Banking StandardsWritten evidence from the Financial Services Authority

QUESTIONNAIRE ON SANCTIONS (CRIMINAL, CIVIL AND REGULATORY) AND THE APPROVED PERSONS REGIME (APER)

The FSA welcomes the opportunity to contribute to the Parliamentary Commission on Banking Standards’ examination of sanctions and the approved persons’ regime. In this memorandum, we set out our response to the Parliamentary Commission’s questionnaire received on 7 January 2013.

The FSA—and both the PRA and FCA—are committed to ensuring not only that the right individuals are appointed at the approval stage but that we remain satisfied that they are fulfilling their responsibilities throughout their life as approved persons. We believe that this requires an effective process for holding individuals to account both formally and informally. We are a strong supporter of criminal action in appropriate cases, for example in insider dealing. However, we think that where mismanagement rather than deliberate misconduct is concerned, improved regulatory approaches—including more proactive and intensive supervision—rather than criminal sanctions—is more likely to be successful.

Extending criminal sanctions would provide a further credible deterrent if there was a real likelihood that successful prosecutions would take place in future. However, we believe that the difficulties involved means that this might not be the case. Instead, it would be better to strengthen the powers available to take regulatory action. We, therefore, extend our support for HM Treasury’s proposal to introduce a rebuttable presumption that a director of a failed bank should not be subsequently approved as a director of another bank.

As expressed in our previous submission (September 2012), whilst we consider that our enforcement powers to be largely effective, there are some areas where we think legislative change may assist. With appropriate safeguards, we believe the following changes could help us address some of the existing limitations in this area:

The extension of the limitation period for taking disciplinary action against approved persons;

A power to prohibit an individual from performing a controlled function on an interim basis; and

A power to take action against individuals that commit misconduct, yet fall outside of the approved persons regime.

We expand on these points further in our submission.

We acknowledge that a number of respondents to the Commission have proposed the establishment of an independent professional body. Whilst we would welcome any initiatives that seek to raise standards across the industry, we believe the scope of any such body would need to be clearly defined to ensure that it does not duplicate or undercut the work of the regulators.

Finally, we also draw attention to the work the PRA and FCA have underway to make more effective use of our existing powers. Since the financial crisis there has been an increasing focus in the FSA on the regulation of individuals, under our approved persons regime, as well as regulation of firms. We are planning for this work to continue, and be further developed, in both the PRA and the FCA.

Criminal Sanctions

As you are aware, on 3 July 2012 HM Treasury published a proposal to create a new criminal offence of serious misconduct in the management of a bank. The proposal considered four main possibilities for the kind of managerial misconduct by bank directors and senior management that might be subject to new criminal sanctions:

(i)Strict liability—being a director at the relevant time of a failed bank.

(ii)Negligence—failure in a duty of care which leads to a reasonably foreseeable outcome.

(iii)Incompetence—failure to act in accordance with professional standards or practices.

(iv)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.

1. What are your views on extending criminal sanctions to cover managerial misconduct by bank directors?

The main objectives for extending criminal sanctions to such misconduct are that: (a) bankers would act more cautiously in taking risks with the bank’s and customers’ funds; and (b) the public would have greater confidence that something could be done to take action against mismanagement. We are not convinced that the creation of a criminal offence would be likely to achieve those objectives.

As illustrated by the FSA’s Board Report on the Failure of the Royal Bank of Scotland, the causes of a major bank failure are always likely to be complex and include a combination of decisions made within the bank and inextricably linked external events. Establishing the essential causal link between a bank’s misconduct and the acts or omissions of an individual senior manager will rarely be easy. Establishing this causal link in disciplinary cases, where our policy requires strong evidence of an individual’s personal culpability in the events which led to the failure is necessary can be difficult. 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.

Criminal offences already exist for fraud and misleading statements or impressions but the Commission should be cautious of recommending the introduction of a criminal offence in relationship to mismanagement of financial institutions.1 We believe that a better solution could be found within the regulatory sphere whereby (a) it is easier for the regulators to ensure—and it is clearer to senior bankers—that those who have previously been involved in mismanagement of financial institutions are prevented from practising again in the financial services industry and (b) it is easier for the regulators to take disciplinary action against such individuals as well. Further consideration also ought to be given to ensure that the structure of remuneration and incentivisation of Boards of banks and financial institutions, including non-executive directors, is designed to ensure that proper account is given to downside risk (as raised in the FSA Board Report into the failure of RBS). We expand on this further in our response to Q37.

2. What are your views on the possible formulations of a criminal offence based on options (i) to (iv)?

It is unlikely that a strict liability offence would be suitable for the complexities of a bank failure. Whilst the definition of “failure” could potentially be narrowly constructed, we agree with the difficulties identified in HM Treasury’s Consultation Paper on Sanctions for the Directors of Failed Banks2 regarding what constitutes the “relevant time” at which a bank could be said to have failed and the impact on directors who had been brought on to the board just prior to the failure to assist in the bank’s rescue. This risks the punishment of persons who were not culpable in the bank’s failure.

Proving to a criminal standard that an individual, or group of individuals, has acted negligently or incompetently in a business context will always be a challenge. As pointed out above, the reasons for massive corporate failure are rarely simple. There needs to be proof that the individual failed to observe the requisite standards of behaviour in much the same way that the FSA currently needs to prove in a disciplinary case that the individual’s standard of conduct is below that which would be reasonable in all the circumstances. However, in criminal proceedings the evidential burden would be higher than is the case for a disciplinary action. Similar considerations apply in the context of proving recklessness.

We note, by way of comparison, that the Department for Business, Innovation and Skills (BIS), can in certain circumstances seek to make a Company Directors Disqualification Order where it believes that a person is unfit to be concerned with the management of a company. The tests that have to be met are strict ones and we note that no such action, as far as we are aware, has been taken against the directors of any of the recently failed UK banks.3 If criminal proceedings are successfully brought, a disqualification order can be made as part of the sentence.

3. Do you think that an offence based on one of those options would be likely to discourage those considering positions of leadership within banks?

There is a risk that the introduction of a criminal offence for mismanagement of a financial institution might discourage some from considering leadership positions within banks: we are not aware of any specific evidence on this but would expect that there must be some risk that if your exposure is greater at a bank than any other corporate it would deter some people. This risk would be greater the more exposed an individual becomes (ie the stricter the liability). However, we do not think that this risk should be an overriding factor in deciding whether this sort of misconduct should be criminalised.

4. Will the possibility of criminalising behaviour which can already be sanctioned under Financial Services and Markets Act 2000 (FSMA) act as a greater deterrent?

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. Similarly, we agree that the prospect of prosecution for mismanagement of a financial institution would act as a greater deterrent than disciplinary proceedings. However, the deterrent would only be effective if the existence of the offence were to be supported by successful prosecutions with custodial sentences. Further, 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.

