Alison McHaffie’s Financial Services Investigations and Enforcement Column: February 2017

09 March 2017

Report contents:

  1. The Enforcement Review – significant change or more of the same?
  2. Focused Resolution Agreements
  3. Changes to FCA settlement procedures
  4. Faster access  to Upper Tribunal
  5. Referrals to Enforcement
  6. Co-operation between FCA and PRA in enforcement matters
  7. Transparency in enforcement investigations
  8. A new era?
This article first appeared on Practical Law and is published with the permission of the publishers 

The Enforcement Review – significant change or more of the same?

The long running review of the FCA and PRA enforcement process has finally reached an end, at least for the FCA, with the publication of a joint policy statement (FCA PS17/1 / PRA PS2/17) on 1 February 2017.

The PRA is expected to publish a new guide to its own enforcement processes during 2017, alongside other reforms to its processes. Regular readers of my column will recall that I mentioned in my December 2016 column that one of the main issues on the horizon for 2017 was how the regulators would seek to close out this review. In this edition of my column, I take a look at the more significant changes being made and offer my views about their likely practical impact. The enforcement process has long been in need of reform, lacking transparency and consistency, too often feeling as if the outcome is pre–determined, and far too slow. Any reform which seeks to tackle these issues is welcome and, indeed, I have commented previously on some constructive changes to practices that FCA has made already in the way it conducts investigations. However, while welcome, whether these reforms will in practice deliver significant change and crucially leave those who have been subject to the process feeling that they have been fairly treated through a transparent and efficient process remains to be seen. Much will depend on their practical implementation.

Focused Resolution Agreements

A number of key changes to the procedures of the FCA’s Regulatory Decisions Committee (RDC) are being made to introduce a process for partly contested cases. Previously, a firm or individual who was unable to settle an enforcement case by agreement with the FCA (for example because they disagreed with the penalty or the scope of the FC A’s findings), in practice had to continue to defend the case in its entirety through the RDC process.

A new focused resolution agreement (FRA) procedure will be introduced from 1 March 2017 which will allow the subjects of investigations to agree a partial settlement with the FCA whilst still contesting certain aspects before the RDC (or the Tribunal, if the subject opts for the expedited route described below). The FRA will be available in broadly three circumstances:

  • Where the dispute is over penalty only (that is, where the subject of the investigation agrees all relevant facts but wishes to contest the FCA’s proposed penalty in front of the RDC). In this case, the 30% early settlement discount will still apply;
  • Where the dispute is over the existence of a breach (that is, where the subject of the investigation agrees all facts relevant to the proposed enforcement action, but wishes to make submissions and contest whetherthe breaches alleged by the FCA arise from those facts).In these cases, a settlement discount of between 15-30% will apply; and
  • Where the dispute is narrowed to particular issues (that is, where the subject agrees one or more issues relevant to the proposed enforcement action, but not all, and wishes to contest a narrowed down list of facts). A settlement discount in a range of between 0- 30% will be available in this case.

In deciding on the settlement discount to be applied to the penalty the RDC will take into account the extent to which the eventual outcome reflects the position taken by the subject and any consequential savings of time and public resources resulting from the FRA.

While this is a significant change to the FCA procedures, much will depend on how the FCA decision-makers exercise their discretion to agree to an FRA. However, if exercised appropriately, FRAs could deal with a common frustration in the investigation process when a settlement is all but agreed, but the FCA - often in the knowledge that the subject will agree rather than fight the whole case - remains firm on the level of penalty or its view of the facts, despite reasonable objections. For example, where the firm simply does not think the penalty reflects the alleged breach or where the firm accepts a failure in its systems and controls, but does not accept that it meant it did not treat its customers fairly.

The level of penalty and the nature of the findings, both of which are made public, are very important from a reputational perspective for the subject of any investigation. All too often, in my experience, genuine and fair concerns have been dismissed by the FCA during the settlement process without appropriate consideration. In such cases the subject finds itself with very little choice but to agree to the FCA’s position and suffer the resultant publicity, rather than incur significant time and expense of contesting the entire case before the RDC. This also means that unhelpful precedents are set for those cases that follow.

