Supplementary Memorandum by the Association
of Unit Trusts and Investment Funds (AUTIF)
Q1. Do you believe that there will be sufficient
certainty as to what constitutes breach of FSA rules, individual
misconduct, and market abuse? If not, what can be put in the Bill
to ensure greater certainty?
Q6. Do you believe that the enforcement procedures
as now proposed, including those for market abuse, meet the standards
of natural justice and the ECHR? If not, what more needs to be
done? Are the Government in danger of writing in too many safeguards,
and rendering the powers ineffective?
Q7. Do you find the Government's arguments against
putting intent into the Bill, and Mr Davies's assurances, persuasive?
If not, how would you like the Bill amended?
These questions are related, so I will consider
No, we do not believe the rules are sufficient
or clear. For two reasonsfirstly, something I will call
the exaggerated behaviour syndrome, secondly because hindsight
plays such an important role.
In my experience, market abuse is often just
an exaggerated form of normal behaviour. Let me give you an example,
large City brokers issue research reports every day on stocks.
They may also own a position in a stock they write a positive
report about. Will the FSA be able to say in advance when the
issuance of a glowing report on a stock that the broker owns becomes
market abuse? Will not intent come into it? Or will the FSA simply
have to show that the price of the stock went up as clear evidence
of intent to abuse? I hope not.
How about a company which takes a short position
in a stock? If the stock subsequently goes down, is this evidence
of market abuse, or simply good investing?
In most markets, the everyday buying and selling
of stocks has the effect of moving prices up and down. When does
an otherwise normal action become abusive action? How will the
FSA know the difference when in both cases the effect of the action
may be the same?
This is what concerns me most, that hindsight
will be used to determine whether a given behaviour was market
abuse or not, when in practice both normal behaviour and intentional
market abuse can have the same consequence.
When is selling a loss leader product a legitimate
strategy to gain share, and when is it predatory pricing to wipe
out your competitor? Consumers benefit from the first, but can
lose out if competition is reduced. How will the FSA know when
something is OK for consumers and when it becomes market abuse?
The Committee is right to be delving into this
matter. In my mind, we are in danger of penalising honest people
with 20/20 hindsight. Let me give you a live example. Today tracker
or index funds are very popular, but in the future we might well
come to believe that they distorted markets because of the way
they invest in companies without thinking. Will the marketers
of tracker funds be held to account under the market abuse regime
even though they had no intention to abuse the market? In my experience,
it is not easy to see that unintentional market abuse is taking
place except with hindsight.
The market abuse regime proposed to introduce
a code of behaviour. Like the Committee, I am anxious to see how
this is crafted without intent forcing its way in.
While not yet accepting intent, Mr Davies in
his response to a question by the Chairman said, "It is quite
clear that we do not propose to prosecute people for accidental
offences". Now the Oxford English Dictionary defines accident
as "Anything that happens without foresight or expectation".
Sounds like unintentional to me. I think the Committee is wise
to continue probing this issue since I fail to see how any concept
of natural justice can ignore intent in the financial services
world where the chance outcome of risky transactions plays such
an important role.
We recommend that market abuse cases fall to
the Enforcement Committee that will have to examine each case
based on the facts.
Q3. Do you believe that the proposals for guidance
and waiver will allow the FSA to give responsible traders enough
certainty and comfort? If not, what more needs to be provided
Guidance is mostly tied to innovation. Firms
that plan to do business following normal practice don't need
guidance. But if the UK is to be a centre of innovation and if
the FSA is to meet its principle of taking innovation into account,
then it must have a robust system of guidance on which regulated
firms know they can rely. One particular concern for the investment
fund industry is that we do not know whether the rule waiver power
is intended to cover the investment fund rules. We are severely
hampered at the moment because under the present regime it does
Firms most often ask for guidance because an
existing rule has become obsolete. It's important to be clear
here. I am talking here about when the firm isn't asking for guidance
on how to comply with a rule. It's asking for the FSA's agreement
to actually breach the rule.
For instance a rule that says you have to get
something in writing from the consumer will have firms seeking
guidance from the FSA about whether a fax is OK, or a recorded
phone conversation, or an email. Consumers benefit from such innovation.
