Financial Services and Markets Minutes of Evidence

Examination of witnesses (Questions 280 - 299)




Lord Fraser of Carmyllie

  280.  Can I try and approach it the other way round? The mischief I would be seeking to avoid is where someone who has complied to the letter with the guidance in place from time to time and has no intent to bring about any abuse of the market, nevertheless is regarded by the FSA as having breached Clause 56 without intent and could find himself in breach of that. That would seem to me to be unfair and the modification you have suggested seems to me to be a helpful way, if I may say so, of avoiding that mischief.
  (Mr Clarke)  I agree it is unfair. Somebody said at one of the earlier evidence sessions that it was necessary to have offences of strict liability to ensure certain sorts of conduct were not carried out and offences of strict liability do exist under the law but they are usually concerned with "You shall not do a particular course of action." In this case the code can say, "You shall not do a particular course of action and if you then carry out that action in breach of the code you are going to be in trouble, you do not have the code to protect you." The situation I am describing is when you are trying to prevent people manipulating the code or manipulating the market, or whatever, and in those circumstances I believe that intent is a necessary element.


  281.  I think this would be a useful time to return to Mr Whittaker. We have this familiar group of issues to do with guidance, principles and intent or lack of it. I think it would be helpful if we could have your response, particularly to what Lord Fraser has been saying, about the interaction between these.
  (Lord Archer of Sandwell)  My Lord Chairman, if you are concluding this part of the matter, I wonder if I might make one comment?

  282.  Of course.
  (Lord Archer of Sandwell)  The House of Lords Select Committee on Delegated Legislation is also considering this subject. I think you will have the advantage of reading our report before we have the advantage of reading yours, but it might just be worth seeing what each other says before we conclude.

  283.  Thank you very much.
  (Mr Whittaker)  As I indicated when we last met, we for our part have no difficulty with the idea that guidance which we issue should have a special status in providing comfort to people who act in accordance with it. This would not legitimise conduct which is criminal under other parts of the law, but could be relevant for the purpose of the market abuse provision which we are discussing. We very much want to have a co-operative relationship with the firms we relate to in which firms feel free to come to us for guidance. We regard this as good for compliance, good for the industry. We are not necessarily very enthusiastic about the idea there should be a duty on us to give guidance in a big range of situations. That seems to us to raise the issue of who determines the resource allocation within FSA. Is it the board of the FSA determining where they think the risks most lie, or is it those in the industry who come to us and ask us to give guidance? We know that some overseas regulators find much of their resource is taken up in giving guidance rather than in the areas they would themselves wish to target. One further point before we leave the issue of guidance. We are conscious there is conflict, or potential conflict, between giving guidance to firms on individual transactions and the responsibilities of the senior management of those firms for the management of their businesses. We would not want to encourage a situation in which there was in any particular area of operation the growing up of a dependency culture in which firms felt unable to take action themselves without seeking guidance from the regulator. With that caveat, we are generally supportive of the idea.

  284.  Do any of the witnesses want to respond to that? How far do you think that takes us?
  (Mr Sylvain)  My Lord Chairman, on the issue of intent which the FSA seem to want to keep out, as some of the discussion shows here I do not think you can keep it out. In my experience, market abuse and something that is intentional is just an exaggerated form of normal market behaviour. For instance, every day a large City brokers in the United Kingdom will issue research reports on stock and it might be a stock that they own. If they issue a very glowing report about a stock and the price goes up, was there an intent to abuse the market or is that just everyday business in the financial services world? Similarly, if you take a short position on a stock and the stock goes down, is the fact that the stock went down evidence that you meant to abuse the market? My point is that I do not think you can distinguish very easily behaviours which have the same impact between the one who intended to have a manipulative impact from the one who simply was engaging in normal markets where in markets it is the behaviour of buying and selling which forces prices up and down. So actions all the time in the market will create outcomes which, with 20/20 hindsight, one might say were intended to drive the price up or down but which are actually just normal. That is what happens if you sell a load of stock that you have. The price will go down but it is not your intent. Your intent is to capture as much price as you can for that while you are selling. So the intent is very important in that and I do not see how you can do any better.
  (Mr Vipond)  My Lord Chairman, I think that is exactly right. The problem is with market abuse and it is in clauses 56 and 57, which you have discussed already, rather than many other clauses, but the intent issue is so critical. Beyond that I think there is an important issue about guidance, that is, the guidance from the FSA, and that is that if guidance is to be sought, then in general the FSA have an obligation to have an open relationship with firms that will allow them to give that guidance on an informal basis, where possible, and formally, where necessary. The danger I think we face at the moment is that people will be reticent about having that open relationship with their regulator precisely because of the growth in emphasis on enforcement on a more legalistic basis.
  (Mr Blunden)  Just a very quick point on the resource allocation required for guidance. The FSA could take a leaf out of the industry's book. Where we do not have sufficient resources to do something we out-source it and perhaps the FSA could make whoever is requiring the guidance pay for it and make it available to all on the Internet.

