Written evidence submitted by John Howard,
former Chair of the Financial Services Consumer Panel and a former
Non-executive Director of the Financial Ombudsman Service |
1. At the heart of the ill fated court action
by the banks over Payment Protection Insurance was a growing sense
that the Ombudsman service was becoming a quasi regulator.
2. And the judge in the case accepted that the
Ombudsman can go above and beyond the FSA rules. Mr Justice Ouseley
said in his judgement
that the FOS could hold that a firm should pay compensation even
though (the firm) had complied with the specific rules.
3. This endorses the findings of the Court of
Appeal in the case of Heather Moor & Edgecomb Ltd v FOS,
that the Ombudsman was not bound by the
common law and could exercise his own judgement as to what was
fair and reasonable.
4. This has created uncertainty in the financial
services industry, which means additional risks for firms, which
create more costs that must eventually be paid by customers.
5. I think that the uncertainty is misplaced
and firms can be much more confident about the products they sell
and the advice processes they use but they will need to change
their approach to deciding what is fair to customers.
6. Just about all consumer legislation seeks
to do one thing; to even up the negotiating positions of buyers
and sellers. This is true in financial services as well. Most
financial regulation has been put in place to try to overcome
the knowledge asymmetry that exists between buyers and sellers
of financial products. The seller knows all there is to know about
the product, the buyer knows very little, apart from the advertising
hype and, if they have read and understood them, the restrictions
and conditions in the contract.
7. If a customer understands all there is to
know about a product and purchases it willingly (without coercion
or deceit) then the sale must be "fair" and the customer
must stand by their decision to purchase.
8. The retail regulations put in place by the
regulator are requirements to provide certain information, and
present it in a particular way, to aid the customer's understanding.
The rules are the regulators attempt to ensure the customer understands
what they are buying.
9. Successive layers of regulation set out what
can and cannot be said in adverts; what must be explained in key
documents; what the sales person should tell the customer, all
in an effort to help the customer understand the product.
10. But even the best rules cannot ensure understanding.
Instead regulators use the provision of information as a proxy
for understanding. If the customer was given the required information
about the product in the right form, the regulator presumes the
customer understood what they were buying.
11. If a firm has not stuck to the "rules"
there is, in effect, a presumption that the consumer did not fully
understand what they were buying and that the transaction was
12. If a complainant goes to the FOS, and the
firm has not fulfilled the information requirements, the FOS is
most likely to find against the firm and in favour of the consumer.
13. But this simple approach fails to acknowledge
the weakness in all regulation and law making. It is not possible
to make rules that cover all possible circumstances. This is why
the FOS has the power to fill in the gaps. It is required to take
into account any rules and regulations in making its decisions
but the overriding consideration of the FOS must be the much wider
consideration of what is fair and reasonable.
14. The FSA Handbook sets out the FOS powers.
The Ombudsman will determine a complaint
by reference to what is, in his opinion, fair and reasonable in
all the circumstances of the case.
In considering what is fair and reasonable in all
the circumstances of the case, the Ombudsman will take
rules, guidance and standards;
of practice; and
appropriate) what he considers to have been good industry practice
at the relevant time.
15. A firm may follow to the letter the regulations
for the sale of a particular product but this cannot guarantee
that a particular consumer, in their specific circumstances, has
understood what they have bought.
16. I believe that this is the strength of the
Ombudsman system. It is in this situation that the FOS has the
power to ignore the law and the regulations and come to a decision
that, in the particular circumstances of that case, the deal was
17. Fairness is a question of judgment and so
the Ombudsman service is charged with making a judgement about
whether the consumer understood what they were buying. If the
Ombudsman's judgement is that they did not, he can then decide
that the transaction was unfair despite what the rules say. This
is a fundamental principle which must be preserved.
How Should the FOS Reach its Judgements?
18. In the simplest case, if the FOS finds that
a product or process does not meet the FSA rules, it must find
in favour of the customer.
19. If the firm or firms have sold the same product
in the same way to many customers, the FOS will have identified
a systemic problem. If, of their own volition, the firm or firms
are not prepared to recompense all customers with similar cases,
the FOS should not be placed in the position of hearing hundreds
of similar cases. In those circumstances it should be required
to notify the regulator. (This is a step beyond the "Wider
20. The regulator is empowered to deal with systemic
issues and it should be required to take up those cases
and, using its enforcement powers for a breach of the rules, order
compensation for the affected consumers and approve changes to
the product or process before their continued sale.
21. If the product or process is fulfilling the
regulator's requirements, then the FOS should still go on to ask
a number of other questions.
First, "Did this particular consumer
understand the product they were buying?".
If the customer did understand the product the FOS
must find against the consumer, because he understood and accepted
22. If it believes that the consumer did not
understand, it must then ask: "Given the circumstances of
the case and the information and advice provided, could
this particular consumer have understood the product if they had
If it concludes that it was unlikely that the consumer
in question could have understood, it must decide that they were
treated unfairly and find against the firm.
