CENTRE OF ATTENTION
Regulatory enforcement in lockdown and beyond
The pandemic has created a raft of new risks for firms and their employees alike. What effect will the events of 2020 have on the enforcement activity of the FCA and PRA in the year ahead? And what will be the impact on individuals under investigation?
How active have the UK regulators been on the enforcement side during the pandemic?
Over the last year, our experience is that both of the UK’s financial regulators, the FCA and the PRA, have continued to be very active on enforcement investigations and that the pandemic has not disrupted this in any significant way. Information disclosed by the FCA confirms this, with 121 new cases opened in the nine-month period to October 2020 – of which 76 were commenced following the implementation of Covid-19 restrictions in March. We have also seen the FCA being active on case closures, and the statistics bear out that the number of open FCA investigations now appears to have plateaued at around 650 (after a steep rise over recent years). This is still an unmanageably large number of investigations for the FCA to handle effectively, the consequences of which we discuss later.
Where an investigation is launched into suspected failings in a larger firm’s systems and controls, it has now become regular practice for both the FCA and PRA to launch multiple parallel investigations at the outset into the firm, one or more members of senior management on the business side, and also one or more individuals operating in the second line of defence. This contrasts with the historical approach of investigating firms first, and then launching follow-on investigations into individuals that the regulator felt were culpable (often after the case against the firm had been settled). This results in many more individuals being placed under investigation.
Logistical challenges – enforcement interviews
One aspect of enforcement investigations that changed drastically during lockdown has been the conduct of compelled interviews. We have represented a range of individuals at interviews with the FCA since the lockdown restrictions began, all of which have been held remotely over video conference. Typically the audio is recorded over Skype, with Microsoft Teams being used in parallel for the video only.
Remote interviews do create different challenges for interviewees beyond simply answering the FCA’s questions.
Putting to one side the importance of respecting social distancing requirements, there are some real benefits for interviewees, as well as some downsides of this new approach.
Remote interviews do create different challenges for interviewees beyond simply answering the FCA’s questions. In particular, many interviewees will be naturally anxious about whether their home technology will work. It can also be more difficult for interviewees to successfully navigate the document bundle without their legal advisor sitting beside them (pointing them in the right direction). Finally, interviewees must ensure they are in a quiet and confidential environment for the interview – this can be difficult given that interviews often run all-day (sometimes for multiple days) and many interviewees have children or otherwise don’t live alone.
On the positive side our experience is that interviewees feel more comfortable in their home environment and not having to attend the FCA’s offices in person makes the process feel less daunting and traumatic. Although interview bundles have been provided by the regulator in electronic format, we have always provided hard copy files to interviewees (as well as our team) as this reduces the stress of accessing documents and having to switch between multiple screens. We have found that it has been easy to consult with witnesses by separate VC systems during breaks, and to request breaks wherever needed to ensure that they are not getting too tired. The video and recorded line technology has also held up fairly well, and when it has failed, the FCA have been quick to pause interviews and solve the issue.
Overall, our experience is that the remote interview process has worked well for the regulator and for the interviewee, and the more relaxed environment has led to interviewees performing at a high level in providing their evidence.
Enforcement activity in 2021 will be a combination of pre-existing priorities for the regulators, and new issues arising from the pandemic.
What will the regulators be targeting in the year ahead?
In particular, the FCA and PRA will be assessing how banks, insurers and investment managers have responded to the unprecedented nature of the customer-facing demands on them, together with the impact of financial institutions having virtually all of their employees working from home. Coupled with huge volatility in financial markets, these circumstances create new risks for firms and their employees – and the regulators have been keeping a close eye on whether those risks are being managed effectively.
The reality is that we have not yet seen many of these cases progress to the enforcement stage, which is unsurprising as regulatory investigations are often launched many months or years after the relevant events.
It will undoubtedly be the case that enforcement activity in 2021 will be a combination of pre-existing priorities for the regulators, and new issues arising from the pandemic.
Market abuse will remain a key priority in a number of different guises. These will include investigations into listed companies for delays in publishing inside information and potentially publishing misleading information against a backdrop of fast-moving changes in their business performance. It will also include instances of suspicious trading, given both the levels of market volatility and the risk of inadvertent or deliberate disclosure of inside information by individuals working from home. We will also see further investigations into firms’ automated trade surveillance systems as well as other methods of identifying suspicious trading activity (whether by the firm itself or by others), and systems and controls for protecting inside information within financial institutions.
Insurers and banks will also come under close scrutiny for their treatment of customers facing difficulties as a result of the pandemic.
Insurers and banks will also come under close scrutiny by the regulators for their treatment of customers facing difficulties as a result of the pandemic. In the general insurance sector this will cover products where high numbers of claims have been made (in particular, business interruption insurance and the response to the FCA test case) and products where risks of claims have significantly reduced due to the lockdown, such as car and travel insurance. Have firms met the standards expected in relation to their communications with policyholders on these evolving issues? Has due regard been paid to the interests of policyholders and have they been treated fairly?
Similar issues will apply for banks and mortgage companies in their treatment of commercial and individual customers facing financial difficulties as a result of the pandemic, as firms seek to balance the need to treat customers fairly – including through payment holidays and other appropriate forbearance – with the need to protect their assets.
The systems that firms had in place were seriously tested during 2020 and where that revealed weaknesses there is a real risk of regulatory action.
A further area under scrutiny by regulators will be the operational resilience of financial institutions, with particular focus on effective oversight of third party providers of critical services. The systems that firms had in place were seriously tested during 2020 and where that revealed weaknesses there is a real risk of regulatory action.
There are a range of other high priority issues for the regulators that are not directly related to Covid-19 but which will continue to receive disproportionate attention in the coming year. These include:
- anti-money laundering systems and controls:-
- implementation and operation of the Senior Managers and Certification Regime (SMCR);
- protection of whistleblowers;
- the treatment of employees suspected of non-financial misconduct (such as discrimination, bullying, sexual harassment, and dishonesty outside of the workplace);
- the impact of remuneration structures on the culture of firms;
- governance arrangements for international groups; and
- openness and transparency with regulators – something viewed as sacrosanct by the PRA.
A high priority for the FCA ought to be how it will address the backlog of enforcement investigations which remain on its books.
Alongside these key enforcement themes for 2021, a high priority for the FCA ought to be how it will address the backlog of enforcement investigations which remain on its books. As mentioned above, the number of its open cases has hovered at around 650 over the last two years – up from 247 as recently as 2016. While it is good to see that case numbers are not rising yet further, the reality is that the FCA does not have the capacity to handle 650 investigations in an effective way. Too often, many months (and sometimes over a year) will pass with the subject of the investigation hearing nothing from the FCA about the case. It can often be unclear whether the FCA investigators are giving any attention at all to a case, given the caseload they are having to manage. As discussed during our Emerging Themes webinar on 14 January 2021, the impact for firms and individuals under investigation is that cases are taking longer and longer to progress, placing undesirable and unnecessary strain on those caught up in an investigation.
The FCA’s most recent annual enforcement report confirms what a serious issue this has become. The report explains that cases now take – on average – nearly two years from the appointment of FCA investigators to be completed. Where disciplinary action is pursued and the case settled, this now takes an average of over three years; and where the case is referred to the FCA’s Regulatory Decisions Committee this now takes an average of nearly four and a half years. This is even before the case is referred to the Upper Tribunal, the first stage at which a defendant receives an independent hearing to determine whether any breach has been committed. This is a cau