Joint Committee on Financial Services and Markets Minutes of Evidence



Examination of witnesses (Questions 40 - 59)

TUESDAY 16 MARCH 1999

MR HOWARD DAVIES, MR MICHAEL FOOT and MR PHILLIP THORPE

  40.  Or by independent financial advisers.
  (Mr Thorpe)  Yes. I do not want to play tennis, but that is an issue which is primarily supervisory. That goes back to an earlier comment about box ticking where you are dealing with a mass market of, as in the case of the old PIA community, some 4,000 either one or two-men firms or individuals and getting out to see them is a very difficult task with any kind of regularity.

  41.  So will you delegate?
  (Mr Foot)  We would consider delegating in particular areas in terms of, let us say, the recognised professional bodies, but only where we are convinced that it is more cost-effective to do so and only where we are convinced that the standards that we would get meet those that we require.

  42.  Can you give an example of where you might delegate?
  (Mr Foot)  One possibility would be with the recognised professional bodies, the ones who become authorised for investment advice such as accountancy firms. We would consider the possibility of delegating supervision to the relevant professional body if they met the criteria I have just set out. We have not begun to discuss with the bodies concerned whether they would (a) be interested and (b) could meet those needs.

  43.  Would you envisage delegating to Trading Standards Officers, for example, at the very local level?
  (Mr Foot)  I have heard of these proposals that Trading Standards Officers have made. We have not considered that in detail. At the moment we have not got a viable package to put out to tender to consider how we would assess different capabilities of performance. One would not want to rule it out, but I think I would go no further than that at this stage.
  (Mr Thorpe)  Enforcement as such cannot be delegated under the legislation as envisaged. Breach of a rule or a principle has to be something that the FSA gets involved in. Supervision, yes, but enforcement, no.

Mr Loughton

  44.  The term practitioner has been used a lot to support the FSA keeping in touch with the real world and how business is done. Is it not the case—and certainly we saw this from the conference last week—that many people that you have taken on board as practitioners are in fact compliance officers? Were they necessary, though they may be, those people with experience in the City may see compliance officers as a somewhat stifling enterprise. What is the balance going to be between real practitioners, i.e. those people who do the business at the sharp end and make money for their customers, and those people whose whole life revolves around the rule book?
  (Mr Davies)  I think it is typically true that our committees include people who are in your terminology "real practitioners", though I immediately will get lots of letters from compliance officers which I will pass on to you. I think that the real practitioners are quite keen and extraordinarily willing to give up time in policy areas, have been in the SROs in the past and we do find it perfectly possible in our policy work now. It is undoubtedly true that quite a lot of the people whom we recruit as monitoring officers are the sort of people whose jobs might otherwise be in compliance functions. At the junior and middle levels I agree that it is the case that we would—not always—typically get people who are that sort of person. I think it is difficult for us and I am not sure entirely appropriate for us to want to attract derivatives traders, etcetera. We do get some who come in from front-line business areas, but typically we are getting people who see their careers in that way.
  (Mr Thorpe)  I would add that the compliance side of the business, certainly in the more clear thinking firms, is viewed as a business function rather than merely a robot function and, in fact, the people that are involved in that have the unusual advantage of having oversight of a whole range of activities in a firm and for us that is a very valuable skill.

Dr Cable

  45.  The Treasury recently confirmed to me in a written answer that there was not a single case in the last five years where they had felt that the abuse of regulation was sufficiently serious to have referred the matter to the police. Do you think that in your own enforcement procedures you will not be looking to make more use of the criminal law and, if so, what is the process by which the relationship with the police would be developed?
  (Mr Thorpe)  We are having to confront this much more in terms of the draft legislation because we will have our own criminal provisions to enforce. That has caused us to look at how we would make referrals through to other agencies, particularly the police and we have put forward a set of propositions about how we will determine to deal with something as a criminal or a civil matter and we are proposing to use the guidelines that are commonly used by the Crown Prosecutors in doing that, that has been part of our consultation and we have also embarked on the process of establishing memoranda of understanding with the various agencies, whether it is the Crown Prosecution Service, the Serious Fraud Office or the police to allow us to know when to talk to each other and to determine who goes first and in what circumstances. We do anticipate that when the legislation is in place we will be looking to use the criminal powers from time to time. Experience has shown us that the civil powers that have been available in the past have tended to be powers of choice because they allow more rapid resolution of matters and particularly when we are focussing on consumer issues and wishing to see compensation delivered, they do give us the flexibility to deliver those matters quickly, but we will have in place mechanisms for passing matters to the criminal authorities.

