Living with personal liability

Transcription

1 Living with personal liability Our opinion News of senior executives being banned from future roles in financial services has become less shocking. The FCA is now more likely to intervene in a firm s strategy and is increasingly holding individuals to account. In addition, the regulator will soon be able to make criminal prosecutions for taking decisions that cause a bank to fail. Understanding the FCA s expectations and your personal obligation is now more important than ever. By taking an active approach to personal liability you can ensure long term stability and minimise your risk of prosecution. If you are an approved person you need to take an active approach to your personal liability understanding what it means in practice and minimising your risk of discipline. The financial crisis has had major implications for the regulatory system in the UK and elsewhere. In the UK, the Financial Services Authority was perceived to have failed in its mission and has been replaced by the Financial Conduct Authority (FCA). The prudential supervision of banks and insurance companies, together with some other significant financial institutions has been passed to the Bank of England through its oversight of the Prudential Regulation Authority (PRA). The FSA s approach to regulation has been criticised as light touch, and in the aftermath of the crisis almost no senior banking figures were subjected to personal disciplinary action, despite the existence of an approved persons regime which was designed to apply personal responsibility and accountability. That has led to criticism and has led to a review of that regime. While the FSA concentrated its disciplinary armoury at the level of the firm, the FCA is quite likely in any action against a firm to consider whether any individuals should be disciplined. The powers available include issuing fines and prohibition orders. These orders can result in a person being prohibited from any form of employment by an authorised firm, so the stakes are high. The decision to take action against individuals is a realisation that firms amount to no more than the people who work for them. Painful discipline of individuals is, from the FCA s viewpoint, much more likely to change behaviour than actions taken against the firm. Now, more than ever, it is important that people who run financial firms and who carry approved person responsibility understand the standards that are being applied and how those standards are being enforced. If you are an approved person you need to take an active approach to your personal liability understanding what it means in practice and minimising your risk of discipline. You can prepare by: Ensuring you are familiar with the FCA s required standards of behaviour Understanding what the standards of behaviour mean in practice Clarifying responsibility and accountability across your firm to support requests from the FCA for attestation..

2 Ensuring you are familiar with the relevant FCA standards Approved Persons Personal culpability arises where an approved person s conduct was deliberate or where the approved person s standard of conduct was below that which would be reasonable in all the circumstances. The Financial Services and Markets Act 2000 (FSMA) sets out a number of controlled functions. Individuals performing these functions must apply for authorisation from the FCA and are known as approved persons. Most of the controlled functions are classed as significant influence functions (SIFs) generally held by those in a position of management. The customer function covers day-today activities carried out for customers, such as investment advice. Firms who wish to appoint individuals to carry out any of the controlled functions must apply to the FCA to get approved person status for them. In assessing the applications, the FCA will consider the applicant s: honesty, integrity and reputation competence and capability financial soundness. Required standards of behaviour In brief, the principles state that an approved person must 1. act with integrity in carrying out his accountable functions 2. act with due skill, care and diligence in carrying out his accountable functions 3. observe proper standards of market conduct in carrying out his accountable functions 4. deal with the FCA, the PRA and other regulators in an open and cooperative way and must disclose appropriately any information of which the FCA or the PRA would reasonably expect notice 5. take reasonable steps to ensure that the business of the firm for which he is responsible in his accountable function is organised so that it can be controlled effectively 6. exercise due skill, care and diligence in managing the business of the firm for which he is responsible in his accountable function 7. take reasonable steps to ensure that the business of the firm for which he is responsible in his accountable function complies with the relevant requirements and standards of the regulatory system. In considering whether a person complies with the principles as a whole, the FCA will also look at whether the conduct relates to activities that are subject to other FCA provisions or are consistent with the requirements and standards of regulatory systems relevant to the firm. For an approved person in a significant influence function they will also consider: whether he exercised reasonable care when considering the information available to him whether he reached a reasonable conclusion which he acted on the nature, scale and complexity of the firm s business his role and responsibility as an approved person performing an accountable significant influence function the knowledge he had, or should have had, of regulatory concerns, if any, arising in the business under his control

