Why should I even consider enforcement risk?

The word “enforcement” will send shivers down the spine of many of those involved in the financial services industry both individuals and firms alike. Arguably, the ultimate regulatory tool backed up with weaponry that can fine, ban and publicly admonish. However, it does not necessarily need to be viewed with complete fear and trepidation. While it is true that there have been some recent proposals relative to the enforcement process, which I go on to consider further below, a healthy approach to regulatory compliance and a robust system of good governance will see most out of the woods on the basis that enforcement is generally the regulator’s tool of last resort. The FCA will have a preference for dealing with most issues as part of the supervisory process and avoid cases ever reaching the enforcement arena. Enforcement action tends to take place, aside from in cases involving fraud and other forms of dishonesty, in those cases of big picture or systemic malfunction where there has been a failure to identify an issue or collection of issues that reflect an underlying and fundamental or broader overall failing which suggests poor governance, ineffective risk management and control, and where supervisory interventions have failed to reach a non-enforcement based solution. 

Assuming that you are not a ‘bad actor’, in which case the FCA will want to manage you out of the industry, a good mantra to adopt is ‘prevention is better than cure’. A sound and robust system of governance, accompanied with good policies, processes and controls, and a recognition that mistakes do happen but can be managed with a positive approach and an open and cooperative relationship with the regulator, will generally keep the wolf from the door.

What are the topical issues?

There are several regulatory areas to consider as particularly topical for enforcement purposes and these include those ‘watch’ areas of recent substantive regulatory change including the Consumer Duty, which is a good example of a non-enforcement-based driver of positive regulatory change, and other specific focus and trending areas for the FCA such as non-financial misconduct and motor finance. 

How will the Consumer Duty affect the FCA’s approach to enforcement?

The answer to this question is that nobody really knows just yet. It is too early to see enforcement actions arising out of Consumer Duty breaches because it simply has not been around for long enough to have generated an enforcement outcome yet. However, we can surmise that the outcomes-based approach under the Consumer Duty will have implications for the FCA’s engagement with firms for supervisory and enforcement purposes and may mark a significant change in the FCA’s approach. Pre-Consumer Duty the FCA had less ability to commence investigations where it was not possible to identify a specific breach but there were nonetheless poor outcomes for consumers. A consequence of the outcomes-based approach is that it results in a broader concept of ‘breach’ and gives the FCA a much wider footing from which to start an investigation when it can identify poor consumer outcomes. This enables the FCA to look backwards from a poor outcome and appears to give the FCA a broader ability to open investigations. 

As part of the implementation of the Consumer Duty, firms are expected to implement processes that enable them to identify poor outcomes and to act to put things right before intervention from the FCA becomes necessary. Firms need to be monitoring the outcomes that they deliver to their customers and to be identifying and gathering the data required to do this. The FCA has warned firms to think carefully about the data required to demonstrate customer outcomes and not just the good ones but also the bad ones, and relative to those, the data required to understand the cause and the plan to adapt and change to improve outcomes. The FCA is likely to ramp up its own data and information gathering via its supervisory channels and to use complaints data and FOS decisions to identify any patterns or concerns with Consumer Duty implementation and evidence of poor outcomes. 

What is this about recent enforcement proposals from the FCA?

The FCA has recently announced proposals to make changes to its enforcement policy. One of these proposals concerns possible changes to how the FCA publicises its enforcement investigations, providing the FCA with the ability, in certain circumstances, to bring the pre-final enforcement process into the public domain, including publication of the fact that a firm has been referred for investigation. It is important to put this proposal into context: 

1. it is only a proposal at this stage and a consultation period is currently open until the end of April; and
2. there is some important scene setting to do around why the FCA is proposing this seemingly radical shift in its approach. 

A closer look at the Consultation Paper reveals that the regulator’s intentions broadly relate to increasing transparency around the enforcement process; modernising and updating the enforcement guide to reduce inconsistent, redundant, duplicative and out of date information; making information about the enforcement process more accessible, for example by moving key information to the website; rewarding cooperation with the regulator; disseminating best practice and making the most of the deterrent effect of enforcement.

What is this about deterrence?

One of the key purposes of the enforcement process is deterrence. Public enforcement outcomes are a significant and effective deterrent tool. However, enforcement outcomes typically come right at the end of the enforcement process, and that is a process that in most cases can take many years and, by the time those outcomes are made public, relate to regulatory standards that have long since been superseded.  Currently, save in exceptional circumstances (there has been some pre-final publicity recently in relation to high profile cases involving allegations of non-financial misconduct in financial services firms), very little is publicised about ongoing investigations. Accordingly, the FCA is looking at shifting its approach to focus on more timely deterrence, to focus on the here and now, and on current issues and standards, educating the market on what is important now and the types of behaviours that will currently drive the FCA to open an investigation.

Why now?

The FCA considers that there is a pressing need to shift its approach because of the new and complex threats that exist to consumers and investors. It also wishes to be a transparent regulator, and to be clear, open, and accountable about the way it works, including relative to its enforcement investigations. Other related reasons behind the proposed changes include the need to speed investigations up, with the overall intention of having fewer and faster moving investigations and aligning investigations more closely with strategic priorities. The FCA’s objective is to prevent more market abuse and more financial crime. 

Are there any safeguards proposed?

