Law Firms

Boiler rooms are illegal offices which seek out consumers through unsolicited phone calls or circulars, promoting and selling overpriced, non-existent or non-tradeable shares. The boiler rooms then often vanish, leaving investors reeling from financial losses and owning shares which have little or no value to them. Boiler rooms are mainly based overseas, therefore the Financial Services Authority (FSA) has generally not been able to shut them down directly.

The regulator has instead sought to target companies based in the UK which are thought to have assisted such boiler rooms. Early this year, the FSA froze the assets of Chesteroak and Bingen Investments and subsequently shut them down in September for assisting boiler room activities in the UK. Furthermore, last month the FSA ordered the arrest of two men who worked for Universal Management Services, believed by the FSA to have been helping illegal overseas boiler rooms. This was the FSA’s first criminal investigation into this area.

More worryingly for lawyers, the FSA has not hesitated in pursuing law firms that are also suspected of being involved in such practices. By using firms to ‘approve’ their financial promotions and, in some circumstances, collecting investors’ money through the law firms’ client account, illegal overseas offices have attempted to shroud their activities in a cloak of legitimacy.

Leeds law firm Fox Hayes was initially fined £150,000 last year by the FSA for its dealings with boiler rooms. Fox Hayes had approved financial promotions by unauthorised overseas companies which were then sent to private UK investors. These promotions offered free research reports — also approved by Fox Hayes — into a company in which the investors already had shares. Investors would then be contacted by consent by the overseas companies directly and offered OTC Bulletin Board shares. Once purchased, payment for the shares was sent by investors, as instructed, to Fox Hayes to be placed in an escrow account, which was in fact part of the firm’s client account.

The firm also forwarded the share certificates to the investors. Fox Hayes was aware that these OTC Bulletin Board shares were subject to certain restrictions with regard to onward sale or transfer by investors. Investors subsequently complained about high pressure sales tactics employed by the overseas companies, and in the long term, almost all of the shares sold by these companies lost most of their value.

The FSA argued that:

1. Fox Hayes had not taken reasonable steps to ensure the promotions were clear, fair and not misleading (Conduct of Business Rules (COB): 3.8.4R1);

2. Fox Hayes had reason to doubt that these companies would deal with the investors in an honest and reliable way (COB 3.12.6R(2)).

3. The firm had not carried out the confirmation exercises properly (COB 3.61R1/R2)

4. It had not conducted its business with due skill, care and diligence (principle two of Principles for Businesses).

In September 2007, the Financial Services and Markets Tribunal disagreed with the FSA’s arguments in respect of (1), (3) and (4) above, and reduced the fine to £70,000. However, the Tribunal upheld in part the FSA’s criticism that the firm did have reason to doubt that these companies would deal with the investors in an honest and reliable way, once Fox Hayes had received queries from journalists as to the companies’ credentials and complaints from investors with regard to pressurised sales tactics. In addition to the financial penalty, such a finding is likely to cause damage to the firm’s reputation.

The FSA has brought actions against other law firms, including partners John Martin and Adrian Sam of law firm Adrian Sam & Co, which assisted a boiler room in Spain. Both partners were made bankrupt in August 2006 after a Court of Appeal ruling in November 2005 that Martin and ASC must pay £360,000 to 63 investors who were victims of the scam.

Overseas boiler rooms look to law firms to provide a cover of legitimacy, particularly if the law firm allows payment into their client accounts by the investors for the shares they are purchasing. This lulls investors into a false sense of security that their money is being guarded by up-standing UK law firms.

In consequence, law firms looking to operate in this area should:

- be wary of financial promotions companies which use high pressure sales tactics and which are keen to use the law firms’ client accounts to receive the share purchase monies;

- be wary of companies that are unauthorised in the UK, and must undertake full due diligence on the companies themselves and, if relevant, the introducer of the companies;

- keep a full paper trail of their confirmation checks in accordance with COB and be open and transparent in their dealings with such companies;

- follow up on references and be comfortable with the results of their checks; and

- monitor FSA press releases and ‘blacklists’ of overseas companies.

If firms are in any doubt, they should contact the FSA for clarification.

Charles Hewetson is a partner and Rebecca Duncan an associate in the commercial litigation and disputes team at Reed Smith Richards Butler.

Latest Jobs

• Private Equity C. £200,000 - Immediate Partnership
• Funds PSL (Full or Part time)
• Company Secretary - Vodafone
• *** CORPORATE LAWYER-MANAGE INDIAN DESK ***
• GLOBAL TECHNOLOGY COMPANY – ASSISTANT GENERAL COUNSEL EMEA - LONDON
• *** TOP UK FIRM seeks CONTRACT EMPLOYMENT LAWYER ***