Financial services and regulation - Distinction between regu...

Learning Outcomes

This article outlines the distinction between regulated and unregulated activities under the Financial Services and Markets Act 2000 (FSMA), the scope of the general prohibition and how the Regulated Activities Order (RAO) determines specified activities and investments, and key exclusions including introducing, execution-only, acting as trustee/personal representative, and the takeover exclusion. It details the conditions of the designated professional body (DPB) exemption in s.327 FSMA as policed by the SRA Financial Services (Scope) Rules and Conduct of Business Rules, including incidental tests and records requirements, and identifies when insurance distribution or credit-related work is permitted. It also discusses financial promotions risks and the main professional and legal consequences of carrying on regulated activity without authorisation or a valid exemption.

SQE1 Syllabus

For SQE1, you are required to understand the regulatory perimeter under the Financial Services and Markets Act 2000 (FSMA) distinguishing regulated and unregulated activities, with a focus on the following syllabus points:

• the scope and meaning of regulated activities under the Financial Services and Markets Act 2000 (FSMA)
• the general prohibition on unauthorised regulated activities
• the main exclusions and exemptions for professional firms (including the SRA Scope Rules)
• the consequences of carrying out regulated activities without authorisation
• identifying when FCA authorisation is required and when an activity is unregulated

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the general prohibition under the Financial Services and Markets Act 2000?
2. Give an example of a regulated activity and an unregulated activity relevant to solicitors.
3. What is the main exemption that allows solicitors to carry out certain regulated activities without FCA authorisation?
4. What are the risks of carrying out a regulated activity without authorisation or exemption?

Introduction

Understanding the difference between regulated and unregulated activities is essential for any solicitor involved in financial services work. The Financial Services and Markets Act 2000 (FSMA) sets out a strict regime: certain activities are regulated and require authorisation from the Financial Conduct Authority (FCA), while others are unregulated and can be carried out freely. For the SQE1 exam, you must be able to identify which activities fall into each category, know the main exclusions for professional firms, and recognise the consequences of breaching the rules.

It is helpful to distinguish FSMA-regulated activities from reserved legal activities under the Legal Services Act 2007. Reserved legal activities (for example, conducting litigation or reserved instrument activities) relate to legal services regulation and authorisation by approved regulators such as the SRA. FSMA regulates specified investment activities in relation to specified investments. A solicitor may be fully authorised to carry on reserved legal activities but still be prohibited by FSMA from undertaking regulated investment work unless the solicitor is FCA-authorised or can rely on a valid exclusion or exemption.

Regulated Activities and the General Prohibition

The FSMA creates a clear boundary: only authorised or exempt persons may carry on regulated activities in the UK. This is known as the general prohibition.

Key Term: general prohibition
The rule in s.19 FSMA that no person may carry on a regulated activity in the UK unless they are authorised by the FCA or exempt.

A regulated activity is defined as a specified activity relating to a specified investment, carried on by way of business. The details are set out in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO).

Key Term: regulated activity
An activity of a specified kind (e.g., advising, arranging, dealing as agent, managing, safeguarding), relating to a specified investment, carried on by way of business, and subject to FCA regulation.

Carrying on a regulated activity without authorisation or exemption is a criminal offence and can result in prosecution. Agreements made in breach may be unenforceable, with courts able to order restitution. Professional disciplinary action may also follow.

Specified Activities and Investments

The RAO lists the activities and investments that are regulated. Common examples relevant to solicitors include:

• dealing in investments (buying or selling shares or bonds) as agent
• arranging deals in investments (e.g., introducing terms or bringing about transactions)
• managing investments (exercising discretion over a client’s portfolio)
• safeguarding and administering investments
• advising on investments (merits of buying/selling specific investments)
• insurance distribution activities (e.g., arranging defective title insurance)
• certain consumer credit-related activities (e.g., credit broking, debt collecting, debt advice) where these fall within s.22 FSMA and the RAO

Key Term: specified investment
A financial product or asset listed in the RAO, such as shares, debentures, government securities (gilts), units in collective investment schemes (unit trusts/OEICs), insurance contracts, regulated mortgages, home reversion/home purchase plans, pension schemes, and deposits.

