5Enforcement - The way ahead
The FSA’s enforcement powers
131.This section of the report provides a short summary of the FSA’s enforcement powers and processes at the time of HBOS’s collapse. A more detailed account is provided in Part B of the Green report.
132.The Financial Services and Markets Act 2000 provided the statutory basis for the FSA’s operations, requiring any firm conducting a regulated activity to be authorised by the FSA. Those members of a firm responsible for performing controlled functions also had to be approved by the FSA as being fit and proper to hold that particular position.185 The FSA judged the conduct of approved persons against statements of principle and could take disciplinary action against an approved person if it appeared that person was guilty of misconduct. This covered either a failure of the person to comply with one of the statements of principle, or that the person had been knowingly concerned in a breach by the authorised firm under the Financial Services Act.186 Importantly, however, Andrew Green’s report notes:
[the] FSA would not bring disciplinary proceedings against an approved person for misconduct merely because a regulatory failure had occurred in an area of the business for which that person was responsible… More was needed i.e. ‘personal culpability’.187
133.Proceedings into potential misconduct by individuals were judged against the civil standard, meaning that guilt would be determined on a balance of probabilities basis, rather than requiring proof beyond all reasonable doubt.188 If found guilty, the most notable sanctions open to the FSA were to impose a financial penalty and/or to prohibit a person from undertaking a regulated activity in the financial services industry. 189
134.Commenting on the overall legal regime in place at the time for conducting enforcement investigations into misconduct, Andrew Green acknowledged that it was “difficult to bring successful enforcement action against senior bankers” and that the regulatory scheme “did not … encourage an ambitious approach”.190 Explaining why this was the case, he added:
There can be little doubt that establishing ‘personal culpability’ was a difficult task in the context of the failure of a substantial multi-divisional corporate entity such as HBOS, where strategy was frequently the result of collective decision-making by a Board over an extended period of time.191
135.Andrew Green suggested that the statement of responsibilities under the new Senior Managers Regime may improve things in future, noting:
[ … ] the allocation of responsibilities in this way will enable the regulator to decide, at an early stage, if this is somebody we should be investigating, and then we would investigate them and decide whether, ultimately, we are going to be able to establish personal culpability in subsequent prohibition or misconduct proceedings.192
136.Andrew Green’s assessment that the regulatory regime in place at the time of HBOS’s collapse did not encourage ambitious enforcement action is concerning. The Committee agrees with this assessment. In order to be a credible last line of defence, there must be a perception that regulators are able to undertake even the most challenging and complex of cases. It is to be hoped that the Senior Managers and Certification Regimes will enhance the credibility and fairness of enforcement in future, given that they should lead to much clearer lines of individual responsibility. If the regulators find in future that these changes are not enough to establish a credible enforcement regime, they should say so.
The enforcement context within the FSA
137.The Green report outlines the normal procedure for an enforcement case at the time within the FSA.193 Typically a referring department (Supervision in the case of HBOS) would raise a potential matter for investigation with the Enforcement division. Enforcement and Supervision would then engage in discussion and reach a joint decision about whether to pursue the case. At this point a member of staff within the Enforcement division would typically become the Project Sponsor.194 The FSA had at the time some limited internal guidance for helping staff decide which cases to pursue. Following a review of this guidance, the Green report notes that:
It is apparent from the above that the FSA would not conduct an investigation merely because the statutory threshold test … was met. Rather, the FSA, in deciding whether or not to conduct an investigation … would consider “all the relevant circumstances” … by reference to ‘assessment criteria’/’referral criteria’ which included consideration of the ‘regulatory objectives’ and whether the issue being considered was relevant to the FSA’s ‘strategic priorities’.195
138.Once the decision to investigate had been made, the Enforcement division would appoint an investigation team and issue a Memorandum of Appointment of Investigators to the subject of enforcement action. Following the completion of the investigation, Enforcement would produce a Preliminary Investigation Report setting out the evidence and assessment of the case. This was then subjected to review by an FSA lawyer and, following this, would be sent to the subject of the investigation for comment.196
139.A decision was then taken by the Project Sponsor (typically a member of Enforcement) and the legal reviewer. If it was agreed to take enforcement action, a case would be submitted to the FSA’s Regulatory Decisions Committee (RDC). The latter was a function within the FSA, separate to Enforcement, tasked with reaching judgements over cases. If the RDC agreed the case had merit, it would inform the subject of investigation, who could then make representations to the RDC. Following this, the RDC would issue its final decision. A decision adverse to the subject could be appealed by the subject in the Upper Tribunal. If the FSA wanted to reach a settlement with the subject of an investigation, it could do so through a separate process. 197
Andrew Green’s assessment of the FSA’s HBOS investigations
140.The Green report highlights numerous instances of deficiencies in the FSA’s approach to enforcement action following the collapse of HBOS. According to Andrew Green, one of the FSA’s first major shortcomings was its failure to conduct a reasonable decision-making process in the period between December 2008 and late February 2009.198 In his criticism of the FSA’s approach, he states that the FSA did not give “proper consideration” to the investigation of other HBOS Board members and executives i.e. other than Peter Cummings.199 This failure to conduct a reasonable initial decision-making process was then compounded by the subsequent failure properly to consider the scope of the initial investigations i.e. whether it should be wider than just Peter Cummings.200 The Green report makes clear that these problems stemmed from, among other matters, a number of procedural and institutional limitations within the FSA.