Lord Poole

  285.  May I say that I do feel there is a very considerable difference of opinion between Mr Buxton and Mr Vipond and Miss Hutchinson, which I suggest is there in graphic terms. Mr Vipond has just said no, the legalistic approach would, he felt, be damaging to a good relationship between the regulator and the industry and Miss Hutchinson's plea for certainty seems to be exactly that. Similarly—and I wrote it down—Mr Buxton said he was against formal rules, which seems also to be contrary to the notion of the continuous desire for categorical certainty. I quite understand the position taken by Mr Buxton and Mr Vipond because it sounds very much like the process by which the SIB rules were interpreted and the rule book developed and so on and so forth. So I wonder if I have interpreted it correctly and if Miss Hutchinson could say if she felt that the regime of the SIB principles and developed rule book equally fell into the dangers to which she has tried to alert us today?
  (Ms Hutchinson)  I think the concern we have is that, given the strict penalties, the severe penalties, there may be for market abuse, people have to be clear, or as clear as they can be, what is and what is not market abuse, but we do live in a moving world and, as Dominic said, you cannot legislate for everything, the market is always going to be ahead of you, but you do need some safe harbours. If there is a code you ought to be all right if you comply with that code, subject to an intent to abuse it. If you ask for guidance and you are given guidance, you ought to be all right if you comply with it and that is the certainty working, that in certain situations you know you are going to be on the right side of the line. We are not trying to make it more legalistic. What we are trying to do—and I am sorry if this is not coming over—is to make it workable and user-friendly for the people in the market so that they know where the line is, and if they do not, they know where they can go to find out.
  (Mr Buxton)  I hope I did not say I was against all rules. What I said was that the legislation empowers the FSA to make more rules and what I wanted is for more rules actually to be in the legislation on some points. I mentioned particularly clauses 56 and 57. I think they are very important, but let me give you a practical example. Andrew Whittaker has talked about senior executives and their liability. I do not know whether the Committee is aware that all non-executive directors—I am talking about non-executive directors—of financial companies are also completely liable and actually sign a liability document when they become a director of a financial company. I believe that those people need to know what their liability is and I think it needs to be spelt out because otherwise it may be very difficult to get non-executive directors to be non-executive directors of financial companies. So I am not against the rule book but I think I take really exactly the same view as Miss Hutchinson has just taken. We need as much certainty as we can get within the context of a relationship with the FSA that we have talked about on guidance.

Mrs Blackman

  286.  Just a small point on this issue. Howard Davies has said on record that he favours an informal pre-clearance on many occasions and Andrew Whittaker mentioned that as one of the courses of action they may well take, and I suspect that course of action may well be taken far more frequently than an official request for guidance. What kind of conversations and what kind of culture need to be developed at the FSA to get that relationship built up?
  (Mr Vipond)  If I were starting I would pay tribute to the old supervisory culture that the Bank of England had, and some of the old SROs, where I think a great deal of what one would hope exists in the future already existed. It is not beside the point that London's success as a financial centre is partly due to the quality of the regulation and I think you will find that international firms particularly have appreciated the way in which they can talk openly and honestly to regulators about complex deals and get guidance. It is something they cannot do in other parts of the world very often. The culture is one which is very much a sharing, not a symbiotic culture but one that shares values, shares aspirations. One of the biggest tasks Howard Davies has in merging nine different regulatory cultures is to sustain that basic ability to work with businesses in the market place. I think that is something we would all strongly endorse. In a sense the debate about market abuse, which, is, I repeat two clauses in the Bill, is a discrete area of special civil offence and we should not allow that to cloud the overall view of the business of enforcement of the FSA.


