Enforcement: Priorities and issues for 2006
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Speech by Margaret Cole, Director of Enforcement, FSA
AIG Financial Institutions Seminar
11 April 2006
Introduction
I am pleased to have the opportunity to talk to you today about some of our priorities and issues for 2006 and going forward. I plan to tell you about how we go about our business in the Enforcement Division and to set the work of the Division in context.
I am also going to touch upon some of the changes to our Enforcement processes following the implementation of last summer's Enforcement Process Review. I will also make some remarks about "effective deterrence" and the use of the Enforcement tool to change behaviour. And I propose to wrap up by saying something about Principles based regulation, why that is important to us at the FSA and why it is therefore increasingly important for you.
The things I am talking about today concerning our approach to Enforcement activity and our processes are of general applicability – not just of relevance to the insurance sector, - but they are certainly of equal importance to the insurance sector.
When I am asked to talk, as the FSA's Director of Enforcement about our priorities, the first thing I make clear is that the FSA does not have a set of Enforcement priorities as distinct from the priorities of the FSA as a whole.
The Enforcement Division does not sit in an ivory tower devising its own strategies, priorities and objectives. The reality is that we align what we do with what is going on elsewhere in the organisation. Our priorities are necessarily, therefore, a subset of the FSA's overall priorities.
In fact, our key priority is to ensure that the Enforcement Division operates at the heart of the FSA as a fully integrated tool focused on the delivery of the FSA's aims and objectives.
To reinforce this, in the 2006/07 Business Plan we have not listed a separate set of Enforcement priorities. The FSA has re-emphasised its commitment to the effective use of Enforcement in areas which pose the greatest risk to our statutory objectives. We will closely align with our Wholesale and Retail Business Units to achieve this. More about their priorities can be found in the Business Plan.
They include in the wholesale area, wholesale insurance, routine insurance, market abuse, and market misconduct particularly the area of systemic and organised insider dealing. And in the retail area, general insurance, the Treating Customers Fairly agenda, payment protection insurance, equity release and mortgage endowment complaints handling.
This doesn't mean Enforcement action will only happen in the FSA's priority strategic areas. Enforcement action will also be necessary in egregious cases, ad hoc cases where consumer protection is a key issue, or where a case is necessary in the interests of achieving effective deterrence.
We have already restructured the Enforcement Division to align with the FSA's Wholesale/Retail business unit model. This enables us to focus our efforts, skills and resources so that we can better deliver our strategic aims of promoting efficient, orderly and fair markets, helping retail customers achieve a fair deal and improving our business capability and effectiveness.
We have also created a new department within the Enforcement Division, LLR. This will focus on Legal Review, Litigation and Advocacy. It will provide an additional resource for case teams when preparing for and presenting to the Regulatory Decisions Committee. It will enable us to create a centre of excellence for our litigation and advocacy functions.
Some words about the EPR
Our key aim for the Enforcement Process is that it should not only be fair but that it should be seen to be fair – like the old saying about "Justice."
To that end we have, following last year's Enforcement Process Review, introduced a number of changes to the Enforcement Process. We want to make sure that however much firms and individuals dislike being involved in Enforcement action (and that of itself is part of the deterrence theme), they will feel that they have been treated fairly and with respect.
From our perspective this is equally important. We do not intend to be diverted from our task of obtaining efficient, speedy and robust outcomes in the interests of protecting the integrity of the markets and ensuring a fair deal for consumers, by fundamentally unproductive debates about processes. Now that we have reviewed our processes carefully and have implemented significant changes following due consultation, I would urge individuals and firms (and your legal advisers) to focus your attention on the real issues in cases. No one will gain from tactical process driven skirmishes. If, as we hear from you, you genuinely wish to achieve prompt, practical, proportionate business like outcomes, please work with us to achieve that end.
