Banking StandardsWritten evidence from the Financial Services Authority

1. We are submitting this memorandum as a follow-up to the oral evidence given by Tracey McDermott, Director of Enforcement and Financial Crime, on 29 January 2013.

2. The Commission requested that we provide any further thoughts on how we could improve the likelihood of being able to hold senior management, particularly in large institutions, to account for failures to meet regulatory requirements (whether prudential or conduct). As discussed during that hearing, this is not an area where there are simple solutions but we set out below some thoughts on changes that could be made together with some of the pros and cons of each which the Commission may want to deliberate on further. This memorandum focuses on the investigation and disciplinary process rather than the wider operation of the Approved Persons Regime.

3. The Commission will, of course be aware that the FCA Board has not yet been established. The approach to this very important issue is a matter that we expect the Board to consider in the early days of the FCA.


4. Personal accountability is an important part of an effective regulatory regime and of maintaining public confidence in both the system and its regulator. This has been recognised since the beginning of the FSA. Our approach has been to set out in our rules the conduct we expect of approved persons, and to take action if they breach those rules. Typically, for example, this would mean that we might take action for a failure to act with integrity or a failure to take reasonable care in the performance of a controlled function. This will normally mean that we must establish some fault or culpability before we can impose any disciplinary sanction. However, to date, it has proved difficult to bring such cases against senior individuals in large organisations. The reasons for this include:

(a)The individual did not, in fact, do anything wrong, in the sense of being in breach of our rules. They made judgements which were not clearly unreasonable at the time even though some of those may have proved, with the benefit of hindsight, to be disastrously wrong.

(b)The individual did not act alone. Decisions were made by properly constituted boards or committees. Such decision making is a standard feature of corporate structures and is normally expected to produce better decisions by allowing for challenge (particularly by non-executives). While the fact a decision was made by a group of people is not a complete defence, it does make it more difficult to establish that the conduct of any single individual (or the group) fell below the relevant standard—put simply the defence is “we cannot all have been acting outside the bounds of what was reasonable”. This is a more acute version of what in civil litigation might be referred to as the “battle of the experts”. One professional says X and another says Y and the Tribunal is left to decide between them. In disciplinary cases the Tribunal will not only be faced with the independent experts on both sides but also with a series of other individuals involved in the decision making all of whom also bring some expertise to bear and who will, almost inevitably, be ranged against the regulator.

(c)The responsibility for a particular area may have changed over the relevant period so that no single person is responsible for the entirety of the misconduct.

(d)Decisions were made further down the chain of command. If the delegation was appropriate (ie to an appropriately qualified person with suitable resources etc) the more senior individual will not be at fault. In conduct cases (although perhaps less so in prudential matters) the decisions which are made which impact adversely on customers may sometimes be made a long way from the top of the organisation and the senior management and/or board currently have relatively little visibility of them.

(e)It is unclear who was responsible for a decision (or series of decisions) because lines of accountability are unclear or confused, or because they pass, at some point, through people who are not approved (and are not required to be).

(f)Even in cases where there is a strong suspicion that more senior management “must” have known what was going on, it is difficult to find the evidence to substantiate that suspicion.

5. Any solutions that are sought to the problem of personal accountability therefore need to consider which of these issues they are seeking to address. Some of the challenges are concerned with securing the necessary evidence to establish whether individuals are genuinely responsible for particular decisions or actions and their consequences. But there is a more fundamental question about whether some form of wrongdoing or culpability should be a pre-condition for imposing punitive sanctions. In this context, it is worth noting that typically a CEO would not be held personally responsible for a breach lower down the organisation eg if employment laws were broken.

6. However, in any organisation, staff lower down the hierarchy (and indeed sometimes the non-executives) will, typically, act in a way which they believe reflects the culture and approach of the organisation. That culture will manifest itself in many ways:

what senior management say and, more importantly, what they do;

the incentives and reward structure in place; and

the qualities and characteristics of those who are promoted or otherwise recognised.

7. Large organisations will also establish systems to ensure consistency of approach, to manage legal, regulatory and reputational risk, and to monitor and measure performance and profitability. These structures will be approved by senior management and operated under their delegated authority.

