No change to the FCA’s approach to enforcement and penalties

On 12 February, the FCA’s Executive Director of Enforcement and Market Oversight, Mark Steward, delivered the keynote address at the City & Financial Global Investigations and Enforcement Conference in London. This was Mr Steward’s second speech in as many weeks, – the previous one, on 6 February, was concerned with market integrity and the FCA’s strategic approach to market regulation (see our blog post on that speech here). This latest speech focused more broadly on the FCA’s approach to enforcement.

In this article, we explore the implications for firms of some of the key messages of the speech.These can be summed up, in brief, as follows:

• The purpose of financial penalties is deterrence but this should not be confused with the wider purpose behind enforcement, which is to ensure just outcomes.
• Financial penalties in excess of £310m were imposed in 2019, with an additional £231m in restitution payments
• Firms should be using the FCA’s Principles for Businesses as a baseline; the FCA expects that the Principles should form an integral part of the operational process of planning and decision-making at all levels.
• In response to a question from the audience, Mr Steward confirmed that as part of the FCA’s review of its penalty policy and Enforcement Guide – which the FCA had previously indicated would be the subject of a consultation paper – it had determined that there was no need to update the Decision Procedures and Penalties Manual (DEPP) of the FCA Handbook.
• Both the FCA’s approach to Enforcement, and the practical application of that approach, are set to remain much the same for the foreseeable future.

Financial penalties

The majority of Mr Steward’s speech focused on the FCA’s penalty policy, which has been the focus of some recent commentary around whether DEPP remains fit for purpose. At the outset, he drew a distinction between the purpose of penalties and the purpose of enforcement. The purpose of the former, he said, is specific and general deterrence, whereas the purpose of the latter is broader than deterrence and is focused on ensuring just outcomes and the prevention of serious misconduct. This includes the detection (as early as possible) and remediation (to repair harm after the event) of misconduct.

In other words, although it is clearly important that the FCA, as a conduct regulator, takes action to penalise serious misconduct, an equally important part of the FCA’s mandate is to ensure the consequences of such misconduct are dealt with and rectified so far as possible. Mr Steward noted that, in 2019, the FCA imposed financial penalties totalling over £310m on firms and required payment of restitution and compensation to affected persons of over £231m. This exemplifies the FCA’s outcomes-based approach to enforcement, which includes dealing with serious misconduct and ensuring its consequences are addressed.

Although prevention leading to absence of misconduct may be the overarching aim of any regulator, Mr Steward acknowledged that the complete absence of misconduct is unrealistic. This is why a key area of focus for the FCA is firms’ reactions and responses after things go wrong, and the importance placed on systems and controls designed to ensure early detection of such issues. It is no secret that the FCA may impose tougher sanctions on a firm which fails to correct relevant deficiencies and/or provide appropriate compensation to victims of their misconduct. Similarly, sanctions may be reduced where firms demonstrate proactive, cooperative and thorough remediation, in particular consumer redress. Mr Steward emphasised that this is consistent with DEPP 6 (specifically DEPP 6.2.1(2)).

Penalty policy in practice

Mr Steward noted that there have been several cases where the FCA has materially reduced financial penalties on firms in excess of the automatic 30% discount for cases that are fully resolved at stage 1. In order to qualify for such reductions, the FCA expects firms to go “beyond expectations” and take “immediate, unprompted steps” to swiftly remediate any harm caused by their conduct failures. In this regard, we note that Mr Steward may have been referring not solely to discounts but also to reductions to the starting point for calculating penalties which, coupled with a subsequent discount, might serve to bring the penalty down by more than 30% from what it otherwise might have been. If this is the case, it would suggest a lack of transparency in how the FCA calculates penalties and potential discounts as there could be debate over how the starting point was reached. In addition, there are also some cases where financial penalties are reduced because of financial hardship – typically in relation to individuals. However, in these cases the circumstances are made clear in the Notice.

Mr Steward underlined that discretion in the area of penalty-setting is important, given the wide range of circumstances to be taken into account and the need to avoid a rigid, mechanical process. DEPP provides some certainty by setting out relevant factors to be considered when determining penalty levels which, in Mr Steward’s words, serve to “guide the decision-making mind in a rational and reasonable way”, although he added that these factors must be considered against the facts in each particular case. The key point, in Mr Steward’s view, is that DEPP 6 should serve as guidance against which to interpret the facts of a case, rather than try to be a one-size-fits-all prescriptive route to penalty-setting. He remarked that this was “a difference that still appears to confuse some critics”.

Mr Steward accepted that revenue from a relevant business area may be used as a yardstick for determining the size of the financial penalty, but emphasised that a degree of adjustment in the name of proportionality would often be required. Importantly, the purpose of a financial penalty is not retribution, but deterrence, a point Mr Steward said even “well-respected observers” often get wrong. He encouraged the audience to review the FCA’s Final Notices, which summarise how DEPP 6 has been applied in a given case.

A question from the audience noted the FCA’s ongoing penalty policy review, in respect of which the FCA had stated in its 2018 Approach to Enforcement that it planned to publish consultation papers in 2018 and 2019, and queried whether the FCA also intends to look at DEPP in this context. Mr Steward’s response was that the FCA had looked at DEPP internally and decided that an update was not necessary at this stage. He did not mention the consultation papers which, as of February 2020, have yet to be published.

Observations on the Principles for Businesses

Mr Steward went on to make some observations on recent cases involving serious breaches of the FCA’s Principles for Businesses (the “Principles”). He noted that a common thread running through these cases is the fact that neither the offending firms nor senior management engaged directly with the Principles in carrying out or managing their regulated activities, including in relation to the implementation of systems and controls to identify and address any misconduct.

Mr Steward acknowledged that the Principles are sometimes criticised for encouraging “enforcement by hindsight” on the basis of their generality, which makes it difficult for firms to determine the difference between compliance and non-compliance. In response to such criticism he noted that, in the FCA’s experience, the main issue is that firms do not apply the Principles in their planning from the outset, and that “what we need is less hindsight and more foresight”. He went on to outline the different purposes served by rules and principles: whereas rules are effective for regulating simple, repeatable circumstances, principles are designed to respond and guide in more complex instances. He agreed that compliance with the Principles cannot be “satisfied by accident”, but rather requires deliberate and intended thought, planning and organisation.

The Principles, Mr Steward said, are “sound, simple propositions” which form the foundations of good conduct. He encouraged firms and senior management to use the Principles as a foundational guide in their approach to any business activity from the outset, suggesting that this would surely lead to less unintended harm caused by misconduct.

Conclusion

In our view, there should be no fundamental objection to the Principles, and we recognise that high level overarching guidelines are a useful framework for firms and individuals to determine their conduct. It would be practically impossible to attempt to reduce all the necessary content that comes from applying the Principles to a set of codified rules, and any such expanded rulebook would risk being unwieldy to the point of not being usable.

However, the key is in the way the Principles are applied, in the context of specific rules, and the judgement which must be formed about genuine attempts to abide by them. In our experience, that is where firms under investigation complain of a hindsight-driven approach. It is to be hoped, and expected, that this is recognised in investigations and informs the just outcomes that enforcement is designed to provide.