  287.  Andrew Whittaker, I think we should wrap up this part of the discussion but do you want to have a last word?
  (Mr Whittaker)  There are two things I would particularly point to in terms of promoting the right relationship between regulator and regulated. I think, first of all, it needs to start at the top and I think it has started at the top. I think there is a clear message going out to staff that a good relationship with the regulated community is important to us in terms of the regulator we want to be. Secondly, from a personal point of view I would say that I think a degree of empowerment is important, that people need to know that in fostering a good relationship and in taking responsibility in giving views to people in the industry the organisation will back them, and I think we also have that as well. So I think those two things are what I would regard as important. I think they are both in place.

Lord Montague of Oxford

  288.  Mr Buxton, I want to take up one point you made about non-executive directors and the difficulty you might have in securing them. Would they not be protected by insurance, and, therefore, not be so worried?
  (Mr Buxton)  There is a degree of insurance that can protect them but they are not completely protected. I believe that the protection they have is knowing that they can only be prosecuted by the FSA for actions for which they are responsible, i.e. policies that they have laid down that have resulted in a breach.
  (Mr Roe)  There is just one point I might make for balance in some of this discussion. I think it is worth bearing in mind when we are talking about intent what the underlying objective of the policy that we set out in the market abuse provisions is. Essentially the new regime is concerned with the effects of behaviour and very central to the Government's policy here is the idea that we must have efficient, well-run markets which can allocate resources effectively and so on. So we are primarily, I think, concerned with market efficiency and it seems to me and to Ministers to be the case that confidence in markets is affected by actions regardless of intentions, and what is important, I think, is for people to act with due care and attention when they are operating in financial markets. I say this not because the Government necessarily disagrees with all of the points that have been made but I think it is worth keeping in mind that particular background.


  289.  I hate to attempt to sum this up because it will immediately cause a whole series of disagreements. But what I am taking from this is that if there is no intent that can be shown and if people do stick to the guidance and if they do take due care and diligence, then they will be reasonably safe. Is that an over-strong statement?
  (Mr Whittaker)  I am not sure, Chairman.

Lord Fraser of Carmyllie:  If you have regard to the FSA's formal guidance and if you also go along and ask them, "What I am about to do, is that okay?", is that not a proper discharge of due care?

Chairman:  And there is no intent to do something else?

Lord Fraser of Carmyllie

  290.  I go to the FSA and I say, "I am going to do this. I do not know whether you would regard this as abuse. I have looked at your guidance. I cannot see that there is any breach. Can you tell me on any formal basis?" I understand that Howard Davies said there is not going to be a formal procedure but if the qualification that is now being suggested is one of paying due care and attention, if I have gone through both those steps it would seem to me that is a very clear indication that I have discharged that duty that is incumbent upon me, is it not?
  (Mr Whittaker)  As the Bill now stands, if you were to come to us for guidance on a particular transaction and we were to say that we thought that transaction was consistent with the market abuse provisions, then provided you had been open with us in what you said and the situation was as you described it, I think we would be extremely unlikely to take any action in relation to those provisions. There is not currently in the Bill as it stands at the moment anything that says that anyone who has acted with due care and attention can, in the absence of having gone to the regulator, nevertheless regard themselves as protected from action.

Chairman:  I think we may have moved a little way forward on this but we will have to look at the record and we ourselves will have to consider this. I would now like to move on to general issues about FSA powers of discipline and enforcement against authorised persons and their staff.

