FCA Enforcement – is it fit for purpose?

The FCA’s approach to investigating and punishing suspected misconduct within authorised firms has evolved significantly since the appointment of Mark Steward, Director of Enforcement and Market Oversight in October 2015. The financial services community now sees the risk of enforcement investigations as much more tangible.  The FCA’s new approach has been influenced by the recommendations of the Green report, published just a month after Mr Steward’s appointment.  How is it working in practice and what impact is it having on the market?

The Legacy of the Green Report

In the period prior to Mark Steward’s tenure, the FCA’s approach to enforcement was to conduct formal investigations of firms and individuals only where the regulator had a preliminary view that a disciplinary outcome was reasonably likely. The main exception to this was in cases of suspected market abuse, especially where the timing of a transaction gave rise to suspicions of trading based on inside information.  In those cases, the regulator approached the facts with a fairly open mind and would quickly discontinue the case where a proper trading rationale was given for entering into the specific transaction. 

Where other types of misconduct were suspected, such as inadequate systems and controls to manage risks in an area of the business, the FCA’s traditional approach was to dedicate resources only to cases that it thought had a reasonable prospect of a “public outcome”. This strategy was heavily criticised in a public report by Andrew Green QC published in November 2015, which reviewed the regulator’s approach to enforcement following the failure of HBOS plc. 

The Green report recommended that the regulator should identify and then consider investigating each firm and individual in respect of whom the statutory threshold test for conducting an investigation was met, namely whether there were circumstances suggesting that a breach of a rule may have occurred.

The FCA’s new approach introduced under Mr Steward’s leadership appears to have been influenced by the Green report, as well as his experiences as a securities regulator in Hong Kong. It has the following eight key hallmarks:

1. The FCA now expressly applies the much lower threshold in determining whether to investigate firms and their individuals. As a result, many more cases will be referred to formal investigation by enforcement. By way of illustration, in 2015 the FCA’s Enforcement division had a total of 97 open investigations. This rose to 213 in 2016, 341 in 2017 and 427 as at 31 March 2018.

2. In systems and controls cases, the FCA will now typically place three to five individuals under formal investigation, in parallel with the investigation into the firm itself. These individuals will typically include one or two senior business individuals with responsibility for the area of the business where the suspected breach occurred, and three or four senior Compliance personnel whose responsibilities extend to the relevant area.

3. Since the introduction of the Senior Managers & Certification Regime (SMCR) for banks (fully in force in March 2017), potential targets for disciplinary action are no longer limited to approved persons / Senior Manager Function holders, but can extend to all employees, consultants and contractors working for the firm in any role other than purely administrative or ancillary roles (such as catering or security staff). We are therefore beginning to see cases being pursued by the FCA against less senior individuals within the firm who – prior to the introduction of SMCR – would have been exempt from the risk of financial penalties. The process of rolling out the SMCR regime to all UK authorised firms is ongoing.

4. Where the facts could potentially give rise to criminal as well as regulatory consequences, the FCA’s standard approach is now to include both criminal and regulatory matters within scope, even where the practicalities of a criminal prosecution make the prospect of the criminal offence being pursued extremely low. Most notably, where firms are suspected of having inadequate anti money-laundering systems and controls in place, the FCA’s standard approach is now to place firms under investigation for breach of the Money Laundering Regulations (with criminal consequences) in addition to a breach of FCA Handbook rules.

5. The FCA takes a more creative approach to its investigations, looking to get an early - higher level - view on the nature of any misconduct, and determining at this early stage whether it merits the resources necessary to conduct a wider investigation: its 2018 “Approach to Enforcement” document stated: “We take a strategic approach in our investigations. We aim to quickly identify the heart of the case so we can focus on the key evidence and decide whether to continue with or close the investigation.

6. The FCA enforcement staff who undertake the investigation are now viewed as pure “fact gatherers”, rather than decision-makers on the scope or approach of the investigation. Those decisions are now made by the FCA’s Project Board (a committee of Enforcement heads of department for the more significant cases). The investigation team reports to the Project Board approximately every six weeks on the facts that have been identified, the steps taken in the investigation and the proposed next steps. The Project Board then directs the investigation team on the steps to be taken, including whether additional individuals should be placed under investigation, who should be interviewed, and whether an investigation should be discontinued or its scope changed.

