High Court quashed ex parte inspector appointment under MiFID Regulations as disproportionate infringement of constitutional fair procedure rights.

Neutral Citation Number: [2011] IEHC 298

THE HIGH COURT

2011 219 MCA

IN THE MATTER OF CUSTOM HOUSE CAPITAL LTD.

AND IN THE MATTER OF AN APPLICATION UNDER

REGULATION 166 OF THE EUROPEAN COMMUNITIES

(MARKETS IN FINANCIAL INSTRUMENTS) REGULATIONS 2007

AND IN THE MATTER OF AN APPLICATION

BY THE CENTRAL BANK OF IRELAND

JUDGMENT of Mr. Justice Hogan delivered on the 18th July, 2011

1. In the late evening of 15th July, 2011, on the ex parte application of the Central Bank of Ireland, I made an order pursuant to

Article 166(1) of the European Communities (Market in Financial Instruments) Regulations 2007 (S.I. No. 60 of 2007) (“the MiFID

Regulations”) providing for the appointment of two inspectors, George Treacy and Noel Thompson, to Custom House Capital Ltd.

(“Custom House”). Mr. Treacy is the head of the Investments Service Providers Supervision division of the Central Bank and Mr.

Thompson is an authorised officer within that division. Since this was the first occasion an application of this kind has been by the

Central Bank, it seems appropriate that the reasons for my decision be set out briefly in writing.

The background to the application

2. Custom House is an investment fund management firm which was incorporated in 1997 with its registered office in Merrion Square,

Dublin 2. In March, 2011 the firm reported to the Central Bank that it had approximately assets in value to some €1.15bn. under

management on behalf of its clients and that it held approximately €24m. in cash in designated client accounts.

3. Between 2009-2010 there were extensive contacts between the Central Bank and Custom House following the receipt of

information from an individual to the effect that some clients’ monies were being invested without their knowledge or consent in an

investment framework described as the Mezzanine Bond Fund. According to Custom House’s own promotional literature, it appears

that the fund had been created in order to enable it (i.e., Custom House) to assist in the short term financing of properties in the

European market.

4. Along with members of the prominent accountancy firm, KPMG, Mr. Thompson was then appointed as an authorised officer to

investigate a sample of property transactions which included such mezzanine financing. Further directions were then given under the

MiFID Regulations. These included a requirement that Custom House clarify the financial position of each syndicated special purpose

vehicle for individual properties by reference to identifying current valuations compared with the valuation at the time of purchase

along with any shortfalls in equity being raised and that the level of regulatory capital be raised to €5m. to cover potential liabilities

arising from the Mezzanine Bond.

5. Further directions issued in April 2010 and these directions were (with one minor exception) renewed in April 2011. These directions

included a direction not to pay any dividends to shareholders or to provide any loan to a director. Significant restrictions on the right

of the firm to advertise for or solicit new business were also imposed.

6. In February, 2011 the Central Bank wrote to Custom House and Mr. Harry Cassidy (the chief executive officer) alleging breaches of

regulatory requirements relating to the sale of the mezzanine bond to clients and an administrative sanctions procedure under Part

IIIC of the Central Bank Act 1942 (as amended) was initiated. Responses were supplied by Custom House in April, 2011.

7. So far as the mezzanine bond is concerned, the evidence to date suggests that over €10m. is owed to investors. The regulatory

capital requirement of €5m. which the Central Bank imposed has been varied to take account of the fact that Custom House now has

to deduct any contingent liability arising on the mezzanine bond when calculating its regulatory capital. A further complication is that

the Central Bank maintains that inconsistent views have been expressed by Custom House as to whether the mezzanine investors

rank pari passu with ordinary equity investors in the special purpose vehicle or whether the former enjoy priority. This uncertainty

clearly had implications for the question of whether Custom House’s capital reserves were adequate for this purpose.