Mr Sheerman

  291.  I think it moves seriously on to whether the FSA's powers are coherent and are they sufficient. I want to come back to Lord Eatwell's theme which has really run through this, and what Mrs Blackman mentioned, that, on the one hand, we can hear two voices, one saying, "Let us have a good informal relationship with the FSA backed up by known powers and rules." On the other, there is a voice coming quite strongly—and I am not pointing particularly to Andrew Buxton but one or two of you are saying, "Don't specify too closely. We have a good relationship. It is a very dynamic market, and if that dynamic means the rules get out-of-date, then we need an informal process by which we can clear that." What would worry some of us in terms of this being too flexible is that there are other players in this and we have to remember there are consumers and very often we hear the views of the big players and the wholesales but the consumers also have to know there is a dynamic and that the rules are changing, are becoming more flexible, that there is a smooth and easy relationship between the wholesale market which may outpace consumer knowledge. So in a sense do we think that the FSA's powers here are coherent and are they sufficient? Can I pick on Antony because Antony is the prime suspect. He has a strong view and most of us have had the benefit of his presentation to the conference two or three weeks ago.
  (Mr Blunden)  I was rather hoping to leave it to the lawyers.

  292.  You made it a theme in your presentation that you were concerned about not having a rule book, rules that were understood, guarantees of safe harbours and so on.
  (Mr Blunden)  Yes, certainly. That concerns me greatly. Again, I apologise, my Lord Chairman, I find myself drifting back to certainty but it seems that most things come back to that. The FSA's powers are huge, they are enormous, and I find it troubling that with a great degree of uncertainty as to what market abuse is the FSA has such an unmitigated amount of powers. I think particularly with regard to individuals, when the FSA is pursuing individuals, there is again such a discrepancy of resources that I welcome Lucy Hutchinson's thought of an independent enforcement committee and the ability for that independent committee to give Legal Aid to individuals. Firms can go one on one against the FSA without too much of a problem but when you are being prosecuted by the FSA you are looking at bills of hundreds of thousands of pounds and very few individuals, even in the financial services sector, can afford that sort of money.

  293.  The FSA did point out that out of 1,850 staff there are only 110 engaged in enforcement against authorised persons. In a sense are you not getting your fears for this enormous power of the FSA, as you describe it, out of balance? The voice I hear from the other side of the room is "go on, we understand that people want a seamless transition to build on a culture that already exists", okay nine regulatory authorities coming under one, but the aim is to have a seamless transition where one does not disturb a culture that is working very well anyway. Are you not getting these fears out of proportion?
  (Mr Blunden)  If that bit of the existing culture that is working well, and I acknowledge that part of it does work well, if that was transferred to the FSA and enlarged then it would certainly allay some of our fears, although not all of them. I am aware that a number of times I have had a number of meetings with the FSA in various bodies and Howard Davies and a number of his staff have all said "do not worry, it will be fine". I would love to believe that, and I am sure they genuinely mean it and they want it to be fine, the problem is we cannot have a system that is going to exist for hopefully a considerable number of years relying on the initial chairman, the initial managing director of enforcement, who I am sure are dedicated to ensuring that it will be fine but five years down the road we do not know who this vast amount of power will be handed to and that does concern me.
  (Lord Archer of Sandwell)  My Lord Chairman, I think everyone is in favour of an informal relationship where people can talk and get advice. As I said earlier, there are a number of authorities which operate in this way. If I might suggest what I think is probably a good example, the Occupational Pensions Regulatory Authority tries to work in this way. But at the end of the line if there has to be enforcement action then they are in the business of quasi-judicial decisions. I think they rather regard it almost as a failure on their part if it gets that far but if it gets that far that cannot be a reason for slipshod procedures and I think there would be some impact probably of Article 6 on this if we did have slipshod procedures. If I might just suggest one or two things that occurred to the Council on Tribunals on this. First of all, Chinese walls are quite important in this context. Whether they should be Chinese walls or whether they should be written into the Bill, I do not think I would want to be dogmatic. But, for example, if anything was said by someone who was going to be the potential recipient of disciplinary procedure to the staff at an earlier stage they should be able to do that without feeling that it might be disclosed to the enforcement committee at a later stage. There ought to be some sort of barrier between what is said to the staff and what the enforcement committee is told otherwise you will not get people being frank and you will not get them asking for advice. The second thing is that there ought to be an opportunity, we believe, to present your case orally at least to the enforcement committee. It should not be a question of passing judgment on you without you having had an opportunity orally to argue your case. I would support strongly what Ms Hutchinson said about the independence of the enforcement committee. I would want to argue two things about that. The first is that they should not be in any sense employees of the FSA. We would recommend that the chairman should be someone like a High Court judge, or a retired High Court judge if the Lord Chancellor objected to seconding a judge, but someone of that status who would operate as chairman and who would not be in any sense under the control of the committee. In relation to the other members, the representatives of public interest, I think we would want to argue—it is not spelt out in the Bill, it may be intended—that they should have votes together with the chairman so that they might actually outvote the chairman if that arose. If there is a disagreement it should be made known to those concerned. When there is a question, as I think is suggested in the paper, of the chairman issuing a warning we believe that the other members should not be associated with that. If they are then they should be different members who actually hear the complaint. There are a number of these matters. Perhaps it would be quicker if we put in a document about it. There are a number of matters of this kind which we would regard as essential if the FSA is going to make binding decisions on people.


