Changing Banking for Good - Parliamentary Commission on Banking Standards Contents

10  Sanctions and enforcement


1116. In previous chapters we have examined various ways in which the standards and culture of banks and individuals working in banks can be changed—through changes to the competitive environment (Chapter 5), through radical changes to the incentives offered by remuneration (Chapter 8), through a new framework for individual responsibility (Chapter 6), through changes to bank governance and culture (Chapter 7) and through changes to the supervisory and regulatory approach (Chapter 9). Our proposals in those chapters are predominantly preventative in their aims—to reduce the chances of things going wrong. However, it is essential that preventative measures are backed up by suitable sanctions when things do nevertheless go wrong. It is also important to consider the role which effective sanctions and powers of enforcement can play as a deterrent in changing behaviour. Box 21 sets out how the recommendations from these chapters will together result in significant changes to individuals' incentives and the consequences for standards.

Box 21: The effects of reforms on individuals

The Commission's reforms are intended to create a banking sector where failures in banking standards are less likely to arise, where there are stronger mechanisms for correcting failures when they start to escalate, and where, when serious failures do nevertheless occur, there are robust tools for holding those responsible to account and imposing appropriate penalties. The prospect of such penalties would in turn feed back into better incentives for bankers to behave correctly in the first place. This box sets out some illustrations of the practical differences which some of the proposed reforms might make.


Senior managers of banks will no longer be able to hide behind an accountability firewall, where they are too distant from the consequences of their responsibilities to be held directly accountable when things go wrong. A future investigation into a scandal such as Libor manipulation should not result in the trail going cold half-way up an organisation, but should be capable of leading directly to the senior executive whose lack of oversight permitted it to happen. More clarity over responsibilities should also help avert future disasters comparable to PPI mis-selling, where shared responsibilities and decisions by committee meant that nobody felt responsible for checking that the products were appropriate for customers and appropriately sold to them.

The Senior Persons Regime will clearly attribute responsibilities to individuals. Senior Persons will know that they can be held accountable and subjected to enforcement measures if they fail to uphold those responsibilities. The regulators will have two enhanced enforcement tools which can be applied to those individuals within the Senior Persons Regime.

The proposal to reverse the burden of proof for imposing regulatory penalties on Senior Persons in certain circumstances would make sure that those who should have prevented serious prudential and conduct failures would no longer be able to walk away simply because of the difficulty of proving individual culpability in the context of complex organisations. Once successful enforcement action had been taken against a bank, such as for the failures relating to Libor manipulation or the near-failures of RBS and HBOS, the Senior Persons with responsibilities for the areas that failed would have to show how they upheld those responsibilities and acted properly in trying to prevent the failure.

The introduction of a criminal offence for reckless mismanagement of a bank would provide a new range of sanctions, which could include imprisonment. It would provide stronger deterrence for individuals in the Senior Persons Regime. Criminal prosecutions would only be used in cases resulting in the most serious public harm and with the most serious misbehaviour, where civil penalties alone would not suffice.


The Licensing regime will cover a broader range of individuals than those who are currently within the Approved Persons Regime. For example, all the traders and rate submitters who were involved in Libor manipulation, as well as their managers, would have been within scope of the new Licensing regime as their actions could—and did—cause serious harm to the bank. Many of these individuals were not covered by the APER. The APER has since been extended to cover rate submitters, but moving to Licensing avoids reliance on such a reactive approach and makes it less likely that the next scandal will emerge in an area found again to be outside scope of the framework for enforcement.

The Licensing regime requires individuals to sign up to and abide by the new Banking Standards Rules. The Rules should be much clearer and more accessible than the Principles for Approved Persons, and banks will have a duty to ensure Licensed staff fully understand how the Rules apply to their work. As a result of the Licensing Regime, no bankers who can cause serious harm to the bank or to customers, such as those involved in areas such as the submission of Libor rates or selling interest rate swaps, will be able to claim ignorance of what is and is not acceptable behaviour.

The Licensing regime allows the regulators to use their existing range of enforcement tools against anybody within its scope when the Rules are breached. Available sanctions include suspension, prohibition and unlimited fines.


The Commission's proposals for a new Remuneration Code would encourage a much higher degree of deferred compensation, and for a wider range of employees. It would ensure that more compensation would be lost to employees if it emerged that they contributed to failures in banking standards or were awarded compensation on the basis of illusory successes. For example, this could cover executives who presided over weak control frameworks which led to scandals such as Libor or money laundering. Likewise, it could cover individual bankers who engaged in excessively risky lending which gave high returns for a few years—resulting in high bonuses—then caused a large loss when the loans went bad. Aligning the length and amount of deferral more closely with the period over which risks in banking become visible will help reduce the chances of bankers playing "heads I win, tails you lose" with the bank's money. In addition, where a bank received taxpayer support, the authorities would have powers to render void all deferred compensation, entitlements arising from change of control and unvested pension rights for Senior Persons and other licensed staff, ensuring that the taxpayer would not pick up the bill for paying those who drove the bank to failure to head off into comfortable retirement.

Enforcement against banks


1117. When there are significant failings within a bank, one regulatory response has been enforcement action against the bank in question. In relation to one of the largest prudential failings of recent years, the FSA issued an enforcement notice against HBOS in 2012 for serious misconduct during the period 2006-2008, which contributed to its failure. The FSA enforcement notice stated:

    The severity of Bank of Scotland's failings during this time would, under normal circumstances, be likely to warrant a very substantial financial penalty. However, because public funds have already been called on to address the consequences of Bank of Scotland's misconduct, levying a penalty on the enlarged Group means the taxpayer would effectively pay twice for the same actions committed by the firm. Therefore, to reflect these exceptional circumstances, the FSA has not levied a fine against Bank of Scotland but has issued a public censure to ensure details of the firm's misconduct can be viewed by all and act as a lesson in risk management failings.[1820]

The FSA has not taken enforcement action against the firm in relation to most of the other notable prudential failures in recent years, including RBS, Northern Rock, and Bradford and Bingley, even though the logic of the HBOS enforcement action could be held to have applied in those cases.

1118. The most notable recent enforcement actions against banks were those in relation to LIBOR manipulation. This Commission was established in the aftermath of the first fine announced in late June 2012 against Barclays. Since then, the FSA has imposed two even larger fines on UBS and RBS in relation to the same issue. There have been a number of less high profile actions, for example a £1.5m fine on Santander in 2012 for failing to clarify Financial Services Compensation Scheme cover on structured products,[1821] a £4.3m fine on Lloyds Banking Group in 2013 for delayed PPI redress payments,[1822] and a £9.45m fine on UBS in 2013 for mis-selling an investment fund.[1823]

1119. In relation to one of the biggest conduct scandals of recent years—PPI mis-selling—formal enforcement action against the largest perpetrators has been limited. Clive Briault, a former Managing Director at the FSA, told us that, following a thematic review in 2006, five firms were referred to enforcement, one of which was Lloyds TSB:

    the FSA's enforcement division then spent the best part of two years in a much more extensive investigation of the sales practices of Lloyds TSB in the area of PPI. [...] at the end of that, although the enforcement division found that there were a number of sales practices which were not necessarily of the highest standard, nevertheless, overall, there was not a case to bring enforcement action against that particular firm.[1824]

He noted that enforcement action was pursued against the other four firms investigated in 2006, but conceded that these were:

    much, much smaller institutions, where it would have been much easier for the enforcement division to review the relevant files and take a view whether the deficiencies in sales practices were such as to merit enforcement action.[1825]

The largest penalty imposed on a bank for mis-selling PPI was the £7m fine on Alliance and Leicester in 2008, a tiny proportion of the revenue gained from selling the product.

1120. Far more significant as a penalty, in the case of PPI, has been the cost of providing customer redress, for which Natalie Ceeney told us banks have already provisioned over £12bn.[1826] Such compensation payments are likely to exceed the level of fines that could have been sustained had the FSA pursued enforcement action. It is notable that in the case of interest rate swap mis-selling, the response to-date appears to be focused on redress. No enforcement investigations have yet been announced, although Martin Wheatley has been reported as saying that enforcement would not be ruled out.[1827]

1121. In order to initiate enforcement proceedings, regulators consider that they must have a basis for investigating. Sir Hector Sants told us that "you need a trigger", noting that in cases such as LIBOR manipulation it was unrealistic to expect the supervisor to spot the wrongdoing before it became apparent to the firm itself:

    When we are talking about misbehaviour by individuals in very large institutions, it is difficult to envisage that you could ever construct a regulator that would be able to discover that misconduct if it was not visible to the firm. [...] It would take a regulator of massive resource to find these sorts of issues. The number of instances of them is very small. There are millions of e-mails and documents involved, so the idea that a conduct regulator will proactively spot these issues on its own is a false hope [...]without a trigger of information it is relatively unlikely that, even if a supervisor had 40 people rather than four, it would make a huge difference.[1828]

1122. Sir Hector Sants and Tracey McDermott argued that the FSA had responded swiftly and decisively once evidence of LIBOR manipulation emerged,[1829] but Ms McDermott also identified some indicators that the regulators could employ more effectively to assist in identifying potential problems in future:

    one of the things that drives bad behaviour is that people think it is a way of making profit. If you look at PPI or if you look at LIBOR, it is driven by that. As a conduct regulator, we need to be much clearer about where the firm's money is actually being made, and then we need to be looking very clearly at whether there is adequate control around that.

