Select Committee on Treasury Written Evidence


Supplementary memorandum by the Financial Services Authority

A.  INTRODUCTION

  1.  When we gave evidence to the Committee on 24 October, we undertook to provide further information on:

    —  what we are doing for consumers in Northern Ireland;

    —  our recent Discussion Paper on "The responsibilities of providers and distributors for the fair treatment of customers";

    —  our involvement in the Information Commissioner's inquiry into offshore information security;

    —  the Transparency Directive and suspected back-dating of stock options; and

    —  our approach to enforcement.

  2.  We also agreed to provide further information about Payment Protection Insurance and our approach to financial promotions. These are covered in Callum McCarthy's separate letter of 17 November to the Committee Chairman.

B.  THE FSA IN NORTHERN IRELAND

  3.  Our Financial Capability survey published in March 2006 demonstrated that NI fares particularly poorly relative to the rest of the UK when it comes to planning ahead, staying informed about financial matters and choosing financial products effectively. As a result, we have significantly accelerated our activity in NI:

    —  We co-chair the NI Financial Capability Strategic Partnership with the NI Consumer Council. This was established in June 2006 to help implement the FSA's National Strategy for Financial Capability in NI and brings together representatives from the public, private and voluntary sectors.

    —  To implement that strategy effectively, we have proposed to fund a Financial Capability "champion" to coordinate and take forward the work in NI identified by the Strategic Partnership. The Consumer Council is currently considering our proposal.

    —  We are working with the Personal Finance Education Group on the NI Financial Education Forum which met for the first time in March 2006. This allows participants to exchange ideas, resources and information to take forward our Schools programme and make the most of changes to the maths curriculum in NI.

    —  In September 2006, we recruited a secondee from Northern Bank to be an Employer Relationship Manager, based in Belfast, for our programme of financial education in the Workplace. With strong support from the FSA, her role is to secure further employers throughout NI and then ensure effective delivery.

    —  Also, as part of the Workplace programme, we have delivered financial education packs and seminars to the Department of Enterprise, Trade and Investment (NI). Four more employers with a presence in NI—the BBC, Business in the Community, the Consumer Council and the British Medical Association—are also joining the programme. We are encouraged by the strength and depth of interest so far and are working with employers' organisations, consumer bodies, trade unions and trade associations to really step up the pace in signing-up further employers.

    —  In collaboration with Citizens Advice NI, we are delivering training to organisations such as the Western Education and Libraries Board to improve financial capability among young adults. Workshops are to be delivered to Opportunity Youth, a charity working with the hardest to reach young people, and at resource fairs in Belfast and Londonderry with the NI Youth Service Curriculum Development Unit.

    —  Omagh Independent Advice Services (OIAS) was one of twelve beneficiaries of the FSA's 2005 Innovation Fund. OIAS received over £13,000 to produce a financial booklet and website for people with cancer and their carers. The FSA Innovation Fund team have spent several days in Omagh providing advice on the project's set up, launch and evaluation.

  4.  We are currently reviewing our consumer campaigns strategy, press relations and distribution of our consumer publications to ensure that, where relevant, these are achieving maximum impact in NI and in other parts of the UK. We will launch a specific media campaign on financial capability in NI in early 2007.

  5.  We have also been heavily involved in addressing financial crime in NI. In late 2005, we reviewed what the four main NI banks could do to reduce the possibility of their institutions being used for fraud, money laundering and, in particular, terrorist financing. Our colleagues in the Northern Ireland Office (NIO) had raised concerns that:

    —  The NI bank practice of not issuing cheques crossed "a/c payee only" as standard was leading directly to money laundering, particularly linked to fuel smuggling;

    —  procedures for handling "stained" banknotes (ie notes likely to have been obtained via armed robbery) were disjointed; and

    —  there was confusion over new staff vetting arrangements.

  6.  We visited all four NI banks in December 2005 and worked closely with colleagues in the NIO, Police Service of Northern Ireland (PSNI), HMRC, and Assets Recovery Agency (ARA). This work has led to a number of successes—since April 2006 all the NI banks issue their cheques automatically crossed "a/c payee only"; there are now homogenous procedures for dealing with stained banknotes, and we have made the banks more aware of forthcoming changes to staff vetting procedures, with the aim of enhancing banks' overall systems and controls. We continue to have bi-annual meetings between NI banking supervisors and representatives from NI law enforcement and have been invited to sit on the NI Organised Crime Task Force. Our work has helped ensure that banks and, as a result, their customers are less likely to be used as a vehicle for serious financial crime.

  7.  In addition to all the above, we continue with our usual regulatory activity including regular contact with the larger regulated firms in NI, as well as training, speeches and roadshows targeted at smaller firms in NI.