3 Importantly, the rules emphasise that an approved person is only in breach where he is personally culpable : Personal culpability arises where an approved person s conduct was deliberate or where the approved person s standard of conduct was below that which would be reasonable in all the circumstances. Understanding the practicalities of following a required standard of behaviour As well as familiarity with the rules and the types of behaviour which fall short, it is useful to stay abreast of recent disciplinary decisions. The following examples are each very different cases, but together illustrate that Principle 4 (being open with the FCA) and Principle 7 (compliance) are particularly important for all approved persons, not just the Compliance Officer. Angela Burns This case shows the importance of managing conflicts of interest, and also that the FCA standards overlap the responsibilities of an individual when acting as a company director. The case concerned an alleged breach of Principle 1, the requirement to act with integrity. Ms Burns was the non-executive director (NED) of two mutual insurance societies. The FSA found that Ms Burns had failed to disclose to the Societies a manifest conflict of interest, that she was soliciting a NED position together with consulting work from an investment manager while at the same time she was recommending the investment manager to the Mutual Societies. In addition, that she had used her NED position with the Mutual Societies to solicit the NED and consulting roles at the investment manager. The FCA imposed a fine of 154,800 and also a banning order under section 56 of FSMA. Tidjane Thiam The FSA took action against Mr Thiam on the basis that he was knowingly concerned in the failure of Prudential to comply with the principles that apply to the firm itself and he was publicly censured by the FSA. This case is interesting in that the FCA took action based on Mr Thiam s involvement with the company he led; there was no action taken under the Code, including under Principle 4 (being open with the FCA). On 1 March 2010, Prudential announced its intention to acquire AIA, a wholly owned subsidiary of AIG. The size of the deal meant it would be transformative for Prudential and, had it succeeded, would have led to the largest ever rights issue in the UK. Subsequently, negotiations failed and Prudential withdrew. According to the FSA, Prudential failed to inform the FSA that it was seeking to acquire AIA from AIG until after the proposed transaction had been leaked to the media, despite having met with them the previous month to discuss group strategy. The CEO, Tidjane Thiam, was present at the discussions, and the FSA noted that Mr Thiam played a significant role in the decision not to contact the FSA about the proposed acquisition until after it had been leaked to the media. The FSA took action against Mr Thiam on the basis that he was knowingly concerned in the failure of Prudential to comply with the principles that apply to the firm itself and he was publicly censured by the FSA.

4 Alexander Ten-Holter The FSA commented: His behaviour also demonstrates a lack of competence and capability, such that his is not fit and proper to perform the Compliance oversight (CF10) and Money laundering reporting (CF11) significant influence functions. The FSA found that Alexander Ten-Holter breached Statement of Principle 6 (due skill, care and diligence) in the manner in which he exercised the Compliance oversight function. Mr Ten-Holter was employed as a trader at Greenlight Capital UK. His role included the execution of trades according to instructions received from the portfolio management team. Mr Ten-Holter held a number of controlled functions: CF30, CF4, CF10 and CF11. In 2009, Greenlight Inc instructed Greenlight UK to sell shares in Punch Taverns PLC. Mr Ten-Holter executed the order despite being aware that conversations had taken place between the person placing the order and Punch management which may have resulted in confidential information being passed to Greenlight. Some days later, Mr Ten-Holter became aware of additional information that should have further prompted him to question the sell order. Specifically, on 15 June 2009, Punch announced its intention to raise capital through a firm placing an open offer of new shares and also its intention to make a tender offer to holders of convertible bonds. The announcement had a substantial detrimental effect on the price of Punch shares. The FSA alleged that Mr Ten-Holter should have been alerted to the risk of market abuse and should at least have made further enquiries about the sell order. However, he did not recognise the risk and took no action, amounting to a breach of Statement of Principle 6. The FSA commented: His behaviour also demonstrates a lack of competence and capability, such that his is not fit and proper to perform the compliance oversight (CF10) and money laundering reporting (CF11) significant influence functions. The FSA therefore imposed an order prohibiting him from holding the CF10 and CF11 controlled functions and also imposed a financial penalty of 130,000. Goenka, Davis and Parikh This trio of cases shows the subtlety that the FCA will adopt in taking action against various people in connection with the same facts, depending on their own involvement. The cases concerned market abuse committed by Rameshkumar Goenka in October A Dubaibased private investor, he had engaged in trading which artificially inflated the closing price of global depositary receipts in industrial group, Reliance. Mr Goenka agreed to settle at an early stage in the FSA action and was required to pay a substantial fine of $9.6m. David Davis was the holder of CF10 (compliance oversight). He had approved Mr Goenka s deals that amounted to market abuse. The FSA imposed a penalty on Mr Davis comprising a financial penalty of 70,258. They also imposed a prohibition order, prohibiting Davis from performing the CF10, CF10A and CF11 controlled functions. The FSA s case concerned Mr Davis s breach of Statement of Principle 6 (due skill, care and diligence). The FSA warned that detecting and preventing market abuse is a key part of Davis s compliance oversight role. The FSA asserted that information he held should have alerted Mr Davis to the risk of market abuse. Furthermore, he should have spotted afterwards that Mr Goenka s order accounted for 90% of the auction trading and moved the closing price by 1.7%.

