Enforcing Financial Services Regulation: The UK FSA Perspective
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Speech by Margaret Cole,
Director of Enforcement, FSA
European Policy Forum
4th April 2008
The challenges we face in today's turbulent times make this an opportune moment for a robust debate about regulatory philosophy including the area of enforcement. We live in interesting times and it is always right that we should keep our approach to the job we do under review, and make changes if we need to make sure we are fit for purpose. That is a commitment we made in relation to our review of Northern Rock. Our conclusions there were that we must significantly enhance our supervisory skills and resource.
I recently spoke at a major conference of securities regulators and compliance practitioners in the US. In all the major sessions of the week senior regulators in the US expressed their admiration of the FSA. Just this week, the US Treasury's Blueprint recommends the merger of the SEC with the CFTC operating on a principles based model. All of the major regulators are actively engaged with working out how they too can adopt a principles based model. Some are already drafting their own principles which look remarkably like ours, although they all seem to prefer the idea of 10 principles to our 11.
In today's refined atmosphere I have to issue a disclaimer. I am the FSA's director of enforcement. I am not going to attempt a detailed analysis of Professor Coffee or Professor Ferran's work. I am not going to tackle Professor Coffee's main hypothesis that the cost of capital is lower in the US than the UK because of a more intensive enforcement regime in the US. I think there are many other factors that come into play and I am not sure that the premise that US markets are cleaner is right either. Recent market timing issues in the US suggest the UK and US are facing similar patterns.
I would like to offer some observations on what I think enforcement activity is about, how we approach it at the FSA and what we have done over the last two or so years to equip ourselves for the challenges we acknowledge that we face. We are all agreed that market cleanliness is the goal and it is critically important to the success of our markets. Clearly in that respect at least we dream the same dreams, we want the same things.
It is fair to say that when Professor Coffee's article was published late last year, it didn't exactly receive totally favourable reviews. This from the country that gave us Enron and Worldcom was the response of the London Evening Standard. More reasoned observers noted that leading figures in the US, such as Secretary Paulson and Mayor Bloomberg tended to a different and less rose tinted view of the US market's competitive position.
But Professor Coffee's report does raise an important question – one that we had already spent time considering – how much enforcement should we be doing, what sort, and what effect will this have on market behaviour. This is not just a subject troubling the FSA and leading academics any more – current conditions – see for example the unsubstantiated market rumours that affected the financial sector – have firmly put the spotlight on this area.
And that goes for the other side of the pond as well. I also saw in yesterday's US papers that the SEC is to be investigated by the US congressional watchdog after questions about whether it has enough staff and funds to police the markets. This seems to have been triggered by the fact that the total value of the SEC's fines have halved last year.
But let me move on to talk about the FSA's philosophy on enforcement. Enforcement is one of the tools we have available to tackle non compliant behaviour. We obviously want to deter wrongdoing across the full range of our remit and to bring about good outcomes whether these be fair treatment for consumers or clean markets. Ex-ante supervision is an important part of this approach reducing the need for ex-post enforcement. The emphasis and resource we give to supervision clearly distinguishes us from the SEC. But we know that it is also vital to have a credible enforcement strategy. As a risk based and proportionate regulator we describe our use of enforcement as "strategic" because we do not attempt to punish every single violation we find through enforcement penalties. Sometimes the right result can be achieved through a remediation programme against the backdrop of supervision.
Where enforcement is key is where we need to be visible in the market place sending tough messages about wrongful behaviour and imposing sanctions (which doesn't just mean fines) which are severe enough to have deterrent effect. We recognise that we need to do enough enforcement cases of the right sort to have "demonstration effect" to bring about our strategy of "credible deterrence."
Today's discussion is focussed on insider dealing. Shifts in approach take time to accomplish. Enforcement cases have a long lead in time – especially the more complex hard fought ones – criminal prosecutions for insider dealing always fall into this category. Even when the facts seem relatively simple there is rarely any direct evidence and circumstantial evidence must be pieced together by painstaking investigation and the application of dedicated staff with good noses and the right skills and experience.
