Enforcement under the spotlight in 2014


Enforcement in 2014

The FCA levied 40 fines in 2014 with 27 of these being imposed on firms and 13 on individuals as well as imposing bans on 40 individuals. This compares to a total of 48 fines in 2013 and 53 in 2012, the last full year of the FSA, with a broadly similar number of those penalties being imposed on firms. So, the FCA has not so far proved itself to be a more active enforcer in least in terms of the number of disciplinary cases it brings. While this may be partly due to the resource heavy bank investigations in 2014, it may also be partly due to the way in which the FCA exercises its early intervention policy and enforcement increasingly collaborates with supervision to achieve good consumer outcomes.

Despite its tough words on senior management responsibility, we have yet to see this policy translating into an increase in actions against senior individuals although 2015 may be the year this changes. However, for those firms and individuals who do find themselves subject to enforcement action, the penalties have soared under the new regime and since the new penalty framework introduced for breaches post 2010 has taken effect. 2015 will see the FCA review its penalty policy to assess whether it is working in terms of justice and promoting the right behaviours.

Benchmarks and FX: the banks under fire

In terms of enforcement activity, 2014 went out with a bang, with the FCA announcing a global settlement in November 2014 imposing record fines of over £1.1 billion on five banks for failing to control their business practices in their G10 spot foreign exchange trading operations. Not only were these the largest ever fines imposed by the FCA or its predecessor, it was the first time that the FCA had a reached a settlement in this way with a group of firms which it also coordinated with regulatory action in the US and Switzerland.

During the course of 2014, the FCA also continued to pursue actions in connection with the LIBOR benchmark. While this appears to be the tail end of the LIBOR investigation for the banks themselves, with the focus now on the introduction of benchmark regulation and the FCA thematic work on controls around trader behaviour, 2015 will see the FCA continuing its pursuit of a number of individuals accused of LIBOR misconduct. Having gained the power to publish warning notices at the end of 2013, 2014 saw the first exercise of this power with the FCA publishing 11 warning notices (of a total of 16 warning notices) against unnamed individuals at various banks for being knowingly concerned in the banks’ breaches of Principles in connection with interest rate benchmarks.

A warning notice is the first step in the FCA’s formal enforcement process and these cases are likely to be considered by the Regulatory Decisions Committee (RDC) this year. 2014 also saw the first criminal conviction arising from the SFO’s LIBOR investigation, with a trader pleading guilty to conspiracy to defraud, and more criminal charges being brought.

The LIBOR and FX related actions were not the only FCA actions brought against the banks in connection with benchmark setting in 2014; other fines were imposed in relation to the London Gold Fixing and the Repo rate, and the FCA has said that Barclays remains under investigation for FX issues.

The banks have certainly suffered this year at the hands of the regulators; it is to be hoped that 2015 will mark a turning point as the banks put the historic issues behind them and build on the cultural changes that have been made.

TCF: a continuing theme

One of the key drivers for the FCA in deciding to take enforcement action is actual or potential customer detriment and a failure to treat customers fairly. As in other years there was therefore a steady stream of cases brought against regulated firms for breaches of Principle 6 (the requirement to treat customers fairly). In the retail markets this included the largest ever retail fine against Homeserve in February 2014 of over £30 million for mis-selling home emergency and repairs insurance policies and not dealing with complaints fairly. Stonebridge was also fined over £8 million for its failings in the telephone sales of its accident policies.

The FCA has also turned its attention this year to misconduct in the wholesale markets which disadvantages retail customers, so the year began with the fine of £22 million against State Street for mark-ups on transactions that had not been agreed with or disclosed to the customer. This was a significant case as the FCA found it to be at the most serious end of the spectrum of misconduct determining it to be the highest level of seriousness, level 5, under its penalty setting framework, the same level as for the FX fines. Similarly, the FXCM Group was also fined for allowing profits to be withheld that should have been passed to UK customers.

2014 also saw the FCA making it clear that when it focuses on good customer outcomes, the fault does not just lie at the end of the distribution chain, the manufacturer also has a responsibility. In fining both Credit Suisse and Yorkshire Building Society for financial promotions failures, the first time the FCA has fined the producer and distributor of a product at the same time, Tracey McDermott, then FCA Director of Enforcement and Financial Crime, warned that: “It is crucial that firms consider the needs of their customers from the time that products are being designed through to their marketing and sale.”