5 Vandana Parikh was given a penalty of 45, for failing to exercise due skill, care and diligence in her accountable function (Principle 2). She had engaged with and assisted Mr Goenka in the practicalities of auction trading and the impact that various orders would have on the price of securities. The FCA found that she should have challenged and made adequate enquiries to satisfy herself that no such risk existed before continuing to assist Mr Goenka. Ms Parikh was a customer function approved person, so the case illustrates the standard of care applicable to such persons. The FSA pursued the matter to the Court of Appeal, to require the Tribunal to decide on the matter of fitness and propriety. The Court agreed and required the Tribunal to make a decision on that point. David Hobbs This case illustrates the doggedness of the FCA in pursuing a person for not telling the truth even where the initial allegation of market abuse was not made out. David Hobbs was pursued by the FSA for alleged market abuse in his trading of coffee futures on 15 August The FSA had sought a financial penalty of 175,000 together with a prohibition order on the ground that he was not a fit and proper person. The FSA sought to construe statements that Mr Hobbs had made to his broker, in which he referred to doing the ultimate as an intention to commit market abuse. Mr Hobbs, however, sought to characterise the exchanges as his strategy of confusion he was trying to confuse the broker as to the nature of his position in the market. The initial FSA action was taken by Hobbs to the Upper Tribunal who did not uphold the allegation of market abuse. However, the Tribunal did not conclude whether or not Mr Hobbs was fit and proper to be an approved person. In setting out the strategy of confusion, Mr Hobbs had in effect told untruths to the FSA and to the tribunal. The FSA pursued the matter to the Court of Appeal, to require the Tribunal to decide on the matter of fitness and propriety. The Court agreed and required the Tribunal to make a decision on that point. The Tribunal s second decision found that the conduct of Mr Hobbs in lying repeatedly is such that renders him as lacking in integrity, and consequently as not fit and proper to perform functions in relation to a regulated activity. As a result, the Tribunal decided to make a full prohibition order against David Hobbs, prohibiting him from performing any function in relation to a regulated activity. John Pottage The case of John Pottage is particularly interesting because the Upper Tribunal did not uphold an FSA action to hold a CEO accountable for failing to take reasonable steps in compliance. It is very rare indeed for the regulator to lose a Tribunal case. The FSA had sought to impose a penalty of 100,000 on John Pottage, CEO of two UBS subsidiaries. The allegation was that Pottage had failed to take reasonable steps to ensure that the business of the Firm complied with the requirements of the regulatory system (Principle 7). The FSA s case was that, on becoming CEO, Mr Pottage had failed to: carry out an effective initial assessment question effectively assurances he received that there were no fundamental deficiencies carry out continuous monitoring, in particular to consider adequately the wider implications for governance and risk management of a series of warning signals commence early enough a systematic overhaul of the systems and controls in place.

