FSA Investigations & Enforcement 2007 : A Practitioner's Guide for Regulated Firms
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Speech by Margaret Cole, Director of Enforcment, FSA
City and Financial Conference
24 January 2007
Good morning and welcome to you all. I am very pleased to have been invited to speak to you today. I have been billed to talk about the FSA's evolving approach to Enforcement and that topic gives me quite a bit of scope to talk about some of my favourite things – like our philosophy behind enforcement activity, the use of enforcement to change behaviour in the interests of accomplishing the FSA's overall strategic agenda, and the way the Enforcement Division goes about its business. I also want to say something about our experience of the first full year post EPR. But first, a bit of shameless praise of UK plc’s achievements.
2006 was a very successful year for the UK’s financial services industry – demonstrated not only by the large bonus and pay awards reported in the press but by the record-breaking number of IPOs on the London Stock Exchange. London, ahead of Hong Kong and New York, is now the most popular place for companies to float new stock listings. Last year, in 89 IPOs, companies raised £29.4 billion in capital on the main market of the London Stock Exchange. This was more than the New York Stock Exchange and NASDAQ combined!
There are no doubt many reasons why capital is increasingly attracted to London. At the FSA we believe that our risk-based approach to regulation has bolstered London's status as the world's leading centre for mobile capital. We find support for this in the views of various commentators. Only this week a McKinseys report commissioned by the Mayor of New York commended the FSA's enforcement style as being more measured, results driven and effective. We, of course, welcome such praise but we cannot afford to rest of our laurels – there are always risks lying just around the corner waiting to catch out the complacent regulator.
For example, a recent report by BDO Stoy Hayward has suggested that there has been an increase in financial fraud in the UK. The implication is that financial fraud has followed the migration of stock offerings. The FSA takes the risk of financial crime, and our objective to reduce the extent to which it is possible for a business to be used for a purpose connected with financial crime, extremely seriously. We recognise that the risks in this area inevitably evolve quickly and we have to be fleet of foot in our responses to match them.
As announced on Monday, we have established a new Financial Crime and Intelligence Division to lead the FSA's work in this area and meet the increased challenges ahead. We want firms to focus on the outcome of reducing financial crime in a risk based fashion. Consistent with our approach in other areas, we will look to senior management to deliver effective and proportionate systems and controls that are embedded in the firm’s practices to achieve this end.
The FSA is concerned with three broad areas in financial crime – fraud, money laundering and market abuse – and we work closely with other agencies including law enforcement and other regulators, in this area. We will also look carefully at the possibility of bringing enforcement actions to support our financial crime objective.
There are close synergies between our financial crime objective and our objective to ensure orderly, clean and fair markets. I want to pause on that point for a moment as I think there are some important things to say. This year, as last year, tackling market misconduct is a key priority for our Wholesale Business Unit and thus for the Enforcement Division in our role supporting the business units. We will continue to investigate and, where we can gather the requisite evidence, prosecute cases of market misconduct. We will use all the options at our disposal in an Enforcement context, administrative proceedings under section 118 of FSMA, criminal prosecutions under the Criminal Justice Act and the use of our Principles, specifically Principle 5.
What I find disturbing when I talk to market participants and practitioners about market misconduct is that we still see a blind spot when it comes to associating market misconduct with financial crime. Some people, it seems, don’t believe that market manipulation, market abuse and insider dealing is as serious an issue as fraud. There is still a way to go in bringing about a cultural shift in this area. This is why it is important that we keep this subject high on our agenda. We take our responsibilities with respect to market integrity very seriously and we are determined to make inroads into changing behaviour in this difficult area. But we have another limb to our strategic approach. We want to intensify our focus on working with the industry to combat market abuse.
