Regulatory enforcement action against Significant Influence Holders (SIFs) and senior management: recent developments and practical considerations

August 2013 | SPECIAL REPORT: WHITE-COLLAR CRIME

Financier Worldwide Magazine

Why have UK regulators not taken action against more individuals after the financial crisis?

‘Never Mind the Quality, Feel the Width’ was the title of a British sitcom popular in the late 1960s. However this could also describe the content of the recent Parliamentary Commission on Banking Standards (PCBS) report ‘Changing banking for good’. At 571 pages long and relying on over 2500 pages of oral and written evidence, the report is, cynics might say, a political reaction following the FSA’s LIBOR settlements which began with Barclays in June 2012.

The FSA was the statutory regulator of financial services in the UK from December 2001. When the FSA took the regulatory reins from a dozen or so smaller regulators, it made much of its new ability to take disciplinary action against senior management at the firms it regulated. The FSA’s recent replacements, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) will, if the current proposals of the PCBS are implemented, gain significantly greater powers to prosecute senior figures (at banks) and hold them to account.

The difficulties the FSA faced are best summarised by the response to Andrew Tyrie MP’s opening question to Tracey McDermott, Director of Enforcement and Financial Crime, FSA during her oral evidence to the PCBS (Tuesday 29 January 2013).

Andrew Tyrie said: “Could I begin, Tracey McDermott, by asking you why, apart from the Pottage and the Cummings cases, there have been so few actions against the most senior executives at large banks?”

Tracey McDermott responded: “The reasons are partly to do with the difficulties of establishing the evidence when you have large organisations in which a number of decisions are, quite properly, made by committees, so attributing individual responsibility for those decisions can be difficult. They are also partly to do with the problems of complexity in structures and a lack of clarity in structures about which senior management are directly responsible for individual decisions. They are also partly about the fact that the test for taking enforcement action is that we have to be able to establish personal culpability on the part of the individual, which means falling below the standard of reasonableness for someone in their position. The way in which our guidance is drafted makes it very clear that we will not hold somebody to account simply because there is a failure on their watch, particularly if they have properly delegated and so on.” (Emphasis added)

While the numbers of SIF cases commenced and discontinued since 2001 is unknown, the FSA’s track record, measured by the number of cases prosecuted successfully with public outcomes, is indisputably poor.

Recent developments: PCBS recommendations

While the PCBS report is voluminous, its recommendations are likely to be unhelpful for the establishing of any common standard of individual behaviour in the UK regulated financial services sector. The report’s recommendations concern banks and bankers. Taking a step back, the proposals indicate a retreat from the regulatory consolidation of 2001. In practical terms, the CEO of a UK bank had one regulatory master in 2012, but if the recommendations are implemented, the CEO will soon have three (FCA, PRA and the ‘Senior Person’ regulator, as outlined below).

The PCBS report concluded that too many top bankers had “dodged accountability for failings on their watch by claiming ignorance or hiding behind collective decision-making”. The PCBS formed a dim view of the approved persons regime and stated “The approved persons regime has created a largely illusory impression of regulatory control over individuals, while meaningful responsibilities were not in practice attributed to anyone. As a result, there was little realistic prospect of effective enforcement action, even in many of the most flagrant cases of failure” (PCBS, Volume I, page 8).

It is true that, until the financial crisis, the FSA was not particularly concerned with how firms structured themselves and how senior management responsibility was allocated under the SIF regime. The FSA left firms to decide for themselves how to interpret its rules leading to inconsistent implementation of SIF responsibilities at different firms. Experience of previous FSA enforcement cases indicates that the FSA’s Supervision Division, often consulted by firms on its SIF rules, was unclear on its application.

The current recommendations of the PCBS involve, amongst other things, the establishment of a new regime of individual registration, termed the ‘Senior Persons Regime’ imposing a reverse burden of proof. In other words, it would no longer be up to the regulator to demonstrate culpability of a Senior Person. In a case of successful enforcement action against the bank, it would be up to the relevant Senior Person, or Persons, to demonstrate that they took all reasonable steps to prevent or offset the effects of a specified failing. Should a Senior Person be unable to do so, individual enforcement action will follow, effectively switching the burden of proof away from the regulators. The net effect would be an easier ride for the regulator; but for the individual concerned, this could, in practical terms, amount to being presumed guilty until being able to prove innocence. The practical difficulties posed by mounting such a defence mean that many individuals would be unable to finance and resource a defence while holding down the senior management position for the duration of the regulatory proceedings (assuming the firm and individual have not parted company).

