Select Committee on Public Administration Second Report

5  Lessons for the future

(a) Investigating failure

90. Since Equitable Life closed to new business in 2000 there have been numerous inquiries into what went wrong. Each has had a different remit, but all have been united in lacking the jurisdiction to review comprehensively all those organisations and individuals who were potentially to blame. The Ombudsman's remit did not extend to reviewing the actions of Equitable Life's former directors. While Lord Penrose's investigation considered the directors' role, his report could not consider the further issues of regulatory failure and redress. The Ombudsman has described this fragmented approach as "iniquitous and unfair" and has stated her hope that she "never again [has] to draw Parliament's attention to such a disjointed process for resolving complaints that have affected so many of the constituents of almost every Member."[145]

91. The Ombudsman has made it plain that she views the Government as responsible for failing to establish a "comprehensive and fit for purpose inquiry":

    It seems to me that there is a direct link between the time that it has taken since the closure of the Society to new business to seek a final resolution of the complaints made about that closure and related matters and the piecemeal approach that the Government has adopted to handling the relevant issues.

    The failure at the outset to establish a single inquiry which was not hampered by terms of reference or a statutory jurisdiction which limited the issues that could be addressed and resolved has resulted in such an extended and long drawn out process. The adage 'justice delayed is justice denied' has rarely been far from my thoughts as publication of this report has drawn nearer. And the continual uncertainty that this has caused for many individuals - and also for the Society itself - must have been difficult to bear. I find it hard to accept that the establishment of a comprehensive inquiry was not possible in this case. [146]

92. The former Chair of the FSA, Sir Howard Davies, set out his view of the approach that should have been taken by the Government:

    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.[147]

He believed this to be an important lesson for the future: "a series of partial reviews … 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."[148] Lord Norton added that "the present mechanisms in relation to accountability and the law in this process are extremely slow."[149] While the Economic Secretary acknowledged these concerns, he added that it was not necessarily the case that one inquiry would have been sufficient to review all the issues that were raised.[150] Although it may on occasion be desirable to holder a number of smaller inquiries to review discrete issues, this does not, however, remove the need for a central inquiry that can achieve the core aims outlined by Howard Davies.

93. The Government is responsible for failing to establish a comprehensive and fit for purpose investigation into the Equitable Life affair. Not only has this failure caused unnecessary expense, but worse still it has resulted in years of delay, anxiety and unanswered questions. The Government must review the way in which serious failures of this kind are investigated in the future. In the meantime, the Government has reason to apologise not only for the maladministration identified by the Ombudsman, but also for the delay and frustration caused by its piecemeal approach.

(b) Approach to regulation

94. The Ombudsman has focused her criticism upon the way in which the regulators carried out their role rather than on the system of regulation itself. She has criticised among other things an over-reliance on the status and reputation that Equitable Life then enjoyed:[151]

    The central story of this report is that this robust system of regulation was not, in respect of the Society, implemented appropriately - that is, consistently, fairly, and with proper regard to the interests of those directly affected - by the prudential regulators and those providing assistance and advice to those regulators … Assessing the risks relevant to a particular insurance company cannot be appropriately achieved through relying on its longevity or reputation.[152]

95. Vanni Treves, the current Chairman of Equitable Life, concurred: "the system was there, the structure was there, it was simply that it was not operated as it should have been. Therefore, I do not think we could say that there were serious failings in the system."[153]

96. The Ombudsman went as far as to state that (prior to the FSA's involvement) the regulators were "mesmerised by the Society":

    Here was a long-established, extremely well-thought of, highly successful Society that had been that way since anybody could remember and therefore somehow, although the stark facts were in front of them, they could not quite believe it. There is a sort of sense that somehow it would come right. The metaphor I have used again in my own mind is that the regulators were on the bank really watching this pleasure steamer sailing towards the edge of Niagara Falls; all of the information was there in front of them and they could even see this boat taking on new passengers, but it was heading inexorably for disaster. Somehow there was a sense that because it was Equitable they were going to do a miraculous u-turn at the last minute and it would all come right. There is something in there, a sense that because it was Equitable it could not go down.[154]

97. The "central lesson" that the Ombudsman draws from her investigation is "the need for absolute clarity as to what can and cannot be expected from the system of financial regulation".[155] She has observed a "big gap between what the system was designed to do, what people in charge of it said it would do and what government has said in response to my report now", adding that:

    One of the responses to a fairly early draft of my report from the FSA was a comment which basically said the system of regulation I was describing here would not be recognised anywhere in the world. My response to that comment was that that may be so, but it is the law.[156]

98. The Ombudsman has also drawn a tentative comparison to the regulation of Northern Rock arguing that a similar assessment about its status and reputation appears to have been behind the way in which it was regulated.[157] She added that other comparisons were "matters for others - and perhaps history - to consider."[158] Paul Braithwaite was less tentative: "the current banking bail out, has very close similarities. These were companies with flawed business models who were not satisfactorily regulated by the FSA."[159] Colin Slater, also of EMAG, added:

    They had lessons to learn in Equitable Life, two in particular. One was to watch very carefully companies with unique business models, which may sound familiar and was certainly Equitable Life. The second one was to look very hard at complex legal documents which purported to be worth huge sums of money. If they had had to pay compensation in 2001 as a result of not doing those things, they would have tried much harder in the subsequent period and we may not have had Northern Rock, because they would have seen that business model coming. We may not have had much of the banking crisis because they would have looked much harder at all those collateral debts and whatever they called them, the various complicated documents that turned out to be valueless. The cost of that has been infinitely more than the cost of paying up for Equitable Life in 2001.[160]

99. Howard Davies reflected upon the current regulatory regime in light of recent events, before concluding:

    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.[161]

100. In contrast, John Kay suggested that regulation should focus upon "consumer protection" in the future:

    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.[162]

101. Lord Norton, however, emphasised the "danger of generalising about the regulatory state from this particular case", stating that in his view this case was "particular through its light-touch approach because the FSA is in a distinct position relative to other regulators."[163]The Economic Secretary also pointed out that there have been major changes to the system of regulation that was in place during the period under investigation. In this respect, he emphasised that lessons had been learned and, where appropriate, the Government would be willing to "take it on the chin".[164] He also added that the Chair of the FSA, Lord Turner, has been tasked with considering "whether the current system of regulation is working sufficiently well", particularly in light of recent events in the banking sector.[165]

102. The "central story" of the Ombudsman's investigation is the failure of regulators to exercise their powers to ensure that a company with a sound reputation was in fact observing minimum standards. It is not for us to assess whether a failure to learn this lesson has contributed in whole or part to the crisis that is currently being experienced worldwide in the banking sector. Nonetheless, we urge the Government to take this opportunity to consider carefully - and to set out in its response to this Report - what lessons need to be learned from the criticisms that have been (and continue to be) levelled against the regulators. This includes the need for absolute clarity as to what can and cannot be expected from the system of financial regulation.

(c) Accountability of regulators: Who watches the watchmen?

103. A report from the House of Lords Constitution Committee, The Regulatory State: Ensuring its Accountability (May 2004),[166] noted that two of the key elements of holding regulators to account were, firstly, exposing regulators to scrutiny and, secondly, ensuring "the possibility of independent review" of the decisions that they reached.[167]

104. The FSA no longer falls within the Ombudsman's jurisdiction, but rather has its own specific complaints commissioner.[168] It was only because the FSA was acting on behalf of the Treasury (rather than independently) for the period under investigation that the Ombudsman was able to investigate maladministration on its part.

105. The Ombudsman felt that it was not for her to comment upon whether her Office should regain its remit over the FSA, but she expressed her general view that "any public body should be in an ombudsman's jurisdiction unless there is a good reason for them not to be."[169] She provided the following compelling reasoning:

    there is nothing like a recommendation from the ombudsman for compensation to concentrate minds in government departments and with permanent secretaries and ministers, but whereas compensation should never be a penalty - it should always be a remedy for a wrong done - if that were removed then the feedback, the learning and the improvements in public services which come from having to provide remedies is in danger of being diminished and diluted. I would be very concerned if we got ourselves into a situation where actually civil servants could simply live in a world where there were never any consequences for their failings.[170]

106. In addition to not being subject to the Parliamentary Ombudsman's jurisdiction, the FSA has statutory immunity against the courts awarding compensation, which (in broad terms) applies unless "bad faith" is proven on its part. Colin Slater of EMAG objected to this immunity. Tom Winsor stated: "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."[171] He added: "I think that the statutory immunity of the FSA… 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."[172]