Although we have a statutory responsibility, we consider that there is a moral responsibility on market participants to work proactively to preserve the integrity of the markets. But it is not just about moral responsibility – there are sound economic reasons in ensuring the cleanliness of UK markets and their overall attractiveness to investors. We are looking for heightened co-operation from firms and we encourage a broad view in identifying matters of concern not just through suspicious transaction reporting process. Where firms identify market abuse through their closeness to a particular market (and not a suspicious transaction) we would still encourage reporting to us. I believe that market participants will benefit in their relationships with the regulator by accepting that they have an important role to play here. We have seen some significant progress here but we want to see more.
With several successful Enforcement outcomes last year, we believe that we have made a real impact in punishing the types of behaviour which are not acceptable and serving notice to the market. I want briefly to mention some of these cases as I expect there will be the opportunity later today for you to examine them in greater detail.
The first case I want to mention is Deutsche Bank. We fined Deutsche Bank £6.3 million for breaches of Principle 2 – failing to conduct its business with due skill, care and diligence – and Principle 5 – failing to observe proper standards of market conduct. The conduct we found unacceptable in this case concerned two separate transactions – material trading that was not transparent during a book build in shares and stabilisation of shares on the Swiss Exchange. We also fined a senior employee Mr David Maslen £350,000 for being knowingly concerned in the Principle breaches by giving proprietary trading instructions during a sensitive time during the book build. We are committed to act against institutional market misconduct and this case highlights the standards we expect of firms involved in running book build transactions.
More recently, in November we fined Sean Pignatelli for breaching Principles 2 and 3 for failing to exercise due skill, care and diligence and failing to observe proper standards of market misconduct when carrying out his role. Mr Pignatelli, an equity salesman at CSFB, had received an analyst's email which was worded in such a way as to appear as though it might have contained inside information. Despite the warning signals, Mr Pignatelli did not discuss the email with his senior manager or Compliance and in fact, he then proceeded to embark on a series of calls to clients passing on the information and giving the impression that it was inside information, when in fact it was not. This was the first reported case of “outsider dealing” and had a big market impact, emphasising the care and attention that Approved Persons must give to the information they disseminate to the market. Feedback from firms suggests that this case has really hit home with traders who are asking compliance lots of questions about what is or is not acceptable.
The FSA’s investigation into the conduct of GLG and Philippe Jabre was an important case for a number of reasons. Firstly it concerned that most topical of subjects – a hedge fund. In this case the misconduct concerned Mr Jabre short selling restricted stock after being wall crossed. As with many current investigations, there was an international dimension and in this instance we benefited from significant assistance and cooperation by the Japanese Securities and Exchange Surveillance. The Tribunal also made two important decisions about the scope of market misconduct and their jurisdiction. It has been made clear that it is not possible for someone with confidential information on a UK traded stock to circumvent the market abuse regime by trading in that stock on an overseas exchange. Following a contested hearing on a preliminary issue, the Tribunal also confirmed that it is open to it to impose a different and greater sanction than that imposed by the RDC in its original decision. Both GLG and Jabre were fined £750,000 each for market abuse and breaches of our Principles.
In the Parker case the Tribunal also confirmed the principles to be considered when determining penalty based on the factors listed in Chapter 13 of the Enforcement Manual. Following the Tribunal's judgement, the FSA fined Mr Parker – a senior accountant employed by a listed company who engaged in market abuse by dealing in and spread betting on shares – £250,000 for market abuse.
We also acted in the reinsurance markets and fined GenRe £1.225 million for arranging two improper insurance transactions. We found that GenRe UK breached FSA Principle 2 by not conducting its business with due skill, care and diligence and FSA Principle 3 by not organising and controlling its affairs responsibly and effectively. The FSA's action reinforced the message that both conventional and finite reinsurance transactions should only be used where there is a legitimate commercial purpose and sufficient risk transfer. The FSA will take robust action against reinsurance firms and their staff who act in contravention of these basic principles
Whilst mentioning our successes on the Wholesale side I shouldn't avoid touching on the Tribunal's decision in the case of Mr Davidson and Mr Tatham. We have looked long and hard at the decision and the lessons that we can learn from it. In this instance we decided not to appeal but to get on with the difficult challenges that we face in the future. We consider that much about this decision was fact and case specific and we do not therefore envisage that the costs decision will have major implications for the way we go about our work. It will not deter us from taking on difficult cases nor will it alter our resolve to pursue appropriate cases.
