VI. DISCIPLINE AND ENFORCEMENT
147. According to the Progress Report, "The
main focus of comment on the draft Bill has been on the disciplinary
process. There has been a perception that the FSA internal procedures
may lack fairness and transparency, or be unduly costly and burdensome,
and that the FSA will be able to act as 'prosecutor, judge and
148. The processes in question are modelled on those
of the existing SROs; but it seems they appear more frightening
when transferred to a single statutory authority. The level of
feeling on this issue may also be linked to concern that the culture
of the FSA may be different from that of the regulators which
it is to replace, and in particular less practitioner-based. It
may be that anxieties have been increased by the proposals for
a wholly new regime for market abuse (see below). Mr Marc Sylvain,
Managing Director, Fidelity Investment Management Limited, crystallised
this fear for us by raising the possibility of the FSA engaging
in "regulatory abuse".
It is not hard to see the connection between the concerns, noted
above, about the FSA's accountability and those that are expressed
in relation to its disciplinary powers: the more power is vested
in the FSA, the more those who may be affected by the exercise
of such power will be concerned to see that the FSA's powers are
tightly defined and controlled, and that the FSA can be held properly
149. There is obviously a balance to be struck, between
giving the regulator efficient and effective means to protect
the consumer and the good name of UK financial services, and producing
procedures which are fair and are seen to be fair.
150. In seeking this balance, regard must be had
to the danger of being over-prescriptive in the primary legislation.
If, in pursuit of fairness, so many safeguards are written into
the Bill that the FSA cannot act quickly and effectively, this
will not serve the interests of the markets. Also an overly-detailed
statutory scheme runs the risk of becoming out-of-date very rapidly.
151. The FSA will be subject to judicial review.
If it fails to comply with the principles of natural justice and
fairness, the courts will be able to intervene.
It will also be open to action on the basis of the European Convention
on Human Rights,
which is to become part of UK law when the Human Rights Act 1998
is brought into force (which is expected to be next year, around
the time of the passage of the eventual Financial Services and
Markets Act or soon afterwards). The availability of judicial
review reduces the need to set out detailed procedural safeguards
in the Bill. However, if the Bill puts in place disciplinary and
enforcement regimes that would clearly fall foul of the ECHR,
it will set up the FSA for defeat in the courts. This could have
damaging implications for the whole financial services sector
and the international position of the City of London.
152. ECHR concerns were emphasised in much of the
evidence we heard and also in the written submissions we received.
There is a very real difficulty, as we explain below, in applying
ECHR jurisprudence to regulatory and disciplinary decision-making.
The Minister told us that there was "room for disagreement
between lawyers" about the application of the ECHR, and that
the case law was complex and inconsistent; but the Government
would satisfy themselves that the Bill as introduced would be
No doubt they will, before Ministers sign statements to that effect
under s.19 of the 1998 Act. But the courts will take their own
view; they may interpret the legislation in unexpected ways in
the light of the ECHR, and might even declare some provisions
incompatible with the ECHR altogether.
153. This would not invalidate the legislation. However
it would seriously undermine the moral authority of the FSA, to
the detriment of confidence in UK financial services and markets.
This would be a highly undesirable outcome. We have therefore
paid special attention to this issue.
154. These issues must be kept in proportion. The
business of financial services regulation is not, or should not
be, carried on predominantly by means of discipline and enforcement.
The aim must be to cultivate in the industry a culture of compliance
and openness, in which the regulator's business consists largely
of supervision and guidance, and in which (in the words of Mr
Philip Telford of the Consumers' Association) "firms that
adopt good practices have nothing to fear".
The IFAA, the BBA and the London Investment Bankers Association
(LIBA) all told us that this is their aim;
so did the FSA.
The question is, whether the Treasury's proposals will foster
such a climate, or militate against it.
FSA powers of discipline and enforcement against
authorised persons and their staff
155. Before considering the procedures for the exercise
of the FSA's powers, it is necessary to know what those powers
are proposed to be. According to Mr Davies, "For the firms
we regulate they are no more than a consolidation of the powers
the different regulators have now"with
the important exception of the new powers over market abuse (see
156. Under Part XII of the draft Bill, breaches of
FSA rules (including the rules written at a high level of generality
which the FSA refers to as "Principles for Businesses")
by authorised persons may be punished by the FSA by public censure,
or withdrawal of authorisation
or of permission to carry on a particular regulated activity.
It is up to the FSA whether or not breach of a rule is actionable
at the suit of a "private person" as defined by the
FSA, or at the suit of any other person.
Action by a private person will generally be possible unless the
rule in question expressly states otherwise; for other persons,
the position is the other way round and the rule must expressly
confer a cause of action.
157. Under Part V, if individual employees of authorised
persons are found not to be "fit and proper", the FSA
may withdraw approval to carry out regulated functions,
or prohibit them from employment altogether.
In addition, approved persons will be subject to statements of
principles and codes of conduct under Clause 48; if an approved
person breaches such a principle or code, or is "knowingly
concerned" in breach of any requirement under the Act, the
FSA may fine or publicly censure him.
158. In addition, the FSA may seek an injunction
or restitution order from the courts,
and may prosecute offences.
159. According to the Progress Report, "The
need for the FSA to be equipped with a range of disciplinary powers
was generally accepted by consultees".
160. The FSA's power to define "private person",
for the purpose of determining rights of action for breach of
causes the Delegated Powers Committee "considerable unease".
Lord Lester considered it "quite extraordinary" and
"constitutionally improper" that such a power should
be exercised by anyone other than Parliament or a Minister.
161. The Treasury's Explanatory Notes on the draft
Bill explain, "This clause does not remove any common law
cause of action which a person might otherwise have. It allows
a class of people to be able to recover losses just by showing
that there has been a breach of a rule as a result of which they
have suffered loss rather than having to rely on that breach as
evidence of negligence". The FSA explain that the power to
define private person "would allow us to ensure, in the interests
of firms and consumers, that the same definition of private person
is used to determine both who is a private person protected by
particular rules, and who is a private person able to sue for
breach of those (or other applicable) rules. This is a useful
contribution to our ability to distinguish between the different
levels of protection appropriate for different categories of consumer."