5. Do you think that it is likely that the threat of criminal action will stifle perfectly legitimate activity and ultimately deter growth in the banking sector?

Whilst these are risks, again they are unquantifiable. However, we do not think that these risks should be an overriding factor in deciding whether this sort of misconduct should be criminalised.

Civil and Regulatory Sanctions

Rebuttable Presumption

HM Treasury also published proposals to amend FSMA in order to put in place 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. The Government also proposed two groups of “supporting measures”, which could be taken forward by the regulators under existing FSMA powers:

(a)Introducing clearer regulatory requirements on individual responsibilities and the standards required of people performing certain key roles; or, in the alternative, a “firm-led approach” (with the onus on the firm and individual to set out a detailed written statement of the responsibilities and duties of each role); and

(b)Requiring banks explicitly to run their affairs in a prudent manner, and requiring bank boards to notify the regulator where they become aware that there is a significant risk of the bank being unable to meet the threshold conditions for authorisation.

6. What are your views on the proposal to introduce a rebuttable presumption that the directors of failed banks are not suitable to hold senior executive positions in other financial institutions?

As set out in our previous submission to the Commission (September 2012), 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.

However, as the questions below imply, there are certain risks to the proposal which would need to be successfully mitigated in order for it to be beneficial.

7. Does the rebuttable presumption go any further than the current regulatory regime?

This is certainly an important issue. The current regime requires any applicant for approval to satisfy the FSA that they are fit and proper: the burden is on the individual to demonstrate this to the FSA. For the rebuttable presumption to be effective, it would need to be articulated in a way which clearly does go further than the current regulatory regime and ensure that a higher hurdles is put in place. It would also need to be clear whether the presumption applied to certain types of roles within institutions and if this would mean a change to the fit and proper test for those candidates to whom it applies.

8. Do you think that the introduction of the “rebuttable presumption” could discourage skilled individuals from accepting key management positions?

We are conscious of the risk that the rebuttable presumption could discourage skilled individuals from accepting a management position, particularly at a firm which was perceived to be in difficulties. It would not be desirable to make it harder for a struggling firm to recruit new management. In order to avoid this, there would need to be a recognition, either in the legislation itself, or in associated guidance, that the presumption would either not apply, or would be easily rebutted, by someone who joined a firm which was already fatally damaged and was unable, despite their best efforts, to rectify the situation.

We recognise that it may be challenging to frame this guidance in such a way that gives complete reassurance to the “white knights” it is intended to apply to, without undermining the general effect of the rebuttable presumption.

9. Do you think introducing the presumption would send a clear message that bank senior executives and boards have a responsibility to ensure there is a strong focus on downside risks?

Yes, as noted in our original submission to the Commission we believe that introducing the rebuttable presumption would send such a message.

10. What are your views on the possible supporting measures aimed at clarifying management responsibilities and changing the regulatory duties of bank directors?

A lack of clarity as to who was directly responsible for a particular area, and/or what was a reasonable standard to expect of someone in a particular role, has proved a barrier to bringing disciplinary action in the past. Therefore, we believe there is certainly merit in exploring the ideas set out in a) above. A firm led approach may have certain advantages, as it may prove impossible for a regulator to set out detailed expectations of every different role in all the different organisational structures under which banks or financial institutions may operate. Gaining greater clarity as to which individuals hold responsibility for which areas, in higher impact firms at least, has been identified as a priority for supervisory work after legal-cutover. Please see our answer to Q17 below for further details on this.

Looking at the measures discussed in b) above: we believe that the draft PRA and FCA Threshold Conditions already make it clearer that banks need to conduct their business in a prudent manner. And we would already expect firms to notify us if there is a significant risk that they will unable to meet the Threshold Conditions. However, we can see merit in further emphasising that it forms part of a bank director’s personal duties to ensure that this happens, and that the firm has an appropriate prudential culture in place. This is something the PRA plans to explore when reviewing the standards of conduct it imposes on approved persons through its Statements of Principle and Code of Practice for Approved Persons.4 This review is scheduled to take place later this year. FCA will be undertaking a similar review as outlined in our response to Q17.

Existing Regulatory Sanctions

11. Despite the range of enforcement powers currently available to the regulator, are additional powers necessary? If so, what would those powers be?

The FSA already has a broad range of enforcement powers to discipline approved persons and also take action in respect of their fitness and propriety. The FSA can:

impose a penalty on an individual of such an amount as it considers appropriate;

suspend, for such period as it considers appropriate, any approval of the performance by the individual of any function to which the approval relates;

impose, for such period as it considers appropriate, such limitation or other restrictions in relation to the performance by the individual of any function to which the approval relates;

publish a statement of the individual’s misconduct (ie a public censure);

withdraw his approval; and

prohibit him from performing a specific function, any function falling within a specified description or any function.5

As we stated in our submission to the Commission (September 2012), we consider that we have a range of effective enforcement powers, although we suggested that the Commission may wish to consider the case for further refinement across certain areas. This could include the following changes:

the ability to take disciplinary action against employees outside the scope of our approved persons regime;

the extension of the limitation period for taking disciplinary action against approved persons; and

a power to prohibit an individual from performing a controlled function on an interim basis.

These are covered in more detail below in our answers to questions 20, 14 and 12 respectively.

12. As part of your response to the Commission’s initial call for evidence, you suggest the introduction of a power to prohibit an individual from performing a controlled function on an interim basis. Please provide further detail of why this would be a significant tool in addition to the current powers?

When the FSA takes action against an individual on the grounds of a lack of fitness and propriety (ie to withdraw his approval or prohibit him), we have no direct power to remove him from his position (whether as an approved person or otherwise) pending determination of the action against him which in complex cases can take years before the RDC and Upper Tribunal.6 Such a power would be desirable in cases where we have sufficient evidence that an individual has been involved in serious misconduct and where they continue to pose a material risk to the FCA’s or the PRA’s objectives.

A power to prohibit an individual on an interim basis from performing controlled functions would enable the FCA/PRA to temporarily remove individuals from the financial services industry where they continue to pose a risk to our objectives whilst the action against them is ongoing. The power could also extend to individuals who do not hold controlled functions by temporarily banning them from performing any functions in relation to a regulated activity.

We recognise that this power would be a significant extension to our current powers and should only be used in cases where there is strong evidence of a need to remove an individual immediately on the grounds of a lack of fitness and propriety. Appropriate safeguards would need to be established to ensure that the power is properly used. For example these might include:

FSMA would need to set out an appropriate threshold that the FCA/PRA would need to satisfy before it could exercise this power.

The power could be exercised through the Supervisory Notice process which gives the subject an immediate right to refer the matter to the Upper Tribunal as well as the right to make representations to the regulator.

s133(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.

