Consultative papers relating to the Financial Services and Markets Bill - FSA’s approach to enforcing the new regime

United Kingdom
FSA announces its approach to enforcing the new regime

In perhaps the most important of the Consultative Papers yet issued by the FSA, in CP17 the FSA has explained its approach to its enforcement powers.

This document is lengthy and detailed, partly because of the reaction to the lack of accountability of the FSA contained in the Bill, and partly the press speculation that FSA might mis-use its very considerable powers.

In this consultation paper, the FSA has both attempted to calm these fears, and to set out in detail the policies which it will follow when enforcing its rules. If the proposals in this Consultation Paper are adopted, firms will undoubtedly use the final guidance as a means of checking whether they are being fairly dealt with, and as a tool in preparing their defence to any possible disciplinary action.

The decision-making process

The FSA has acknowledged that its decision making process must be:


  • fair and seem to be fair, by providing those subject to FSA action with sufficient information to understand the FSA's grounds and to have a reasonable opportunity to challenge them, and to ensure that the FSA's powers are subject to consideration by persons who are independent of the FSA's case;

  • efficient and effective, by ensuring that decisions are taken by suitably informed persons with adequate experience and expertise, avoiding unnecessary expense, delay and duplication, and providing sufficient flexibility to give an opportunity for the FSA and the regulated firm to reach agreement as to the action which should be taken.

To this end, the FSA has decided to establish an Enforcement Committee, to be chaired by a person employed specifically for that purpose and additionally to include practitioners and public interest representatives. This is a major reversal of FSA's previously stated position that practitioners could no longer expect an input as of right into the new regulator's enforcement process. Whilst the Board of the FSA will set out its policies and procedures, and the initial recommendation for any exercising of the FSA's administrative enforcement powers will come from its operational staff, in all cases alleging non-compliance the decision will be referred to the Enforcement Committee. In addition, any decision to impose a civil fine will be referred to the Committee.

It will be the duty of the Enforcement Committee to consider whether a Warning Notice should be issued by the FSA, and to do so the Committee must be satisfied that the evidence substantiates the alleged breach, and that the proposed enforcement action is appropriate in all the circumstances. Such a Notice will set out the FSA's preliminary findings of fact, the alleged breaches of its Rules, and the proposed action to be taken. Prior to the issue of a Notice, or at any stage afterwards, the individual or firm concerned will be able to discuss the proposed action with the relevant FSA staff without prejudice, in an attempt to reach an agreement as to the action which should be taken by the FSA against the individual or firm.

If no agreement can be reached, the firm will be asked to explain to FSA why certain facts contained in the Warning Notice are disputed, which aspects of FSA's interpretation of legislation or its Rules the firm takes issue with, whether the firm considers the action proposed by FSA to be excessive, and to put forward any further evidence which the firm considers should be considered by the Committee. If, upon receipt of such representations, the Committee Chairman considers that there are both substantial disputes of material fact or law, then he will consider what further enquiries are needed to resolve the issues and, if necessary, nominate two or more persons from the practitioner/public interest representative panel to consider the case with him in greater detail.

This process is in addition to the right of individuals and firms eventually to appeal their case to the Financial Services and Markets Appeal Tribunal, which will have the power to conduct a full adversarial rehearing.

The use of the Enforcement Committee will not extend to decisions to withdraw or approve authorisations, or to use intervention powers. The latter may be explicable in terms of urgency and the need to act without forewarning a firm, but the lack of jurisdiction on authorisation is a serious omission, unless there is to be a separate (and equivalent) authorisations committee.

The establishment of an Enforcement Committee is a very important development in the administration of regulatory justice in the UK. It means that, for the first time, firms will be able to put their case to persons who are removed from the regulatory process, such as public interest representatives or fellow practitioners. This is actually an enhancement over and above the present disciplinary process, whereby a firm that cannot convince, or settle with, its regulator goes straight to a formal Disciplinary Tribunal hearing. Firms will henceforth be given a number of opportunities to explain their case, starting with the FSA staff responsible for considering whether to recommend disciplinary action to the Committee, followed by the Committee Chairman, and finally a full meeting of the Committee, including the non-regulators.

We consider that the power to make a full appeal to the Financial Services and Markets Appeal Tribunal will be used sparingly, and most likely only in cases of a near breakdown in the relationship between regulator and regulated firm. However, firms are likely to ensure that they use all the opportunities to put their case to the new Enforcement Committee to the full.

Investigation

The draft Bill gives FSA a range of information-gathering and investigation powers, which have proved controversial during the consultation period for the Bill. For example, persons can be forced to answer questions put to them by FSA, whether they are regulated or not, with refusal constituting a criminal offence.

FSA has pointed out that when exercising its powers to investigate it must have regard to its statutory objectives of maintaining market confidence, protecting consumers and reducing financial crime. It will also consider whether the exercise of the powers are likely to assist in the effective performance of its overall functions, will ensure that those who are subject to FSA investigation are treated fairly, and will use FSA's resources in an efficient way.

