UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 1143-iii

House of COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE

PUBLIC ADMINISTRATION COMMITTEE

 

 

EQUITABLE LIFE

 

 

Thursday 13 November 2008

SIR HOWARD DAVIES, LORD NORTON OF LOUTH, MR TOM WINSOR,

MR IAN COWIE and MR JOHN KAY

Evidence heard in Public Questions 231 - 287

 

 

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Oral Evidence

Taken before the Public Administration Committee

on Thursday 13 November 2008

Members present

Dr Tony Wright, in the Chair

Paul Flynn

Kelvin Hopkins

Julie Morgan

Mr Gordon Prentice

________________

Witnesses: Sir Howard Davies, former FSA Chair, Lord Norton of Louth, a Member of the House of Lords, Former Constitution Committee Chair, Mr Tom Winsor, former Rail Regulator, Mr Ian Cowie, The Telegraph, and Mr John Kay, Financial Times, gave evidence.

Q231 Chairman: Could I say how grateful we are to you all for coming along this morning. We lost one witness, Patrick Collinson from the Guardian, because he is ill, but we are delighted that John Kay has been able to join us instead. As you know, we have been taking evidence on the whole Equitable Life issue following the report of the Parliamentary Ombudsman. Having taken some evidence from the Ombudsman and from the various interested parties, and before we took evidence finally from the Government, we wanted to hear from a range of informed commentators who we suspect may have different views on it, so that we could test some of the arguments that we have been exploring so far. We are very grateful to you for coming along and giving us your spread of expertise. There are really two areas that we want to explore with you. First, can a case for compensation from public funds for Equitable Life policyholders be sustained, as recommended by the Ombudsman and all the issues surrounding that? Second, if it can be sustained in principle, what kind of redress arrangement, on what scale, and of what nature could we begin to think about? I suppose a third area is perhaps the implications of doing this for future cases. Could I start with the first area and ask people for their views at this stage on whether the case for compensation in relation to Equitable Life has been made. Perhaps I could start with John.

Mr Kay: I did not expect to have to start, Chairman. The basic question is: is there a case for public compensation in respect of regulatory failure. My starting point would be to think there ought not to be any sense that there is entitlement to such compensation but that there would be arguments for providing such compensation in cases either where the failure is egregious or where there is conspicuous hardship being caused to particular groups of individuals. That would take us on to the question: does this particular case fit into either of these categories? My perception would be that it could be fitted into these categories but it does so rather weakly. In terms of regulatory failures across the scope of regulation, this is by no means the most egregious case one could come up with and it is not at all clear that the regulatory failure could be regarded as a major contribution to the failures. In terms of the hardship caused to individuals, there may be some particular cases, particularly some with-profits annuitants, where the hardship caused is substantial, but across the piece this is not the most deprived group of people who may have suffered from ineptitude of government policy of one kind or another.

Q232 Chairman: So you come down against, on balance. In saying that, I would remind you that the Ombudsman's argument is a rather stronger one than you have perhaps characterised it as. She does say explicitly that she set the bar very high, that it was not just, as it were, ordinary regulatory failure, that this was regulatory failure of a high order, and she thinks it is that which brings it into a different category. Do you not accept that?

Mr Kay: I think that is reframing the issue as I put it of how egregious it was. To some extent, I think I may be taking a different view from the Ombudsman as to the magnitude of the regulatory failure in that sense.

Q233 Chairman: Okay. Let us work along the line. Ian Cowie from The Telegraph. The Telegraph is not an organ which generally says that public money should be shelled out to compensate people for things that go wrong.

Mr Cowie: I would disagree with you there because we also campaigned for compensation to be paid to the people who lost their company pensions recently, where a decision was at long last made that they should be paid. So we do stand up for victims of injustice where we find it and we do believe that more needs to be done to protect savers and investors. Addressing your third question last, if I may, on the point of the implications of any decision that is made in this case I think the costs of compensating the victims of Equitable Life need to be seen in the context of what amounts to a savers' strike that has been underway in this country for many years now. According to the Office of National Statistics we have seen the household savings ratio collapse from about ten per cent a decade ago to about one-fifth of that level now, depending on how you measure it. People have looked at Equitable Life and formed their own conclusions: Saving does not pay. Unless the Government takes decisive action here - and I would suggest decisive action on a scale which we have recently seen with banks in Iceland, of all places - more people will decide that saving does not pay. Putting money in a pension is no fun at all. It is the exact opposite of what every other marketing campaign urges us to do as we walk along the street, open a newspaper, switch on TV. Most advertising, most marketing says, "Give us your money and we will give you instant satisfaction." Pension providers say, "Give us your money, we will lock it away for several decades and when you are very old, which may be a very distant prospect, we will endeavour to provide you with a comfortable retirement." It is not an easy sell. It is an even more difficult proposition when people can see intelligent, well-educated, professional people, accountants, lawyers, MPs, who put their money in Equitable Life and bitterly regret doing so. There are tens of thousands of effectively negative salesmen out their in the country now saying to people, "Whatever you do, don't put any money in a pension. I did. It was a waste of time." I really do not think we need to go back to the question of should compensation be paid. The Ombudsman has addressed this exhaustively over 2,819 pages of her report, there was real injustice suffered, but there is the wider question of people looking at what has happened to Equitable. Equitable was not some dot.com fund that attracted reckless investment from people seeking the highest possible returns. It was not a company that had recently been set up on the internet, as I say, based in Iceland or wherever, offering the highest rates of return. It was a company that had been around for more than 300 years. It appeared to be offering low risk investments. It was regulated, it was authorised, and it turned into a disaster.

Q234 Chairman: Your argument is that there are wider public interest reasons.

Mr Cowie: Very much so. Without wanting to go on too long, ask any actuary, ask any informed person, there is an enormous savings shortfall in this country. We can opt out of saving but we cannot opt out of growing old. The Association of British Insurers estimates it is 27 billion a year. Something has to be done about this and letting the Equitable victims continue to suffer in the way that they have suffered over the last eight years will surely make that situation worse.

Q235 Chairman: Thank you for that. Lord Norton, you know about everything, you know about the Ombudsman, you used to Chair the Lords Constitution Committee, and you did a report The Regulatory State. I would like to know what your take on this is.

Lord Norton of Louth: Thank you for making that point. I was going to make that as a lead in for qualifying what I was going to say, because I feel slightly in an uncomfortable position, being sat in the middle here, and perhaps on a limb starting on this particular question. I really can express views from two perspectives. One is a purely personal view. The other, as you say, as a former chairman of the Lords Constitution Committee where we did the first comprehensive investigation into the accountability of regulators. Speaking in that capacity, there are various points I could make that are relevant, if you like, to the second recommendation raised by the Ombudsman. Your question relates to the first, which is the remedy in this particular case. The question on which I can speak authoritatively is: What lessons should Parliament draw from that for the future? One can address this particular case, but what are the implications for preventing this happening again? I think there is an important question there for Parliament. Can it do anything? Can it put structures in place that would limit this happening again? The question you have put is one I can merely answer on a personal basis and not speak authoritatively on, from the perspective of looking at regulation per se. I think the Ombudsman has made rather a powerful indictment in this particular case. As you have said, she has set the bar high, and therefore I see this as a case that has to be looked at on its individual merits. There are possible wider implications for how the public perceive it. There are implications for regulators themselves in terms of deterring them from falling below standards in the future if there is a particularly strong compensation awarded in this case. But I look at it on a particular basis: that the Ombudsman has made a very strong report, found maladministration, and I think in principle there is a case for considering compensation on the basis of that particular report.

