The FSA’s cosy deals are a travesty of regulation

By Ian Fraser

Published: QFINANCE

Date: December 5th, 2011

Ever since its failures as a regulator first became widely apparent with the collapse of Northern Rock in September 2007, the UK’s Financial Services Authority has shown a remarkable lack of enthusiasm for rooting out financial crime, and very little introspection or contrition about its own pre-crisis performance.

The reported attempts to brush the 2008 near wipe-out of Royal Bank of Scotland under the carpet, via a 450-page report blaming RBS’s failure on the ‘global financial crisis’ and Johnny Cameron, its ex-head of investment banking, while skirting around the roles of chief executive Sir Fred Goodwin and chairman Sir Tom McKillop, is just another symptom of the culture of cover-up and denial that renders the Canary Wharf-based institution useless.

Depressingly, the same culture of ‘circling the wagons’ to protect the rich and the powerful looks set to permeate the successor bodies that are due to replace the FSA in early 2013.

The FSA’s chief executive Hector Sants (pictured above) and Martin Wheatley, its managing director of the consumer and markets group and a former Hong Kong SFA regulator, appeared before the Treasury select committee of the UK’s House of Commons on November 1, alongside FSA chairman Lord (Adair) Turner and interim managing director (conduct of business unit) Margaret Cole.

The session was supposed to be about the UK government’s program for scrapping the FSA and replacing it with the Prudential Regulatory Authority and Financial Conduct Authority from late 2012, early 2013. The FCA, which was originally going to be called the Consumer Protection & Markets Authority, will focus “on the use of firms as a conduit for financial crime”, and the PRA will come under the Bank of England and be responsible for “macro-prudential oversight” of markets and financial institutions (the former is to be run by Wheatley, while the latter is to be by Sants).

What disturbed me the most about the November 1 session was the regulators’ nonchalance about criminality in the UK’s banking sector. At times, using the tortured and obfuscatory phraseology that is their wont, they sought to pretend that criminality and fraud do not, or cannot, exist in the domain they’re supposed to police. This struck me as bizarre in the extreme.

All four of the senior financial regulators in the Treasury committee hearing must, for example, be aware of Thames Valley Police’s ongoing Operation Hornet investigation into money-laundering, corruption and large-scale fraud involving the corporate lending division of HBOS (now part of Lloyds Banking Group) which one of the policemen involved has described as “the largest fraud inquiry of its type in UK history”.

They must also be aware that, in their desperate pursuit of short-term profits, many of the banks and financial institutions in the City have effectively “gone rogue” and would have few qualms about destroying loyal clients in exchange for a fast buck, cooking their books, deceiving investors etc, etc. They will also be aware of high-profile cases such as that of the UBS “rogue” trader Kweku Adoboli. Against this backdrop, their “hear no evil” attitude to criminality in City, a word used to describe the UK’s banking and financial sector, seemed ill-judged.

Instead of seeking to root out such criminality, the FSA executives universally expressed a strong preference for cosy backroom deals – in which  financial wrongdoers and malefactors are coerced into agreeing to lifetime bans from working in the financial sector, often in exchange for agreements from the FSA  call a halt to their investigations.

The FSA has already struck deals along these lines with former head of investment banking at RBS Johnny Cameron, and unsuccessfully sought to strike such a deal Peter Cummings, the former head of corporate lending at HBOS (despite the ongoing criminal investigation into large-scale fraud and corruption etc in the division that he oversaw). However such deals are an absolute travesty of regulation.

Such deals are favoured by the FSA for the same sort of reasons as they are favoured by the Securities & Exchange Commission and other financial regulators in the US. They are much, much easier to pull off than proper, thorough, criminal investigations and prosecutions, especially when court cases must be heard in front of a jury. They also have the huge advantage of enabling the regulator to sweep high-level ‘white collar’ crime, as well as evidence of its own past failures (as well as its seeming complicity in certain frauds), under the rug.

But it is thanks to the FSA’s approach that many of the robber barons of British banking whose stupidity, greed and treachery caused the financial crisis and subsequent recession, continue to ply their trade, assuming they are untouchable, in the City of London. The chances of prosecutions — without which we have little or no hope of building a properly functioning financial system — recede further and further into the distance.

The session can be watched in full below:-

So what of the detail of the Treasury committee session?

Turner, Sants, Wheatley and Cole told the MPs they do not favour the drafting of any further criminal laws on the mismanagement of banks and financial institutions, beyond the existing powers to prosecute for fraud or deliberately mislead the market (which they don’t really use anyway). According to the Hansard transcript of the session, Cole claimed:-

“There isn’t a criminal offence that is pertinent to the behaviour of bankers. Some may say it should be, but it is not a criminal offence to be incompetent.”

