Response to Commission's Santion Communication and Mifid Sanctions Proposals

UNCLASSIFIED

Joint HMT/FSA response to the European Commission’s Communication: reinforcing sanctioning regimes

in the financial services sector

1. Introduction

The UK welcomes the Commission’s Communication and agrees that it is important that all Competent Authorities (CAs) in all Member States have sufficient tools for enforcement and deterrence. Sanctioning regimes must be robust if they are to be effective - a lack of severity in the sanctioning powers of some CAs encourages regulatory arbitrage and risks undermining the EU regulatory regime.

The UK therefore agrees with the Commission that some “minimum common standards” should be set at an EU level and that CAs in Member States should continue to allocate and administer the regime. As the appropriate disciplinary action in a particular case depends on the unique facts of that case, we consider that minimum harmonisation would be more appropriate than a maximum harmonisation approach.

The UK would encourage the Commission to explore and develop a framework of basic principles to promote coherence of EU action. Such a framework would be more effective than seeking to harmonise sanctions by way of a little by little approach as part of the MiFID and MAD reviews.

2. Appropriate types of administrative sanctions for the violation of key provisions

The UK agrees that CAs should have the power to impose injunctions, either administratively or via a court. In the UK the FSA can apply to the civil courts for an injunction in market abuse cases; or where there has been, or is likely to be, a breach of FSA rules; or where a person is not authorised to engage in financial services business. The court may make three types of injunctive order: to restrain a course of conduct; to require a person to take steps to remedy a course of conduct; and to restrain a person from disposing of, or otherwise dealing with, assets.

In the UK, the FSA also has the power to vary or cancel a firm’s permission to carry on regulated activities. The FSA may do this where it considers: that the firm is failing or is likely to fail to satisfy the threshold conditions (i.e. the minimum standards the FSA requires firms to meet to become and remain authorised); that the firm has not carried on any regulated activity for a period of at least 12 months; or that it is desirable to do so to meet any of its regulatory objectives (i.e. maintaining market confidence in the UK financial system; contributing to the protection and enhancement of the stability of the UK financial system; securing the appropriate degree of protection for consumers; and reducing financial crime).

It is important that any harmonisation does not restrict a CA’s ability to impose injunctions or cancel a firm’s authorisation, regardless of whether rules have been breached, in a situation where for example regulatory action may need to be taken to prevent harm to consumers, , or because of concerns about the financial viability of a firm. This is an important tool for the regulation of markets, the FSA has this power and it has proved effective. Furthermore, a distinction needs to be made between a CA’s supervisory powers and its enforcement powers. We believe that the Commission’s proposal should focus on the latter rather that the former.

We agree that managers of financial institutions should be removed if appropriate. Any such removal might be a punitive measure to discipline the individual and deter others from similar misconduct; or might be intended to protect against further harm because of an individual’s incompetence or lack of integrity. It may be appropriate to remove senior managers even if they are not dishonest or morally culpable if they lack the skills and competence to perform their role.

In the UK, the FSA is able to “suspend” certain “approved persons” from performing their role within a firm for up to two years as a disciplinary measure. The legislation also allows the FSA to “prohibit” or ban anyone, whether approved by the FSA or not, if they are not fit to engage in “regulated activity”. We see a prohibition order as a protective measure rather than a penal one. In other words, we consider the imposition of a penalty to be penal, whereas the prohibition of a person from carrying out certain activities within a particular firm, or across the industry, is imposed in order to protect the public from misconduct reoccurring.

We are unclear if the Commission is also suggesting that CAs should have the power to replace managers it prohibits. We would consider such a power to be supervisory in nature rather than enforcement related.

3. Publication of sanctions

We agree that the final decision of the CA to impose disciplinary sanctions should be published, whether or not that decision is appealed to a higher judicial body.

However we believe that it would be inappropriate to have a requirement to publish a sanction in every single case. Even publishing a sanction on an anonymous basis could still have negative repercussions. Often it may be obvious to whom the sanction applies or, arguably more seriously, people may wrongly assume that the sanction applies to a particular firm when that firm has not in fact been sanctioned.

We consider that CAs should be able to refrain from publication only where to publish would be prejudicial to the interests of consumers or unfair to the person who is the subject of the enforcement action (e.g. where publication could damage market confidence or undermine market integrity in a way that could be damaging to the interests of consumers). These are the two exceptions allowed for in UK legislation.

We also believe that, should they so wish, CAs should retain discretion to publicise investigations at an earlier stage than the final decision.

4. A sufficiently high level of administrative fines

We think it would be extremely difficult to set minimum levels of fines for every single type of breach. Every case is specific to its facts. We also note that the Commission’s own fining policy in relation to anti-competitive misconduct does not set out minimum fines for specific breaches. However, we consider that for certain breaches, there may be a case for setting a minimum level of fine. This may be the case in relation to breaches by individuals who commit market abuse. The FSA has recently adopted a new penalty framework (see the attached Annex for a summary) in which an individual who commits serious market abuse can expect a minimum fine of £100,000. This fine can be reduced for mitigating factors such as co-operation or on the grounds of serious financial hardship. The FSA set this minimum in order to send a strong message in relation to market abuse, a breach which is often committed by individuals and which involves many of the same elements and similar facts for most breaches. We do not consider these factors to be present in most breaches of the rules which implement EU Directives. Consequently we feel that setting minimum fines in other areas is likely to be unworkable.