Clearly, the FSA can't then turn around and
prosecute the firm for breaching the rule. So some certainty is
In fact because innovation and guidance go hand-in-hand,
requests for guidance will often be the FSA's early warning system
that a rule has become obsolete. This Committee has already heard
about the need for re-writing existing rulebooks. I think it must
be accepted that rules do become obsolete because of innovation
and firms need to be able to rely on the FSA's guidance in this
Q4. Are the FSA's proposed powers coherent? Are
The FSA itself believes strongly that its powers
should be used to promote "prevention instead of cure".
But I fear they may have confused a firm's duty to try
and prevent problems, with an absolute duty to prevent
problems in all cases.
I can tell you from experience that no processing
environment is foolproof. No manager can know of every glitch
in the system. You solve problems by having a process to identify
them quickly, before they can harm consumers, and by refining
the process on an on-going basis.
I think we can be certain that if the powers
of the FSA are used to fine firms when they themselves find a
problem in the normal course of carrying out their controls reviews,
then a climate of distrust will grow between the FSA and the regulated.
I am concerned that hindsight will be used to
say that when a company's system of controls uncovers a problem
(say a dishonest employee) that the failure to prevent the problem
in the first place is evidence the controls were weak. It is this
Catch-22 logic that is the most dangerous part of the proposed
Bill. Who will discipline the FSA if it goes down this regulatory
Individual accountability is a good principle.
Management should be expected to develop compliance procedures
that are reasonably designed.
But plainly, due diligence by management should
be a defence against personal liability. Otherwise in the UK your
only absolute defence is to be lucky. Anyone who tells you that
you can run a financial service business error free every day
has never tried to do it.
Q5. Are you satisfied with the proposals for the
Tribunal, as they now stand? Do they make sense?
Yes, we welcome the revised proposals for a
Tribunal of first instance.
But the Tribunal in procedural terms is after
the fact. You get to the Tribunal far too late. Which is why we
propose a stronger Enforcement Committee (see below).
We want a fair system for all concerned. Neither
the FSA nor industry should decide what is fair. Instead, the
Enforcement Committee must be truly independent with a non-FSA
Chairman and majority voting by independent members.
In his testimony, in response to a question
from Viscount Trenchard, Howard Davies described how firms will
want to settle a matter quickly. As Mr Davies said "Sometimes
they are not sure how strong their case is or they would like
to get things settled and move on . . . "
Isn't this the central issue? That in most cases,
we are talking shades of grey. How well supervised was an employee
who turns out to be dishonest? Here again hindsight is being used
to say that the evidence of his dishonesty is proof that he was
badly supervised. How strong is anyone's case where a dishonest
employee has been particularly crafty?
In his reply to Mr Kidney's question, Mr Thorpe
described a process where the "option is then for the parties
to sit down and discuss it and determine whether there is agreement
about it." That sounds like a plea bargaining session to
This is where much more strengthening and balancing
of powers is required. Yes, of course, the option of going to
a Tribunal exists, but it is expensive, time consuming and drawn
out and as Mr Davies himself said firms prefer to "get things
settled and move on".
This is why we believe an Enforcement Committee
enshrined in the Bill with an independent Chairman is essential.
It needs both practitioner and public interest members and all
should have votes.
Only this way, can a set of guidelines be developed
by the Enforcement Committee about when discipline is called for
and when it is not.
When we talk about the behaviour requiring a
sanction by the FSA, many have in the mind the Maxwell, Barings
or Morgan Grenfell situations. In fact, often we are talking about
breaches of detailed rules, where no consumer lost money, but
where firms failed to achieve perfection in the way they carry
out their affairs. In many cases the firms find the errors themselves
and bring them to the attention of the FSA.
Many of the regulatory issues that will actually
come before such an Enforcement Committee will concern proposals
to discipline firms for relatively minor back office and administrative
breaches. For this we need an enforcement regime that is quick,
efficient and flexible. It needs to be both fair and transparent
to those accused and also one that consumers can have confidence
in, which I believe our proposals will achieve.
We consider it essential that both the Enforcement
Committee and the Tribunal are able to award costs against the
FSA where there is a finding in favour of the accused. The prospect
of high legal costs deters many firms and individuals from exercising
their rights, and leads to pressure to settle earlyto "plea
bargain" in the American terminology.
