Claims Management Companies are now subject to FCA regulation -18/7
3rd September 2018
On 1st April 2019, the FCA will take over from the Ministry of Justice and become the regulator for Claims Management Companies (CMCs) that are established or serving customers. This change will affect all CMCs operating within England, Wales, and Scotland. The Financial Ombudsman Service (FOS) will also become responsible for resolving disputes regarding CMCs. In preparation of these changes, the FCA have drafted a consultation paper to outline how they propose to regulate CMCs when they inherit responsibility, and to offer a brief summary on the main changes being proposed. The official consultation period ended in early-August, and a finalised policy statement will be issued in Quarter four of this year.
What are the problems with the current system of regulation?
The FCA have currently identified the following harms in the sector which they seek to address, namely:
- Customers may experience financial loss due to lack of clarity about how much they will pay and the services they will receive
- Poor service (e.g. poor communication on claim status)
- Customers may pay higher prices in other markets due to spurious or fraudulent claims
- Customers may buy inappropriate services, and nuisance can be caused to wider society by poor conduct through aggressive or misleading marketing or sales tactics (e.g. unsolicited calls and texts)
- Customers may buy inappropriate services due to unauthorised activity
- Customers may suffer financial loss or delays to their claim as a result of disorderly wind down
How will the FCA address this?
To address the above, the FCA are seeking to implement the following key changes:
Short Summary Document
Before a CMC agrees a contract with a customer, there are certain pre-sales disclosures which need to be made in the form of a short summary document containing key facts and information. Amongst other things, this will include an illustration or estimate of the fees charged, an overview of the services that the CMC will provide, and the tasks the customer will need to conduct themselves. If there exists a statutory ombudsman scheme or statutory compensation scheme in relation to the claim, the document must also contain a statement confirming that the customer is not required to make use of the CMC, as they will be permitted to present the claim for free by themselves.
Finally, where CMCs have ongoing relationships with their clients, regular updates must be provided with information about the status of their claim.
Openness of fees
Customers of CMCs are often unaware that they would need to pay fees to the CMC handling their claim. This has been addressed by requiring CMCs who advertise their service as being ‘no-win, no-fee’ to include information about the fees they charge or how they will be calculated in a prominent manner.
CMCs are to record all calls with customers and keep recordings for a minimum of 12 months. A record should also be kept of all electronic communications (e.g. e-mails and text messages). The FCA has introduced this measure due to the fact that a large proportion of CMCs conduct business by telephone, which is where much harm – such as poor service or misleading or aggressive marketing – occurs.
CMCs that are not solely lead generators should hold sufficient capital resources to withstand unexpected shocks to their finances, in order to reduce the risk of harm on customers and markets who rely on their services. Therefore, applicable CMCs will need to meet prudential requirements related to the area of business they undertake, their total income, their expenditure, and if they hold client money.
Client money must be segregated from the firm’s own money. In addition, an accurate and updated record must be maintained that identifies the money they hold on behalf of each client.
CMCs that buy leads (a list of people with possible claims) from third parties must do so having conducted sufficient due diligence. This is to ensure the lead generator is authorised and has appropriate measures in place to ensure compliance with relevant data protection, privacy and electronic communications legislation. CMCs must keep a record of this process.
Compliance with the FCA Supervision Manual
The FCA are currently consulting over amendments to their Supervision Manual so that it will also apply to CMCs, but this is forthcoming.
Scope of FCA Regulation
When the FCA begin regulation, they will do so by regulating six activities across six claims sectors. These activities involve how CMCs seek out persons who may have a claim; referring details of a claim, potential claim or of a potential claimant to another person; identifying a potential claim or potential claimant; investigating or commissioning the investigation of the circumstances, merits or foundation of a claim with a view to using the results in pursuing the claim; and representation in writing or orally, regardless of the tribunal, body or person before which or to whom the representation is made. The scope of the FCA’s regulation will now apply to Scotland as well, but claims management conduct by legal practitioners (SRA regulated law firms) is excluded from these changes.
Included in the scope of the legislation is a fee cap, meaning that CMCs will only be able to charge 20% (excluding VAT) of the amount recovered for the customer. This cap will come into effect from July 2018 and will be enforced by the CMR until responsibility for regulation is fully transferred to the FCA.