    The other thing that I would say is a series of red flags—it was demonstrated by UBS, but also by some other firms—is a series of serious failures in different bits of the business. Some of them may not individually be massively significant, but what does that say about the culture if people in quite disparate parts of the organisation can basically get around the rules?[1830]


1123. While a completed enforcement action might have reputational effects on the bank concerned, the most direct effect can be in the form of a fine. Former regulators indicated that the level of fines historically had done little to dent bank balance sheets. Clive Briault noted, in the context of PPI mis-selling, that, "if you compare the level of the fine against the big profitability of the business, you could choose to regard it as a cost of doing business".[1831] This view was echoed by another form member of FSA staff, Thomas Huertas:

    If the penalty were only monetary and only on the firm, the great danger is that the firm will simply see this as a cost of doing business. There is no more insidious element from a supervisory standpoint than trying to deal with a firm when it has a view that bad behaviour is something that can simply be priced in.[1832]

Sir Hector Sants acknowledged that:

    the deterrence element of the historical approach of the FSA was not sufficient for this type of wilful wrongdoing. I think we do need to be very clear about the distinctions between different types of regulatory action, but I'm talking about the fact that people ought to believe that if they are wilfully engaged in conduct wrongdoing, they have a reasonable chance of being caught, and that if they are caught, the sanction is significant, both to the firm and to the individual.[1833]

1124. The three FSA fines relating to LIBOR manipulation, of £59.5 million on Barclays, £160 million on UBS and £87.5 million on RBS, were the largest that the FSA has ever imposed. The FSA pointed out that the Barclays penalty, the lowest of these, was "approximately double the previous highest penalty that the FSA had imposed on a firm".[1834] The fines imposed on these three firms by the US authorities were significantly larger, at $360 million, $1.2 billion and $475 million respectively. The US authorities have recently imposed a series of other large fines on UK banks, including a $1.9 billion fine on HSBC for inadequate compliance with money-laundering and sanctions rules,[1835] and a total of $667m of fines on Standard Chartered in relation to inadequate compliance with sanctions rules.[1836]

1125. The FSA explained that the legal basis for imposing fines was different in the two countries. The UK regime requires the fine to be determined in relation to a number of factors in the round, including consideration of penalties in comparable cases. In contrast, the CFTC in the US imposes penalties by applying a tariff to each violation, although the CFTC orders did not disclose the basis for its calculations of LIBOR fines.[1837]

1126. Sir Hector Sants noted that the FSA has already taken steps to allow larger fines to be imposed on firms:

    it has been a consistent approach of mine, during my time at the FSA, to seek to change the FSA's regime so that its fines would increase in size. Those changes were brought in [...] so any offences that occur after 2010 are likely to lead to much higher fines.[1838]

The FSA confirmed that the policy change with effect from March 2010 had led to a doubling or trebling of penalties compared with the previous tariffs.[1839] They also noted that, because most of the misconduct relating to LIBOR manipulation had taken place before 2010, the penalties were calculated on the basis of the old policy.[1840]

1127. The FSA's penalty policy now allows for the level of fines to be adjusted to take account of a number of factors. These include aggravating or mitigating factors such as the firm's level of cooperation, whether the case is brought to the attention of the regulators quickly, and whether the misconduct was the result of a breach of previous warnings or requirements.[1841] For example, the FSA stated that they took consideration of the co-operative approach by Barclays in the investigation into fixing of LIBOR when determining the fine.[1842] A fine can be increased if the resulting fine would otherwise provide insufficient deterrence,[1843] and a discount of up to 30 per cent is available for early settlement, intended to reduce the probability of protracted and costly litigation.[1844]

1128. Banks have moved towards linking fines more strongly to employee remuneration, so that the cost of fines is not simply passed on to shareholders but also falls on employees, thereby creating incentives for good behaviour.[1845] However, the tendency to deduct fines predominantly from the current year's bonus pool reduces transparency and undermines the effectiveness of the policy. Sir Philip Hampton, when questioned in evidence, was unable to state clearly how RBS would prove that its bonus pool would actually be reduced as a result of the Libor fine, given that the initial size of the bonus pool had yet to be determined:

    Mark Garnier: How do we know that you are not just going to increase the bonus pool sufficiently to be able then to reduce it by the fine, getting around the vexing problem that way?

    Sir Philip Hampton: As we said earlier, we have to be very clear and public—to this Commission and elsewhere—that we have exercised clawback properly.

    Mark Garnier: Is it clear when something doesn't exist yet—this year's bonus pool?

    Sir Philip Hampton: We will have to support the argument that we have committed to clawing back the US elements of this fine.[1846]

Sir Philip Hampton admitted that the pool of unvested bonuses from previous years would more than cover the size of the fine, but was unable to confirm how much was coming from this pool compared to the current year's bonus pool.[1847]


1129. Effective enforcement action against firms represents an important pillar of the overall approach to enforcement. In many cases, it serves as the gateway to enforcement action against responsible individuals, which is also necessary. It can draw wider attention to a failure, providing incentives for firms to strive to maintain high standards, and establishes penalties when banks depart from those standards. The record of the regulators in enforcement against firms is patchy at best. It is notable that both significant prudential failures, for example at RBS, and some widespread conduct failures in the selling of PPI did not lead to successful enforcement against banks. In the investigations those at the top often absolved themselves by attesting their ignorance about the organisation of which they were in charge. It would run contrary to the public interest if the idea were to gain currency that banks can be too big or complex to sanction.

1130. It is to be hoped that the LIBOR investigations have set a pattern for the future. In relation to prudential failings, formal action will assist in determining what went wrong and help to provide the basis for pursuing responsible individuals. In relation to conduct failings, a visible and costly redress process may not be enough: enforcement has the benefit of more clearly setting out where failures occurred and that rules were broken, so that culpability is not obfuscated and so that lessons can be learned.

1131. It is right that an element of the fine should fall on shareholders, to provide a continuing incentive for them to monitor standards of conduct and supervision within the banks they own. However, our recommendations on recovery of deferred payments in Chapter 8 are designed to ensure that, in future, a significant proportion of fines on firms may be met from deductions from the remuneration of staff of the bank at the time of the misconduct, thereby making the prospect of fines on firms a more direct incentive on individuals to prevent it. There should be a presumption that fines on banks should be recovered from the pool of deferred compensation as well as current year bonuses. The recovery should materially affect to different degrees individuals directly involved and those responsible for managing or supervising them, staff in the same business unit or division, and staff across the organisation as a whole. The impact and distribution of fines on deferred compensation should be approved by the supervisors as part of a settlement agreement.

1132. Firms cannot be permitted to regard enforcement fines as a "business cost". The FSA recognised that in the past the level of its fines was too low to prevent this. The reforms to its penalty policy are supposed to address this, but they have yet to be properly tested, and the credibility of enforcement has been damaged by a legacy of fines that were pitiful compared to the benefits banks gained from the misconduct. To provide greater incentives to maintain high levels of professional standards, both the FCA and the PRA should be prepared to review again their penalty setting framework in the future to allow for a further substantial increase in fines. They should ensure that in responding to any future failures they make full use of the new rules for calculating fines and build on the encouraging examples set by the LIBOR fines. If regulators believe that the current legal framework still inhibits them from imposing the necessary level of penalties, they should tell Parliament immediately.

1133. In its Report on LIBOR, the Treasury Committee concluded that "the FSA and its successors should consider greater flexibility in fine levels, levying much heavier penalties on firms which fail fully to cooperate with them".[1848] We agree. Cooperation by firms in bringing issues to regulators' attention and assisting with their investigation should be a given. Regulators should make full use of the flexibility in their penalty policy to punish cases where this does not occur. However, regulators should also make it clear to firms that the same flexibility will be used to show leniency where inadvertent and minor breaches are swiftly brought to their attention and rectified, so that the fear of over-reaction does not to stifle the free flow of information.

1134. Enforcement action against individuals normally only takes place after completion of enforcement action against the firm, in part because the risks of delay with individual enforcement are greater.[1849] A protracted process of enforcement with a firm can delay enforcement against individuals, weakening the prospect of its success and of meaningful penalties, particularly if the delay means that the individual can continue lucrative work for several more years and approach retirement. The Commission recommends that the regulators bear in mind the advantage of swift resolution of enforcement action against firms, in particular in cases where settlement with the firm is a precursor to action against responsible individuals.

Enforcement against individuals


1135. As we noted in Chapter 3, one of the most striking features of the recent years has been that the failures of the banking sector—including both the prudential failures which led to the near collapse of some major banks and required massive taxpayer bailouts, and the conduct failures which led to large-scale mis-selling—did not lead to action against individuals on anything approaching a seemingly commensurate scale. Actions against individuals are still outstanding in relation to LIBOR, but the evidence received made clear that these actions would not be against the most senior individuals within the banks subject to enforcement action.