FSA does not consider that it will often need to use its statutory powers, as authorised firms and persons will normally provide it with the information it requires. This is, indeed, the current experience. However, where necessary, FSA will use its investigation powers if it considers that firms may have acted to the prejudice of consumers, or contrary to its Rules, or may no longer meet the qualifying conditions for authorisation, or may be involved in financial crime, or give rise to similar concerns. In addition, FSA may make use of its powers to require firms to commission independent reports by professionals approved by FSA.

FSA has acknowledged that, because a failure to comply with the requirement to provide it with information would amount to a criminal offence, its powers to require the divulgence of information must be used in a manner which is proportionate to the concern, and fair to those whose conduct is the subject of enquiry. In general, FSA will not make public the fact that it is (or is not) investigating a particular matter, and does not generally propose to publish details of information found or conclusions reached. Any publicity which may be given will only happen at the enforcement stage.

FSA has emphasised that it will not be able to use the answers to any questions required to be given under compulsion as evidence in criminal proceedings brought against the person giving the answers. The extent to which FSA can genuinely ignore such information, or to which answers may lead to the FSA finding further evidence, is open to question.

Discipline

The FSA has available statutory powers of public censure and fines. It can also withdraw authorisation and restrict the extent to which firms and individuals can conduct investment business.

FSA considers that pro-active supervision and monitoring of firms internally is essential to promoting compliance and many instances of non-compliance will satisfactorily be addressed by a firm's supervisors without the need to resort to formal disciplinary action. FSA will only exercise its powers to impose financial penalties or make public statements to deter the authorised firm or person concerned from future breaches, to deter other firms or persons from similar misconduct, and indirectly to compensate compliant firms.

When considering whether to discipline a firm, FSA will consider:


  • whether it will assist FSA in pursuing its statutory objectives;

  • the nature and severity of the breaches including the loss caused or damage to the orderliness of financial markets which occurred, the amount of any benefit gained or loss avoided, whether the breaches were deliberate or reckless, the duration and frequency of the breaches, and whether the misconduct reveals serious or systemic weaknesses in respect of a firms internal controls;

  • the conduct of the authorised firm, including whether breaches were identified and brought to FSA's attention quickly and completely, the degree of co-operation shown, and steps taken to address the concerns since the breach was identified, including steps taken to compensate consumers, disciplinary action taken against staff, and steps taken to ensure that similar problems do not arise in the future; and

  • any other relevant factors, such as previous disciplinary action against the authorised firm or person, and action taken in any similar cases by FSA.

These criteria are similar to those currently published by the regulators. It is clear that, in order to avoid disciplinary action against a firm, it will be helpful for the firm to be able to demonstrate to FSA that the breach was identified by the firm as part of its ordinary monitoring programme, and that the concern has been addressed effectively, with a full plan for investor compensation being drafted, with disciplinary action being taken against staff where necessary, and with systems and controls being revised (if necessary) to ensure that a similar problem does not occur in the future. In addition, prompt and full notification is likely to carry a very heavy weight with FSA when deciding whether to institute disciplinary proceedings.

It is likely that discipline will (as at present) be considered necessary most often where a firm has either acted without proper systems of control, or where it is necessary to deal with any apparent management inertia.

FSA has acknowledged that firms can only operate through the individuals that act on its behalf, and that there may be circumstances where it would be unreasonable to attempt to hold a firm responsible for the actions of an Approved Person. This may include where firms can demonstrate that they have adequate systems and procedures and took all reasonable steps to prevent the misconduct in question.

Action against individuals is likely to be appropriate where the person has been concerned in a serious act of misconduct or has clearly failed to carry out his responsibilities. The circumstances in Barings and Morgan Grenfell Asset Management provide indicators of when such circumstances may arise. If the failing happened as a result of failings in the firm's systems and controls, rather than unacceptable individual behaviour, then the firm will be more likely to be disciplined than any individual.

Special considerations apply in the cases of directors and senior managers, who will be held responsible for ensuring a firm's compliance with regulatory requirements as a whole. Where any breach warrants disciplinary action against the firm, such action signals senior management collective responsibility, and may signify that disciplinary action against management is appropriate.

FSA does not propose to adopt any tariff of fines, either in relation to firms or individuals, but it has stated that fines will usually reflect a number of factors:


  • the need to provide an adequate disincentive to future non-compliance;

  • the amount of any fines previously imposed by FSA or its Appeal Tribunal; and

  • the general principle that the person concerned should pay the regulator's costs.

FSA will make public the imposition of disciplinary sanctions, although not until the outcome of them is finally determined, including any possible appeal to the Financial Services and Markets Appeal Tribunal.

The FSA has also clarified that it does not consider that mutual organisations should have immunity from the imposition of fines, a position which had been suggested given that any fine would affect the investors rather than shareholders.

Intervention

The FSA considers it to be the responsibility of authorised firms, and their directors and senior management, to ensure that business is conducted in compliance with FSA's Rules. FSA will only intervene in the conduct of a firm in order to secure compliance and/or to address the consequences of non-compliance, and in the vast majority of cases the FSA expects to agree with firms what steps need to be taken. In addition, FSA will usually consider exercising its intervention powers only if it thinks it is not safe to rely on a firm to take effective action themselves. This, again, reflects the current position.