We accept that there is a good reason for a power to define
"private person" but we are persuaded by the constitutional
argument for not giving this discretion to the FSA. We therefore
invite the Government to justify this provision or to amend it.
162. More information about the various forms of
FSA power envisaged in the draft Bill is given in Tables I and
TABLES OF APPLICABLE REQUIREMENTS UNDER
Table I : Authorised Persons
Nature of Requirement
Public Announcement of FSA Decision (after Tribunal Hearing (if any))
general (cl 70)
asset identification (cl 73)
price stabilising (cl 75)
financial promotion (cl 76)
money laundering (cl 77)
auditors & actuaries (cl 196)
*FSMB refers only to "rules". Term covers rules at high level of generality (which FSA refers to as principles) as well as detailed rules
FSA enforcement and FSMB action by other persons (details below)
Contravention is not an offence and does not affect validity of transactions (cl 81)
Yes in respect of FSA enforcement action (details below)
Not generally mandatory; will depend on nature of enforcement action taken or FSA policy (details below)
Rule can state that compliance with, or contravention of, it tends to establish compliance with or contravention of, another rule (cl 79)
Breach of rule containing such a statement cannot itself lead to enforcement action (cl 79)
FSA public censure (cl 135)
FSA financial penalty (cl 136)
FSA's general policy will be to announce but it suggests that there may be exceptional cases
FSA withdrawal of authorisation (cl 27)
As for fines. Also, person will be removed from public register of authorised persons (cl 33)
FSA cancellation of permission (cl 37)
As for fines. [Will this be apparent from register of authorised persons (cl 33)?]
Table I: Authorised Persons (Continued)
Nature of Requirement
Public Announcement of FSA Decision (after Tribunal Hearing (if any))
FSA restitution order (cl 206)
No stated policy
FSA can ask court for injunction (cl 202) or restitution orders (cl 204)
Civil law claim by private persons unless rule excludes this or it is a rule about having/maintaining financial resources (cl 80)
Civil law claim by other persons if rule provides for it (cl 80)
FSA Guidance (cl 87)
- it is standing guidance if it is in writing/other legible form and is intended to have continuing effect
- guidance (standing or otherwise) may be on any matter
No formal evidential status
FSA Modifications/Waivers (cl 78)
FSA can modify/waive its rules (other than asset identification rules) in their application to an authorised person
Table II : Approved Persons
Nature of Requirement
Public Announcement of FSA Decision (after Tribunal Hearing (if any))
Statement of Principles (cl 48)
FSA enforcement (cl 50) (details below) but no FSMB action by other persons (cl 48)
Not generally mandatory; will depend on nature of enforcement action taken or FSA policy (details below)
FSA fine (cl 50)
FSA's general policy will be to announce but it suggests that there may be exceptional cases; FSA expressly authorised to publish information about any decision not to proceed with proposal to impose fine (cl 53)
FSA public statement of misconduct (cl 50)
FSA prohibition on employment (cl 40)
FSA policy, as for fines]
FSA withdrawal of approval (cl 47)
FSA policy as for fines]
Codes of Practice (cl 48)
code must accompany any statement of principles
Non-compliance with code of practice may amount to contravention of statement of principle to which it relates (cl 48)
Code may be relied upon so far as it tends to establish whether or not conduct complies with statement of principle (cl 48); has evidential value but is not conclusive
Requirements Applicable to Authorised Persons
Liable to enforcement action if knowingly concerned in contravention by authorised person (cl 50); forms of enforcement action as for contravention of statement of principles
Not generally mandatory; will depend on nature of enforcement action taken or FSA policy
Civil or criminal?
163. Article 6 of the ECHR guarantees the right to
a fair trial. The precise content of this right depends on the
classification of the proceedings in question for the purposes
of the Convention. Where proceedings are classed as criminal rather
than civil, individuals enjoy more extensive safeguards. On the
face of the Bill as drafted, and in UK law, the disciplinary regimes
will be civil rather than criminal in nature. For instance, Clause
81 expressly provides that breach of FSA rules is not an offence;
and Part VI is headed Civil fines for market abuse. However,
the courts will be bound to apply the Convention, and they might
conclude, on the basis of the nature of the offence or the penalty,
that proceedings which were civil in domestic law nonetheless
attracted the provisions of the ECHR applicable to criminal cases.
164. Lord Lester pointed out to us, "These are
not alien, foreign, curious European standards; the standards
in Article 6 of the Human Rights Convention were drafted by British
legal civil servants reflecting ancient British principles of
natural justice and fairness and Article 6 is described in Strasbourg
as the 'British' Article of the Convention."
165. This issue has been a central part of many of
the concerns that we have heard about the disciplinary and enforcement
provisions of the Bill. We consider it here because it has influenced
our thinking generally in this area; we also return to it specifically
in the context of the proposed market abuse regime.
166. There are two key points: procedural safeguards,
and certainty. First, for all proceedings, the ECHR entitles everyone
to "a fair and public hearing" before "an independent
and impartial tribunal".
167. Further safeguards are imposed in criminal trials.
Article 6.2 enshrines the presumption of innocence where someone
is "charged with a criminal offence"; this is taken
to include the privilege against self-incrimination. Article 6.3
gives additional rights in criminal cases, including:
- Prompt and detailed information of the "nature
and cause" of the charge;
- Time and facilities to prepare a defence;
- Right to representation;
- Right to free legal assistance "when the
interests of justice so require";
- Right to examine and cross-examine witnesses.
168. Finally, the ECHR requires criminal offences
to be clearly defined in law.
This is an issue we return to later in this chapter in relation
to enforceable principles, and which we also consider later in
the context of market abuse.
169. There has been much argument as to whether the
general disciplinary and market abuse regimes of this Bill will
count for these purposes as civil or criminal. Mr Guy Morton,
a partner in Freshfields, considers them to be criminal.
So do Clifford Chance,
on the ground that the penalties at stake are criminal in nature,
being intended to punish and deter.
Herbert Smith consider that the market abuse regime is criminal
but acknowledge that there are arguments both ways with regard
to the disciplinary procedures.
170. The question is considered in detail in an Opinion
by Lord Lester of Herne Hill QC and Javan Herberg, and a subsequent
Advice by Lord Lester and Monica Carss-Frisk, commissioned by
LIBA, BBA, the Futures and Options Association (FOA), the International
Swaps and Derivatives Association (ISDA), the Institutional Fund
Managers' Association (IFMA), Clifford Chance, Freshfields and
Linklaters & Paines, and kindly supplied by them to us.