The introduction of FRAs is likely to mean that more cases will go to the RDC and these will therefore benefit from the increased scrutiny of this more objective process. As I commented in my March 2016 column, the arbitrary nature of the FCA’s penalty policy and the lack of transparency is a particular concern for those caught up in the enforcement process. This reform will hopefully go some way to addressing this.

Changes to FCA settlement procedures

The FCA will now aim to give subjects 28 days’ notice of the start of stage 1 settlement negotiations and enforcement teams will hold a preliminary “without prejudice” meeting to explain the FCA’s view of the misconduct, including the key legal and factual bases for its view. In my experience, this is already happening, but the amendments to the Enforcement Guide (EG) will formalise the practice and are, in my view, an important improvement to the transparency and efficiency of the process. By the time stage 1 is imminent, the subject of an investigation is likely to have made multiple rounds of disclosure to the regulator, interviews may well have taken place, and (even with the new periodic update meetings) there is likely to have been a period of silence as the enforcement team works through the evidence and reaches a view. The subject will likely have made its own assessment of the evidence and will be mindful of the advantages and disadvantages associated with the settlement. Stage 1, once it commences, is often a period of very intense negotiations and is critical for all concerned. Therefore an opportunity for the subject of the investigation to gain a proper understanding of the FCA’s views prior to kicking it off has considerable benefits for both the subject and the FCA. There is little point in either party going through a settlement process if there is no agreement on the key issues.

These stage 1 procedures will also take on even greater importance because, as expected and
despite objections from many in the industry, the FCA’s current graduated settlement discount scheme is being reformed. Under the new rules, a settlement discount of 30% will remain available where the FCA and the subject of the investigation reach a settlement during stage 1, however the 20% and 10% discounts will be abolished. A failure to reach agreement in stage 1 will therefore result in no discount on financial penalties being available, even if a settlement is reached shortly afterwards.

The FCA does however retain the discretion in exceptional circumstances to effectively extend the
stage 1 period. While most cases that settle do so within the stage 1 period, there are reasons why cases settle at a later stage and the removal of the graduated discounts will mean some firms will not now get the credit they would have done under the old regime.

Faster access  to Upper Tribunal

The Treasury Review recommended that the regulators put in place a “clearly signposted, expedited procedure” allowing the subject to proceed directly to the Upper Tribunal, without making representations to the RDC, should they wish to contest the case within a tribunal environment. The FCA’s response to this was to point out that, to some degree, this possibility already exists, essentially because a subject can already elect not to make representations to the RDC and any decision notice may still be referred to the Upper Tribunal. However, the FCA will amend its procedures from 1 March 2017 to provide a right to the subject of enforcement action to bypass the RDC, either before or after a warning notice has been given, and make an expedited reference to the Upper Tribunal.

Referring any FCA decision notice to the Upper Tribunal is a material step that requires careful tactical consideration. Whilst there are some advantages, such as access to normal tribunal procedure, and in particular the ability to call and cross-examine witnesses, account also has to be given of the fact that tribunal proceedings are public, time-consuming and costly.

The expedited procedure is likely to be of most interest to individuals who feel they have been unfairly treated by the FCA and who, understandably, want their day in court. It is less likely to be of interest to firms, for whom the prospect of a settlement (and associated discount), or if no settlement can be reached, the confidentiality associated with an RDC hearing, will often remain more attractive than a tribunal hearing.

Referrals to Enforcement

I have previously covered the FCA’s July 2015 revised enforcement referral criteria. The joint policy statement includes some further details about the internal process that FCA will follow when deciding whether it should open an enforcement investigation. The FCA also confirms that it has two teams dedicated to liaising between Enforcement and other areas of the FCA which make referrals. These meet with managers in each area of Supervision and Markets on a regular basis. As I commented in my December 2016 column, I am starting to see these measures have a practical effect by allowing firms to constructively engage with the FCA to put things right without the need or distraction of an enforcement investigation.

At the moment, no further substantive changes are being made to the referral criteria which will remain broadly drafted allowing the FCA maximum discretion. I recognise the need for the regulators to retain this discretion. However, in my experience, it is not always exercised consistently. So, it will continue to be very difficult to predict whether a particular set of circumstances will push a firm into enforcement or whether the FCA will exercise its discretion and supervise any remedial action without subjecting the firm to an enforcement investigation.

