The unprecedented events of the global financial crisis have caused much hand wringing among regulators and policy makers both in the UK and abroad. The causes of the crisis were complex with no one factor taking precedence over others. In spite of this, a view that has obtained widespread agreement is that the behavoiur of individuals within financial services firms was at least partly to blame.
The inability of regulators to take effective enforcement action against some of the main characters involved in firm failures at the time of the crisis was one of the catalysts that led to the establishment of the Parliamentary Commission on Banking Standards (PCBS), which published its recommendations in June last year. It delivered excoriating criticism of the Approved Persons Regime, recommended it be scrapped in relation to bankers, and replaced with a stricter set of requirements, supported by new conduct rules. The Report, ‘Changing Banking for Good’ labeled the existing regime “a complex and confused mess”.
Some of the recommendations have now taken legislative form in the Financial Services (Banking Reform) Act 2013, which received Royal Assent in December last year. Part 4 of the Act is entitled ‘Conduct of Persons working in financial services sector’. It will not come into force until the Financial Conduct Authority and the Prudential Regulation Authority have consulted upon and created new rules and procedures governing how the law will operate in practice. These consultations will occur over the course of this year. However, there is much solicitors can do now to help their financial services clients to prepare for the changes, which are extensive, and may impact upon a high percentage of the 400,000 staff currently employed by Banks in the UK. They are summarized below.
The Act creates a new function that will apply to certain categories of senior staff in banks and PRA-regulated proprietary trading firms, and will carry with it the threat of a presumption of misconduct and, where firm failure occurs, the possibility of criminal liability.
Section 19 of the Act inserts a new section 59ZA into the Financial Services and Markets Act 2000, which provides that a senior management function (in relation to the carrying on of a regulated activity by an authorized person, i.e. a firm), is one which will require the person performing it:
Managing one or more aspects of a firm’s affairs includes a reference to taking decisions, or participating in the taking of decisions, about how one or more aspects of those affairs should be carried on.
Currently, this provision only applies to those working in Banks or PRA-regulated proprietary trading firms (who are ‘relevant authorised persons’ as per section 71A of the Act) . The FCA and the PRA will be responsible for ‘designating’ certain function as Senior Manager Functions. However, the PCBS has indicated that it would like to see changes to the approved persons regime applied across the entirety of financial services, rather than being restricted to a sub-set of activity. It is not yet known whether the application will be extended.
The senior manager population is intended to be small, and to comprise board members and senior directors of banks and PRA-regulated investment firms. It aims to capture the most senior leaders and decision makers within a firm. In the language of the current approved persons regime, it is reasonable to assume that designated senior managers will be those who occupy the ‘governing functions’. However, it is not clear whether all of the other ‘significant influence functions’ will be caught.
There are a number of provisions within the Act that have been inserted with the aim of making it far easier to hold senior managers to account when things go wrong within their firm, as follows:
The duty to produce a ‘Statement of Responsibilities’: Senior persons will be required to formally accept a written statement of responsibilities which sets out their role. The purpose of this is to allow firms and regulators to ensure that a named individual is accountable for each key risk in their businesses, and will help regulators hold these individuals to account in the event of failure.
The presumption of misconduct when things go wrong: Misconduct will be presumed where a senior manager in a bank or PRA-regulated proprietary trading firm has been such a manager and there has been (or continued to be) a contravention of a relevant requirement by the firm, and the senior manager was at that time responsible for the management of any of the firm’s activities in relation to which the contravention occurred.
This creates an assumption of guilt on the part of a senior manager where a contravention occurs in his area of oversight. He bears the burden of proof for establishing (on balance of probabilities) that he should not be held responsible. If the manager can satisfy the regulator that he took such steps as a “person in his position could reasonably be expected to take” to avoid the contravention occurring (or continuing), he will be not guilty. There is no requirement for either regulator to take successful action against a firm prior to taking action against an individual for misconduct.
The Act also doubles the time scale within which the regulators can take action for misconduct, from three to six years (from the date of the misconduct).
The Nuclear option – The criminal offence relating to a decision causing a financial institution to fail:
Section 36 of the Act creates the criminal offence applicable to designated senior managers in UK banks or PRA-regulated proprietary trading firms. The offence is committed when the senior manager takes a decision (or fails to prevent the taking of a decision), that leads to the failure of the firm or another firm in the same group, and at the time of taking the decision is aware that it may lead to failure, and his conduct falls far below what would have been reasonably expected of a person in his position.
In order for liability to be established, the firm, or a firm in the group, must fail. Failure is defined as being where the firm enters insolvency (which includes bankruptcy, liquidation, bank insolvency, administration receivership, a scheme of arrangement of its affairs); or any of the stabilisation options in Part 1 of the Banking Act 2009 is achieved in relation to the firm, i.e. bank sold to a private sector purchaser, bridge bank or into temporary public ownership; or the firm taken for the purposes of the Financial Services Compensation Scheme to be unable, or likely to be unable, to satisfy claims against it.
The offence is punishable on indictment with up to seven years’ imprisonment.
The PCBS itself conceded that it would not be easy to secure convictions for this offence, but nonetheless recommended its insertion onto the statute book in order to focus the minds of senior decision makers, and to underline the heavy responsibilities they bear.
The prosecution in any case brought under this section would have to prove, beyond reasonable doubt, all elements of the offence. The two trickiest elements to establish are likely to be that the senior manager was aware of a risk that the implementation may lead to failure, and also that in all the circumstances his conduct fell “far below what could reasonably be expected of a person in his position”.
The concept of “reasonableness” will alter depending on the circumstances, and it is likely that in some instances where a bank is about to fail, senior managers need to make quick decisions under extreme pressure. The involvement of the regulator (most likely the PRA if there is a risk the firm could fail) at an early stage of the decision making process may assist. It is likely that there will be a requirement to notify the PRA in any event if a decision carries the risk a firm may fail (depending on the size of that risk, of course).
Senior persons must prepare a handover certificate when leaving a role or passing on duties. This will describe how they have met their responsibilities under the regime, and any issues the person taking on those responsibilities should know about. This requirement will be contained in rules made by the FCA and it implements one of the recommendations of the Parliamentary Commission, although it is excluded from the Act.
The flesh on the bones of the legislative provisions will be consulted upon this year. All firms involved in the provision of advice to banks and those who work in them need to apprise themselves of these changes, which mark the biggest shake up of the employee/employer/regulator relationship in the financial services sector that has been seen for a generation.
The Bulletin does not touch upon the other major area of development found in the Act, namely the creation of an entirely new population of regulated staff within a bank, known as ‘licensed staff’. These people will not be approved persons, but they will be staff who perform a ‘specified function’, which will be a function which either regulator is satisfied is a ‘significant harm’ function. Banks themselves will be responsible for running the licensing scheme. This too will create a substantial burden on firms and their advisors.
The biggest unanswered question is the extent to which the approved persons regime as it applies to staff working in other financial services firms (i.e. not just banks), will be shaken up. The PCBS has made its desires clear. In a Press Release issued on 7th January, Andrew Tyrie, Chair of the PCBS said:
“Financial services firms other than banks still operate under the discredited APR (approved persons regime). That is a mistake. Mr Adamson agrees. He told us that, in the FCA’s view, the reforms being applied to banks should also apply across the rest of the financial services industry. The regulators now need to tell us how and when this will be accomplished.”
A further Bulletin will be produced once the regulators’ consultations have come out. No date has yet been set, but by the end of the second quarter of this year is widely regarded as a likely timescale.
 Changing Banking for Good – Report of the Parliamentary Commission on Banking Standards, paragraph 86.