However, this power would be a significant tool which would allow the regulators to act swiftly to counter any threat to their objectives by an individual remaining in position pending a final determination by the tribunal.

13. Considering the current powers and measures, do you think the perceived shortcomings in being able to hold individual directors personally culpable are as a result of statutory or regulatory deficits or as a result of regulators and law enforcement agencies not utilising the powers already available to them as fully as they could?

We believe that the main difficulties in bringing cases against senior managers of financial institutions arise from the current need to evidence strongly an individual’s personal culpability for the failings of his employer and, in some cases, from a lack of clarity over the allocation of responsibilities within firms. We have suggested a number of ways we could explore achieving greater clarity for accountability in Q17.

The FSA currently does not have the power to take enforcement action simply because a failure occurs in an area for which an individual is responsible (ie there is no strict liability requirement). The FSA Handbook provides instead that we can only take enforcement action against a senior manager (and approved persons in general) where he/she is personally culpable and defines personal culpability in two ways:

Deliberate misconduct; and

A standard of conduct below that which would be reasonable in all the circumstances (APER 3.1.4(1) G and DEPP 6.2.4G).

In cases concerned with the competence of senior managers, the key issue is the extent to which their standard of conduct was reasonable given all the circumstances at the time. The FSA may not apply standards of conduct retrospectively as this would raise serious issues of unfairness.

14. The Commission notes your suggestion for extending the limitation period for taking action against approved persons. Please could you suggest what time frame you think would be appropriate and give an indication of the percentage of cases that have fallen foul of the three year time limit but which would likely have been viable if the limitation period was set at the number of years you have suggested.

When taking disciplinary proceedings against an approved person (ie when imposing a censure, fine or suspension/limitation) the FSA must commence proceedings (ie give the individual a warning notice) within three years of the first day on which it knew of the misconduct. The FSA is treated as knowing of misconduct if it has information from which the misconduct can be reasonably inferred. This time limit does not apply when the FSA takes action against an individual on the grounds of a lack of fitness and propriety (ie when it seeks to withdraw an approval or prohibit a person). The PRA and the FCA will be subject to the same restrictions.

The FSA and its successors are committed to holding senior management to account where they fall below the standards that we set—if we are to fulfil this commitment, we will have to take on increasingly complex cases which will take time to investigate to the standard required. Based on our experience of complex cases, we consider that three years may not always give the regulator sufficient time to determine whether there is a case to answer. Aside from the length of time it takes to investigate such matters thoroughly, the deadline can be a matter of dispute. A regulator will have had frequent contact with a bank’s senior managers as part of its supervisory function—for good reasons we may wish to work with a firm to try to fix problems before considering disciplinary action—and may have accumulated information relating to a senior manager’s competence over a period of time. The time limit creates the legal risk that a senior manager under investigation could successfully argue that the time limit commenced with the receipt of any initial information rather than at a later stage when the regulator received further information on which it based its decision to investigate the misconduct.

Although we do not keep statistics on cases where the three year limit has caused significant operational difficulties, it 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. External factors may also mean that the time limit becomes a significant issue. For example, overseas regulators may be running parallel investigations which can inevitably lead to delays in how quickly the investigation can proceed. Further, where criminal authorities may be investigating or considering investigating the same conduct, this may mean in some cases that our investigation is delayed in order to avoid prejudicing any criminal investigation.

These difficulties could be resolved by amending FSMA to redefine the commencement of proceedings as the issue of a Notice of Appointment of Investigators rather than the issue of a warning notice. Alternatively, section 66 could be amended to increase the time limit to, say, six years in order to correspond with the standard limitation period for civil proceedings. There is no time limit when we take action for market abuse which applies to any individual and not just to approved persons. Further, no time limit applies when we are taking disciplinary action against authorised firms. We are aware of the impact that regulatory enforcement action has on individuals and we agree that regulators should progress their investigations efficiently and without undue delay. However, we would note that given senior managers are responsible for the conduct of their firms it is not clear why they 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.

Legislation Versus Regulation

15. In order to make bank directors more accountable (due to the adverse impact a large failed bank can have on the wider economy), do you think there would be merit in amending the Companies Act 2006 and the Insolvency Act 1986 as well as amending the approved persons’ regime under FSMA? To the extent you consider changes should be made to the legal framework, please articulate how you think this could be achieved given the legislation would apply to all company directors

We believe that, as a general principle, issues which relate specifically to bank directors (and do not have a similar bearing on directors of other companies) are generally best dealt with through the sector specific legislation in FSMA, rather than more general legislation. Amending other legislation should only be considered where the desired result cannot be delivered through FSMA, or where that other legislation is itself a barrier to achieving the desired result. We do not think that has been shown to be the case in this instance.

Indeed, because we believe that the damage to society caused by the failure of a bank is of a different order to that caused by the failure of other companies, there is a strong case for saying that directors of banks should operate, and be held accountable, according to a different set of priorities to that which applies to the majority of companies—a point made in the Chairman’s Foreword to the FSA Board Report into the failure of RBS. Changing legislation in a which would affect all company directors is obviously unlikely to be compatible with this differentiated approach.

The Approved Persons’ Regime (APER)

16. The Upper Tribunal ruling in John Pottage v The FSA (FS/2010/0033) highlighted that enforcement action against senior managers is only likely to be successful where there is evidence of actual wrongdoing by the executive concerned. In your opinion, what changes could be made to some of the statements in APER about the standard of conduct expected of directors in order to make it easier to bring enforcement?

APER contains guidance as to the type of conduct which is likely to satisfy (or fall foul of) a senior manager’s regulatory obligations. However, APER does not seek to set out an exhaustive description of every potential situation in which a senior manager’s actions might be viewed as reasonable or unreasonable. Rather, it seeks to give high level guidance indicative of the types of issue which may need to be considered. For example, it is made clear that a senior manager needs to have a sufficient understanding of the business to allow him to understand the risks of the business—the guidance does not however go on to list all the ways by which they might achieve such an understanding or the specific matters they needs to apprise themselves of. These will vary from firm to firm, and from individual to individual. Thus, while the principle is clear, the steps which need to be taken by a particular individual at a particular firm need to be assessed in the overall context rather than in a vacuum.

In John Pottage v The FSA [FS/2010/033], the Upper Tribunal accepted that the scope of the obligation imposed by APER was clear. The key question for determination was whether the steps Mr Pottage had actually taken were reasonable in all the circumstances. The point in issue was actually very narrow—the FSA did not contend that Mr Pottage had taken no steps to discharge his obligation. It accepted that he had taken a number of significant steps. However, the FSA contended that there were further steps he should reasonably have taken. Having considered the evidence in detail, the Tribunal took a different view.

