The FSA’s decision to fine John Pottage £100,000 for misconduct under section 66 of FSMA was overturned by the Upper Tribunal last week.
Essentially, the Upper Tribunal disagreed with the FSA’s assessment that Mr Pottage’s conduct had fallen ‘below that which would be reasonable in all the circumstances’. Although this case was decided based on the FSA standards applicable in 2006/7, it will be interesting to see what effect it has. The decision might embolden other individuals to initiate similar challenges and/or lead to further revisions to FSA requirements for senior management so as to minimise the scope for disagreement/doubt as to what is reasonably required in future.
The backdrop to this case was the FSA’s finding that UBS AG and UBS Wealth Management (UK) Ltd (collectively “UBS”) did not have adequate systems and controls to prevent employees using client accounts for unauthorised trades; as a result, in November 2009, the firms were fined £8 million. Mr Pottage was the CEO of UBS during the period to which the FSA’s findings related and, following its decision to fine UBS, the FSA also took action against him personally as holder of controlled functions 3 and 8. The FSA alleged he had breached his regulatory duty as a Significant Influence Function (“SIF”) holder under Principle 7 of APER.
APER Principle 7 requires that an SIF holder must take reasonable steps to ensure that the business of the firm for which they are responsible in their controlled function complies with the relevant requirements and standards of the regulatory system.
The FSA’s case relied on the serious flaws it had identified in UBS’s systems and controls. It argued that, when appointed as CEO in 2006, Mr Pottage should have been more proactive, for example less readily accepting of the responses of others. If he had done so, it was argued this would have led to him identifying the flaws in the governance and risk management frameworks and overhauling them earlier than he actually did. As a result, the FSA had imposed a fine of £100,000 on Mr Pottage in October 2010. It was this decision that Mr Pottage was challenging in the Upper Tribunal.
The Upper Tribunal’s Decision
The Upper Tribunal agreed that, whilst Mr Pottage was in charge, there were serious flaws in the design and operational effectiveness of UBS’s governance and risk management frameworks. However, on the evidence, it concluded that Mr Pottage’s conduct had not contravened APER Principle 7. On the contrary, it found he had a detailed understanding of the risk management framework and took a hands-on approach, including appropriate interaction with those to whom risk management roles were delegated. He did identify all of the serious flaws the FSA pointed to and took steps to remedy them; in the Upper Tribunal’s view, he did so within a reasonable time period. It considered that Mr Pottage’s approach of trying to resolve problems individually before ultimately deciding to undertake a full overhaul was reasonable. The Upper Tribunal was not satisfied therefore that Mr Pottage had failed to act reasonably in the circumstances.
The FSA has confirmed that, in accordance with the Tribunal’s direction, it is discontinuing its action against Mr Pottage.
The Upper Tribunal’s judgment provides helpful commentary on the scope of regulatory duties owed by senior management, and the proactive steps individuals must take.
It is particularly notable that the FSA’s broad interpretation of what APER Principle 7 requires was accepted. This imposes on an SIF holder the requirement to conduct a detailed initial assessment when starting the role, as well as duties to continually monitor matters, even though there is no reference to such assessments in the Code of Practice. This initial assessment must provide a thorough understanding of various aspects of the firm’s business, including:
- its operational risks and the current systems of control;
- significant compliance issues arising during their predecessor’s time in charge; and
- an assessment of the quality of the management information available to assess how effectively the governance and risk management frameworks operate.
In particular, as regards CEOs, the Upper Tribunal emphasised that their role is one of oversight of the business as a whole; they are not required to design or implement controls themselves or to perform the functions they have appropriately delegated. They are only required to ‘take reasonable steps to ensure’ that the firm has compliant systems and controls and they will not be in breach of their obligations unless they are personally culpable. What is reasonable is to be assessed in all the circumstances as they were at the time. These latter points are of course also potentially relevant to other SIF holders. Examples of behaviour that might fall short include: failing to react appropriately to warning signs and/or not reaching a reasonable decision as to how to respond.
Clearly in this case there was a significant difference in the views of the FSA and the Upper Tribunal on reasonableness. The most obvious knock-on effect from this may be an increase in the number of individuals looking to take their cases all the way to the Upper Tribunal in the hope of a favourable outcome.
It remains to be seen what effect this might have on the FSA’s work on accountability of senior management. Arguably, what was reasonably expected in all the circumstances back in 2006/7 is likely to have shifted; in cases regarding actions of senior management in more recent times, what is reasonably expected may well be more onerous than in the period which the Upper Tribunal was considering.
Further, personal responsibility of senior management is clearly an area the FSA wants the industry to take seriously. Although the FSA accepts this decision, it has been clear that this will not deter it from taking other actions against senior management, albeit it is frank about the challenges it faces in doing so successfully. Given the potential impact this type of action can have on individuals and the detailed duties and actions that the Upper Tribunal agreed were required from SIF holders, there may now be calls on the regulator to expand on the existing rules and guidance and clearly set out exactly what is required from senior management in respect of risk management.
Overall, this decision should provide some comfort to SIFs for the time being. In particular, it is reassuring in its emphasis that senior management of firms will not be found to have committed misconduct just because regulatory failings occurred in respect of matters for which they were responsible or which happened whilst they were in charge. Some degree of personal culpability - a failure to have acted reasonably - is also required. On the other hand, this may also lead to calls for rules to be made specifying instances when senior management should be strictly liable for failure in the firms they are responsible for. This links to a point Lord Turner raised when the FSA published its report into the failure of RBS late last year. Clearly if rules to that effect are duly consulted upon and made, then firms and senior management would need to adapt accordingly. However, this decision of the Upper Tribunal makes very clear that, in the absence of such requirements, it will not apply the existing framework in a way which effectively imposes strict liability on individuals.