Land and most general business advice are not specified investments, so activities relating solely to land or general legal advice are not regulated under FSMA. However, note that certain home finance arrangements (for example, regulated mortgages, home reversion and home purchase plans) are specified investments, even though they involve property.

The "By Way of Business" Test

For an activity to be regulated, it must be carried on by way of business. This requires a commercial context: a sufficient degree of continuity/regularity and expectation of remuneration. One-off personal acts or incidental, non-commercial acts may fall outside this test, but if a firm habitually undertakes the activity for reward, the business test is likely satisfied.

Unregulated Activities

Unregulated activities are those that do not meet all the criteria above. Examples include:

• giving general legal advice on business structure or contracts
• advising on land transactions (unless also advising on investment products)
• providing tax or accounting advice (unless it involves recommending specific investments)
• negotiating and drafting transaction documents where no RAO-specified activity in relation to a RAO-specified investment is undertaken

Solicitors can carry out unregulated activities without FCA authorisation, but must be careful not to stray into regulated territory. For example, due diligence on a share purchase is not itself a regulated activity; however, advising the client whether to buy the shares is “advising on investments” and is regulated.

Exclusions and Exemptions

There are important exclusions and exemptions that allow professional firms to carry out some regulated activities without FCA authorisation.

Exclusions

Exclusions remove certain activities from the scope of regulation, even if they would otherwise be regulated. Key exclusions for solicitors include:

• introducing a client to an authorised person (e.g., a stockbroker), provided the solicitor has no further involvement and does not advise on the merits
• acting as a trustee or personal representative (PR) in relation to investments, provided no separate remuneration is received for the investment-related activity
• execution-only exclusion: the solicitor only transmits client instructions to buy/sell a specified investment without giving advice on merits (this does not apply to many insurance products)
• professional/necessary exclusion: activities which are a necessary part of providing legal services, and not separately remunerated (must be incidental to the legal service)
• takeover exclusion: advising/arranging in relation to an acquisition or disposal of shares in a body corporate where control passes (generally 50%+ voting shares) or day-to-day control is acquired; this does not apply to insurance contracts

Key Term: exclusion
A rule that removes an activity from being regulated, even if it would otherwise fall within the definition.

A few points on common exclusions:

• Introducing: there must be no advice on merits and no undisclosed reward from a third party. The solicitor should decline to advise and suggest the client seeks advice from an authorised person.
• Execution-only: the solicitor must ensure the client is not relying on the solicitor’s advice; for retail investment products (including many life/insurance-based investments), this exclusion is not available.
• Trustee/PR: investment functions undertaken as part of trust or estate administration may be excluded if not separately remunerated; separate fees for investment selection or management risk removing the exclusion.
• Professional/necessary: the investment-related action must be genuinely necessary to the legal work (e.g., completing settlement mechanics), not a separate remunerated service of investment advice.
• Takeover: the exclusion applies to specified transactions where control is acquired or day-to-day control reasonably appears to be the transaction’s object.

Key Term: takeover exclusion
An exclusion allowing investment advice/arranging in corporate takeover scenarios where 50%+ control (or day-to-day control) of a body corporate is acquired or disposed, excluding insurance-related work.

Key Term: execution-only client
A client who instructs the firm to execute a transaction without seeking or relying on advice on the merits.

The Professional Firms Exemption (s.327 FSMA)

The main exemption for solicitors is the "designated professional body" (DPB) exemption under s.327 FSMA. This allows solicitors to carry out certain regulated activities without FCA authorisation if:

• the activity is incidental to the firm's professional services (both specifically incidental to the matter and generally incidental to the firm’s business)
• the firm does not receive any pecuniary or other advantage from a third party unless it is accounted for to the client
• the activity is permitted by the SRA Financial Services (Scope) Rules
• the activity is not prohibited by Treasury order or FCA direction
• the firm does not carry on other regulated activities that require FCA authorisation (firms authorised by the FCA cannot use s.327 for other activities)

Key Term: exemption
A rule that allows a person or firm to carry on a regulated activity without FCA authorisation, provided certain conditions are met.