Q236 Chairman: I hope we can come back to some of those wider issues a little bit later. Howard Davies, you have financial expertise, you also chaired the FSA for part of this period. I just wonder how you respond to Ian Cowie's point about there being a public interest reason for the public purse picking up the bill in cases like this which are said to be of serious regulatory failure.

Sir Howard Davies: His argument, Chairman, based on the disincentives for saving, is not one which necessarily leads you to think that compensation in this case is the right answer. I think his diagnosis of our savings shortfall in this country is generally correct, but of course we have had an explosion in household debt, where household debt to GDP is higher here even than it is in the United States, but I am not sure that it is easy to prove that that is related to issues to do with either the regulatory regime generally or to the regulatory regime in relation to Equitable Life. It seems to me to be much more to do with the availability of credit, the price of credit, and perhaps, to some extent, the general rewards to long-term saving that people have received. While that is an interesting argument about savings, I am not sure if you said, "That's my main problem" that compensating Equitable Life policyholders would be your principal policy response to it actually. On the general question of whether there is or there can be a case for compensation in the case of regulatory failure, I think I would have to answer yes to that. Indeed, the complaints scheme set up when the FSA was established envisages that there could be ex gratia payments, et cetera. The difficulty is of course determining which cases are appropriate. I think the case is strongest where there is some clear evidence of alienation of funds from the original saver or depositor, by which I mean if there is fraud, for example, which the regulator might reasonably have spotted and did not spot and that has resulted in money net disappearing. If there is imprudent investment which was outwith the regulator's requirement and the regulator did not spot it and therefore there was a loss to depositors or policyholders I can see a strong case there. In this case, of course, it is a rather different issue because no one has asserted that there has been any fraud in Equitable. Equitable's investment performance was, I think, middle of the pack. Its costs were relatively low. We are not talking about money that disappeared from Equitable policyholders in total which happened as a result of regulatory failure; we are essentially talking about an issue of distribution within that fund between different classes of policyholders and a fund that over-distributed, it would now appear, at certain times and therefore was left with inadequate funds to meet promises given to other policyholders. That is a case where it is much more difficult to establish the principle that there should be compensation for regulatory failure.

Q237 Chairman: Are you accepting what the Ombudsman has said? She says there were ten areas where there was maladministration, five of which applied to the FSA, and she documents each one. I am not sure whether you are accepting that or whether you are resisting it.

Sir Howard Davies: I am sorry, you had not asked me that question. Of the ten I cannot comment on the first. That applied to a period for which I was not responsible and where I have never seen the papers at all. As for the later five, I have to say that I do not know what the Government's response will be. I have not so far been consulted on that response. I am not sure that I will be, except perhaps on one small point. I have not been involved in this in any way. I have not been interviewed by the Ombudsman at all. I speak against that background of having had absolutely nothing to do with this for over five years. That said, I did not find the five criticisms of maladministration of the FSA during my period there to be persuasive.

Q238 Chairman: I am sure we will come back to that as well. Perhaps I could move on to Tom Winsor. A former Regulator has expressed views on the nature of regulation. You offer a sort of informed internal/external view on this. What is your approach to this?

Mr Winsor: I should, if I may, begin, Chairman, by saying that I am an Equitable Life policyholder, like most of the legal profession, and I am also a former partner in the law firm which acted for Equitable Life since the 1740s when the company was established. How relevant those matters are, I do not know. The regulators are emanations of the State. They are the creations of Parliament. They are the custodians and stewards of a precious public interest. They are part of the apparatus of government. They are given functions and duties and they must adhere to standards, high standards - standards which in this case have been found to have been woefully neglected. There is a considerable degree of public interest, public trust, public confidence, public reliance, in the regulators doing their job properly. If regulatory failure is the direct and proximate cause of people sustaining loss, then my view is the State should pay financial compensation. Yes, in this case it is a lot of money. If it were 10 million and not 10 billion, the Chancellor would probably write a cheque to make the problem go away. The degree is not relevant. The principle is. The State has failed these people and the State should compensate them. Justice requires it. Justice at the discretion of ministers is not justice. Justice delayed is justice denied. In this case, there is a very high probability that justice will be denied, simply because ministers do have that discretion. A right without a remedy is no right at all; it is almost only a statement of honourable intent. In these cases, I think that is inappropriate. People talk about ex gratia payments as if the State is giving away something that it does not have to give away. I do not think we are in that territory. I think this is a matter for pure legal redress.

Chairman: Thank you for that. That is a good spread of views. We will explore those, if we may, for a while with you.

Q239 Paul Flynn: Ian Cowie, you mention the collapse in the faith of the public in financial products. I can recall The Telegraph in 1987/1988 being the principal cheerleader for the then government in urging people to move out of occupational pensions into money purchase pensions, which was the policy of the government at the time, which resulted in six million people being mis-sold personal pensions and I do not think they were very active in pursuing the over-selling of endowment policies at that time. Is it not true that any loss of faith in financial products goes back a long way beyond what happened with Equitable Life?

Mr Cowie: You can certainly go back as long as you wish tracing financial failures. You are quite correct, The Telegraph is a conservative newspaper and we were in favour and supported most of the actions of the government at that time. However, we also campaigned for redress for the people who were incorrectly sold personal pensions towards the end of the 1980s and 1990s. We were at the forefront of that campaign when the Securities and Investments Board was asleep at the wheel, just as the Financial Services Authority was later. We campaigned for redress on both of those points.

Q240 Paul Flynn: Yes, you have made those points, but would you not agree that many of the things that were going on in the 1970s and 1980s - it was a bit of a jungle, the whole financial set up then - were corrected by the establishment of the regulator. The regulator has been of great benefit.

Mr Cowie: As the Ombudsman's report sets out at great length, they were not corrected. It is important, I think, to distinguish between investment losses in the market, for which there is no claim for compensation. Nobody claims that the taxpayer should pick up the tab when an investment does not work out. The problem here is that over a period of a decade, as the regulator points out, these investments were sold as low risk investments. They were nothing of the kind. It was an over-promised fund in a way that only the regulator could really see. Because these are opaque products, with-profits funds, it is very difficult for an outsider to attempt to assess the balance between assets held and liabilities being written. The regulator was in a position to see that this was going on. As the Ombudsman repeatedly points out, they missed their opportunities to stop that happening, and, as a result, tens of thousands of people bought policies who would not have done so had the correct position been made clear.

Q241 Paul Flynn: This is the third major investigation. The Penrose Report and the first Ombudsman's report on this found that there was not a case to answer, and the Ombudsman said she did not want to raise false hopes after the first investigation. Do you think the reason it has gone on into this investigation now has more to say for the fact that most of the people involved are professional, articulate people, who had put pressure on the system in order to make this third investigation happen?

Mr Cowie: No, I do not. In fact, I would take exactly the opposite view. In some ways, the fact that many of Equitable Life's policyholders are professional, middleclass people has worked against them. I remember writing very, very moving pieces, if you like, about the failures of Allied Steel and Wire, one of the company pensions that went bust, again as a result of the failure of the regulators to do their job, and it was a much easier piece of journalism because these were people of very modest means who had lost everything.