My jaw nearly hit the floor when she said that. The committee’s chairman, Andrew Tyrie MP, then asked Cole how many bankers have been found guilty of offences which, under the FSA’s proposals, would be likely to lead to a prison term? Cole replied:

“If there were to be a criminal offence relative to behavior of bankers and the running of banks, that would require new legislation. It is not framed in this current draft legislation.”


Jesse Norman MP, taken aback, reminded the regulators of their earlier affirmations that more “proper accountability” is needed. Norman said: “One thinks of HBOS, which fired its head of risk before going bust, and similar concerns at the RBS. These executives are very highly paid and they bear very large private and public responsibility, so my question for you, Mr. Wheatley, is would you support making certain actions into criminal offences? For example reckless mismanagement of a financial institution?”

According to the Hansard transcript this is what followed:-

Martin Wheatley (pictured left): I think we have to be very careful about what we consider to be criminal actions. The challenge that we all have is we want good people in those roles, and so we want good people to take on the roles of directors, to take on the role of chief executives.

Jesse Norman: You are not suggesting that Messrs Goodwin, Stevenson, Crosby, and so on, were successful exemplars of good management in banking?

Martin Wheatley: I think we have to have the appropriate level of penalties for the appropriate level of offences. I think that is something we just have to think very carefully about.

Jesse Norman: But would you, in principle, support the idea of making certain actions into criminal offences in this area?

Martin Wheatley: When you say “in this area”, the principle of making certain actions criminal offences, yes. I think we need to be very specific.

Jesse Norman: In the area of management of financial institutions?

Martin Wheatley: Reckless or willfully misleading, possibly. Genuine business mistakes – people make genuine business mistakes.

Jesse Norman: No, certainly not for that. For reckless mismanagement, that kind of category.

Martin Wheatley: Again, and maybe I could ask Margaret to comment as she has more experience of this, I think we just have to be quite cautious about where we push the criminal sanctions into.

Margaret Cole: Clearly where there is fraud, that is a clear issue. We also have a criminal offence of misstatements to the market, and that is already there. I think I would be extremely wary of introducing a criminal offence in connection with management or mismanagement of a financial institution. [She then talked about lifetime bans for ‘incompetence’ etc]

Jesse Norman: Your view is a significant toughening up but not extra criminalization?

Margaret Cole: That is my view, yes.

Hector Sants: [Said he endorsed tightening up of legislation around lifetime bans]

Lord Turner: I did want to add one point. The criminalization route…does not address the core of the problem…People make business misjudgments in balancing risk and return, but that in banks, we want them to make a different balance of risk and return from other sectors of the economy…the difficulty we have in banking is that, when you take some of those risk/return trade-offs…there [might be] a disaster for the economy as well…

We are more likely to make progress by thinking about whether we should simply face people who are the directors of banks…with a sense of automatic non-criminal sanction …”You cannot have future employment in the financial services industry unless you positively prove to the regulator that you were the person who was putting up the red flags and trying to warn against the concerns.”

Overall, it seems to me that the FSA’s thinking can be summarized as follows:-

“Since ‘white collar’ crime is so hard and so expensive to prosecute (and risks showing up our earlier failures), there is little point in us even trying. We would obtain better results by simply vetting candidates for senior banking and City of London roles more thoroughly, and then offering the sanction of banning them from ever working in finance again if they “mismanage” their institutions.”

However this is a wholly unacceptable cop out from the regulator. Unless the crimes and misdemeanours that caused the UK’s banking and financial crisis are rooted out and prosecuted, London will lose its already disappearing mantle as a world-leading financial centre. This would represent a massive risk to the UK economy as more financial business would ebb away to properly regulated jurisdictions such as Singapore.

In conclusion, I’d like to quote Hector Sants’s answer to a question from George Mudie MP, concerning whether the FSA has any idea of what’s really going on inside Britain’s leading banks, let alone inside the “shadow banking system.” Sants replied:

“The short answer to your question is yes [we do now have full transparency from British banks, unlike in 2007-08], but nevertheless I should draw to the committee’s attention a couple of points. First of all, of course, it is possible for fraud –rogue trading – to occur within an institution, which will mean that its position turns out to be different to that which the institution has reported to us. But I believe we have full transparency of those positions. We also have the capability, which we did not have pre-2007, to make our own judgments on the quality of those positions, in the sense that we have hired 200 or so risk specialists. The FSA, as you know, had no risk specialist capability pre 2007; it was not set up to do that. And we now employ multiples of individuals on supervising individual banks compared with that period. So we do have full visibility.”

That’s quite a brave claim for Hector Sants to make. And possibly one that will come back to haunt him.

A version of this article was published on QFINANCE on December 5th, 2011

Further reading on Britain’s FSA and financial regulation:

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  1. […] financial crime, and very little introspection or contrition about its own pre-crisis performance. Continue reading… This entry was posted in Uncategorized by MFG UK Clients. Bookmark the […]

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