Key Term: designated professional body (DPB)
A professional regulator designated under FSMA, such as the SRA, that supervises exempt regulated activities carried out by its members under s.327 FSMA.

The exemption is policed by the SRA, which has its own rules governing how exempt regulated activities are carried out.

Incidental tests

There are two “incidental” tests under the SRA Scope Rules:

• Specific incidental: the regulated activity must arise out of, or be ancillary to, the provision of a particular legal service to the same client. The legal service must be the primary service, with the regulated activity subordinate.
• General incidental: regulated activities must not be a major part of the firm’s activities (for example, investment income should not comprise half or more of total income). The firm should not hold itself out as providing standalone investment services.

Permitted activities and prohibitions

The Scope Rules set out the activities that firms can carry out under the professional exemption and identify prohibitions (including activities listed in the FSMA (Professions) (Non-Exempt Activities) Order 2001). Examples include:

• prohibited: recommending that a client disposes of rights under a personal pension scheme; advising a client to become a member of a particular Lloyd’s syndicate; creating or underwriting contracts of insurance
• insurance distribution activities: firms must notify the SRA, be registered on the Financial Services Register via the SRA for insurance distribution, and appoint an Insurance Distribution Officer (IDO)
• credit-related activities: only limited, permitted credit-related regulated activities may be carried out (e.g., certain credit agreements in relation to the firm’s fees)

Key Term: insurance distribution activities
Regulated activities connected to insurance (e.g., advising on, proposing, or arranging insurance), subject to additional registration and conduct requirements under SRA rules when undertaken under the s.327 exemption.

SRA Financial Services (Conduct of Business) Rules (COB)

When undertaking exempt regulated activities, firms must comply with the COB Rules, including:

• status disclosure: confirm the firm is not FCA authorised and explain redress mechanisms (clear, fair and not misleading)
• best execution: act in the client’s best interests when executing transactions
• record-keeping: keep records of client instructions and instructions to third parties to carry out transactions
• commissions: keep records of commissions received and how they were dealt with; account to the client unless agreed otherwise
• execution-only clients: for retail investment products, send a letter confirming the client is not relying on the firm’s advice and retain a copy
• insurance distribution: provide fair and clear information, including the nature of remuneration, before concluding the insurance; comply with IDO oversight

Key Term: financial promotion
An invitation or inducement to engage in investment activity; under s.21 FSMA unauthorised persons must not communicate financial promotions unless an exemption applies or the communication is approved by an authorised person.

Financial promotions: professional firms relying on s.327 may use certain exemptions under the Financial Promotion Order (FPO) 2005, including:

• real-time promotions to current clients where the controlled activity is exempt or excluded by the necessary exclusion (art 55)
• non-real-time promotions that include specified statements (art 55A)
• one-off, personal communications (arts 28/28A)
• introducers’ communications (art 15), subject to conditions (no connection to the authorised person, no undisclosed reward, and the client is not relying on the solicitor’s merits advice)

Worked Example 1.1

A solicitor is acting for a client in the sale of a business. The client asks the solicitor to arrange insurance for the transaction. The solicitor arranges the insurance and receives a commission from the insurer, which is not disclosed to the client.

Answer:
The solicitor may rely on the professional firms exemption to arrange the insurance, but must account to the client for any commission received (or obtain the client’s informed agreement to retain it). Failing to do so breaches both the exemption and SRA rules.

Worked Example 1.2

A law firm provides advice to a client on buying shares in a private company and recommends a specific investment. The firm is not FCA authorised and does not rely on any exemption.