Lord Lester's view is as follows. "The case law of the European
Court of Human Rights in this area is complex and sometimes inconsistent
and unclear" . However "it is strongly arguable that
all of the disciplinary offences, and in particular the market
abuse offences, are indeed 'criminal'", because of "the
nature of the offences, and the nature and severity of the penalties".
Mr Davies put up counter-arguments, in relation to market abuse,
in his Chancery Bar Association and Combar Spring Lecture, Financial
Regulation and the Law, at Lincoln's Inn on 3 March;
Lord Lester addresses these arguments in his Advice in relation
to both market abuse and general discipline and enforcement. In
oral evidence at the end of our inquiry, Lord Lester and Lord
Hobhouse of Woodborough agreed that proceedings involving the
prospect of a large fine ought to attract the criminal safeguards.
However Lord Lester admitted that this was "a question of
degree", depending on the seriousness of the penalty at stake.
171. The question whether the proposed market abuse
regime is civil or criminal in ECHR terms is discussed in more
172. The Delegated Powers Committee draws attention
to the uncertainty as to whether the Bill's processes are civil
or criminal. It concludes, "We believe this uncertainty is
unacceptable and that the position should be clarified in the
This view is consistent with a view expressed by Mr Morton of
Freshfields: "whoever is right on these perhaps arcane matters
it is essential, I would submit, that the position be clarified
before the bill is passed, because nothing could be more damaging
than to proceed and to find that there remained uncertainty or,
even worse, that the first time the powers were used they were
struck down on Convention grounds".
173. We agree, and consider that it would be naïve
not to expect someone to take the point, sooner rather than later.
In our view, on the evidence, it is at least possible that the
courts would find FSA disciplinary proceedings under the legislation
to be of the nature of criminal justice. This creates a dilemma:
building in criminal justice safeguards to the entire regime would
make for an unwieldy, adversarial and expensive regime which neither
the FSA nor the industry wants; not doing so creates the risk
of successful legal challenge, leading to embarrassment and the
need for further primary legislation.
174. We have no doubt that the Government will reflect
seriously on this matter before finalising its proposals However,
although s.19 of the Human Rights Act requires the Government
to publish its conclusion as to whether or not the Bill as introduced
into Parliament is compliant with the ECHR, it is not required
to show its reasoning. In the present situation, this is unsatisfactory.
We recommend that the Government should publish, as soon as
possible, its reasoned view as to what ECHR standards will apply
to FSA disciplinary proceedings, and its reasons for believing
that the Bill will meet those standards. We can then reconsider
the matter with both sides of the argument before us; and Parliament
can then give the issue proper consideration as the Bill goes
Standard of proof
175. As a matter of English law, criminal charges
must be proved beyond reasonable doubt; civil actions are decided
on the balance of probabilities. On the face of it, therefore,
designating a regime as "civil" rather than "criminal"
advantages the prosecutor by making it easier for him to get a
favourable result. This raises the question whether using the
civil burden of proof would fall foul of the ECHR in relation
to provisions which are criminal for that purpose.
176. We have been told that this concern may be misplaced,
since it is well-established that the court or tribunal in a civil
action can apply a "sliding scale" of proof, applying
more or less the criminal standard where criminal-type penalties
are at stake. The FSA confirmed that this was its understanding;
and we understand that this would be sufficient to satisfy the
Disciplinary process: a moving target
177. The Treasury has indicated that, as a result
of consultation, the disciplinary processes envisaged in the draft
Bill are to be modified in certain important respects. Also, the
FSA's proposals for operating within the statutory framework have
developed as a result of its own consultation exercise and the
Treasury's review. Whilst our recommendations are based on the
Treasury's and the FSA's latest positions, we set out the background
briefly below as this is helpful in understanding the current
position. Time constraints meant that we were unable to take views
from many witnesses on the FSA's latest proposals.
178. The disciplinary process envisaged in the draft
Bill, in respect of contraventions by authorised persons, was
as follows. For convenience, we refer to the person subject to
proceedings as the "defendant".
- If the FSA proposed to impose a financial penalty
or public censure, it would give the defendant a warning notice,
- The defendant would have a reasonable period,
specified in the notice, of at least 28 days, to make representations.
- The FSA "must then decide, within a reasonable
period, whether to carry out its proposal".
- If the FSA decided to impose penalty or censure,
it would give the defendant a decision notice,
- "The Authority may publish such information
about the matter to which a decision notice relates, in such way,
as it considers appropriate".
- At this point, the defendant could appeal to
the Financial Services and Markets Appeal Tribunal to be set up
under Clause 67.
- From the Tribunal, there would be a right of
appeal on a point of law to the High Court, by leave, or the Court
179. The process in respect of individual approved
persons was similar.
Treasury's proposals: procedural safeguards
180. According to the Progress Report issued in March
1999, the Government is proposing in the light of consultation
"to make significant improvements to the provisions relating
to disciplinary procedures".
The FSA is to be required to establish and publish procedures
and to act in accordance with such procedures; defendants are
to be entitled to see the evidence against them; and FSA is not
to publicise enforcement action until the full process, "including
any tribunal procedures", is over.
The BBA and LIBA advocated these changes in their submissions
to the Treasury; AUTIF welcome them.
181. Also, following the Saunders judgment,
oral evidence obtained under compulsion will not "generally"
be admissible in criminal proceedings:
Treasury's proposals: first-instance tribunal
182. The Treasury have also announced changes to
their plans for the Tribunal. The Tribunal is to be "a tribunal
of first instance, fully able to consider the merits and facts
of each case and with the authority to substitute its own conclusions
for those of the FSA"; its name will be changed to reflect
its role more accurately.