Cold calling in relation to claims management services has also been prohibited under the legislation, except where the customer has consented to such calls. This will be enforced by the Information Commissioners Office.
In an effort to improve standards across CMCs, the FCA are also proposing that they adhere to Principles for Business (PRIN), which are fundamental obligations that firms must comply with at all times. Firms will also be required to meet the Threshold Conditions (COND) in order to become authorised, after which they would need to continue to satisfy those requirements should they want to retain their FCA Authorisation.
Moreover, Senior Management Arrangements, Systems and Controls (SYSC) must also be followed, which sets out how the FCA expect senior management in firms to take responsibility for the running and oversight of the firm, as well as the systems, controls and compliance arrangements that should be in place.
The FCA will be publishing a separate consultation paper that will set out how they plan to apply the Senior Managers or Certification Regime to CMCs in autumn 2018.
A new Handbook Sourcebook will be created called ‘Claims Management: Conduct of Business sourcebook’ (CMCOB). This will seek to raise standards across CMCs and tackle harms such as lack of clarity some CMCs provide in respect to their services.
Amongst other things, CMCs will need to comply with: the client’s best interest rule; the general conduct of business rules; a mandatory provision of a cooling off period the undertaking of sufficient due diligence on lead generators; standards for customer contact. The client’s best interest rule would be found in COBS 2.1.1.
Prudential Standards & Wind-down procedures
One of the FCA’s main aims is to ensure market integrity and protect consumers from potential harm. In achieving this, the FCA has proposed to apply prudential standards and wind down requirements to all FCA regulated CMCs which they must follow should they plan to cease carrying on claims management activities, or if they are going out of business.
Supervision of CMCs will be done by the FCA on a proportional basis, and one of its main tasks is to classify CMCs into two groups depending on the probability that harm can be caused to the market and its customers. The FCA proposes to base the classification on the companies’ reported annual turnover as stated on their Accounting Reference Date (“ARD”), this will be as follows:
- Class 1 CMC – CMCs with an annual total income of £1million or above;
- Class 2 CMC – CMCs with an annual total income below £1million
- all CMCs, including sole lead generators will need to have sufficient financial resources to meet their liabilities as they fall due
- CMCs will have an initial capital requirement, which is the higher of: – £10,000 for Class 1 CMCs and £5,000 for Class 2 CMCs
- CMCs holding client money will have an increased capital requirement, increasing their capital requirement by £20,000
- CMCs will be required keep their existing professional indemnity insurance (PII)
- CMCs will be required to carry out specific wind-down procedures if they decide not to carry on claims management activity, or are going out of business (whether voluntarily or involuntarily)
For CMCs that haven’t started trading and are seeking authorisation, their prudential requirement would be:
- The fixed minimum amount of either £10,000 (for Class 1 CMCs) or £5,000 (for Class 2 CMCs) based on their projected total income for the next year, or
- The fixed overheads requirements calculated as the projected total expenditure for the first 12 months of trading
Moreover, one of the general requirements proposed to be applied to FCA regulated CMCs, is to have Professional Indemnity Insurance (PII), currently only CMCs that represent customers in personal injury claims are obliged to have it, however the FCA does propose to extend this requirement to all CMCs.
The minimum level of indemnity must be £250,000 for each and every claim, and at least £500,000 for all claims dealt with during the period of insurance. CMCs are not permitted to pay more than £10,000 per claim on the policy, and should provide cover for legal defence costs, and should be underwritten on a claims made and reported basis.
The abovementioned requirements are all about safe existence of CMCs, however the FCA are concerned about potential harm caused to consumers as a result of CMCs deciding to cease carrying on claims management activities. CMCs must therefore:
- Notify their customers if they are to cease carrying on claims management activity or if they are going out of business
- Explain to steps their customers can take, including whether the customer may be able to make the claim themselves for free, either to the respondent, statutory compensation scheme or an alternative dispute resolution scheme that the CMC is aware its customer uses
CMCs will need to provide their customer with all information and documents relating to them within 40 working days of it being determined that the firm is to cease carrying on claims management activity. All third parties must also be informed and, must also be made aware of who act for the customers in place of the firm going forward.
