On review

In October, the Financial Services Authority (FSA) announced the final changes to its enforcement process, which was designed to meet the serious criticisms expressed in the judgments of the Financial Services and Markets Tribunal in the Legal & General (L&G) case.

Widespread concern in the financial services industry about the fairness of the FSA’s decision-making process was brought to a head in the tribunal’s criticism of the lack of transparency, causing the announcement of a review in February this year, to be led by the FSA’s director of retail firms David Strachan. The report on that review was published on 19 July, proposing substantial changes, in particular the establishment of a clear separation between the Regulatory Decisions Committee (RDC) and the Enforcement Division.

The enforcement process review is an exercise of remarkable candour. Its avowed purpose was to meet the criticisms made by the tribunal in the L&G case, revise its procedures to meet those criticisms and re-establish confidence in the fairness of the enforcement process.

This is not its first review. The FSA announced in September 2003 that it was reviewing its enforcement process to enable it to act more quickly in the face of misconduct. The objective of that review – described as the end-to-end review – was to identify ways in which the enforcement process could be improved and speeded up. In July 2004 the FSA published its conclusions in respect of case referral, investigations and decision-making. The main message that emerged was that there would be a more simple process for the referral of cases to enforcement and more speedy moves to interview and discuss investigations with senior management, with a view to early settlement, but with no changes to the substance of the decision-making process culminating in a decision by the RDC.

The aspect of the decision-making process that caused most concern was the lack of clear separation between the investigative Enforcement Division and the RDC. Section 395 of the Financial Services and Markets Act 2000 (FSMA) requires only that the decision should be taken by “a person not directly involved in establishing the evidence on which that decision is based”.

That requirement had been interpreted in the FSA’s procedures as allowing the enforcement team to have ‘special access’ to the RDC. That special access involved the provision of submissions and legal advice to the committee, in the form of a case review paper, purportedly subject to legal advice privilege, which was not disclosed to the person who was the subject of the decision.

Prior to the criticisms expressed by the tribunal in the L&G case, the FSA had been resistant to any suggestion that this special access infringed the basic right of the person under investigation to know the full extent of the case made against them and have an opportunity to answer all the points taken into account.

The effect of the Strachan review is that proper Chinese walls have now been instituted between enforcement and the RDC. All material shown to the committee will be disclosed to the person under investigation. The committee will take its own legal advice from its appointed lawyers and thus will have no need to take legal advice from enforcement. Any meeting between enforcement and the RDC, usually before the issue of a warning notice, will be minuted and the minutes disclosed.

As a result, we can expect to see a reformed and reinvigorated RDC exercising an independent judgment. Committee hearings will prove to be more interventionist and those representing the person under investigation at the meeting will need to be ready to deal with new points raised by the committee. The RDC is not a court or tribunal and it will, subject to the requirements of fairness, be master of its own procedure. We can expect to see more cases, such as the recent Sir Philip Watts decision in Shell, in which the enforcement case is rejected by the RDC. The FSA will publicise some information on the outcome of its process, thus reinforcing the perception of independence of judgment and restoring confidence in the process.

The price of these changes is an increase in the time taken to move through the process from warning notice to decision notice, and a lack of predictability. The RDC may disagree with the view taken by enforcement in the draft warning notice or investigation report, but it may also decide that the evidence requires a more serious charge or penalty than that which had been proposed. The FSA has reinforced its commitment to reaching settlements in enforcement cases and has instituted a tariff of discounts, which will apply to early settlements. Settlements may prove more attractive to enforcement and the person under investigation, who may in equal measure wish to limit their risk of a more adverse decision being taken by the committee.

Charles Flint QC is a barrister at Blackstone Chambers