The FSA must make sure that its tough new approach doesn't backfire

FINANCIAL services firms have come under the increasingly intense gaze of the Financial Services Authority (FSA) in recent months. Its supervisory approach has changed dramatically as a result of the credit crisis. The upshot of this is that the risks for somebody who is FSA authorised, or is an &ldquo;approved person&rdquo; at an FSA authorised firm, are greater now than they have ever been. <br /><br />As recently as 2006, the FSA operated a &ldquo;light touch&rdquo; supervisory approach of seeking to stimulate market solutions rather than bringing enforcement action. However, since the credit crisis, the FSA has &ndash; in the words of its Director of Enforcement Margaret Cole &ndash; turned into a body committed to &ldquo;intensive, intrusive, outcomes-focused supervision&rdquo;.<br /><br />The FSA now has a &ldquo;creditable deterrence&rdquo; policy, which includes conducting search warrant and arrests, as appropriate, seeking custodial sentences and imposing bigger fines. In the year 2008/9, the FSA imposed 55 fines totalling over &pound;27m, in contrast to 21 fines totalling just under &pound;4.5m in 2007/8. The FSA has already imposed over &pound;14m in fines this year.<br /><br />Furthermore, while the FSA previously focused on firms, it is now concentrating on disciplinary action against individuals who are &ldquo;approved persons&rdquo; at authorised firms, and individuals who are fulfilling a role which requires FSA &ldquo;approved person&rdquo; status. Increasingly, when the FSA investigates firms for potential breaches, it is requesting the names of individuals who may be responsible. <br /><br />Approved persons include directors, senior management, compliance officers and those in customer-facing roles at an FSA authorised firm. The regime has recently been extended to any person who exercises significant influence over the regulated firm whether in the UK or overseas, including those at a parent company who has decision making power over the actions of the authorised firm. It has also been extended to include proprietary traders who are likely to exert significant influence, on the basis that they can commit the regulated firm. <br /><br />Approved persons have a contract with the FSA and have to obey its principles and code of conduct. They can be disciplined by the FSA for breaches of these, with penalties including a public reprimand (which has associated reputation issues) and/or a fine, or a prohibition order, which prevents the individual from acting in the financial services industry. Therefore the stakes are high.<br /><br /><strong>ULTIMATE SANCTION</strong><br /><br />Clearly, the FSA thinks that action against individuals is more effective than action against firms. Recently, the FSA exercised its ultimate sanction of a prohibition order in the case of of Andrew Cumming, a UBS investment adviser who attempted to disguise losses made as a as a result of unauthorised transactions. He was fined &pound;35,000 and banned from working in the financial services industry. <br /><br />In August, Steven Moorley, a mortgage broker and the managing director of Premier Network Group Limited, had his registration to perform chief executive function or &ldquo;apportionment and oversight&rdquo; functions taken away. He escaped a &pound;30,000 fine by arguing that he could not afford it. In the past, firms were reluctant to appeal against FSA punishments, as they worried this could damage their relationship with the regulator. However, the stakes are much higher for individuals, and they are appealing against the FSAs judgments. <br /><br />For example, two Dresdner Kleinwort (now Commerzbank) employees were censured for selling Barclays bonds after receiving inside information about an upcoming bond issue. They argued that they did not know what they were doing was wrong, and that insufficient guidance was available, and as a result managed to escape a hefty fine and lifelong ban.<br /><br />The FSA is also bringing in more intrusive policies for those applying to be an approved person. The regulator previously concentrated on the honesty, integrity and reputation of applicants seeking approved persons status. The focus now has shifted to industry experience, competence and capability. <br /><br />Applicants to large financial institutions for positions with &ldquo;significant influence&rdquo; are now subjected to competency-based questioning and are expected to demonstrate an understanding of the firm&rsquo;s business model, relevant industry risks and to detail plans to mitigate the risks of failure.<br />In the year to October 2009, over 10 per cent of candidates applying for significant influence positions withdrew their applications after interview, in many cases to ensure their application was not rejected. Significantly, as a result of withdrawing their applications, they give up the chance to appeal against the FSA&rsquo;s decision.<br /><br />This suggests that the FSA&rsquo;s &ldquo;intensive and obtrusive&rdquo; approach could backfire. The FSA needs people to be &ldquo;approved persons&rdquo;, and it needs to have a regime that does not deter potential applicants. It must steer a course of acting as a creditable deterrent without scaring people out of wanting to become an approved person. <br /><br />In becoming so intertwined in the recruitment of senior management, there would be reputation issues for the FSA if a vetted employee was to be disciplined. With intensive supervision, including regular assessments under ARROW, the FSA&rsquo;s risk-assesment framework, for &ldquo;very-high impact firms&rdquo; like banks and broker-dealers, it must be asked whether the FSA has the resources to conduct such all-pervading, invasive supervision.<br /><br />Jacqui Hatfield is Partner and Head of the Financial Services Regulatory Group, Reed Smith