Assessing the reasonableness of steps which have been taken necessarily involves issues of judgment, and is not always straightforward. While there might be scope to expand the guidance in APER to give more detail of specific scenarios, it would not be possible to do so in an exhaustive fashion—as with all regulatory rule-making and guidance, there needs to be sufficient flexibility to cover all future potential scenarios as well as those that have occurred to date. This is not an area which lends itself to codification. However, whilst we will never be able to cover every scenario the regulators will be considering whether there is more we can do in the Approved Persons’ Regime and through day-to-day supervision to make our expectations clearer.

17. In your opinion, has a lack of direct senior management accountability inside firms for specific areas of conduct contributed to the shortcomings in holding individuals personally culpable? Do you think APER should be revised to remedy this?

The allocation of individual responsibility within some firms for specific areas of conduct is not always clear and, in some cases, this has been an important factor in no significant influence function (SIF) holders being held to account when things have gone wrong. This has, in some cases, been exacerbated by complex structures, often spanning jurisdictions, coupled with unclear, complex and confusing allocation of responsibilities amongst SIF holders.

Board structures are usually made up of a number of executive directors and non-executive directors (NEDs). It is a feature of Company Law that places responsibility on directors collectively and our current regime tries to acknowledge this. However, we also need to take account of the important differences in the roles performed by NEDs and executive directors in practice. Executive directors will have a closer day to day involvement in the business, and will be responsible for much operational decision making, as well as the implementation of policy agreed by the board as a whole. NEDs could be seen as having a more strategic role, and will have a particular focus in oversight and challenge of proposals and decisions made by the executive. Failures can occur at either the operational or strategic level—or at both—any decision by us in particular cases as to whether action would be taken against individual executive directors and/or NEDs would need to take into account the nature of the decision(s) concerned, including at what level it was taken, and at what level it ought to have appropriately been taken.

Below board level, in some cases, a decision may be delegated to a committee, sub board or executive committee whose make up may include both SIFs and non-SIFs. These groups might consider an issue seriously, obtain advice but collectively make a bad decision. This leads to the question of who we would take action against: the person who made a recommendation to the group (who may use the committee’s decision as a defence), the individual(s) who executed the decision (but can they really be held to account for the bad decision); each member of the decision making committee (which would be unwieldy and often impractical); or a more limited number of individuals who were particularly involved in the decision making or had particular roles or expertise.

Whilst it might be unrealistic (and, indeed undesirable) for every risk within a firm to be owned by a particular senior manager, we do believe that greater clarity over who is responsible for what within firms is desirable and could lead to a clearer line of accountability.

The FCA is therefore planning to look, at least for the higher impact firms, at how it allocates responsibilities across its SIFs. This will encourage greater clarity within the firms themselves (to enable them to have better corporate governance and enhanced accountability), provide greater clarity of whom the regulators can look to address issues and to enable a more effective ongoing assessment of the fitness and propriety of SIF holders. Ultimately, ensuring that there is a clear allocation of responsibilities within firms, will provide a firmer starting point for taking formal enforcement action against individuals where shortcomings are material. We will keep APER under review in regard to this.

18. Would it be beneficial for the regulator to adopt a more intrusive approach to senior appointments as part of the Significant Influence Function (SIF) process? How could such an approach be adopted?

In October 2008, the FSA implemented an enhanced process for approval of SIFs within higher impact firms. The main effect of this focus was to introduce a more robust approach to the fitness and properness of individuals put forward for such positions. Such assessments typically involve formal interviews conducted by senior regulators and senior advisers. An internal review of this process was undertaken in April 2012 to ensure that decisions to interview a candidate are robustly risk focused and in line with the PBU/CBU objectives. The aim is to have a process that conducts high quality assessments of those individuals who are genuinely in a position to put our objectives at risk (ie Chair; the senior independent director; the chair of the risk and audit committee; CEO, finance director and chief risk officer with others being judged on a firm specific basis).

19. Do you see merit in requiring the regulator to re-appraise SIF individuals at set intervals and on other occasions if it believes that circumstances justify it?

Approved persons must—on an ongoing basis—continue to comply with the FSA’s Fit and Proper Test and APER. Approval letters to all individuals clearly set out that non-compliance of these standards by the approved person may result in the FSA taking action against them.

We therefore believe that the ability already exists for the regulator to re-appraise whether an individual is no longer meeting the regulatory expectations of them in the role. In fact, as part of ongoing supervision we would expect supervisors of higher impact firms, on a risk-basis, to keep under the review the ongoing suitability of key approved persons within firms. However, this need not involve a SIF interview.

It should be noted that, in circumstances where we view that an individual is no longer fit and proper under the current regime, this requires us to take formal enforcement action unless the firm and individual willingly cooperate in withdrawing the approval.

The burden of proof to evidence that an individual is no longer appropriate to be an approved person is with the regulator once the individual is approved and involves us evidencing someone is no longer fit and proper. This is in contrast to decisions prior to approval where the burden of proof for a particular individual’s fitness to take on a particular function rests with the applicant firm and individual.

On balance, therefore, we do not see merit in requiring the regulator to re-appraise all SIF individuals (bearing in mind many will be in smaller firms) against a particular schedule, or against certain criteria. This would require us to allocate considerable resources to checks which in many cases would not be justified by the risks involved. However it may be worth exploring the possibility of a more focussed and selective approach for certain categories of SIFs to either be reassessed in post or limiting their approval to a certain time period (in which case we may require them to reapply). This type of approach would likely only be applied to certain types of SIF approvals and limited to firms we consider present the greatest risks. In any case, the regulators should be prepared to take robust action against individuals who fall short against our regulatory obligations.

20. What are your views on extending APER so that it applies to all bank employees in order to enable the regulator to take disciplinary action against employees who are currently outside the scope of APER—a proposal that you put forward in your response to the initial call for evidence?

In our response (September 2012) to the Commission’s initial call for evidence we said:

“It is worth noting that we have limited powers against individuals who are not approved. Whilst systems and controls and “tone from the top” are clearly key, it is obvious that a banking sector which functions well for consumers and the economy as a whole cannot be achieved unless employees below the level of senior management also act with honesty and integrity. Therefore, having the power to take action against individuals that commit misconduct, yet fall outside of the approved persons’ regime, could enable us to address existing limitations in this area.”

The current way that our approved persons regime applies to individuals in the financial services industry means that those who have been approved by the FSA are liable to pay financial penalties for misconduct, whilst others, who might commit the same misconduct, are not liable. It is not necessarily the case that those who are liable are more senior; whilst a number of relatively junior individuals may be approved to perform the customer function (CF30) as their role requires them to engage directly with customers, the line management above them (provided they are not deemed to be senior managers or directors) do not currently need to be approved and are, therefore, not liable. Similarly proprietary traders are not all required to be approved. Extending the approved persons regime so it applies to a wider number of bank employees would remove these anomalies.