7. Having completed an investigation, the FCA will only approach a firm or individual to seek to settle the case if it is satisfied that the case is “litigation ready”. The evidence will have been through an internal review process to assess the strength of the case, and then the FCA’s proposed findings will be presented to the firm or individual in the form of an “annotated warning notice”. This contains the factual findings, the breaches and the sanctions that the FCA believes are appropriate in the case, with endnotes annotated throughout to refer to the evidence that the FCA has relied on for each statement in the notice. It is the annotated warning notice that forms the basis for negotiation with the FCA if the disciplinary case is to be settled.

8. Since March 2017, the settlement process has included provision for “Focused Resolution Agreements”, under which a firm or individual can reach agreement on part (but not all) of the terms of a proposed disciplinary notice, and refer the points in issue to the FCA’s Regulatory Decisions Committee (RDC). For example, if a firm that agrees (following negotiation) to the facts and breaches contained in a proposed notice but contests the level of financial penalty, it can enter into a Focused Resolution Agreement with the FCA and refer the issue of financial penalty to the RDC. The firm will then still qualify for a 30% discount on the level of the financial penalty, as it would if it had agreed all of the notice at the earlier stage. Two years on from their introduction, Focused Resolution Agreements have not yet revolutionised the enforcement landscape.  

How is the new approach working in practice?

The FCA’s approach of pursuing parallel civil and criminal investigations (for example, in relation to suspected AML systems and controls failings) has complicated their investigation process, given the different approach to matters such as conducting interviews and preserving evidence. In many cases the FCA has discontinued the criminal element of the investigation mid-way through the investigation, making it difficult to see on what basis it was helpful to the regulator to include the criminal aspect of the investigation from the outset.

The fact of so many more investigations being conducted has resulted in a significantly heightened sense among market participants that misconduct will be uncovered and punished. Even where an investigation leads to discontinuance, this visible activity from the FCA serves to make individuals sit up and pay attention to their regulatory duties in a way that they were not doing a decade ago. 

Of course, the consequences for an individual of being placed under investigation are significant and can include potential suspension, removal from core responsibilities, deferrals of variable remuneration, loss of promotion opportunities, inability to move firms, time spent having to prepare for interviews and also negative impacts on relationships and personal health. In the longer term, even where an investigation has been discontinued without any adverse finding, the shadow of having been under investigation by the FCA will make it much more difficult for the individual to land a new job or promotion. 

These adverse consequences should be properly taken into account when the FCA decides to place numerous individuals under investigation, including business and compliance individuals who are responsible for an area of the business but against whom there is no suspicion of active misconduct.

Another point for the FCA to consider is the fairness of conducting their initial “high level” interviews with individuals, without providing copies of relevant contemporaneous documents relating to the events in question. Unless the FCA compiles and provides the witness with an interview bundle to help them refresh their memories, the witness will be left in a deeply unfair position in preparing for interviews and giving a clear account of the relevant matters.  This leads to the difficult judgment call of whether witnesses should bring their own documents to the interview, even if no such documents have been included in the interview bundle.

A fair approach from the FCA and the PRA?

The enforcement changes introduced by Mark Steward seem well-intentioned but have suffered from the fact that the FCA has finite resources. The regulator is unlikely to continue taking on such a significant number of cases, and the market may witness a string of discontinuances over the coming months as the FCA recognises the need to free up resource for important new cases. 

While far from perfect, the FCA’s approach to investigating suspected breaches feels significantly fairer and open-minded than the equivalent approach adopted by its sister regulator, the Prudential Regulation Authority (PRA). The PRA conducts only a tiny fraction of the number of investigations that the FCA undertakes.  Despite this, its approach seems to focus on achieving a public outcome – much like the FCA’s approach prior to the Green Report.  As a result, the PRA appears more focused on securing the necessary evidence for a disciplinary outcome, rather than getting a clear and full picture of the relevant events. 

In contrast, the FCA has repeatedly emphasised that it does not pre-judge the outcome of an investigation and that “Our approach is to make sure we fully understand what may have happened and make a decision based on the best admissible evidence available”. If this approach could truly be adopted by both of the UK regulators, this would be an important positive development.

The authors specialise in financial services regulatory investigations and enforcement, representing firms and individuals on complex regulatory issues opposite the FCA and the PRA.

Originally published by ThomsonReuters © ThomsonReuters.