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Enforcement of financial penalties: the FSA bares its teeth
Practical Law UK Legal Update 0-386-7890 (Approx. 4 pages)
Enforcement of financial penalties: the FSA bares its teeth
by Neil Mirchandani and Elaine Penrose, Lovells LLP
| Published on 17 Jul 2009 • United Kingdom |
On 6 July 2009, the Financial Services Authority published a consultation paper proposing a change of policy on the enforcement of financial penalties. The proposals aim to increase transparency in the way the Financial Services Authority sets penalties, improve consistency in penalty-setting, and, most worryingly for financial services practitioners, increase significantly the level of penalties imposed.
On 6 July 2009, the Financial Services Authority (FSA) published a consultation paper (CP09/19) (the consultation) proposing a change of policy on the enforcement of financial penalties in cases brought under its Financial Services and Markets Act 2000 (FSMA) powers and non-FSMA powers.
The proposals aim to increase transparency in the way the FSA sets penalties, improve consistency in penalty-setting and, most worryingly for financial services practitioners, increase significantly the level of penalties imposed. To achieve these objectives, the consultation proposes a five-step framework for calculating fines:
Step 1: disgorgement
The starting point for calculating the fine is based on the principle that a person should not benefit from a breach. As such, wherever possible, the FSA will seek to deprive firms and individuals of any benefit or profit that they have derived directly from the breach.
Step 2: discipline
In addition to the Step 1 figure, the FSA will impose a stand-alone fine that reflects the nature, impact and seriousness of the breach. In cases brought against firms, the fine can be up to 20% of the firm’s income from the product or business area linked to the breach over the relevant period.
In cases against individuals that do not concern market abuse, fines can be up to 40% of an individual’s salary and benefits (including bonuses) from their employment in connection with which the breach occurred, and for the relevant period of the breach. In market abuse cases, the financial penalties for individuals will be subject to a minimum fine of £100,000.
Step 3: adjustment
Where appropriate, the FSA will adjust the Step 2 figure to take account of any mitigating or aggravating factors. These will reflect the firm’s or individual’s wider behaviour and co-operation and will include:
- The conduct of the firm or individual in bringing (or failing to bring) a breach to the FSA’s attention.
- The degree of co-operation the firm or individual showed during the investigation.
- The previous disciplinary record and general compliance history of the firm or individual.
Step 4: deterrence
If, after having applied Steps 2 and 3, the FSA considers that the financial penalty is insufficient to deter both the person who committed the breach, and others in a similar position, from committing breaches in the future, then it will increase the amount of the fine. The FSA recognises, however, that fines must be proportionate, and may reduce a fine if it is disproportionately high for the breach concerned.
Step 5: discount for settled cases
In order to negotiate early settlement of cases, where the person concerned is willing to agree the amount of the financial penalty in principle, the FSA may reduce the level of the fine calculated in Steps 2 to 4. Depending on the stage of the FSA’s investigation at which an agreement is reached, the person subject to the enforcement action can receive a reduction in the fine of up to 30%.
Credible deterrence
The consultation is another step along the FSA’s path to achieving “credible deterrence”. The FSA has already taken steps to achieve this by increasing the number of criminal prosecutions for insider dealing, for example. The proposals are consistent with this theme and the aim is to make market participants and authorised persons recognise that the fruits of their misconduct are not worth it when weighed against the risk of the punishment they could potentially face for their actions.
Much of the proposals already form part of the FSA’s approach to the setting of penalties. The aim to disgorge profits and the availability of specific discounts for early settlement are not new and have already been applied in enforcement cases. There are, however, a number of key changes which make the proposals noteworthy:
- The five-step process will make the rationale behind the fines more visible. It has sometimes been difficult to understand why a particular penalty was imposed when compared to fines for similar misconduct. In theory, the new proposals should produce a more standardised approach by the FSA and this should, in turn, give the penalties greater precedent value than is currently the case.
- The “discipline” part of a firm’s fine (Step 2) will now be directly referable to the income from the product or business area to which the breach relates. The FSA has recognised that there may be cases where income will not be indicative of the harm or potential harm that a firm’s breach may cause, in which case it will use alternative appropriate means of arriving at a Step 2 figure (for example, for breach of the Listing Rules, the FSA may consider the firm’s market capitalisation figure). However, it is easy to foresee arguments about what income should be included, and what the relevant period is, leaving the door open for challenges by firms, which may have an impact on how long the FSA takes to conclude cases.
- The FSA’s policy of targeting senior individuals within firms is not new, but this approach is more likely to have an impact in the context of higher fines. Those responsible for the actions of the firm are more likely to be cautious not to allow their company to breach FSA rules if they fear that they could be held personally liable. This will be especially the case if the FSA clarifies its new position on “serious financial hardship”, as the FSA has suggested that, where appropriate, it will not shy away from imposing fines that could bankrupt firms and individuals.
- There is no doubt that the approach of applying percentages to the firm’s or individual’s relevant income for the relevant period will increase fines significantly. In effect, we are seeing the FSA start to move closer in approach to the US Securities and Exchange Commission by placing greater emphasis on enforcement.
Overall, the proposed changes are not surprising in the context of the FSA’s more aggressive approach of credible deterrence, but they do represent another nail in the coffin of “light touch regulation”.
Neil Mirchandani is a partner and Elaine Penrose is a senior associate in the Investment Banking and Funds Litigation practice at Lovells LLP.
The full version of the consultation is available at www.fsa.gov.uk/pubs/cp/ cp09_19.pdf. The consultation period will close on 21 October 2009. Any new policy that the FSA adopts is likely to apply to breaches committed after February 2010.