23. In that case the Ombudsman must then go on
to ask: "Would a reasonable person involved in an identical
transaction have understood what they were buying?".
If the Ombudsman concludes that a reasonable person
would have understood the product there are no wider implications.
If the Ombudsman judges that a reasonable person
would not have understood the product, it will again have identified
a systemic problem which should be referred to the regulator.
Implications for the Financial Services Industry
24. This approach does require a major shift
on the part of the financial services industry.
The industry must recognise that retail regulation
is the FSA's attempt to ensure that customers understand what
they are buying. But inevitably simple adherence to the rules
cannot guarantee that a customer understands.
25. The final decision on whether the customer
understood what they have bought belongs to the Ombudsman in any
individual case. This means it is not sufficient to simply comply
with the rules. Firms must judge whether the Ombudsman will accept
that the customer understood the deal.
26. When designing products and processes firms
must ask, "would a reasonable consumer provided with this
information, presented in this way, understand what they were
buying?" If the firm can answer "yes" to this question
it will avoid a systemic complaint.
27. If the firm then receives a complaint about
that product it must again ask if that particular consumer
understood what they were buying or could have understood if they
had tried. This is the question the Ombudsman will ask.
28. Firms must ensure that each customer understands
what they are buying and they must be prepared to live with the
consequences if they do not succeed in conveying that understanding.
29. This will present a major challenge to the
industry. It has always relied upon processes which treat customers
en mass; solutions which generally produce a fair outcome
for the majority of customers. This is probably no longer adequate.
Firms must attempt to produce processes which will identify if
individual consumers understand what they are buying.
30. It also raises a number of ethical questions
which the FSA has said society must decide. The first is, should
customers who do not understand a product be denied the opportunity
of buying it? How much of a product and its associated risks should
they understand? This could exclude sections of society from purchasing
products of benefit to them. If they cannot understand the nature
and risks of a mortgage should they be prevented from becoming
31. If they do purchase without understanding
the product, they are relying on the seller to make paternalistic
judgements on their behalf. The seller is obliged to ask himself,
"If I was this person, but knowing what I do, would I buy
this product?" and if the answer is no, not selling it to
them. This debate will be the subject of another of my papers.
FOS AND FSA
32. When, in the circumstances above, the FOS
notifies the regulator of a systemic unfairness, this could create
a point of disagreement between the regulator and the ombudsman.
The FOS may decide that a systemic issue is creating unfair outcomes
for consumers and refer it to the regulator. The regulator may
disagree and say, on balance, the product or process is not producing
unfair outcomes for consumers.
33. Any MOU between the FCA and the FOS must
therefore contain a mechanism whereby a decision on fairness about
a systemic issue identified by the ombudsman and referred to the
regulator, must be agreed by the regulator and the ombudsman.
The FSA must have the final decision and the ombudsman must sign
up to that interpretation.
34. Any subsequent departure from the agreed
position on the point must only be allowed if any new case can
be distinguished by the Ombudsman on its particular circumstances
from the original point.
FOS PUBLISHING IT'S
34. It is entirely appropriate that the FOS publishes
details of the Ombudsman's determinations (but not adjudicators
rulings) but it must be accepted that these are not precedents
and will not be binding in future, because the Ombudsman is making
a decision which relies on the particular circumstances of each
35. So the FOS should also explain whether it
regards the decision as turning on the particular facts of that
individual case or whether there are likely to be many similar
cases. As described above, if the ombudsman believes there could
be many similar cases then the FSA should be required to take
regulatory action to deal with those cases.
36. The publication of details of cases have
a number of advantages:
will widen understanding of the Ombudsman's view of fairness and
his approach to particular types of cases.
will encourage confidence in the FOS because the industry will
have a greater understanding of the FOS approach.
will encourage consistency of approach within the Ombudsman Service
37. Case reports should be anonymised to protect
members of the public and ensure that they are not discouraged
from bringing their cases to the FOS.
38. The Ombudsman's discretion to ignore the
law and FSA regulations and make a judgement based on what is
"fair and reasonable" is central to the success of the
service and should not be tampered with in any way.
39. Success in these terms is a speedy, uncomplicated,
efficient and accessible dispute resolution service that is free
to the public.
40. Purists may challenge the legal robustness
of the process but to try and improve the service by making it
more legalistic will defeat its purpose and do consumers and firms
54 R(BBA) v FSA and FOS EWHC 999 (Admin) at para183 Back
(Heather Moor & Edgecomb Ltd) v FOS  EWCA Civ 642, 
Bus LR 1486.) Back
R(BBA) v FSA and FOS EWHC 999 (Admin) at para183
R(Heather Moor & Edgecomb Ltd) v FOS 
EWCA Civ 642,  Bus LR 1486.) Back