Efficiency versus Fairness?
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Speech by Margaret Cole, Director of Enforcment, FSA
Enforcement Law Conference
16 June 2006
John has opened this conference by talking about a number of key themes which we are going to consider in greater depth throughout the course of the day. Today I would like to talk about a matter which has an impact on all of the topics under discussion. This is something which has often been described as a balancing act. It's a subject which, I hope, will be thought provoking but which may even be seen as controversial. Consistent, however, with our aim of being open, transparent and direct about the way we do business I am going to take a risk, hopefully a proportionate one, and talk about the topic of 'efficiency versus fairness': how do we balance these two very important aims in the way we do our work? Can efficiency and fairness cohabit harmoniously or are they, in fact, irreconcilable?
It has always been the FSA's objective that its enforcement process should be efficient and effective, and not only be fair (which is, of course, required by law), but also be seen to be fair. Is it possible to achieve both of those aims? You could be forgiven for thinking, when you listen to people talk about the enforcement process, that the two are mutually exclusive, that an increase in efficiency must automatically lead to a decrease in fairness or vice versa, but is that really right? Is it the correct premise that fairness and efficiency are to be put on different sides of the scales? I believe this is too simplistic.
To take one example - speed. Concluding investigations more quickly is often, indeed almost invariably, talked about under the heading of increasing efficiency or improving effectiveness. Clearly if we can conclude cases more quickly it is more efficient for the FSA: it allows us to release resources to focus on new priorities. It is also more effective in that, as we have always made clear, one of the principal purposes of the use of the FSA's Enforcement tool is the deterrent effect that enforcement action can have. That deterrent effect can be significantly reduced if, by the time the outcome of the case is known, the issue is one of historic interest only.
I would, however, venture the opinion that speed is not just about effectiveness or efficiency. In fact it is also an essential component of fairness. Conducting investigations more quickly means that it is more likely that we will be able to ascertain the true facts of the matter - as the recollections of the subject of the investigation and the witnesses will not have been dimmed by time or clouded by hindsight and documentary or other evidence is more likely to remain intact. Further, the costs, inconvenience and pressure that we recognise can be caused by an enforcement investigation will be brought to an end more swiftly. It therefore seems to me that even taking the paradigm example of a matter which could be said to be efficiency driven, there is a clear and indisputable fairness angle to it too.
Of course there can be times when the requirements of fairness will lead to delays in concluding a matter. We absolutely accept, and believe we have demonstrated, in particular, through the Enforcement Process Review that we are committed to ensuring that our process is not only fair but is also seen to be fair. Some of the structural changes we have made in order to address concerns about perceptions of unfairness will add delay to the process, for instance the legal review conducted within the Enforcement Division by a lawyer who has not previously been part of the case team and the consideration of papers submitted to the RDC by its own independent legal adviser. We believe, however, that in contested cases those measures are important to retain confidence in the process. Without that confidence we cannot truly say that the enforcement process is effective. If the regulated community do not believe in the integrity of our enforcement process our decisions will be devalued and their usefulness to us in transmitting FSA messages will be lost. Again, therefore, I do not see the steps taken to ensure that the process is seen to be fair as being contrary to our objective of achieving an effective use of the enforcement tool.
As a result of the end to end review which was conducted in 2004, which focused on improving our efficiency, and the Enforcement Process Review which focused much more on addressing concerns about the fairness of the process, there has been a considerable focus on how we investigate cases and how decisions in those cases are taken. The end to end review, for example, introduced the concept of scoping meetings, as an early way of identifying and addressing issues in a case with a firm and enabling us to make rapid progress in our investigation. I would note in passing that we can only achieve this aim where scoping meetings are approached by firms in the same spirit rather than being seen as a way of challenging the question of why the firm is being investigated at all. The end to end review also introduced internal reviews which enable us to close cases more quickly where we perceive that, in fact, the situation is not as we had originally thought or it is clear that disciplinary action is not the appropriate tool. You will no doubt also be familiar with the recommendations of the EPR and, in particular, the significant changes made to the RDC structure and policies which ensure a greater transparency of the decision-making process and clearer separation between the RDC and Enforcement. Obviously right at the end of the decision-making process there is the Financial Services & Markets Tribunal (created by the Financial Services & Markets Act and administered by the Department for Constitutional Affairs) whose independence is incontrovertible as demonstrated by the fact that it can, and does, disagree with the FSA.