Answer:
Advising on investments is a regulated activity. Without FCA authorisation or a valid exclusion or exemption, the firm is breaching the general prohibition and may be committing a criminal offence. The agreement could be unenforceable and the SRA may take disciplinary action.

Worked Example 1.3

In a share sale, the buyer will acquire 75% of the voting shares of Merron Ltd. The solicitor advises on the transaction structure and drafts the sale agreement. The firm is not FCA authorised.

Answer:
The takeover exclusion applies where 50%+ control passes, or where day-to-day control is acquired. Advising/arranging in relation to that transaction can be excluded from regulation (other than insurance). The firm may proceed without FCA authorisation, ensuring no insurance distribution is undertaken without meeting s.327 conditions.

Worked Example 1.4

A client instructs a solicitor to purchase units in a unit trust and confirms they do not want advice. The solicitor transmits the instruction to an authorised platform provider. No merits advice is given.

Answer:
This can fall within the execution-only exclusion, provided the firm does not give advice and the client is not relying on the firm’s judgment. For retail investment products, the COB Rules require an execution-only letter confirming the client is not relying on the firm’s advice and the firm must retain a copy.

Worked Example 1.5

A solicitor introduces a client to a stockbroker. The broker pays the solicitor £500 for the introduction, which is not disclosed or passed on to the client.

Answer:
Under the s.327 exemption and SRA rules, any third-party advantage must be accounted to the client unless agreed otherwise. The solicitor must disclose and account for the payment (or obtain the client’s informed agreement to retain it). Failure to do so may breach the exemption and professional conduct rules.

Worked Example 1.6

A solicitor emails a brochure recommending investment in specific shares to a client and invites them to proceed. The firm is not FCA authorised.

Answer:
This is likely a financial promotion under s.21 FSMA. Unless an exemption applies or the promotion is approved by an authorised person, the communication is prohibited. Professional firms rely on limited FPO exemptions; the firm should either use a valid exemption (e.g., one-off personalised communication meeting conditions) or have the promotion approved by an authorised person.

Consequences of Breaching the Rules

Carrying on a regulated activity without authorisation or exemption is a criminal offence. The FCA can prosecute, and any contracts made in breach may be unenforceable, subject to court discretion and possible restitution. Civil liability may arise, and the SRA may take disciplinary action (rebuke, fine within jurisdiction, practising restrictions, or referral to the Solicitors Disciplinary Tribunal). Undertaking financial promotions without approval or exemption may also breach s.21 FSMA and attract criminal and regulatory sanctions.

Exam Warning

Carrying on a regulated activity without authorisation or exemption is a strict regime. It is not a defence to say you did not know authorisation was required. Always check whether an activity is regulated and whether an exclusion or exemption applies. Be alert to financial promotions risks.

Summary Table: Regulated vs Unregulated Activities

Key Point Checklist

This article has covered the following key knowledge points:

• The FSMA creates a general prohibition: only authorised or exempt persons may carry on regulated activities.
• Regulated activities are defined by specified activities, specified investments, and the "by way of business" test.
• Exclusions (introducing, trustee/PR, execution-only, professional/necessary, takeover) and exemptions allow some activities to be carried out without FCA authorisation.
• The professional firms exemption (s.327 FSMA) is the main exemption for solicitors, but strict conditions apply (incidental tests, accounting for rewards, permitted activities, prohibitions).
• SRA Financial Services (Conduct of Business) Rules apply when undertaking exempt regulated activities (status disclosure, best execution, record-keeping, commissions, execution-only letters, insurance distribution).
• Financial promotions are restricted under s.21 FSMA; professional firms must rely on FPO exemptions or obtain approval from an authorised person.
• Carrying on a regulated activity without authorisation or exemption is a criminal offence and may result in unenforceable contracts, restitution orders, and disciplinary action.

Key Terms and Concepts

• general prohibition
• regulated activity
• specified investment
• exclusion
• exemption
• designated professional body (DPB)
• insurance distribution activities
• execution-only client
• financial promotion
• takeover exclusion