C.  THE RESPONSIBILITIES OF PROVIDERS AND DISTRIBUTORS

  8.  We believe that providers and distributors of financial products have differing but interlocking responsibilities for treating customers fairly (TCF) and need to work together to help avoid potential future detriment to consumers. We published a Discussion Paper in September 2006 to help providers and distributors understand their respective responsibilities to consumers and help improve cohesion, confidence and efficiency in the combined distribution effort. The paper sets out our view of what the existing Principles for Business mean in a practical sense. It does not introduce new rules.

  9.  The paper articulates providers' responsibilities—to design their products with greater care, to provide higher quality information, to monitor distribution channels more effectively, and to undertake better post-sale analysis of the performance of products.

  10.  It also articulates distributors' responsibilities—to scrutinise more closely information they receive from product providers and ensure that specific products are suitable for the target consumer group. This should result in fewer cases of unfair outcomes for consumers, for example, where a distributor believes on the basis of information from a provider that a product is suitable for a customer. Our paper includes a number of case study illustrations designed to help firms think through the implications of the Paper for their own businesses. The deadline for feedback on our paper is 29 December. We will then communicate our findings with the industry.

D.  THE INFORMATION COMMISSIONER'S INQUIRY INTO OFFSHORE INFORMATION SECURITY

  11.  The security of personal data is an increasing concern for consumers and the FSA. Personal financial data is increasingly held outside the financial sector for payment reasons (for example, by telephone or utility companies) and outside the UK in offshore administration and call centres. As a consequence, the reputational risk to the financial services sector is increasing. We are therefore considering the risks with other relevant regulators, including the Information Commissioner, so that we can clarify our joint responsibilities. The next steps will be to assess the relative roles, responsibilities and resources of these other regulators to decide how and when we should examine collectively the methods used by all types of firms to protect and control consumers' personal data which is sent offshore. A key concern for us at this stage is that the lack of security can arise in non-financial sectors; however, the abuse of personal data always affects the financial sector in terms of both loss and reputational damage.

E.  THE TRANSPARENCY DIRECTIVE AND STOCK OPTIONS

  12.  The Transparency Directive forms part of the EU's Financial Services Action Plan and is designed to enhance transparency across the EU's capital markets by harmonising information requirements for regulated markets. The Directive will introduce requirements in three areas:

    —  publication of financial information;

    —  disclosure of shareholdings; and

    —  the dissemination of the financial information required by the Transparency Directive, including financial reports and information relating to shareholdings.

  The Directive does not deal with the granting of stock options, other than generally requiring the timely disclosure of major shareholdings (which might include potential holdings through options). Therefore, we do not believe that the Transparency Directive will have any impact on the suspected back-dating of stock options.

F.  OUR APPROACH TO ENFORCEMENT

Impact of our Enforcement Process Review on our approach to enforcement

  13.  The changes made as a result of the Enforcement Process Review (EPR) have:

    —  made a significant difference to how the FSA uses enforcement and the fairness of our processes, as well as the perceived fairness of our processes;

    —  provided greater transparency about the decision-making process; and

    —  led to better co-operation between our Enforcement Division and supervision teams.

  14.  One of the most successful and most welcomed aspects of the EPR changes has been the new settlement process under which we have, since October 2005, been able to settle cases on the basis of agreement by two FSA Directors. Indeed, the majority of our disciplinary cases are now being concluded by executive settlement.

  15.  In relation to those cases that do not settle, the introduction of additional checks and controls, such as our Enforcement Division's legal review process and the separate legal support now available to the Regulatory Decisions Committee (RDC), has significantly enhanced the stringency with which the grounds for taking regulatory enforcement action are tested before formal decisions are made by the RDC.

The impact of the Paul Davidson case and the Tribunal's test of reasonableness

  16.  The Financial Services and Markets Tribunal (the Tribunal) may order the FSA to pay the successful party's costs if the FSA's decision leading to the referral was "unreasonable" (FSMA, Schedule 13, paragraph 13). In the Davidson case, the Tribunal confirmed that its approach is to consider whether the FSA's decision was unreasonable, given the facts and circumstances which were known or ought to have been known by the FSA at the time the decision was made. On the facts of the case, the Tribunal concluded that the decision to fine Mr Davidson was unreasonable; it was concerned at the FSA's approach to the evidence, to the law, and the level of penalties. These concerns were case-specific. The Tribunal accepted that success by an individual or firm before the Tribunal does not automatically entitle a party to recover its costs.

  17.  The Tribunal also said that the matters it had identified as unreasonable are unlikely to recur in the future as our original decision was taken before the implementation of the enforcement process review's recommendations. Against this background, we are not proposing to reassess our enforcement procedures in light of the outcome of the case. We are, however, as a matter of routine good practice, considering whether there are any other lessons to be learned from the case.