Interestingly, the FCA does cross-refer to its separate consultation on its future mission, and states its intention to consider separately in light of responses to that whether the existing enforcement referral criteria need further amendment.

Co-operation between FCA and PRA in enforcement matters

The Treasury Review recommended a series of measures to improve co-operation between the FCA and PRA in joint investigations, such as regular update meetings between representatives from the enforcement and supervisory teams of both regulators and providing more guidance about the conduct of joint investigations, information requests being clear as to which investigation they relate, and on how they will approach decision-making in contested cases following joint investigations. These recommendations have generally been accepted and many have already been implemented.

There have been relatively few joint PRA and FCA investigations to date, but these changes are nevertheless welcome as the Treasury Review was correct to identify that such joint investigations can be especially onerous for subjects.

Transparency in enforcement investigations

A number of minor incremental changes have been introduced from 31 January 2017 with the aim of making enforcement investigations more transparent to those under investigation. While any attempt by the regulators to be more transparent is to be welcomed, as this has quite rightly been a key concern with the current process, whether these changes will deliver greater transparency in practice remains to be seen.I have begun to see signs of improvement in how the investigation teams engage, albeit the process is still painfully slow. 

The key changes are mostly by way of amendments to EG, which came into force on 31 January 2017, and are as follows:

  • The FCA will provide more information at the start of an investigation by explaining and setting out the criteria applied in coming to the decision to refer and giving a summary of the circumstances and the reason for the referral at the start of the investigation. I have already seen the FCA give more information at the outset of an investigation than the very high-level limited information it used to provide at this stage.
  • Scoping meetings, which are held at the start of an investigation, will include an indication of the likely timing of the key milestones and next steps in an investigation. In practice, this will mean that scoping meetings are likely to take place later than they have done in the past. If this means that the regulators will use these meeting as an opportunity to be more transparent about the particular course of an individual investigation, this is to be welcomed. Too often these meetings were generic and formulaic and of little benefit.
  • Periodic ongoing updates will be given to the subjects of investigations, on at least a quarterly basis, covering the existing and likely future steps in the investigation. This, of course, should not prevent the subject of an investigation taking the initiative and approaching the regulators for an update when they want one.

Strengthened provisions recognise that Supervision will have a role in informing the investigation team about a firm’s business, business model and market practice issues, and that it may be appropriate for a supervisor to attend an investigation progress meeting. These are small but welcome changes, as for many firms under investigation, the practical reality of dealing with Enforcement in the past has often involved an apparent disconnect between different divisions of the regulator. Hopefully, this will result in firms needing to spend a little less time assisting newly instructed Enforcement teams to understand their business.

A new era?

Certainly the regulators have had to take a long hard look at their enforcement processes and have made some important changes to their processes. It remains to be seen how these will play out in practice as the regulators retain a great deal of discretion. However, the signs are encouraging from the working practices and cultural changes I have seen, particularly in how the regulators are engaging with firms in resolving issues in their businesses.

I am also hopeful that the introduction of FRAs will rebalance the current settlement process, which is weighted heavily towards the investigation team, so that it delivers a fair outcome for firms.

One area that it is not clear will be addressed by the reforms is the pace of investigations and of senior decision-making and the impact this has on individuals in particular. Once the regulator decides to investigate, it is only fair that it does so (and reaches a conclusion) within a reasonable timescale. All too often progress is far too slow.

From the FCA’s perspective, this largely closes the enforcement review begun by the Treasury in 2014, although there may be further changes to come.The one key outstanding issue is the long awaited review of the FCA’s penalties policy, which was announced at the end of 2014 (and on which I have previously commented). The joint policy statement says that, once this penalty review is completed and FRAs have had an opportunity to take effect, the FCA will also consider, in a further review of EG, the more general points over the enforcement process that were raised by respondents to the consultation.

The PRA also appears to have further work in progress. The joint policy statement refers in a number of places to the fact that the PRA is expected to publish a new guide to its own enforcement processes during 2017, alongside reforms such as its forthcoming equivalent of the RDC: the Enforcement Decision Making Committee (EDMC), on which it consulted in 2016. 

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