The power in the draft Bill,
for the Lord Chancellor to rule certain kinds of new evidence
to be inadmissible before the Tribunal, is to be dropped; and
the Government propose to "enhance [its] status and shorten
the path to justice" by providing for appeal (on a point
of law) direct to the relevant appeal court rather than via the
183. In Lord Lester's opinion, the proposals for
the Tribunal now meet the requirement of Article 6.1 of the ECHR
for an entitlement to be heard by an "independent, impartial
FSA's December proposals: Quasi-Judicial Enforcement
184. In December, before the Treasury's Progress
Report, the FSA set out its proposals for operating the disciplinary
process in Consultation Paper 17. Its aim was "to produce
a process that will operate in an effective, efficient and demonstrably
fair manner. In particular, there will be a clear separation between
those who investigate and those who determine whether the FSA
should impose sanctions and we propose to involve practitioners
and public interest representatives in the process. There will
also be an opportunity for oral hearings".
185. CP17 proposed an Enforcement Committee, established
by the FSA Board, "to consider cases in which FSA's operational
staff believe that the exercise of the FSA's powers to impose
a disciplinary sanction, restitution order or civil fine for market
abuse is appropriate",
and to act on the Board's behalf. The Committee would have a full-time
Chairman, employed by the FSA specifically for that purpose, recruited
by open competition, and reporting to the Board. Committee staff
would not be part of any FSA operational directorate. The Committee
would have legal expertise, either in the person of the Chairman
or another member, or through dedicated advisers. The Committee
would have practitioner and public interest representatives, who
would consider cases and hear representations alongside the Chairman;
CP17 posed the question whether the decisions would be made by
majority, or by the Chairman alone.
186. The Treasury Select Committee welcomed these
187. The arrangements described above would be internal
to the FSA, and would not have statutory backing. It would therefore
be open to a future FSA Board to adjust or abandon them at will;
but they would continue to be bound by the requirements of fairness
and the ECHR. The Delegated Powers Committee
and some of our witnesses
consider that the Enforcement Committee should feature in the
Bill. In the view of the Minister,
this would be unnecessary and inappropriate, since "its entire
legal being stems from...the
Act and from the existence of powers of the Board of the FSA".
Relationship between Enforcement Committee and
188. This report represents a snap shot at a moving
target, and nowhere is this more apparent than on the question
of the relationship between the Enforcement Committee proposed
by the FSA and the first-instance Tribunal proposed by the Treasury.
At the end of two hearings devoted largely to this subject, Mr
Whittaker acknowledged, "We are all finding it difficult
to accommodate the implications of there being a first instance
tribunal". What is wanted is a system "which provides
people with confidence that their decisions have been dealt with
fairly but nevertheless by more speed than they might get with
189. In the course of our hearings, the role of the
Enforcement Committee was discussed largely in terms of two models,
Model 1 Quasi-Judicial Enforcement Committee
190. In model 1, the FSA Enforcement Committee reaches
decisions of a quasi-judicial character, as to guilt and penalty,
from which the defendant can resort to the Tribunal. This appears
to be roughly what the Treasury originally had in mind, as indicated
by the Tribunal being called an "Appeal Tribunal" in
the draft Bill.
191. In evidence, many witnesses told us about additional
safeguards that would, in their view, have to be written into
the Bill in order to ensure the fairness of this model. Lord Archer
of Sandwell QC, Chairman of the Council on Tribunals, offered
the following list:
- A "Chinese wall" between FSA supervisory
and enforcement staff, perhaps reinforced by physical separation;
- Oral hearings;
- The Enforcement Committee Chairman to be independent
of the FSA and legally qualifiedperhaps a judge, either
seconded or retired;
- The other members of any Enforcement Committee
panel to have votes, rather than merely advising the Chairman.
192. Mr Sylvain of AUTIF supported Lord Archer's
On the other hand Mr Peter Vipond, Director of the BBA, said that
it would make the Enforcement Committee look "awfully like
193. Clifford Chance and Herbert Smith considered
that it would demand more than a Chinese wall within the FSA.
The former suggested that the Enforcement Committee might be split
into two panels, for prosecution and adjudication.
The latter considered that the Enforcement Committee would have
to be "a separate independent body, accountable to the Treasury".
Model 2 Non-Judicial Enforcement Committee
194. In model 2, the Enforcement Committee cannot
make decisions of a judicial character and its role is akin to
that of a prosecuting authority rather than a court. If a case
cannot be settled by agreement, the Enforcement Committee decides
whether there still appears to be a prima facie case to
if there is, it goes to the Tribunal.
195. This model was advocated to us by Clifford Chance.
In their view,
it met the requirement for clear separation between prosecution
and adjudication. By creating a climate of fairness, it would
encourage defendants to "buy into the result" at the
Enforcement Committee stage, so that most cases could be agreed
and few need go to the Tribunal. At the same time, because the
Enforcement Committee was not an adjudicator, it could dispense
with the full rigour of natural justice, and deliver the "fast
and efficient results" required by the regulators
and by the industry.
196. Model 2 was also advocated by Herbert Smith.
They argued that building into the Enforcement Committee stage
the safeguards required under model 1 would be "cumbersome"
and "not practical".
In their view, "The Enforcement Committee would act as a
would be able to have settlements without admitting liability...I
would not expect the breaches which have been described as administrative
to find their way up to the Tribunal".
FSA's April Proposals: Non-Judicial Enforcement
197. On 13th April, following our hearings
on these issues, the FSA and the Treasury gave us clarification
of their thinking on the enforcement process.
The main points are:
- Following the Treasury's clarification of the
role of the Tribunal, the Enforcement Committee would not operate
in the quasi-judicial manner envisaged in CP17. Instead, as the
Treasury put it, there would be "a distinct separation between
the regulatory procedures of the FSA, which are administrative
in nature, and the judicial procedures of the Tribunal".
- The practitioner and public interest members
would have votes. (The Treasury confirm that this would present
no legal difficulty.)
- The Committee would make the decision to issue
a Warning Notice.
- At this stage, there would (according to the
FSA) be an opportunity for settlement discussions, and for independent
mediation between FSA staff and the defendant. The latter is intended
to reduce the scope for oppressive plea-bargaining.
- There would also be disclosure by the FSA, and
the opportunity for written or oral representations, but no witness
- The Committee would ratify the terms of any settlement
reached at this stage.
- Settlements would be embodied in a Decision Notice,
which would generally be published.
- If no settlement were reached, the Committee
would either dismiss the case, or issue a notice stating (in the
FSA's words) "the action that the FSA considers appropriate
(including any proposed penalty)".