Key issues that used to trouble the regulated community have now been dealt with. The foremost of these were transparency and separation. There is no longer any special access for the Enforcement team – an issue which we know used to cause consternation in the community. Any significant contacts between the Enforcement team and the RDC will be minuted. Both Enforcement and the party in discipline will now arrive at and leave oral representations meetings at the same time.
On the subject of oral representations meetings, the RDC has indicated that it wishes these to be more interactive. They have also made it clear that they wish to foster an atmosphere of informality and the FSA Executive is committed to maintaining a considerable degree of informality in the way the RDC operates. We are opposed to the judicialisation of the RDC. Our experience is that the RDC, in deciding what action it is appropriate for the FSA to take, finds it more useful to hear from someone who is close to the business, for example the CEO, about what happened, why and any remedial steps taken, rather than hearing lengthy legal submissions, however eloquently delivered.
It is worth revisiting the fact that the RDC is accountable to the Board and separate from the Executive and it is worth stressing once again, as the EPR recognised, that the RDC is not, has never been intended to be, and will not now be, a wholly independent body separate from the FSA. Nor is it intended to resemble a Court or a Tribunal or to have a quasi-judicial function. It is the organ by which the FSA makes disciplinary decisions and its decisions are those of the FSA. The RDC does not set FSA policy, rather its role is to implement that policy taking into account the facts and matters before it. The RDC is not there to make a judicial determination between the parties and neither the RDC legal adviser nor the RDC itself will be making determinations between competing views of the law. Consistent with the fact that the RDC is an FSA committee, it will make its decisions based on the FSA's interpretation of the law. Obviously the RDC (and indeed Enforcement) will carefully consider any legal representations made by another party and the FSA may modify its position as a result. If there is an irreconcilable difference between the parties on a point of law then, ultimately, that will be resolved in the Tribunal.
The RDC now has its own separate legal resource.
I mentioned earlier that we have set up a new department – Litigation and Legal Review. As you may know a key recommendation of the EPR was that each matter should be scrutinised by a lawyer without previous involvement in the case before the preliminary investigation report is sent out and before the matter comes to the RDC. Although this did happen previously in many of our cases, adoption of this recommendation enables us to create a consistent framework for stress testing our cases. It will enable a dispassionate review of the way a case is put and whether it is supported by sufficient evidence. It should counter concerns that we have heard expressed about a prosecution mind set.
Concerns have been expressed about delays to the process caused by an independent legal review within the Enforcement Division, coupled with the advisory role of RDC Counsel. We will work to ensure that timescales are minimised. It is with this in mind that we have set up the new Litigation and Legal Review Team.
We have also implemented the recommendation that settlement discussions should be made entirely separately from the RDC - this way the integrity of the RDC can be maintained in contested cases. I will return to the subject of settlements in a moment.
Effective deterrence
The next topic I want to touch on is "effective deterrence."
A key issue for the FSA for 2006 and beyond is deterrence – the effective use of the Enforcement tool as a way to achieve behavioural change.
Enforcement is only one of a number of regulatory tools available to the FSA and it is not by any means the most widely used. Only 8% of the FSA's employees work in Enforcement and we take up a corresponding amount of the overall budget. Enforcement is actually a very small part of the regulatory relationship. And yet it often doesn't feel that way.
The potential impact of Enforcement action is significant. Enforcement activity generates more publicity (whether positive or negative) about the FSA than any other single issue. Enforcement outcomes can therefore play a very significant role in educating the industry and consumers about issues of concern and the FSA's approach to them. It can also be a very powerful way of changing behaviour. Obviously we want to encourage and promote high standards of behaviour, both in terms of our market integrity and our protection of consumers' objectives.
The FSA will actively look for new ways to make sure our penalties bring about the deterrent effect we want to achieve. That means considering not only the types and levels of penalties we impose but making sure that the penalties impact upon the right people. It also means acting with confidence and resolutely taking Enforcement action where appropriate to convince wrongdoers that there is a real risk that they will be caught and proceeded against.
Senior Management Responsibility
This brings me to senior management responsibility. This subject remains high on our agenda and we do understand that in this, as in many other areas of our work, it is important that we do not only "talk the talk" but we also "walk the walk."