Having spoken about market misconduct – a major wholesale priority – I want to say something about our major priority in our retail area, which is the Treating Customers Fairly initiative. 2007 will be an important year for the TCF initiative – it’s the year in which we are expecting to see notable progress in firms implementing TCF programmes and actually bringing about change in their front line interactions with customers. We have said that we expect to see measurable change in outcomes for consumers this year. This is a major priority for our retail business unit and the Enforcement Division will support the Retail Business unit by targeted investigations and enforcement action.
We have publicly stated that we are more likely to take enforcement action in cases where a firm has not responded to indications that there are problems, has failed to identify shortcomings and develop a strategy to deal with them, where there has been a serious breach of Principle 6 or other relevant principles, or where there has been significant actual or potential consumer detriment. We expect senior management to take responsibility for ensuring that their firms treat their customers fairly including identifying risks, having appropriate systems and controls in place to mitigate these risks and ensuring that these are effective. Where we detect a breach which requires enforcement action we will consider taking action against individuals if we consider that senior management have failed in their responsibilities.
In 2006 you will have already seen some important Principles based cases in the TCF area. Last year we published disciplinary outcomes in relation to six firms investigated for TCF failings, particularly in relation to the selling of payment protection insurance – a key thematic area we have identified and worked on. Fines ranged from £56,000 for Regency Mortgage Corporation, to £270,000 for home shopping company, Redcats, to £455,000 for insurance broker Loans.co.uk. All these companies breached Principles 2, 3 and 6 in their poor PPI selling practices. Our aim in taking and publishing action is not only to ensure that the specific customers are treated properly but to change industry behaviour. It was interesting to note that the published outcomes in respect of some of these cases appeared to generate a more general debate about PPI and selling practices. We expect senior management to review these cases and pick up on any lessons learned for their firms’ systems and controls. You can expect to see more PPI-related outcomes in the near future.
I have been talking for a while about published outcomes but I do also want to make the point that achieving the right regulatory outcome in investigations is not just restricted to published outcomes, although there are many. There have been instances where cases have been investigated and revealed new facts that mean that the case does not warrant further investigation or action by FSA Enforcement. This can occur at various stages of investigation, even, as occurred recently, after representations have been received by the RDC.
I highlighted earlier the use of enforcement activity to bring about changes in behaviour. The purpose of Enforcement is both specific and general deterrence, not just to punish the individual wrongdoing but to send a wider message to a wider audience to achieve change. But Enforcement is only one of the tools we have available to deal with non-compliant behaviour. In deciding on the appropriate regulatory outcome we will recognise that the approach we take to firms that consistently behave well with the regulator and address issues proactively can and should be different to those where we do not see that behaviour. That might mean in some cases that a matter might be dealt with entirely by supervisors, in others that, although we investigate, no formal disciplinary action is taken, or that the sanction and/or public statements about the matter will be less severe than would otherwise be the case. We see all of these as quite proper "rewards" for those firms who deal with us in the right way.
I would like to draw this to an end by saying something about the Enforcement process in its first full year post EPR. We think that the changes have bedded down well – anecdotal feedback and the formal feedback meetings that take place following the conclusion of enforcement action suggest that practitioners, firms and their legal advisors accept that the new ways of doing things work well. Hopefully if I give this speech at this conference next year I wont need to talk about EPR again – it will be ancient history. Tim Herrington will talk this afternoon about how the Regulatory Decision Committee works in practice in the post EPR world. I want to focus on one particular aspect of the changes which I think has made a very significant difference in practice and on the ground – and that is the new executive settlement procedures.