6 Mr Pottage disputed the FSA s case and the matter went to the Upper Tribunal for decision. As part of his initial assessment, Mr Pottage had conducted detailed interviews with the firm s Management Committee and staff concerned with risk management, legal and compliance. He had held meetings with relevant global heads, internal audit, the COO, and his predecessor none of whom made him aware of any issues. As a result, Mr Pottage assumed that the existing governance and risk management frameworks were appropriate. the FSA had failed to demonstrate that Mr Pottage s standard of conduct was below that which would be reasonable. The Tribunal found that there were, indeed, serious flaws in the firm s risk management system; compliance monitoring and management information. However, in considering Mr Pottage s position with regard to the charge of misconduct, they referred to the APER guidance on personal culpability: an approved person is liable only where his conduct was deliberate or fell below that which would be reasonable. The Tribunal found that there was no reason for Mr Pottage to have questioned the information that he was given during his initial assessment and that it was reasonable to rely on the views of his specialists. They concluded that the FSA had failed to demonstrate that Mr Pottage s standard of conduct was below that which would be reasonable in all the circumstances and that the actions that Mr Pottage took to deal with the operational and compliance issues as they arose were reasonable steps. Clarifying accountability across your firm to support attestation In May 2012, the FCA approved internally the use of attestations as a supervisory tool. In brief, this entails the FCA asking for individuals employed by the firm: to resolve a particular issue and to write to [the FCA] asserting that the issue has been materially resolved. This letter should be signed by the most appropriate Significant Influence Function holder in relation to the matter being resolved. Individual FCA Supervisors are responsible for identifying the most relevant Significant Influence Function (SIF) holder. A 2013 internal FCA note, obtained by Stephenson Harwood as part of a Freedom of Information request, observes what the consequences will be if the FCA later establishes that the action, promised by the attester, has either not been taken or has not been taken to the expected standard or within the specified timeline: If the FCA is not notified of the failure to comply with the terms of the attestation, the firm will be in breach of Principle 11 and the SIF holder will be in breach of Statement of Principle 4 and therefore of APER. The firm most likely will also be in breach of other underlying rules in the Handbook, SYSC, CASS, COBS etc. depending on the issue in question. The SIF holder most likely will also have breached SYSC. We may decide to take disciplinary action against the firm and the individuals for these breaches. We know that attestations have been widely used by the FCA for approved persons of all types. In some cases, attestations have been requested from company boards.

7 The attestation may relate to a matter over which the proposed attester is only partially accountable within the firm. If that is the case, it is important to ensure that all those persons who are internally responsible and accountable sign the attestation. Initially, the FCA appeared to be requiring the attestation to be given in a precise form. However, the FCA s internal note observes that the precise wording of an attestation can be the subject of negotiation between the supervisor, the firm and the SIF holder. It is debatable whether the FCA can, under its statutory powers, compel the creation of a new document such as an attestation, as opposed to requiring disclosure of an existing document. Moreover, the statutory powers are to require the provision by an authorised person (i.e. the firm) of information or documents of a specified description. In providing the information, the individual acts on behalf of the firm. Note that giving false or misleading information in response to a requirement to provide it is a criminal offence. The request for an attestation should focus the mind of the person giving it. It is clear that the FCA regards such a document as given both by the firm and by the individual, so that disciplinary action can be taken against both if the attestation turns out to be false. The attestation may relate to a matter over which the proposed attester is only partially accountable within the firm. If that is the case, it is important to ensure that all those persons who are internally responsible and accountable sign the attestation. However, this will not be possible where more junior staff are concerned. In such cases, it is advisable as a matter of good management to require internal attestations within the firm, so that the importance of the matter is cascaded appropriately to staff whose confirmation is needed to make the attestation work effectively. Of course, any disciplinary action against junior staff would be taken by the firm as a matter of internal discipline. Taking an active approach to personal liability The FCA is undoubtedly much more prepared than its predecessor to take action against individuals, in addition to action taken against the firm. The FCA rules on Senior Management Arrangements, Systems and Controls (SYSC) are aimed at imposing requirements for the effective management of firms. This includes making sure that individuals are accountable for their actions indeed, the whole APER approach is built on controlled functions which themselves divide and apportion responsibility for aspects of the firm s business. The Pottage case is a good illustration of the standards applying to a Chief Executive on taking up a new role. The FCA s new approach to attestations is a more aggressive way of imposing accountability. In this new world of personal liability, it seems essential that firms take steps to ensure that they clearly apportion responsibility and accountability to individuals. Openness with the regulator is vital and a failure to be open is perhaps the surest way to create a problem. Understanding the required standard of behaviour is crucial for all staff, both in terms of understanding the provisions of the Principles and Code, but also in understanding how it is being applied in practice; the Upper Tribunal decisions are a form of legal precedent, as are the FCA s disciplinary cases. The FCA has limited resources for enforcement actions, so they will pursue those cases where they want to make a point to the industry.

8 Openness with the regulator is important and a failure to be open is perhaps the surest way to create a problem. Tribunal cases can also be useful in flagging issues that you might want to double check in your own firm. The Pottage case, for example, raises at least a couple of contextual flags: The risk management system was in existence but was not fully embedded There was inadequate compliance monitoring. There are likely to be many firms with the same failings, so taking an active approach to personal liability will help approved persons ensure that their own risk of regulatory censure is minimised. Ashley Kovas As well as eight years at the FSA, Ashley has held a number of senior compliance roles in fund management, banking and insurance, most recently as Head of Group Compliance Policy at RBS. He leads the Funds team at Bovill and works with clients on all aspects of financial regulation.