The FSA expects senior management to take responsibility for ensuring firms identify risks, develop appropriate systems and controls to manage those risks, and ensure that the systems and controls mitigate the risks in practice. Failure to manage risks properly is now, more then ever, likely to result in disciplinary action being brought against individuals as well as firms. Senior managers need to understand this and ensure that they are taking appropriate action to identify and mitigate risks to protect their firm, and increasingly, themselves.
We recognise that cases against individuals are very different in their nature from cases against firms. Firms and companies have a different business imperative – often they wish to resolve cases quickly to limit commercial damage to their ongoing business and corporate reputation. An individual faces greater risks from a successful Enforcement action, in terms of financial implications, reputation and livelihood. Generally, cases against individuals are hard fought, at many practical levels harder to prove, take longer to resolve and are less likely to be settled. Nonetheless, we are committed to ensuring that appropriate cases against senior management are pursued robustly and with sufficient resource.
Our intention is to be resolute in this regard. This means that we will take difficult cases, including some cases where we recognise, from the beginning, that it might be difficult to obtain a disciplinary outcome. These cases are likely to be cases which are of significant individual seriousness as well as strategic importance.
Penalties
To achieve effective deterrence wrongdoers must not only realise that they face a real and tangible risk that they will be held to account, but they must expect a significant penalty. We will seek to ensure that the sanctions we impose, including financial penalties, are fixed at levels that are sufficient to deter potential wrongdoers and where necessary we will increase penalties to achieve this.
We intend to be bold in our approach particularly in cases where the regulatory requirements have been clear for some time and where we need to ensure that regulatory fines are not simply regarded as just another cost of doing business.
One example of this is in the area of market misconduct.
Given that the appropriate standards of market behaviour have been clearly set out since 2001, we view very seriously conduct which falls below the standards set out in the Act or which contravene our Principles.
I would also like to take the opportunity to emphasise that, where we consider that behaviour justifies criminal rather than civil penalties, we will be prepared to pursue such cases through the criminal courts. We demonstrated our commitment and ability to do so last year by our successful prosecution of the directors of AIT for providing false and misleading statements to the market.
Settlements
Settlement decisions are now made on behalf of the FSA by two decision makers of at least Director status. I will usually be one of the decision makers, the second being designated as appropriate to the case. This is already proving an efficient and effective way of concluding settlements promptly. It has the advantage of involving FSA senior management in the decision making process and facilitates close interaction between the Enforcement Division and the Wholesale and Retail Markets Business Units which will ensure consistency of approach to settlements and impact of outcomes.
For those who are concerned about how we will achieve consistency in our approach to penalties between RDC decisions in contested cases and Executive Settlement Decisions, let me offer some reassurance. Although the RDC and the Enforcement Division are separate, we will have regular liaison at a policy level to ensure consistency of approach and to make sure that the RDC is fully briefed on the factors the FSA considers are important for penalty setting. We will also, of course, be able to discuss the detail of the rationale for penalties in concluded and published cases. It is in no-one's interests for there to be forum shopping between the RDC and Executive Settlement Decision Makers.
Finally a point of clarification on our settlement philosophy.
It is important to us to achieve early settlements. They facilitate prompt redress in consumer related cases and enable us to achieve swift and effective outcomes so that we can utilise our resource more efficiently and move on to the next important issue. We are, however, only interested in getting the right settlements – ones which are justified on the basis of the law, principles and the facts. We will not compromise the integrity of our decisions and outcomes by rushing to tie up settlements on bases which are inappropriate. And you should not approach settlement discussions as if you are trying to resolve a commercial transaction. There will be limits beyond which we will not go and we will not engage in pure horse trading.
You can also expect to see us becoming more time sensitive in settlement situations. We are finding that settlement negotiations can drift on for extended periods. If you want to negotiate settlements you need to be prompt and co-operative in moving the matter towards resolution. In the interests of efficiency and effectiveness we are intending to put stricter time limits on settlement negotiations.
