The failure of the Presbyterian Mutual Society - Treasury Contents

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 2009—see 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 attention—not 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 members—the 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



  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


  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


  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 FSA—because 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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