DORIAN DREW<br /><strong>PARTNER, NORTON ROSE LLP</strong><br /><br />THE FSA has sometimes been called a watchdog with no teeth. That has begun to change, and in recent months there has been a notable increase in success. This, perhaps, is a result of increased activity following criticism of the watchdog. But all of this progress could be undermined. It is possible that the economic downturn could actually lead at least to a perceived reduction in the FSA’s effectiveness.<br /><br />Firstly, we have to understand why the FSA has become more effective. In its early days, it relied on the civil “offence” of market abuse – a non-criminal regime for tackling insider dealing and related conduct – in the hope that this alone would reduce market misconduct. The reality is more complex. The civil market abuse regime suffers from the same problems as the criminal insider dealing regime: a high standard of proof, the frequent need to rely on circumstantial evidence, and the difficulty in establishing each element of the offence. Clearly, a multi-faceted approach to dealing with misconduct is required.<br /><br />So the FSA has changed its approach. Its current policy has been described by Margaret Cole, its Director of Enforcement, as “delivering results that make people sit up and pay attention. It’s about making people realise that they can suffer meaningful consequences if they break the law and they don’t improve their standards of behaviour.”<br /><br />On the punishment side, the FSA believes that the deterrent of a criminal conviction outweighs almost any civil financial penalty. It has, therefore, boosted its ability to bring criminal prosecutions, including hiring criminal lawyers and working more closely with other law enforcement agencies.<br /><br />On the risk of getting caught, a new obligation on regulated firms to report transactions which appear to involve market misconduct has helped the FSA. Furthermore, it has invested in new software that will help identify possible misconduct from the trading information provided by exchanges and firms. Initiatives such as plea bargaining and granting immunity from prosecution in exchange for assistance, will be implemented in the near future.<br /><br />It all sounds positive. But some worry that these initiatives will be neutralised by the recession. The FSA’s latest statistics about the cleanliness of UK financial markets, published in April, looks at the extent to which share prices move ahead of the regulatory announcements that companies make to the market, a useful indicator of market misconduct. The statistics, which cover 2006/7, show that while the percentage of informed price movements ahead of FTSE 350 company announcements have decreased over the years to 7.7 per cent, the figure for movements ahead of public company takeovers is much higher, at 28.7 per cent.<br /><br />Will the 2009 figures show an improvement? A deterioration is a real possibility. In its 2008 Financial Risk Outlook, the FSA warned that in poor economic conditions firms divert resources away from tackling financial crime. Also, increasing financial pressures could tempt some to commit financial crime. If that happens, the FSA will need to explain why.<br /><br />The regulator has recently gained ground by changing its legal focus. It must now make sure that it does not lose ground in the recession. If it does not explain sufficiently why there appears to be more fraud, it risks looking weak and its deterrance effect will be undermined.