Systems and controls failings

More action is taken for breach of Principle 3 (the requirement to have appropriate systems and controls) than any other of the FCA’s Principles. It was the breach of this Principle which was the foundation of the action against the banks for their FX trading operations and often Principle 3 cases involve breaches of other Principles, such as Principle 6 and 7. 2014 was no different and the FCA imposed a number of fines for controls failings for a variety of issues ranging from IT system failings to a lack of anti-money laundering (AML) and bribery controls.

One of the most significant fines of the year in this area was the fine imposed on Invesco Perpetual in April 2014 of over £18 million for breaches of Principles 3 and 7. The FCA found that it had failed to take reasonable care to ensure that the systems and controls that it put in place around the front office of its fixed income business were sufficient to record trades on a timely basis and to enable it to value the funds it managed accurately. This included a failure to invest adequately in the systems and controls around its front office. The case is also significant in that it is an example of FCA taking enforcement action when it identifies a risk rather than actual detriment. As the FCA stressed in a press release when announcing the fine: “As a forward looking regulator, the FCA takes action where we see risks to consumers, not just after they suffer losses.”

Other themes

In keeping with its credible deterrence agenda, the FCA continued to take enforcement action in 2014 in other key areas, demonstrating the importance it places on firms complying with its rules on:

  • Client money and assets.
  • Financial promotions.
  • Dealing with conflicts of interest.
  • Transaction reporting.

Senior management responsibility

While the end of 2014 did see the FCA imposing fines and bans on three former Swinton executives for breaches of the Principles applying to those exercising significant influence functions in firms (APER Statements of Principles 6 and 7), it remains to be seen whether this will mark a turning point in the FCA successfully bringing actions against senior managers for the failings in their firms. 2014, in keeping with previous years, continued to see a number of fines and bans brought against individuals for honesty and integrity failings.

2014 did, however, see the introduction of the new individual regulation regime for banks, with particular significance for senior management, which once it comes into force is likely to result in more actions being brought against banks’ management, and the introduction of a modified, less far-reaching, regime for the insurance sector.

Consumer credit

In April 2014, the FCA took on responsibility for the regulation of consumer credit, some 50,000 firms, from the OFT. This is a significant challenge for both the FCA and for the firms themselves.

Enforcement clearly sees that it has a role to play in driving up standards and using its tools to get its messages across as to how it expects firms to behave and manage the way they do business in this sector. For example, in June 2014 the FCA announced that Wonga had agreed to compensate customers for unfair and misleading debt practices. The FCA has also issued final notices against firms who have had their applications refused, frozen firms’ bank accounts to protect client money and had firms agree to stop taking on new business.

I expect consumer credit to be a key area of focus for FCA enforcement in 2015/16 as it seeks to embed its cultural and customer focused expectations into the newly regulated firms. The FCA clearly has a concern to ensure good outcomes for customers, particularly the most vulnerable, and has confirmed that a number of debt management firms and individuals are currently under investigation.

The PRA as an enforcer

The PRA also has disciplinary and other enforcement powers, although it has made clear that its preference will be to use its powers to secure ex ante, preventative or remedial action. 2014 gave the first insights into how the PRA will exercise these powers.

At the start of 2014, the PRA issued a press release confirming that, along with the FCA, it would also be investigating the events at the Co-operative Bank and that this would include looking at the role of former senior managers. This investigation remains ongoing.

The year ended with the outcome of the first joint FCA and PRA enforcement action against RBS, National Westminster and Ulster Bank for IT failures that meant their customers could not access banking services. The FCA imposed a fine of £42 million and the PRA a fine of £14 million, its first financial penalty. Both fines were imposed after the regulators found that the banks had breached Principle 3 by failing to have adequate systems and controls to identify and manage IT risk. A joint investigation was considered necessary because the failings encompassed both conduct and prudential issues. The PRA’s final notice explains that the action was taken because properly functioning IT risk management systems and controls are an integral part of a firm’s safety and soundness, and of particular importance to stability of the UK financial system. This is in keeping with the PRA’s statutory objectives.

While the FCA will continue to be the most active regulatory enforcer with its focus on conduct and customer outcomes, we can expect to see the PRA also exercising its muscles when systemically important firms encounter issues which have the potential to threaten their safety and soundness or that of the stability of the financial system as a whole. The Treasury review of enforcement, discussed in HM Treasury review of enforcement: some important changes below, recognised the onerous nature of such investigations for dual regulated firms and made some recommendations to try and mitigate this burden through the provision of more detailed guidance on the way in which they will cooperate and more clarity from the PRA on when it will seek to exercise its enforcement powers.