When considering whether to use its powers, FSA has set out in some detail the factors to which it will have regard. In particular, the FSA has pointed out that the conduct of the firm will be of crucial importance, and that the FSA will consider:


  • whether the firm identified the issue, and whether any such identification was by chance or through the firm's normal controls and monitoring;

  • whether the firm brought the issue promptly to FSA's attention;

  • the willingness of the firm to take effective action to address the problem itself;

  • whether the firm has already taken any steps to address the misconduct or its consequences; and

  • the firm's past history, management ethos and compliance culture.

Firms will need to bear these facts in mind when they discover any non-compliance which gives rise to serious concerns, because by explaining to FSA the extent to which it meets the above criteria, a firm will reduce the risk of FSA using its intervention powers against it.

Because intervention action is remedial in nature, FSA does not consider it necessary to publicise all of the intervention actions which it will take. However, it will make intervention action public where it is appropriate to bring it to the attention of existing or potential customers of the firm, or if necessary in order to allay any significant concern which the activities of the firm may have on the financial system as a whole, or if it is appropriate to bring the intervention action to the attention of other authorised firms.

Redress for consumers

All regulated firms must be members of the Ombudsman scheme, which will have the power to require payment of compensation by a firm. Firms will also be members of the new compensation scheme, to provide protection for consumers who suffer loss as a result of an authorised firm being unable to meet its liabilities. Where losses have occurred as a result of a breach of regulatory requirements, FSA will use its statutory powers to secure redress only if that will be more effective than using the Ombudsman or the compensation scheme.

If it considers that its powers will be more effective, then FSA will bear in mind the number of consumers who may have suffered and the extent of their loss, and whether the costs incurred by FSA in securing redress make the action justified.

FSA will first seek to agree compensation arrangements with the firm concerned, and therefore does not expect to have to use its formal statutory powers on a regular basis.

Market misconduct and FSA's civil and criminal powers

FSA is being given the power to institute criminal proceedings in respect of insider dealing and misleading statements and practices. These powers will be shared with other authorities. FSA will also receive new civil fining powers for market abuse which are intended to compliment (not replace) the existing criminal regime.

FSA will liaise with the other criminal prosecution authorities if it is considering bringing a prosecution to agree the most appropriate authority to pursue the suspected offender. If FSA itself undertakes a prosecution, it will apply the basic principles set out in the Code for Crown Prosecutors, meaning that FSA will have to consider whether there is sufficient evidence to provide a realistic prospect of conviction, and whether the prosecution is in the public interest.

In cases where FSA considers it is inappropriate to commence proceedings itself or to refer offences to another prosecuting authority, the FSA will consider whether to use its civil powers. In general, FSA will not seek to impose civil fines for market abuse against persons who have been subject to criminal prosecution. However, FSA may still take civil action against the firm.

When considering whether to take any civil action, FSA's prime concern will be the public interest in the protection of the integrity and efficiency of markets. FSA will also need to satisfy itself that the imposition of a fine is appropriate in all the circumstances, including the nature and seriousness of the misconduct in question, the conduct of the person concerned including whether they co-operated with FSA's enquiries, and the extent to which the misconduct is capable of being adequately addressed through action by other market authorities.

There will be no tariff of fines, but they will reflect ability to pay and the need to provide an adequate disincentive to future abuse, follow the general principle that the person concerned should pay FSA's costs, and take account of the level of any previous fines imposed.

The draft Bill enables FSA to apply to the courts for restitution orders in cases of market abuse. It is often extremely difficult to identify any victims of market abuse to compensate, but FSA will exercise its powers to require or seek restitution where identifiable persons interests have been seriously prejudiced as a direct result of market abuse, and the prejudice either takes the form of a quantifiable loss or is the result of an abuse of a relationship of trust. Restitution powers will not normally be exercised for the benefit of contemporaneous traders, or companies or issuers whose investments have been manipulated.

Conclusion

By setting out so comprehensively the policies which it will follow when deciding how to use its enforcement powers, FSA has given regulated firms and individuals a valuable opportunity to consider how to avoid the regulator taking action against them, and if action is taken to ensure that they are being correctly treated. Using the guidance which will eventually be published, and which is likely to follow the proposals contained in this consultation paper very closely, firms will be able to ask the following questions when considering the evidence which is being used by FSA or put before the Enforcement Committee:


  • Am I being treated fairly?

  • Is the proposed action in line with FSA's statutory objectives?

  • Are FSA following their own administrative procedures?

  • Are FSA following their own guidance on when they will exercise their enforcement powers?

If the answer to any of these questions is 'no' then the firm will have good prima facie grounds for contesting FSA's proposed action before the Enforcement Committee, and in particular any practitioner or public interest representatives who may be looking at their case. Even if the answer to each of these questions is yes, the Consultation Paper gives a useful insight into the circumstances which are likely to be taken into account in mitigation.