- If within 28 days the defendant did not opt for
the Tribunal, the notice would be published and take effect.
- If the defendant did opt for the Tribunal, the
notice would not be published, and statements made by the defendant
to the FSA during settlement discussions on a "without prejudice"
basis would not be disclosed to the Tribunal.
198. This is neither model 1 nor model 2, but an
elegant hybrid which we find attractive. The touchstone is the
nature of the decision notice issued by the FSA at the end of
proceedings before the Enforcement Committee. According to the
FSA, this will contain a statement of the Committee's views on
the action that the FSA considers appropriate, including any proposed
penalty; in that respect, the Enforcement Committee will go further
than a prosecuting authority. However, according to the FSA, the
notice would embody a conclusion "that there remained a case
to answer", rather than a "judicial determination";
if the case went to the Tribunal, the decision notice would not
be published. According to the Treasury, "That decision is
intended to be an administrative decision, for which the FSA must
be accountable alongside its other decisions, and which must be
taken in a fair and reasonable manner". If the defendant
does not exercise the right to go to the Tribunal, the decision
notice will take effect, as in model 1. If he does, it will be
"set aside", becoming merely "the basis of the
FSA's case to be put before the first instance Tribunal",
as in model 2.
Opinion of the Committee on the disciplinary process
199. This is an area of the Treasury's original
proposals which has given rise to great concern, and we commend
both them and the FSA for responding to this concern and clarifying
their thinking in this area. The Treasury's proposals in the Progress
Report regarding the Tribunal are crucial, and are now broadly
satisfactory, subject to matters discussed below. This
has enabled the FSA to develop its thinking in relation to the
pre-Tribunal stage, producing the hybrid model described in the
previous paragraph. We are broadly satisfied with this too, again
subject to the following points.
200. In our view, even if the Enforcement Committee
is to have a non-judicial and purely administrative role, considerations
of procedural fairness mean that it should still be clearly separate
from the operational FSA. There must be sufficient procedural
safeguards to give confidence, but not so many that the Enforcement
Committee duplicates the Tribunal. It is desirable that most cases
should be settled at the pre-Tribunal stage, as is the case at
present; too many cases going to the Tribunal would create a bottleneck
and expose everyone to enormous costs. The pre-Tribunal process
must lead as transparently as possible to a fair and just decision
in the public interest; it must avoid any impression of secretive
and collusive plea-bargaining.
201. We therefore recommend that the Bill should
be amended to require the following:
- The FSA should set up an Enforcement Committee,
or some equivalent mechanism to separate the functions of investigation
- The Chairman of the Enforcement Committee
should have appropriate legal qualifications.
- The appointment of the Chairman of the Enforcement
Committee by the FSA should be subject to approval by the Lord
Chancellor (with appropriate protection for the Scottish interest).
- The Enforcement Committee should give the
defendant the opportunity of making oral representations before
issuing a decision notice.
- The Enforcement Committee should reach decisions
by majority of all the members involved, rather than by the Chairman's
- In the interests of public confidence, all
final decisions (i.e. decisions which are subject to no further
appeal) should be made public, save in exceptional circumstances
which would require to be justified.
202. As noted above, by virtue of Article 6.2 of
the ECHR, in criminal proceedings, defendants have privilege against
self-incrimination. Under the draft Bill, FSA investigators would
have wide powers to require information
and to require persons to answer questions on oath;
failure to comply would be a criminal offence punishable by imprisonment.
Clause 104(5) provides that statements made under compulsion are
not admissible in evidence in "criminal proceedings"
(unless those proceedings are for perjury or for providing false
information). Also, as noted above, following the Saunders
judgment, oral evidence obtained under compulsion will not "generally"
be admissible in criminal proceedings.
203. However in the terms of the draft Bill proceedings
before the FSA Enforcement Committee or the Tribunal are not criminal
proceedings, and there is no provision to prevent them from seeing
such evidence. If the courts took the view that the regime was
nonetheless criminal in nature in ECHR terms, they might well
strike down FSA or Tribunal verdicts obtained in this way.
204. According to Lord Lester, "This is an area
of the most serious potential mismatch between the statutory scheme
and Article 6 of the Convention, and it is essential that the
mismatch should be removed in the legislation itself, rather than
leaving it to the courts to attempt to imply appropriate Article
6 safeguards into the legislation".
205. To the extent that the courts hold disciplinary
proceedings under this legislation to be criminal in ECHR terms,
as discussed above, compelled oral testimony will be inadmissible.
This would not render the power to compel information useless,
since prosecutors could still use the "fruits" of such
information, provided they were able to present their case to
the Committee or Tribunal without relying on it.
We agree with Lord Lester that this matter is better resolved
by Ministers and Parliament before enactment, rather than afterwards
by the courts; we therefore look forward to seeing what the Government
say about it in their reasoned response.
Costs before the Enforcement Committee
206. The draft Bill makes no provision for persons
who incur costs defending themselves before the Enforcement Committee
to receive any form of legal aid; nor does it provide for defendants
who are vindicated by the Enforcement Committee to recover costs
from the FSA. On the other hand, if the FSA imposes a financial
penalty or fine, nothing in the draft Bill would prevent it from
including in the amount an element of cost recovery.
207. The costs position for the stage internal to
the FSA is perceived in some quarters as unfair. According to
Mr Morton of Freshfields, it is a criticism of the current regime
that "people have been effectively deterred from pursuing
defences because they simply felt they could not afford it and
ran the risk of being bankrupted if they tried to do so".
208. Mr Morton added that this is an ECHR issue.
Article 6.1 of the ECHR is understood to require "equality
of arms" between the parties, in all cases whether civil
or criminal. In criminal cases, Article 6.3 enshrines the right
to free legal assistance "when the interests of justice so
209. Mr Antony Blunden, Company Secretary of Credit
Suisse Financial Products, suggested that legal aid might be made
available at least to individuals, as opposed to firms.
The BBA agree.
Mr Sylvain suggested that provision for award of costs might be
restricted to individuals.
210. The FSA claims that its thinking with regard
to the disciplinary decision-making process is to keep costs to
a minimum for firms or individuals who are involved in the proceedings
and for the FSA itself.