Our perception from the formal and informal feedback we have received, is that, following these two reviews, people are broadly comfortable that the FSA's investigation and decision-making processes, and just as important, practices on the ground are fair and that our commitment to achieving that fairness is recognised. I would like therefore to focus on something which does still seem to spark controversy and debate and where, whatever we have said before, there still seems to be confusion. Specifically, I want to talk about the FSA's overall approach to the use of enforcement and, in particular, why certain matters end up in Enforcement when others do not. This is often described as a question of fairness but is also an issue which is clearly related to efficiency and effectiveness.
The starting point here is to reiterate that the FSA is a risk-based regulator. We currently regulate some 30,000 firms and approximately 165,000 individuals. The FSA's approach to its regulatory responsibilities has to be sufficiently flexible to deal with the very different types and sizes of firms and markets that we regulate. The approach ranges from large firms having a dedicated supervision team and close and continuous supervision, through medium-sized firms who have a relationship manager but will not receive one hundred per cent of that individual's attention, to small firms with individually low impact on our statutory objectives whose relationship with the FSA may be primarily through the Firm Contact Centre. We also seek to address cross-cutting industry issues across all sizes of firms through thematic work where firms operating in a particular industry or offering a certain product might be selected for a thematic visit. Themes are, in general, selected to enable the FSA to improve its understanding of particular industry areas or to assess the validity of concerns we have about risks those areas may present to our objectives. The Enforcement Division investigates cases arising in all areas and all types of firms. That is because we believe the most efficient way of carrying out statutory investigations and pursuing disciplinary action to support the FSA's priorities is to have a specialist Enforcement Division. The Division, however, while separate, is fully integrated with the rest of the FSA.
You only need to look at the number of Final Notices issued by the FSA to see that the vast majority of rule breaches are not addressed by the FSA taking disciplinary action. Nevertheless Enforcement is, as John has already mentioned, an important part of our overall approach which we use, and will continue to use, to support our overall supervisory strategy. Our risk-based approach means that not every matter will be suitable for investigation by Enforcement. Decisions as to what, on a strategic level, might be a suitable area for use of the Enforcement tool are made by supervisory areas.
I want to make it absolutely clear that in considering this, supervisors will take into account a range of factors such as, for instance, whether the issue is one of significance to the FSA – does it pose a threat to our statutory objectives, is it widespread, what would the potential impact of a disciplinary outcome at the end of an investigation be, would it encourage others to improve their behaviour or encourage consumers to take more responsibility for their decisions? How much do we need to do to achieve a deterrent effect in a particular area and who are we trying to deter? Could we achieve the desired effect – which may be an industry-wide or a firm specific effect – by using other tools; what are the cost/resource implications of pursuing particular areas.
Enforcement does not prowl the corridors seeking out potential cases. After the priorities have been decided we do, of course, then discuss, on an individual case basis, whether an enforcement investigation is appropriate and whether there are grounds to appoint investigators: I will return to this below.
There has long been a perception by large firms that the size of firm is directly related to your likelihood of being referred to Enforcement. Similarly, there is a view that if you are selected for inclusion in thematic work undertaken by the FSA, you are more likely than other firms operating in the same area who are not included in the thematic visits, to end up in Enforcement. The first thing I should say is that clearly there is an element of truth in this. We devote far more of our supervisory resources to high-impact firms. Accordingly it is more likely that problems in those firms will be identified through day-to-day supervision work and, given the nature of some of those firms, where such problems are identified the potential impact can be of great significance. Accordingly, an enforcement investigation with a possible disciplinary outcome may be appropriate. That is not to say that simply the fact that a firm is large will by itself be a reason for contemplating enforcement action as a tool to address a particular issue, rather than any other supervisory tool. It is, however, important that there is an understanding of the reality of the way in which we go about our business which may make investigations by Enforcement of larger firms more frequent and for which we make no apology.