The drive to focus on investigating and potentially prosecuting individuals is further aided by the PCBS’ proposed new criminal offence which will apply to Senior Persons who are seen to carry out their responsibilities in a ‘reckless manner’, which may carry a prison sentence. Following a conviction, remuneration received by an individual during the period of reckless behaviour should be recoverable through separate civil proceedings. Reckless individual behaviour in a commercial context, in complex governance structures, is not defined by the FCA and will be the subject of fierce legal argument.

SIF investigation: immediate issues for consideration

In the current regulatory environment (PCBS recommendations aside), the effect of a regulatory investigation into alleged SIF misconduct is likely to be extremely disruptive for the firm and personally distressing for the SIF and their immediate family. The stress and strains of regulatory proceedings on an individual should not be underestimated. Given that an investigation from inception to appeal ruling could last as long as four years in the current framework, then this is likely to be a significant event in the life of a professional with consequent effects on career progression and remuneration.

When a SIF is investigated at the same time that the firm faces a parallel investigation, many uncertainties arise. Each scenario will be different but common themes will be conflicts, legal representation and funding. A non-exhaustive list of questions arising follows. Does the SIF’s position conflict in any way with that of the firm? If so, what thought should be given as to separate legal representation? How is the SIF’s separate legal representation to be funded? Does the investigation affect the SIF’s ability to perform the ‘day job’? Is the SIF’s authority or position undermined internally? Do third parties – for example, other regulators, domestic and overseas – need to be notified of the investigation of the SIF? What employment issues arise? Are there grounds for termination or suspension? Is there a temptation for the firm to terminate the SIF’s employment to appease the regulator? What is the risk of ‘investigation creep’ – i.e., will the investigation look at areas of the firm previously outside the scope of the investigation? What is the risk that other SIFs will be drawn into the investigation and face investigation themselves? How can the risk of the confidential investigation being leaked, or otherwise made public, be minimised?

Legal representation issues

Both SIF and the firm will need to consider at an early stage whether the FCA’s (and/or PRA’s) dual (i.e., the firm and SIFs) investigations lead to a conflict between their respective interests. The firm’s retained legal advisers cannot advise multiple parties in a situation of conflict and the SIF will need to secure separate legal representation.

During an investigation a number of individuals will be interviewed and the firm and SIF will have to consider whether the firm’s legal representative will be able to observe the SIF’s interview (and potentially vice versa). There was no hard and fast view with the FSA as to how this was handled and each enforcement team will have its own view in a particular investigation.

In a situation where no conflict has arisen, it is preferable that the firm and SIF allow their respective legal advisers to sit in on as many interviews as possible and understand the investigators’ lines of questioning and enquiry. By way of illustration, in a recent investigation, the SIF underwent eight full days of interview. The same investigation interviewed a further 17 senior managers with each interview lasting between a half and full day. In this case the investigation lasted three and a half years from the initiation of the investigation to publication of the FSA’s Final Notice.

Summary

The PCBS recommendations make an already daunting experience for SIFs at banks facing investigation even more uncomfortable. The move to treat banks and bankers differently marks a likely shift to additional similar individual licensing and regulation in other industry sectors, creating a plethora of standards, codes and regulators. George Osborne, on 8 July 2013, backed the sweeping reforms to 'create a stronger and safer banking system”. Following implementation of the recommendations, other than fulfilling their responsibilities as diligently as possible, there is little that SIFs can do to mitigate any powers other than ensure that they are adequately covered by the firm’s D&O insurance for what may be significant legal defence costs which may dwarf any fine eventually imposed. Further worrying news for SIFs is that insurers and firms are prevented from paying a SIF’s fine, which can vary from thousands to over a million pounds.

In the Treasury’s bid to move the banking sector from ‘rescue to recovery’ there are no safety nets or comforts for SIFs. However, the effectiveness of the regulator’s use of new powers is yet to be tested.

Harvey Dyson is an associate and Rachel Watts is a trainee solicitor at Stephenson Harwood. Mr Dyson can be contacted on +44 (0)20 7329 4422 or by email: harvey.dyson@shlegal.com.

Harvey Dyson and Rachel Watts

Stephenson Harwood