If the PRA is to become an active enforcer, further consideration needs to be given to its decision making framework. Unlike the FCA, which has the independent Regulatory Decisions Committee (RDC), the PRA does not have an independent body for objectively considering contested enforcement cases. This was recognised by the Treasury in its review as a major drawback to the current arrangements and it led to its recommendation of the establishment of a functionally independent enforcement Decision Making Committee to secure appropriate objectivity. This must be the right course of action

Widening the role of Enforcement and early intervention

The move to the FCA from FSA heralded a change to the way in which the FCA regulates to a more proactive, interventionist, judgment-based approach. We are starting to see this change take effect in the way that Enforcement operates. I am seeing Enforcement getting involved earlier in a firm's issues and a closer working relationship between Enforcement and their colleagues in Supervision. Previously, Enforcement focused only on investigating and taking action for past misconduct; it now takes a more proactive “early intervention” approach to issues and gets involved with Supervision in advising on consumer contact exercises, remediation projects and voluntary variations of permission.

This more constructive approach may mean fewer firms are being referred to Enforcement for investigation, allowing firms to focus on putting things right and remediating any customers impacted. It also means that Enforcement can concentrate its resources on the more serious cases and where fines and the public notices will support its credible deterrence policy and send out the right messages to the industry. Having said that, in my experience, the Enforcement decision to investigate a particular firm still remains somewhat of a lottery, with some firms being allowed to put things right below the radar and others having the book thrown at them. The Treasury’s recommendations, considered in HM Treasury review of enforcement: some important changes below, may go some way to addressing this concern.

This new approach is not just seen on a firm specific level, but also where wider issues are involved such as in the interest rate hedging product (IRHP) review and the CPP redress scheme, which became effective in 2014 and, as at last October, had paid out £450 million.

Enforcement has also made use of the other tools it has at its disposal, using its suspension power for the first time, banning two of the Financial Group’s subsidiaries from recruiting new appointed representatives and individual advisers for a period of four and a half months.

HM Treasury review of enforcement: some important changes

At the end of the year, the Treasury published its final report following its review of enforcement decision making at the financial services regulators. While broadly supportive of the way in which decisions were made, the Treasury did make a number of important and sensible recommendations.

The review focused on the importance of ensuring that the enforcement process allows it to focus on the right cases, provides sufficient objective scrutiny, allows for early resolution and ensures efficient investigation and cooperation between the regulators. The report makes a number of high level recommendations and correctly identifies a number of drawbacks and inefficiencies to the current process which are evident to those that help firms manage enforcement investigations. It is to be hoped that the FCA and the PRA take note.

There is considerable focus on the need for transparency and the need for an objective and consistent approach. As I commented in Widening the role of enforcement and early intervention above, we are starting to see the FCA make more use of proactive supervisory action and other alternative regulatory responses. This is a positive step for firms particularly where they have self-notified and been proactive in resolving the issues and taking remedial action to protect customers. The report encourages consideration of alternative responses, making a number of recommendations which would support this approach and improve transparency for firms, including:

  • The publication of referral criteria that explicitly consider if enforcement is the right course of action.
  • An explanation of the basis for a referral to enforcement in the Memorandum of Appointment of Investigators expressly linked to the criteria.
  • For the FCA to provide more information on when a firm’s response to a breach has been a factor in decision not to take enforcement action.

The adoption of such measures would help to counter the feeling that referral can sometimes be a lottery.

Another issue the review identifies and which is a particular concern for firms which find themselves in an investigation is the lack of opportunity for constructive dialogue particularly at an early stage of the process. This leads to frustration and delays in reaching a resolution which could so easily be avoided saving both the FCA and the firm valuable time, expense and resources. Scoping meetings, which are generally held at the outset of an investigation, to introduce the team and provide a high level view of the case and the process are, in my experience, too often nothing more than a recap of the standard process and a read through of the Notice of Appointment of Investigators. Yet, by this point, Enforcement will have usually reviewed a considerable amount of documentation in order to decide if the case meets the referral criteria and more openness and engagement at this stage could help to resolve those cases where the firm essentially acknowledges the key aspects of the misconduct being alleged. The review seeks to achieve this by recommending that scoping meetings are held only once the investigators are clear on the direction and likely timings and that the subjects are invited at that meeting or at another early stage to provide an indication as to whether they accept any aspect of the allegations adding that consideration should be given as to whether admissions should be expressly incentivised at this stage. Of course in other cases, the subject will want the ability to defend the case through a full investigation and so care needs to be taken that this does not place unfair pressure to settle, particularly on individuals.