1136. Enforcement action against Approved Persons at senior levels is as rare as hens' teeth. As Andy Haldane put it: "the sanctions are never imposed. Everyone is 'fit and proper' all of the time".[1850] Exceptions prove this rule. Peter Cummings, the former head of the Bank of Scotland's corporate division, has been fined £500,000 and given a lifetime ban from the industry.[1851] The FSA intended to pursue an industry ban on Johnny Cameron, but ended their investigation in 2010 when he voluntarily agreed not to work in the industry again. In neither case did enforcement action intrude into the world of those at the very top of these failed banks. The Chairmen and successive Chief Executives of HBOS have so far escaped any public enforcement action. The same can be said in the context of the Chairman and Chief Executive of RBS. Nor has the most significant conduct failure of recent years with the largest impact on bank customers—the systematic mis-selling of PPI over a long period—led to any enforcement action against senior individuals in banks, as we noted earlier.[1852]

1137. The apparent failure of the sanctions regime in the context of the multiple failures of standards in banking industry matters for several reasons. One reason was set out by Lord Turner in his Foreword to the FSA's Report on the failure of RBS:

    Banks are different because excessive risk-taking by banks (for instance through an aggressive acquisition) can result in bank failure, taxpayer losses, and wider economic harm. Their failure is of public concern, not just a concern for shareholders.

    There is therefore a strong public interest in ensuring that bank executives and Boards strike a different balance between risk and return than is acceptable in non-bank companies. This argues for ensuring that bank executives face different personal risk return trade-offs than those which apply in non-banks.[1853]

1138. Second, as we noted in the context of the collapse of HBOS, the absence of fitting sanctions for those most responsible meant that such sanctions could not serve as a suitable deterrent for behaviour contributing to the next crisis.[1854] Andy Haldane emphasised the importance of sanctions in encouraging those at the most senior levels to assume greater personal responsibility:

    Not knowing cannot be a legitimate excuse. If it was made clear that, whatever the product or whatever the asset, if it is not doing what it is meant to be doing, the sanction will be meted out at the highest level of the firm, and that those incentives would run down the core of the firm from the top, that would help. I think that if the CEO, or the chief risk officer or the chief operating officer, knew that their job was on the line, their behaviours would then rub off all the way down the organisation. You would find fewer of these products being sold in the first place; you would find fewer of these assets finding their way on to the balance sheet.[1855]

1139. Antony Townsend, Chief Executive of the Solicitors Regulatory Authority, suggested that a credible sanctions regime was an essential component in creating a professional ethos:

    The risk of public identification and, of course, ultimately, loss of livelihood, is a very powerful sanction. There is an element of regulation being an act of faith, but the research we have [...] suggests that those we are regulating see the existence of the sanctions regime as an important part of being in a regulated profession, almost driving professional pride.[1856]

1140. There is also a simple utilitarian reason why a sanctions regime that bites upon more individuals matters. Many of those who served at senior levels in banks that failed during the financial crisis have gone on to work elsewhere in the financial services sector. For example, many members of the RBS board and executive committee went on to work for other banks or financial services firms.[1857] Some of the facts released about LIBOR fixing in just three banks indicates that certain key individuals implicated in wrong-doing moved on from bank to bank. If it were to be demonstrated that such individuals bear responsibility for failings in standards in one bank, and they are prevented from carrying in activities in the banking sector, then the further damage is prevented as a consequence.

1141. An effective sanctions regime is also essential for the restoration of public trust in banking. The public distaste, and at times even revulsion, at the failures of bank standards in recent years has been magnified by outrage that those who were rewarded so well when things seemed to be going well can walk away without any realistic likelihood of enforcement action or the imposition of sanctions, having benefited from very high levels of remuneration and with massive pension entitlements


1142. The regulators have several sanctions available to them in relation to those individuals—around 10 per cent of bank staff—who are subject to the Approved Persons Regime and thus required to act in accordance with the Statement of Principles—concepts we explained in Chapter 6. In respect of such people the regulators can, for example:

·  publish a statement of the individual's misconduct (i.e. a public censure);

·  impose, for such period as the regulators consider appropriate, such limitation or other restrictions in relation to the performance by the individual of any function to which the approval under the Approved Persons Regime relates;

·  suspend, for such period as the regulators consider appropriate, any approval of the performance by the individual of any function to which the approval under the Approved Persons Regime relates;

·  withdraw an individual's approval;

·  impose a financial penalty on an individual of such an amount as the regulators consider appropriate.[1858]

These are civil penalties which can be imposed directly by the regulator (subject to independent decision-making through structures we consider further in the next chapter) without reference to the courts. However, an individual who does not accept a finding or a proposed penalty may appeal to the Upper Tribunal, effectively a court of law.[1859]

1143. For all bank staff, including the 90-odd per cent who operate outside the Approved Persons Regime, the regulators can apply their power to prohibit such an individual from working in the financial services industry, although it is harder to justify exercise of this severe power (in relation to both approved and non-Approved Persons) because an extended set of criteria needs to be met.[1860]

1144. Some witnesses argued that the range of sanctions available, at least in relation to those within the Approved Persons Regime, was adequate. Jon Pain, a former managing director of supervision at the FSA, characterised the sanctions as "pretty severe", including as they did a ban from the industry.[1861] Professor Julia Black also remarked:

    the FSA has a decent range of sanctions. It can fine and it can ban somebody from working in the industry, which probably has a much bigger impact than a fine because it has a long-term impact on the ability to earn a living in a very well-remunerated business.[1862]


1145. The severity of these sanctions in principle has, of course, been circumscribed in practice by the rarity of their being applied in the context of the banking sector. As Tracey McDermott put it, "even the regulatory sanctions at the moment we have not been able to enforce".[1863] She attributed this inability first and foremost to the evidential standards required:

    the test for taking enforcement action is that we have to be able to establish personal culpability on the part of the individual, which means falling below the standard of reasonableness for someone in their position. The way in which our guidance is drafted makes it very clear that we will not hold somebody to account simply because there is a failure on their watch, particularly if they have properly delegated and so on.[1864]

Under this guidance, an Approved Person will only be held to be in breach of a Statement of Principle where he is personally culpable. Personal culpability arises where an Approved Person's conduct was deliberate or where the Approved Person's standard was below that which would be reasonable in all the circumstances. With a director and senior manager, the following factors are to be taken into account:

·  whether he exercised reasonable care when considering the information available to him;

·  whether he reached a reasonable conclusion which he acted on;

·  the nature, scale and complexity of the firm's business;

·  his role and responsibility; and

·  the knowledge he had, or should have had, of any regulatory concerns.[1865]

1146. As set out above, the basis for a judgement on a decision by an individual director is not whether that decision can be shown to be wrong with the benefit of hindsight, but whether at the time he failed to reach a reasonable conclusion. Of the two cases that the FSA has brought against senior bank executives in recent years, only one went to the Upper Tribunal, and that decision was overturned because this standard of proof had not been met. The Tribunal decision concluded:

    The FSA has not satisfied us [...] from the evidence as a whole that Mr Pottage's standard of conduct was 'below that which would be reasonable in all the circumstances' [...] In particular we are not satisfied that [the alleged failure] was beyond the bounds of reasonableness. Put positively, we think that the actions that Mr Pottage in fact took prior to July 2007 to deal with the operational and compliance issues as they arose were reasonable steps.[1866]

1147. The direct challenges from the evidential standard can be compounded by the complexity of decision-making structures in banks. Decisions might be taken by committees, thus making it harder to trace individual responsibility. Sometimes the attribution of responsibility at senior levels has been unclear. Professor Julia Black said:

    For the FSA to bring a case under [the Approved Persons' Regime] they have to be able to pinpoint whether you were the person who made this particular decision and were responsible for this particular line of business over probably quite a period of time.[1867]

These may well have been important factors in explaining the absence of enforcement action against senior managers in cases such as PPI mis-selling and LIBOR manipulation. Despite the clear failures in senior leadership collectively, identifying individual responsibility and culpability is likely to have been more difficult.

1148. Tracey McDermott emphasised the particular difficulties of enforcement action against individuals in large and complex institutions in explaining why it appeared that the US authorities were successful in taking action against individuals—the FDIC told us that they had brought 742 cases against individuals in 2012[1868]—while the UK authorities were less so:

    The big distinction between the FDIC's actions and ours is that the FDIC's constituents are largely smaller institutions [...] They are focused on the smaller institutions for which, as I have already said, it is actually much easier to find evidence. That is a practical matter, because the chains of command are shorter. If you look at the larger US institutions—the ones that failed, such as Lehman's, or those that were bailed out—there has not been any enforcement action that I am aware of, and I have checked this with the Americans, against the senior management of those institutions.[1869]


1149. Underpinning the challenges arising from evidential standards and complexity there might also lie issues of approach. As Tracey McDermott noted, the recent improvement in the FSA's track record in enforcing the criminal sanctions in relation to insider trading related to the priority accorded to it and increased regulatory determination, rather than any change in the law.[1870] Professor Julia Black pointed out that one of the most important factors in determining whether the credibility of the enforcement regime was the attitude of regulators:

    When people ask me what a regulator should be, I say that they should be three things: they should not be captured; they should not be conned; and they should not be cowed. A lot of what we are trying to drive at here is possibly not so much, 'If we change the sanctions regime, what kind of impact will that have?' but driving the tougher, more credible, and less cowed approach to very powerful individuals who are very successful and very used to getting their own way.[1871]

Professor David Kershaw implied that, taking the case of RBS as an example, enforcement action against individuals might simply have been placed in the 'too difficult' pile:

    One thing to focus on is an example of possible poor behaviour where the directors and senior management are clearly on the hook, such as the ABN AMRO decision in the context of RBS. There a decision was taken that, in hindsight, looks highly problematic. Clearly, those directors were involved in making that decision.

