Water industry regulator Ofwat recently landed Southern Water (SW) with a penalty and redress package of £126 million following wastewater spillages from sewage plants. Beyond the headline figures and stories of failure, there are a number of points of wider application for regulated businesses.
Failure to invest in compliance
SW was found to be in breach of statutory obligations (set out in the Water Industry Act 1991, which also gives Ofwat its powers of investigation) to maintain its sewers effectively. SW also breached conditions of its instrument of appointment (ie licence) by having insufficient resources and systems in place to fulfil its regulatory obligations.
Ofwat concluded that the (possibility of) the contraventions would have been apparent to a diligent company. SW did not have suitable systems and controls to avert, spot and tackle problems.
Similar obligations arise in other regulatory regimes, via legislation, regulator expectations and approaches to eventual penalties: in addition to specified outcomes, businesses must ensure they are investing and have robust systems to ensure compliance. For example, there is a statutory requirement for regulated energy networks to be operated economically and efficiently. Penalties in all regulatory regimes are likely to increase where businesses arenot seen to be taking their obligations sufficiently seriously.
Misreporting and senior management involvement
SW also breached conditions by misreporting information. Unsurprisingly, Ofwat found this damaged trust in the sector.
Making matters worse, Ofwat found that this was deliberate, with senior employees’ intending to mislead the regulator; there was evidence senior employees were aware of and even assisted with illegal activities. Senior management oversight was inadequate.
The provision of accurate information and honest responses to the regulator are crucial in all regimes. Regulators and regulatory regimens are invariably dependent on the information given to them for their proper functioning. Deliberate misreporting will be seen as particularly egregious (think VW emissions) and potentially criminal.
Senior management’s approach to compliance and engagement is also likely to be important in how the regulator engages and approaches penalty and redress issues. In some regimes, senior management may themselves have specific obligations in respect to compliance.
Failure to take notice of previous warnings
Regulated businesses must learn from previous regulatory decisions: not taking notice is likely to make any subsequent regulatory intervention more costly.
Ofwat had already taken enforcement action against SW twice and in 2008 warned it about manipulating and hiding information. Ofwat also took into account its previous decision on a breach of the general duty to develop and maintain an efficient and economical system of water supply.
The headline figure of £126 million consists of a £3 million fine, with the remainder made up of rebates to the company’s customers via their bills over the next five years.
It is increasingly common for economic regulators to try and resolve compliance matters, firstly by pushing a business into line and, where breaches and harms are historic, by concluding with a package that sees money going to consumers as redress and not to the Treasury as a fine. This often means using a combination of powers set out in legislation plus administrative steps to ‘agree’ an outcome with the regulated party in lieu of more formal penalties (see, for example, most Ofgem investigations).
Ofwat reduced the penalty element to £3 million (from £37.7 million) in light of SW’s rebates to customers and proposed undertakings benefitting consumers. Reducing a penalty like this is provided for in Ofwat’s Statement of Policy on penalties.
Ofwat’s approach to the penalty, redress and overall package reflects the standard approach of economic regulators:
- costs of compliance that have been avoided need to be accounted for, as does consumer and other third party detriment (this can be a fraught process);
- the penalty needs to act as a deterrent;
- the length of the breach is important;
- aggravating and mitigating factors are applied to the baseline penalty (which may itself take account of redress). These are often crucial and go beyond the simple question of whether there has been a breach (for example, here, senior management’s role in the performance and reporting of breaches, failure to take notice of past warnings etc). How the business (eventually) responds to the discovery of non-compliance and any investigation is also crucial.
It is not unusual for the same circumstances to give rise to liability in more than one regulatory regime, in criminal law, and under contract or tort in respect to third parties such as customers. At the time of writing, SW has reported being additionally under investigation by the Environment Agency and Drinking Water Inspectorate over historic performance issues.