International Financial Services, London
29 June 2004
Speech by Callum McCarthy

  1. I have now been at the FSA for some nine months, though it seems, depending on the day, either yesterday or a lifetime – a mark of the business of the FSA, and its very wide agenda. Indeed last week John Tiner and I gave evidence to the Treasury Select Committee on its enquiry into long term savings. The questions ranged from particular issues – splits, precipice bonds or endowment mortgages – to our general approach, which is designed to produce efficient and fair markets, retail and wholesale, for financial services. Today, I would like to take the opportunity to discuss the FSA's enforcement policy – to put it into the context of our general approach, and to explain how we intend to develop this important arm of our work.

  2. Effective enforcement plays an important role in two of the FSA's central aims: to ensure markets are efficient, orderly and clean and that the retail customer gets a fair deal.

  3. The FSA's enforcement powers and responsibilities have also been in the headlines recently: barely a day goes by without a story about the work we are doing to secure a settlement for split capital investment trust investors. And announcements like our confirmation that we are investigating Shell or the share dealings associated with the possible bid for Marks and Spencer have also hit the business pages and, indeed, the front pages. You will also have seen in the newspapers details about the case which is before the Financial Services and Markets Tribunal, where Paul Davidson is appealing an FSA fine for alleged market abuse. I would like to make clear the importance the FSA attaches to the independence of the Tribunal. In this case, the FSA became aware of a conversation between the Chairman of the Regulatory Decisions Committee, Christopher FitzGerald, and a member of the Tribunal considering the appeal. We acted with determination and speed to bring to the Tribunal's attention a matter which might be seen to cast doubt on the independence and integrity of the Tribunal process. We supported the position adopted by the Tribunal that it should recuse itself. And Mr Fitzgerald has resigned. So no-one should be in doubt about our commitment to the integrity of the process.

  4. But before I turn to discuss enforcement in more detail, I would like to impress on you that we are not an enforcement-led regulator. Indeed, one of the challenges of any enforcement policy is to make sure that it does not disturb the openness and candour which are essential for day to day supervision. The majority of our work and our staff are focused on the business of regulation – meeting firms, analysing risks, monitoring markets – and the majority of our firms are, we believe, getting on with running their firms perfectly properly and without any need for enforcement action on our part. But there can be no doubt that enforcement action is necessary from time to time and when it happens it is high profile. So with that in mind I would like to try and set the context of our enforcement history.

  5. It is sometimes difficult for observers to identify themes and priorities in respect of our enforcement activities – for understandable reasons. The Financial Services and Markets Act gave the FSA the responsibility for enforcing a very wide range of duties of companies and individuals in the financial services sector. It is only to be expected therefore that we should have acted – selectively – to take enforcement action against misselling; breaches of listing rules; market misconduct; misleading advertising; maladministration; breaches of threshold conditions – for example to stop firms which do not comply with ombudsman awards from continuing in business; money laundering; or what we call perimeter cases – essentially trading by persons or firms which are not authorised, and where basic dishonesty is often involved.

  6. What I would like to do today is to pull together the main themes that lie behind our various enforcement actions, and to describe some of the developments which you should expect as our enforcement policies evolve.

  7. All our enforcement activities are connected to and derived from the FSA's priorities in two important senses. First, the various activities we are seeking to discourage or stop are all directly linked to our two themes of external work. Enforcement aimed at discouraging breaches of listing rules, at preventing money laundering, stopping insider dealing or other market misconduct contributes to the work on efficient, orderly and clean markets. Enforcement aimed at preventing misselling, or misleading advertising or dishonest provision of financial services equally clearly contributes to the work on achieving a fair deal for the retail customer.

  8. The clearest way to demonstrate this is with some number – crunching so bear with me (most of these numbers are available on our website with our Annual Report – published tomorrow, and a good read I can assure you!)