Our approved persons regime consists of a number of elements including (i) pre-approval by the FSA for a particular controlled function (ii) publication of the name of the persons approved on the FSA register (iii) an obligation to comply with the requirements of APER once approved, which carries with it (iv) the possibility of enforcement action against these persons if they fall short of the APER standards.

The FCA view is that whilst it is desirable to apply the full regime to senior management and other defined groups where there is a particular risk of significant consumer detriment should misconduct occur, it has until now been considered disproportionate to apply this to all bank employees. However, while the risks arising from conduct by those outside the approved persons group are lesser they are not negligible, and it may be that these could be addressed by a modified approach which included some, but not all, of the components of the approved persons regime. In particular, for this wider group we could dispense with the requirements for pre-approval and registration and apply only the requirement to comply with a code of conduct, of the type already applied to approved persons, and the liability to enforcement for breaches of this.

Such an arrangement would not be as intrusive or costly as the existing regime—because there would no requirement for pre-approval—but it would provide the ability to take action against these people in the case of misconduct. In addition, it could raise standards in the industry because a code would provide a clear statement of the requirements of behaviour we expected from the financial services industry.

If this proposal were to go ahead, there would be a number of issues that would need to be addressed, notably the content of the code of conduct that would apply to the persons concerned—which might be a modified version of APER—and also the coverage of the new arrangement. It would be desirable for this to be expressed in such a way that it was clear to those who were covered that this was the case.

21. Do you see merit in the establishment of an independent professional body with mandatory membership which has the power to impose civil and possibly criminal sanctions? In your view, could such a body provide a solution for the issue of global matrix management structures that can exist within universal banks?

We would welcome any initiative that seeks to raise professional standards within the industry. However, the key will be that any initiative adds value rather than duplicates or overlaps with functions that are already provided for in the existing regulatory framework.

A number of respondents to the Commission have proposed the establishment of an independent professional body, or “Banking Standards Board” as a way of raising standards within the industry. If this was to be established on similar lines to the professional bodies that already exist within eg law and medicine, it would have the following characteristics:

The professional body/Board would be established by statute—otherwise it would not have the power to compel membership by the target population—it would be operationally separate from any industry representative/trade bodies and it would have a governing body that was not composed primarily of practising members of the industry;

The Board would produce a Code of Conduct to which bankers would have to adhere;

It would maintain a public register of those bankers who subscribed to the Code;

It could take civil enforcement action against those who breached the Code.

Breaches of the Code could be subject to a range of sanctions, up to and including prohibition from further practice within the industry;

Those accused of breaches would have the right to refer their cases to an independent tribunal.

But although existing professional regulatory bodies generally have powers to impose civil sanctions on their members, it would be highly unusual for these to be accompanied by criminal prosecution powers.

The FSA—and in due course the FCA and PRA—already carries out these functions, at least in respect of some members of the banking industry. As explained above, we require certain employees of banks (directors, senior management, and some customer facing staff) to obtain FSA approval before appointment (as “approved persons”). Approved persons are then required to adhere to a code of conduct set out in APER, their names appear on the FSA public register and they can be subject to enforcement action for misconduct, which can result in penalties, including banning from the industry.

Any proposal to establish a new professional body with mandatory membership which was separate from the existing regulator(s) could therefore duplicate and overlap with the FSA/FCA/PRA existing powers. Alternatively it could take over the role of regulation of individuals from the FSA/FCA/PRA. The first of these outcomes could lead to confusion of responsibilities and an increase in regulatory costs, whilst the second would lose the benefits arising from regulators which can look at the conduct of both firms and the individuals working within them on a unified basis. Any legislation drafted would need to take account of these points.

There is a role for voluntary bodies, separate from the regulators, in raising standards above the level required by rules. There already exist a number of organisations that work in this area by eg providing training and setting professional examinations. Such voluntary bodies could make it a requirement their members adhere to a code of conduct. But because they are voluntary in nature, and have not been given powers by Parliament to impose civil sanctions or undertake criminal prosecutions, the only action that they can take themselves against breaches of their code would be expulsion from the voluntary body itself. (They would, of course, be able to report misconduct to the regulators to consider if they wished to take action.) We do not think it would be either necessary or appropriate for any new body to have powers to take civil or criminal sanctions against their members, as this would simply duplicate functions which are carried out by the FCA and PRA.

Costs

22. Please could you give us an indication of the internal (for example, FSA employees) and external (for example, legal fees) costs for bringing a case such as the ones involving John Pottage and Peter Cummings.

In the Peter Cummings case, approximately £1.4 million was spent on internal case costs and approximately £4 million on external fees.

Approximately £1.7 million was spent on internal costs and approximately £2.2 million on external fees in pursuing the case against John Pottage, UBS and a number of other individuals. Of these amounts, approximately £460,000 was spent on internal costs and approximately £1.1 million on external fees in the proceedings against Mr Pottage between the issue of a decision notice and the Upper Tribunal reaching its decision.

23. Please provide a summary of how decisions are taken on whether to proceed based on the likely cost including the role of the cost benefit analysis.

It may be helpful to explain first how the overall Enforcement budget is arrived at before turning to how costs are dealt with in individual cases.

General

The annual budget for Enforcement is set by the FSA Board alongside the budgets for all other functions as part of the annual planning and budgeting process. This then determines the amount that we need to recover through the levying of fees. The Enforcement budget reflects the likely demand for Enforcement activity in the coming year. This is based partly on prior experience (ie how many cases of a particular type would we expect to see in a particular year and what are the resource requirements to deliver those), partly on discussions with Supervision and Markets in particular about their work plans for the coming year and what role Enforcement is to play in that, and partly on the likely resource requirements of ongoing cases (the majority of Enforcement cases span more than one budget year).

The sum allocated to Enforcement includes the budget for internal specialist resource within the Division and also a sum for external case costs, ie the costs of engaging external counsel or other specialists to assist on specific cases. This latter sum includes an amount for cases which are not yet known about at the time of the budget which allows Enforcement to take on cases without having to seek separate additional funding. Enforcement, like every other area of the FSA, is expected to run itself efficiently and to seek to stay inside the allocated budget. However, if that funding is not sufficient, for instance, because of a particularly significant investigation then additional funding can be made available either through internal re-allocation or by a request to the Board for additional funding.

For instance when the investigations into the failures of the large banks commenced in 2009 it was clear that the resources required would be substantial and, in the event, external resources were appointed to do a large proportion of the initial investigatory work (working alongside FSA staff). The costs of this were substantial and were met by an increase in Enforcement’s budget and, in the case of RBS, by the imposition of a special levy on RBS.

The amount of the FSA budget allocated to Enforcement has increased over the last few years from £36.4 million in 2010–11, £38.5 million in 2011–12, and £43.7 million for 2012–13. Enforcement’s budget for the financial year 2013–14 is £51.1 million. This is largely driven by staff costs as we have increased headcount and recruited more staff into the Division over this period—headcount has increased from 319 in 2010–11 to 358 this financial year. We have a budgeted headcount of 390 for 2013–14.