In addition to prudential requirement, the FCA proposes to subject firms who hold client money to the CASS provisions. Those rules are:
- CMCs must pay out client money to clients as soon as reasonably practical
- CMCs must appoint a person responsible for client money oversight
- requirement for CMCs to hold all client money in one or more client bank accounts and in accordance with the statutory trust requirements set out in CASS 7.13
- requirement for CMCs must maintain accurate records and accounts
- requirement for CMCs have an annual CASS audit, carried out by an external auditor
Due to the heightened risk that this type of activity may pose to the market and its customers, CMCs who hold client money will see their capital requirement increase £20,000.
Once the FCA becomes the new regulator for CMCs, the Financial Ombudsman Service will become responsible for resolving disputes about CMCs. For this reason, CMCs will also be subject to the FCA’s Dispute resolution: Complaints’ Sourcebook (DISP).
As a result,
- CMCs carrying on business in Great Britain will be subject to the compulsory jurisdiction of the Ombudsman Service
- CMCs not subject to Compulsory Jurisdiction may have access to Voluntary Jurisdiction which will ensure that a greater range of CMC customers can make complaints to the FOS.
Being authorised and regulated by the FCA includes being subject to extensive supervision, therefore there are severe consequences for those CMCs and individuals who do not follow the FCA’s rules and cause actual or potential harm to its customers, and affect the integrity of the market. For this purpose, the FCA also proposes to apply the same approach to CMCs when carrying out enforcement investigations, creating decision-making processes and imposing sanctions as they do with all other regulated firms.
This gives FCA the power to:
- require firms and individuals to give information and documents
- get a search warrant to search and seize documents
- require individuals to give information in an interview
- censure firms and individuals through public statements
- impose financial penalties
- apply to the Court for an injunction to stop certain conduct or to freeze assets
- seek an order requiring redress or restitution where the misconduct has caused harm to customers
- prosecute firms and individuals who carry out regulated activities without authorisation
- withdraw a firm’s authorisation, preventing it from operating in financial services
Supervision and reporting
Taking into account that the FCA will become the regulator of CMCs, there are certain rules that the FCA has proposed to help supervise CMCs. They will be required to report key information, events and changes to the FCA, which in turn will enable the FCA to analyse data and have good communications with regulated firms.
The FCA proposes the following:
- to apply the relevant sections of FCA Supervision manual (SUP) to CMCs: SUP 1A, SUP 2, SUP 3, SUP 5, SUP 6, SUP 7, SUP 8, SUP 9, SUP 11, SUP 15, SUP 16
- to require CMCs to notify FCA of significant changes in their business, such as, change in control of firms, significant breach of a rule or requirements in or under the Act, any civil, criminal or disciplinary proceedings brought against firm, etc.
- when carrying out due diligence on lead generators, requiring CMCs to notify FCA if they become aware of other firms carrying on claims management activity without authorisation
- to require CMCs to report important data about their business to FCA annually.
The FCA has also proposed to apply additional reporting obligations to CMCs, mainly on the annual basis and in electronic form.
Steps towards authorisation
Once a finalised policy statement has been issued, all CMCs will need to apply for re-authorisation. There will be two application periods, and each CMC type (personal injury, financial services and products, housing disrepair, specified benefits, criminal injuries, employment) will be allocated to one of these application periods. CMCs must submit their application for authorisation during that period, otherwise will have to cease carrying out regulated activities altogether.
The first application period (1 April 2019 until the end of May 2019) will apply to all CMCs involved with financial services. The second application period (1 June 2019 until the end of July 2019) will apply to all other CMCs (e.g. personal injury firms).
Subject to the Treasury’s consultation and parliamentary approval, all CMCs that are currently regulated by the current Claims Management Regulator (CMR), and those who will be regulated for the first time, will be entitled to register for temporary permission, under the temporary permission regime. (Although this is not officially approved yet, the regime allows relevant EEA firms and funds which passport into the UK to continue operating in the UK for a limited period if the current passporting regime falls away abruptly when the UK leaves the EU.) However this would not be applicable to new CMCs setting up after 1 April 2019.
How can CPA Audit help?
CPA Audit are ready and able to assist firms in applying for authorisation from the FCA. Should this be of interest to you, contact us to discuss your firm’s needs.
© CPA Audit LLP 2020.