Introduction

Following publication of the FCA’s first Enforcement Annual Performance Account in July 2014, this article considers what progress has been made by the new conduct regulator and whether there are indications of what the industry can expect in the future.

Following in the footsteps of the FSA, the FCA published its first Enforcement Annual Performance Account in July 2014 (the EAPA 2014), providing a round-up of enforcement action over its first year and an opportunity for the market to assess (i) what progress has been made in terms of achieving credible deterrence; and (ii) whether it is possible to detect any change of approach or emphasis by the new conduct regulator.

Of course enforcement is a time consuming business and the outcomes we have seen over the last year or so since the advent of the FCA relate to investigations that were commenced by its predecessor. According to the FCA’s statistics, it takes between two and three years for a case to conclude following referral to enforcement, depending on the course that the matter takes and whether early settlement is achieved.

This means that the recent EAPA 2014 has to be judged to an extent by reference to the previous business plans of the FSA. Nevertheless, the approach taken and the focus of the current outcomes may provide an indication of the FCA’s direction of travel and what the industry can expect from its new regulator in the future in relation to the key areas of retail and wholesale conduct, senior management and market abuse.

Retail conduct

The FSA signalled some years ago that taking enforcement action after consumer detriment had been suffered was not going to be sufficient to deal with persistent conduct issues in retail financial services and that a new consumer protection strategy was needed involving earlier, more robust supervisory interventions, backed by stronger enforcement with a focus on securing redress.

The FCA is now charged with the implementation of that strategy and, in the context of retail enforcement action, it is clear that agreeing a redress package will be a significant element to any settlement with the FCA. The most significant outcomes mentioned in the EAPA 2014 include the £28 million fine imposed on Lloyds Banking Group in connection with inappropriate incentives and the fines for HomeServe Membership Limited (£30.6 million) and Policy Administration Services Limited (£7.3 million) in relation to low-cost insurance. All these cases involved potentially significant redress for customers. More recently (and too late for the EAPA 2014), the insurer Stonebridge International Insurance Limited was fined £8.4 million but was not required to disgorge profits having committed to a redress programme.

Although fines have been rising and are increasingly based solely on a percentage of the firm’s revenue as a result of conduct occurring after March 2010, the redress factor means that the true cost of enforcement action for firms can be significantly higher than the headline penalty. Not only are firms required to compensate customers, they must also pay the costs associated with implementing a redress programme and any remedial action that is required, such as improved procedures, increased resourcing and training programmes.

In terms of the subject matter of the retail enforcement outcomes, as far as banks are concerned, the FCA has not yet demonstrated any particular focus on a retail sector or product and it may be that we have to wait a little longer for any trends to emerge. Given the recent transition of responsibility from the OFT to the FCA, consumer credit is one area in which we may see enforcement action as firms adjust to a new regime and the FCA looks to deliver messages to the market about the importance of embedding a culture of treating customers fairly.

In the meantime, there is little to be gleaned in relation to current retail enforcement activity from the ‘work in progress’ represented by recent decision notices or warning notice statements. Although the FCA makes the point in the EAPA 2014 that some of the cases that the retail enforcement team has been working on are still ongoing and that a number of decision notices have been published, none of these decision notices relates to significant retail misconduct against a major institution.

Wholesale conduct

In keeping with the retail focus on redress for customers, the EAPA 2014 highlights the FCA’s focus on misconduct which disadvantages clients making reference to cases involving overcharging (State Street UK fined £22.8 million) and failing to pass on profits (Forex Capital Markets Ltd and FXCM Securities Ltd fined £4 million).

Benchmarks have also continued to generate outcomes with fines for ICAP Europe Limited (£14 million) and Rabobank (£105 million) in relation to LIBOR (following in the footsteps of earlier FSA cases). The EAPA 2014 also makes reference to ongoing forex investigations but the basis on which action may be taken is not yet clear and it seems likely that it will be some time before we see any enforcement outcomes emerge or even the publication of warning notice statements or decision notices.

The only other significant systems and controls outcome was the £137.6 million fine imposed on JP Morgan in connection with the London Whale. This has been described by Tracey McDermott as ‘an all too familiar story’ and there is certainly nothing new in regulatory action being taken against a bank following a rogue trading incident.