Q242 Paul Flynn: You are coming to the point I want to make here. It is unfortunate that Patrick Collinson is not here but he has written on this particular area and he has raised this point. He says, "The beneficiaries will be lawyers, doctors, dentists, and dare I say journalists." He could also say "MPs and media folk."

Mr Cowie: Yes, quite. It is relatively easy to mock them but I really do not think that is the point.

Q243 Paul Flynn: The difficulty that we all see on this is that the sum involved, as is mentioned now, is not 10 million, but is likely to be 10 billion, which has to be taken from the pockets of taxpayers.

Mr Cowie: The figure in the report I think is 4.8 billion.

Paul Flynn: The Ombudsman would not give a figure, would she?

Chairman: We have heard very different figures, so it is difficult to say.

Q244 Paul Flynn: The one from the various groups involved comes to about 10 billion.

Mr Cowie: We can agree it is a vast sum. I think it needs to be seen in the context of public policy and public confidence. People will not save for their old age, they will continue to grow old and even more people than is currently the case will have to rely on state benefits. There is an argument to be made that, although, yes, the sums involved in setting up an adequate compensation fund are huge, so will the costs, going off into the future, of doing nothing. If I can be forgiven getting involved in political point scoring, which is really the aspect of this that I am not interested in - I am not here to make a case for any of the political parties, I am here to make a case for the savers who have been desperately let down - if nothing is done and even more people than is currently the case say, "Pensions are a fool's game. I won't be putting any money in a pension" - you already see articles from people boasting about the fact that they do not have a pension - those people will continue to grow old and more of them will reach retirement and find themselves reliant on state benefits.

Q245 Paul Flynn: Sir Howard Davies, can I ask you what the FSA has done compared to what was prevailing before. I think there is a great deal of concern that if we have regulators who are in a position where they have to be excessively cautious in future, because of the number of judgments they made on this in which they are likely to involve the taxpayer in spending out billions of pounds, it is likely to hamstring them in future and mean that they are unlikely to do their job as well as they have in the recent past?

Sir Howard Davies: I think I would take the view that some more caution in relation to the regulation of life insurance companies was needed at the point that the FSA took over. The original conception of the FSA in fact did not include insurance supervision, then that was added a little bit later. When we took over the relevant parts of the Department of Trade and Industry/Treasury - it was moved for a year - the numbers of people involved in the regulation of life insurance companies were very small. It was, I think one might fairly say, an ill-considered part of the DTI. It had not exactly been a place to make a great career in the DTI. There were, in total, if you took the Government Actuary's people who were separate and the insurance regulators, just under 30-35 people involved in regulating 200 life companies, which was about one-third of the resource that would be devoted to a comparable set of banks in the Bank of England. We took the view then that this needed to be beefed up and the relationship between the regulator and the life companies needed to be significantly strengthened. I also strongly took the view, which was resisted at the time but eventually was overcome, that the Government Actuary's people should be brought together with the regulators because that division had not been successful. I took the view that this needed to be strengthened, and, indeed, it has been. Subsequently there was an internal FSA report which suggested it should be strengthened further in the light of Equitable, which was then done. So I have a slightly cautious response. I think it did need to be tightened up significantly because the regulators were not in the kind of communication with these companies which I think was necessary in order to make informed judgments about them, had not been in the past. As to whether we now have the balance right, I think in the light of the current financial crisis many people would conclude that tougher regulation was needed in parts of the economy and parts of the financial sector. Indeed, my successor but one at the FSA has said - and I am sure he is right - that he needs more people in order to get a grip of the current financial crisis. This question of regulatory intensity is one that you do need to revisit from time to time, but I personally think there is a happy medium which is somewhere between what was done pre-FSA - I think in the case of life insurance companies where they went to visit them perhaps every three years if they had time - and where we are now. I think that has been a positive move.

Q246 Paul Flynn: One of the findings of the Ombudsman was that at one point there was a possibility that Equitable Life could have been taken over by another company - some white knight coming in and rescuing them. It was a serious possibility and it was a matter of decision at the time, a judgment on that. Unfortunately, with hindsight we know they took the wrong judgment. There was not anyone coming out of the wings to rescue them, but it would have been beneficial to everybody if that had happened. Will the regulators in future not be cautious against taking any risk on their policy, with an eye to this judgment now and the possibility of these monies coming in? Will that not affect the value of the regulators' job if they behave in that way?

Sir Howard Davies: I think that is an important point. Regulators do have to make in real times some very awkward judgments on the basis of imperfect information. The issue that we faced after the House of Lords' judgment was whether the company should be closed immediately or whether we should allow the company to look for a purchaser. At that time there seemed to be good grounds for thinking that a purchaser would be forthcoming. A lot of companies wanted to get into the data room with Equitable. A lot of them started on the process and, sadly, none of them concluded the process. I have often asked myself in the intervening period: Was this, therefore, a mistake? In hindsight you may say: Yes, there was no purchaser and therefore it would have been better had people not been allowed to come into the company during that period. But what would have happened had the regulator taken that view? Had the regulator said, "In the light of these criticisms we must not allow that kind of procedure to happen in the future" and you would have closed them straight away, I could imagine the outcry from policyholders, who would say, "You are denying us the possibility of selling this business as a going concern. You have with a stroke of a pen reduced our prospects of getting capital support, destroying the asset which we have, which is the name and the functioning of the life sales force and everything of the company," I think the regulator would have been exposed to intolerable criticism had he chosen that course of action when there were companies that would say, "Yes, we wanted to have a look at whether we would buy it or not" - and of course they would never have said, "No, we will not ever buy it," because they would not have got to the end of the process. I think you need a system where regulators can take that kind of judgment. There were other judgments taken in relation to life insurance around that time or a little bit later, but there were also risky judgments which at the time proved to be sensible ones. We, for example, adjusted the solvency requirements when the equity market was collapsing in 2002. Had we not done so, insurance companies would have been forced into being forced sellers of equities to meet their solvency requirements, which would have kicked the equity market down further and would have forced more companies to close. We took a risk that in changing the solvency requirements we could prevent that dangerous spiral developing and companies could re-establish themselves. That worked out. That was an example of a risk which we took which worked out, I think, quite well. Had it not worked out and had the market continued to fall even further and the funds had to sell later, then we would no doubt have been criticised for damaging policyholders' interests thereby. I think it is important for people to understand that these judgments are very, very awkward ones for the regulator to make. Sometimes they turn out well, sometimes they turn out less well, but in my view a system which did not allow regulators to make those judgments would be one which would be very hazardous for policyholders and depositors because precipitate judgments would be made on the basis of a small breach in regulatory requirements, "Close them straight away because you are going to be criticised if you do not," and I think that, in the net, would be a bad decision.

Q247 Chairman: Tom Winsor wants to come in.

Mr Winsor: I do not agree with most of that. The regulator's accountability is absolutely critical. Regulators may not be elected but they are far more accountable than some of the institutions that preceded them. They face criticism from all sorts of places, political intervention possibly, judicial review, but I think the case for financial redress is a sound one. This case is not a case of the regulators being timid in exercising judgments. Regulators who exercise proportionate, professional, competent judgments in hard cases may get it wrong but as long as they have engaged properly and in the way that I have just described then there should not be financial redress because the judgments will have been honestly and competently made. But this is not a case like that. This is, as I understand it, a case of regulators neglecting their duty, looking the other way in some respects, and not understanding their powers. Those are not judgmental errors; they are culpable errors. The distinction needs to be made.

