Even within the short lifetime of the FSA’s Enforcement Division, 2005 will undoubtedly be seen as a pivotal year in its development.
Legal & General
The year started inauspiciously when the Financial Services and Markets Tribunal delivered its judgment in the Financial Services Authority’s (FSA’s) case against Legal & General (L&G), concerning the alleged mis-selling of mortgage endowment products. In the first major challenge of its kind, the tribunal considered L&G’s appeal against the decision of the FSA’s Regulatory Decisions Committee (RDC) and found that there had been no widespread mis-selling. The tribunal criticised the RDC’s examination of the evidence and reduced the original £1.1m penalty to £575,000 in May.
The enforcement process review
The FSA responded in February by announcing an internal review of its enforcement processes, to be conducted by the FSA’s director of retail firms David Strachan. The recommendations of the Strachan review, published in July, helped to clarify the division of responsibility and operations between those in the FSA who investigate and prepare an enforcement case and those who decide whether the conduct in question should be subject to sanction or penalty, namely the RDC. The review recommended creating a dedicated legal function to assist the RDC in decision making and that substantive communications between the enforcement case team and the RDC be disclosed to the subject of the investigation.
June saw the announcement of the FSA’s second largest fine of £13.9m, following an investigation into a eurobond trading strategy followed by Citigroup, which had temporarily disrupted the operation of the relevant bond trading platform, resulting in a short-term drop in bond prices. The FSA found that Citigroup had breached FSA Principles 2 and 3 as it had failed to conduct its business with due skill, care and diligence, or take reasonable care to organise and control its affairs responsibly and effectively. Notably, the FSA did not find that the trading amounted to market manipulation. While no specific rule had been breached by Citigroup, this decision shows a willingness by the FSA to use its Principles to censure firms for what could be considered minor controls and systems failures.
August saw two directors of banking software firm AIT convicted in the first criminal market abuse case taken to court by the FSA. They were found guilty of recklessly making a statement to the market, which was misleading, false or deceptive in connection with forecasted profit, which wrongly included revenue from three non-binding contracts. In October, the directors were sentenced to between two and three-and-a-half years imprisonment and both were disqualified from being company directors for several years.
This shows an increased willingness by the FSA to prosecute individuals and hold them personally responsible for statements made to the market – a salutary warning to other directors.
Sir Philip Watts
Following the FSA’s decision last year to fine Shell £17m after its overstatement of oil and gas reserves, the former chairman Sir Philip Watts asked the tribunal to consider the provisions relating to third-party rights for the first time in a market abuse case. Although not named in the final notice concerning Shell, Watts argued that he had been “identified and prejudiced” as he had been a senior executive at the relevant time and that people reading the notice would know that he was one of the individuals responsible for Shell’s actions. The tribunal found against Watts on the grounds that the relevant provision did not apply when it was possible to identify an individual “externally to the notice”.
The decision was welcomed by the FSA, which claimed that if the tribunal had found for Watts, it would have had serious implications for the way that the FSA deals with investigations into corporate entities. However, having secured this clarification from the tribunal, the FSA closed its investigation in relation to Watts without further action.
With the apparent climbdown by the FSA in such a high-profile matter, it is hard to avoid the conclusion that the shadow of L&G continues to hang over Canary Wharf and that 2005 has been a year of mixed fortunes for the FSA. However, while 2005 might have tarnished the Enforcement Division’s reputation, the procedural changes which it has now implemented should secure a more positive future for both investigators and the investigated.
Simon Hart is a partner and Rebecca Melling is a solicitor at Richard Butler