8. These developments obviously gave grounds for concern. These concerns were plainly heightened by developments which have

taken place within the last few days. According to the grounding affidavit sworn by Mr. Thompson, a senior staff member of Custom

House requested a meeting with Central Bank on 11th July. At that meeting, the staff member concerned expressed concern that

monies may have been taken from pooled client asset accounts by Custom House without appropriate authority and used to cover

shortfalls in property investments on behalf of clients. It was similarly contended that equity unit trusts and cash unit trusts were

also improperly used in this way. There is concern that the shortfall in respect of the trust assets may be upwards of €13m.

9. Running in tandem with this are the separate concerns voiced by Appian Asset Management Ltd. (“Appian”) and Mr. John O’Dwyer,

the Chairman of Custom House. Appian entered into a services agreement with Custom House in May, 2011 and it is duly authorised

under the MiFID Regulations for this purpose. In the course of familiarising itself with the services to be rendered, Appian became

aware of certain apparent discrepancies in records of the firm relating to some clients. These included incomplete information between

valuations of assets supplied to certain clients and the underlying records of Custom House relating to those client’s accounts, along

with other issues relevant to the security and good order of the holding of client assets. In the light of these developments it appears

that Appian are now taking steps to terminate their appointment with Custom House. It is proper to record that Appian at all times

have acted with utmost propriety and have been very helpful and co-operative with the Central Bank.

10. Mr. O’Dwyer had been asked to join the firm as a non-executive director in 2009 in the wake of a request from the Central Bank to

strengthen the board by bringing in an experienced outsider who could assist the independence of the decision making within the

company. To that end, Mr. O’Dwyer agreed to join Custom House in July, 2010 and he subsequently took over the role of Chairman in

late 2010. It is equally proper to record that Mr. O’Dwyer’s integrity is beyond question and that illness this year hampered his ability

to perform his task as Chairman.

11. On 11th July Mr. Thompson received a telephone conversation from Mr. O’Dwyer in which the latter stated that he could no longer

regard the information he received from Custom House as dependable. While senior figures within the company had assured Mr.

O’Dwyer over the weekend of July 9-10 that investor monies had not been misused, he now considered that the opposite was the

case. Shortly after this development senior figures within the company either resigned or communicated their intention to do so. At

that point the Bank issued further directions requiring Custom House to desist from making any payments to investors and resolved to

make this application.

12. For completeness, I should record that Mr. Treacy gave evidence before me at the hearing of the ex parte application of a further

meeting with senior staff on 14th July, all of whom expressed similar concerns, including concerns regarding the reliability of

information relating to customer accounts.

The nature of the application

13. Article 166(1) of the MiFID Regulations provide:-

“Without prejudice to the powers of the Bank under these Regulations, where the Bank is of opinion that it is

interests of:-

(a) the proper and orderly regulation and supervision of investment firms or regulated markets, or

(b) the protection of investors,

that an investigation should be held into the affairs of an investment firm or the market operator of a regulated

market, the Bank may apply to the Court for an order authorising such an investigation.”

14. I would pause here to observe that the requirement that the Bank should be “of opinion” that it would apply to this Court under

Article 166(1) should be understood as importing the requirements that the Bank must act bona fide in a reasonable fashion and that

the underlying facts on which it bases its opinion are factually sustainable: cf. by analogy the comments of Blayney J. in Kiberd v.

Hamilton [1992] 2 I.R. 257, 265. Without necessarily expressing any final view on this question, not least given that the present

application is ex parte, everything suggests that these three conditions are satisfied.

15. Article 166(2) empowers the Court, as it thinks proper, to appoint one or more inspectors to conduct the investigation on the

application of the Bank. Article 166(2) (b) provides that the inspectors must report the results of the investigation in such manner as

the Court may direct.

16. Article 166(3) provides:-

“Before applying to the Court to appoint an inspector under this Regulation, the Bank, if it is of the opinion that it

would not be prejudicial to the interests of shareholder or creditors or investors, may notify the investment firm or

the market operator concerned in writing of:-

(a) the application, and

(b) reasons for the application,

and, in that case, the investment firm of the market operator, within such period as the Bank may set out in the

notification, shall be entitled to give to the Bank a statement in writing explaining the relevant activities of the

investment firm or market operator, as the case may be.”

