Financial Conduct Authority - Treasury Contents

Written evidence submitted by John Howard, former Chair of the Financial Services Consumer Panel and a former Non-executive Director of the Financial Ombudsman Service


1.  At the heart of the ill fated court action by the banks over Payment Protection Insurance was a growing sense that the Ombudsman service was becoming a quasi regulator.

2.  And the judge in the case accepted that the Ombudsman can go above and beyond the FSA rules. Mr Justice Ouseley said in his judgement[54] that the FOS could hold that a firm should pay compensation even though (the firm) had complied with the specific rules.

3.  This endorses the findings of the Court of Appeal in the case of Heather Moor & Edgecomb Ltd v FOS,[55] that the Ombudsman was not bound by the common law and could exercise his own judgement as to what was fair and reasonable.

4.  This has created uncertainty in the financial services industry, which means additional risks for firms, which create more costs that must eventually be paid by customers.

5.  I think that the uncertainty is misplaced and firms can be much more confident about the products they sell and the advice processes they use but they will need to change their approach to deciding what is fair to customers.


6.  Just about all consumer legislation seeks to do one thing; to even up the negotiating positions of buyers and sellers. This is true in financial services as well. Most financial regulation has been put in place to try to overcome the knowledge asymmetry that exists between buyers and sellers of financial products. The seller knows all there is to know about the product, the buyer knows very little, apart from the advertising hype and, if they have read and understood them, the restrictions and conditions in the contract.

7.  If a customer understands all there is to know about a product and purchases it willingly (without coercion or deceit) then the sale must be "fair" and the customer must stand by their decision to purchase.

8.  The retail regulations put in place by the regulator are requirements to provide certain information, and present it in a particular way, to aid the customer's understanding. The rules are the regulators attempt to ensure the customer understands what they are buying.

9.  Successive layers of regulation set out what can and cannot be said in adverts; what must be explained in key documents; what the sales person should tell the customer, all in an effort to help the customer understand the product.

10.  But even the best rules cannot ensure understanding. Instead regulators use the provision of information as a proxy for understanding. If the customer was given the required information about the product in the right form, the regulator presumes the customer understood what they were buying.

11.  If a firm has not stuck to the "rules" there is, in effect, a presumption that the consumer did not fully understand what they were buying and that the transaction was therefore unfair.

12.  If a complainant goes to the FOS, and the firm has not fulfilled the information requirements, the FOS is most likely to find against the firm and in favour of the consumer.

13.  But this simple approach fails to acknowledge the weakness in all regulation and law making. It is not possible to make rules that cover all possible circumstances. This is why the FOS has the power to fill in the gaps. It is required to take into account any rules and regulations in making its decisions but the overriding consideration of the FOS must be the much wider consideration of what is fair and reasonable.

14.  The FSA Handbook sets out the FOS powers.

DISP 3.6.1

The Ombudsman will determine a complaint by reference to what is, in his opinion, fair and reasonable in all the circumstances of the case.

In considering what is fair and reasonable in all the circumstances of the case, the Ombudsman will take into account:

—  (1)  relevant:

—  (a)  law and regulations;

—  (b)  regulators' rules, guidance and standards;

—  (c)  codes of practice; and

—  (2)  (where appropriate) what he considers to have been good industry practice at the relevant time.

15.  A firm may follow to the letter the regulations for the sale of a particular product but this cannot guarantee that a particular consumer, in their specific circumstances, has understood what they have bought.

16.  I believe that this is the strength of the Ombudsman system. It is in this situation that the FOS has the power to ignore the law and the regulations and come to a decision that, in the particular circumstances of that case, the deal was unfair.

17.  Fairness is a question of judgment and so the Ombudsman service is charged with making a judgement about whether the consumer understood what they were buying. If the Ombudsman's judgement is that they did not, he can then decide that the transaction was unfair despite what the rules say. This is a fundamental principle which must be preserved.

How Should the FOS Reach its Judgements?

18.  In the simplest case, if the FOS finds that a product or process does not meet the FSA rules, it must find in favour of the customer.

19.  If the firm or firms have sold the same product in the same way to many customers, the FOS will have identified a systemic problem. If, of their own volition, the firm or firms are not prepared to recompense all customers with similar cases, the FOS should not be placed in the position of hearing hundreds of similar cases. In those circumstances it should be required to notify the regulator. (This is a step beyond the "Wider Implications" process.)

20.  The regulator is empowered to deal with systemic issues and it should be required to take up those cases and, using its enforcement powers for a breach of the rules, order compensation for the affected consumers and approve changes to the product or process before their continued sale.

21.  If the product or process is fulfilling the regulator's requirements, then the FOS should still go on to ask a number of other questions.

First, "Did this particular consumer understand the product they were buying?".

If the customer did understand the product the FOS must find against the consumer, because he understood and accepted the risks.

22.  If it believes that the consumer did not understand, it must then ask: "Given the circumstances of the case and the information and advice provided, could this particular consumer have understood the product if they had tried?".