Two settlement outcomes this week
During the course of this very week, that is yesterday and today we have published 2 final notices in cases which have been dealt with by Executive Settlement procedures.
Yesterday we announced a fine of £550,000 on Royal Liver Assurance Limited for mis-selling with profits savings policies. This case was based on a combination of Rules and Principle breaches including Principle 2 – a firm must conduct its business with due skill, care and diligence and Principle 3 – a firm must take reasonable care to organize and control its affairs responsibly and effectively with adequate risk management systems. This morning we have announced that we have imposed a penalty of £6.3 million against Deutsche Bank for breaching Principle 5 by failing to observe proper standards of market conduct and Principle 2 by failing to conduct its business with due skill, care and diligence, in relation to two separate transactions in 2004, a bookbuild in Scania B shares and the stabilization of Cytos shares. We also imposed a financial penalty of £350,000 on Deutsche's former Head of European Cash Trading, for being knowingly concerned in the failure to observe proper standards of market conduct in the Scania transaction. The very significant penalties in this case actively demonstrate the commitment we have made towards increasing penalties in the area of market misconduct in the interests of deterrent effect. This case also sends a very powerful message, not just to institutions but to senior staff. We have also been making it clear that we expect firms to demonstrate an appropriate response when dealing with individuals involved in regulatory wrongdoing. We have expressly indicated in this case that we have taken into account Deutsche's approach to the internal disciplinary issues when setting its penalty.
Principles
This brings me to my final theme for today – principles-based regulation, since both of the cases I have just mentioned demonstrate the use of principles in an Enforcement context, the Deutsche case being an example of a Principles only case.
Currently the FSA's approach to regulation is a hybrid of high-level principles and detailed rules and guidance. While this broad structure is both necessary and desirable, we aim where we can, to change the balance significantly towards a more principles-based approach. By this, we mean relying on general principles, rather than detailed rules, where we can.
This doesn't represent a radical change of direction for us – the FSA has been advocating a more principles-based approach to regulation for some time. The eleven high level Principles for Businesses have been in place since 2001. They set overarching requirements for all financial services firms and provide the backbone of our regulatory regime. They focus on what we are trying to achieve and are therefore expressed in terms of outcomes rather than processes or procedures.
I want to emphasise today that where appropriate, we can and do take Enforcement action on the basis of principles alone. The key thing to note here is predictability. In order for consequences legitimately to be attached to the breach of a principle it must be possible to predict, at the time of the action concerned, whether or not it would be in breach of a principle. So long as the action or actions in respect of which discipline is being brought could reasonably be predicted to be in breach of the principle we do not consider that there is anything unfair about taking Enforcement action for the breach of principles. In other words where the requirement of predictability is met it is legitimate for consequences to follow even though the principle is expressed in general terms.
We do, of course, also use guidance to supplement the principles, where we think that this is helpful in setting out the standards we expect, or in assisting firms to decide what action they need to take to meet the necessary standard. Guidance is clearly also helpful from the point of view of predictability
We see very significant positive implications in this approach for our stakeholders: for example, firms will face less prescription from our regime, will have greater flexibility and will need to make more decisions themselves about how to meet their regulatory responsibilities, using their understanding of our high-level principles and desired outcomes. We do also believe that consumers will get better treatment through firms' own initiatives and actions than through regulatory detail. In our view, this approach will provide better quality regulation than would be achieved simply by imposing a mass of detailed rules. We do also see significant challenges - for both the FSA and the industry we regulate.
To conclude, I have mentioned today some of our priorities and key issues. I hope that I have given you a flavour of some of the areas we think are important. The FSA is committed to the effective use of the Enforcement tool to assist us in achieving our strategic aims and objectives, not just in 2006 but as we move forward. We believe that a firm and confident approach to our Enforcement activity is an essential part of that commitment. We believe that our outcomes will demonstrate this approach.