Specific

Regulatory action is different from commercial disputes where, for example, the costs of bringing a claim for damages can be assessed against the prospects of succeeding in that claim. The fines recovered in disciplinary cases against individuals are often outweighed by the costs of bringing the specific case. The benefits to the regulatory system are, however, not limited to the amount of the penalty. Enforcement cases ensure the protection of consumers or the markets, eg by removing those who lack integrity, by improving standards cross the industry by making it clear people will be held to account and by ensuring transparency. In considering whether to commence or continue any Enforcement action, we take a risk-based approach: this includes considering our Regulatory Objectives (ie market confidence, financial stability, the protection of consumers and the reduction of financial crime), the Principles of Good Regulation and our Referral Criteria.7

We have a dedicated team within Enforcement who consider all cases where the use of Enforcement may be one of the appropriate options. That team, working with colleagues across the FSA, will consider the strength of the evidence (as known at that time), the nature of the misconduct, whether other regulatory tools might achieve a suitable outcome and, importantly, the likely impact a case will have on the wider market. Cases are then prioritised to decide which should be referred and which should be subject to other regulatory measures, eg supervision action. These decisions are not always straightforward and there can sometimes be difficult choices as to whether a case should be referred or not. We consider carefully what course of action would be a proportionate response, exercise a common standard of fairness in the use of our powers and act in a manner consistent with the Human Rights Act 1998. We consider in each case the likely impact of the action (ie how significant it will be in terms of general and specific deterrence), the need for protection and the probability of success.

So we will take on cases we assess to be high impact and even where the probability of success is lower in order to send messages to the wider industry and to change behaviour. We view successful enforcement action against senior managers as very high impact. When we take enforcement action in new areas we expect more cases to be contested until we build up a track record when we see people increasingly willing to enter into early settlement discussions. We regularly assess ongoing investigations to determine the progress of the investigation against its objectives and whether resource (both internal and external costs) can continue to be justified on the matter or whether that resource is better spent on other investigations. This assessment focusses heavily on the evidential strength of the case (ie how likely is it that a successful outcome will be achieved) and the impact (ie has the nature of the case changed since referral and do we still believe it will deliver a significant message).

24. Please provide an overview of how enforcement action is funded.

The costs of Enforcement activities, in common with the other statutory activities of the FSA, are funded by the periodic fees levied by the industry on the organisations that it authorises or registers. Further details of how the FSA sets its periodic fees can be found at: http://www.fsa.gov.uk/doing/regulated/fees/periodic.

The FSA is now obliged to pay Enforcement fines it recovers to HM Treasury after it has deducted its Enforcement costs.

25. Would the appetite for pursuing enforcement action be increased if additional funding options were available to the regulator?

If the regulators had additional funding then this would be likely to increase the amount of enforcement action it would take. However, any increase in Enforcement budget would have to be justified within the limits of the FSA’s overall budget on the basis that the additional money is better spent on Enforcement activities than other FSA activities such as authorisation or supervision. In any event, an increase in overall funding would be unlikely to affect decisions about whether to continue to pursue specific cases where we nonetheless consider that the resource is better spent on other cases.

26. Understandably, there is considerable cost in pursuing individual actions. What changes do you think could be made in order to ensure that cost does not act as a deterrent in pursuing all but the largest cases?

As explained above, costs when taken in isolation do not deter the FSA from pursuing cases where we consider senior managers of large financial institutions are personally culpable for failures. We recognise that cases against individuals are very different in their nature from cases against corporate entities and are mindful that an individual will generally face greater risks from enforcement action, in terms of financial implications, reputation and livelihood than would a corporate entity. As such, cases against individuals tend to be more strongly contested, and at many practical levels are harder to prove. They also take longer to resolve. Individuals are likely to be represented by experienced law firms and Counsel who may be funded either by their employers or by insurance policies. We acknowledge above that the FSA’s resources are of course limited, but whilst this in and of itself does not stop us from taking action where it is important, doing so means that we cannot do other things. However, taking action against individuals sends an important message about the FSA’s regulatory objectives and priorities and the FSA considers that such cases are an important deterrent. The FSA is therefore committed to pursuing appropriate cases robustly, and will dedicate sufficient resources to them to achieve effective outcomes.

International

27. Do you think introducing additional criminal, civil or regulatory sanctions would have an impact on the international competitiveness of UK banks?

Additional criminal, civil and regulatory sanctions would be expected to encourage directors to run their banks in a more cautious manner. More cautious banks will probably have smaller balance sheets than would otherwise be the case and efforts to promote greater caution in banks might also encourage greater complacency, meaning banks are less efficient than they would otherwise be. These results, plus the risk that greater sanctions may discourage talented individuals from joining UK banks, might make banks based in the UK less competitive against banks based in other jurisdictions and potentially deter some banks from basing themselves in the UK.

However, this would need to be weighed against the positive effects on the UK’s competitive position of investors having greater confidence in the capability and honesty of those running banks, plus the more general (and very considerable) benefits of avoiding another financial crisis.

28. In your opinion, are there other legal or regulatory regimes that the Commission should be considering? Please provide your reasons for suggesting the applicable regime.

Whilst our approach to regulatory action against senior managers is similar to many other countries, there is nothing that stands out about these other regimes which we would recommend the Commission look into further.

Case Study—HBOS Enforcement Action

Given the Commission’s case study of the failure of HBOS, the Commission would like to seek more information from the FSA in relation to the fine that was imposed on Peter Cummings. Please could you provide a written response to the following questions:

29. Why was enforcement action taken only against Peter Cummings?

Please see our response to Question 30 below.

30. Did the FSA consider taking enforcement action against anyone else from HBOS? If not, why not?

The FSA is producing a report on the failure of HBOS which will set out what it believes were the reasons for the failure of the bank. It will also explain why the Enforcement action focused on Peter Cummings’ management of the Corporate Division and collective failings in the governance of this division at Group level.

In the FSA Board report into the failure of RBS, we explain the general principles that apply when the FSA decides whether to take action against an approver person such as a senior manager. The legislation requires the FSA to prove that either the individual has failed to comply with APER or that he or she was otherwise knowingly concerned in a breach by the firm. If it can demonstrate either of these matters, it can impose a financial penalty, publicly censure that person and/or suspend or restrict their approval. In more serious matters, if it appears that the individual is not a fit and proper person, the FSA can also seek a prohibition order preventing the individual from holding either any roles or specific roles within the financial services industry.

The burden of proof is on the FSA and the standard of proof required is the civil standard (ie the balance of probabilities). However, the FSA can take disciplinary action against an approved person only where there is evidence of personal culpability on his or her part. Personal culpability arises either where the behaviour was deliberate or where the approved person’s standard of behaviour was below that which would be reasonable in all the circumstances at the time of the conduct concerned.