Costs before the Tribunal
211. It appears to be generally agreed that the Treasury's
proposals for the Tribunal are now satisfactory, save in respect
This is an important qualification. As the FSA concedes,
the costs to a defendant of taking an action to the Tribunal are
likely to be great, and the FSA's costs are likely to be no less.
The draft Bill provides that the Tribunal can award costs against
including the FSA.
The draft Bill says nothing about legal aid.
212. The Council on Tribunals is concerned that costs
"may deter people from pursuing their remedies".
Lord Archer observed that most tribunals do not award costs; he
suggested that parties should perhaps face paying the other side's
costs only for vexatious, frivolous or unreasonable behaviour.
213. Clifford Chance and Herbert Smith argue for
The latter (according to their submission to the Treasury) are
particularly concerned about unregulated persons, who may not
have insurance. Lord Lester considers that the ECHR demands provision
for legal aid "in a sufficiently serious and complex case".
214. The FSA, in its second memorandum,
argues that "In general, the FSA should not be required to
pay the costs of a respondent, except where it acted unreasonably
in bringing the proceedings". On the other hand, if the FSA
was unable to recover its costs from an unsuccessful defendant,
"The FSA's costs would then fall to be paid by compliant
firms through the FSA's fees".
Costs and fines
215. Nothing in the draft Bill would prevent the
FSA from setting the amount of any fine or financial penalty to
cover the cost of investigation and enforcement; and in CP17 it
expresses the intention to do just that.
Clause 107 of the draft Bill expressly provides that, if investigation
leads to a criminal prosecution and a conviction, the court may
order the defendant to pay the costs of the investigation.
216. LIBA consider wrapping up costs in a fine to
Herbert Smith consider that fines and costs should be kept separate.
Lord Lester agrees;
in his view, any award of costs to the FSA should be by the Tribunal.
Opinion of the Committee on costs
217. The issue of costs is an important one. Defendants
may well be deterred from pursuing their remedies by the prospect
of their own costs, to say nothing of the costs of the FSA. This
will be particularly true when the defendant is an individual.
It should be noted that members of any regulated community already
face a significant disincentive against contesting regulatory
action, since win or lose they must continue to live with the
regulator if they are to stay in the industry;
costs make this matter worse.
218. We therefore recommend that:
- At the Enforcement Committee stage, each side
should bear its own costs, save that the Committee should be able
to award costs against the defendant or the FSA if they have behaved
frivolously, vexatiously or unreasonably.
- The FSA should be expressly prohibited from
including its own costs in the amount of any fine.
- The Treasury should consider whether the Tribunal's
power to award costs either way should be restricted to cases
of frivolous, vexatious or unreasonable behaviour.
- Legal aid should be available at the Tribunal
stage, so far as necessary to satisfy the ECHR.
Position of individuals
219. We have considered the position of individual
employees who may be made scapegoats as part of a settlement with
the FSA over some regulatory breach.
In written evidence (to which the FSA had nothing to add),
the Treasury tells us that, if a warning notice to a firm identifies
an employee in prejudicial terms, the employee "generally"
has a right to receive the notice and to make representations.
If the decision notice identifies him, he may have recourse to
"to challenge the substance of the decision itself, or to
challenge any opinion expressed by the Authority in relation to
220. We would observe that, as the proposals stand,
such an employee would have no prospect of legal aid; and, whereas
some employees might be supported by their firm, professional
body or trade union in such circumstances, and some might have
insurance, others might not. A court might come to such a person's
aid, on the ECHR ground that there was not "equality of arms".
However some such cases might never get to court: an employee
might reasonably be reluctant to take to the Tribunal a decision
which his employer had accepted, and wary of risking an adverse
costs order. We make no recommendation for amendment to the
draft Bill, beyond our recommendation above for legal aid at the
Tribunal. But we draw attention to these issues, which might become
relevant in the future.
221. The Treasury adds that, if an employer were
to take disciplinary action against an employee arising out of
dealings with the FSA, whether those dealings explicitly implicated
the employee or not, the employee would have the usual protection
of employment law.
222. The draft Bill sets no limit on the FSA's power
to impose financial penalties and fines. In respect of fines against
individual employees under Clause 50, the FSA must publish guidance
as to the likely amount of fines, and must have regard to this
guidance in particular cases.
Similarly, they must publish and have regard to statements of
policy on financial penalties against authorised persons,
and civil fines for market abuse.
223. Fines are to be retained by the FSA. The Minister
explained: "The principle is that the people who breach the
rules should help to pay the regulatory costs of those who abide
by the rules".
As a precedent, she cited the new powers of local authorities
to retain parking fines.
224. The FSA has explained to us how fine income
will be budgeted and accounted for, in order to offset the cost
of regulation to the industry, rather than providing the FSA with
a budgetary windfall.
The FSA will present a "control total" of its running
costs, excluding case-specific external enforcement costs. These
will be accounted separately, and fine income will be set against
them. If fine income exceeds external enforcement costs, the surplus
will be used to discount FSA fees.
225. Mr Morton
considers that nonetheless this situation gives the FSA a conflict
of interest. So do Herbert Smith;
they consider that fine income should go to the Treasury. On the
other hand the BBA and AUTIF, APCIMS, the ABI and the FSA Practitioner
Forum are content that fines should go to the FSA, subject to
the accounting conventions proposed.
The Consumers' Association observed that in the end the cost of
regulation is borne by consumers; they are content for fine income
to reduce that cost, provided there is transparency.
Mr Farrow of LIBA suggested that fine income might instead be
earmarked to provide legal aid in FSA proceedings; Mr Tim Herrington
of Clifford Chance suggested hypothecating it to support the Compensation
and Ombudsman schemes; either way, it would stay, as Mrs Knight
put it, "within the system".
226. We note that representatives of the industries
concerned would rather that fine income went to reduce the cost
to them of regulation, as proposed, rather than being returned
to the taxpayer at large via the Treasury. We too are content
that fine income should go to the FSA. However we recommend that
it should be returned gross to the regulated community as a discount
on fees, with no offset for enforcement costs, in order to give
the FSA the least possible interest in maximising fine income.
227. We acknowledge that this would make the control
total of FSA running costs more volatile than if an offset operated.
On the other hand, an offset would not always operate fairly,
since enforcement costs and fine income would sometimes fall in
different years and on different fee-payers. To avoid excessive
fluctuations in fees, the discount could be spread over a period,
perhaps 3 years.
