The FCA has announced that there has been a 75% increase in the number of enforcement cases over the last year. At the same time, in an effort to disarm concerns about the enforcement of the new Senior Mangers Regime, the FCA has said that it wants to move away from a fear based culture of regulation. How can these apparently conflicting positions be reconciled?
The Senior Managers Regime – where are we?
The introduction of the Senior Managers and Certification Regime (SMCR) has given rise to concerns that Senior Managers will be subject to greater liability and enforcement risk.
The SMCR been in place for banks and some other regulated firms since March 2016. The FCA recently published its Consultation (CP17/25) on the roll-out of the SMCR for the broader FCA community. FCA regulated firms will become subject to the SMCR from towards the end of 2018. Implementation is likely to be phased according to different categories of firm.
A fear based culture of regulation
In a speech given on 20 September 2017, Jonathan Davidson (FCA Director of Supervision – Retail and Authorisation) made the point that the FCA wanted to move away from a “culture of fear” and that fines and redress for misconduct were not enough to bring about the cultural shift that the FCA expects to see. Whilst Mr Davidson acknowledged that the FCA would be upholding standards under the SMCR through enforcement, he was keen to stress that the regime was “not all about enforcement”.
Those words are both reassuring and disarming. The SMCR is at present untested and it is likely to take well over a year before the first cases under the original SMCR regime come into the public domain. Where the needle will be set for the required standards under the SMCR is presently unknown.
The mixed message
On the same day, Mark Steward, the FCA’s Director of Enforcement and Market Oversight, also gave a speech highlighting the fact that there has been a 75% increase in the number of FCA investigations over the last year. A large proportion of the increase is down to cases against individuals.
A first sight, this seems to be at odds with the desire to focus on achieving an ethical culture and to rely less on enforcement and fines as a tool to bring about cultural change.
Mr. Steward attributed the increase in the number of investigations to three factors:
- more investigations into capital market disclosures;
- the extension in scope of the reporting regime under the Market Abuse Regulation (the FCA has more and better quality information on market conduct); and
- the FCA’s change in approach when deciding to open an investigation.
The third factor – how the FCA decides whether to open an investigation – is perhaps the most interesting of these.
The test for opening an investigation
Investigations by the FCA are subject to Part XI of the Financial Services and Markets Act 2000 (FSMA). The threshold for commencing an investigation depends on the issues of misconduct being investigated. For example, in the case of an investigation into a rule breach, an investigation may be commenced where there are circumstances suggesting that a contravention may have occurred. On the other hand, a general investigation into the state of business of a firm may be commenced where there are good reasons for doing so.
In deciding whether to commence a regulatory investigation (i.e., to appoint enforcement investigators) the FCA will have regard to its Referral Criteria. These say that the FCA will ask itself “Overall, is an enforcement investigation likely to further the FCAÕs aims and statutory objectives?” In relation to this, the FCA will consider:
- the strength of the evidence and the proportionality and impact of opening an investigation;
- what purpose or goal would be served if the FCA were to end up taking enforcement action in the case; and
- relevant factors to assess whether the purposes of enforcement action are likely to be met.
The Green Report
In 2015 Andrew Green QC looked into the reasonableness of the FCA’s investigations into the failure of HBOS. The concern in this connection was that the FCA had not taken sufficient action. Andrew Green concluded that the FCA did not commence investigations when it could have done because of the FCA’s view that its investigations would not have been successful. In other words, that the matters would not have led to successful enforcement actions.
In his speech on 20 September, Mark Steward made the point that while the prospects of success are an important element in considering whether enforcement resources should be deployed, it is often difficult to evaluate prospects before evidence has been obtained. In other words, it is often necessary to investigate and obtain information before prospects can sensibly be evaluated.
Investigations with no prospects of success – shoot first and ask questions later
This leaves open the possibility that in order to address Andrew Green QC’s criticism, the FCA will commence large numbers of investigations where the evidence against the individual is weak and where there is little prospect of enforcement action being taken. As part of this change the FCA has implemented the practice of recording in its Enforcement Referral Document all the potential subjects of investigation and recording the reasons why each was referred, or not referred, for investigation.
It seems clear, that the threshold that the FCA will apply in practice to bringing cases has been lowered. Individuals in particular are more likely to be investigated than before. While the number of investigations might increase, it is by no means clear that there will be a corresponding increase in enforcement cases. Investigations will be opened only to be closed down.
This does not herald the restoration of the “shoot first and ask questions later” policy announced by Martin Wheatley (the FCA’s former Chief Executive) in 2012. However, it does represent a significant shift in approach that has accounted for a dramatic rise in cases.
The FCA’s approach means that there is likely to continue to be a greater risk of enforcement action being taken against individuals.
The new policy is also likely to mean that individuals will find themselves facing less well formulated cases, with the FCA grappling in the initial phases at least to get on top of evidence and putting together issues. Even if an investigation is subsequently dropped that will not spare the senior manager from the loss of time taken up with defending the case and the stress and anxiety.
Investigations are also likely to last longer with individuals having clouds hanging over their heads.
This is hardly good news for senior managers who will face enhanced exposure under the SMCR