If it concludes that it was unlikely that the consumer in question could have understood, it must decide that they were treated unfairly and find against the firm.

23.  In that case the Ombudsman must then go on to ask: "Would a reasonable person involved in an identical transaction have understood what they were buying?".

If the Ombudsman concludes that a reasonable person would have understood the product there are no wider implications.

If the Ombudsman judges that a reasonable person would not have understood the product, it will again have identified a systemic problem which should be referred to the regulator.

Implications for the Financial Services Industry

24.  This approach does require a major shift on the part of the financial services industry.[56]

The industry must recognise that retail regulation is the FSA's attempt to ensure that customers understand what they are buying. But inevitably simple adherence to the rules cannot guarantee that a customer understands.

25.  The final decision on whether the customer understood what they have bought belongs to the Ombudsman in any individual case. This means it is not sufficient to simply comply with the rules. Firms must judge whether the Ombudsman will accept that the customer understood the deal.

26.  When designing products and processes firms must ask, "would a reasonable consumer provided with this information, presented in this way, understand what they were buying?" If the firm can answer "yes" to this question it will avoid a systemic complaint.

27.  If the firm then receives a complaint about that product it must again ask if that particular consumer understood what they were buying or could have understood if they had tried. This is the question the Ombudsman will ask.

28.  Firms must ensure that each customer understands what they are buying and they must be prepared to live with the consequences if they do not succeed in conveying that understanding.

29.  This will present a major challenge to the industry. It has always relied upon processes which treat customers en mass; solutions which generally produce a fair outcome for the majority of customers. This is probably no longer adequate. Firms must attempt to produce processes which will identify if individual consumers understand what they are buying.

30.  It also raises a number of ethical questions which the FSA has said society must decide. The first is, should customers who do not understand a product be denied the opportunity of buying it? How much of a product and its associated risks should they understand? This could exclude sections of society from purchasing products of benefit to them. If they cannot understand the nature and risks of a mortgage should they be prevented from becoming home owners?

31.  If they do purchase without understanding the product, they are relying on the seller to make paternalistic judgements on their behalf. The seller is obliged to ask himself, "If I was this person, but knowing what I do, would I buy this product?" and if the answer is no, not selling it to them. This debate will be the subject of another of my papers.


32.  When, in the circumstances above, the FOS notifies the regulator of a systemic unfairness, this could create a point of disagreement between the regulator and the ombudsman. The FOS may decide that a systemic issue is creating unfair outcomes for consumers and refer it to the regulator. The regulator may disagree and say, on balance, the product or process is not producing unfair outcomes for consumers.

33.  Any MOU between the FCA and the FOS must therefore contain a mechanism whereby a decision on fairness about a systemic issue identified by the ombudsman and referred to the regulator, must be agreed by the regulator and the ombudsman. The FSA must have the final decision and the ombudsman must sign up to that interpretation.

34.  Any subsequent departure from the agreed position on the point must only be allowed if any new case can be distinguished by the Ombudsman on its particular circumstances from the original point.


34.  It is entirely appropriate that the FOS publishes details of the Ombudsman's determinations (but not adjudicators rulings) but it must be accepted that these are not precedents and will not be binding in future, because the Ombudsman is making a decision which relies on the particular circumstances of each individual case.

35.  So the FOS should also explain whether it regards the decision as turning on the particular facts of that individual case or whether there are likely to be many similar cases. As described above, if the ombudsman believes there could be many similar cases then the FSA should be required to take regulatory action to deal with those cases.

36.  The publication of details of cases have a number of advantages:

—  (a)  This will widen understanding of the Ombudsman's view of fairness and his approach to particular types of cases.

—  (b)  It will encourage confidence in the FOS because the industry will have a greater understanding of the FOS approach.

—  (c)  It will encourage consistency of approach within the Ombudsman Service itself.

37. Case reports should be anonymised to protect members of the public and ensure that they are not discouraged from bringing their cases to the FOS.


38.  The Ombudsman's discretion to ignore the law and FSA regulations and make a judgement based on what is "fair and reasonable" is central to the success of the service and should not be tampered with in any way.

39.  Success in these terms is a speedy, uncomplicated, efficient and accessible dispute resolution service that is free to the public.

40.  Purists may challenge the legal robustness of the process but to try and improve the service by making it more legalistic will defeat its purpose and do consumers and firms a disservice.

September 2011

54   R(BBA) v FSA and FOS[2011] EWHC 999 (Admin) at para183 Back

55   (Heather Moor & Edgecomb Ltd) v FOS [2008] EWCA Civ 642, [2008] Bus LR 1486.) Back

56   R(BBA) v FSA and FOS[2011] EWHC 999 (Admin) at para183
R(Heather Moor & Edgecomb Ltd) v FOS [2008] EWCA Civ 642, [2008] Bus LR 1486.) 

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Prepared 13 January 2012