228. We have considered the case for fine income
going to finance the Financial Services and Markets Compensation
However we do not recommend this. It would involve cross-subsidy
between different parts of the industry; and there is no reason
why the amount of fines and the appropriate amounts of compensation
should be related.
229. According to the IFAA, "There has been
an element of headline-chasing in the fining policies of the previous
they would like the FSA's power to fine to be capped. We have
considered the case for setting an upper limit on the fines which
the FSA can impose; we consider it better that there should be
no such limit. We note that the amount of fine at stake is
likely to be a factor in the courts' consideration of whether
or not to apply the criminal justice standards of the ECHR: see
above. Therefore one way to strengthen the case for treating the
regime as civil would be to cap the FSA's power to fine; but we
suspect that, to have this effect, the cap would have to be set
so low as to be unrealistic in the context of financial services.
230. Certainty as to what conduct is permitted and
what is not is in principle desirable for the sake of business
confidence, compliance cost, and the encouragement of innovation.
Certainty is also an ECHR requirement.
231. The draft Bill would impose some requirements
by direct operation of statute: e.g. the "general prohibition"
in Clause 7 against carrying on a regulated activity unless either
authorised or exempt. In addition, authorised persons (i.e. businesses)
are to be governed by rules, made by the FSA under Clauses 70-86.
The FSA proposes to use its general rule-making power to lay down
a set of "Principles for businesses".
Furthermore, approved persons, i.e. staff of authorised persons
holding responsible posts, are to be governed by principles of
conduct issued by the FSA under Clause 48, each of which must
be underpinned by a code of practice; the code will "help
to determine" or "tend to establish" whether a
principle has been breached, but will not be definitive.
232. According to Lord Lester, the general disciplinary
provisions can be expected to meet the standard of Article 7 of
the ECHR, "provided that the statements of principle and
other 'requirements under the Act' are not themselves hopelessly
In his view, the draft Principles for Businesses fail this test.
LIBA consider that disciplinary action should have to be based
on breach of a particular rule, not merely a principle;
and that compliance with the underpinning rules or code should
constitute a "safe harbour" against charges of breaching
233. The FSA defends the proposed Principles for
They continue a form of regulation introduced in 1989 to meet
industry demands for short, simple rules, and to provide "underlying
moral content" to the more detailed requirements. They give
flexibility for both the regulator and the regulated. They will
be amplified "through a combination of rules, evidential
provisions and guidance" (see below); but, the FSA insist,
circumstances in which it will be proper to take disciplinary
action, based exclusively on one or more of the Principles".
Arbitrary operation of such rules by the FSA will be checked by
practitioner involvement in the Enforcement Committee, and by
234. Mr Whittaker also mounted a general defence
of non-prescriptive rules.
Such rules could focus on desired outcomes rather than prescribed
methods, as recommended by the Better Regulation Unit of the Cabinet
Office (formerly the Deregulation Unit); and case law suggested
that broadly-worded provisions were not necessarily incompatible
with the certainty requirement of the ECHR.
235. Clifford Chance consider that even some of the
statutory offences are inadequately defined, e.g. the authorisation
offence in Clause 12.
This issue is particularly acute in connection with market abuse:
236. The obvious way to give greater certainty is
to write more detailed rules. This however is not necessarily
what is wanted. Fear of over-prescription was expressed to us
by the BBA
and the Consumers' Association.
The BBA told us that over-prescription "can easily undermine
the open relationship that currently exists between regulated
and regulator"; it would also make the process more "legalistic"
and slow. The Consumers' Association concede that, within clear
principles, "firms should be left to run their businesses
as they see fit".
Pre-Clearance, Guidance and Waiver
237. Writing more rules increases certainty at the
expense of flexibility. Yet in the fast-moving world of financial
services flexibility is very important.
A way to improve certainty without losing flexibility is for the
FSA to elaborate on its requirements by guidancewhat Mr
Whittaker called "gentler forms of law"or
to modify or waive them in particular situations.
238. Clause 78 of the draft Bill gives the FSA power
to waive or modify some of its rules in respect of a particular
authorised person. This applies to the following rules: auditors
and price stabilising.
The FSA cannot waive asset identification rules,
or any other rules.
Rules may be waived only if compliance would be unduly burdensome
or pointless, and waiver would not expose others to risk. Waivers
must be published, subject to commercial confidentiality and international
239. Clause 79 allows the FSA to make what may be
referred to as "non-actionable rules". Breach of such
a rule is not a disciplinary offence in itself. But breach "may
be relied on as tending to establish contravention of such other
rule as may be specified"; and compliance will likewise tend
to establish compliance with another rule.
240. Clause 87 gives the FSA a powerbut not
a dutyto issue guidance, or to pay others to do so. The
FSA may charge for guidance, and/or publish it. "Standing
guidance" must be notified to the Treasury. The Bill gives
FSA guidance no special evidential status.
241. The Delegated Powers Committee calls for the
Bill to be amended to provide that "those who are seeking
the certainty which is not necessarily granted either by the legislation
or the FSA rules should be entitled to seek advance rulings...which
enable them to know in advance of taking any particular action
that it does not contravene the rules".
242. Herbert Smith consider that compliance with
guidance should constitute a safe harbour.
Mr Blunden agrees;
he too would like the FSA to be obliged to give guidance on request.
Lest this requirement should overburden the FSA, he proposed that
they should "out-source" the guidance function, and
charge for it.
The City of London Law Society suggested to the Treasury that
the FSA might be given authority to give its guidance evidential
or safe harbour status. Clifford Chance believe that FSA guidance
on statutory provisions should be evidential, and that FSA guidance
on its own rules etc. should be evidential or even definitive.
As a precedent, they cited the money laundering regulations, which
give evidential weight to industry guidance on identification
243. According to the Treasury's Overview,
the Government intends the powers of waiver and guidance to achieve
the same effect as "no action letters". In the Progress
the Government acknowledges demand for guidance to have evidential
status; it regards this as unnecessary, because "it is unlikely
that the FSA would wish to or could properly discipline firms
who have been following its guidance". (The Minister said
the same, but added "in good faith".)