Improving co-ordination
141.In order to rectify the failings discussed above, the Green report makes a number of recommendations to improve future enforcement procedures.201 One of these is for the regulator to take steps to improve communication between Enforcement and Supervision during an investigation.202 This reflects the fact that the current set-up of Enforcement means Enforcement personnel will be reliant on supervisors to draw their attention to areas of developing concern. In the HBOS case this mattered because asset quality in other areas of HBOS’s balance sheet, especially the International and Treasury divisions, began to deteriorate rapidly as the financial crisis progressed.203 The Green report notes, however, that there was a failure to pick up on this change in circumstances in the enforcement process, stating:
During the Report interviews, it became apparent that some former FSA employees thought that the possible expansion of the scope of an investigation was a matter for Supervision to raise with Enforcement; others thought it was a matter for Enforcement to raise with Supervision; and others thought it was a matter which would be raised by a dialogue between Supervision and Enforcement204
142.As a result of this lack of communication, Andrew Green argues that the enforcement process began, and remained, too narrowly focused on HBOS’s Corporate division.205
Clearer decision-making
143.Another of the Green report’s recommendations concerns pre-referral decision-making, the stage of the enforcement process during which the regulator decides which (if any) investigations to start. Andrew Green suggests that before making a referral in connection with a case, the regulators should “identify each firm or individual in respect of whom the statutory threshold test for conducting an investigation is met”. 206
144.Again, this recommendation draws on some of the key failings uncovered by the Green report. In particular, the FSA’s Enforcement division failed to keep a clear record of which HBOS executives had met the statutory bar for investigation. This was also not clearly communicated to senior management. As the Green report notes, one of the most striking instances of this was when Sir Hector Sants was apparently not informed that Andy Hornby (CEO of HBOS 2006–09) had met the statutory bar for investigation (see Chapter 3).207
145.Andrew Green argues in his report that, once the regulators have noted every person or firm which has met the bar for investigation, they should then also clearly record which cases they will and will not pursue, along with explanations for the chosen course of action.208 This change would potentially help to address another key problem identified in the Green report: that when deciding whether to undertake an investigation into certain individuals, the FSA would first attempt to assess the probable chances of achieving disciplinary success in the case. As the Green report notes:
the problem with this approach was the difficulty in accurately evaluating the prospects of success in disciplinary proceedings before an investigation had even begun. This approach, therefore, had a tendency to discourage the FSA from starting investigations even though the threshold test for investigating was met and even though the public importance of investigating was high.209
Internal procedure and standards
146.A further common theme throughout the Green report is the repeated occurrences of poor record keeping. In one instance, the report identifies a crucial meeting on 9 January 2009, the outcome of which was to determine that the FSA would make the Corporate division of HBOS and Peter Cummings the focus of its investigations. Yet Andrew Green goes on to note that:
There appears to be no attendance note of the meeting, or any other clear record of the matters discussed; and none of the people who attended that meeting could remember anything about it in their report interviews.210
147.The problem of poor record keeping was also identified at a more senior level. In his report, Andrew Green cites the example of when the FSA’s executive committee (ExCo) was considering whether it should begin work on the HBOS report while enforcement action against Peter Cummings was continuing. In this case, Andrew Green states that “insofar as a decision was made on this important issue, any such decision is not properly recorded in the poorly drafted ExCo minutes. This is an unsatisfactory situation.”211 The Green report finds that the ExCo minutes were also deficient on a separate occasion, when ExCo was considering a potential investigation of Andy Hornby.212 The Green report addresses this by recommending a much higher standard of minute taking at ExCo in future.213
Next steps
148.A further recommendation from the Green report was that:
Given the inadequacies in the FSA’s decision-making processes [ … ], the FCA and/or the PRA should now consider whether any other former senior managers of HBOS (including, but not limited to, Mr Hornby and Lord Stevenson) should be the subject of an enforcement investigation with a view to prohibition proceedings. There is plainly a public interest in this being considered afresh.214
149.Andrew Bailey and Sir Brian Pomeroy both indicated during their hearing that they did not object to any of Andrew Green’s recommendations.215 The FCA and PRA have since publicly announced that they are undertaking investigations into some former HBOS executives.216
150.The scope of the FSA’s original HBOS enforcement investigations was not reasonable. There were also significant procedural failings. In particular, the FSA’s Enforcement division formed the view in early 2010 (having not considered the position in 2009) that the statutory threshold test for starting an investigation had been met in the case of Andy Hornby (CEO of HBOS 2006–09), but it decided not to investigate him. However, because of a failure in communication, the Enforcement division never informed Sir Hector Sants of its view that the statutory threshold test for investigating Andy Hornby had been met.