He went on to argue that the standards against which individual directors and managers could be held to account were in place and said:

    The question then becomes: why haven't they been deployed in relation to that particular example that, on the publicly available facts, looks highly problematic? The answer to that question is that it is still very difficult to prove that someone has not taken the requisite degree of care in making a decision of that magnitude. It is also clear from the public record that you could make such a case. That leads directly to the question: why did the FSA elect not to make that case?[1872]

1150. Tracey McDermott indicated that the FSA's methods of investigation often explained the limitations on enforcement:

    What you do in an investigation is follow where the lines of inquiry take you. You do different investigations in different ways, but typically you will start working up from the bottom to get through the process, and see which direction you are pointed in, in terms of who are the people with responsibility and who are the people who are aware. You expect people who you are interviewing-if they think that it is not their fault, but that somebody more senior was actually responsible—to point you in that direction. The questions you ask are around where the trail takes you, and where this stops.[1873]

This approach can lead to the trail going cold well before it reaches those in the most senior or supervisory positions leading to the emergence of an "accountability firewall", as discussed in Chapter 3. Martin Wheatley acknowledged the difficulty in holding senior individuals to account:

    You have to be able to show the clear evidential trail from a senior figure, a particular abusive decision, to what actually happened. There may be some—I am not saying that [there] will not be any—but in many large organisations it is very hard to provide that evidential trail.[1874]

1151. Tracey McDermott acknowledged that the FSA had not usually succeeded in holding individuals to account, but told us that the FCA was now focused on correcting this:

    The FSA has attempted to hold people accountable. I would accept [...] that we have not succeeded at doing that. We are now looking to see how we can do that better. You can say that we should have done that sooner—that is an absolutely fair point—but I do not think that it is fair to say that that was down to regulatory capture or a lack of integrity on the part of the FSA. [...] It is something which has a huge amount of focus for us, as I have said, across the organisation; not just enforcement. I am confident we will do better.[1875]

Martin Wheatley also spoke about the FCA's focus on holding individuals to account, but warned that this was a difficult and resource-intensive task:

    We have made it a policy that we want more individual accountability, so we are pursuing more cases [...] you will see a change of philosophy and approach, but what I am saying, and being very realistic, is that it is difficult. We have to put a lot of resource into it and it is difficult.[1876]

Enforcement of civil sanctions: proposals for reform


1152. In his Introduction to the FSA's Report on the failure of RBS, Lord Turner proposed one way to make enforcement more effective by:

    Establishing rules which would automatically ban senior executives and directors of failing banks from future positions of responsibility in financial services unless they could positively demonstrate that they were active in identifying, arguing against and seeking to rectify the causes of failure.[1877]

He told us that he believed such an automatic mechanism was needed because of the inherent difficulty of proving an individual responsible:

    I am much more attracted [...] to sanctions that have a degree of automaticity, and which affect a large number of people, rather than trying to pin it on one person [...] I honestly feel, having looked very carefully at how these processes of legal proof work, that it will always be difficult in courts of law to have people proved directly responsible for prudential problems going wrong.[1878]

1153. In July 2012, the Treasury published proposals to introduce a mechanism along these lines, by creating a "rebuttable presumption that a director of a failed bank is not suitable to be approved by the regulator as someone who could hold a position as a senior executive in a bank".[1879] The FSA supported the Treasury's proposal:

    we would welcome an effective rebuttable presumption and believe that this would send a clear message that Parliament views the failure of a bank as a very serious matter with significant consequences for the careers of those senior figures involved in the failure. If successfully implemented, the rebuttable presumption should make it easier and more efficient for us to reject someone whose involvement with a past failure makes them unsuitable to hold another senior position in the financial services industry.[1880]

Lord Turner argued that the great strength of the proposal for a rebuttable presumption was its automatic nature. By removing discretion from the regulator on whether to pursue an action, it removed the challenge of having to prove individual culpability.[1881]

1154. The proposal for introducing a rebuttable presumption has met with a number of objections. First, the Financial Services Consumer Panel argued that "the presumption of guilt rather than innocence of directors of failed banks [...] offends notions of natural justice and due process".[1882] This concern was echoed by Gregory Mitchell QC, who believed that a rebuttable presumption would be "wrong in principle", arguing that the resulting penalty was significant enough to require "proof of wrongdoing". He pointed out that "A director who was entirely innocent of any wrongdoing might be unable to afford the cost of rebutting any such presumption and be unable to work".[1883] The Law Society expanded on this concern:

    Individuals may struggle to gather the evidence necessary to rebut the presumption if they have already left the bank and no longer have access to documents and other relevant material. The problem is particularly acute where the cause of a bank's failure is a complex set of inter-related circumstances, some of which may have been outside the control (and possibly the knowledge) of a particular director. Gathering such evidence could be time-consuming and costly, and in some cases not possible at all for individual directors. This may mean that the director is unable to prepare a proper case to rebut the presumption, which raises obvious issues of fairness.[1884]

1155. Concern was also expressed about the effects that an automatic mechanism of this kind would have on management challenges of a failing bank. The Financial Services Consumer Panel suggested that "such a mechanism might have a perverse effect, discouraging the far-sighted and diligent from accepting key management positions".[1885] The Law Society also noted that a mechanism which applied to all directors at the point of failure could have perverse effects on banks facing difficulties, because "directors might be incentivised to abandon a distressed bank before it failed" and it could also "lead to difficulties in recruiting well-qualified people to try to rescue failing banks".[1886] Andrew Bailey also observed that a rebuttable presumption "may hinder our ability to ask good people to go into firms in difficulty, something that we do quite often—I would therefore not favour this approach". [1887] The Law Society noted that trying to address the first of these problems by extending the presumption to directors who had left the failed bank would carry its own problems, most notably that it could cause disruption for any banks to which such directors had subsequently moved.[1888]

1156. Questions were also raised about the scope of a rebuttable presumption. The Treasury's proposal was restricted to directors of failed banks. When we raised the point that there may be cases where senior executives who are not directors are to blame for a failure, Lord Turner responded that other senior managers could be included in the proposal: "I did not intend it that was limited to the board. It includes, but is not limited to" the board.[1889] A bank could be considered to 'fail' if the regulator judges it to no longer meet threshold conditions, thereby triggering entry into Special Resolution Regime under the Banking Act 2009, but Andrew Bailey pointed to definitional problems with failure:

    it will often be difficult to determine when a firm is said to have failed. Our experience suggests that the seeds of firm failure are often sown by decisions which are made long before the firm is placed into the resolution process, or public funds are used to support it.[1890]

1157. In view of the problems identified with the scope of the rebuttable presumption as proposed by the Treasury, Andrew Bailey proposed an alternative approach involving

    reversing the burden of proof in cases where a significant failing has been identified. This would require an approved person who had responsibility for a particular area to show that they had taken all reasonable steps to avoid the failing concerned. The FSA believed this would make clear to approved persons that delegation of authority does not equate to delegation of responsibility or allow the person concerned to avoid accountability if something goes wrong.[1891]

Sir David Walker make a similar proposal:

    It may be that the regulators should have greater capability to reverse the burden of proof and say that a senior executive who had been involved in a palpable failure would be struck off unless he could show that he had been effective, diligent and challenging in seeking to avert that failure. This is relevant to directors on bank boards and senior executives. That is not a power that is currently available to the FSA. I would invert and give them greater power.[1892]

1158. Tracy McDermott also made the case for linking a rebuttable presumption to a concept of responsibility:

    We currently state that we will not discipline someone simply because something went wrong in an area for which they were directly or indirectly responsible. We could look to reverse that position by introducing a rebuttable presumption that, in certain circumstances and for particular types of misconduct, where something goes wrong in your area you are responsible unless you can demonstrate that you took all reasonable steps to avoid the misconduct and/or that there were no other reasonable steps that could practically have been taken.

    [...] It would be helpful for the regulator in that the starting point would be that the relevant person would have to establish why the steps taken met the standards and respond to any areas of challenge where the regulator identified that other steps could have been taken. This would shift, in a significant way, the nature of the investigation and would in itself have an important signalling effect.

She emphasised that such a change would not short-circuit the requirements of a full investigation:

    In order to meet requirements of fairness it would be necessary to ensure that the presumption could actually be rebutted. Although it should enable investigations to be more focussed and limit the areas on which expert evidence is required it would not avoid the need for detailed and complex consideration of the steps taken by the relevant individuals.