8. So, although direct involvement in misconduct may be limited, senior management ultimately have the tools at their disposal to control or limit it. This combined with the sheer number and extent of the issues in the financial services industry over recent years, which in itself reflects deep seated issues within the culture of certain parts of the sector, justifies a different approach to the liability of senior management within the financial services sector.

Who should be Subject to Disciplinary Sanctions

9. As referred to in our submission of 18 January 2013 (and discussed during the hearing on 29 January 2013) we think it is important, to ensure proper accountability, that we are able to take disciplinary action against individuals who are not Approved Persons.

Culpability vs Accountability

10. If the intention is simply to ensure that, where things do go wrong, an individual is seen to bear the consequences, the simplest way to achieve that would be to impose a strict liability regime and dispense with any notion of fault (other than by the firm) being required. This would, on the face of it, be quick and simple. It would be likely to have some desirable consequences in that it may encourage more risk averse behaviour by management. It would also enable the regulator to demonstrate that something is being done. It does however have significant downsides. The potential issues include:

(a)Identifying what event or action should give rise to the automatic sanction

For example, one might say that being a director of a bank at the time of its “failure”, in the sense of it going into administration or receiving emergency public funding, should of itself be a justification for the imposition of a sanction. For actions adversely impacting on consumers, one would need to define the facts or circumstances that should be the trigger for disciplinary action. These would need to be defined with sufficient clarity to avoid the sort of arguments and uncertainty we currently face in pursuing disciplinary action.

(b)If the aim is to encourage better behaviour then introducing a system where the sanction is the same however well or badly you have done your job may not achieve that. There would be no reward for doing the best possible—only for perfection.

(c)Part of the deterrent effect of a sanction is the stigma that goes with it. If it is perceived that the sanction comes without any “blame” attached it may have little, or no, deterrent effect. People, for instance, regularly break the speed limit despite the risk this might result in sanction.

(d)The imposition of a sanction—in the absence of establishing culpability - might be perceived as unfair. This perception would be magnified the greater the sanctions imposed (or available). If an individual faced, for instance, being barred from the industry it is likely that this would engage protections under human rights legislation and a strict liability approach may not be upheld by judicial authorities here or in Europe. That risk could be mitigated, to some degree, by imposing lesser sanctions. However, they may not have the desired deterrent effect and may be perceived by society as equally as inadequate as the current position.

(e)The reality of the financial crisis has been that many senior management in large firms have lost their jobs and often considerable sums of money. It is difficult to imagine that they may have behaved differently, in a prudential sense, because of the threat of a small sanction imposed through strict liability given that they did not think, at the time, that their conduct was wrong.. It is however fair to say that in the conduct context the impact of past failings may not have been quite so keenly felt at the most senior levels. Therefore, a strict liability approach may have a greater impact in that area not least in ensuring that senior management take greater interest in, and have greater awareness of what might expose them to liability.

11. One way of addressing concerns about the efficacy of the sanctions available under a strict liability regime could be to adopt an approach equivalent to points on a driving licence eg to provide that an individual who had received more than, say, 3 strict liability sanctions would be presumed to be no longer fit to perform their role or would be liable for some other more severe sanction. This might be particularly effective if combined with a time limited approval for certain roles in certain firms eg if there were a 5 year appointment then, on renewal, the regulator could consider whether the number of sanctions accumulated meant any new application should be refused. However, identifying sensible “trigger points” for the imposition of staged sanctions would be critical to the viability of such an approach and to the perception of its fairness.

Rebuttable Presumption

12. If the intention is not to hold people to account simply because something happened on their watch but instead to distinguish between the good and the bad then an option may be to make it easier to establish a case.

13. 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.

14. This would be more targeted than a strict liability regime as it would ensure that an individual who could show they had taken all reasonable steps would have a defence to discipline.

15. 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. It would however not be a panacea:

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.1

This option is likely to require legislative change to give the regulators a clear foundation on which to impose “evidential burdens” on those potentially subject to disciplinary action.

Other Approaches

16. As mentioned at the hearing we are also exploring practical ways to try and address some of these issues (particularly around clarity of responsibility and delegation) eg through conducting audits of the responsibilities of Significant Influence Functions (“SIFs”). In addition to those matters which are in train, we set out, for completeness, other areas we are considering.