Sir Howard Davies: I reject that, of course, in the case of the FSA.

Q248 Mr Prentice: Mr Winsor, you told us earlier that if the cost of settling Equitable was 10 million a cheque would be written, but since it could conceivably be as much as 10 billion there are other considerations. If we are talking about huge sums of public money, given what you have told us about the need for redress and so on, can there ever be a cap on public funds that could be used to compensate people who have suffered as a result of acknowledged regulatory failure or would you write the cheque whatever it is?

Mr Winsor: In order to establish a case for financial compensation you are going to have to establish that there is a proximate and direct relationship between the regulatory failure and the loss that has been sustained. That may not be easy to do and it may be that the sums involved are not as great as there, but in principle I would not put a cap on it because the citizen has a contract with the State and the regulators are emanations of the State. If the contract is broken, there should be redress and that redress should not be diminished by the willingness, the inclination, of the person against whom the redress is determined.

Q249 Mr Prentice: Is there a problem with the FSA not being accountable to the Ombudsman, having statutory immunity, and not being able to be taken to court? The FSA could, in one sense - and I am looking at you Sir Howard - walk away from its failure to regulate properly.

Sir Howard Davies: That argument was debated very extensively in Parliament on two occasions in the 1980s in relation to the Financial Services Act and then in the late 1990s in relation to the FSA. The conclusion Parliament reached in both cases was that statutory immunity was justified and that without it the regulator would be subject to a whole variety of claims - the argument typically related to claims from firms who would pursue the regulator to contest regulatory action against them - and that the system would thereby be much less effective. I note, in passing, that one of the principles of banking supervision globally, established by the Basle Committee, is that regulators should have that kind of protection and we meet that requirement. I do not think it is quite right to say that the FSA cannot be taken to court. There is provision for judicial review of FSA decisions and the Government put in place a complaints investigator and also has a power to carry out investigations into the FSA's regulation if it wishes. I think a set of compensatory mechanisms were put in place at the time the decision was made.

Q250 Mr Prentice: I am a lay person here. In what circumstances can the FSA be taken to court for a failure of regulation?

Sir Howard Davies: If you are talking about enforcement actions, there is a Financial Services and Markets Tribunal which is independent of the FSA's executive which carries out the adjudicative process on enforcement decisions, and then that can be of course appealed into the court system. Indeed, on several occasions it has been. Some the FSA has won and some the FSA has lost. In the enforcement area there is a very clear route whereby people can go.

Q251 Mr Prentice: You told us earlier that there were simply not enough people to do the job - I think you mentioned the numbers in the DTI and the numbersin the Government Actuary's Department - but you did something about it, you spoke about it at the time. Someone must be responsible, surely, for constructing a regulatory system where there simply were not enough people to police it.

Sir Howard Davies: Well, yes, I would not disagree with that.

Q252 Mr Prentice: If you were not responsible, because you inherited this situation, who was responsible?

Sir Howard Davies: What I was saying was that we inherited a situation - this was said by the Baird internal audit report on the regulation of Equitable Life in the period up to its closure - where the numbers of people were inadequate and should be strengthened. All I can be responsible for is taking account of that and strengthening. I cannot take responsibility for the regime before I inherited it.

Q253 Mr Prentice: I understand that. Were you surprised that the Ombudsman did not seek your views, interview you, when she was putting together her report?

Sir Howard Davies: Yes, I was.

Q254 Mr Prentice: Did you write to her, in a sense offering your services?

Sir Howard Davies: Yes, I did.

Q255 Mr Prentice: What response did you get from the Ombudsman?

Sir Howard Davies: This exchange occurred after I saw the report which was sent to me by the FSA in late 2007. So I had had no communication of any kind on Equitable Life with anybody between September 2003, when I left the FSA Of course, as I left the FSA, the Ombudsman's first report had concluded that the FSA's regulation had not been maladministrative, and that was the position that I left. Then I saw the report which was more or less the final report, with fully developed conclusions in it. That was sent to me in the autumn of 2007 and to my two key lieutenants at that time, Michael Foot, the Managing Director, and Martin Roberts, the Director, who appeared much more frequently in this than before. They had both been interviewed in the first investigation by the Ombudsman, as, indeed, had many other staff. As a matter of fact, I had not been interviewed at that time. I think she must have concluded that my direct role was not sufficiently germane to her considerations at that time. But we were very surprised to find that the whole process had been undertaken without any interviews of the regulatory staff and so we made that point to the Ombudsman. She did two things. One, she kindly did agree to meet us, but we both agreed that this could not in any way cure the fault of not being investigated before she had reached her provisional conclusion, and so we had a rather general discussion, not a particularly lengthy discussion. She said that the FSA had asked her not to interview former staff. The FSA say they did not ask any such thing. Since I was not in the FSA at the time, I find that difficult to reach a judgment on, but the FSA are very clear on this point. I do think this is unsatisfactory. When I read the description of the regulatory period for which I was responsible, I find that it does lack understanding of the dilemmas the regulators faced and what we were trying to do. I furthermore find it surprising that the Ombudsman should now seek to characterise the state of mind of people and say that they were reluctant or frozen in the headlights or whatever phrase she has used ----

Q256 Mr Prentice: Mesmerised.

Sir Howard Davies: Mesmerised -- which I think might cause people listening to that to think that she had talked to those people and reached that conclusion having done so. I think it is important that I say that she has not done that.

Q257 Mr Prentice: You are telling us that the Ombudsman's report is really a flawed piece of work because someone as central as you and your colleagues were never interviewed, and there is a difference in what the FSA are saying and what the Ombudsman is saying.

Sir Howard Davies: Yes, that is what I am saying to you. I think that in a process which deals with the behaviour of individuals and which at the end seeks to characterise the attitudes and mindset of those individuals, I think most people would expect that those individuals would have been interviewed in that process. I recognise that the Ombudsman has discretion. I am not saying that she has made an illegitimate decision, because I believe it is for the Ombudsman to decide how she carries out her investigation. I am not saying that she has made an illegitimate decision; I am just saying that from my point of view it produces a report which I do not think fairly characterises the mindset, the attitudes, and the dilemmas faced by the regulators at the time.

Q258 Chairman: In a way this goes to the heart of what we are trying to get our heads around. I imagine it must be the case that although Equitable Life is a particular case with particular consequences, the approach to regulation that the regulators, critically the FSA, were using during this period was common to the system. It was not singular in their treatment of Equitable Life. The common approach to regulation is one that involves the kinds of judgments that you have described across the board.

Sir Howard Davies: Yes and no, Chairman. Yes in the general sense, but I do think Equitable Life was a very particular case at the time because - and I think the Ombudsman report describes this perfectly accurately, I am not contesting her description of the sort of handover period - we inherited a very messy situation. We inherited a situation in which the regulators were in dispute with the Equitable on a whole range of issues. That was a unique situation that we faced. I do not think we took over any other circumstance where there was that kind of ongoing fundamental disagreement with the company about very significant aspects of its business and its reserving, et cetera. So it was particular in that sense, although the general question of how you reach these judgments is ----

Q259 Chairman: I have been reading some of your collected works and interesting they are. I particularly enjoyed the lecture you gave in 2003 called Managing Financial Crises. These are your words: "... our insistence at the FSA that we are not running a 'no-failure' regime. Failure is an inherent part of a flexible, competitive, innovative capitalist system. We should not aim to oversee a race in which all shall win prizes." If the regulatory context was one which says that some firms will fail: "It is not our job to stop some jobs failing. We will take proper regulatory risk assessments and so on but it is not our job to underpin the system, to offer any kind of guarantee," if that was the underlying philosophy - which is at odds, in a sense, with what Ian Cowie is arguing, that without such a guarantee on savings, why would people save - is that not a fundamental issue?