She noted that such a change would almost certainly require legislative change to give the regulators a clear foundation for imposing "evidential burdens" on those potentially subject to disciplinary action.[1893]


1159. A second proposal for reform made by the FSA related to the period pending the completion of an investigation:

    a regulatory power to prohibit an individual on an interim basis from performing controlled functions [...] would be a significant tool which would allow the regulators to act swiftly to counter any threat to their objectives by an approved person remaining in position pending an appeal.[1894]

Such a power has parallels with other professions such as medicine, where doctors can be suspended during an investigation in order to limit the risk of harm to patients.[1895]

1160. In making the case for a power of interim prohibition, Tracey McDermott referred to the time taken for the full enforcement process, citing an instance relating to the director of a stock-broking company:

    Even if you take the time from [...] the end of the FSA's internal decision making through the tribunal, we have a case when it took one individual [...] two years and 11 months to go through that. Until that process is finished, he is not prohibited. That is an extreme example, but most cases take well over a year and usually closer to two years in the tribunal.[1896]

She argued that such delays could mean that an individual could continue to work in the industry while there were significant concerns of which the public might be unaware:

    Many of them may not be working in the industry any more, and many employers will dismiss them at least at the end of our decision-making process, if not before, but as they are not on the register as prohibited, the warnings to the public who may deal with them are not there. That is the key issue: there can be an extended period when someone we have serious concerns around is still on the register.[1897]

1161. The FSA acknowledged the need for appropriate safeguards to ensure that an interim prohibition power would be properly used:

·  Primary legislation would need to set out an appropriate threshold that the regulators would need to satisfy before it could exercise this power;

·  The power could be exercised through the Supervisory Notice process which would give the subject an immediate right to refer the matter to the Upper Tribunal as well as the right to make representations to the regulator.[1898]

1162. Andrew Bailey thought that interim prohibition "would need to be carefully drafted to ensure the rights of the individuals are adequately protected, and I think could be quite difficult to put in to effect for the same reasons".[1899] The BBA also noted that appropriate safeguards and compensation arrangements would be required:

    We see a case though for the circumstances in which such a facility could be utilised being well defined and the application of suitable safeguards including a high expectation that full prohibition will be the outcome once due process has been completed. We also see grounds for compensation in the event that the regulatory action subsequently proves unjustified.[1900]


1163. Under current legislation, for a regulator to be able to take action against an Approved Person it must issue a warning notice against them within three years, starting from the date that the regulator becomes aware of the offence.[1901] The FSA proposed that this limitation period be extended:

    three years is likely to be insufficient time for the PRA or FCA to determine whether there is a case to answer in complex cases, some of which may require information from overseas. This can include action taken against senior managers of large firms where the regulators will need to establish personal culpability on the part of those managers for their actions or omissions. Such cases often lead to the regulators having to obtain and process significant volumes of information, which can take a great deal of time.

    The time limit can mean that the investigation into the individual's conduct is truncated, making it more difficult for the regulator to pursue its case. In extreme circumstances, this can mean that if the regulator is not in a position to issue a warning notice within the three year time period then no action can be taken against the individual concerned. [1902]

The FSA noted that no time limits apply to market abuse cases, or to disciplinary action against firms. They queried why senior managers, responsible for the conduct of their firms, "should benefit from a limitation period for action particularly when cases are often more difficult to bring against individuals than they are to bring against firms".[1903] The FSA stated that the limit:

    has informed our decision in several cases not to commence an investigation where the appropriate outcome would have been a disciplinary sanction but not a prohibition. In other cases, we frequently have to make difficult decisions to streamline or limit our investigation in order to ensure that we meet the time limit - this creates litigation risk and means that we may not put forward as strong a case as we might otherwise be able to.[1904]

The FSA also pointed out that holding senior managers more to account will result in regulators taking on "increasingly complex cases which will take time to investigate to the standard required".[1905]

1164. The BBA opposed an extension, arguing that a three year limit "should be viewed as providing suitable discipline upon the regulatory authorities to progress an action reasonably". They went on to argue that "if anything the timeframe should be shortened", on the grounds that this would ensure enforcement action concluded more rapidly and because of "the significant impact such action can have over the livelihood of Approved Persons and their families, in circumstances where some will not be found to have been ultimately culpable".[1906]

Civil sanctions and powers of enforcement over individuals


1165. Faced with the most widespread and damaging failure of the banking industry in the UK's modern history, the regulatory authorities seemed almost powerless to bring sanctions against those who presided over massive failures within banks. Public concern about this apparent powerlessness is both understandable and justified, but the need for a more effective enforcement regime does and should not arise from a public demand for retribution. It is needed to correct the unbalanced incentives that pervade banking. These unbalanced incentives have contributed greatly to poor standards. Redress of these is needed not merely as a step to restoring public confidence, but also to create a new incentive for bankers to do the right thing, and particularly for those in the most senior positions fully to fulfil their duties and to supervise the actions of those below them.

1166. Later in this chapter, we consider the case for a new criminal offence specific to the banking sector. However, in the context of civil sanctions, the Commission has not heard the case advanced for a range of penalties which go beyond those already available. The problems, and the proposals for change which follow, reflect the fact that the sanctions already available to the regulators, such as very large fines and permanent disbarment from the UK financial services sector, have so rarely been applied.


1167. The foundations for a new approach are laid in the Commission's recommendations in Chapter 6. In that chapter we recommended that a successor to the Statement of Principles in the form of Banking Standards Rules designed to ensure that the full range of enforcement tools could be applied to a wider range of individuals working in banking. This would be supported by a system of licensing administered by individual banks, under the supervision of the regulators, to ensure that all those subject to the Banking Standards Rules were aware of their obligations. This approach would prevent one barrier to effective enforcement that we identified, namely that regulators lacked effective powers to sanction misconduct by bankers who were not Approved Persons.

1168. In Chapter 6 we made another proposal designed to address one of the most dismaying weaknesses that we have identified, whereby a combination of collective decision-making, complex decision-making structures and extensive delegation create a situation in which the most senior individuals at the highest level within banks, like Macavity, cannot be held responsible for even the most widespread and flagrant of failures. We proposed the establishment of a Senior Persons Regime to replace the Approved Persons Regime in respect of banks, whereby all key responsibilities within a bank would be assigned to a specific, senior individual. Even where certain activities in pursuance of the responsibility were either delegated or subject to collective decision-making that responsibility would remain with the designated individual. The Senior Persons Regime would be designed to ensure that, in future, it should be possible to identify those responsible for failures more clearly and more fairly. This should provide a stronger basis for the use of enforcement powers in respect of individuals.

1169. These changes would also need to be accompanied by a change of approach from the regulators. In respect of insider trading, the increased effectiveness of criminal enforcement owes less to changes in the law than changes in the approach of the regulators, in particular to a realisation that a large-scale commitment of time, effort and resources to seeing cases through is both necessary and worthwhile. The same determination has not been so apparent in enforcement action relating to bank failures, LIBOR or mis-selling. At the root of this failure has been what the regulators themselves have characterised as a bottom-up approach. A key to success in the future is likely to be a top-down approach, drawing on the clarity that the Senior Persons Regime is intended to provide about who is exercising responsibility at the highest levels, what they knew and did, and what they reasonably could and should have known and done.


1170. The proposal to create a rebuttable presumption that directors of failed banks should not work in such a role again is a well-intentioned measure for addressing the difficulty of proving individual culpability, but it is a blunt instrument with several weaknesses. The blanket imposition of a rebuttable presumption risks having perverse and unfair effects; it will act as a disincentive for new directors to come to the aid of a struggling bank; it could encourage power structures in which key decision-makers eschewed the title and responsibility of director. Furthermore, the Government proposal as it stands is too narrow to be of significant use. Notably, it would probably not have been triggered in most of the recent scandals ranging from the bail-outs of RBS and HBOS to PPI mis-selling and LIBOR manipulation. We have concluded that a more effective approach than the blanket imposition of a rebuttable presumption would be one which reverses the burden of proof in a wider, but clearly defined, set of circumstances covering both prudential and conduct failures.

1171. Greater individual accountability needs to be built into the FCA's and PRA's processes. The Commission recommends that legislation be introduced to provide that, when certain conditions are met, the regulators should be able to impose the full range of civil sanctions, including a ban, on an individual unless that person can demonstrate that he or she took all reasonable steps to prevent or mitigate the effects of a specified failing. The first condition would be that the bank for whom the individual worked or is working has been the subject of successful enforcement action which has been settled or upheld by tribunal. The second condition is that the regulator can demonstrate that the individual held responsibilities assigned in the Senior Persons Regime which are directly relevant to the subject of the enforcement action.

1172. The FSA made the case for a power to impose an interim prohibition on individuals against whom enforcement action has been commenced. The case made by the FSA was not clearly targeted on banks. An interim prohibition could cause serious harm if used unfairly or arbitrarily. In the case of very small financial firms in particular, having a key individual prohibited for even a short period might cause irreparable damage to their reputation and see clients leave never to return, even though the case might be dropped or not upheld. Given that the FSA has only rarely taken public enforcement action against senior individuals in large banks, it may be that the cases through which they have identified the need for a suspension power involve smaller firms or non-bank financial institutions. Based on our consideration of issues relating to banking standards, the Commission has concluded that the case has not been made for providing the regulators with a general power to impose interim prohibitions on individuals carrying out controlled functions in the financial services sector.

1173. The current time limit of three years between the regulator learning of an offence and taking enforcement action against individuals could act as a constraint on the regulators' ability to build credible cases. This could be a particular barrier to the regulators' ability to place greater priority on pursuing senior individuals in large and complex banks, as we are recommending. In view of our proposal that enforcement action against a firm must be completed before the regulator can deploy the new tool of a reversed burden of proof, more than three years may well be required to complete this process and make the new tool usable. The Commission recommends that the Government should address this problem by allowing for an extension of the limitation period in certain circumstances. However, swift enforcement action should be the priority. Regulators should be required retrospectively to provide a full explanation for the need to go beyond three years. They can expect to be challenged by Parliament if it were to transpire that they were using this measure as an excuse for delaying enforcement action.

A new criminal offence?