Mr Kidney

  46.  Mr Davies, the present prosecutors of criminal offences in financial crime are the DTI, the Crown Prosecution Service and the Serious Fraud Office and presumably they all apply the Crown Prosecution Service code of when to decide to prosecute and your Chancery Bar speech shows that as a result there are very few prosecutions. I think from 1993-98 there were five successful prosecutions and eight acquittals. In the same period, not in your speech, the RIEs have referred over 100 suspected cases. It is a pretty dismal record of criminal prosecutions. Do you not welcome the civil proceedings simply because you can ditch criminal prosecutions and go along with an easier burden of proof and impose the fines yourself and very nice fines they are with an unlimited top level?
  (Mr Davies)  A seductive question, Mr Kidney, but that is not quite the way that we would see it. We would not see the civil route as a cheap alternative to the criminal route. We think that if there is criminal intent then the criminal route should be chosen and that is what you should attempt to do, but we do believe that there can be a category of market manipulation-type offences which are more in the character of civil offences and, therefore, where a civil regime is the appropriate one as long as it is backed by a code of market conduct which clarifies the regulator's expectations in terms of what is and is not market manipulation.

Chairman

  47.  Perhaps I could move the questioning on to this whole question of your various functions as prosecutor, judge, jury, etcetera. There have been a lot of complaints that there are dangers in the process as it has been set up in the Bill. One of your responses has been to propose an Enforcement Committee. I wonder if you could take us through how you have responded; what you think of the worries that there are undoubtedly on this front; how it is that you have responded to them; and the extent to which you think that this now meets people's concerns.
  (Mr Davies)  Initially, of course, what people saw was the draft Bill last July without seeing the way in which we proposed to operate our general enforcement processes and in the absence of any clarity from us about how we would operate our processes I think people did react and say that this was potentially oppressive and burdensome, etcetera. We then put out a consultation paper on our enforcement processes which made it clear that we did envisage an Enforcement Committee with public interest representatives, of whom some would be practitioners. Since then I think the debate, whilst it has not stopped, has moved on to more detailed questions about the precise composition of that committee and also its relationship with our enforcement staff. Then also the Treasury have made a change to the draft Bill. The new clauses have not yet appeared but they have announced a change whereby it is clear that the tribunal, which was previously characterised as an appeal tribunal with a window open to it largely on points of law, will now be more in the character of a first instance tribunal able to hear evidence and hear the facts of a case. If you take that change and look at our procedures alongside that change, then my own judgment is that the level of anxiety has reduced again. Nonetheless, there remain some issues about how we structure that and I might hand over to Phillip, who is going to pick up the story.
  (Mr Thorpe)  We have been continuing discussions with commentators who have expressed this "judge, jury, prosecutor" fear and one of the late realisations on all our parts was that the conversion of the tribunal to a tribunal of first instance had a material effect in terms of dealing with that separation. As that is a first instance tribunal it can hear, as the name suggests, matters afresh and it does meet concerns about the ECHR proposals and their impact. What we have been trying to do—and I think we are close to concluding—is produce an administrative procedure beneath that that allows cases to be settled wherever possible, and it does so again with an eye to the ECHR requirements. We think we are close to having a procedure which will meet the objections of the commentators that we have heard voice concerns so far and in part that seems to be likely best met by providing a form of mediation between the party who is accused of having breached a rule and the FSA in the course of that settlement process. So we think we are quite close to having an agreed approach with the industry and their advisers. That will maintain the ability to refer the matter to that independent first instance tribunal set up by the Lord Chancellor but nevertheless meet our concern that we try to provide an administrative process which, hopefully, has the advantage of promptness, cost-efficiency and relative flexibility.

Mr Kidney

  48.  I am still not quite clear. Let me go through it. If there is a possibility of a criminal prosecution, your staff investigate and you can actually be the prosecutor, as it happens, but at least there is going to be a criminal court, judge and jury at the end of the case. If there is a supervisory breach I understand that you investigate and then there is going to be an Enforcement Committee and they will make decisions about whether to issue the notices or not. Is that right?
  (Mr Thorpe)  The intention at the moment, as evidenced by the Bill, is that if we believe there has been a breach of a rule or principle that is sufficient to require regulatory discipline, we will issue a notice to the firm of that intention. The option then is for the parties to sit down and discuss it and determine whether there is agreement about it. If agreement is not reached, then as the Bill is currently drafted the FSA will issue a notice indicating what its view of the matter is. If neither party were content with that as a mechanism for resolving it, it can go on to the tribunal where a full judicial avenue is available.

  49.  For those people who do not choose the tribunal, as far as a supervisory breach is concerned, it is inside the FSA. You have your investigating staff and then the enforcement staff who are separate from the investigating staff?
  (Mr Thorpe)  What we are talking with the industry and their advisers about is creating an internal mechanism that within that general framework allows right of representation, the right to make submissions, allows the use of the Enforcement Committee. It is independent of the staff who are prosecuting, yes.