Sir Howard Davies: I do not think so. I do not think there is very much between me and Ian Cowie on this point actually. Ian accepted, if I recall, that the regulatory regime cannot underpin poor investment decisions.

Mr Cowie: Absolutely right.

Sir Howard Davies: That was really what we were seeking to do there. I do not think you should construe what I said and, indeed, my successors have said about not running a no-failure regime as being an anticipatory defence of getting the regulations wrong. I am not saying we did get the regulations wrong necessarily, but it certainly should not be read as saying, "Things will screw up, so accept that." That is not the point. We were saying that a regulator cannot create an environment in which investment decisions are underwritten and business strategies which turn out to be risky are underwritten, as long as those are properly described. Here again it is right that the key thing is how you describe things. If you set up your shingle as an investment advisor and you put on the door, "Abandon hope all ye who enter here" as long as it is clear that you are going to throw all their money away and you tell them, then in a sense that is okay - within reason. We were trying to explain that that was not a defence of not getting the regulation right or of not describing the characteristics of the institution correctly. It was saying, "The regulator cannot deal with the fact that markets will go up and down."

Q260 Chairman: Here was a mutual company. If it was not a mutual company there would be shareholders and presumably shareholders would also be queuing up for compensation in this case. It just happened to be a mutual, but that is by the way. That is one issue. The second issue is how this relates to these other financial failures that are around at the moment. Your piece on Managing Financial Crises. Do people who invested in Northern Rock not have some plausible case for compensation from public funds because everybody seems to agree that there was massive regulatory failure here. What are the differences?

Sir Howard Davies: If you read further into my collective works, Chairman - which I do not recommend you waste your time doing - normally one would say that the regulatory regime is not there in the service of shareholders. I guess there can be particular circumstances - in the case of fraud, et cetera - where that might conceivably be true, but generally shareholders are taking risks, they are not subject to the regulatory protections that are available to depositors or to investors. It is a very unusual set of circumstances where shareholders have redress against the regulator. As to whether Northern Rock is one of those unusual circumstances, I could not say.

Mr Kay: It seems to me that it is not very clear in fact what the regulation is there for at the moment. It concerns me greatly that it appears to impose a generalised duty of prudential supervision, and that is the duty which the Ombudsman has considered failed to be discharged in this case or discharged properly. If we are saying - and I can see the argument - that if there is such a duty and it is not discharged properly there is no obligation on the State (which means the taxpayer) to provide compensation, then Mr Winsor has talked rather as if there is some entity called the State which has, as it were, resources which are plucked from the air in some sense. There are not. The resources of the State are the resources of the taxpayers. If there is a generalised duty of prudential supervision, if there may be a requirement to compensate for the event of failure of that, if within the financial services sector the financial consequences at large of such failure may be very large - and, as Howard Davies has said, there are bound to be regulatory failures: there are difficult calls to be made that from time to time regulators, with the best will in the world, will get wrong, and there will be lapses in work that is in most cases done by our junior officials - my view is that, as a taxpayer, I am extremely scared of the idea of taking on the obligations which that structure implies. That takes me to say that either we have to greatly increase the resources which we devote to prudential supervision - in a way that seems to me quite unrealistic - in a way that will prevent business failures largely in this sector, or we have to limit the scope of regulation, we have to abandon the idea that there is a generalised duty of prudential supervision and focus narrowly on consumer protection. My strongly felt view is that the latter is the direction in which we should take it. All our experience, I believe, of regulation from other sectors is that regulation works best when it identifies specific evils and is targeted at them, and worst when it is allowed to interfere in the generalised management of businesses in the sector. I would take the lesson of this case as being an important lesson for the structure of financial services' regulation generally and one which to some degree leads in the opposite direction to that in which government thinking is taking it.

Mr Winsor: I am a taxpayer too, I can tell you. Shareholders hold management to account and if their supervision of that management has been inept in some way and their shares diminish in value or are extinguished then they have no complaint because they could have done something about it. But the regulatory regime we are talking about here is about protecting the public interest and protecting the market participants and those in the market. We are not talking about a case where the regulator just got it wrong having exercised an honest and competent judgment about something. We are talking about spectacular regulatory failures, if that is what is established. We are all shareholders in UK PLC and the shareholders take pain for their management failures. It is the same for taxpayers.

Q261 Mr Prentice: Howard Davies told us earlier that there was no fraud in this case but the regulator failed to do what the regulator should have done. The regulatory framework was there. What penalties should be applied to regulators who do not do what they are expected to do?

Mr Winsor: They will face criticism of all sorts, but the regulatory institution, which is an emanation of the state as we have discussed, should pay financial compensation if the failure is sufficiently culpable. If it is culpable, and we are not talking about honest judgement failure; we are talking about, as we have said before, a deliberate denial - a deliberate refusal in some respects - to discharge the regulatory functions given to them by Parliament, that is not acceptable. Frankly, if they can just shrug their shoulders helplessly and say, "It does not matter. We cannot face any kind of sanction for this", then of course they will have a tendency to neglect their duty and not be diligent and honest in their prosecution of their duty in many cases.

Q262 Chairman: Can I ask Howard Davies just on this though before we lose it, because I know that you are disputing the argument about regulatory failure here: on the general point that Tom Winsor raises let us assume that you did not dispute that. Let us assume that there is a case in which regulatory failure is established beyond doubt. Does the argument then stand up in terms of the public redress that should kick in?

Sir Howard Davies: That is a hypothetical question but I did say at the beginning in my first answer that I thought there could be circumstances in which redress should be payable as a result of regulatory failure. Yes, I do believe that in principle that could be the case.

Q263 Paul Flynn: How do we apportion the share of responsibility for the losses suffered by Equitable Life people? At the moment we are putting 100% of the blame on the regulator, that 100% of the compensation should be paid by the regulator because only the taxpayer is likely to have 10 billion to pay, but if we look at the responsibility for the losses, certainly there was a great deal responsibility by their auditors and a great deal of responsibility by their actuaries as well, how would you apportion it out? Surely it is entirely unreasonable, although the regulators are certainly at fault, that the taxpayer should pay for the entire compensation.

Mr Winsor: The legal system in this country has a concept of proportionate and contributory negligence and a thorough judicial process would be able to allocate responsibility among the various players who have failed in some respect. If I may just add, mention has been made of judicial review and the accountability of regulators to judicial review. That does not really come close to meeting the difficulty in this case, but there are other legal means of redress which already exist. The Ombudsman and then ministerial discretion is not the only way. There may be, and I simply do not know in this case, a case for misfeasance in public office. The elements of misfeasance in public office are that the decision-maker, in this case the regulator, acted unlawfully and, if it is established that there was a wilful failure to discharge their obligations, that would amount to an unlawful act, that they knew they were acting unlawfully, that they knew that people might sustain loss as a result of that failure, and they did. Those are the four elements of misfeasance in public office, and if they can be established - and I do stress "if" - then the right to redress is a full legal right of redress.