1174. A number of 'financial crimes' already exist relating to money laundering, insider dealing, market abuse, misleading statements and fraud or dishonesty. The Serious Fraud Office, for example, is able to investigate and prosecute investment fraud, corporate fraud and public sector fraud under the Fraud Act 2006, the Theft Act 1968, the Proceeds of Crime Act 2002 and the Money Laundering Regulations 2007. Individuals are prosecuted under these and other powers. Eleven people were sent to prison in 2012 for insider trading as a result of FSA enforcement actions. The FSA confirmed that a number of individuals connected with LIBOR manipulation were being investigated by the SFO in relation to potential criminal offences.[1907] However, the types of offence which give rise to criminal sanctions at present tend mostly to involve individuals or small groups, and do not cover the apparent mismanagement and failure of control by senior bankers which has been at the heart of the recent concerns about standards and culture in banking.

1175. There is a widespread view, reflected in some of our evidence, not only that more bankers implicated in recent failures should have been sanctioned, but also that these sanctions should have included criminal sanctions. Joris Luyendijk summarised this when he said:

    the rules themselves are deficient. Otherwise, after the crisis of 2008, a lot of people would have gone to jail. The fact that nobody went to jail after such a breakdown means that there is something wrong with the rules themselves.[1908]

The Financial Services Consumer Panel stated that it "strongly supports tougher and more effective criminal sanctions for directors of UK banks—and of other financial institutions—in appropriately defined circumstances".[1909] The FSA acknowledged that, in cases where the option of criminal sanctions existed, there were benefits to pursuing that route for its deterrent effect:

    One element of the FSA's credible deterrence strategy over the past few years has been to pursue criminal prosecutions for insider dealing and market manipulation in appropriate cases notwithstanding that the FSA also has the ability to bring regulatory cases for market abuse under FSMA. This is based on the belief that the threat of a custodial sentence is a greater deterrent than the threat of a financial penalty.[1910]


1176. Following the FSA's report into the failure of RBS in December 2011, the Government consulted on proposals to extend the current criminal regime by creating a new offence geared specifically to the circumstances of the banking industry. In July 2012, the Treasury published a consultation on creating a new criminal offence of serious misconduct in the management of a bank. The Treasury's proposal for a new offence of managerial misconduct in a bank considered four main possibilities for the kind of managerial misconduct by bank directors and senior management that might be subject to new criminal sanctions:

·  Strict liability—being a director at the relevant time of a failed bank;

·  Negligence—failure in a duty of care which leads to a reasonably foreseeable outcome;

·  Incompetence—failure to act in accordance with professional standards or practices;

·  Recklessness—failure to have sufficient regard for the dangers posed to the safety and soundness of the firm concerned or for the possibility that there were such dangers.[1911]


1177. Strict liability for directors of failed banks would be similar to the rebuttable presumption examined earlier, in that it would involve an automatic mechanism. However, it would go a big step further because it would remove the right to a defence and make being a director of a failed bank itself a criminal offence. It might create stronger incentives to avoid failure, but it might also recreate, in magnified form, some of the problems and perverse incentives already identified with the rebuttable presumption, such as the incentive to jump ship ahead of failure and the difficulty of attracting directors to a bank that is facing difficulties. The Treasury consultation recognised that imposing severe criminal penalties on individuals who "were not plainly at fault would be controversial".[1912] Professors Black and Kershaw observed:

    In other areas of regulation where there are strict liability offences, for example in health and safety or environmental regulation, the result has been that the sanctions imposed have often been negligible. This weakens the deterrent effect and diminishes the stigma attached to the criminal liability standard.[1913]

The FSA echoed this view:

    custodial sentences may be less likely if the offence of mismanagement were a strict liability offence, due to the absence of the element of personal culpability.[1914]

1178. Some witnesses argued that neither negligence nor incompetence were sufficiently rigorous standards to support criminal convictions. Professors Black and Kershaw referred to a Law Commission recommendation that

    criminal liability should only be imposed where there was a 'harm-related moral failure' and not simply to act as a deterrent. Individuals should not be subject to criminal liability unless their wrongdoing was knowing or reckless.[1915]

Professors Black and Kershaw also noted that, even if a criminal offence using these standards were created, in practice courts would be likely to be unwilling to impose meaningful penalties as a result.[1916] They concluded that the preferable standard for imposing criminal sanctions would be recklessness, which was a more established and tested basis for judging an offence in English law.[1917]

1179. Tracey McDermott told us:

    A criminal offence will have a real deterrent impact and satisfy public concerns only if it can be practicably prosecuted. There are some big issues of fairness and individual rights in relation to criminalising bad business decisions. There are various stages along the spectrum in relation to business decisions, but it is a very big step to say that we should criminalise incompetence or negligence. It is a much wider question than simply whether the public are angry about this.[1918]

She went on to say:

    Recklessness is much more familiar to the criminal law, so it is less of an issue. You can be prosecuted for recklessness.[1919]


1180. In its consultation document of July 2012, the Treasury identified a number of practical considerations to be considered in securing criminal convictions:

·  The necessity to establish causation;

·  The need to decide who to prosecute;

·  The complexity and range of the material that would to be examined, so that "investigations would be extremely costly, and result in prosecutions that could run into years rather than months".[1920]

As discussed earlier in this chapter, it is the difficulty of proving individual culpability which already represents the greatest barrier to imposing individual civil sanctions. The FSA pointed out the main obstacle to the successful use of criminal sanctions:

    For a criminal case the evidential burden will be even higher. There is, therefore, a risk that a criminal offence of mismanagement however constructed would rarely be prosecuted and consequently lose its deterrent value through its lack of use.[1921]

Tracey McDermott added:

    we invested a significant amount of time and resource into the investigations we did into the failed banks, but we were not able to establish the evidence necessary to take regulatory action, so even if there had been a criminal offence on the statute book, that would not have got us there [...] a note of caution has to be sounded that this will not be an easy offence to prove [...] If the evidence is not there, it will not be there for criminal cases in the same way as it won't be there for regulatory cases. You can debate whether we got that call right or wrong, but ultimately the evidential standard is higher in criminal cases rather than lower.[1922]

To these practical considerations might be added another, namely that the possibility of criminal action, with the associated risk of prejudice, might greatly inhibit the publication of information about a particular sets of problems within a bank until such time as it is a decision is taken on whether the criminal path will be followed.


1181. In consulting on a possible criminal sanction for a criminal offence last year, the Treasury made no reference to the possible penalties for commission of the offence.[1923] Wide-ranging civil penalties, including large fines and effective denial of livelihood, are already available to the regulator. It might therefore be thought that the penalties for any criminal offence might need to be significantly different to make it worthwhile to seek to overcome the practical barriers facing an attempt to secure a conviction, unless it were felt that the stigma associated with criminal conviction alone warranted such action. Sir Donald Cruickshank argued for severe penalties to be available for an offence: "the penalties for individuals would be unlimited fines and up to 10 years in jail".[1924] Gregory Mitchell QC argued that prison would not be an appropriate response to many of the failures seen in banking:

    The wrongdoing that one has seen in the various reports to what led up to the crisis appears to be largely a failure on the part of people who should have known better to exercise a greater degree of care and skill, so the culpability essentially appears to be that of negligence. In our system, people do not generally get sent to prison for negligence.[1925]

By way of contrast, the maximum sentence for a director found guilty of consent, contrivance or neglect where a company has been convicted of health and safety offences is an unlimited fine and to a prison sentence of up to two years, even in cases where that has led to someone's death.[1926]


1182. The Commission has concluded that there is a strong case in principle for a new criminal offence of reckless misconduct in the management of a bank. While all concerned should be under no illusions about the difficulties of securing a conviction for such a new offence, the fact that recklessness in carrying out professional responsibilities carries a risk of a criminal conviction and a prison sentence would give pause for thought to the senior officers of UK banks. The Commission recommends that the offence be limited to individuals covered by the new Senior Persons Regime, so that those concerned could have no doubts about their potential criminal liability.

1183. The Commission would expect this offence to be pursued in cases involving only the most serious of failings, such as where a bank failed with substantial costs to the taxpayer, lasting consequences for the financial system, or serious harm to customers. The credibility of such an offence would also depend on it being used only in the most serious cases, and not predominantly against smaller operators where proving responsibility is easier, but the harm is much lower. Little purpose would be served by the creation of a criminal offence if the only punishment available to the courts were the imposition of a fine, because substantial fines can already be levied as a civil sanction with a lower burden of proof. We would expect the determination of the available sentences to have regard to relevant comparable offences.

1184. It is inappropriate that those found guilty of criminal recklessness should continue to benefit from remuneration obtained as a consequence of the reckless behaviour. Fines may not claw back the full amount. The Commission recommends that the Government bring forward, after consultation with the regulators and no later than the end of 2013, proposals for additional provisions for civil recovery from individuals who have been found guilty of reckless mismanagement of a bank.

1185. The Commission's support in principle for a new criminal offence is subject to an important reservation. Experience suggests that, where there is the possibility of a criminal prosecution, public disclosure of failings might be greatly limited until the criminal case is finished. It is important to expedite any civil sanctions against individuals and to publish information into banking failures in a timely manner. The Commission recommends that, following a successful civil enforcement action against a bank, the decision on whether to bring criminal proceedings against relevant Senior Persons must be taken within twelve months.

