Written evidence submitted by the Financial
Services Authority
Thank you for your letter of 10 January arising
from the evidence received by the Committee during its recent
session on the Presbyterian Mutual Society (PMS). In this letter
we deal with your questions in turn and provide some information:
(i) on the FSA' s approach to its function as the registering
authority under the Industrial & Provident Societies Act 1965
(the Act which applies in Great Britain); and (ii) some background
on the application of the Financial Services and Markets Act 2000
(FSMA) to Industrial & Provident (I&P) Societies generally.
The Regulatory Gap
You note in your letter that during the session
a regulatory gap was exposed. As we explain below, in our view,
the circumstances of the case were highly unusual and should not
be used to justify a general conclusion. As you will he aware.
PMS was registered by the Department of Enterprise Trade and Investment
(Northern Ireland) (DET I) under the Industrial & Provident
Societies Act (Northern Ireland) 1969 (1969 Act). We believe PMS
represents an unusual use of the corporate vehicle for which provision
is made in the I&P Acts, and the "gap" would be
apparent only in circumstances such as those relating to the PMS.
Under both the I&P Act s. the registering
authority (DETI or FSA ) must be satisfied that a society meets
one of the specified conditions for registration set out in section
1(2) of the respective Acts and that it continues to do so throughout
the period during which it is registered. These conditions are
that the society must be either a bona fide co-operative or a
community benefit society (see Appendix A). PMS appears from its
rules to have been registered as a co-operative society.
The Acts do not define a "bona fide co-operative"
so it is a matter for DETI (and the FSA in Great Britain) to determine
the characteristics which an applicant society must exhibit in
order to qualify for registration. In determining these characteristics
the FSA works closely with the co-operative movement as we see
our role as that of a gatekeeper. In addition, and while there
is no obligation on us to do so, we take account of the regulatory
consequences of registration under the I&P Act, which include
exemptions from the protections provided by FSMA. So if, for example.
we consider that a society's activities would be better suited
to an alternative mutual model, such as a building society or
a credit union. we would advise the applicants of this. We believe
that this approach is proportion ate to the risk: it ensures that
applicants are properly advised, but docs not impose an increase
in the regulatory burden on the overwhelming majority of co-operative
societies for which the absence of regulation does not give rise
to any consumer risk. Further information on the FSA' s approach
to registration is given later in this letter.
The FSA's involvement in PMS
The FSA had no knowledge of the PMS before HM
Treasury told us in November 2008 that it was in difficulty. However,
once we were aware of the situation, we requested PMS's rules
and latest annual return and made our own enquiries as there was
evidence in these documents that it might be carrying on regulated
activities without appropriate authorisation under FSMA. Further
more detailed investigations led us to conclude that this was
in fact the case and we confirmed this in our statement on 9 April
2009see Appendix B.
The FSA is not resourced to look proactively
for evidence of unauthorised activity. However, if evidence comes
to light, we look into it. We have a general duty under section
2(3)(a) of FSMA which requires us to use our resources in the
most efficient and economic way and we consider that our targeted
approach to the risks posed by unauthorised activity complies
with this requirement. We have sought and received assurances
from DETI that no other I&P societies registered by it are
conducting a similar business to PMS.
Consequences of Administration
The procedures available in the case of an insolvent
I&P society have been limited to winding up and in certain
circumstance s. to the appointment of a receiver. The Insolvency
(Company Arrangement or Administration Provisions for an Industrial
and Provident Society) Order (Northern Ireland) 2008, made by
DETI, extended parts II and III of the Insolvency (Northern Ireland)
Order 1969 and section 899 of the Companies Act 2006 specifically
to the insolvency of the PMS.
The different treatment on insolvency of the
two forms of investment in PMS arose as a consequence of the decision
of the PMS Board to invite investment above the £20,000 permitted
for its share capital by the 1969 Act. As the society could not
lawfully accept more than £20,000 from each member as share
capital, it chose to invite further investment in the form of
loans, which made the holding members creditors of the society.
This would appear to have been a device of the society to circumvent
the statutory limit. This limit would have afforded some protection
to members by restricting their investment and so exposure to
loss.
We have no view on the desirability or otherwise
o f amending the insolvency law for I&P societies in Northern
Ireland (which is a devolved matter), but we question whether
the PMS provides a basis on which to recommend a different approach
if similar legislation for Great Britain is contemplated in the
future. Societies in Great Britain cannot currently enter into
administration.