Q264 Paul Flynn: And the compensation should come from the taxpayer entirely?

Mr Winsor: The regulators are part of the machinery of government.

Q265 Paul Flynn: Can we just bring you down to earth on the question of the high hopes that have been raised now by people, constituents, - we all have them round this table - who believe they are going to get full compensation, including the market loss which EMAG suggested was at least 37%? Their hopes have been raised very high now but it seems to be that there is another argument coming in to say that those people who are in genuine hardship, who do not expect to live very long, people in their seventies and so on, should be treated as special cases. We are not going to get a solution to this which is satisfactory to everybody concerned or, if it is going to be a solution it is going to take many years anyway. Is there a strong case for the Government to accept responsibility and pay out to those cases of proved hardship as soon as possible?

Mr Winsor: If there is an admission of failure and the only issue is the quantum then the legal system provides for interim damages to be awarded in deserving cases before the full determination has been finished and that is something that could be worked out in this case, but I very much doubt whether, given the magnitude of the likely damages in this case, the Government would be inclined to accept liability and only fight on the question of quantum.

Q266 Julie Morgan: It was on that particular issue that John Kay said in his opening remarks that he thinks particular circumstances should be looked at. How would it be feasible to work out who was in hardship and who was not in hardship? How would you do that?

Mr Kay: Is that a question for me?

Q267 Julie Morgan: Yes.

Mr Kay: I think that is something that Government does in very many other contexts, in effect, means-testing, but I am clear on that that the reason for providing compensation is that people are suffering hardship as a result of these actions rather than that they have some right to call on us for support, which this is an interim discharge of.

Q268 Julie Morgan: That would mean a means test?

Mr Kay: That would mean a means test of some kind.

Mr Cowie: And surely, while it is true that the Government does that in many areas, it is equally true that the Government does it very badly, according to Age Concern, for example. They estimate that something like 5 billion worth of means-tested tax credits are not claimed by people who are eligible for them, so going down that route surely is a recipe for further delay?

Q269 Julie Morgan: Does anyone else think it would be realistic to go down that route?

Mr Winsor: Means-testing is an established mechanism and it could be done.

Paul Flynn: There are mechanisms available. You can spot how many people are on income support or other benefits and then it is a simple matter.

Q270 Julie Morgan: If the Ombudsman's report is accepted and compensation is paid, there is also the issue about whether it is calculated on an individual basis for each individual person or, as EMAG suggests, in groups of people. Have you any views on that?

Mr Winsor: It is a question of the number of possible claimants. They could be grouped but justice really requires individual assessments and it may very well be that the number of hardship cases is relatively few.

Sir Howard Davies: May I make one observation, and I say this against the background of what I have said about my views on the FSA parts of the report? I do think that, whatever decision the Government makes on where it wants to go on this, which, as I say, I am not privy to, whatever solution is chosen should be faster rather than slower because it seems to me that nobody can be particularly satisfied by the length of time which this whole process has taken. The Ombudsman herself has drawn attention to weaknesses in the original decision to look at only a part of the period and that created delay and there has been endless delay in this. The worst thing, as Mr Flynn said, is to have expectations raised and then find that another ten years go by before you get some cheque, so I would be inclined to say that if you are going to go down this route at all then go down it in as fast and as simply and potentially in as by-and-large a way as you can because I think that to create a further very complicated process would be unreasonable.

Q271 Julie Morgan: The Ombudsman says two years. Do you think it is feasible to do it in two years?

Sir Howard Davies: I should think it really should be. If the Government decides to do that I think it should say that that will be done.

Mr Winsor: It really comes down to the admission of liability. If there can be an admission of liability then two years, it seems to me, is entirely feasible. In some of the misfeasance cases, and I do not recommend that they go that way, it can take a very long time. In the Railtrack shareholders' case it took four years to come to court. That is a long time if people are suffering financial hardship now, so for a scheme of that kind where liability is established and it is just a question of assessing the quantum of claims two years I would expect would be entirely feasible.

Q272 Julie Morgan: And, of course, people are dying every day.

Mr Winsor: Justice delayed is justice denied.

Q273 Kelvin Hopkins: First of all I have to declare an interest in a very small way with Equitable Life. It is a tiny amount of money and I will probably give it to charity if I get it but that is not what I am arguing. A second point I should make is that I agree entirely with Ian Cowie and Tom Winsor on the cases they have made. I think they are absolutely right and I shall argue that from now until whenever, so I am not coming from a neutral position, so to speak. Regulation of Equitable Life used to be under the DTI, then the Treasury, and then the Government gave it to the FSA but it specifically removed the FSA from the remit of the ombudsperson and from the courts, and then we are told by Sir Howard that we must not undermine the spirit of enterprise and all that. If I am wanting to invest in a savings scheme or a pension scheme I want security for my money. If I want to invest in enterprise and make a profit I will go and buy shares in a super casino. Can you not see the difference?

Sir Howard Davies: I did not link statutory immunity to the spirit of enterprise at all. You are putting words into my mouth there. I can see exactly the difference and I think that that is what the regulatory regime should focus on and I would argue that the changes made to the regulatory regime in 1997 and 1998 were beneficial in that they brought together the Conduct of Business Regulation and prudential regulation. Here I do part company rather with John Kay. I think there is a role for prudential regulation. I think it needs to be redefined and recalibrated somewhat in the light of what we have learned recently but nonetheless I think there is a role for it. One of the past problems in relation to the regulation of Equitable Life, it seems to me, and this again came out in the FSA's own report on the subject, was that in the past there had not been adequate linkage, or indeed any linkage at all, to be frank, between the prudential regulators looking at the robustness of the fund or otherwise and the promises out of that fund and the conduct of business regulators, which were the PIA and its predecessor bodies, who were responsible for overseeing what people said to individual potential investors in that fund, what the Equitable salesmen said. Clearly there is a linkage between the two. It is clearly important, as Ian Cowie points out, that people should be told the character of the investment they are getting into and I think that the change in 1997/1998 where these two strands of regulation were brought together in one place has been a positive improvement in the system. It took a little while to merge them together but it now means that the same team looking at a life insurance company, which we are talking about in this case, is looking at the strength of its balance sheet and looking at what the company and advisers or salesmen on its behalf are saying to potential investors, and that is crucial, I think, and a net improvement as a result of this Government's changes in the late 1990s.

Q274 Chairman: Can I ask Philip to help us with some of this because I particularly wanted you to pick up on this point of, in a way, is the point of regulation not that we seek to give independence to various bodies but how that independence then runs up against this question, as you said at the beginning, of accountability? Is it right that bodies like the FSA should have an immunity that sits outside a normal redress system?

