So far, in the 2016/17 financial year Financial Conduct Authority (FCA) penalties stand at £18m compared with the total of £885m in 2015/16. At two-thirds of the way through the FCA's financial year it is unlikely that the number of enforcement outcomes or value of penalties will get close to the figures for recent years by the end of March.
The reason for the lower financial penalties and fewer outcomes from large investigations this year could be a sign of a new conciliatory approach from the FCA, or the long lead in time for new enforcement actions as large wholesale market conduct investigations come to an end and staff are redeployed to other cases.
Also, resources are committed to conducting and following up on a large number of thematic reviews and market studies, which, history shows, tend to lead to enforcement or other action eventually. Below, we consider aspects of enforcement trends in 2016, and then some likely themes for 2017 and beyond.
Aspects of enforcement
Openness and cooperation
Principle 11 (and the equivalent for individuals) requires self-reporting, openness and cooperation. The FCA pursues action aggressively when individuals deliberately provide inaccurate information but recent enforcement action shows that the obligation is broader than that. The FCA found that Threadneedle Asset Management failed to implement remedial action relating to the running of its fixed income trading. The FCA fined Threadneedle for the original failings and for inadvertently making misleading statements about the remedial action taken. In another case, an individual, Achilles Macris, took sensible steps to manage the risks created by the so-called "London Whale" trades, but was enforced against by the FCA for underplaying the magnitude of the risks to the FCA. The FCA wants individuals to be transparent with it about risks and problems no matter how unattractive they appear for the firm or individual.
Enforcement against individuals
The FCA also wants senior managers to be open and communicative within their own organisation, so that risks are openly managed rather than downplayed. For example, the FCA decided to publicly censure and prohibit a former COO at Barclays, who failed to circulate to other key decision-makers internally an independent report that he had commissioned which was critical of the bank's culture. Andrew Tinney is challenging this decision.
Enforcement against senior managers is an ongoing priority for the FCA. It is too soon for enforcement outcomes under the senior managers and certification regime (SMCR) introduced for banks in 2016 (and soon to be extended) but it will be easier to hold senior managers responsible for regulatory breaches in the future. As Mark Steward has said:
"What I like about the senior managers regime is that it focuses on the people who can make a difference, the senior management and it is top down rather than bottom up, which seems to start the inquiry into firm culpability in the right place. While that may not be where such an inquiry ends, I think it reinforces the real responsibility that we, as regulators and as members of the community expect."
The FCA has not yet used its concurrent competition powers to bring any competition enforcement actions. Instead, the FCA seems to be using a competition mind-set to identify conduct issues.
For example, in relation to annuities, the FCA conducted a thematic review and market study that identified a market failure in that customers failed in the FCA's view adequately to shop around (i.e. a competition issue). The FCA has characterised the issue as a failure to disclose adequate information to customers (a conduct issue).
Proposed Changes to the FCA and PRA enforcement processes
The proposals for change of most interest to firms relate to transparency and timing. The FCA intends to provide more information about the allegations made to subjects of investigations initially and give regular updates on the FCA's progress throughout. On timing, subjects of enforcement will be able to leapfrog the RDC process and go straight to the Upper Tribunal for determination. This reduces the time, cost and period of adverse publicity for a firm or individual prepared to challenge the FCA.
More individuals than firms refer a decision to the Upper Tribunal but the leapfrog mechanism gives firms the option of challenging a legal issue more efficiently than before. There is also a benefit to firms if this speeds up cases, and encourages challenge, thereby helping to create a body of tribunal decisions interpreting regulatory provisions.
Use of alternatives to fines
The FCA may become more reluctant to give private warnings in the future because they do not meet the FCA's objective of public deterrence. The FCA is, however, making greater use of other measures within its arsenal in addition to or as an alternative to financial penalties. As in the action against Bank of Beirut in 2015, the FCA recently restricted Sonali Bank from taking on new customers for a period to give the bank an opportunity to improve its anti-money laundering processes in addition to a financial penalty.
And when the FCA raised concerns about the treatment of customers in arrears by mortgage lenders, it has given lenders an opportunity to remediate to avoid enforcement (and a financial penalty). The FCA is overseeing firms' remediation to ensure it achieves fairness.
Back in 2013 when it was created, we expected that the Prudential Regulation Authority (PRA) would bring enforcement rarely, preferring its supervisory powers. The FCA brings many more enforcement actions (even in the quiet year of 2016), but the PRA has become more active in enforcement than expected. The PRA published five enforcement decisions in 2016; including enforcing against a general insurer and a manager for failing to place sufficient limits on the business that an agent could write on the firm's behalf, and former Cooperative Bank directors in relation to how they viewed and treated the proportion of loans that were impaired.