17. In the present case the Bank did not give advance notice of its intention to apply to this Court to seek to have inspectors

appointed. Again, without necessarily expressing any final view on this question having regard to the ex parte nature of this

application, one can immediately appreciate why, in the light of the information already in its possession, such advance notification of

this application was not given by the Bank.

18. This brings us directly to the nature of the order sought. Counsel for the Bank, Mr. Barniville SC, submitted that in such

circumstances that any order which I made under Article 166(2) appointing inspectors to investigate the affairs of Custom House was

in the nature of a final order, albeit that it was accepted by counsel that Custom House should be given liberty to apply to have the

order set aside. If that were the case, this would have the effect that a final order could be made with significant reputational,

financial and other implications for a company without any advance warning or notice or without it having been given the basic

opportunity to make its case.

19. In my view, such a construction of Article 166(2) would have to be rejected as unconstitutional as being inconsistent with the

constitutional guarantee to fair procedures. The task of this Court on an application of this kind is not simply, so to speak, to beautify

by judicial order by purely formally confirming what might seem to many as the inevitable necessity of a full scale investigation to be

conducted by Central Bank inspectors. It is rather to ensure that there is, objectively speaking, a necessity for an investigation and

that the procedural and, where merited, the reputational rights of the company are appropriately safeguarded by the judicial branch.

It is true that the allegations here are very serious and, at first blush, would appear to be supported by an abundance of evidence.

But if justice is to be administered in an even handed fashion, it means that Custom House must be given an effective opportunity to

demonstrate why the making of an order under Article 166(2) is not warranted. It is true that the finality of the order might be

tempered by giving Custom House the opportunity to apply to have the order set aside, but even in such circumstances the burden of

proof which the Central Bank as applicant should properly carry would effectively be reversed.

20. This is underscored by two leading decisions of the Supreme Court: DK v. Crowley [2002] IESC 66, [2002] 2 I.R. 712 and Dellway

Investments Ltd. v. National Asset Management Agency (No.2) [2011] IESC 14. In DK the Supreme Court held that s. 4 of the

Domestic Violence Act 1996, was unconstitutional insofar as it permitted the District Court to make an order in an ex parte fashion

without providing at the same time for appropriate procedural safeguards. As Keane C.J. noted, this had the effect that a person

affected by such an order might be excluded from their family home by an order of indefinite duration. The Court observed, however,

that it was ultimately the lack of appropriate procedural safeguards which led it to the conclusion that the section represented a

disproportionate interference with the constitutional right to fair procedures ([2002] 2 I.R. 744 at 760):-

“It is undoubtedly the case that the respondent may apply to the court at any time to have the interim order

discharged or varied. No reason has been advanced, however, presumably because there is none, as to why the

legislature should have imposed on respondents in this particular form of litigation, with all its draconian

consequences, the obligation to take the initiative in issuing proceedings in order to obtain the discharge of an

order granted in his or her absence which, it may be, should never have been granted in the first place. It has not

been demonstrated that the remedy of an interim order granted on an ex parte basis would be in some sense

seriously weakened if the interim order thus obtained were to be of a limited duration only, thus requiring the

applicant, at the earliest practicable opportunity, to satisfy the court in the presence of the opposing party that

the order was properly granted and should now be continued in force.

The court fully appreciates the considerations which the executive and legislature would have had in mind in

providing for the granting of interim barring orders on an ex parte basis. In the many cases where the spouses are

still living together and one is being subjected to violence by the other which may also extend to the children, it

may simply not be practicable for the application to be made on notice to the respondent. It is not the existence of

a jurisdiction to grant interim barring orders on an ex parte basis which creates a serious constitutional difficulty. It

is the manner in which the legislation has provided for the granting of such orders.”

21. It is clear from this passage that the mere fact that the person or entity affected by a far-reaching order of a final nature

granted ex parte can apply to have the order set aside may not in itself sufficiently protect the legitimate procedural rights of the

person so affected.