Lord Norton of Louth: Thank you for that, and I was going to pick up on Kelvin Hopkins' point. It leads into that because there is an important point to be made in distinguishing between fault-finding and lesson-drawing. In terms of the principal work you are doing it is relating to this fault-finding and the remedies that then flow from that. If you find fault should there be compensation paid and, if so, to what amount? What proportion do you allocate to a failure on the part of regulators? However, there is a wider question of lesson-drawing. What lesson do you draw from this for the future? Is it the fault of the regulatory machine? Was it the fault of the regulators? If it is the fault of regulators can you put a mechanism in place to prevent them repeating it? In effect, who regulates the regulators? You are quite right: the whole purpose of regulation was to have an arm's length relationship with Government with some degree of independence. The Government decides policies, regulators are then left with the operational side of it, but the important point is that they may be independent but that is not incompatible with accountability. It is then what form of accountability and that is the reason I was going to pick up on Kelvin Hopkins' point, because he is quite right about the FSA. It is a rather distinct form of regulator relative to the others in terms of its lack of accountability to the Ombudsman. It does not come within the remit of the NAO, which was one of the recommendations we made in our report, that it should, so it is somewhat detached. I think you can introduce not only accountability but greater accountability into the system and it needs to do it in such a way that it does not interfere with that operational independence, but you need to do it in such a way that you are keeping an overview of what regulators are doing. There is a problem with some elements of accountability, as with the Ombudsman, simply because it is reactive; it only kicks in when there is a problem. How do you keep an overview of what regulators are doing, and particularly how do you ensure that there is public accountability through Parliament, because there is no parliamentary mechanism for consistent scrutiny of regulation qua regulation? You have select committees which can look at particular regulators. You do not have a body that can look at regulation in an informed manner on a continuous basis and ensure that there is, if you like, a whole Parliament view of regulation. This comes back to John Kay's point in a way about deciding what level of regulation and what it is about and how it should be implemented. There is a problem within Government because there is not a whole of Government view of regulation, so there is no understanding regulation qua regulation. When we did a second inquiry into economic regulators we had three ministers before us each responsible for regulation of a particular sector. That was the first time they had come together to discuss the nature of regulation. Similarly, there is no parliamentary view of regulation, there is no mechanism in place for that, so, rather like this Committee, it is a one-off investigation and quite often it is reactive. There are two elements from Parliament's point of view: deciding the overall framework of regulation but then making sure you have got some mechanism for keeping a check on what regulators are doing, holding them to account, not interfering necessarily, but determining best practice, keeping a check on it and making recommendations in the light of that.

Chairman: That is very useful.

Q275 Kelvin Hopkins: If I may continue, is not the FSA then really a bit of political decoration to disguise the fact that the Government is saying to people, "You are in the market now", to give some reassurance so that people will not come back to the state and say, "We have not got sufficient security. We want state guarantees", or even a state pensions scheme, which is I think what the Government was really about? Is not the FSA bit of a decorative part of the constitution, not an effective part?

Sir Howard Davies: Chairman, I think at some point you really ought to have the FSA to answer for itself. I feel slightly reluctant to comment. It is well over five years since I was Chairman and I have never been to the FSA since.

Q276 Chairman: You are proving extremely helpful to us. Do not sell yourself short.

Sir Howard Davies: Thank you very much. I am doing this in my spare time now, and no doubt my students at the LSA think this is what I should be doing. No, I do not believe it is a decorative part of the constitution and I do not believe that people in financial markets would consider it to be such. Of course, one can argue about the intensity of regulation. I think a more coherent view of what we are trying to achieve in regulation generally should be beneficial and I agree with Lord Norton on that point. Indeed, I have written myself about the slightly peculiar way in which we devise regulation in this country, which tends to be in lurches here and there in response to crises without a clear framework within which to think about it, but I think the system is justifiable in its construction. The way I like to think of it is that there is a kind of social contract between the authorities, the state and the financial sector. Particularly you can see this in relation to banks. No bank would undertake what banks do, which is maturity transformation fundamentally, cite deposits into long term loans, unless there were some underpinning by the state because it is inherently a risky activity. It is a confidence trick because we all know at some level that if we all wanted to go to a bank and get all our money it would not be not there, so banks will not undertake that activity, which is essentially beneficial to the economy, unless two things are in place: one, there is some kind of deposit guarantee scheme because people will not put their money in if they think there is no guarantee, and, two, unless there is some lender of last resort primarily to provide liquidity. Of course, recently we have had the boundary between liquidity and solvency merge rather, but no bank would do the thing we want them to do - provide loans for business and individuals, unless there was that underpinning. Of course, the quid pro quo for that must be that no rational government would supply a lender of last resort deposit guarantee scheme unless it was doing some prudential regulation because it would not provide an underpinning and then pay no attention to what the banks were doing because then it is a one-way ticket - heads they win, tails you lose. They take more and more risky investments and earn more profits in the good times and in the bad times the Government pays. That is the essential nature of the contract. It is a little bit different in life insurance, which is what we are talking about, but it is not that different because on the whole people would not be prepared to entrust their funds to long term savings institutions unless they felt that there was some oversight of what they were doing with their money, that they were putting it in a combination of equities, bonds and property and not putting it on the roulette wheel.

Q277 Kelvin Hopkins: But that is precisely it. The FSA is apparently a regulator and gave some implied assurance that people's money would be safe but it was not safe and now they are saying, "I am sorry but you are on your own".

Sir Howard Davies: I think that is a somewhat heroic over-simplification of a rather complicated story. As I said at the beginning, it is not that the money went away. The Equitable did not take the money and put it on a roulette wheel. It did not engage in fraudulent practices. What happened was a complex redistribution mechanism where the fund was over-promised to some people and promises to other people were then not able to be met. I think that is a particular problem but I do not think it helps us understand that problem by generalising this and saying that the FSA does nothing economically useful.

Q278 Mr Prentice: But the annual returns that were submitted by Equitable Life, the Ombudsman tells us, were inaccurate and misleading. I just find it astonishing that the taxpayer may be asked to stump up 10 billion and no-one is behind bars for this because there is no fraud. Mr Winsor mentioned misfeasance. I do not know where that takes us but I just find it astonishing that there is no-one in the dock over this failure. Is that not astonishing?

Mr Cowie: I share your astonishment.

Q279 Mr Prentice: Is it not astonishing that the taxpayer should be asked to pay 10 billion and we cannot point an accusatory finger at anyone, and the person responsible at Equitable Life, who was both the managing director and the appointed actuary, the worst that happened to him, Mr Roy Ranson, was that he was struck off the Institute of Actuaries in 2007, years and years after this happened?

Mr Cowie: I think a lot of people share your astonishment. It is one of the peculiarities of regulation of financial services in this country that so much money can be lost on behalf of so many people and nobody should even face charges.

Q280 Mr Prentice: No wonder the Ombudsman says that people have a right to feel outraged.

Mr Cowie: She went further and said that they deserve an apology from the Government. In America, for example, it is inconceivable that something like this would have happened without anybody facing charges.

Q281 Kelvin Hopkins: Can I just continue my theme, which is ultimately that Government is responsible, that Government is ultimately culpable? We have been living through an era of deregulation where the Government has espoused light-touch regulation. The whole spirit of the times has been withdrawing the state from the world and leaving things to the market, but to give people reassurance that they would not be left entirely at the vagaries of the market they installed regulators, particularly in the financial sector, so that we would not feel too insecure and we would not demand too much of the state later on, and this is what has happened. This is the result of that. The banking crisis has arisen because of a failure to regulate banking in the way it was regulated in the past, an absolute failure. Banks were left to do what they liked and they have got into serious trouble, which is now bringing forward an incredible economic crisis, because of deregulation. Is this not a lesson which Government will be taught which will make them re-regulate and start to organise society in a more democratic and controlled way in future?