  9. If I cast an eye over the cases we have taken on over the last financial year, the 'growth areas' are mis-selling and financial promotions, threshold conditions and market abuse. In these three areas we have seen a year-on-year increase in cases on the books of 50%, 100% and 66% respectively. If I just look at cases opened (the figures above are net new cases) these three areas account for over 80% of new cases opened in the last financial year. These figures show to me that we are focusing our enforcement resources on priority areas that map very clearly to our consumer and markets objectives. All are designed to achieve our aim of efficient and fair markets for financial services.

  10. But taking on the right cases is only half the battle. It is also important that we know when not to pursue a case. In a world of scarce resources it makes sense to focus our enforcement cases on serious breaches that undermine our objectives and not seek to prove ourselves on more borderline issues. So I am keen to ensure that we close cases where we can and refine our case load. At the end of the last financial year we had fewer enforcement cases open than we did the year before, despite taking on 175 new cases. This is clearly a move in the right direction.

  11. All those numbers relate to our present stock of cases. What about past flows? How do they map against our aims of ensuring customers are treated fairly and that markets are efficient, clear and orderly: if we look back over the last 18 months, we have levied fines totalling £8.725 mn for misselling and misleading advertising and other breaches as part of our work on achieving a fair deal for the retail customer. But levying a fine can be only a small part of the total cost to a firm, since compensation can also be required: Lloyds TSB was fined £1.9 million for misselling precipice bonds, but agreed to compensation of nearly £100 million; Lincoln Assurance was fined £485,000 for misselling of 10-year savings plans by a representative, but provided £8.8 million in compensation. In fact, over the last 18 months a total of £135.4 mn has been paid or set aside in compensation as a result of FSA action. This is addition to the total redress paid to consumers (or set aside to be paid) for endowment mis-selling of around £1bn. And our efforts to obtain compensation for customers in relation to Split Cap Investment trusts – either through mediated settlement or as a consequence of the full enforcement process –are well documented.

  12. In relation to our other key theme – ensuring efficient, orderly and clean markets – we have levied fines totalling £6.510mn. This includes fines for breaches of the Listing Rules, market misconduct and other actions that undermine the operation of the UK markets.

  13. Fines levied do not tell the whole story here either. We have, for example, publicly censured at several listed companies – Marconi, SFI and Sportsworld Media Group for breaches of the Listing Rules because either the breach happened before our fining powers took effect or they did not have the financial resources to pay a fine. Either way, there is no doubt that they have all helped to signal quite clearly to Listed Companies and their advisers what behaviour is and is not acceptable.

  14. Enforcement is clearly not an end in itself : its principal purpose is to change behaviour; to stop actions which are unacceptable – contrary to law or regulation; to make future behaviour different by making it clear that there is both a high probability of unacceptable behaviour being identified, and of action being taken which will hurt the offending organisation or individual. The purpose is forward looking: to identify the types of behaviour against which action will be taken, so that it is prohibited; and to establish that the sanctions involved will be designed to change behaviour. Note that enforcement does not necessarily involve fining: I have touched on the payment of compensation and public censures but it can also involve the much more serious sanction of withdrawing authorisation (the FSA banned the former dealing director and three former traders of Brandeis (Brokers) Ltd for deliberately mispricing customer orders and more recently banned the former Equitable Life Chief Executive Christopher Headdon for failing to disclose a side letter to the FSA); and it can involve criminal sanctions (John Rourke, who acted dishonestly, was twice jailed for ignoring FSA injunctions. On 14 June he was sentenced to a year in prison for illegal deposit-taking and to two years for making false statements (to run concurrently). He was also given four months imprisonment for forgery and six months for perverting the course of justice (to start once the two year sentence has been served); the chairman and two other directors of AIT group plc have been charged with offences under section 397 of FSMA).