The FSA's Approach to the Registration of Industrial
Provident Societies
I hope it may assist the Committee if I take
this opportunity to outline how we mitigate the risk that a society
registered by us might carry on a regulated activity without authorisation.
Our mutual's registration team examines each society's rule book,
both at the time of first registration and when applications to
register subsequent alterations to rules are received. This is
because. as mentioned above, the FSA has to be satisfied that
a society qualifies for registration; the rules under which it
will operate are fundamental to this consideration. If it is evident
from examination of the rules that a society wishes to carry on
an activity for which authorisation under FSMA might be required,
we advise it to consider whether it should apply for authorisation,
although there is no statutory obligation on us in our capacity
as registering authority to do so. As I have already mentioned.
in appropriate cases we also recommend the use of an alternative
mutual model.
If our registration team has reason to suspect
that a society is conducting a regulated activity without authorisation
we refer the matter to relevant FSA colleagues for further consideration.
That expectation applies across the FSA to all businesses which
come to our attentionnot just to I&P societies. In
a notice on our website for mutual societies we have alerted societies
to the need to consider whether or not they need to apply for
authorisation see Appendix C.
The FSA works with trade associations such as
Co-operatives UK to develop Codes of Practice which are designed
to ensure that their member societies understand their obligations
to their own members and that they provide them with all of the
information they need to make an informed judgement on matters
such as the risk attached to investment in a society's shares.
The Governance of Co-operatives
Co-operatives should be democratically controlled
by their membersthe FSA looks for evidence of this in a
society's rules as part of the routine process of confirming that
the society qualifies for registration. The concept of "member
control" carries with it an expectation that the members
will play a full role in the governance of the society and will
elect a board in which it can have confidence, It is the responsibility
of the Board to understand its obligations under the Act and the
impact other legislation, such as FSMA, may have on the business
of the society. In the absence of the necessary skills, we expect
a Board to take steps to ensure that it has access to suitably
qualified people who can advise it on these and other important
matters.
The Application of the Financial Services &
Markets Act 2000 to Industrial & Provident Societies
Appendix D provides a general overview of the
application of the Financial Services & Markets Act 2000 to
Industrial & Provident Societies.
1 February 2010
Appendix A
Conditions for Registration (extract from the
Industrial & Provident Societies Act [Northern Ireland) 1969
PART I
SOCIETIES WHICH MAY BE REGISTERED
1 Societies which may be registered
(1) The societies which may be registered under
this Act are
(a) subject to sections 2(1), 7(1) and 78(4),
a society for carrying on any industry, business or trade (including
dealings of any description with land), whether wholesale or retail,
if
(i) it is shown to the satisfaction of the registrar
that one of the conditions specified in subsection (2) is fulfilled;
and
(ii) the society's rules contain provisions
in respect of the matters mentioned in Part 1 of Schedule 1; and
(iii) the place which under those rules is to
be the society's registered office is situate in Northern Ireland;
Para. (b) rep. with saving by 1985 NI 12
(2) The conditions referred to in subsection
(I1)(a)(i) are
(a) that the society is a bona fide co-operative
society;
(b) that, the business of the society is being,
or is intended to be, conducted for the benefit of the community.
(3) In this section. the expression "co-operative
society" does not include a society which carries on, or
intends to carry on, business with the object of making profits
mainly for the payment of interest,dividends or bonuses on money
invested or deposited with or lent to the society or any other
person.
Appendix B
Public Statement on the FSA's Investigation
of the Presbyterian Mutual Society
9 April 2009
PRESBYTERIAN MUTUAL
SOCIETY INVESTIGATION
The FSA's normal practice is neither to confirm
nor deny that we are investigating a particular firm or individual.
However, in the light of the information already in the public
domain about the FSA's involvement and the public interest in
this case, the FSA can confirm that it has investigated the activities
of Presbyterian Mutual Society (PMS), now in administration, to
consider if it was conducting regulated activities without the
necessary authorisation or exemption.
We have concluded our investigation and have
decided that it was conducting regulated activities without the
necessary authorisation or exemption. However, on the basis of
the information currently available to us, and applying the criteria
in the Code for Crown Prosecutors, we have decided that it would
not be right for us to take a case against any of those involved
in running the PMS. However, we remain in touch with the administrator
and, if further information comes to light relating to the issues
we have investigated, we will look into it.