151.The Committee finds this wholly unacceptable. Knowledge of which individuals had met the statutory test for investigation was crucial to allow the FSA’s leadership to judge whether the scope of the HBOS enforcement investigations was appropriate. Furthermore, it is clearly unacceptable that important meetings and decisions among Enforcement staff, where major decisions were made concerning the scope of the HBOS enforcement investigations, went unrecorded. These oversights add to the already extensive evidence that the FSA was not up to the job. It was clearly a highly dysfunctional institution and its legacy continues to pose a major challenge for its successor bodies, particularly the FCA.
152.Improvements in the approach taken to enforcement at the regulator are just as important as the new rules embodied in the Senior Managers Regime. Andrew Green makes several recommendations to deal with the severe procedural failings identified in his report. These include steps to require the regulators in future to retain a far clearer record of which persons have met the statutory threshold test for starting an investigation. It is welcome that the PRA and FCA have already incorporated Andrew Green’s recommendations in their recent consultation document. The establishment and performance of a new enforcement decisions committee at the PRA will also be carefully examined by the Treasury Committee in due course.
Should enforcement and supervision be separated?
153.The Green report identified a number of failings in the level of dialogue and coordination between the Supervision and Enforcement divisions at the FSA, raising the question of how best to manage the relationship between these two regulatory functions. Although the FSA has since been disbanded, different parts of the former Enforcement division continue to reside alongside supervision functions in the FCA and PRA respectively. The question over how to manage the relationship between the two functions therefore remains relevant.
154.In 2013, the Parliamentary Commission on Banking Standards (PCBS) identified the relationship between the supervision and enforcement functions as an area of concern. In the PCBS’s view, there was an inherent tension between the two functions that could not easily be resolved. 217 First, the experience of the FSA proved that it was difficult to ensure that both functions received adequate attention within a single organisation. This was a particular concern during a period of financial crisis, when the FSA’s focus was on supervision and maintaining financial stability, at the expense of enforcement. Secondly, the PCBS noted that the two functions could suffer from having conflicting objectives. For instance, historical actions taken by Supervision could be relevant to an enforcement investigation. This had the potential to put the Enforcement division in a position where during an investigation it had to reach judgements on prior actions taken by supervisors.218
155.Reflecting these concerns, and in order to address the inherent tension between the enforcement and supervision functions, the PCBS suggested that the FCA’s Enforcement division could be placed within a separate statutory body. This would ensure that both functions received adequate attention, as well as clarifying their objectives. Nevertheless, at the time the PCBS declined to make this a formal recommendation, as the regulators were already in the process of completing a preceding series of organisational changes.219
156.By contrast, in December 2014, the Treasury completed a separate review into enforcement, in which it concluded against the case for separating enforcement and supervision. While the Treasury review accepted that there was the potential for a degree of tension between the two functions, it argued that co-operation between supervision and enforcement was likely to be “imperilled”, not improved, by separation.220 It was suggested that this would follow from both practical difficulties, such as issues around information sharing, as well as the potential for the two different organisations to have divergent priorities.221
157.In their hearing with the Committee, the regulators indicated that they supported the Treasury’s conclusions that enforcement and supervision should stay within the same organisation. Sir Brian Pomeroy noted that there was a trade-off between “co-ordination, a free exchange of information and independence”, but added that it was the FCA’s view that co-ordination was facilitated by being in the same organisation, as was the effective use of the whole range of the FCA’s tools. This, Sir Brian argued, justified “leaving things as they are”.222
158.In its final report, the Parliamentary Commission on Banking Standards identified some of the problems that arose as a result of keeping both the enforcement and supervision functions within a single regulator. The PCBS noted that both functions had different objectives which, at times, could be a source of tension, especially if the Enforcement division had to reach judgements about matters in which supervisors were involved at the time. There was also the danger that insufficient priority would be placed on enforcement within a larger organisation, reducing its effect as a credible deterrent. One solution discussed by the PCBS was to place the enforcement function into a separate statutory body. This option was subsequently rejected by a Treasury-led review.