  50.  I see that has been consulted upon rather than actually being a Bill decision yet?
  (Mr Thorpe)  Indeed. We have consulted once. We have a lot of very keen interest in those proposals and we are doing as good consultants ought to do, going back and thinking about it some more and discussing it.

  51.  Just to complete the picture, that is the prosecutions and the breaches of regulations. Now the new civil power that sits in the middle between those two. The Enforcement Committee would be the one that decides levels of fines as well?
  (Mr Thorpe)  Forgive me if I am getting the wrong end of the stick here but from our perspective the regulatory action and the criminal action—I am using the terms inexactly here but that is the civil. The regulatory is the civil. Is that what you mean?

  52.  Yes, but imposing a fine for market abuse is a new civil power that has been developed for the first time in our jurisdiction. I am just asking, on top of the regulatory stuff is the new fine for market abuse to be via the Enforcement Committee?
  (Mr Thorpe)  It could be progressed in the same chain of discussion and decision, indeed.

  53.  Could I say it does worry me a bit about the confusion. Civil is just a bit more on the regulatory side and I really think it is much more fundamental than that. Could I push you on one point. It is a seductive question, Howard. If you want an injunction you will go to a judge in the court, if you want an order for disgorgement you will go to the court and the judge will make the order and in both cases the judge can also award a fine to the FSA, so why do you not just say, why does not the legislation just say, you go to the court to start proceedings for fines? What is wrong with that?
  (Mr Thorpe)  What I believe the Government's intention is, and our own experience bears out as being good experience, is that the civil structure or the administrative structure or the regulatory structure, whichever term you fasten on, has worked very well for dealing with a myriad of essentially administrative offences. I think you may have said yourself the track record in taking forward criminal prosecutions is not one which seems particularly exciting. What it does show, I believe, rather than failure necessarily on the part of the prosecutors to do a good job is the difficulty in achieving criminal prosecutions in a wide variety of cases. What we have found, and I think the industry supports this, is that a lot of the matters which we deal with as civil are not matters that are amenable to criminal resolution and I do not think we are suggesting anything which is unusual in terms of the history of this and I do think the proposition which the legislation puts forward is one which will lead to the most expeditious disposal of cases.

Viscount Trenchard

  54.  I do not want to leave this theme alone just yet. I would like to come back to it because by your own admission, Mr Davies, the Authority does have very considerable powers and we have talked about the need to separate the functions of prosecution and decision-making, but I still think for a body which has the considerable powers that you have acknowledged the proposals contained in your Enforcement Committee do not go as far as, say, the SEC in the United States, where I think those who are performing the judicial role or the decision-making role are completely separate and separately accountable from those who are carrying out the prosecution role. In your speech last week I think you referred to the third way, about which we hear a lot these days. I am a little bit sceptical about what it actually means and either you separate the functions of prosecutor and judge or you do not and it seems to me that we have not quite got there yet. On the subject of the European Convention on Human Rights, which I believe requires such a separation, it also requires the need for offences of which individuals are accused to be made clear. I think also in the Bill there is, as yet, a lack of an adequate degree of clarity in the definition of offences. It seems that the Authority is going to discipline people for breaches of general principles, such as behaviour—"behaviour" is used extensively in the Bill—and I wonder whether we have drawn offences and breaches tightly enough to be compatible with the requirements of ECHR?
  (Mr Davies)  You raise a great complexity of issues there. I just make two or three points on it. One is that the question of whether we have achieved an adequate separation, people can take different points of view but we have set up an Enforcement Committee which would have, as we envisage it, a chair appointed specifically for that purpose and appointed quite separately from the rest of the staff, and the other members of the committee would be people drawn from outside the FSA as public interest representatives, either consumer representatives perhaps or practitioners. We think this creates a very separate structure, albeit within the overall administrative framework of the FSA. The second point really is that, as I understand this, perhaps imperfectly, the ECHR question, which I think ultimately will be a matter on which ministers will have to make a statement, is determined by the totality of the processes available, both taking into account the tribunal and the administrative procedures within the FSA, and in order to meet the ECHR requirements you look at the two alongside each other. We have, therefore, taken the view that if you do that, if you look at this first instance tribunal alongside our administrative procedures, their separation but also the ability of the tribunal to hear things afresh, our view is that those requirements are met in the totality of the system.