Appendix C
Extract from the FSA's website for Mutual Societies
INDUSTRIAL &
PROVIDENT SOCIETIES
An industrial and provident society is an organisation
conducting an industry, business or trade, either as a cooperative
or for the benefit of the community and is registered under the
Industrial and Provident Societies Act 1965.
The FSA is the registering authority for societies
which register under the Industrial and Provident Societies Act
1965 (I&P Act 1965). This registration function is separate
from our role as regulator of the financial services industry
in the UK, as provided by the Financial Services and Markets Act
2000 (FSMA) and the statutory instruments made under FSMA.
Most I&P Act 1965 societies are not regulated
by the FSA under FSMA. Members of these societies will not have
access to the Financial Ombudsman Service (FOS) or the Financial
Services Compensation Scheme (FSCS). However, members of societies
which are both registered under the I&P Act 1965 and regulated
by the FSAbecause they are authorised to conduct financial
services business under FSMA will have access to FOS and the FSCS.
In addition borrowers from societies which have Consumer Credit
Licences will have access to FOS on issues relating to their loans.
A Society is responsible for considering whether
any of its activities are regulated activities under section 19
of the Financial Services and Markets Act 2000. If any of Its
activities are regulated activities, the Society must either rely
on exemptions[1]
or apply for authorisation from the FSA for the conduct of such
activities. The registration of a rule relating to a regulated
activity does not provide the necessary authorisation - there
is a separate application process for authorisation.
Co-operative societies are run for the mutual
benefit of their members, with any surplus usually being ploughed
back into the organisation to provide better services and facilities.
Societies run for the benefit of the community
provide services for people other than their members. There need
to be special reasons why the society should not be registered
as a company.
Appendix D
Overview of the Application of the Financial
Services & Markets Act 2000 to Industrial & Provident
Societies
Under the Financial Services and Markets Act:
2000 ("FSMA") organisations of any kind which carry
out regulated activities, as defined in the Act, anywhere in the
UK need to be authorised by the FSA or otherwise legally exempt
from authorisation.
The position with regard to authorisation and
exemption is set out in FSMA and its subsidiary legislation .
Section 417 of FSMA provides that the term "industrial
and provident society" means a society registered or deemed
to be registered under the Industrial and Provident Societies
Act 1965, or the Industrial and Provident Societies Act (Northern
Ireland) 1969.
FSMA includes a general prohibition, in section
19, on any person (natural or legal) carrying on a 'regulated
activity' unless that person has either been authorised to do
so by the FSA, or exempted by the legislation from the need for
authorisation.
Withdrawable share capital is a long established
feature of co-operatives and industrial & provident societies
generally. In common with shares issued by companies, it is normally
issued "at risk" i.e. the holder may lose all or some
of his investment if the society becomes insolvent. FSMA does
not apply to withdrawable shares issued on such terms, so there
is no obligation for the issuer to apply for authorisation to
carry on the activity of raising funds in this way.
However, the definition of "accepting deposits"
provided by article 5 of the FSMA: 2000 Regulated Activities)
Order 2001 (SI 2001/544) would be wide enough to catch withdrawable
shares issued as deposits and certain forms of loan capital issued
or accepted by societies. The definition includes money paid on
terms that it will be repaid on demand or in agreed circumstances
and used by the recipient either to fund lending or to finance
to a material extent any business activities.
Articles 4 and 24 of the FSMA 2000 (Exemption)
Order 20001 (SI 2001/1201) exempt industrial & provident societies
(other than credit unions) from the FSMA: 2000 general prohibition
(and thus FSA regulation) in respect of accepting deposits in
the form of withdrawable share capital.
Section 6 of the Industrial & Provident
Societies Act (Northern Ireland) 1969 provides that except in
certain specified circumstances, no member of a registered society
shall have an interest in the shares of a society which exceeds
£20,000. If therefore a society wants to raise more than
£20.000 from a member, it will have to do so in another form
and if that involves a loan that may require the society to be
authorised to accept deposits.
Upon authorisation, the society would lose the
benefit of the exemption mentioned above for all of its shares
issued on those terms. This is because Section 38(2) of FSMA has
the effect of removing the benefits of any exemptions from regulation
of certain activities where a person is authorised for any purpose.
A society which used the capital raised by way
of deposits for the purpose of lending would need to be regulated
as a credit institution.
1 As, for example, set out in: Back
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