In his reply to a question by the Chairman,
Mr Thorpe allowed that perhaps another avenue will exist. He mentioned
"a form of mediation between the party who is accused
. . . and the FSA." Clearly, it would be interesting to know
more of how this mediation process might work. For instance will
the mediator be independent? Does the Enforcement Committee suggest
mediation before considering a matter further? I suggest, though,
that a truly independent Enforcement Committee could avoid the
need for yet another layer.
Q9. Are the FSA's powers of investigation excessive?
This is a regulator which has unprecedented
The FSA can enter your house at night without
a warrant and take whatever papers it wants. If you try and stop
them you commit a criminal offence. They then require you to attend
an interview, at which you will not have a right to silencein
fact using your right to silence will be an offence itself. They
get no joy from you so they call in your spouse. He or she likewise
has no right to silence.
Plainly anyone would find these powers alarming.
There seems to be a great deal of consternation
over the question of investor responsibility. We all want to avoid
the pitfalls of moral hazard and of mis-selling.
What are we to do?
We think the issue is very simple.
The first principle should be that consumers
are accountable for all investment risk so long as they received
a fair explanation of what they were buying.
There are two qualificationsif
a firm gives advice on an investment, the advice should be suitable
given the investor's circumstances at the time. This last
point is quite important. Suitability must be viewed in light
of the situation when the advice was given.
All too often again, hindsight is the criterion
used to determine if someone was mis-sold. But almost all investment
and saving decisions involve making assumptions about the future.
For instance, before you tie up your money in a 90-day notice
account, you need to be pretty sure you won't need the money in
that 90 days. But if you lose your job the next day and now need
the money, were you mis-sold?
We have to guard against encouraging financial
consumers down the road of "someone else is to blame if I
lose money". For example, someone trapped in a negative equity
housing situation may well wish to say they had a mortgage foisted
on them by a greedy financial services company. Whereas someone
who has made money congratulates himself on the wisdom of having
borrowed and taken his chances in the housing market.
We have to accept that in the financial world,
there is an important difference between a good investment decision
and a bad outcome. If with hindsight, bad outcomes are to be used
as evidence of poor advice at the time, then consumers will be
able to invest risk free, knowing someone else is to blame.
Much is proposed about consumer education. It
is obvious we need the public to understand more about money and
financial matters. But if the Treasury is right and a large part
of the population doesn't understand what a percentage figure
is, then we are talking about a failure of the school system.
I don't believe the FSA will ever have a budget large enough to
educate consumers sufficiently from such a low level.
Separately, participants in the market, and
AUTIF itself, all provide educational materials for consumers.
It actually is in the industry's interest for consumers to know
how to tell a good product from a poor one.
Much is talked about educating consumers about
financial products. And that rules need to make sure that they
only buy suitable products. But no one talks about educating consumers
about how to purchase a house. Yet, this will likely become their
largest financial asset or financial drain.
No. The consolidation of the regulators will
have a positive effect on the efficiency of the regulatory system
if done properly. Currently all three SROs have published guidance
about the Internet, which differs each from the other (e.g., where
to put authorisation status of the owner of a website).
The consolidation of five different compensation
schemes and eight separate Ombudsmen schemes is also beneficial
to the investor and to the industry.
Can you object to a robust enforcement regime
given the pensions mis-selling scandal, Barings, Morgan Grenfell
No, but I can object to an unfair one. Any regime
which does not provide for a right to be heard, for due diligence
to be a defence, for the right to examine the witnesses and evidence
against you will never be acceptable. In the end a regime that
is not fair will not be respected. In the UK we have long set
the standard for justice by demanding that it not only be done
but that it manifestly be seen to be done.
The FSA should not be able to intervene or initiate
a prosecution against a firm or an individual except where there
was a clear statement of what is required of the firm and there
is reasonable evidence that the firm has failed to observe that
in a material way and in a way that puts investors at risk.
The various functions of investigator, prosecutor,
judge and jury should be clearly split, and a number of them made
independent of the FSA executive.
All disciplinary processes should provide for:
The right to a pre-enforcement hearing.
Independent composition of the judicial
arm (the Enforcement Committee).
Due diligence as a defence.
The right to examine witnesses and
evidence against you.
31 March 1999