Trouble for the top

For the first time, the Financial Services Authority (FSA) has taken enforcement action directly against senior management of an insurance company, Chiyoda Fire and Marine Insurance Company (Europe). Hot on the heels of that came the Penrose Report on Equitable Life, which put much of the blame for the debacle on senior management and strongly criticised the “light touch” pre-FSA regulatory regime during the 1990s, under which management failings were allowed to flourish.

It is clear that senior managers can expect much tougher regulation and enforcement from the FSA from now on.

Prohibitions on Chiyoda directors

At the beginning of February, the FSA published its press release and Final Notice in relation to the action it had taken against six former directors of Chiyoda. Three of the directors were prohibited from performing any function in relation to any regulatory activity carried on by any authorised person – effectively a life ban from involvement in insurance in the UK. Another three were prohibited from performing any function involving the exercise of management authority over any other person in relation to any regulated activities carried on by authorised persons – effectively a life ban from directorship or similar of UK insurance entities.

The directors were all found to have been involved in misleading Chiyoda’s auditors and reporting to the FSA significantly misstated figures in the accounts. Their actions resulted in an apparent reduction of Chiyoda’s losses for 1999 from £34m to £4m, principally by disguising loans as reinsurance contracts.

The FSA considered the regulatory breaches by these directors to be very serious. Andrew Procter, director of enforcement at the FSA, said: “All of these individuals abused their positions, and as such they’re not fit and proper to work again in senior positions in the UK insurance market.” Five of the directors were described as failing to “satisfy the criterion of honesty, integrity and reputation” and operating to the risk of the FSA’s objectives of maintaining market confidence and preventing financial crime.

In fact, had the directors’ misdemeanours not taken place as they did before 1 December 2001, when the FSA received its full powers and assumed responsibility for insurance regulation, the FSA might have considered taking more wide-ranging action. As it was, the only disciplinary tool available to the FSA against individuals was the use of prohibitions.

FSA’s enforcement powers

The FSA’s enforcement powers in cases of compliance failures by senior management are now much wider than those that were available to the authority in the Chiyoda case. The FSA can still withdraw approved person status and/or prohibit an individual from performing a specified function in relation to a regulated activity – the fate suffered by the Chiyoda directors. The FSA can place prohibition orders against an individual if it considers that the individual is not fit and proper to carry out functions in relation to regulated activities. In addition, it now has further disciplinary measures that can be taken against individuals. These range from a private warning in the case of a minor breach (particularly where the FSA is satisfied that the firm or individual has taken steps to ensure that the breach will not recur) through to public statements and public censures and the imposition of financial penalties.

The FSA has powers to levy unlimited fines on approved persons where it considers it appropriate, in particular to deter other approved persons from committing or continuing to commit breaches. When deciding whether to impose a fine and/or the size of a fine, the FSA will consider:

  • The seriousness of the misconduct.
  • The extent to which the misconduct was deliberate or reckless.
  • The size, financial resources and other circumstances of the individual (the policy of the FSA is not to use the power to render an approved person insolvent).

The FSA’s powers of investigation

The FSA has extensive powers of investigation against approved persons. As a first step, the FSA will often require information and/or documents to be provided. Management will need to discuss with the FSA the scope of the information and documents required, so as to try to reduce the burden of time and costs in complying.

Where the FSA has more general or more serious concerns about a firm, or where it wants to interview staff and review documents, it may appoint investigators (usually members of its staff) to conduct an investigation into, among other things, the ownership or control of a firm, or the nature, conduct or state of business of a firm. The investigator can require senior management to attend interviews and provide such information as it requires.

The FSA also has the power in certain circumstances to require a “skilled person” to produce a report. If this happens, it may be more difficult to work with the FSA and costs are likely to spiral since the firm has to meet the costs of the skilled person.

Cooperation

Cooperation with the FSA’s investigation is not only a requirement under the FSA’s principles for businesses – and in some circumstances failure to cooperate is a criminal offence – but it can also produce tangible benefits. If the FSA is satisfied that a firm or individual is being open and honest, and/or has formulated a sensible plan of action to prevent any recurrence of the events which have aroused its suspicions, it may agree to a narrow scope to its investigation, or even take no action.

Despite the action taken against the former directors, Chiyoda was a case in point, as the FSA decided against taking action against Chiyoda itself (which is now known as Aioi Insurance Company of Europe). The FSA specifically cited the extent of cooperation provided by Aioi during the investigation as one of the factors which led it to this decision.

The FSA was undoubtedly swayed by Aioi’s cooperative and pragmatic approach to the FSA investigation. Aioi was able to show that the change in shareholders, the replacement of senior managers and the adverse impact on Aioi policyholders that would have been caused by disciplinary action meant that said action was not appropriate.

Nevertheless, while reasonable cooperation is important, this does not mean that individuals who are the subject of investigation must blindly submit to the FSA’s demands without a thorough consideration of whether to do so is really in their best interests.
The skill is to achieve the right balance between cooperation and not being forced into action that is against the individual’s best interests where there is a legitimate alternative route.

In this respect it is often vital for a firm to obtain expert professional advice as early as possible in the process.

The process if the FSA decides to take action

Except in very urgent cases, the FSA will send a preliminary findings letter to the individual under investigation. If the FSA has made a factual error, or omitted to take account of facts the individual considers relevant, then the person under investigation will be allowed a reasonable period of time in which to inform the FSA of this.

If it decides to take action, the FSA will then issue a Warning Notice setting out the action it proposes to take and giving the recipient a reasonable period of time to make any representations. The FSA will then either issue a Notice of Discontinuance (if no action is to be taken) or a written Decision Notice, setting out its reasons for deciding to take action. The recipient then has a further period of time during which it can refer the matter to the independent Financial Services and Markets Tribunal.

In practice, there will usually be informal discussions between the firm and the FSA with a view to reaching agreement on any action to be taken, such as the imposition of fines. Where no agreement is reached, or no referral is made, the FSA will issue its Final Notice, setting out the action it has decided to take. If a referral is made, there will be a full re-hearing of the matter, with statements of case, written and oral evidence, and often an oral hearing at which the parties may be legally represented.

At the end of the hearing, the tribunal will issue an order specifying the action to be taken. The parties can then ask the tribunal to review its decision, or seek permission to appeal to the Court of Appeal on a point of law, although there is no right of appeal on issues of fact. The parties will usually bear their own costs of the tribunal process, unless one party has acted unreasonably.

Conclusion

Senior management in regulated entities who are found guilty of misconduct by the FSA should prepare themselves for strict enforcement, and where the FSA considers it appropriate, the imposition of fines.

When issuing its ruling on Chiyoda, the FSA’s Procter: “Nobody should doubt our resolve to deal with any similar instances in the most robust manner available to us”.

The FSA has also made it clear that larger fines can be expected. It seems clear that there will be no return to the days of the sort of “light touch” regulation so heavily criticised by Lord Penrose in his report.

Nigel Davenport is a solicitor in the insurance regulatory team at Eversheds