It also acknowledges demand for the FSA to be obliged to give
guidance on request; the Government considers that this would
be too burdensome. It adds, "the FSA intends to make active
use in future of guidance, and also of the waiver power".
244. The FSA is "exploring ways" to improve
Mr Whittaker told us, "We have no particular problem with
the idea that our guidance should be given some special status".
However he cautioned against putting the FSA under an obligation
to give guidance on demand: "We know that some overseas regulators
find much of their resource is taken up in giving guidance rather
than in the areas they themselves would wish to target".
He also pointed to the danger of engendering a "dependency
culture" among business managers.
245. It appears that there is room for movement on
this issue. Mr Roe told us on 25th March, "If the Committee
comes up with some new and...specific
ideas about precisely what is meant by evidential weight, I am
sure that Treasury Ministers will be happy to consider suggestions".
246. In our view, strengthening the role of guidance
is a better way to meet the legitimate demand for greater certainty,
than writing more rules. We do not recommend that the FSA be required
to give guidance or pre-clearance: this would be an unreasonable
burden, and a restriction on its freedom of action. Nor do we
recommend any absolute safe harbours; traders in financial services
are adept at finding loopholes, and any indemnity risks being
left behind by the market as soon as it is committed to paper.
247. However we recommend that the following should
be given enhanced evidential status:
- FSA non-actionable rules, in respect of statutory
requirements and FSA actionable rules, including rules expressed
- Codes of practice, in respect of principles
of conduct for approved persons.
248. The enhanced status which we have in mind
is as follows. When the FSA or any other authority or person pursues
an alleged breach of a statutory requirement, actionable rule
or principle of conduct, the defendant may assert that he has
complied with an underpinning non-actionable rule or code of practice.
Where the regulator cannot disprove this, it should be required
to prove either intent to breach the requirement, actionable rule
or principle, or recklessness or possibly negligence as to whether
it was breached.
249. Besides the rules and processes, many of these
things will in practice depend on the people who apply them. LIBA
is anxious that the FSA should recruit people with market experience;
Mr Farrow acknowledged that this is "far from easy".
250. Mr Davies told us that, in responding to the
FSA's consultation paper on costs and fees, industry expressed
concern that the FSA should pay salaries adequate to attract good
He said that most FSA recruits have "some market experience",
which is complemented by the presence of senior practitioners
on the Board itself and on various committees.
He also told us about the FSA's "grey panthers", staff
recently retired from senior positions in banking and insurance.
He admitted, however, that FSA has difficulty retaining its best
staff: "it is very difficult for us to pay top dollar".
He also admitted that most recruits to junior and middle levels
of the FSA's monitoring functions have compliance experience rather
than trading experiencethough he did not concede that this
was a weakness.
251. In its second memorandum, the FSA provided us
with more information.
Staff turnover was "unsustainably high" just after the
merger of the SROs in June 1998 (19 per cent in the first three
months), but has since fallen to an annual rate of 7 per cent
(7.9 per cent for senior staff). 360 staff have been recruited
since June, including "high calibre individuals"; most
of those recruited to front-line regulatory posts have come "from
the firms that we regulate". Total staff in March was around
1,850, and 85 below complement; the budget for the current year
allows for an increase in headcount by 105. Base pay at the FSA
is pitched "against median or second quartile pay levels
in the relevant sectors of the financial services market";
"in feedback from employees who have resigned from the FSA,
pay has rarely featured as the dominant reason for leaving".
A "significant number" of senior staff currently have
a public sector background; but 29 per cent of senior staff in
front-line regulatory work have private sector market experience;
15 per cent are lawyers. "55 per cent of the management team...in
the supervisory area of our Investment Businesses Division have
market experience; 25 per cent of that 55 per cent have experience
in the compliance field. We expect this profile to be more typical
of the experience of our managers in the future". There are
both inward and outward secondments.
252. The Minister told us that the FSA needed "'real'
practitioners" on its staff, rather than just compliance
She hoped that a spell at the FSA would come to be a highlight
of a City CV.
Mr Alan Whiting, Director of Regulation and Compliance at the
LME, observes that this is the situation in the USA, and sees
no reason why it should not happen here.
253. The staffing of the FSA is not a matter for
the Bill; but we observe that it will crucially affect how the
Bill's provisions work in practice. It will therefore be important
for the FSA to attract appropriately qualified staff; this means
that salaries need to be competitive. There is also merit in practitioners
with up-to-date experience of trading in the regulated industries
being seconded to the FSA, so as to bring that experience to bear
directly on the regulatory process.
180 para 6.2 Back
Q 340 Back
Q 94 Back
139, 201, 263, 286 Back
4, QQ 6 & 287 Back
B, para 23 Back
243, 247 Back
Annexes C and D Back
also Appendix 61 Back
439, 453-462 Back
B, para 20 Back
200; cp Lester Q 434 Back
Q 207 Back
C, paras 55-57 Back
6.5; cp Appendix 4, para 20 Back
Report, para 6.10 Back
Report, para 6.4 Back
Report, para 6.5 Back
6, cp para 208, and Appendix 4, para 19 Back
AUTIF Q 264 Back
264, 300 Back
Q 314 Back
Q 239, AUTIF Q 300, BBA QQ 263, 301, Securities Institute Q 301 Back
2 and 9 Back
QQ 434 and 440, Whittaker Q 448 Back
Report, para 6.10 Back
QQ 200 & 240, Clifford Chance QQ 202 & 243 Back
C, para 61 Back
202, 241 Back
5, para 14 Back
Clifford Chance Q 202 Back
5, para 15 Back
10 para 10 Back
para 11.2 Back
C, para 44 Back
5, paras 17-18 Back
434, 455 Back
55, 239 Back
113-5, 304 Back
5, para 30 Back
10, cp Appendix 5, para 20 Back
261, 321-9 Back
5, para 20 Back
7.1 and Lester, Q 434 Back
Consultation Paper 13 Back
C, para 67 Back
D, para 7 Back
Q 200, LIBA QQ 220-2 Back
201 & 226 Back
224; Appendix 5, paras 22-27 Back
also Appendix 61 Back
Q 276 Back
a complete list of proposed rule-making powers, see para 14 of
Annex B Back
B, para 20 Back
227 & 231 Back
4, para 40 Back
37; Appendix 5, para 28 Back