22. In Dellway Investments the Supreme Court held that the National Asset Management Agency was required to give borrowers an

opportunity to be heard before their loans were transferred from commercial banks to the agency. The Court stressed the reputation

impact such a transfer might have and it also noted that the statutory powers of the Agency were far more extensive than those

enjoyed by commercial banks. Applying standard East Donegal principles (East Donegal Co-Operative Ltd. v. Attorney General [1970]

I.R. 317) the Court rejected a construction of the National Management Agency Act 2009, which would have excluded the right to fair

procedures in the circumstances.

23. As Murray C.J. put it:-

“In the course of the hearing it was at one point argued on behalf of the State that the exclusion of a right to a

hearing might be justified by reason of the crisis affecting the national banking system and the urgency of the

measures needed to counter systemic threats to that system. I have to say that there was no evidence or material

before the High Court to suggest that the time involved in permitting persons such as the appellants to make

representations to NAMA before it made a final decision would impinge on, let alone be fatal for, its effective

functioning. Moreover I find it difficult to envisage circumstances where the principles of constitutional justice

ensuring that decisions are fair for the individual could be overridden. To do so would be to abrogate a

constitutional protection which every citizen enjoys when the State decides to exercise a power which encroaches

on individual rights.

The State in exercising its powers through the organs of government designated by the Constitution have extensive

powers to regulate and limit the exercise of individual rights in the interest of the common good and this may be

relevant where the State is faced with a national crisis, such as one of a fiscal nature. The State has the power to

act in the interests of the common good because the Constitution, in its provisions, expressly envisages that. It

also envisages that in exercising such powers the State must act within the ambit of the Constitution as a whole.

In a democratic State founded on the rule of law there are definite limits to the extent to which the State can

interfere with or restrict constitutional rights or rights vested in or acquired by individuals - freedom of expression,

assembly, freedom of religion, right to education, right to earn a livelihood, property rights (including contractual

rights), right to strike - to name but some, even when it is acting or purporting to act in the interest of the common

good in a national crisis. In common with international instruments, such as Covenants of the United Nations and

the European Convention on Human Rights, the Constitution envisages that rights may be regulated and limited but

not to an extent that it is disproportionate or in a manner which is arbitrary or discriminatory in an invidious sense.

In particular the State cannot act in a manner which would abrogate a right or deprive it of its very essence.

If the State were to succeed in its argument, namely that the Act of 2009 prohibits NAMA from giving any

consideration to representations from persons in the position of the appellants, it would be denying the very

essence of a right to a hearing, a concept at the core of the principle of constitutional justice and due process.”

24. In the light of these authorities, I could not constitutionally sanction the appointment of inspectors by means of the making of a

final order on an ex parte basis. It cannot be said that such an appointment represents merely some routine procedural step and that

Custom House will have its opportunity of defending its position before the inspectors. It is rather a step which will have significant

reputational issues for the company, whose business may be severely affected by the publicity attendant on such appointment. This

is much more comparable to a decision by a professional body to commence an investigation into a professional person, a decision

which in itself attracts the right to fair procedures: see, e.g., An Bord Altranais v. O’Ceallaigh [2000] IESC 21, [2000] 4 I.R. 54.

25. It follows, therefore, that the application of Article 166(2) must be re-fashioned somewhat beyond its bare language in order to

make it operate, East Donegal-style, in a constitutional fashion by, if necessary, interpolating appropriate safeguards in order to

vindicate the company’s constitutional right to fair procedures and, indeed, the protection of its property rights in the manner

required by Article 40.3.1 and Article 40.3.2 of the Constitution. If the ex parte nature of the original appointment can be justified on

the basis that it was necessary so to act in order to protect investor funds, the principle of proportionality correspondingly requires

that this must be counter-balanced by a stipulation that the appointment be in the nature of an interim order or on a provisional

basis.

Conclusions

26. I will accordingly stipulate that the order under Article 166(2) be made returnable to this Court for Wednesday, 20th July. In the

event that the making of such an order is challenged by Custom House, then it will be necessary for the Central Bank to renew the

application for the appointment of inspectors. Should that occur, then by analogy with the principles expressed by Keane C.J. in DK,

the onus will rest with the Central Bank (and not on Custom House) to justify the continuation of the order.