Changes in Regulatory Approach

17. Expanding the Statements of Principle which we issue under our approved persons regime to impose wider duties on senior management eg to require them to operate their business in a way which puts customers first or reflects a long term view or a duty to society. To make such a provision effective would require very careful thought to be given to the drafting both to ensure that it supported the right outcome and also to manage any potential conflict with other duties (whether regulatory or otherwise) eg putting a customer first could mean turning a blind eye to money laundering or market abuse. Such a provision would, however, have an important signalling effect and may also provide additional support for those within firms who are trying to do the right thing. A change of this nature would require consultation and could be expected to be met with significant resistance from the industry.

18. Amending our Handbook to allow us to ensure we can identify a SIF within a firm who is responsible for ensuring clear lines of accountability. This would enable us, in cases where the relevant person responsible for the decisions leading to misconduct cannot be identified, to take action instead for a failure to apportion responsibility properly.

19. Making other handbook changes. For instance we currently state in our Handbook that “principal responsibility for compliance is with the firm”. That statement could be reversed to make it clear that we regard primary responsibility for compliance as being with individuals.

Addressing the Accountability Gap

20. Another option to address the “accountability gap” would be to consider ways in which those lower down the hierarchy within a large company could hold those higher up to account. Currently we have tended not to pursue middle management or compliance officers in most cases. This has been driven by the view that they are often a convenient scapegoat but lack the real power to change things so we are targeting the wrong people. Further, in the case of compliance in particular, we are penalising the person who should be a regulatory ally and reinforcing the view that meeting regulatory requirements is the job of compliance not of the business.

21. We could change this approach and adopt an approach that said, in each case, we would take action against the most senior person we could identify even if they were comparatively junior. This would have the effect of bringing home to those individuals their own responsibility. It may thus incentivise different behaviours, ie better escalation of issues, more forceful demands for resource, a better audit trail of who knew what when etc. Over time this may provide us with the evidence to pursue more senior individuals

Whistleblowing/Notifying the Regulator of Issues

22. We could also focus more on taking disciplinary action for breaches of Principle 4 of our Statement of Principles for Approved Persons where someone fails to report wrong doing to us. The potential implications of this could be significant if we ended up punishing the innocent, but silent, bystander rather than the wrongdoer (albeit the two are not mutually exclusive). This may require changes to the current FSA guidance particularly if we wished to make it clearer that individuals should notify us of issues outside their own firm.

23. For the reasons set out in our submission of 11 December 2012 we are currently unpersuaded of the benefits of financial incentives to whistleblowers. One area which may merit further consideration however is the consequences to individuals in the industry of notifying us of misconduct. Where there is no suggestion that there has been any involvement in the misconduct then, while there are obvious risks to whistleblowers of being stigmatised etc, these are largely the same as in other industries.

24. Where an individual has been involved in misconduct however the position is different. If someone provides us with information which indicates that their fitness and propriety is in question then we have taken the view that we cannot, as the regulator, ignore that. So the consequences may be that an individual who comes forward is prohibited from working in the industry as we cannot be satisfied they are fit and proper. This acts as a further disincentive to report misbehaviour.

25. We could consider whether or not we could operate a scheme similar to that used in cartel enforcement or the leniency provisions which we have adopted in connection with insider dealing. This would mean adopting a more lenient approach to those who are the first movers in bringing misconduct to our attention eg by agreeing not to prohibit them or imposing a more limited prohibition.

26. This is an approach is used routinely by US criminal prosecutors but is much less frequent in the UK. This is partly because the consequences (in terms of length of sentence) are typically greater in the US but also because it is something UK jurisprudence has historically been suspicious of.

27. Clearly if we in our role (as regulator rather than prosecutor) were to adopt such an approach we would also need to be able to impose suitable supervision requirements on the individual to ensure that they did not put other market users or customers at risk.

13 February 2013

1 The recent Tribunal decision in Sime highlights that even in Authorisations cases, where the burden is on the applicant for approval to satisfy the regulator of his fitness, that does not mean the regulator can simply rely on unproved and unresolved allegations. The Tribunal stated in that case that it considered to be its duty to reach conclusions on the allegations and if on examination they are not substantiated, they should disregard them.

Prepared 19th June 2013