  55.  I think, though, there is a valid point especially for foreign firms here, which is that they may well think that if they choose to go to the tribunal they are going to incur the displeasure of their regulator and that represents a considerable incentive for them to say, "Well, let us keep it within the FSA because if I go to the tribunal then the regulator is going to be very much stricter on me and regulate me more severely than he would have done otherwise."
  (Mr Davies)  I could not make a window in men's minds and work out what their motivation might be in terms of staying within the system or going out of the system. It is true to say that one of our principles is that we will take account of the openness with which firms deal with their regulators in terms of all our disciplinary processes. We think that that creates a positive incentive and typically most firms who encounter problems will come to us at a very early stage and say, "We have encountered this problem. We recognise a regulatory breach has occurred. These are the measures that we think are appropriate in response to it. How does that look to you?" Most of the time this is a collaborative process. In the figures that I quoted in my lecture last week, on average out of 100 cases something like four go to tribunals. It would be difficult for me to disprove a contention, that some people settle because they did not want a tribunal. Why did they not want a tribunal? I doubt if it was particularly because they wished to keep their regulators sweet. Sometimes they are not sure how strong their case is or they would like to get things settled and move on without dragging things out. I would not under-estimate this. Many firms say to us that what they are keen to ensure is that there are administrative processes to handle regulatory breaches in an expeditious way and what they do not want is a very long drawn out process whereby on the word processor of every City journalist it says, "Bloggins and Bloggins, a firm under a regulatory cloud for their activities in so and so" which stays for the whole three-year process of going to tribunals. They would like to be able to achieve rapid resolution in many of these cases and move on with their business.

Lord Poole

  56.  Lloyd's is not just a wholesale market, it has a very important retail component. It would seem to me to be a situation which is very unsatisfactory because of the existence of the Lloyd's Act and other Government decisions not to fold Lloyd's into the FSA. What are you going to be able to do from an enforcement point of view to ensure that the sort of standards you have been enforcing in other industries will be applied within the Lloyd's market for the protection of policy holders, customers in general and, to the extent that they are still remaining, the investors?
  (Mr Davies)  You are right that we will have to operate within the existing Lloyd's Acts, but the Government have given us some new powers in the draft Bill to take responsibility for oversight of the regulation of the Lloyd's market and we have set out some preliminary proposals in a consultation paper which explain that there are roughly two options, i.e. either we could do a lot of the Lloyd's regulatory work in-house or we could have a relatively small team in-house and delegate the functions of direct day-to-day regulation of the market to the Lloyd's regulatory division and we are genuinely open minded on which course we should go down. But for those powers that we have we would bring Lloyd's into the enforcement framework of the rest of the FSA and therefore the same enforcement procedures as we have been describing would apply to breaches of those elements of the Lloyd's market which we will be able to oversee.

  57.  Did you worry about people falling through holes?
  (Mr Davies)  I worry about little else.

Mr Heathcoat-Amory

  58.  You have stressed the advantages of a speedy resolution by administrative procedures and I understand that, but am I right in saying that you have the power to levy unlimited fines and to deprive people of their livelihoods on a balance of probabilities and not beyond reasonable doubt which would be required in criminal proceedings? It seems to me that you have the advantage of being essentially a rule maker and investigator and a prosecuting authority and yet you can levy these really draconian penalties on a balance of probability. What is more, it does not have to be proved that the culprits intended any wrongdoing, you can be judging by their actions, so they could be bowled out for incompetence rather than any malicious intent. This worries me. Although you have made efforts to separate out your investigative and your decision-making powers, it is all in one huge organisation and although the Government has moved on the question of the tribunal, it still does not seem to me to measure up to the standards of impartial judicial decision-making and that standard of proof that is commensurate with the penalties that may be levied.
  (Mr Thorpe)  Could I perhaps take, firstly, the point on the standards of proof. It is often put to us as being highly attractive that we should work to a balance of probabilities standard and in the normal course of events that would be attractive from the point of view of the prosecutor. What we have found in practice is that in dealing with matters of the type that you describe, matters where a business may be closed down, where an individual might be banned from the industry or where substantial fines might be imposed or, indeed, where severe reputational damage might be incurred, it has been put to us—and tribunals have determined that it is correct—that the standard of proof is on a sliding scale and it slides very close to the criminal level of proof in cases of the type you describe. We find that we are going nine-tenths of the distance in terms of the standard of proof for cases that carry that heavy penalty.

  59.  But that is up to you, that is your discretion.
  (Mr Thorpe)  Like all bodies, we are bound by the precedents that go before us and we have to take the arguments of those we try and take through the disciplinary process. We are also very concerned, as any administrative body exercising administrative powers is, that if that should be reviewed then our actions would be found to be reasonable and we do take our reasonableness quite seriously. I think the totality of that is that we have a very high burden of proof to discharge when it comes to the serious offences. On the more general point about the accumulation of powers, it is a point that has a bit of history to it, but the powers that we are looking at receiving under this legislation, save for the area of market abuse where there are some genuinely new powers that have not existed in the past and we are not looking at a new panoply of particularly onerous powers, they have been onerous before, they were there before and we are of the view that put together with the process that we have been working at with the industry and their advisers it will deliver the fairness that must be required of us and will meet the ECHR requirements as well.

  Chairman:  We will come to market abuse in a moment.


 
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