159.Nonetheless, the findings of the Green report reveal that the relationship between enforcement and supervision within the FSA was indeed highly problematic. Keeping both functions within the same organisation did not result in a high degree of co-operation, undermining the argument that the two functions should remain under the same roof. In the light of this, the Committee believes the merits of structural separation bear re-examination.
160.First, the Committee notes that the collapse of HBOS, along with other UK financial institutions during the crisis, was the result of prudential failings. It is far from satisfactory that the bulk of enforcement staff and expertise still lies within the FCA, which has no role in prudential supervision of banks. An independent enforcement function could and should sit equidistant between the PRA and FCA.
161.Secondly, a separate statutory body would bolster the perception of the enforcement function’s independence. The current system, whereby the same organisation both supervises, applies and prosecutes the law is outdated and can be construed as unfair. By moving enforcement away from supervision, it can focus independently on undertaking its key functions: interrogating evidence and assessing whether a regulatory breach has been committed. This could increase confidence in the impartiality of regulatory enforcement decisions, and facilitate objective scrutiny of supervisors’ actions by enforcement staff.
162.Thirdly, separation would allow all three regulators - the FCA, PRA and an enforcement body - to enjoy much greater clarity over their objectives. There is a danger, especially with the FCA, that its multitude of objectives and initiatives are leading to regulatory overload. An FCA with fewer objectives, and a single separate body responsible for enforcement, would probably result in better accountability and better outcomes.
163.The Committee concludes that the case for structural separation has merit. The Treasury Committee expects the Treasury to appoint an independent reviewer to re-examine the case for a separate enforcement body.
185 Andrew Green QC, Report into the FSA’s enforcement actions following the failure of HBOS, 19 November 2015, pp 7-8
186 Ibid, p 9
187 Ibid
188 Ibid, pp 9-10
189 The legislation governing the time limit for bringing misconduct proceedings was originally two years and was subsequently amended, extending the period first to three, and then to six years
190 Ibid, p 87
191 Ibid
192 Q 3
193 A full timeline of the relevant enforcement events in the case of HBOS is contained in Appendix 6.
194 Andrew Green QC, Report into the FSA’s enforcement actions following the failure of HBOS, 19 November 2015, pp 12-13
195 Ibid, p 14
196 Ibid, p 16
197 Ibid, p 17
198 Ibid, p 4
199 Ibid, p 4
200 Ibid, p 4
201 Ibid, pp 91-92
202 Ibid, p 91
203 PRA and FCA, The failure of HBOS plc (HBOS), 19 November 2015, p 26
204 Andrew Green QC, Report into the FSA’s enforcement actions following the failure of HBOS, 19 November 2015,
p 69
205 Ibid, p 69
206 Ibid, p 91
207 Ibid, p 89
208 Ibid, p 91
209 Ibid, pp 87-88
210 Ibid, p 23
211 Ibid, pp 85-86
212 Ibid, p 35
213 Ibid, p 92
214 Ibid, p 5
215 Qq 98-99
216 Bank of England, News release - FCA and PRA investigations into HBOS Senior Managers, 28 January 2016
217 Parliamentary Commission on Banking Standards final report, Changing banking for good, 12 June 2013, HL Paper 27-I/HC 175-I, Vol II, Paras 1199–1202, pp 521-22
218 Ibid
219 Ibid
220 HM Treasury, Review of enforcement decision-making at the financial services regulators: final report, December 2014, pp 10-11
221 Ibid
222 Q 112
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22 July 2016