We decided two years or so ago that we needed to do more in the fight against insider dealing. We are very serious about this task – we also recognise that it cannot be a short term strategy. It is linked to our work on market cleanliness. We are the only major regulator to attempt a detailed study to assess the cleanliness of the markets. We publish this report – it is a visible sign of our commitment to making progress in this area.
For the last two years or so I have been signalling our intention to use our powers as a criminal prosecutor. Why? Its a direct reaction to the findings of the market cleanliness study, anecdotal evidence from the marketplace and the media, the things we see as a result of real time market monitoring, and the belief that criminal prosecution where a custodial sentence is a real risk will act as a stronger deterrent than a civil/administrative market abuse prosecution under FSMA, even though we have the power to impose unlimited fines. I don't think this can be described as being enforcement averse. It is a significant shift of emphasis for the FSA and it comes with risk. Commentators are always eager to point out the UK's poor record on prosecutions for insider dealing.
I have said that this is a long term strategy. We cannot afford to change this strategy if we hit choppy waters. If we are to make a significant impact in this area we must prosecute a steady stream of insider dealing cases, gaining the invaluable experience that will bring, and learning what we need to learn from cases where we fail to gain convictions. The inevitable fact that not every case will be successful does not undermine the strategy.
And there is something else I need to be clear about. We are often likened to the SEC. The SEC can only bring civil proceedings. The DOJ can only bring criminal proceedings. We can do either and this implies choices. I expect to see us bringing criminal prosecutions and I expect us also to use our internal administrative and Tribunal processes to bring market abuse cases under the Act. We can only bring criminal cases where they pass the test for crown prosecutors. We must be satisfied that there is sufficient evidence to secure a "reasonable prospect of conviction" and, if that hurdle is achieved, that it is in the public interest for us to prosecute the particular offence.
We also need to accept the practical reality that a criminal case will be heard by a jury and that, historically, juries in this country have struggled to convict in insider dealing cases. Perhaps this has something to do with the lower level of retail ownership here or the absence in the UK of the high profile corporate scandals such as Enron where the man in the street more directly feels the effects of the greed and dishonesty. These are choices we will make case by case. The message for you to take from today is not that FSA switches tack and does criminal cases – but that FSA is determined to use all the avenues, powers and tools available to it, and expects to present a tougher all round edge.
That brings me neatly to another topical subject, immunity agreements and plea bargaining. I have met my counterparts at the SEC many times. A common theme in our discussions is that what really makes the difference for the SEC and DOJ when they are building the evidence to bring a case is the co-operating witness. In most cases being contacted by SEC investigators will prompt a participant to come forward and offer testimony in return for some form of leniency. In the US this is plea bargaining. It is something which the UK justice system until recently did not formally approve of. There is movement here with the announcement yesterday of the AG's proposals.
In the UK under the common law there has been a different sort of power – again not much used, again regarded with distaste – the power to give immunity from prosecution to a participant, typically a lesser actor, in return for hard witness evidence against other participants. Certain prosecutors have also been given this power on a statutory basis under SOCPA. The FSA was not a specified prosecutor. Last week the Chancellor announced that we would be added to the list of specified prosecutors to equip us with more of the tools we need to tackle insider dealing. This will not bring overnight success – it is only part of the picture. But giving us this power is important messaging.
As I already said, evidence gathering and building a case requires careful painstaking work by skilled enforcement staff, both investigators and lawyers. It also requires the backdrop of robust processes and procedures. In 2005 we reviewed and amended our procedures and practices in the Enforcement Process Review (interestingly the SEC is under further pressure to review its processes). And last year we looked carefully at the skills and experience that we needed in the Enforcement Division and carried out a major change programme which has seen us recruiting actively to fill a number of vacancies at more senior levels, including criminal barristers and staff formerly with the serious fraud office. We are building a team of lawyers and investigators with the depth of knowledge and experience to tackle the very difficult challenges we face in our work. That recruitment programme is largely complete and we are now in a very strong position to seize the momentum and push forward our agenda of credible deterrence. We have a strong, committed Enforcement Division. Professor Coffee as a result of a misunderstanding states that we do not have full time permanent staff. That is wrong. We have around 250 permanent staff in the Division and they can be supported if necessary by the outside bar. We are acutely aware of the practical real life challenges we face and we don't shy away from the task. We know that we will be judged, in time, by our results.