You now have access to executive decision makers (drawn from a pool of FSA Directors) and can expect the FSA to respond swiftly and proactively to attempts by you to seek to agree a basis on which enforcement action can be concluded. I think there has been a real change in style around this process and I will be interested to hear your further feedback about this.
Since the implementation of the new procedures in October 2005, there have been 41 settled cases. Most firms and individuals are now proactively seeking settlement and a smaller number of cases have progressed to be heard by the RDC.
Firms and individuals can receive up to a 30% discount on their financial penalty for settling their case early. You will have seen the recent action against W Deb MVL (formally Williams de Broe) for widespread failings in its systems and controls resulting in poor accounting systems and inadequate client money protection. The firm settled early and their fine was reduced from £800,000 to £560,000.
I have said many times before why settlements are of interest to us. Early settlement is in the public interest. It allows the FSA to facilitate prompt redress in consumer related cases and achieve swift and effective outcomes so that we can utilise our resource more efficiently and move onto the next important issue. However, we are only interested in achieving the right regulatory outcome and we will not compromise the integrity of our decisions and outcomes by rushing to tie up settlements that are inappropriate. Settlements may be a sensible commercial outcome for the community – but we don't have that commercial imperative. Our settlements are published and precedent setting so we are obliged to ensure that we are getting the right outcome.
It is worth emphasising that you do not have to settle and that it is ok if you do not wish to settle. I know that there are some commentators out there saying that settlements are a bad thing because they are of less precedent value than cases that go through the RDC and Tribunal stage. When we engage in a settlement negotiation we will indicate what breaches we believe arise on the facts as they appear from our investigation. If you don’t agree with this you are not bound to settle. The RDC and Tribunal route is open to you. Equally we won't change our position just to get the deal done if we think it isn’t the right thing to do.
Whether discussions result in a concluded settlement or not, we do, however, expect co-operation and engagement. We want senior management (not just Compliance) to engage and consider the bigger picture, particularly where the issue is indicative of a wider systems and controls issue. Firms cannot just leave this to the professional advisors. Focussing on the real issues and seeking to establish the facts as quickly as possible will assist you in our eyes. Notifying the regulator at the earliest opportunity, taking action to identify the nature and extent of the problem and ensuring that lessons learnt are communicated to staff is obviously very important. So is dealing appropriately with the wrongdoers.
You will have noticed I am sure that many of the settlements we have concluded in the last year have been Principles cases and have ranged from treating customers fairly cases – for example the recent PPI cases – to market misconduct and Principle 5 cases, such as those I mentioned earlier. This reflects our alignment with and support of the FSA strategic shift to more Principles based regulation.
In the more Principles-based landscape, we want to see mature outcome-focussed behaviour from firms, individuals and advisors. We hear that you want us to be sufficiently flexible yet consistent so that you are able to run your businesses. You want to see a real regulatory dividend for good behaviour. We believe that Principles-based regulation can bring you that dividend, that flexibility and the opportunity for you take decisions that are the right decisions for you. The Principles for Businesses provide a framework and clearly set out our expectations of the right behaviour by industry participants. We are absolutely convinced of the overall merits of a Principles-based approach and the FSA is committed to using Enforcement tool selectively and strategically to support that approach.
The FSA will not be changing its priorities dramatically this year but we will continue to evolve. We will be consistent and you will know what to expect from us and what we expect of you. On the Wholesale side we will continue to focus our attention on institutional market abuse and systemic and organised instances of insider dealing. These cases present us with unique challenges and we are going to think creatively about our powers and how we can achieve effective deterrence. On the Retail side, you can expect to see more proactive warnings about potential scams and advice to consumers, some more Payment Protection Insurance cases and a continued strong focus on treating customers fairly.
We cannot achieve these aims in isolation – we need industry practitioners, participants and their advisors to engage and help us achieve our vision to ensure that London continues to be a world leader and that consumers really do achieve a fair deal.