Substantive areas of focus
There is a renewed focus on systems and controls, manifested in a number of areas and it is no defence to poor systems that no harm occurred. That is not to say that the FCA ignores fraudulent investment schemes, insider dealing or other cases where harm is clear, but just that a number of the significant enforcement actions in 2016 are brought as breaches of Principle 3 in the absence of harm.
Financial crime: AML
Notably, the FCA fined Sonali Bank £3.25m and restricted new business for 168 days for failing to have adequate AML controls in place although there was no evidence of actual money laundering). Although this penalty is not as high as previous fines against banks for AML controls, this penalty was a high proportion of the bank's turnover in the relevant year (reported as £10m) in addition to the serious restriction. A skilled person identified potential under-reporting of suspicious activity, which the FCA viewed as serious.
Responsibility for the firm's breaches was attributed partly to the MLRO at the time, who the FCA prohibited and fined £17,900.
Even though the MLRO was short of resources to perform the function adequately, the FCA highlighted steps that he could have taken, such as escalating the issue to senior management and ultimately the FCA, responding to the issues raised by internal audit and recruiting other staff to assist. Instead, the MLRO failed to tackle the issues raised and reassured the board about compliance.
The FCA is focusing increasingly on all anti-crime systems, not just AML processes.
Insider dealing prosecutions are high profile cases for the FCA and the FCA has just completed the trial of five individuals acting in concert known as Project Tabernula.
This case illustrates the challenges faced by the FCA in more complex cases and the reason for the high level of resources required. In the end only two of the five charged were convicted, even though all of the individuals had used nicknames, encrypted documents and unregistered phones to conceal their conduct.
The FCA identified the failure of WH Ireland to have adequate controls to manage conflicts between its public and private broking businesses, control information flows and set effective restrictions on employee dealing as all giving rise to the risk of market abuse. Consequently, the FCA fined WH Ireland £1.2m and restricted its corporate broking business from taking on new clients for 72 days. Again, there was no evidence of actual harm (in this case market abuse) but the FCA viewed the case as exacerbated because some recommendations from a skilled person were not rectified in the agreed timescale.
The FCA is coming to the end of its large-scale investigations of benchmark setting and foreign exchange trading but it is still intent on improving standards of market conduct generally and is likely to focus on failures by firms to tackle conduct issues as well as working with industry to improve standards across the board.
Other examples of enforcement action based on failure to have adequate systems relate to segregating client assets and outsourcing, neither of which are new enforcement targets.
The FCA fined Towergate Underwriting £2.63m and prohibited and fined its client money officer £60,000 for client asset safeguard failings. The FCA found that four incorrect transfers from the client money account, approved by the client money officer, left the account in deficit. Notably, the FCA was also critical of the error of leaving accumulated interest in the client money account. Although this did not cause any risk to consumers in the event of insolvency, it illustrated noncompliance with the client asset rules.
The FCA also fined Aviva Pension Trustees £8.2m. The firm had deficiencies in internal reconciliation processes but, for the first time, the FCA criticised oversight of outsourcing of client asset administration and reconciliation.
The FCA's Mission Statement illustrates the balance between protecting consumers from harm on the one hand and consumer responsibility for making investment decisions and freedom, on the other.
In its recent decision to curtail retail investors' leverage when investing in contracts for differences, the FCA clearly believes that the risk of harm in allowing unfettered access to these investments outweighed consumer freedom.
The FCA is focusing on the level of disclosure in consumer communications. Too little information prevents consumers from making an informed decision, but too much documentation can obscure the key risks/characteristics of a product or discourage the recipient from reading any of it.
Protecting groups of vulnerable customers rather than protecting all consumers against a particular product is another focus. So, for example, the FCA has identified wealthy pensioners and those coming up to retirement who are able to take advantage of the recent increased pension freedoms as vulnerable to pension scams and investment fraud, which is the rationale behind the FCA's scamsmart education campaign. Other vulnerable consumers include heavily indebted people.
Finally, the FCA is looking at how firms manage consumer expectations as to outcome from long term investment products, whether firms are obliged to review how the performance of the investment is meeting a consumer's expectations over time, whether long-term investors are treated as well as new investors and disclosure of charges. Following the FCA's recent thematic review of annuities, there are a number of firms in enforcement relating to exit charges.
The FCA's enforcement activity is likely to pick up again from the relatively low levels in 2016 and although it is difficult to predict enforcement targets, the following five themes are likely to feature in the future:
- IT operational resilience, not just cyber security;
- Financial crime – criminal prosecutions as well as regulatory obligations to prevent crime;
- Incentives – the FCA views the root cause of many cases as incentive structures contrary to rather than aligned with regulatory compliance;
- Price/value for money – the FCA is looking increasingly at whether high margin on a product is because of innovative features or a market failure/regulatory breach; and
- Enforcement against individuals will continue to be a focus with the broadening implementation of the SMCR.
Note: First published on Thomson Reuters Regulatory Intelligence on 3 January 2017.