So far as thematic work is concerned, the reality again is that work is undertaken in areas which the FSA thinks are important and which potentially present risks to its statutory objectives. There is no presumption that some or all of any sample of firms visited as part of a theme will necessarily be referred to Enforcement. However, where issues are identified in firms which are visited as part of a theme these will be considered for referral to Enforcement as they would if they had been discovered in any other circumstance. And, by definition, the fact that they are in areas that are of importance to the FSA means that, following our risk-based approach through, they are proportionately more likely to result in us determining that an investigation should be carried out by the Enforcement Division than issues in lower priority areas.
This approach is all about how we, as an organisation, can use all of our resources – including Enforcement – effectively and in a targeted manner, ensuring that where Enforcement is used it really adds value.
Firms often express some concern about this and about the element of 'rough justice' which this seems to involve. Is it really fair that investigators were appointed to look into my affairs and my business when Firm X down the road is doing exactly the same thing and no investigation is being conducted into them? Superficially, we can of course understand that argument. However, I think it is instructive to consider other factors. Very few of those that suggest that this risk-based approach to selection of cases is 'unfair' would suggest that it was necessarily unfair that some people who are caught doing 70 in a 30 mile an hour zone are fined for speeding whereas others who are not spotted are not. You would not suggest that if the police were able to identify in a way which was evidentially sufficient, five of a group of 100 people causing public disturbance or rioting, that it would be inappropriate to take action against the five because the 95 were not able to be pursued.
Often here I think this complaint of 'unfairness' is really about consistency. The reality is, of course, that the circumstances of two firms are never identical. There are infinite variables between firms, their market position, the way they are managed, their relationship with the regulator and so on and so forth as well as in the information we have and when we receive it. This means that judgments can be, and are, made as to whether or not an investigation by Enforcement is an appropriate tool to use in a particular set of circumstances. And let me make it abundantly clear, that particular set of circumstances includes, by definition, as part of our assessment of whether or not something presents a risk to our objectives, an assessment of whether or not a matter that we are looking at, whether it be insider dealing or financial promotions or any other matter, is something which is of concern across the industry.
We often talk colloquially of cases being 'referred to Enforcement'. In fact the formal step in the process is, of course, the appointment of investigators most commonly pursuant to Section 168 of the Act, which requires that there be circumstances suggesting a breach may have taken place. That means that we could, if we wished to do so, have many more cases dealt with by appointment of investigators whether or not that ultimately led to disciplinary action being taken. That is not, however, the way the FSA chooses to organise its resources. We do not believe that would be efficient or effective. We want to reserve our use of our investigative resource for cases where a potential disciplinary outcome might add value to our overall approach in a particular area. You will, therefore, continue to see that most breaches of rules or principles are dealt with by Supervision or tools other than Enforcement, for example the use of Section 166 Reports. We do not think the use of different tools for different circumstances is, in fact, unfair.
I would also like to say a word or two on what appears to be a common misconception – i.e. that if you are colloquially 'referred to Enforcement' or more technically if an investigation is commenced under S168 that is part of an inexorable path towards a formal disciplinary outcome. This is simply not the case. Excluding our threshold conditions cases, in 2005/2006 37% of matters investigated by Enforcement concluded with no formal disciplinary action being taken. In a further 9% of cases private warnings were issued. So, you can see, I hope, that we do genuinely commence our investigations with an open mind and with a view to establishing the facts – not pursuing disciplinary action at any cost.
As I hope I have made clear, we accept that consistency in the way we assess which cases should be investigated by Enforcement is important and we accept that we must be fair in this process. We accept that we must look objectively, calmly and fairly at the facts of a particular referral to assess whether or not it meets the test under S.168 for appointment of investigators. But we do not accept that that fairness requires that no firm is ever investigated unless every other firm meeting the same criteria, whether we know about them or not, is also investigated. Nor do we accept that our choice to use investigation by Enforcement and appoint investigators rather than use a supervisory tool in a particular area is a matter which goes to the question of fairness. Rather, it is a question of how we put into practice the FSA's risk-based approach, how we use our resources effectively and efficiently and how we ensure that we are an effective regulator which is about much more than just being an effective enforcer.
Well thank you for listening to me. And I hope you enjoy the rest of the day.