Enforcement decision-making


1186. In the previous chapter we considered the powers of enforcement and sanction that are and should be available to regulators. Even when the powers are changed in accordance with those recommendations, there will remain four challenges for the new regulators in the field of enforcement:

·  To ensure that a higher priority for enforcement action even when it is not an easy or quick option is embedded, so that it can survive a future era when attitudes to bankers are less severe;

·  To reflect the differences between the demands relating to enforcement in the field of banking compared with other areas of financial services, reflecting the particular combination of systemic risk and social utility that is unique to banking, which in turn should lead to the development of enforcement powers specific to the banking sector in accordance with our recommendations;

·  To retain the independence and separateness of the enforcement function bearing in mind the high level of engagement by real-time supervisors with the decision-making processes of banks so that the prospect of ex post enforcement does not become a replacement for effective supervisory intervention as problems emerge;

·  To secure effective coordination between the enforcement processes of the prudential and conduct regulators.

In this section we consider the current arrangements and make recommendations designed to overcome these challenges.


1187. Tracey McDermott, Director of the Enforcement and Financial Crime Division of the FSA, told us that the FSA had still not solved the problem of ensuring that senior figures were properly subject to the enforcement process:

    The focus on senior management is something that we have talked about a lot in the FSA but we have found it very difficult to bring home the responsibility, particularly in larger firms, to those who are further up because of confused lines of accountability and because of confused responsibility.[1927]

On enforcement's interaction with supervisors, Tracey McDermott stated:

    The FSA has been very good at ensuring that things do not get swept under the carpet. One of the things that an enforcement investigation has to do is to ensure that factors that are in favour of the individual or the firm are taken into account as well. Inevitably, where there has been interaction with supervision, which the firm thinks is in its favour, that will be part of it. In terms of how we communicate those lessons internally, it is very much through going back to the head of department or the director of the relevant area in supervision to say, "This is what has come out in this case. We need to think about whether that is just an individual making a mistake or whether it is something about our process and system that does not work.[1928]

1188. Within the FSA and now the FCA, the enforcement process generally begins with an internal referral to the Enforcement and Financial Crime Division for investigation. Staff from the referring department and the Enforcement and Financial Crime Division will work together to reach an initial decision. If a referral is made to the Enforcement and Financial Crime Division, investigators are appointed and scoping discussions with the firm or individual begin. At the end of the investigation stage a preliminary findings letter, usually together with a Preliminary Investigation Report (PIR), is sent by the Enforcement and Financial Crime Division to the person under investigation. If the Enforcement and Financial Crime Division decides to proceed, the matter is submitted to the decision maker (in most enforcement actions this will be the Regulatory Decisions Committee (RDC)).

1189. The RDC is a committee of the FCA Board and is answerable to the FCA Board. It reports to the Board via the Risk sub-committee, with a direct right of access to the Chairman and the whole Board in the event of any major difficulties. The RDC also has its own legal advisers and support staff. All RDC staff are separate from the FCA staff involved in conducting investigations and making recommendations to the RDC. The procedures of the RDC are designed to ensure that there is an appropriate degree of separation from the enforcement case team. All substantive communications between the Enforcement and Financial Crime Division case team and the RDC must be disclosed to the firm or individual. The RDC has its own dedicated legal function. Therefore, the RDC does not take advice from lawyers in the Enforcement and Financial Crime Division. After the giving of a warning notice or first supervisory notice there cannot be any subsequent meeting or discussions between the Enforcement and Financial Crime Division case team and the RDC while the case is still ongoing without the firm or individual not being present or otherwise having the opportunity to respond.[1929]

1190. The RDC is outside the FCA's management structure and, apart from the Chairman, none of its members is an FCA employee. The members of the RDC are appointed by the FCA Board for fixed periods. In April 2013, the RDC comprised an Acting Chairman, two Deputy Chairmen and eight other members. Their biographies on the FCA website indicate that three are qualified lawyers, including one with judicial experience. The other members have backgrounds in audit, consultancy, client management, the insurance industry and the actuarial profession. The RDC will not seek to invite a member to join a particular panel to consider a case where that member has a conflict of interest and RDC members who have potential conflicts of interest are required to disclose them. The FCA Board may remove members of the RDC, but only on grounds of misconduct or incapacity. The members' function is to represent the public interest and the FSA has previously indicated that the intention is that the RDC's membership includes current and retired practitioners with financial services industry skills and knowledge as well as non-practitioners. In April 2013 there was no member of the RDC who did not have either a legal background or a background in the financial services industry.[1930]


1191. The PRA has stated that its "preference will be to use its powers to secure ex ante, remedial action" which if successful "should mean that enforcement actions are rare". [1931] However, it does have a set of enforcement powers analogous to those of the FCA for breaches of regulatory requirements. Graham Nicholson, Chief Legal Advisor at the Bank of England, told us:

    I see enforcement, in the context of the PRA, as being closely related to supervision. I think you will see from our supervision approach document published in the autumn that our focus is very much on accountability, on the management of risks, and the duty of directors, not simply to look at their bottom line but to ensure that they run a safe and sound institution.[1932]

1192. In a consultation on PRA supervisory and enforcement powers, the FSA stated:

    A key element of the PRA's regulatory approach will be the personal responsibility of a PRA-authorised firm's board of directors and senior management to ensure that the firm is run prudently.

    Where a PRA-authorised firm, Approved Person (or a person performing a controlled function without approval), or a qualifying parent undertaking acts in breach of PRA requirements, a financial penalty can act as a direct and quantifiable punishment for the breach. Further, it may provide an incentive to other firms and persons to effect behavioural changes, as well as those who are subject to enforcement action by the PRA. Responding to actual breaches of the PRA's requirements, as well as dis-incentivising future breaches, may therefore ultimately aid the PRA in advancing its general objective.[1933]

1193. The most obvious cases for PRA enforcement will be where a bank has failed and there is evidence of mismanagement. In our Report on HBOS we concluded that simply suspending the Approved Persons status of senior managers in respect of their HBOS roles was clearly inadequate, and that the regulator should consider removing their right to operate within the financial services sector as a whole. In cases where there have been serious prudential problems that have fallen short of failure, the PRA may have an incentive to rely on supervisory actions and informal pressure to replace key people rather than pursuing formal enforcement action against responsible individuals, for fear of destabilising the firm. Given that the number of prudential enforcement cases may well be influenced by the economic cycle, there is also an interesting question about how the PRA will resource its enforcement team and maintain the necessary expertise over time, in comparison to the FCA where misconduct cases might be expected to be less cyclical. The Bank of England said:

    There will be cases that have a bearing on "safety and soundness" of an institution and the competence or integrity of its senior management which the PRA will be keen to pursue, but which may not give rise to issues of concern to the FCA; the PRA would pursue such cases on its own. The PRA will have its own enforcement capability to enable it to act on its own where this is necessary, drawing on external expertise as required.[1934]


1194. The FSA's Approved Persons regime and enforcement powers have been split between the FCA and the PRA, and the two bodies will have to coordinate how the regime operates given the potential for overlap or conflicts.[1935] The FCA has inherited the majority of the staff currently working on enforcement, including its current head of division Tracey McDermott. Graham Nicholson told us that the PRA will be reliant to some extent on the FCA's resources and experience.[1936] He assured us that the PRA and FCA "have worked-up detail below the level of the rather broad MOU, particularly in relation to enforcement actions",[1937] although the effectiveness of these arrangements has yet to be tested over time. The MoU in question sets out that:

    Senior official from the FCA and the PRA responsible for enforcement and legal interaction respectively will meet quarterly to discuss potential and ongoing enforcement actions against relevant firms [...] Any significant public communications related to the general approach to enforcement or related policy that may materially affect the other's objectives will be notified to the other regulator.[1938]


1195. In established professions, a number of steps are taken to separate disciplinary functions from supervision of professional development. In the legal profession, for example, the Solicitors Disciplinary Tribunal is "totally separate" from the Solicitors Regulation Authority (SRA) and has a mixture of lay and professional members. The SRA has no say in its composition; it is in effect a prosecutor before a tribunal.[1939] Sir Peter Rubin, who chairs the General Medical Council, described similar recent developments in the medical profession:

    Following the Shipman inquiry, it was pointed out to the GMC by Dame Janet Smith that our previous arrangements, whereby we were the police, the Crown Prosecution Service, the judge, the jury and everything else, was incompatible with Article 6 of the Human Rights Act. Essentially, no one should be a judge in their own cause. So last year we hived off our adjudication processes, by which cases against doctors are heard, to a separate body in a separate building. It is funded by us but, crucially, it is run by a judge. They now run the adjudication process. The final bit of the jigsaw is we are asking Parliament to give us the power to appeal when we do not agree with one of its findings. That would really get the complete separation going.[1940]

1196. One possible approach to resolving the tensions caused by having supervision and enforcement side-by-side within the same organisation could be to move enforcement powers out of the FCA and PRA to another body. Such a structure could also be the eventual outcome of establishing a new standards body with enforcement powers, such as the Banking Standards Review Council proposed by Barclays and the BBA.[1941] However, we concluded earlier in this Report that the industry is a long way from being at the stage where the assumption of disciplinary powers by an autonomous, self-governing professional body or a distinct sister body of such an organisation would be appropriate.

1197. A single statutory body with a sole focus on enforcement could provide a number of benefits. It could help address the possibility of conflict or missed opportunities from divided responsibilities between the FCA and PRA. It should be able to structure itself in a way which better delivers effective enforcement, rather than having to fit into the structure and staff policies of a broader regulator. It would have clearer objectives and accountability. It could address the risk of conflicts of interest with supervisors and could find it easier to initiate investigations without a referral from supervisors. It could free the remaining supervisory body to focus on day-to-day supervision and risk mitigation, and could generate some useful accountability and feedback channels that could force the supervisors to become more effective. A new enforcement body would represent more of a clean break with the past and assist with more radical changes to the Approved Persons regime.

