L&G case will make enforcement action 'fairer', says Freshfields
Legal & General has said that the halving of its £1.1m fine for mortgage mis-selling will force the Financial Services Authority to consider evidence 'much more fairly' before taking enforcement action.
"The FSA will have to ensure that it has proper evidence on which to base its disciplinary action. Its enforcement processes will have to change generally, including a look at the Regulatory Decisions Committee process. The tribunal criticisms will be reflected in the FSA's enforcement review that is going on now," said Kirsten Younger from Freshfields, L&G's lawyer.
"I think that the FSA was keen to show it was tackling the endowment issue. But it did not fairly and objectively consider the evidence before it. It may have been, or may not have been, because it was keen to fine the firm for perceived failings related to endowment sales," she added.
The FSA decided that L&G had practiced mis-selling and then looked for evidence, Younger said. Instead, it should collect evidence first and then make an objective decision — and this should not take any longer or be any more costly. In its judgment, the Financial Services and Markets Tribunal criticised the FSA for the length of time that it took to deal with the case, she noted.
Younger cited press reports which indicated that the FSA would need more time to prove guilt in enforcement actions. "This could only be the case if there was guilt in the first place. The burden of proof is on the FSA, although it is entitled to do investigations," she said.
Looking for transparency
In Younger's view, the FSA's enforcement review will have to take account of the tribunal's criticisms of the FSA's stance on disclosure and transparency. "There is a lack of transparency in the system, and some submissions may be made under the cloak of privilege. The way in which L&G was treated is common to all firms," she said.
The case has shown that the tribunal can be an effective check on the FSA, according to Younger. "If the FSA is fairer, there will be less need for firms to challenge its enforcement decisions," she said.
Lawyers from outside the case noted that the tribunal's decision to reduce its £1.1m mortgage mis-selling fine to £575,000 was still a 'considerable commercial burden'. L&G invested perhaps £2m and a lot of time in preparing its case. It ended up with a still substantial fine of £575,000 and no costs paid.
This was not the issue for L&G, according to Freshfields. "There was an enormous reduction in the level of the fine, but the important point is not about the money. It is a matter of principle. L&G took on the case because it did not believe it was guilty of widespread mis-selling, and it believed that the enforcement process was unfair. It was vindicated on both of these points," Younger said.
Fine judgments
The tribunal was 'constrained' by the original £1.1m fine, although it could have reduced this to nothing, according to Younger. "The FSA ended up imposing a fine lower than in the four comparable cases mentioned by the tribunal in the judgement," she said.
There was an undeniable reputational benefit to L&G in the result, according to Martyn Hopper, partner at Herbert Smith. "L&G succeeded in limiting the FSA findings to a significant degree and halving the penalty. It paid a high price in terms of time and money, but gained to some degree in reputation, which is a significant consideration in enforcement," he said.
The tribunal will only order costs to be paid if it can be shown that parties acted unreasonably, according to Hopper. "It is a stiff test. Most people would have thought that the chances of L&G getting its costs back were not high," he said.
Firms would think carefully about going to the tribunal because it could cost a significant sum of money, according to Philip Rubens, partner at Finers Stephens Innocent. "They may be better off paying the fine in the first place. Most commercial organisations have to take into account how much an action will cost," he said.
The tribunal did not use its powers to recommend a change in the RDC procedure, as L&G must have hoped, according to Rubens. "Such a recommendation may yet come out of the FSA's Strachan enforcement review, but it could conceivably make things more difficult, rather than easier, for the industry. We don't yet know," he said.
Hopper believed that the tribunal's failure to make this recommendation was not surprising. "It's best not to have issues of policy decided in the adversarial procedure of the tribunal. Such decisions should not be based on one case, but on wider issuers. The tribunal found a lack of objectivity in relation to material given to the RDC but thought it best to refer the decision on the RDC procedure to the Strachan review since it is already up and running," he said.
Bitter relations
Lawyers speculated that L&G might have been better off attempting to negotiate a settlement with the FSA, rather than taking legal action. "L&G will have antagonised its relationship with the FSA as a result of this action. The FSA may not trust it again. There is the rhetoric of the FSA and there is how it feels in practice, and these may not always be the same," one said.
Others blamed the FSA's enforcement lawyers for failing to weigh up evidence properly. "There are serious disadvantages to running litigation of this importance in-house. However competent the lawyers may be, their ability to get closer to, and more involved with, their clients may come at the expense of the detachment enjoyed by litigators in private practice," a lawyer specialising in insurance regulation said.
The impression this case creates is that either the FSA lawyers were unable to make a full analysis of the weaknesses as well as the strengths of their case or, if they did, appropriate notice of what they said was not taken at a senior level, according to the lawyer.
In a wider sense, recent experience suggests that the FSA's capacity for self-criticism may be very limited, according to another lawyer. "Perhaps it could adopt a new principle 12, namely that it should adhere to the same standards as those which it expects of its regulated firms and their senior management," he said.