The Financial Services Authority’s (FSA) enforcement regime is facing the glare of market scrutiny once more following the Financial Services and Markets Tribunal’s unprecedented costs decision in ‘The Plumber’ case.
On 12 October the tribunal handed down its eagerly awaited decision in the case of Paul Davidson & Ashley Tatham v the Financial Services Authority (FSA). The three-strong panel found that the FSA had acted unreasonably when it ruled that Davidson – known as ‘The Plumber’ – and Tatham were guilty of market abuse, a decision the tribunal overturned.
The ruling on costs is the first ever to be awarded against the FSA and has landed the authority with a bill that estimates put at between £5m and £10m. But it has also landed the FSA, and all who deal with it, with serious questions about how the authority’s enforcement regime will be run in the future. While few commentators agree on the exact path the FSA must now take, all agree that changes will be made.
“The FSA is settling more cases than ever before, and there’s a question about the FSA’s appetite to take people on in the tribunal. They’re keen to settle cases wherever they can and this can only make them keener,” says one City regulatory partner.
Clifford Chance finance and capital markets co-head Tim Plews adds: “Don’t tell me the size of the costs is not going to have an impact on things with the FSA as to how cases go forward.”
The Davidson costs decision follows a long-drawn-out process that began in 2002. Davidson, an entrepreneur, and Tatham, a former director of spread-betting firm City Index, were investigated by the FSA for their roles in allegedly placing a spread bet on the AIM listing of biotechnology firm Cyprotex.
By 2003 the FSA had concluded that Davidson, Tatham and investment broker Nigel Howe were guilty of market abuse under the Financial Services and Markets Act 2000. It recommended that the trio should be fined for the offence, but not prosecuted.
After considering the FSA’s report, the Regulatory Decisions Committee (RDC) decided to issue warning notices imposing fines of £750,000 on Davidson, £350,000 on Howe and £100,000 on Tatham.
Despite the trio’s oral and written submissions to the RDC, the penalties on Davidson and Tatham were upheld. Howe’s was reduced to £50,000 “on account of his financial resources and personal circumstances”. Davidson and Tatham both referred the decision to the Financial Services and Markets Tribunal.
In May 2006 the tribunal released its decision, finding that, while the spread bet had indeed taken place, the pair was not guilty of non-disclosure, as there had been no regulatory obligation to disclose, adding that it would not have imposed the financial penalties.
During the costs hearing the tribunal concluded that the FSA’s decision had been unreasonable. The tribunal also said that one of the flaws in the process at the time was the lack of a dedicated legal function “independent of the enforcement division [of the FSA] to assist the [Regulatory Decisions] Committee in its decision-making”.
But the FSA has undergone radical change since the Davidson decisions were made by the RDC. In January 2005 the FSA faced similar market scrutiny after the tribunal cleared Legal & General of the bulk of endowment mis-selling charges brought by the FSA. That decision prompted a review of enforcement processes known as the Strachan Review. Charles Flint QC of Blackstone Chambers describes this review as “an exercise of remarkable candour”.
By January 2006 the FSA had a litigation and legal review unit, headed by Tracey McDermott, in place to review its decisions before they are put before the RDC. This, among other changes designed to separate the disciplinary review and the enforcement processes, went some way towards reassuring the tribunal that a repeat of the Davidson case will not occur in investigations taking place now.
However, commentators believe that the tribunal’s decision is still designed to warn the FSA about the way it is regulating the financial services market.
Bingham McCutchen partner Peter Bibby, who was at the FSA between 1998 and 2002, says: “What it’s saying to the FSA is that you want to regulate with reference to principles, but as a tribunal we’re going to be a little wary of doing that.”
Bibby is one of several lawyers who say that the tribunal’s decision, both in terms of the substantive ruling and the costs decision, raises questions about the way the FSA gathers and manages evidence in its investigations.
However, the FSA’s current director of enforcement Margaret Cole is clear that the authority has already addressed such concerns during the raft of changes implemented in the wake of the Strachan Review, as acknowledged by the tribunal in Davidson.
“We’ve changed our processes already and don’t expect to be in that situation again,” Cole says. “We’re not panicking… We’re just getting on with the difficult job that we have to do.”
Furthermore, she says the trend in settlements is the result of market pressures to deal with cases quickly within the FSA’s budgetary constraints rather than being a reaction to a specific case.
But Norton Rose head of litigation James Bagge says: “I think the decision was an expensive shot across the bows by the tribunal, saying ‘be careful to ensure that your cases are properly supported’.”
Bibby adds: “The tribunal has certainly said that the RDC must take care to make sure that there’s credible and cogent evidence on which it makes its decision. I think a bigger issue is the quality and extent of the evidence that the RDC considers.”
Lovells partner Philip Parish says the tribunal has also set out a lower test of “unreasonableness” for the FSA to comply with. He points out that the decisions against the FSA in Davidson and Legal & General show that the tribunal is exercising its powers correctly.
“One thing that you can say about this tribunal is that it’s acting independently. It’s being very careful with the FSA itself, which is a good thing,” says Parish.
From the point of view of those appealing against FSA notices, the decision is a major confidence boost. Sir Nicholas Bonsor, the barrister who represented Tatham throughout the tribunal, says: “I think that the most unfortunate thing to come out of this is their complete refusal to accept any responsibility for the damage done to the individuals. I hope it would encourage other people who are wrongly attacked by the FSA to stand up and fight it.”