NEDs (and their D&O insurers) will be increasingly exposed to regulatory risk because of the FSA’s new guidance. If the common law has failed to sanction NEDs of non-compliant firms effectively, then the FSA clearly intends to do so now. It wants the financial services sector to be free of nodding ‘yes men’ – and certainly will not tolerate any NEDs nodding off! By shifting its focus on NEDs from financial and prudential matters to conduct, culture and the fair treatment of customers, the FSA is effectively expanding their roles and responsibilities.
This year has seen significant changes to the regulated sector; with the FSA focussing particularly on senior management, directors and now non-executive directors (NEDs). In preparation for the ‘shadow split’ in the FSA from April 2012, the regulator has been talking up the conduct role of the FCA, including a revival of the ‘treating customers fairly’ agenda and particularly the increasing burden to be placed on NEDs as ‘consumer champions’ within firms. It is ironic that this increased focus on NEDs was followed within a week by the FSA’s publication of its report into RBS explaining why no directors were responsible.
NEDs targeted by FSA
Recent figures produced by RPC confirm the FSA trend towards focusing on senior managers and imposing individual responsibility in order to press home its ‘credible deterrence’ message. The average fine in the year to date against individuals is up 100%. At its first retail conduct focused conference for NEDs (entitled “Delivering Fair Treatment for all Consumers of Financial Services”) on 6 December, the FSA issued guidance on its expectations of NEDs in delivering the appropriate management of the risk of treating customers unfairly and delivering inappropriate outcomes.
In her speech, Nausicaa Delfas, Head of Conduct Supervision, delivered a stark message to NEDs, describing their role as “pivotal in driving fair outcomes for customers through your firms” and noting “the cost, in terms of reputation and money, of not doing so is great”. She finished with the threat: “We will be taking an ever greater focus on Boards, NEDs and executive senior management”. Where FSA supervision treads into new areas, FSA enforcement tends to follow.
‘Fair’ culture and governance
Achieving the focus on consumer protection and the governance and culture of firms will represent a significant shift for many NEDs who see their roles as providing challenge from a detached, semi-independent perspective. By the nature of the traditional role and the types of senior and experienced industry figure involved, NEDs can tend towards occasional, high level boardroom involvement only. The FSA accepts that NEDs need not have the in-depth knowledge of the business required by executive management but they should have sufficient to participate actively in the decision making process of the Board and to exercise appropriate oversight over the agreed business strategy.
Root cause analysis and redress
The FSA has clearly identified NEDs as key to shaping and monitoring firms’ culture. The FSA sees “deficiencies in firm culture as a potential root cause of poor outcomes for retail consumers”. One of the key themes of the guidance is that NEDs should be comfortable that the Board ensures resolution is fair to all affected customers when things go wrong and “not just those who have complained”.
NEDs should challenge the Board “to identify the root causes of issues” and “give consideration to whether it may be apparent in other areas of the business”. In one of the case study examples in which a firm found that its call centre staff had been providing advice in respect of what should have been non-advised sales, the FSA said it expects NEDs: to challenge whether the firm identified the root cause of the issues; to consider the wider implications of these findings; to communicate the issues arising; and, (most significantly for the firms and their insurers), whether “remedial action will be taken for those customers affected and whether such plans are adequate, e.g. has the firm taken the approach only to remediate those customers who have complained, or will there be a wider customer contact exercise?”
The FSA’s previous reliance on delivering messages through enforcement action is now being bolstered by reference to the cost of “putting the wrongs right”. To remind industry of those risks, the FSA cited examples including the £3.9 billion provided by Lloyd’s for PPI redress, the £6.3 million fine against Coutts for mis-selling the AIG Enhanced Fund and the past business review (PBR) it is required to undertake in respect of £1.45 billion invested by its customers. Reference to the Coutts final notice is significant in that (as I commented in respect of HSBC/NHFA) it was the first to criticise a firm not simply for failing to conduct root cause analysis to improve its systems and controls but also for failing to carry out a PBR of its own volition once the root cause of failings had been identified.
The FSA clearly intends for NEDs to become consumer champions within their own firms. One of the three key areas identified by the FSA as its expectations for NEDs regarding fair treatment of customers is to play a part in identifying potential risks to customers and not just those to shareholders. NEDs are challenged less on “what product can we make, and how can we persuade customers to buy it?” and more on “what do our consumers need?” and “how can we meet that need?”. Although the call from some quarters to impose a duty to put customers’ interests first in the draft Financial Services Bill has gained little traction, it is clear that the FSA has revived – and will now seek to enforce – the TCF agenda through the new FCA’s particular focus on conduct. Today’s focus on TCF in the FSA’s press release about a fine imposed on an insurance company tends to confirm this revival.
The FSA’s guidance for NEDs is expressly aimed at enabling them to understand better how to deliver against their regulatory responsibilities under the FSA rules and principles. Regardless of what the law says, the FSA is making its position clear.