I trust, market abuse. In addition, they protect the firm from contravening FSA rules which apply when it knowingly does something if the individuals that know are behind the Chinese wall and what is done is done by people in front of the Chinese wall without any cross-contamination.

As I understand it, the Chinese wall is acceptable to regulators and included in the authority's core conduct of business rules. Yet the government amendment does not provide for it at all. The amendment merely empowers the authority to make rules which require any authorised person to withhold information. That would impose an intolerable burden on small firms where there is no effective Chinese wall because none can be constructed; staff will have to segregate information in their minds and not mention it to employees who work alongside them.

So far as I am aware, the authority does not have any such rule at the moment; nor, indeed, do the SROs. Indeed, I cannot believe that the authority would want to introduce such a rule. The current provision for Chinese walls is in Section 48(2)(h) of the Financial Services Act, which empowers the authority to make rules which either enable or require information to be withheld. At the very least, Amendment No. 156 should cover both aspects.

The role of Chinese walls has, of course, changed quite a lot since the Financial Services Act was passed in 1986. In particular, the authority's rules must now cover the right not to use information held by a firm. As a matter of agency law, any information which a firm has about one client, at least arguably, is required to be used also for the benefit of all other clients. In other words, there is a requirement to abuse the inside information. I give just one example. If a firm is about to launch a bid on behalf of one client, it knows that the shares in the target company will go up in value. Therefore, it is required by agency law to buy shares in the target company for all its other clients. Clearly, that is an intolerable situation. Moreover, it is classifiable as illegal insider dealing.

The amendment must be expanded to cover permitting or requiring not only the withholding of controlled information but also the use of that information. The rules must provide that a firm is not required to use information held on the other side of the Chinese wall. That reflects the existing practice of investment banks and stockholders, and probably everyone else as well. Normally there are provisions in the client agreement which allow that to happen. However, it would be extremely helpful and perhaps--I go further--essential that the authority's rules should also allow the non-use of information held behind the Chinese wall.

Our Amendment No. 157VA seeks to solve these problems. This new clause is concerned with the position of authorised persons who comply with control of information rules as defined in government

9 May 2000 : Column 1407

Amendment No. 156 but who also owe their customers fiduciary duties to make disclosure of information in the possession of the authorised person. Control of information rules recognise the concept of Chinese walls which are, as we have already noted, a common feature of the financial services business.

For present purposes, the starting point is April 1992 when the Law Commission produced a long and detailed consultation paper on the topic of fiduciary duties and regulatory rules. The paper considered the impact on fiduciary duties of compliance with regulatory rules, particularly in the context of the regulatory regime established under the Financial Services Act 1986.

One of the matters considered was whether compliance with regulatory rules, which permitted the establishment of Chinese walls, ousted the usual fiduciary duties of disclosure and avoidance of conflicts of interest which would normally have applied.

The Law Commission's consultation paper was followed in December 1995 with its report on the consultation. The Law Commission concluded on the issue of Chinese walls at paragraph 16.6 that:

    "We believe that it is essential to remove any doubts, however tenuous, about the legal efficacy of the practice of withholding information by means of a Chinese wall which complies with the regulatory requirements as a method of managing conflicts of interest and duty. The Chinese wall is an essential device for the operation of the modern financial conglomerate; and the determination of its effectiveness should not be left to the uncertainties of litigation".

The Law Commission's recommendation for resolving the doubt was that:

    "There should be legislative provision that a firm shall be protected from liability where (i) information is withheld from a customer (or is not available for the customer's use) pursuant to a Chinese wall arrangement which complies with the regulatory requirements; or (ii) a firm places itself in a position where its own interest on one side of a Chinese wall which fulfils regulatory requirements conflicts with a duty owed to the customer of a department on the other side of the Chinese wall, and as a result of the Chinese wall neither department knows of the firm's conflicting interest or (iii) a firm owes conflicting duties to the customers of different departments on different sides of a Chinese wall which fulfils regulatory requirements, and as a result of the Chinese wall neither department is aware of the conflict".

The Law Commission also recommended that what constitutes a Chinese wall for the purposes of the legislative provision should be laid down by the authority pursuant to delegated powers under Section 42H of the Financial Services Act 1986. That is effectively the same as the power of the authority to make control of information rules under the new clause introduced by the Government's Amendment No. 156.

The Law Commission made a number of other recommendations concerning Chinese walls and included in its report a draft clause which it was intended should be incorporated in the Financial Services Act which met the requirements of its legislative approach to dealing with the matter. In July 1998, when the Treasury issued the draft of the

9 May 2000 : Column 1408

Financial Services and Markets Bill for consultation, the Treasury's overview of financial services regulatory reform, it stated at paragraph 5.11:

    "We intend that the Bill as introduced into Parliament will ensure that compliance with the FSA rules relating to Chinese walls which manage or avoid conflicts of interest and help prevent insider dealing will protect a firm not only against criminal liability but also against civil action for breach of duty. This will mean that firms are not put at risk of legal challenge where they comply with these important regulatory requirements".

So clearly, in July 1998, the Treasury thought that a provision in the Bill to deal with Chinese walls was necessary. Although the Government at this late stage have tabled an amendment providing for control of information rules it is, if I may say so, of considerable surprise that, given the background to the matter, the Government do not propose to implement the Law Commission's recommendation by including in the Bill an appropriate provision. That is despite the firm statement of intention to do so in the Treasury's consultation document on the draft Bill.

Our Amendment No. 157VA is a redraft of the Law Commission's draft clause set out in its report, amended to take into account the differences between the provisions of the Financial Services Act 1986 and the provisions of the Bill. It may not be perfect in every way but we should like to know why it is that the Government do not propose to table an amendment of their own to reflect the Law Commission's proposal. Has something happened to change the Treasury's thinking on the matter? Do they think the Law Commission is wrong and, if so, why is the Law Commission wrong? A huge amount of work has been done by the Law Commission on this issue and a long consultation process has occurred. In our judgment, it would be most unfortunate if this opportunity for dealing with the issue, one way or another, was not taken.

Finally, I turn to a question of drafting in relation to the Government's amendment. It provides that its provisions should apply only in relation to information obtained from a person other than the client. However, corporate finance advisers and private equity firms would dream up their own ideas about prospective deals and would work on them accordingly. That information would not be obtained from anyone else and, therefore, the Chinese wall provisions will not apply. The amendment deals with information about clients but not information about deals. Those are my submissions.

Next Section Back to Table of Contents Lords Hansard Home Page