Scope of DFSA regulatory jurisdiction substance over form for financial services providers
On 3 March 2016, the DIFC Court of Appeal dismissed appeals by Bank Sarasin and Sarasin-Alpen against the DIFC Court of First Instance's liability judgment (dated 21 August 2014). Among other things, the Court of Appeal upheld the original decision that Bank Sarasin (Swiss based) had operated its business in such a way that it fell within the ambit of the DFSA's regulatory jurisdiction. This is a significant judgment as it reiterates the importance of financial service providers, both in and outside the DIFC, analysing the substance of their business models in relation to the DIFC to avoid breaching the regulatory framework.
We have reported previously on the landmark decision of the DIFC courts on mis-selling in the case of Al Khorafi & ors v Bank Sarasin-Alpen (ME) Ltd and Bank Sarasin & Co Ltd, in which financial services providers in the DIFC and in Switzerland were held liable to investors for breaches of the Dubai Financial Services Authority (DFSA) regulatory framework.1 The first instance decision "had caused shock waves in the European and Middle Eastern financial services markets because the expectation had been that a company authorised to deal in investments outside the DIFC would not be subject to the DIFC Regulatory Law if it sold investments outside the DIFC to clients who had been introduced by a firm carrying on financial service business within the DIFC"2. As a result of the breaches the investors were awarded, on the basis of the Defendants' conduct of deliberately avoiding compliance with the regulatory regime, punitive damages under the DIFC Law of Remedies and Damages (in a separate quantum judgment)3.
The Court of Appeal judgment
The Court of Appeal judgment upheld the findings of the DIFC Court of First Instance that:
- Sarasin-Alpen had mis-sold structured financial products because it had failed to carry out sufficient investigations to satisfy itself that the investors met the necessary client classification criteria for acceptance as a client under the DFSA Conduct of Business Rules;4 and
- Bank Sarasin had, by its own conduct and through the conduct of employees of Sarasin-Alpen, carried out financial services in or from the DIFC without DFSA
authorisation and, therefore, was in breach of the DIFC Regulatory Law. The fact that the relevant employees were employees of Sarasin-Alpen and not Bank Sarasin "was not fatal"
- "it was the substance, not the form, of what was happening that mattered".5
The appeal judgment reconsidered whether Bank Sarasin had breached the Financial Service Prohibition under the DIFC Regulatory Law by carrying out certain financial service activities "in or from" the DIFC without being authorised by the DFSA (ie dealing in investments as principal; arranging credit and/or deals in investments; advising on financial products or credit; and arranging custody). Whilst Bank Sarasin succeeded in overturning the DIFC Court of First Instance finding that it arranged credit and deals in investments in the DIFC, it lost on all other counts.
Bank Sarasin advanced various arguments in the appeal to try to distinguish its activities in Switzerland from the activities of Sarasin-Alpen in the DIFC, which were all rejected. The DIFC Court of Appeal focused on the substance and not the form of how Bank Sarasin and Sarasin-Alpen operated
their businesses and held that it was open to the DIFC Court of First Instance to conclude, as it did, that the "way in which Bank Sarasin carried out its banker/client relationship with the Respondents was through personnel employed by Sarasin-Alpen in the DIFC and that the acts of those individuals in discharging this function were attributable to Bank Sarasin".6
The appeal judgment confirms the importance of DFSA-regulated entities reviewing the structure of their business models in relation to the DIFC and how those business models actually operate in practice. In particular, regulated entities in the DIFC that rely on affiliates not registered in the DIFC to provide regulated services to their clients should ensure that such services are in fact not provided by such affiliates in or from the DIFC. Failure to maintain a clear structural distinction between the entities and their activities could have serious implications. Equally, it is important to have in place robust compliance processes that are truly able to comply with the form, substance and intent of the DFSA's client classification and conduct of business rules.
2 Court of Appeal judgment, paragraph 332.
4 Court of Appeal judgment, paragraph 236.
5 Court of Appeal judgment, paragraph 331.
6 Court of Appeal judgment, paragraph 323.