  15. Whatever the form of enforcement – fine, action against an individual, criminal proceedings, the requirement to pay compensation – there are common themes in the FSA's approach. The first is the importance we attach to senior management responsibility. A central concern of the FSA is that proper behaviour – respect for the law and its derived regulation – is the responsibility of the senior managers of firms, not with their general counsel or their compliance officer. This does not mean seeking to punish managers simply because an offence has happened "on their watch" – as someone who previously had senior management responsibility in a bank, I know how unfair that would be. Those who act with due care, in good faith and within their legal authorities should not be exposed to personal liability. But it does mean that senior managers who breach law or regulation through behaviour which is below the standard reasonably expected in relation to their position, their responsibilities and the size and nature of the firm can expect to be held to account personally. The FSA has taken public action against seven instances of senior management since N2 (Univeral Salvage, Sportsworld, Brandeis, Aioi, CSFB, Hoodless Brennan and ABN Amro); we have started criminal proceedings in another (AIT). You should expect this to be a continuing and growing feature of the FSA's approach. It is an obvious means of motivating senior management to meet the standards they are obliged to follow.

  16. Second, we will keep under review the level of fine we impose. As I said, the fine is not the only cost to the firm: there is damage to its reputation and its brand; and the need to pay in certain instances compensation for greater than the fine. The level of fine should reflect whether a firm or individual has cooperated with an investigation and taken prompt and effective action to stop whatever was wrong (which argue for lower fines). Conversely, if the offence occurred despite clear regulatory guidance, a higher fine is justified: Scottish Amicable was fined £750,000 – and paid compensation of £11 million – for endowment mortgage misselling in 1999 and 2000 at a time when there was clear guidance on what was expected – something which resulted in the fine being larger. In general, the level of fines imposed by the FSA falls between US practice, which tends to be much higher, and Continental practice, which is much lower. Our concern is to affect future behaviour, and we intend to review the level of fines to ensure that they are indeed affecting behaviour. Were there to be evidence that the fines were being treated as a minor cost of doing business we would wish to increase them.

  17. Third, and linked to the level of fine, is the question of appropriate publicity for enforcement actions. I regard this as important: fines – even at the level imposed in the US – are likely to be small in comparison with the turnover of companies, particularly major financial institutions. What is of possibly greater importance is the public attention paid to an enforcement decision: the damage to reputation, brand and future business arising from high publicity cases, as well as the linked compensation when this arises. You should therefore expect us to attach greater publicity to individual cases, as a means of ensuring that misbehaviour has a clear cost. This may involve our becoming even more selective as to the cases against which we take enforcement action.

  18. All these developments – increased emphasis on the responsibility of senior managers; the review of the level of fines; greater publicity for enforcement decisions – are designed to influence future behaviour. They are intended to make the FSA's enforcement process contribute more directly and effectively to our work on achieving efficient, orderly and clean wholesale markets, and a fair deal for the retail customer.

  19. Alongside this, we will also wish to look at our own procedures. We want to improve the timeliness of our enforcement work, to bring down the delay between an event and an enforcement decision in respect of the event. Much of this time reflects the restrictions on the FSA imposed in FSMA and the rights given in law to those subject to enforcement procedures, which we must of course observe. But not all the delay derives from this, and we will look to reduce delay. From this you will see that I believe strongly that justice delayed is justice denied. It is clearly unsatisfactory, for example, that investors who lost as a result of failed split capital trusts are still waiting for our investigation to finish - just as it is unsatisfactory that those subject to investigation still do not know the result of that investigation.

  20. Let me summarise. Enforcement is part of the FSA's toolkit – not the most important, which is our day to day relationship with those when we supervise, but an important component. We use it to support our general approach of promoting markets for financial services which are fair and efficient. Its purpose is forward-looking – to change future behaviour by demonstrating that breaches of law or of regulation will be identified and may prove costly. We will use enforcement selectively, so that they message does not become diluted by lack of focus. We will review whether we can act more quickly; and whether we need to act via larger financial penalties. We will act, where justified, against individuals as well as organisations. And always we will remember that enforcement is a recognition of past failure – and that its purpose is to reduce future failure.

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