Regulatory rules fall foul of the law

In the Johnson case, the Court of Appeal found that the payment of a commission or fee by the car finance lender to the car dealer who introduced the customer was a bribe or an unlawful ‘secret commission’ (depending upon whether the commission was undisclosed or partially disclosed). It ruled that the generalised advance disclosure of the commission arrangements prescribed in the Financial Conduct Authority (FCA) rules was inadequate under the general law and did not constitute informed consent on the part of the customers.

In the joint appeal of Johnson v. FirstRand Bank and two other County Court cases, the Court of Appeal found that the car dealers owed the customers for whom they had arranged finance a ‘disinterested duty’. That is, they ought to provide information on an impartial or disinterested basis, whether or not there was an explicit fiduciary relationship.

The Court also found that the payer of the commission/bribe (in this case, the bank or the lender) could be liable as a primary wrongdoer, and remedies at common law and in equity were available to the customer. The result is potentially billions of pounds to be paid in compensation to customers who took out car finance deals over more than a decade. To put this into context, more than £38.3bn was paid out in compensation following the mis-selling of payment protection insurance, according to the FCA.

The money is only part of the problem. A point often overlooked is that the UK financial services regulatory regime operates within the wider legal framework of common law and contract law. Regulators do not necessarily have the final say and they are clear that the court’s role is to interpret the law.

The media expressed consternation that purported compliance with the FCA’s rules on disclosing a commission arrangement would not satisfy the legal test for informed consent. Consumer guru Martin Lewis said: “When mulling this, I find it more difficult to see the unfairness and that redress is due on car finance firms with fixed commission that were following regulator’s guidelines. And even then… the test surely must be something like: Was it hidden that there was commission and, more importantly, was the commission charged excessive.”

Although the Court of Appeal’s decision was a surprise to many, including the FCA, the motor vehicle finance industry has been in the regulator’s crosshairs for some time. It carried out an ‘exploratory’ review of the motor finance sector in 2017 as part of an investigation into high-cost credit. The FCA said then: “We are concerned that there may be a lack of transparency, potential conflicts of interest and irresponsible lending in the motor finance industry.” The practice was allowed to continue, although the Financial Ombudsman did find a conflict of interest in at least one case.

As a result of this review, the FCA proposed new rules and guidance, including guidance on the policies that authorised firms have for remunerating employees and agents performing credit-related regulated activities. Nothing in the guidance required a firm to act in a way that would be inconsistent with its obligations under employment or contract law. Motor finance continued as before.

In a 2018 update, the FCA said it had identified certain motor finance commission structures (later called discretionary commission arrangements) that created incentives for car dealers to act as credit brokers. These included adjustable interest rate commissions, flat fee commissions and other ‘discounts’, including volume bonuses. The regulator said it was collecting data on motor finance contracts to assess whether commission arrangements had led to higher finance costs as a result of the incentives they created for the brokers.

By 2019, the FCA had “uncovered serious concerns about the way in which lenders are choosing to reward car retailers and other credit brokers”. The then FCA Executive Director of Supervision said: “We found that some motor dealers are overcharging unsuspecting customers over a thousand pounds in interest charges in order to obtain bigger commission payouts for themselves. We estimate this could be costing consumers £300m annually. This is unacceptable and we will act to address harm caused by this business model. We also have concerns that firms may be failing to meet their existing obligations in relation to pre-contract disclosure and explanations, and affordability assessments. This is simply not good enough and we expect firms to review their operations to address our concerns.”

The FCA consulted again on these commission models, and rules prohibiting discretionary commission arrangements were introduced in October 2019. However, the regulator expressly limited its terminology to the economics of these arrangements and not to any “competition law notions or the nature of the legal relationships”.

The FCA also said: “Firms that were previously non-compliant but comply with the new rules would benefit from reduced risk of legal claims.” It added that firms that were already compliant would benefit from added legal certainty provided by clearer rules. In carrying out an econometric analysis on a sample of these loan arrangements, the FCA identified that these practices could cause significant customer harm estimated at a total of £308m.

The rules banning discretionary commission arrangements were finalised by the FCA in July 2020, but it decided to give firms more time to implement them. This was despite estimating that banning discretionary commission models would save consumers “around £165m a year”. The FCA said it recognised that extending implementation of the ban by three months would “come at a loss to consumer in the short term” but that it had considered other factors, including the impact of Covid-19 on the motor finance industry and the proportionality of giving the industry longer to move to other commission models.

The regulator did amend the disclosure requirements, recommending that firms indicate in consumer financial promotions and communications ‘the existence and nature’ of any agreements between the broker and the lender that could be an inducement to choose that lender and that, if the customer knew about it, could affect their financing decision. The disclosure was to be made in a prominent way.

The rules were also amended to require a credit broker to ‘prominently’ disclose any commission or fee, or other remuneration in relation to a credit or consumer hire agreement. They were also required to disclose ‘with equal prominence’ how that might affect what the customer would be paying. In addition, they had to flag up any differences in fees or commission for different credit agreements, although they weren’t required to provide an ‘individually tailored illustration’.

Commission arrangements that were not discretionary only had to be disclosed if they could affect the impartiality of the broker or could have a material impact on the customer’s decision. So, although discretionary commission arrangements were prohibited, other commission models were allowed to continue, albeit with more disclosure.

There is plenty of evidence, therefore, that the FCA turned a Nelsonian blind eye to the fact that delegated legislation (regulatory rules) does not modify legal principles and obligations under common law unless there is a clear intention in the enabling statute for them to do so. We should remember that legal principles and obligations under common law, including fiduciary duties, are not necessarily the same as the requirements under regulatory rules made under statute. Finally, compliance with regulatory rules does not necessarily constitute satisfaction of the parties’ legal obligations under common law.

The next round will take place early this year because the Supreme Court has given the banks involved permission to appeal. These cases have wide-ranging implications not only for the motor finance industry but also for some other intermediated business models where legal obligations and requirements may not align with the regulator’s rules. The next move will be carefully watched.