Examination of witnesses (Questions 240
THURSDAY 25 MARCH 1999
WHITING and MR
240. Can we go on to the thorny subject
of the European Convention and obviously stemming from the role
of FSA as judge, prosecutor, jury, executioner and the beneficiary
of the executed to take it to extreme there as well bearing in
mind that there are probably two main areas where the Bill may
get a conflict within the European Convention in relation to the
FSA and competition on the one hand and the claims by investors
against practitioners in financial services as well. Could we
have potted versions of what the Economic Secretary referred to
last week as "room for disagreement amongst lawyers",
to put it mildly? Bearing in mind that nobody here is notching
up bills of about £350 an hour for their views, could we
have potted versions of where we think there are discrepancies
that may lead to problems with the European Convention which need
to be sorted out before this Bill becomes law as stated earlier
(Mr Morton) There are two main areas of potential
discrepancy. The first is, as David Mayhew referred to earlier,
the classification of market abuse and disciplinary measures as
to whether they constitute criminal or civil proceedings for the
purposes of the Convention. That is significant because criminal
proceedings under the Convention have an additional set of extra
protections which include in particular the privilege against
self-incrimination and therefore classification as criminal carries
with it the consequence that the current provisions which entitle
the FSA to use in evidence material which has been compulsorily
obtained would fall away as being contrary to the Convention.
That is the first issue. The second issue relates to Article 7
of the Convention, which deals with the principle of certainty.
There is a fear that some of the provisions, in particular the
prohibition on market abuse which we talked about earlier, are
insufficiently precise to meet the standard required by that and,
therefore, there is doubt about their enforceability should they
be challenged under the Convention. Those are the two main areas
where there are points at issue.
241. Your views as to how they can be resolved?
(Mr Morton) In the first case I do not see that
there is much scope for resolving them other than by admitting
that it is not possible to use evidence compulsorily obtained
by putting it in evidence before the proceedings in question.
As David Mayhew referred to earlier that probably is not such
a dramatic change as you might suppose because it is still possible
for the prosecutors to have the evidence in deciding how to present
the case. In relation to the question of legal certainty then
I think the remedy is clear, that if the provisions are too uncertain
then they have to be reworded so they are more certain.
242. Mr Morton, is your conclusion as far
as the general question of enforcement is concerned, other than
market abuse, that your view is that this is now all right and
that your uncertainty relates to market abuse, or do you have
some questions also about the more general area of enforcement?
(Mr Morton) There is one particular issue outstanding
on the general area which is this question of whether evidence
which is compulsorily obtained can be used.
(Mr Morton) My view would be that it cannot be
used because jurisdiction is properly classified as criminal under
(Mr Mayhew) Effectively Clause 104 subclause 5
should be extended to include all enforcement proceedings. The
reason for that is that the enforcement proceedings are directed
to achieve punishment and deterrence with quite severe fines.
In a sense this comes back to an earlier point made in relation
to the question "Well, we all know what is misconduct, we
all know what is good or bad conduct". That was fine when
regulators were about regulating a profession and not allowing
people to practise for the protection of the community who were
not fit and proper. If that is what the regulatory system is about
you do not have to worry about the criminal nature of the process
because it can be dealt with in the civil system but having introduced,
as has happened over the last few years, substantial fines and
substantial punishment that is what has brought the criminal element
(Mr Farrow) If I understood Mr Morton correctly,
the problem of an uncertainty would apply to enforcement proceedings
for breach of principles?
(Mr Morton) Correct.
244. Do you want to say anything at this
stage, Mr Whittaker? You do not have to.
(Mr Whittaker) Why not carry on.
245. There is no test of intent in the legislation
as so far proposed for market abuse. The Government have said
this is because unintentional behaviour would still undermine
the proper work of the market and confidence in it. Mr Howard
Davies when he was here said that he agreed with that but, on
the other hand, they have no intention of prosecuting people for
accidental offences. The Minister, Ms Hewitt, told us that the
degree of intent might affect the penalty but not the character
of the offence. Do you find the Government's arguments are persuasive
on this question of including or not including intent?
(Mr Bates) Shall I start because no-one else wishes
to take this point. I do not think we are convinced that one can
ignore the issue of intent altogether. The point which we would
make is that if you have very broadly defined offences then in
order to decide whether it is culpable or not culpable you have
to introduce an element of intent or some sort of mental element.