For example, in cases where there is no indication of a lack of integrity on the part of a senior manager under investigation, the issue may be whether he or she has acted without due skill, care and diligence in carrying out the approved role, or whether he or she is competent to carry out the role. In such a case the FSA would have to show that the actions or decisions of that senior manager fell below those which could be considered reasonable taking into account all the relevant circumstances at the time.

The Enforcement investigation into the conduct of Peter Cummings was begun in March 2009 in the context of £7 billion impairment losses (which by the end of 2011 stood at £25 billion) recognised on the HBOS Corporate book following the merger with Lloyds. The investigation therefore focused on the serious issues within HBOS’s Corporate Division and its oversight. The need to focus on Mr Cummings was clear given his role as both the CEO of the Corporate Division and also a member of the Group Board.

HBOS’s federal structure gave Mr Cummings and other divisional chief executives significant autonomy in how they ran their divisions. Whilst other members of the Board wanted Mr Cummings to increase the Corporate Division’s profitability he was in a unique position to understand, and advise his colleagues on the Board about the risks inherent in the Corporate book and the deficiencies in the division’s control environment. At the same time the structure of Mr Cummings’ remuneration meant that he benefited directly from an increase in the profitability of Corporate’s business.

Mr Cummings was also personally involved in the sanctioning of high value/high risk Corporate transactions and personally involved in the oversight of stressed transactions on the Corporate book, unlike other members of the Board.

The Board placed significant reliance on Mr Cummings’ experience and expertise as a corporate banker, and Mr Cummings’ status as the highest paid member of the Board reflected this.

The evidence gathered in the investigation demonstrated clearly that the most culpable senior manager for the Corporate Division’s failings was Peter Cummings. Nonetheless Enforcement obtained information about the roles that other senior HBOS officers played in overseeing the Corporate Division and kept under review whether the scope of its investigation into the failures within Corporate should be extended to include other individuals. However, the prospects of successfully establishing personal culpability against other individuals were considered to be very low and the decision was taken to focus on the case against Mr Cummings.

31. What are the legislative provisions that govern the imposition and calculation of fines that the FSA can impose?

The FSA has the power to fine a number of entities under FSMA. In particular:

under section 206 the FSA may impose a penalty of such amount as it considers appropriate on an authorised firm which has contravened a requirement imposed on it by or under FSMA or by certain directly applicable EU legislation; and

under section 66 the FSA may impose a penalty on an approved person if he has failed to comply with APER or if he has been knowingly considered in a contravention by the relevant firm of a requirement imposed on the firm by or under FSMA or by certain directly applicable EU legislation.

We are required by FSMA to publish our policy on how we will set penalties under these and other provisions. For fines under sections 66 and 206, this policy must have regard to:

(a)the seriousness of the misconduct in question in relation to the nature of the principle or requirement concerned;

(b)the extent to which that misconduct was deliberate or reckless; and

(c)whether the person against whom action is to be taken is an individual.

(see sections 69(2) and 210 FSMA)

The FSA’s penalties policy is set out in the part of the Handbook called the Decision Procedure and Penalties Manual (DEPP). Following a public consultation, we changed our penalties policy in respect of conduct which took place after March 2010.

32. Please identify the provisions which allow the FSA to negotiate the level of fines and the factors it takes into account in negotiating them

The penalties policy that applies to a specific case is the one in force at the time of the misconduct—as many ongoing or recently concluded enforcement actions relate to misconduct which occurred before March 2010 (eg Peter Cummings) we continue to apply the previous policy (where the period of misconduct straddles 6 March we apply the policy which was in place when the gravamen of conduct occurred). However, we are beginning to see more cases which apply the new policy.

The following is a summary of both policies. They are also set out in full in Annex A and B.

Policy Pre-March 2010

The policy applicable to misconduct up until 6 March 2010 provided that we would determine the level of financial penalty (if any) that is appropriate for the misconduct after considering all the relevant circumstances of the case. DEPP sets out a non-exhaustive list of factors which could be relevant to the particular case.

These include: deterrence, the seriousness of the breach, the extent to which the breach was deliberate or reckless, the person’s financial circumstances, the amount of benefit gained or loss avoided, the person’s conduct following the breach, the person’s disciplinary record and compliance history, and whether action was also being taken by other regulatory authorities. We are also required to consider penalties in other comparable cases: in practice this has been a significant factor to ensure consistency between different cases making it more difficult to increase penalties (which we have sought to remedy in our new policy).

There is no formal weighting of any of the factors, rather it is an assessment in the round. Income and status are relevant in as much as the impact of a breach is more likely to be significant if someone is more senior and therefore likely to make more money but there is no direct correlation.

Policy Post-March 2010

We amended DEPP in March 2010 to:

establish a more coherent and consistent framework;

provide greater transparency in penalty-setting; and

increase the amount of the penalties we impose: we anticipate that our proposals will often double or treble penalties compared to current levels.

The new policy introduced a five step framework which is based on three underlying “Ds”: Disgorgement, Discipline and Deterrence. The five steps of the new framework set out in DEPP are:

Step 1: the removal of any financial benefit derived from the breach;

Step 2: the determination of a figure which reflects the seriousness of the breach;

Step 3: an adjustment for any aggravating and mitigating circumstances;

Step 4: allows us to make an adjustment to ensure that the penalty has a deterrent effect; and

Step 5: if applicable, a settlement discount will be applied (see paragraph 3.14 below).

These steps will apply in all cases but how we apply Step 2 will differ depending on the type of case:

For firms, where revenue is an appropriate measure the Step 2 figure will be 5%, 10%, 15% or 20% of the firm’s relevant revenue for the period of the breach. Where revenue is not indicative of the harm or potential harm that the breach may cause, we use an appropriate alternative.

For individuals in non-market abuse cases, the Step 2 figure will be 0%, 10%, 20%, 30%, or 40% of the individual’s gross remuneration and benefits for the period of the breach.

The new policy therefore more explicitly links the amount of the penalty to the income of individuals and thus results in higher penalties for higher earners.

Settlement

The FSA operates a settlement scheme to award explicit discounts for early settlement of cases involving financial penalties. In all cases settlement is considered once the FSA has a sufficient understanding of the nature and gravity of the issue and settlement discussions can commence if both parties agree. The subject of investigation can benefit from a 30% discount if they settle early in “Stage 1”. Stage 1 begins when we send a letter including an offer of settlement and usually lasts 28 days. If settlement does not happen within Stage 1, this discount is reduced as follows:

to 20% if settlement takes place before the subject makes written representations to the RDC; or

to 10% if the case settles before the RDC issues a decision notice.

