In the Regulator’s Cross Hairs

In the last year there has been a marked shift in the Financial Services Authority’s (FSA) approach towards Approved Persons, with the FSA now taking a much more interventionist role. Hector Sants, FSA Chief Executive, said in a speech on 9 November 2009 that “...[the] FSA…has evolved and has introduced a radically new approach; intensive supervision; designed to deliver our outcomes-focused philosophy…”

A key effect of the move towards “intensive supervision” is that Approved Persons’ influence on regulated firms will be increasingly monitored. Mr Sants made this clear: “...We all recognise that culture is driven by individuals and in particular senior executives who: ‘set the tone from the top’...our authorisation regime should seek to make a determination of an executive’s ability to set a strong ethical framework and to foster the right culture. [The] enforcement regime can also be used where we find cultures that are driving inappropriate behaviours…”

This change in focus means that the screening of potential Approved Persons for regulated firms is under more scrutiny than ever before.

Pre-employment screening

The increased need to conduct pre-employment screening fully was emphasised in July 2009 when the FSA personally fined Richard Holmes of AIF Limited £20k. Mr Holmes recruited an Appointed Representative but failed to obtain appropriate evidence of the Appointed Representative’s competence and then failed to monitor the activities of the Representative. In announcing the fine, the FSA reiterated that: “Senior management at firms are responsible for the standards of conduct of the businesses they run”.

In October 2009, the FSA issued a ‘Dear CEO’ letter to the Chief Executives of all regulated firms. The letter stated that the FSA now “...expects high impact firms subject to close and continuous monitoring, to engage with us at an early stage (short listing of candidates) of the recruitment process for the roles of Chair, Chief Executive, and Senior Independent Director…”

There are concerns that these shortlists will be leaked to the market, which could create situations where unsuccessful candidates for appointment are put in the potentially difficult position of their current employers finding out that they applied for another job.

In addition, increased involvement of the FSA in the recruitment process means there is a risk that the FSA will not just regulate the sector, but control its development. Already the FSA’s more interventionist role in scrutinising senior management jobs has seen firms withdraw applications before the FSA interview stage. Twelve candidates had their applications withdrawn after interviews where they were quizzed by the FSA over issues relating to their “necessary experience and integrity” for the role. A further three applicants for senior roles withdrew their applications in the run up to those interviews.

There is currently no practical method for firms to appeal if they feel that the FSA’s concerns are unfounded. If they did appeal and lost the FSA would put out a public statement saying that the individual had been rejected. Firms do not want to take the risk of being publically accused of putting forward a supposedly substandard candidate. The potential reputational damage to both the firm and individual is great and the ensuing publicity may severely restrict the candidate’s ability to find another senior job.

Follow up checks

The importance of fully carrying out a follow up check, and acting upon the information revealed in that check, was illustrated in August 2009 when the FSA fined Christopher Davies, director of Newquay Investment Services Limited £17.5k. Mr Davies had applied for an adviser to be confirmed as an Approved Person. However, later he became aware that the adviser’s previous employer had suspended the adviser because of concerns about his business methods and ethics. Mr Davies failed to disclose the information he had gained to the FSA.  Margaret Cole, FSA Director of Enforcement and Financial Crime, said “...the fine indicates that the FSA takes a serious view of such failings and serves as a deterrent to directors of regulated firms from acting in a similar way…”

Increased FSA monitoring

The October ‘Dear CEO’ letter also refers to the FSA placing greater emphasis on monitoring persons already performing significant influence functions, including examining more critically the competence of such persons as part of FSA ARROW assessments. It therefore appears that the FSA will, as part of its routine monitoring of firms, be proactively considering the performance of senior management. If that is found to be lacking, enforcement action may follow.

Some commentators have, however, criticised the FSA for not going far enough. The Chairman of the Financial Services Consumer Panel wrote to the FSA: “...until the FSA takes action against the senior management in a major financial firm this policy will lack credibility. We therefore encourage the FSA to take action against senior management in firms when it is clear that senior management have turned a blind eye towards business practices which ran the risk of generating consumer detriment.”

FSA, enforcement led Regulator

In addition to increased monitoring, the FSA has also increased its emphasis on the importance of enforcement as a regulatory tool. Last year, Margaret Cole, clearly set out the new stance of the FSA. She stated: “...enforcement is…a key part of delivering on our goal to achieve credible deterrence. ...If we get ‘credible deterrence’ right we will be well on our way to reforming actual behaviour”. Mrs Cole described a “strategic decision” to investigate more individuals and not only bring enforcement proceedings for dishonesty or market abuse, but also for incompetence.

The Enforcement & Financial Crime Division has stated that by focusing on individuals it will achieve greater impact in terms of deterrence. This focus on individuals should be considered alongside the FSA’s strategy to hold individual senior managers responsible for compliance breaches. The FSA is currently proposing levy fines of up to 40% of an individual’s salary and benefits. The FSA’s revised position means that individuals will not only be penalised for lack of integrity but also for compliance failings.

While the FSA is moving towards increased levels of enforcement, it is too early to know whether it will bring enforcement proceedings against the senior management of any of the so called ‘failed’ financial institutions. Under the Financial Services & Markets Act 2000, proceedings do not become public until they are completed (and only then if a financial penalty and/or censure is imposed). We are therefore unlikely to discover if any enforcement action has been taken in these cases until late 2010 or 2011.

However, the new stance of the FSA will mean that the role of Approved Persons will be subject to substantially increased levels of scrutiny at every stage with increasingly onerous penalties being enforced. Therefore the screening and monitoring of and by Approved Persons is ever more important than before.

“Companies need to recruit and train people in whom they have confidence and whom they can trust. It is confidence and trust that are real safeguards against fraud and disaster, and they can only be fostered and instilled on a sound ethical basis”

Sir Adrian Cadbury, Committee on the Financial Aspects of Corporate Governance, 2002

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