If you have narrowly, specifically focussed offences where the
conduct is clearly prescribed then it is much easier to abandon
the test of any form of mental element or intention. The parking
ticket example where it does not matter that you drove the car
and left it on a double yellow lineit is your car, you
are liable, you can be finedthat is a very clearly defined
act. At the other extreme you can have very broadly defined offences
but you find that, generally speaking, to make them workable and
to make them fair to people you have to introduce the mental element
to make them effective. I think the danger here, particularly
with the statutory testand remembering that the statutory
test can be relied on supposedly on its own without any guidance
from a code of conductthe statutory test is both a broad
testwe are very unclear what the conduct is precisely proscribedand
no mental element is attached to it either, so you end up with
the worst of all worlds on both counts. Even when one moves to
the codes, the codes of conduct, I think you find that the FSA
have found drafting it that they have had to introduce some sorts
of mental elements into the definitionsand they say so
themselvesbut what they have done in some cases is reduce
those mental elements to a very limited extent: for example, and
this shows the width of the quasi legislative power being given
to the FSA, to criminalise negligent mistakes, which as far as
I know is an entirely novel concept, that a fine can be levied
on someone for a mistaken false statement, careless or whatever
but false. Firstly, that demonstrates the width of the power being
given, going back to the delegated powers point, but also demonstrates
that even in the context of the Code the FSA has found that it
has had to have some mental element. We think that ought to be
246. How do you tell? Unless somebody says
"Fair cop", how do you show intent other than by looking
for other corroborative evidence about what it is that they have
been doing? I ask this in a very naive way. If you rely on intent
can you ever catch anyone?
(Mr Bates) Can I just make the point that it is
not the case in the States. The States is different and yet the
American legislation 10b-5, on which most enforcement action is
based, is firmly based around the idea of intent or recklessness,
that is the test of scienter. The idea is that somehow we have
English regulators who need to do away with the intent test because
in other jurisdictions they do not have it either, but I do not
think that is really truly the case. It is possible to prove intent
247. Yes, but that is back to evidence.
(Mr Bates) It is back to evidence, that is the
point. Let us call a spade a spade: being fined £1 million
is a conviction whether you label it civil or not and you should
be convicted on the basis of evidence not on the basis of a vague
(Mr Whiting) Could I just make a personal comment.
The LME does not have a formal policy on this; it does not actually
need one because it does not really affect it. If we are frank,
regulators hate the concept of intent because it is virtually
impossible to prove. I cannot recall a single case where anyone
has been able to prove intent. On the other hand, firms, quite
rightly, not just because they do not want to be found guilty
when they have committed offences, do not like the absence of
intent because it does lay them open to the possibility of being
disciplined for things which they did not intend to do. I think
there is a way through this. If we can introduce certainty in
what market abuse is then I think the issue of intent falls away.
(Mr Farrow) My Lord Chairman, I think you were
present at the FSA Conference a couple of weeks ago. I thought
the SEC judge, who addressed the conference and who said he had
managed to be satisfied as to intent several hundred times in
cases in front of him on the basis of inferring it from behaviour,
was not dismissing it. Intent is quite substantial in US law he
was saying, he was recognising that the test of intent in the
law had to be satisfied but you could reasonably see intent without
actually having the man on tape saying "I meant to do it".
It seems to me we risk making this a yes/no insoluble problem
whereas in a more pragmatic way the US system seems to have found
a way of coping with it.
(Mr Mayhew) I think it is important, to follow
on from what Kit Farrow said, that we understand clearly that
the concept of intent in law is different from how you might use
it in everyday parlance. It is not a question of motive or desire
that the court will look for in this sort of area but should you
have a knowledge of the natural consequences of your actions.
This is where the flaw in the Government's position comes in because
if the aim of this provision is to deter abusive behaviour, by
definition you cannot be deterred if you did not have a knowledge
of what you were about to cause. I may not desire it, I may not
have had that as my purpose, but if I know what is going to happen
then that is sufficient for knowledge.
248. Or you suspect that it might happen?
(Mr Mayhew) Then it is a question of degree. That
is a matter of evidence again. If I know the consequences of my
actions the court will hold me as having intended those actions,
even though that was not my desired outcome.