Lord Norton of Louth: Could I just respond? I agree with your point about light-touch regulation. Coming back to your earlier description, I do not think it is a case of being decorative. It is not a dignified part of the constitution. The query is to what extent it is an efficient part because I think the powers are there; it is the way in which they are used that is important and then how you call the regulators to account for either using them or not using them and what are the mechanisms in place. I think there is a problem there. I do not think it is necessarily with the powers. I think one does need to revisit them in some areas but on the whole there is a danger of generalising about the regulatory state from this particular case. When we look at other regulators some are actually working rather well and the problem is that people are complaining about over-regulation. Indeed, in some respects with the FSA in some areas one had that complaint, so one is in danger of generalising about regulation per se from this particular case, but this case I think is particular through its light-touch approach because the FSA is in a distinct position relative to other regulators. One of the things one may want to think about is what lessons you draw to bring it more within the same remit as other regulators. I know the Government's response to our report. The FSA is in a distinct position as a regulator. It is a private company. It is not funded by public funds and therefore it is in a distinct position and should be far more at arm's length than other regulators. I think we need to come back and revisit those points to say to what extent should the FSA be more accountable. It comes back, as I say, to lesson drawing about the accountability of other regulators rather than always the powers that are given to the regulatory bodies.

Kelvin Hopkins: I have a final point. Sir Howard talked earlier about my reckless enterprise. The Ombudsman's report said that the public authorities were urging regulators not to be over-cautious and they specifically referred to the fact that "it might stifle innovation, enterprise and activity". Well, if I am saving in a pension fund I do not want innovation and enterprise; I want security for my money. Is that not the big failure?

Q282 Chairman: Can I just pick up on a couple of points in the last five minutes, so you can go back to the LSE in a moment? Tom Winsor, did I understand your argument to be that, irrespective of what the Ombudsman has said here, you thought that anyway there was legal redress for the policyholders?

Mr Winsor: There may be, although I think that the statutory immunity of the FSA, insofar as they are in the frame and they are not the only people who are in the frame, is going to have to be reassessed because when you have immunity the incentive to perform well has been diminished. I am not saying it has been extinguished but it has been diminished.

Mr Cowie: At the very least surely the FSA should be brought within the remit of the Ombudsman? It seems extraordinary that the Ombudsman can criticise your work but not intervene where the regulator has fallen down, nor indeed the National Audit Office. The FSA is outside the remit of both of those watchdogs to whom people can complain in most other instances.

Q283 Chairman: Is there broad agreement on that or are there dissenters on that too?

Sir Howard Davies: Can I make a point on that? In a sense I do not necessarily want to agree or disagree but if you look at this issue in the round, and this is abstracting from the merits; let me try to just talk about what you would ideally want, I think that what policyholders in these circumstances might reasonably want is a report that looked at the economic situation of the company, what had actually gone on in terms of the finances of it but looked at the responsibilities of those who had been responsible in the company and the various bits of decoration around them, like the actuaries and the auditors, but also the responsibilities of the regulator, and they would want to look at whether the regulatory regime was adequate and whether the regulatory regime had been well operated, which I guess in some ways are two separate points. They would then want to look at whether there was any justification as a result of all of that for compensation by the state or by somebody else, and then they would want to know what that compensation should be and how it should be calculated. In the eight years since the House of Lords judgment, which I guess precipitated this crisis, we have had a whole series of reports but we have not had a report which did what I have just described. We have had reports that have looked at it in a somewhat narrow way, perhaps because they looked at one particular period of regulation, and the original Ombudsman's decision just to look at the period of the FSA up to closure struck me always as being an irrational decision and likely to delay any proper review of this, and Lord Penrose carried out an extensive and interesting review but it also did not get to the question that was of most interest to the Equitable members, and the Ombudsman report in my view, even the second Ombudsman report, similarly does not deliver what, if I were an Equitable member - that reminds me: I am Equitable policyholder also, albeit a unit-linked one, therefore not centrally addressed by this case ----- When you reflect on what lessons there are in this and what kinds of accountability and review mechanisms there need to be, I really think that you need to reflect very carefully on what the coverage of them should be because a series of partial reviews, and one might add the European one which looked at a particular perspective of the implementation of European legislation, and all of this over eight years, has not in fact delivered an answer, either yes or no, to the big question which the Equitable members asked.

Q284 Chairman: I think the Ombudsman has said very much what you have just said, that it did require one single comprehensive review that took account of all these things. We are ending but can I just come back to one big issue that we have been struggling with, and we have touched it on it once or twice this morning, which is that even if we accept the argument that there was regulatory failure, if we accept the argument that therefore something should happen as a result of that and some kind of redress system should kick in, and this comes out of what you have just said, Howard, in terms of the number of players here, we have run up against the fact that the Ombudsman has said, "Yes, but there should be also a public purse consideration", and yes, we should only talk about relative loss for some people, not absolute loss across the board, so how do we, even in terms of principle, construct a scheme that reflects what was happening to the market during this time and affecting all companies, that reflects the fact, as we keep reciting, that Penrose told us that it was primarily a company failure? How do we segment out the bit that, if we accept there was regulatory failure, is to be accounted for regulatory failure, and how do we therefore compensate for that element only? How is that doable?

Mr Winsor: The doctrine of contribution and a legal and forensic assessment of the culpability of the various institutions in question.

Q285 Mr Prentice: Can I just add to what Tony has said? We had the Chief Executive and Chair of the new Equitable, if I can put it that way, before us the day before yesterday and he said that the Equitable has settled the claims of, I think, 150,000 policyholders, but, given that the taxpayer is expected to pick up this huge tab, is there a case for expecting the Equitable to find more money to compensate those who have lost out?

Mr Winsor: But it does not have any shareholders.

Q286 Kelvin Hopkins: A point I made privately is would this not be actually punishing existing members of Equitable Life for management failures when actually it is a failure of regulation for which the Government should be culpable?

Mr Winsor: I agree with that. The Committee will be considering and anxious about the probable size of the compensation bill. I think it would be legitimate also to look, as Philip Norton has mentioned, at mechanisms for preventing these kinds of regulatory failures in the future, and I think that Parliament should do far more in terms of ongoing proactive scrutiny of the behaviour and competencies of regulators far more than they do now. This after-the-event bloodletting is all very well but what people want is prevention rather than cure or arguments about redress, because the fact is that regulators in this country right now get away with far too much.

Q287 Kelvin Hopkins: Absolutely.

Lord Norton of Louth: May I just reinforce that, and that raises two further questions because once you deal with the present case you then have, as Tom says, to put in place a mechanism to prevent it happening in the future, which is the ideal state, and Parliament has a role to play there, so one might want to reflect upon what is Parliament's failings for itself not picking up on this being involved more in scrutinising regulators. The other thing is that one could create a mechanism that would reduce the likelihood of it happening in the future, but if it does happen in the future what mechanisms are in place to make sure that the issue is resolved much more quickly than happens at the moment, because the present mechanisms in relation to accountability and the law in this process are extremely slow.

Sir Howard Davies: I am hearing these points about lack of accountability. I have to say in deference to John McFall and his colleagues on the Treasury Select Committee that I did not feel that I was not accountable to Parliament when I was Chairman of the FSA.

Lord Norton of Louth: I am sorry; my go was at regulation qua regulation, the regulatory stage, not just particular regulators.

Chairman: Philip is talking across the board and the problem of dealing with it in a general way in terms of a set of principles rather than case by case. Unless any of you feel that you have not said something you would like to say to us I do think we have had an extremely helpful series of exchanges and it will help the Committee greatly (at least I hope it will) to construct a final view on this that it will to the Government, so thank you very much indeed.