Further, where new facts come to light in the course of settlement negotiations this may have an effect on the level of fine initially proposed by the FSA. However, settlement with the FSA is not a commercial negotiation.

Whilst contested cases are decided by the RDC, decisions to settle an enforcement action are taken by two senior FSA executives. There is no legal difference between a settled outcome and an outcome which has been contested through the RDC and referred to the Upper Tribunal. In both cases a final notice is issued setting out the case against the subject of the notice.

33. How was the fine of £1m arrived at in relation to Peter Cummings and, how and on what basis, was it subsequently reduced to £800,000 and then to £500,000?

Please see our response to Q34 below.

34. Why was the FSA keen to avoid a challenge being brought by Peter Cummings against the fine? Please provide copies of any legal advice received in relation to the prospects of success of any such challenge, including any that may have been provided by Counsel.

In order to answer the Commission’s questions fully, we have had to refer in part to the settlement discussions that we held with Mr Cummings at various stages of the Enforcement process. The settlement discussions that the FSA has with subjects of Enforcement action are confidential due to their without prejudice nature. We are aware that Mr Cummings has already responded to the Commission’s questions on this matter.

In accordance with the procedure outlined in our response to question 32 above, settlement was attempted at Stage 1 but not achieved. The RDC issued a Warning Notice proposing a £1 million fine in June 2011 based on consideration of the guidance set out in DEPP on how it will determine the appropriate level of financial penalty. The factors most relevant to Mr Cummings’ fine are set out in paragraphs 6.1 to 6.19 of Mr Cummings’ Final Notice.

Following extensive written and oral representations by Mr Cummings and his legal team the RDC came to the view that, in light of the factors set out at paragraph 6.16 of Mr Cummings’ Final Notice, a reduction of the penalty to £800,000 was appropriate and issued a Decision Notice accordingly on 22 May 2012.

In response to this Mr Cummings threatened to bring judicial review proceedings, alleging that the FSA’s Decision Notice was unlawful on the basis that it failed to provide adequate reasons for the decision to impose the fine of £800,000. After taking advice from leading counsel, the FSA informed Mr Cummings that we did not accept that the Decision Notice was unlawful but that in order to avoid delay we would withdraw the existing Decision Notice, reconsider the issue of penalty and then issue a new Decision Notice. Any legal advice received by the FSA in these proceedings is of course subject to legal professional privilege.

Thereafter, Mr Cummings made clear that he was prepared to consider settling the matter. Until that point it had appeared that Mr Cummings would exhaust all of his options to challenge the FSA’s findings through his judicial review claim and, following that, a reference to the Upper Tribunal. Such further challenge by Mr Cummings would have greatly delayed the resolution of this matter and also publication of the FSA’s report into why HBOS failed, preparation of which was deferred to avoid prejudicing the Cummings’ proceedings. On a conservative estimate if Mr Cummings had taken up all avenues of challenge it would have been between two and three years until the Upper Tribunal had made its final determination (or longer if the matter were appealed to the Court of Appeal).

Therefore, in order to avoid lengthy delay as well as the risks and costs of further litigation, the FSA decided that it would reopen settlement discussions with Mr Cummings. Subsequently Mr Cummings agreed not to challenge the FSA’s findings in the Decision Notice if the fine were to be reduced to £500,000.

In considering whether to settle the case at this moment, we carefully weighed up the implications for the preparation of a public report into the failure of HBOS. We could not commence the preparation of a number of aspect of that report without the risk of prejudice to the ongoing proceedings against Mr Cummings. Accordingly we balanced the public interest in our commencing work on and ultimately publishing the HBOS report against the fact that continuing our action against Mr Cumming would add significant further delay to the preparation of that report. That drove both our decision to issue a new decision notice rather than risk a judicial review (which is likely to have added several years to the process) and our decision to explore settlement. We believed that the appropriate regulatory outcome was a prohibition and a large penalty and that this is what was achieved albeit at a lower level than the RDC had decided. In other cases we would have pursued this matter to the Tribunal but in this case the prospect of a larger penalty was in our view outweighed by the regulatory benefits of publishing a Final Notice quickly and getting on with the preparation of the HBOS report.

35. Please provide any other information you consider relevant to the imposition of the fine.

We have nothing further to add.

Other

36. What are your views on applying different sanctions for different types of directors—for example, non-executive directors?

We do not see a need to distinguish between different types of directors in terms of the kinds of penalties to which they may be subject: NEDs for example ought to be subject to the same sanctions (ie fining, censuring, suspending, withdrawing approval and prohibiting) as Executives. We acknowledge, however, that executive directors and NEDs perform different roles in practice. As we stated in Q17 above, the role of NEDs may be more strategic whereas the role of executive directors may be more operational. That will be reflected in the choices we make about whether to take action against executive directors, NEDs or both in particular cases, which will depend upon the facts of the case concerned. The level of sanction in each case (eg amount of fine, length of suspension, or extent of prohibition) will reflect an individual director’s role, the seriousness of the misconduct, impact of the breach, etc.

37. Are there any other measures or legal/regulatory changes that the Commission should consider?

In our response to the Commission’s initial call for evidence we put forward three specific suggestions for changes to our enforcement powers, namely the ability to take action against employees outside the scope of our approved persons regime, the extension of the limitation period for taking action against approved persons and a power to prohibit an individual from performing a controlled function on an interim basis. These are each covered in more detail above in our answers to questions 20, 14 and 12 respectively. In addition, our submission also expressed our support for HM Treasury’s proposal to introduce a rebuttable presumption that a director of a failed bank should not subsequently be approved as a director of another bank. The detail of our views on this are set out in our answers to questions 6–10.

The FSA—and both the PRA and FCA—are committed to ensuring that not only are appropriate individuals appointed at the approval stage but that we remain satisfied that they are fulfilling their obligations as approved persons.

In the FCA context, we are pursuing some initiatives that will seek to improve our understanding on which an approved person is accountable for all important functions and risk responsibilities—in particular how we separate the concepts of responsibility and culpability. We have made some suggestions as to how this could be achieved in our response to Q17. We believe this will improve firms, and our, understanding of corporate governance and thereby mean that issues for rectification can be more easily targeted. And where things are materially deficient then the FCA will be in a better position to take formal action. We also are considering whether we need to set out more clearly our expectations of approved persons and we are increasingly emphasising our regulatory focus in this area in addition to authorised firms.

Finally, there is an overriding argument in favour of ensuring that senior managers of banks face a different risk return trade-off than those which apply to senior managers of other corporates. In the FSA Board Report into the failure of RBS we state that one way we may choose to address this is through regulating the remuneration arrangements of executives and non-executive directors so that a significant proportion of remuneration is deferred and forfeited in the event of failure. Regulations of this form have already been introduced for executive directors: they could be strengthened by increasing both the proportion of pay deferred and the period of deferral.

18 January 2013