(Mr Whittaker) On this occasion I would like to
agree with one point that Kit Farrow made which is to agree that
this is not something where there is necessarily a yes/no answer
as between intent and non-intent. I would agree that the correct
classification of the issue is what, if at all, should be the
mental element for different aspects of market abuse. I would
emphasise that the market abuse definition covers a wide variety
of different forms of behaviour and it is quite conceivable that
you might want to have a different mental element as between different
forms of behaviour covered in the Code of Conduct. We are certainly
looking at the Code of Conduct again to see whether there is more
scope to introduce a mental element into different parts of it
without making it completely impossible to be able to take any
enforcement action over market abuse as a result. All that said,
I think that Howard made clear when he gave evidence to you that
we are not seeking to take action where someone has taken all
reasonable steps to avoid committing market abuse. I think there
are cases where someone may well not have intended to abuse the
market but where they should be expected to take reasonable steps
to secure that their conduct does not do so.
249. This is the margin between recklessness
(Mr Whittaker) It may well be that if there is
any sort of general solution it is in that area.
250. Could I ask the lawyers about fines.
Mr Morton, would you like to start. It is proposed that the FSA
can fine authorised persons for regulatory breaches and that the
FSA can fine authorised persons and unauthorised persons for market
abuse. Do you see those as two limbs of one administrative regime
or is the first one an administrative one and the second one a
(Mr Morton) I certainly see them as separate regimes.
The market abuse regime is there for a significantly different
purpose which to my mind is more closely akin to what in layman's
terms we would call a criminal regime. I think one can spend an
awful lot of time debating academically whether it is administrative
or civil or criminal but I would see them as two quite distinct
functions. Having said that, I do not see why the power of fining
in principle is not appropriate for each of them.
251. Is it a worry that under the proposed
scheme fines could be unlimited?
(Mr Morton) I think that is a worry but a greater
worry is the need to ensure a reasonable degree of clarity about
the probable scale of fines. There are provisions in the Bill,
as you know, requiring the FSA to publish, and it has published
some material already, the scale of the fines. I would be very
concerned to try and ensure that there is as much clarity as possible
about the likely level of the fines for what particular kinds
of behaviour so that the tariff, using the word loosely, is apparent
to people and therefore the deterrent effect which Chris Bates
referred to before is maximized.
252. Presumably in due course the tribunal
and the civil courts will have a track record of fines themselves?
(Mr Morton) Presumably so because they will have
possibly appeals against the level of fines and, therefore, a
track record will emerge.
253. Lastly, is it a worry that the FSA
is going to keep all the fine income?
(Mr Morton) I think that is a worry. There seem
to be differing levels of concern expressed about this but I do
think that it gives rise to clear conflicts of interest and it
increases the risk that the eye will stray from the ball a little
bit in fixing the fine on the basis of the case rather than on
the basis of extraneous factors like budget and the performance
254. I assume that those who worry about
this do not actually wish the income to come to the Government!
It would be extremely unusual for a group to volunteer that it
should be handed to the Government. Is it not therefore an issue
of trying to find a way of ensuring that in terms of recycling
the money it influences the behaviour of the prosecuting body
as little as possible?
(Mr Morton) I think that is a fair point.
(Mr Farrow) It is not altogether separate from
the question of how should prosecution costs be funded. At the
moment the proposal is that in any case where somebody has been
found guilty in the enforcement process, all the prosecution costs
should be charged against him. One can easily envisage in a case
which turns out to be a difficult case to investigate and much
argument and expense for witnesses that at the end of the day
you are found guilty for something for which the appropriate tariff
fine is £10,000 but you are fined £10,000 with £200,000
costs. That seems to be quite an inappropriate way of setting
about things. I have no simple solution to offer this afternoon
but I think this question that you raised about where do the proceeds
go needs to be looked at alongside where do the prosecution costs
255. I think we have probably kept you all
long enough. I have one last question and short answers would
be preferred. Besides the rules and processes many of the things
that in practice are going to matter here are going to be the
people who apply them. We wonder what advice you would like to
give Howard Davies as he builds his teams and committees as to
how we are going to get the people to do the job?
(Mr Telford) Once point particularly is that we
focus a lot on the punishments of people who do wrong. One of
the greatest things in the minds of those people must be the chance
of being caught, the deterrent effect is partly whether you are
going to be caught as much as what the fine will be. We are quite
clear that there must be effective monitoring and a proactive
regime. I think Howard Davies has already sent out a message in
a variety of ways saying: "I am on your case, I am looking
for potential problems before they become very expensive, very
long term problems." I think the message would be "Look
at the monitoring as much as much as look at the penalties and
the powers in the enforcement regime".
256. Preventing things, getting into this
process which we are discussing this afternoon.
