FSA Enforcement Director Recounts Difficulty of Bringing Individual Actions Against Senior Officers

Pressed by the Parliamentary Commission on Banking Standards on why there have seen so few enforcement actions against senior officers involved in the financial crisis, U.K. FSA Director of Enforcement Tracey McDermott explained that there are some big issues of fairness and individual rights in relation to criminalizing bad business decisions. There are various stages along the spectrum in relation to business decisions, she noted, but it is a very big step to criminalize incompetence or negligence. On the other hand, recklessness is much more familiar to the criminal law, so it is less of an issue. You can be prosecuted for recklessness.

These cases will always be difficult, said the Director. The reality is that it is always going to be difficult to take cases against individuals when you are looking at issues of competence. It is also important to bear in mind the purpose of enforcement actions as opposed to other regulatory action.

To a question from Pat McFadden, M.P on whether the current enforcement system is fit for purpose, Director McDermott said that the system is fit for purpose. While there are issues around the ability to hold senior individuals to account, that is not due to the enforcement process not being fit for purpose.

Questioned as to why U.S. regulators have brought more enforcement actions, Director McDermott said that historically there has been a very significant difference in approach between the U.S. and the U.K., in that the U.S. has historically used enforcement far more actively as one of the tools that the regulator uses. But the U.K. has changed in that regard significantly over the past few years, and now uses its powers more formally.

The Director also mentioned that there has been a cultural difference between the U.S. and the U.K. as to the degree of formality in the way in which the regulator has engaged. A lot of the time in the U.K., if you can get an outcome without using formal powers, that would typically be the starting point, whereas in the U.S. the starting point would be that you would use formal powers. One of the issues there is that the use of formal powers might be something that is escalated more apparently to the board than if you are using a more informal arrangement, or the seriousness may strike home to the board. Again, there is a question of whether the FSA should use formal powers more frequently, as a supervisory tool rather than necessarily an enforcement tool.

The Director also noted that the big distinction between the FDIC’s actions and the FSA’s actions is that the FDIC’s constituents are largely smaller institutions. The U.S. has a significantly higher number of banks than the U.K. They are focused on the smaller institutions for which it is actually much easier to find evidence. That is a practical matter, because the chains of command are shorter. If you look at the larger US institutions, the ones that failed, such as Lehman’s, she noted, or those that were bailed out, there has not been any enforcement actions against the senior management of those institutions.

The Director rejected a suggestion from Lord McFall that the FSA has been the subject if regulatory capture. The FSA has attempted to hold people accountable and has not always succeeded at doing that and is looking to see how the agency can do that better, she averred, but it is unfair to say that that was due to regulatory capture or to a lack of integrity on the part of the FSA.

Asked by Lord McFall to define good corporate governance, the Director replied that good corporate governance would be an organization that is well run and well managed, in accordance with proper ethical and business corporate standards.

Whistleblowing. Commission Chair Andrew Tyrie asked about employing, similar to the SEC, a reward structure for whistleblowing that can enable whistleblowers to share in the fine. The U.S.has had that for a considerable period of time in relation to federal tax issues and for a much shorter time in relation to SEC regulatory issues. At the moment, replied the Director, the FSA does not think that there is a case made out for significant financial incentives for whistleblowers, but the US experience is something the agency would want to keep looking at.

It is a very interesting scheme, she conceded, and the FSA has talked to the SEC about how it is working. The position is that it is still a little too early for it to tell, within a regulatory context, how it works. In relation to the U.K, she continued, there are some particular cultural differences, in terms of the way in which the court system works and the value that is placed on whistleblower evidence, or evidence of co-operating witnesses. That is very different in the U.S., because U.S. courts are used to that, but it is not something with which the U.K. courts are very comfortable. There are also issues around moral hazard in terms of financial rewards, particularly if you are talking about, using LIBOR as an example, a situation in which you pay a well-paid derivative trader a large sum of money.

Pressed further by Chairman Tyrie on the need to transform whistleblowing into something that is going to be effective, Director McDermott did not think that financial incentives for whistleblowers would be the thing that significantly changes the effectiveness of whistleblowing. She added that the whistleblowing system is not defective. The whistleblowing system exists, she said, and, in terms of how we treat whistleblowers and act on that information, I think it is effective. In the Director’s view, a lot of things that get put under the umbrella of whistleblowing are actually not whistleblowing, rather they are self-reporting or action taken by individuals within firms on an open basis, which is not whistleblowing.