107. Howard Davies disagreed. He stated that the decision to provide statutory immunity had been fully debated by Parliament and introduced for good reason, since 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." Howard Davies also highlighted that the Treasury Select Committee contributes to ensuring the accountability of the FSA.[173]

108. Ian Cowie argued that "at the very least" the Ombudsman and the National Audit Office should both be given a scrutiny role in relation to the FSA in the future.[174] Lord Norton took a different approach by suggesting that more needed to be done to oversee the activities of regulators rather than simply to react where there is failure:

    There is a problem within Government because there is not a whole of Government view of regulation, so there is no understanding of 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.[175]

109. Tom Winsor agreed. He stated 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."[176]

110. The Financial Services Authority no longer falls within the jurisdiction of the Ombudsman. The courts are also unable to award compensation against the Authority, except where bad faith is proven on its part. The Ombudsman's candid assessment of the Financial Services Authority leaves us with a question for the Government: can we be assured that if an investor is failed by the Financial Services Authority in the future that it will be held accountable, to enable lessons to be learned and, if appropriate, any loss to be made good? If not, the time may have come to reconsider how our key regulators are held to account. The Government must also heed the adage that prevention is better than cure: in particular, there is a need for reflection upon whether more could be done in Government, Parliament, and the National Audit Office to maintain an overview of regulators as a way of mitigating the risk of serious regulatory failure in the future.

(d) Accountability of directors and advisors

111. The new board of directors commenced claims against the former directors and certain professional advisors of Equitable Life, but the proceedings were later discontinued. Equitable Life ended up paying for its own costs of £35 million, together with an additional £10 million contribution to the costs of some of the former directors.[177]

112. Ian Cowie told us that he shared our astonishment at this situation, adding: "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…. In America, for example, it is inconceivable that something like this would have happened without anybody facing charges."[178] Patrick Collinson of The Guardian has made a similar point:

    The fact remains that the management was principally at fault, but they've paid nothing in compensation. Non-exec directors were supposed to oversee the company; they have paid nothing. Auditors were paid millions to comb through the books; they have paid nothing. The actuaries were supposed to match assets with liabilities; they have paid nothing. Yet you and I - the taxpayers of this country - are supposed to cough up… I just don't get it.[179]

113. We struggle to understand how the former directors and advisors of Equitable Life have walked away without making good any of the losses that have been sustained. Quite apart from any issue of regulatory failure, this represents a serious lack of accountability on the part of those who were viewed as principally to blame. We ask the Government to reflect upon whether this would have happened in other leading jurisdictions and, if not, to consider what must be done to prevent it happening again.

145   Ombudsman's report, Foreword, p x to xii Back

146   As above Back

147   Q283 Back

148   Q283 Back

149   Q287 Back

150   Oral evidence taken before the Committee from Ian Pearson MP on 9 December 2008, transcript due to be published as HC 41-i (2008-09) Back

151   Ombudsman's report, Part 1, Ch 15, paras 13 to 15, 32 to 33 Back

152   Ombudsman's report, Part 1, Ch 15, paras 32 to 33 Back

153   Q226 Back

154   Q43; Q36 Back

155   Ombudsman's report, Part 1, Ch15, para 17 Back

156   Q38 Back

157   Ombudsman's report, Part 1, Chapter 15, para 15 Back

158   Ombudsman's report, Part 1, Chapter 15, para 16 Back

159   Q50 Back

160   Q89 Back

161   Q245 Back

162   Q260 Back

163   Q281 Back

164   Oral evidence taken before the Committee from Ian Pearson MP on 9 December 2008, transcript due to be published as HC 41-i (2008-09) Back

165   Oral evidence taken before the Committee from Ian Pearson MP on 9 December 2008, transcript due to be published as HC 41-i (2008-09) Back

166   Public Administration Select Committee, Sixth Report of Session 2003-04, HL Paper 68,  Back

167   HL Paper 68-I (2003-04) Back

168   Financial Services and Markets Act 2000, Schedule 1, Part 1, Paragraphs 7-8 Back

169   Q35 Back

170   Q21 Back

171   Q89 (Colin Slater); Q261 (Tom Winsor) Back

172   Q282 Back

173   Q287 Back

174   Q282 Back

175   Q 274 Back

176   Q286 Back

177   EQL 24 (Equitable Life) Back

178   Qq 278 to 280 Back

179   Sticking up for the taxpayer, Guardian Money, 19 July 2008 Back

previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2008
Prepared 15 December 2008