A crumb of comfort? The aftermath of the Legal & General hearing — part II
The second part of Complinet's exclusive legal analysis of the Legal & General tribunal hearing looks at the possible outcome of the Strachan review and the future direction of the Financial Services Authority's enforcement procedures.
Despite its criticisms, the Financial Services and Markets Tribunal chose neither to make recommendations regarding the Financial Services Authority's enforcement process nor award costs to Legal & General. Neither of these points should, however, detract in any way from the tribunal's stringent criticism of the FSA, nor do they offer any great comfort to the regulator.
The tribunal signalled fairly clearly that it had declined to make any recommendations; this is principally because, on 2 February, the FSA itself announced a review of its enforcement procedures. The Strachan review comes only six months after the FSA's 'end-to-end' review of its procedures, and it seems reasonable to assume that the FSA initiated this new review solely to avoid having recommendations imposed on it by the tribunal.
The issue of costs is slightly different. The tribunal could only award costs if the FSA's decision had been 'unreasonable' (para 13, schedule 3, Financial Services and Markets Act 2000).
Although the tribunal might not have required the decision to have been 'Wednesbury unreasonable' (i.e., so unreasonable that no sensible person could have arrived at such a decision) for costs to be awarded, it is hardly surprising that L&G failed to meet the requisite threshold.
In this case, the tribunal agreed with the FSA that there had been misconduct and that a 'substantial' fine was appropriate. In such circumstances, it was always unlikely that the tribunal would consider the FSA's decision so unreasonable that costs against the regulator would be justified, however flawed the FSA's decision-making process may have been.
To stand any genuine chance of having costs awarded against the FSA, an applicant would have had to persuade the tribunal to reject the FSA's original findings in their entirety. Even then, costs would not be guaranteed; it would still be necessary to show that the FSA had acted unreasonably.
The knock-on effect
The cumulative effect of the differences between the tribunal's decision and the FSA's original decision was to turn public attention away from L&G and focus it on the regulator. One of the aims of an enforcement process is to make an example of an institution so that other firms are deterred from the same conduct.
Instead, headlines have pilloried the FSA: "L&G's Prosser strikes blow for natural justice" (The Independent), "FSA dealt fresh blow by L&G fine ruling" (The Financial Times), "FSA was wrong over L&G mis-selling" (The Daily Telegraph), "FSA 'humiliated' by overturned verdict" (The Scotsman), "Tribunal slashes L&G mis-selling fine to £575,000" (Complinet).
This, of course, does not mean that the case was a victory for L&G. Through this turning of the tables, however, L&G has achieved what appear to have been its key objectives — namely to redeem its reputation and to have its unfair treatment at the hands of the FSA acknowledged. This vindication may have come at a high price, but in an industry where a firm's reputation can be worth tens of millions of pounds, L&G may well feel that it was worth it.
Does it matter to the industry as a whole which side came out better? One immediate benefit of the case has been a clear demonstration of the independence of the tribunal, which should reassure everyone that the FSA regulates. Although not every institution will be prepared to follow L&G's example, the tribunal's willingness to criticise the regulator where necessary will boost the confidence of any firms or individuals subject to investigation.
The other, more wide-ranging benefit is the potential improvement in the FSA's enforcement procedures. This will hopefully lead to a better relationship between the FSA and those it regulates, and thus better regulation overall. It is difficult, at this stage, to judge the scale of any improvements. The FSA's initial reaction was to suggest that it would be more thorough in its collection of evidence, but this would not address the tribunal's main criticisms and could further alienate those which it regulates.
The Strachan review of the FSA's enforcement procedures goes much further, however. Unlike the 'end-to-end' review, which focused on improving the speed and efficiency of existing enforcement procedures, the current review suggests that fundamental changes to the enforcement procedure could be made. If, as is hoped, the enforcement procedure becomes more objective, fairer and more transparent, and the FSA's analysis of evidence more rigorous, the entire financial services industry will owe a debt of gratitude to both L&G and the tribunal.