  18.  We are currently in discussions with Mr Davidson and Mr Tatham about the level of costs payable to them. We will recover any costs incurred through our normal fee raising procedures.

Bringing successful prosecutions for insider dealing

  19.  The Committee were interested in the practical and evidential difficulties of bringing insider dealing prosecutions. There are two avenues we can pursue when taking enforcement action for the misuse of information in relation to securities trading: we can take action under the criminal insider dealing regime or under the (civil) market abuse regime. Although to date we have brought no prosecutions under the criminal regime, we have successfully imposed significant fines (the highest to date being £750,000 fine of Philippe Jabre) under the market abuse regime.

  20.  The key challenge in prosecuting insider dealing is proving to the required standard ("beyond reasonable doubt") who it was that passed information and what that information was. In many cases where there is a strong suspicion of insider dealing (due to a timely trade, resulting in significant profit or loss avoidance, ahead of a Regulatory Announcement) there is little or no documentary evidence relating to the passage of information; accordingly, cases are often circumstantial, giving rise to a significant evidential challenge in proving who passed information to whom, and when, and what the "inside information" was—including meeting the statutory test that it was specific or precise and likely to have a significant effect on share price. As to price sensitivity, our experience is that it is difficult to find experts who are able and willing to give evidence to a court on an issue which is inherently subjective, although we are working with industry bodies, including the ABI, and firms to identify ways to provide such evidence to courts.

  21.  In addition, there are a number of defences available to defendants, including a defence of "I would have done what I did even if I had not had the information". With the vast range of sources of information available it will often be difficult for a prosecutor to be satisfied that such a defence is unlikely to succeed.

  22.  These issues are compounded because it will only be the most serious cases of insider dealing which are prosecuted under criminal law: if a fine is the appropriate sanction, we would generally take action under the civil market abuse regime (where we have an unlimited power to impose financial penalties); it is only in the most serious cases—including ones where a custodial sentence is a likely sanction—that a criminal prosecution is likely to be brought, which often brings into sharp focus the difficulty in proving beyond reasonable doubt what is usually a circumstantial case with no documentary evidence.

  23.  A further issue is, in contrast to the position in the United States, the fact that plea bargaining is not a recognised practice in the UK. Many criminal convictions in white collar crime cases in the US are secured with the assistance of evidence from co-wrongdoers in return for more lenient treatment. In the UK, however, prosecutors will not encourage suspects in criminal matters to plead guilty to an offence in return for the prosecution not pursuing more serious charges.

  24.  The giving of "Queen's evidence" by a co-accused has, on the other hand, now received legislative endorsement. The Serious Organised Crime & Police Act 2005 (SOCPA) clarified that prosecuting authorities may grant a suspected offender an immunity from prosecution in return for the offender's assistance with the prosecution. This power was available at common law, but the Act provides a statutory framework for its use. SOCPA names certain "specified prosecutors" who may exercise the statutory powers to grant immunity etc. Currently the FSA is not a specified prosecutor.

  25.  We are considering the extent to which it is open to the FSA to conclude agreements with potential suspects in criminal cases in return for their cooperation. It would be desirable for the FSA to be included in the list of prosecutors who have recognised statutory capacity to grant immunity in appropriate cases (the prosecutors who have such power are the CPS, Revenue and Customs Prosecution Office, the SFO and the Northern Ireland Director of Public Prosecutions Office). This would send a powerful message to the market about the FSA's commitment to protecting market integrity and the action we will take if necessary.

Suspicious transaction reports

  26.  The Committee were interested to know how many suspicious transaction reports received by the FSA have led to enforcement action. Between 1 July 2005 (the coming into force in the UK of the mandatory suspicious transaction reporting regime) and 1 November this year, we have received 266 suspicious transaction reports. Of these, 12 have been referred to our Enforcement Division for formal investigation.

Takeover announcements and insider information

  27.  The Committee were interested to know the basis on which the figure of 28.9%—the proportion of takeover announcements that resulted in a potentially significant sign of insider information—was calculated. Our sample included the 102 merger and acquisitions which were announced between January and December 2004. Of these, 57 announcements were deemed to be "significant" (ie they resulted in a significant price movement in the relevant security) and 22 were considered to be indicative of an informed price movement. However, the figure for informed price movements needed to be adjusted for statistical bias since, even if there is a large price movement ahead of an announcement, this may have had nothing to do with insider trading. After these adjustments were applied, this produced the percentage figure that, of the "significant" announcements, 28.9% were indicative of informed price movements.

November 2006





 
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