(Mr Farrow) Not quite answering your question,
I am afraid, but to the extent that the FSA is going to be taking
prosecution decisions and perhaps settlements on the basis of
very market judgments like what is proper market behaviour, I
am conscious of the considerable efforts that the FSA has made
to recruit people with market experience and that it is far from
easy. But, nevertheless, it remains absolutely essential that
they are found because without some experience of what is market
behaviour you cannot be an arbiter of market behaviour.
257. Mr Whiting?
(Mr Whiting) I think that the hope must be, and
I think it is a realistic hope, that when the FSA becomes established
and develops its reputation it will attract extremely good people.
I should say there are already extremely good people. The LME
on the regulation side has had no difficulty at all finding over
the last year extremely capable people. Some times we have taken
them from the FSA I am afraid to say although they are probably
more valuable within the LME than they are there. This is the
experience in the United States where it is perceived to be an
extremely good thing indeed to have done two, three, four years
in the CFTC or the SEC and then they go back into private practice
and sometimes come back into the regulatory body. This can have
mutual benefits for all sides.
Viscount Trenchard: Could
I ask the panel whether they think that the FSA should have some
separation of the powers of chairman and chief executive? We hear
a lot nowadays about corporate governance, companies increasingly
requiring the functions to be separate. The FSA has very extensive
powers and it can be said to be in part legislator, prosecutor,
judge, jury and enforcer all within one body, although admittedly
it is said that there will be separation of functions within the
body. Are the panel satisfied that the powers of chairman and
chief executive should be combined in one person?
258. If you do not wish to answer, fine,
I understand if it is incriminating!
(Mr Bates) My own view, if I might express one,
is that the corporate model is inappropriate because this is not
really a public company. It may be clothed in corporate form but
it is not a company in the traditional sense of the word. Therefore
the governance models adopted for corporate companies, I do not
think necessarily can be thrown straight on to what is essentially
a regulatory body or regulatory agency where it is not that uncommon
to combine the roles. I would not express a view one way or the
other about the appropriate governance model on that particular
point but I do not think you can necessarily say that it is a
company, therefore we ought to separate the two roles.
259. You do not think it should be a company?
(Mr Bates) On that point I think that the question
of whether it is a company or not is not of particular importance.
I understand that there are reasons why it is, not least because
the SIB was in that form and therefore continuity was possible.
What is important is the role that it has, the powers it has,
and the accountability controls that the Bill provides for which
the Government has gone a long way in its recent statements to
strengthen and enhance in line with and in response to comments
made by the industry.
(Mr Farrow) In our very early submissions when
the concept of the FSA was first announced we addressed this by
saying that the majority of the board should be non executives
and should be independent of the FSA. The Government has agreed
with that proposal. I think bearing in mind what Chris has said
that is a reasonable way of dealing with the need for both control
260. There is of course the position of
the senior non-executive in particular. I think it is probably
fair that we should not ask Mr Whittaker about that. Mr Telford
I am aware that on much of what we have been doing today the detail
has not been your concern, but do you have any final comments
you want to make?
(Mr Telford) I think just to emphasise some of
my earlier remarks. Of course we support any fairness and transparency
in the system, we think that should be pushed as far as it can
be. We are aware that in a fast moving market the regulator does
need to be flexible. One thing certainly, in a way we are disappointed
to hear, as we have been told for many years by people in wholesale
and retail markets that they really wish the regulator would just
establish clear principles and let them get on with running their
business as they know how to run it, are comments that in fact
detailed rules are what are required at every turn to give certainty,
putting aside the legal argument about certainty in that context.
We have been receptive to those views and said, yes, principles
are very important and firms should be left to run their businesses
as they see fit. We still support that principle and we would
rather the regulator was not caught up at every turn at having
to go into the detail of every single eventuality. Just one final
point I would make is about companies paying for regulators, they
have consumers and consumers generally also pay for regulation.
Our understanding of where funds go is to reduce the cost of regulation
which is to consumers and also to firms. So long as that is transparent
and we do not see the regulator issuing large fines to make the
budget better then we will be happy with that. Yes, clarity and
transparency but also a strong regulator with teeth will give
consumers confidence in the market place right across the board.
Although you are right to say wholesale markets may seem one step
removed from consumers, what happens in those markets, the fact
they are not corrupt and they are working efficiently does impact
on consumers on the range of investments and institutions they
wish to trust. We do have those concerns.
Chairman: Thank you
all very much. It has been a very interesting session.