· Sidney Myers, partner, and Davina Given, associate, work in the regulatory investigations group at Allen & Overy LLP, the international legal practice.
Bad decisions
Philip Rubens
Although the tribunal levelled heavy criticism at the Regulatory Decisions Committee it acknowledged that it had much more time than the RDC to consider the issues and was also presented with more evidence; the adversarial process before the tribunal lasted for five weeks with L&G spending more than £2m on legal costs alone.
The RDC no doubt reached its decision after having been presented with oral and written representations. The oral hearing before the RDC was likely to have been confined to a much shorter period than that of the tribunal, and no cross examination of witnesses would have taken place at that stage.
One of the tribunal's main criticisms of the committee was that the RDC had not included its opinion of L&G's submissions in its decision notice. Consequently, L&G had no way of knowing whether its submissions had any influence at all on the RDC panel. The Strachan review is likely to address the RDC's lack of transparency and it seems inevitable that the committee will, in future, be obliged to give reasons for rejecting submissions made by the subjects of disciplinary action.
The tribunal explained: "[I]t is the experience of the courts, tribunals and many disciplinary bodies that it is useful for any judgment decision to refer to the competing cases of the parties, if only in very brief terms. This has the benefit not only reminding the tribunal of a party's submissions but also of later demonstrating to it that these were considered when decisions were made". This suggestion appears to be fair and reasonable, and it should not involve too much extra work for the tribunal.
Separate powers
It is open for debate whether the Strachan review will make other fundamental changes to the RDC process. Some practitioners favour a formal separation of powers within the FSA so that the investigation team is separate and distinct from the decision makers. This would enable the FSA to issue warning notices without reference to the RDC.
Such a recommendation would be a bold move by the Strachan review, and it would no doubt be met with strong resistance from the financial services industry. If anything, the industry would want more power to be placed in the RDC's hands at the expense of the FSA's investigation team because the committee has more industry experience in comparison to the FSA team.
There is no doubt that there are some cases which the FSA has brought before the RDC on the basis that disciplinary action ought to commence with the issue of a warning notice, only for the RDC to find insufficient evidence to warrant such a notice.
It would certainly strengthen the integrity of the RDC process and improve transparency if the FSA published details of the number of cases which were refused a warning notice when presented to the RDC.
The fact that the RDC wrongly judged the degree of mis-selling in the L&G case is very unfortunate but hardly surprising given the committee's limited resources. The time restrictions imposed on the RDC mean that it only sees a snapshot of each case.
Unless there is going to be a wholesale revamp of the RDC process, which would allow for detailed examination of evidence and cross examination of witnesses, then there is likely to be many more cases where the tribunal comes to a substantially different opinion from the RDC. It seems most unlikely that the Strachan review will propose to turn the RDC into a full-blown judicial process, in which case the tribunal would effectively have an appellate function.
Another likely change to the RDC process could well see the demise of the case review paper. This is the document which the FSA investigation team prepares for the RDC. The prime purpose of the review paper, which is not disclosed to the party under investigation, is to provide the RDC with an overview of the case from the FSA's perspective.
Clearly, the party under investigation would not be aware of any inaccuracies in the case review paper which could have a material influence on the RDC. It would not be surprising if the FSA was forced, in the future, to disclose the case review paper to the party at the same time as it submits it to the RDC; this would provide the party under investigation with an opportunity to respond.
The FSA could also lose its capacity to make a private oral representation to the RDC after the party under investigation has made its oral statement. This creates the impression that the party, which should be allowed to hear all arguments that the FSA puts to the RDC, has been unfairly treated.
It must have been somewhat of a major disappointment to L&G that, given the enormous amount it spent on legal costs and the tribunal's criticisms of the RDC process, the tribunal did not feel inclined to make recommendations under section 133(8) FSMA 2000 to change the RDC process. Some may feel that the tribunal, having heard all of the evidence, was in a better position to make recommendations than the Strachan review.