  294.  There are two models that are emerging here as I understand it. One is where the enforcement committee is a body which takes a decision and it comes to a judgment and then the tribunal can go through the whole process if anyone is not happy with it. There is another model which was mentioned which is that the enforcement committee, in a sense, is merely a filtering agent which says whether or not a case should proceed. Meanwhile people try to agree on the outcome and it is only if they fail to agree that the enforcement committee should give some indication of how it feels but basically it then goes to the tribunal.
  (Lord Archer of Sandwell)  Yes.

  295.  These are two models which I interpret are being discussed here. Your comments, I take it, are related to the first model which is where the enforcement committee has the power to actually come to a decision. Therefore you want to build in a series of measures to ensure degrees of independence between the different parts of the process and also to ensure that the individuals involved are independent.
  (Lord Archer of Sandwell)  Yes, thank you, my Lord Chairman, that is so. If that were the pattern then it would be in rather a Pickwickian sense of the word that the tribunal would be a tribunal of first instance. It would be a tribunal of appeal. I think probably what was meant by saying that it was a tribunal of first instance was that it could rehear the case and the Lord Chancellor would not make regulations excluding it from hearing particular evidence. If that was all that was meant then there is no difficulty.

  296.  Do you have a view between those two models as to which direction you would prefer to see this moving; one is that the enforcement committee is the body that comes to a decision and then you have the tribunal; or is it that the enforcement committee sends the case forward to the next stage which is the tribunal? Maybe that is an unfair question.
  (Lord Archer of Sandwell)  I cannot be certain it is the view of the Council but my own view is the second one, I think, which was why I was pleased to see what the Economic Secretary had said.

  297.  It has been dashed from our lips!
  (Lord Archer of Sandwell)  Like all of us who have been Ministers someone later construes what we said as to what we ought to have said!

Lord Poole

  298.  Can I just pick that up. So you think there would be some merit in a system that took through the enforcement committee the parties to whatever it is that has taken place in the hope that there would be some sort of agreement, settlement, fines, whatever might be the outcome, and only if that failed then taking it to the tribunal, as it were, for the case to be more formally heard?
  (Lord Archer of Sandwell)  Yes, that would be the model that I had in my mind. I do not know which building they will operate in but if the two things could happen on different floors that would be an advantage.

Chairman:  Can I ask what others think about these two models?

Mr Beard

  299.  If you take the second model where the FSA becomes a sort of Crown Prosecution Service and the tribunal is the one where the decision is made, is that not going to be a very cumbersome procedure? One can imagine a large number of things that are really quite minor in nature ending up going to the tribunal which really ought to have been settled by the FSA if you took the original interpretation of it as being a regulator, which takes these decisions within itself and then uses the tribunal as an appeal court. It does seem to me that before very long the whole thing will become gridlocked with cases pending, waiting, and all the plea bargaining that is going on to try and avoid it going to the tribunal and little will come out and the result could very well be that which is not very well represented around this discussion, that the public at large lose confidence in it.
  (Lord Archer of Sandwell)  I do see that argument and I think it is quite an important one. I would envisage, and I rather thought a number of people in the Committee and a number of witnesses were envisaging, that the plea bargaining would be part of the discussion, it would not entail a decision by the enforcement committee. I can see in a particular case where not very much is at stake and you cannot get agreement that it would be better if you could have a quick sharp decision. Possibly you could have a two tier system.

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