As you will be aware, major changes are being proposed to the regulatory regime for individuals working within banks, building societies and PRA-designated investment firms. A joint PRA/FCA consultation on the implementation of the new regime closed on 31 October 2014. The final rules are expected to be published at the end of this year or early next, with the new regime coming into force later in 2015.
The new regime aims to address concerns raised by the regulators about the current regime, in particular a perceived lack of individual accountability for conduct which the regulators believe contributed to the 2008-09 economic downturn and recent high profile banking scandals. The focus is the most senior individuals within a firm who undertake ‘senior management functions’. Firms will be required to submit a statement of responsibility in respect of each senior manager, which makes clear the scope of that person’s responsibilities, with the aim of increasing individual accountability. When there is a failure by a firm, the regulators will be able to apportion blame on an individual basis to senior managers by reference to the relevant statements of responsibility.
The new regime also radically changes the process by which employees below senior manager level will be judged ‘fit and proper’. There will no longer be an FCA-owned ‘Approved Persons Regime’ for employees (except for senior managers who will continue to be approved under a modified scheme). Instead there will be a ‘Certification Regime’ under which firms will be responsible for certifying, both on recruitment and on an annual basis, that employees who perform a role relating to the firm’s regulated activities which could pose a risk of significant harm to the firm or its customers are ‘fit and proper’ to undertake that role. The pool of employees to which the Certification Regime will apply is larger than that under the current Approved Persons Regime. New Conduct Rules will replace the existing Statements of Principle and Code of Practice for Approved Persons and will apply to all employees whether certified or not subject to certain exceptions.
The new regime raises a number of concerns from a recruitment perspective, which this briefing explores.
Senior managers - increased accountability
Under the new regime, if a regulatory breach occurs within the area of responsibility of a senior manager, that manager will be guilty of misconduct unless he can show that he took reasonable steps to avoid the breach occurring or continuing. This differs significantly from the current position where an individual can only be held personally accountable if he is ‘knowingly concerned’ in the breach or is himself in breach of the Statements of Principle for Approved Persons. Going forward, it will be much easier for the regulators successfully to bring cases of misconduct against senior managers.
In the new regulatory world, a senior manager who is guilty of misconduct could face an unlimited fine from a regulator and/or a ban from performing a particular type of function, or potentially any function, within a regulated firm.
Senior managers – expected demands for higher fixed pay
Given the increased scope for significant personal liability, it seems likely that senior managers will expect a higher fixed salary to compensate them for this increased personal risk. It is expected that firms will face considerable difficulties in attracting and retaining talent, especially against the backdrop of the recent changes in the remuneration landscape within the financial services sector, including the limitations on variable pay [and the Advocate General’s opinion on the UK’s bonus cap challenge issued on 20 November 2014 (for which see our briefings [here]) which make it unlikely that the bonus cap will be overturned]. It could become significantly more expensive to hire the best individuals, particularly while firms learn to navigate this new era of regulation.
The impact of handover certificates
The new rules will require a firm to take all reasonable steps to ensure that a newly recruited senior manager (and his supervisor) has all the information they could reasonably expect to have to perform their responsibilities. As part of this briefing, it is envisaged that an outgoing senior manager can prepare a handover note detailing any unresolved regulatory issues.
The handover process is expected to be a lengthy one, with the focus of both the outgoing and incoming senior manager being on limiting the scope for personal liability. It is very likely that both will seek legal advice on any handover note (and may request that the costs of this are met by the firm). These handover arrangements will make recruitment of a senior manager a more drawn out process, with the incoming senior manager potentially demanding a higher fixed salary if any material regulatory issues are raised in the handover certificate.
Currently there is no express requirement for an authorised firm to seek a reference from a former employer on a potential new recruit. Since a firm is required to notify the FCA of any issues affecting the fitness and propriety of an approved person, including on Form C when an employee ceases to perform a controlled function, and a fresh approval application has to be submitted to the FCA by a recruiting firm, less emphasis has been placed on references which are provided direct from one employer to the next than is the case in other sectors. For employees below senior manager level this will all change under the new regime. The abolition of the Approved Persons Regime in favour of the Certification Regime will mean it is the responsibility of the recruiting firm to find out direct from the former employer whether there are any historic issues relating to a potential recruit (below senior manager level) which may affect that person’s fitness and propriety and therefore their suitability for the proposed role. The new rules will require a recruiting firm to seek a reference from former employer(s) covering the applicant’s previous five years employment history.
However, the draft revisions to the FCA Handbook in this regard appear too limited in scope. The new SYSC5.3 states that a reference is only required to disclose any breach of a ‘Conduct Rule’ (rather than requiring a broader disclosure of any matter relevant to fitness and propriety). For the first few years of the new regime, this requirement would mean that historic disciplinary matters would not need to be disclosed (as the Conduct Rules will only come into force with the new regime). This cannot be the intention of the FCA and it is hoped that the final revised text, when published, will make clear (as the draft PRA rulebook does) that references should disclose any determinations by a former employer that a person is not ‘fit and proper’.
The current obligation on an authorised firm to provide to a proposed new employer on request all information relevant to an individual carrying out a controlled function will remain in place, as will the current rules on the preparation of references, which provide that:
- where a firm supplies a reference it owes a duty to both the former employee and the recruiting firm to exercise due skill and care in its preparation;
- the reference should be accurate and based on documented fact;
- the firm may give frank and honest views, but only after taking reasonable care both as to factual content, and as to the opinions expressed, and verifying the information upon which they are based.
It is certainly the case that the requirements of the new regime on references are not as clearly drafted or comprehensive as they might be. This gives rise to a real concern that different firms will take different approaches to what information should be disclosed in a reference, particularly while the new regime beds down.
Since a firm will have to rely almost entirely on the disclosures made by the former employer in a reference, there is a real risk that individuals who left their previous employment under a cloud will be able to move around the market far more freely than they do now. For example, it is not clear whether a firm is expected to disclose in a reference the fact that an employee resigned part-way through an investigation or was allowed to leave under a settlement agreement before a disciplinary process was completed and therefore before actual misconduct had been proved. This type of situation, which is fairly common in practice, is simply not catered for in the current draft rules.
This is an area which is very much ripe for regulator guidance to ensure that firms act in a consistent way. It is hoped that such guidance will be forthcoming when or soon after the final rules are published.