In any case, any minimum level of fines should be eligible for a reduction on the grounds of co-operation (as mentioned by the Commission, this is one of the factors which should be taken into consideration when setting a fine), and other mitigating factors (such as whether a person brings the misconduct to the CA’s attention). In addition, CAs should be allowed to reduce a fine where firms or individuals agree to settle a case. The ability to settle a case is an important tool which allows CAs to dispose of cases quickly thereby releasing extra resources to allow more investigations. The Commission may also wish to consider the extent to which any fine, including prescribed minimum fines, should be reduced because of the financial circumstances or impecuniousness of the subject of enforcement action. The FSA’s approach to issues of “serious financial hardship” is discussed in more detail below.

We agree that sanctions should act as a deterrent. One important factor in ensuring that fines do act as a deterrent is that they should, at the very least, include any profit (where it is practicable to quantify) that a firm or individual may have made from a breach. Having a statutory maximum for the amount of a fine could prevent CAs from being able to claw back any profit. Consequently we agree with the setting of “minimum maximum” levels of fines. In other words, where a Member State sets a maximum cap on the amount a CA can fine, we agree that the an EU Directive could specify the minimum level of such a cap e.g. CAs must be able to impose a fine above € ‘x’.

5. Sanctions provided for both individuals and financial institutions

The UK agrees, in principle, that all CAs should have the power to impose sanctions on companies/firms and specified individuals. In the UK the FSA can impose fines on authorised firms and approved persons who breach its rules.

6. Appropriate criteria to be taken into account when applying sanctions

In principle, we agree with the setting of a minimum list of factors. These factors should only be required to be taken into consideration where they are relevant to the facts of the case.

On the financial benefits factor , we agree that this should be taken into consideration when setting a fine. For a fine to be a credible deterrent, individuals and firms must not profit from their misconduct. However, there will be instances where it is not appropriate to take into consideration the financial benefit a firm or individual has derived from the misconduct. This will be the case, for example, where the firm has already paid consumers redress or has agreed a redress scheme with the CA. The FSA’s penalty framework states that:

“The FSA will seek to deprive a firm of the financial benefit derived directly from the breach (which may include the profit made or loss avoided) where it is practicable to quantify this. The FSA will ordinarily also charge interest on the benefit.

Where the success of a firm's entire business model is dependent on breaching FSA rules or other requirements of the regulatory system and the breach is at the core of the firm's regulated activities, the FSA will seek to deprive the firm of all the financial benefit derived from such activities. Where a firm agrees to carry out a redress programme to compensate those who have suffered loss as a result of the breach, or where the FSA decides to impose a redress programme, the FSA will take this into consideration. In such cases the final penalty might not include a disgorgement element, or the disgorgement element might be reduced.”

Adjusting a fine to allow for the financial strength or circumstances of the author of the violation is one of the most difficult aspects of penalty-setting. In principle, one can argue that a penalty should reflect the nature of the misconduct in issue; and that the same misconduct committed by different persons should justify the same penalty, in that the essential wrongdoing is the same irrespective of the identity of the miscreant. Against this, however, we recognise that for penalties to be effective in deterring similar misconduct in future the sanction must be more than a “cost of doing business”. How one adjusts penalty to allow for the size of an institution, or for an individual’s personal wealth, however, is difficult and it can be challenging to ensure a consistent approach across a range of cases. The FSA’s penalty framework now provides different starting points in relation to setting fines for firms and for individuals. For firms, the FSA looks at the revenue generated by the relevant business area in which a breach has occurred as an indicator of the scale of the likely harm or impact of the breach. The FSA will then quantify the fine by reference to a percentage of this revenue according to the seriousness of the misconduct. For approved persons, the FSA looks to the income they have received from their employment and again looks to quantify the fine by reference to a percentage of this income. The framework recognises however that this approach will not always deliver an adequate penalty to deter others, and that it may be necessary to increase penalties to dissuade others from similar conduct.

We agree with the Commission therefore that one of the criteria in setting penalties should be the financial resources of the person responsible for any misconduct. We note that prescribing how this should be taken into account is challenging.

We also consider that CAs should be able to lower a fine if payment of it would cause an individual or firm serious financial hardship. To impose a fine in such circumstances may be disproportionate. There may also be reasons why it is better for the consumer that a firm is not forced into insolvency (e.g. so the firm can pay redress to consumers or can be sold as a ‘going concern’). Having said that, the FSA recognises that there may be circumstances where even if payment of the fine would cause serious financial hardship the fine should not be decreased. The FSA’s published penalty policy, for example, states that:

“There may be cases where, even though the firm has satisfied the FSA that payment of the financial penalty would cause it serious financial hardship, the FSA considers the breach to be so serious that it is not appropriate to reduce the penalty. The FSA will consider all the circumstances of the case in determining whether this course of action is appropriate, including whether:

(a) the firm directly derived a financial benefit from the breach and, if so, the extent of that financial benefit;

(b) the firm acted fraudulently or dishonestly in order to benefit financially;