Another frequent barrier to constructive resolution is the lack of engagement from the FCA during the investigation, which tends to be driven by the investigative steps of document requests and interviews. This means that it is often not until the FCA has essentially completed it investigation that it determines it has sufficient understanding to offer a settlement and approaches the firm with its views. Investigations are often allowed to drift, especially where the investigation team may have other competing priorities. Periodic updates, as the review suggests, would help to overcome this issue and ensure investigations proceed efficiently. In keeping with this is the recommendation for training and increased involvement of senior staff to foster constructive dialogue between the subject and the regulator. This would, of course, require a corresponding openness from those subject to investigation, but in my experience firms often want an earlier opportunity to engage openly with the regulator and can be frustrated by the unwillingness of the investigators to open up about their views for fear of committing to a position before senior management have been engaged. The extent to which this happens now is too dependent on the experience of the individual investigators allocated to the case.

Once the regulator is willing to discuss settlement, views have often become entrenched and as those responding to the call for evidence for the review indicated this can lead to an unwillingness to revisit issues or escalate challenges to the proposed settlement to senior management perhaps through fear of having to concede they may have made mistakes. This is unhelpful and can cause a reasonable settlement opportunity to be lost only for it to be resurrected later in the process. The review’s recommendation of the involvement of the relevant Head of Enforcement acting as a conduit between the investigators and Settlement Decision makers is to be welcomed. The review also recommends removing the graduated discount for settlement available at three stages of the process so that only those that settle in stage 1 benefit from a discount with a discretion retained for those that settle outside this period. While it is true most settle at stage 1 and that this would focus settlement at the early stages, there are good reasons for why some cases proceed to the next stages and should continue to benefit from a discount. Indeed, there is an argument for reintroducing the stage 1 settlement at a later stage in the process if a comparable settlement could have been achieved earlier, but was not accepted by the FCA.

The review makes a number of other recommendations which are to be broadly welcomed including methods to expedite the process of taking a case to the independent Upper Tribunal with a clearly signposted process without making representations to the RDC. Some cases require consideration by a truly independent legal process and a clear expedited procedure for this should help to speed up what is currently a very long process, which only those with deep pockets and patience can afford.

Looking ahead in 2015

We can expect to see the FCA continue to bring a steady stream of cases and impose hefty fines particularly where firms have failed to respond to previous regulatory warnings or learn the lessons of previous enforcement action and make the necessary changes to culture to put customers at the heart of their businesses. It is no coincidence that the theme for the FCA’s first enforcement conference was culture and governance, and we can expect this focus to be pursued in 2015.

As the FCA will no longer be occupied with the resource intensive FX and LIBOR investigations, we may see an increased number of cases being brought this year but with a consequent reduction in the size of penalties. Short of another banking scandal, it is unlikely that the total fines imposed in 2015 will match the £1.4 billion of 2014. However, more actions against individuals are likely as the FCA continues in its determination to hold senior management to account and as the cases brought against individuals involved in the LIBOR and FX misconduct progress through the RDC and criminal courts. 2015 is also likely to see the outcome of the joint PRA and FCA investigation into the activities of the Co-operative Bank.

We can also expect to see more enforcement activity in the consumer credit sector as the FCA seeks to get its conduct and cultural messages across both in terms of fines, bans and refusals and variations of permissions. Early intervention and the use of alternative regulatory responses through proactive supervision is also likely to be an ongoing theme of 2015 and the FCA is likely to seek more publicity for its actions in this area.

In terms of processes, the FCA will welcome a new Director of Enforcement and Market Oversight with Tracey McDermott having moved to become Director of Supervision and Authorisations. The new FCA structure, following its own strategic review, and announced just prior to publication of the Davis report at the end of 2014, will also seek to sharpen the FCA’s focus and increase its effectiveness. The Treasury review may also lead to changes in the enforcement processes which should help improve the transparency, fairness and effectiveness and provide more opportunity for constructive outcomes at earlier stages.

2015 will also see the FCA review its penalty setting framework which was introduced in 2010 with the aim of improved transparency and more certainty. It has fallen far short of this, as the framework provides for so much discretion within each of the five steps that predicting the level of fine is not very different to the finger in the air approach of the previous regime.

So there is no doubt that 2015 will be another busy year for enforcement activity. As the outgoing FCA Director of Enforcement commented in a speech made at the end of 2014, enforcement may be a “blunt tool” but it is “a vital one in making plain to all the firms we regulate ... the consequences for those who fail to meet our standards”. However, I hope that alongside the necessary and inevitable enforcement activity, the FCA also shows it is prepared to engage constructively with firms who show willingness to put things right and achieve good outcomes.