What we have not seen so far is a plethora of cases arising from cultural and governance issues nor a wide range of significant penalties imposed on firms in relation to the systems and controls governing wholesale relationships to the extent that we might have expected. The FCA has indicated that action will be taken where a firm’s culture places profits over ethics and allows misconduct to flourish but this stance has not yet been matched by enforcement action against firms that have failed to embed the cultural values that champion positive behaviour.

Senior management

Senior management accountability is an area which has received a great deal of regulatory attention in the wake of the financial crisis and the FCA has made it clear that taking action against firms needs to be backed up by action against the individuals who were responsible for the failures.

Although the difficulty of identifying and penalising individuals within large and complex organisations has been publicly recognised by the regulator, there were signs towards the end of the FSA’s reign that its strategy was making some significant headway. The EAPA 2013 made reference to senior directors of HBOS, Prudential and Mitsui whose conduct gave rise to failures of governance and oversight. These were cases which were the subject of debate within the industry and which threatened to keep senior managers awake at night.

However, the last eighteen months have not seen the FCA building on this with any consistency. For all the speeches and publications making reference to the ‘tone from the top’ and ensuring accountability, the senior management outcomes cited in the EAPA 2014 are more straightforward cases involving lack of integrity issues arising from matters such as misleading clients and the regulator. Arguably the most significant outcome in terms of senior management responsibilities was the £30,000 fine imposed on the former Finance Director of Bradford & Bingley, Mr Willford, which involved issues in relation to dealing with emerging financial information and appropriate follow-up and escalation to the board. Mr Willford’s fine was significantly reduced from the amount originally proposed by the FSA of £150,000 and there is no reference to it in the EAPA 2014.

It is true that the EAPA 2014 senior management cases predate the FCA and that, since January 2014, the FCA has exercised its new power to publish information about warning notices a number of times in relation to individuals, including some directors and managers.

However, the issues arising in these cases (including in relation to client money, UCIS business and condoning the misconduct of others) do not seem likely to significantly enhance the market’s understanding of the expectations of senior management or break new ground in terms of accountability.

We have not seen warning notice statements issued to individuals in connection with some of the more significant enforcement actions against firms to which reference was made in the EAPA 2013 such as the PPI complaints handling cases or misselling of insurance.

Market abuse

The EAPA 2014 only has one conviction for criminal abuse to report. The non-criminal outcomes include the more straightforward cases involving deliberate manipulation (such as Coscia and Swift Trade) rather than the more difficult cases involving the so-called ‘gatekeepers’ of insider information and disclosure.

The outcome in the long-running Hannam case commenced by the FSA was too late for the EAPA 2014 and will no doubt feature next year. In the meantime, the FCA will be keen to demonstrate that it is able to pursue and win more of these complex cases against City professionals as part of its credible deterrence objective.

Conclusion

As well as reflecting on what the EAPA 2014 covers in terms of recent enforcement action, it is also worth noting the omissions such as the total lack of Listing Rules cases as well as the other relatively sparse areas highlighted above.

The EAPA 2014 also reveals that 30.2 per cent of cases (excluding threshold condition cases) closed with no further action being taken. This was up 10 per cent from the previous year. This may be a product of the FCA’s increasing willingness to use other tools such as OIVOPs in order to achieve its objectives. It may also reflect the fact that firms and individuals are engaging more proactively and at an earlier stage with the regulator to address concerns and to attempt to avoid enforcement action. It might also be a sign of a more confident regulator which is willing to bring more cases in the knowledge that not all of these will generate outcomes but that the mere commencement of enforcement action together with a reasonable number of high profile successes may be sufficient to achieve credible deterrence.

The warning notice statements and decision notices being published by the FCA in the course of ongoing enforcement action may be a better indicator of the FCA pipeline and the cases being referred to enforcement.

If that is the case, we will be seeing a significant number of LIBOR-related outcomes against traders and relatively junior managers.

However, the FCA will want to ensure that its EAPA 2015 delivers on its key objectives of holding senior management to account in areas of retail and wholsesale misconduct and further progress in the high profile area of market abuse by industry professionals.