The proposal to publish information about the early stages of enforcement, including the fact of the opening of an investigation and the subject of the investigation, has proposed safeguards around it. These include careful consideration to the need for early publicity to be given on a case-by-case basis, clear statements that the announcement of an investigation does not mean that there has been a regulatory finding, extra caution around the naming of individuals (which will not usually occur), updates on the investigation, and appropriate closing statements, including relative to those investigations which result in no further action being taken. The proposal will form part of a public interest framework, essentially a balancing exercise between the downsides of early publication as against the proposed benefits, which include the faster dissemination of regulatory concerns and regulatory best practices. It is the FCA’s intention that this could therefore be a driver of positive change and an improver of consumer and investor confidence.

What is the bigger picture?

There is important regulatory purpose for the FCA in these proposals, including that the FCA is keen to: (i) boost trust in the regulatory system, (ii) improve clarity around the kind of conduct that its sees as warranting of enforcement investigation, and (iii) improve the efficiency and the pace of enforcement investigations. To return to the example of the Consumer Duty, and to the here and now, it would be helpful for industry to understand what kinds of issues might lead the FCA to open an investigation into failings around the Consumer Duty. However, because of the prevailing and problematic issues around the enforcement process, predominantly case overload and long delays, problems which the FCA is understandably keen to address, it is not possible to get this information to the markets. 

Eeek!

An early public outcomes regime is one that many would be fearful of. Arguably, it could impact upon the attractiveness of the UK as a jurisdiction of choice in which to do regulatory business, although given my opening comments about the ‘prevention rather than cure’ approach to getting regulation right, one might ask what kind of business would have anything to fear and whether the UK regulator would want them operating in its financial services industry. However, given that the UK’s investigative journalism can be aggressive, it is easy to see that no firm subject to such an early publication would survive the inevitable outcomes of the headlines. Indeed, it is predictable that an early publication of this nature could lead customers to go elsewhere, restrict access to finance and insurance options, increase litigation risk and cause employment issues. There would likely be particularly high stakes in the listed sector. In the worst outcome scenarios, there could be a risk of irreparable damage being caused to a business where there has been no breach and there is ultimately no finding of a breach.

What could the alternatives be?

An important part of the consultation process will involve the FCA considering foundational principles such as due process and fairness, potentially conflicting laws such as data protection, alongside the reactions, views, and opinions of those who contribute to the consultation process including industry participants and trade bodies. While the outcome remains to be seen, it is possible to read about and relate to some of the concerns that exist around the early publication of information about an FCA investigation. Importantly, the FCA will also need to consider whether the same desired outcomes might be achieved by equally informative but less potentially harmful means. These could include, for example, the amplification of Market Watch which is specifically designed for the purpose of enabling the regulator to share its observations with industry and is read and acted upon by industry. A publication in which the FCA openly shares more detail on its regulatory concerns and the positive steps that it would like to see firms taking would likely be of significant interest, taken seriously and could lead to enhancements in industry behaviour. In terms of improving the use of transparency as a regulatory tool, publishing current information about investigations, raising awareness of consumers, deterring future breaches, protecting and enhancing the integrity of the UK’s situation, could certainly be achieved in an anonymous (and therefore less contentious and risky) way. The FCA could still obtain the benefits of early announcements about its current enforcement activity, including preventing harm in real time; encouraging witness and whistleblowers to come forward; addressing public interest and speculation; evidencing that it is taking appropriate action; deterring similar breaches and advancing its statutory objectives in the public interest; but without enabling ‘trial by media’ and increasing the likelihood of serious damage to the reputation of a subject firm prior to a final outcome.

Will there be a voice for potential subjects?

The FCA’s focus so far has been on the wider public interest factors and there has been little consideration in the proposals to those who might become the subject of an early announcement. However, the proposals have been controversial and have generated significant interest, including from members of the legal profession active in this space, and these views will of course reach the FCA via the consultation process. It will be interesting to watch how the responses to the consultation are considered and whether there is an outcome that can support the legitimate aims of the FCA to speed up the enforcement process and increase accountability while at the same time offering appropriate protections to firms who are subject to the enforcement process. Lobbying efforts are likely to focus on the necessity of early naming announcements (given the existence of anonymised alternatives), the notice period to be given to subject firms (the current proposal is for just one business day), specific risks around market-sensitive information, and the scope for irreparable reputational and other damage in relation to investigations which are subsequently closed with no finding of wrongdoing. Current statistics suggest that roughly two-thirds of regulatory investigations are discontinued without an adverse finding and so it is certainly possible that there can be ‘smoke without fire’ in respect of some investigations.  It must be hoped that the consultation process will result in the best parts of the proposals, including a faster paced enforcement process and increased availability of current and materially beneficial regulatory information for the markets, being achieved without leaving firms in an intolerable position which could impact upon the attractiveness of the UK as a place to do business. 

Are there rewards for good behaviour?

To echo some of my opening points about good behaviour, enforcement is a regulatory tool of last resort, and it is unlikely that an enforcement investigation would come as a complete surprise to any firm. It is much more likely that it would follow a lengthy supervisory engagement and that, absent dishonesty, the subject firm would have been given several opportunities to remediate its regulatory failings to the satisfaction of the FCA. In fact, some of the proposed changes to the enforcement policy specifically encourage firms to undertake their own investigations and to share the results of these with the regulator. On this basis, striving for good consumer outcomes delivery and for an open, cooperative, and positive dialogue with the regulator, including where things are not going entirely to plan, is likely to be the most conducive approach to steering any firm away from the direction of the enforcement regime. 

I will be watching the progress of this consultation alongside our financial services regulatory team and waiting with interest for the FCA to clarify its future approach to enforcement. Watch this space for further updates. You can also subscribe to our regular financial services update here.