1198. However, there would also be significant obstacles to such a move, not least because it would generate a new regulatory body which could be a source of confusion and conflict. An independent enforcement body would still be reliant on supervisors for many referrals, which could result in fewer cases if there were any problems cooperating with the FCA or PRA. Careful consideration would need to be given to what the scope of a new body would be, in particular whether it should take both individual and firm-level enforcement and whether it should cover the whole financial services sector or just banking.

1199. There is an inherent tension between the role of real-time regulators and the enforcement function, which can involve reaching judgements about matters in which supervisors were involved at the time. Regulators are also focused on the big picture, such as maintaining financial stability. Greater priority needs to be placed on the role of enforcement, with adequate resources devoted to this function and leadership with a willingness to pursue even the difficult cases, often involving the larger and more powerful players, in order to build up a credible deterrent effect.

1200. A higher priority for the enforcement function could be achieved by replacing the Enforcement and Financial Crime Division of the FCA with a separate statutory body, which might also assume the enforcement functions of the PRA. However, we have concluded that to propose this change now would involve a new organisational upheaval for the financial services regulators, almost immediately after a major set of organisational changes have come into effect.

1201. We have, however, concluded that the body responsible for making enforcement decisions arising from the work of the Enforcement and Financial Crime Division of the FCA, namely the Regulatory Decisions Committee, is not best-suited to the specific enforcement needs of the banking sector. At the moment, the Committee's composition seems to offer the worst of all worlds; it appears to contain neither a depth of banking expertise nor a clear lay element separate from banking and allied financial services sectors.

1202. The Commission recommends the creation of an autonomous body to assume the decision-making role of the Regulatory Decisions Committee for enforcement in relation to the banking sector. The body should have a lay (non-banking or financial services professional) majority, but should also contain several members with extensive and senior banking experience. The body should be chaired by someone with senior judicial experience. The body should have statutory autonomy within the FCA. It should be appointed by agreement between the boards of the FCA and PRA. The body should also assume responsibility for decision-making in respect of enforcement action brought by or under the auspices of the PRA. The new body should publish a separate annual report on its activity and the lessons for banks which emerge from its decisions, and the chairman should appear before Parliament, probably the Treasury Committee, to discuss this report. The Commission further recommends that the FCA and the PRA be required to publish a joint review of the working of the enforcement arrangements for the banking sector in 2018. This should, as part of its work, consider whether a separate statutory body for enforcement as a whole has merit.

1820   "FSA publishes censure against Bank of Scotland plc in respect of failings within its Corporate Division between January 2006 and December 2008", FSA press note FSA/PN/024/2012, 9 March 2012 Back

1821   "Santander fined £1.5 million for failing to clarify FSCS cover on structured products", FSA press release FSA/PN/017/2012, 20 February 2012 Back

1822   "Lloyds Banking group fined £4.3 million for delayed PPI redress payments", FSA press release FSA/PN/017/2013, 19 February 2013 Back

1823   UBS, FSA Final Notice, 8 February 2013 Back

1824   JQ 160 Back

1825   JQ 163 Back

1826   KQ 771 Back

1827   "Banks face £10bn bill over swaps mis-selling scandal", The Telegraph, 1 February 2013, Back

1828   Qq 2245, 2252 Back

1829   Q 2306 Back

1830   Q 2317 Back

1831   JQ 191 Back

1832   EQ 57 Back

1833   Q 2308 Back

1834   Ev 1025 Back

1835   "HSBC Announces Settlements with Authorities", HSBC announcement, 11 December 2012 Back

1836   "Standard Chartered pays $327m to settle Iran fine", The Telegraph,10 December 2012 Back

1837   Ev 1052 Back

1838   Q 2308 Back

1839   Ev 1052 Back

1840   Ibid. Back

1841   PRA and FSA Handbook, DEPP 6.5A.3, Back

1842   Barclays, FSA final notice, 27 June 2012, para 208 Back

1843   PRA and FSA Handbook, DEPP 6.5A.4, Back

1844   PRA and FSA Handbook, DEPP 6.5A.5, Back

1845   "RBS reaches LIBOR settlements" RBS statement, 6 February 2013, Back

1846   Qq 4198-4199 Back

1847   Qq 4200-4207 Back

1848   Treasury Committee, Second Report of Session 2012-13, Fixing LIBOR: some preliminary findings, HC 481,para 16 Back

1849   Q 2286 Back

1850   Q 172 Back

1851   Fourth Report, para 129 Back

1852   See Paragraph 198. Back

1853   FSA Board Report, The Failure of the Royal Bank of Scotland, December 2011, p 9 Back

1854   Fourth Report, para 136 Back

1855   Q 172 Back

1856   Q1841 Back

1857   "Where are they now: What became of the18 Royal Bank of Scotland directors who oversaw its demise?", Scotland on Sunday, 11 December 2011 Back

1858   Ev 1474 Back

1859   HM Courts and Tribunals Service, Tax and Chancery (Upper Tribunal) guidance,  Back

1860   PRA and FSA Handbook, FSA Handbook: Enforcement Guide, Chapter 9.9, Back

1861   JQ 218 Back

1862   Q 2626 Back

1863   Q 3034 Back

1864   Q 2992 Back

1865   FSA, APER 3.3 Factors relating to Statements of Principle 5 to 7, Back

1866   Upper Tribunal (Tax and Chancery Chamber), Decision on John Pottage and the Financial Services Authority, FS/2010/33, 20 April 2012, Back

1867   Q 2626 Back

1869  1868   Q 3021 Back


1870   Q 3036 Back

1871   Q 2635 Back

1872   Q 2641 Back

1873   Q2263 Back

1874   Q 4496 Back

1875   Qq 3005, 3007 Back

1876   Q 4497 Back

1877   FSA Board Report, The Failure of the Royal Bank of Scotland, December 2011, p 9 Back

1878   Q 4495 Back

1879   HM Treasury, Sanctions for the Directors of Failed Banks, 3 July 2012, para 3.11 Back

1880   Ev 1477 Back

1881   Q 4495 Back

1882   Ev 1071 Back

1883   Ev 1586 Back

1884   Ev 1192 Back

1885   Ev 1069 Back

1886   Ev 1193 Back

1887   Ev 1499 Back

1888   Ev 1189 Back

1889   Q 4499 Back

1890   Ev 1500 Back

1891   Ev 1499 Back

1892   Q 3578 Back

1893   Ev 1057 Back

1894   Ev 1061 Back

1895   GMC, Imposing Interim Orders: Guidance for the interim orders panel and the fitness to practise panel, 14 February 2012, Back

1896   Q 3038 Back

1897   Ibid. Back

1898   Ev 1474. Section 133(3) of FSMA already allows the Tribunal Procedural Rules to make provision for suspending a decision of the FCA/PRA pending determination of the reference or appeal. Back

1899   Ev 1499 Back

1900   Ev 876 Back

1901   Financial Services and Markets Act 2000, Section 66(4) Back

1902   Ev 1045 Back

1903   Ev 1061 Back

1904   Ev 1479 Back

1905   Ibid. Back

1906   Ev 876 Back

1907   Q 2312 Back

1908   DQ 95 Back

1909   Ev 1069 Back

1910   Ev 1476 Back

1911   HM Treasury, Sanctions for the Directors of Failed Banks, 3 July 2012, para 4.3 Back

1912   Ibid., para 4.4 Back

1913   Ev 821 Back

1914   Ev 1476 Back

1915   Ev 822 Back

1916   Ibid. Back

1917   Qq 2628, 2645, 2647, 2820 Back

1918   Q 3034 Back

1919   Q 3035 Back

1920   HM Treasury, Sanctions for the Directors of Failed Banks, 3 July 2012, paras 4.14-4.17 Back

1921   Ev 1475 Back

1922   Q 3035 Back

1923   HM Treasury, Sanctions for the Directors of Failed Banks, 3 July 2012 Back

1924   Ev 982 Back

1925   Q 2627 Back

1926   Health and Safety (Offences) Act 2008 Back

1927   Q 2295 Back

1928   Q 3051 Back

1929   Morgan Lewis, A summary of the Financial Services Authority's enforcement procedures in the United Kingdom, April 2006 Back

1930   "RDC Members biographies", FCA, Back

1931   Bank of England, Prudential Regulatory Authority, Our approach to banking supervision, May 2011, para 80, Back

1932   Q 3047 Back

1933   Bank of England, Prudential Regulation Authority, The PRA's approach to enforcement: consultation on proposed statutory statements of policy and procedure, December 2012, paras 3.2 and 3.3, Back

1934   Ev 798 Back

1935   FSA, Regulatory reform: the PRA and FCA regimes for Approved Persons, October 2012,; FCA, The new FCA Handbook, PS 13/5, March 2013,; PRA, Regulatory reform: amendments to the Prudential Regulation Authority Handbook,PS1/13, March 2013, Back

1936   Q 3047 Back

1937   Q 3048 Back

1938   Bank of England, Memorandum of Understanding between the FCA and the PRA, paras 47 and 49, Back

1939   Q 1804 Back

1940   Ibid. Back

1941   Ev 809, 852 Back

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© Parliamentary copyright 2013
Prepared 19 June 2013