Out-Law Analysis | 16 Apr 2015 | 1:15 pm | 4 min. read
New regulatory rules applicable to senior staff at banks, building societies and investment firms from next March will effectively shift the burden of proof for responsibility for regulatory breaches from the Financial Conduct Authority (FCA) or Prudential Regulation Authority (PRA) to those staff.
Last month, the FCA published draft guidance on how it would seek to apply this 'presumption of responsibility' to senior staff and the steps that senior managers should take in order to rebut the presumption. Although the consultation, which closes on 16 June, acknowledged the various widespread concerns that had been raised about the regulators' future approach, the new presumption of responsibility guidance only serves to heighten the expectations that will be placed on senior managers.
As an example, the guidance would prevent a senior manager from hiding behind a defence of not knowing or that they had delegated any risk assessments or decision-making given what is a "reasonable step" includes the knowledge that a manager exercising a senior management function (SMF) "had, or should have had, of regulatory concerns". Although it remains to be seen how the regulator will interpret this, recent announcements indicate a strict approach.
However, this approach could have unintended repercussions. The FCA's move towards shifting responsibility and increasing accountability at the top of the management chain could lead to staff in less senior positions feeling able to take a more cavalier approach to their advice and risk management - albeit inadvisably, as the recent Bank of Beirut case shows. Potential senior managers could opt either for a different, less regulated sector or retirement over a high-risk non-executive director (NED) role in a major bank, while those that do stay could demand a very high compensation package to reflect the increased dangers to reputation and livelihood posed by the new regime. Perhaps even worse, senior managers could opt for risk-averse decision-making, which is not conducive to today's dynamic finance industry.
What does the guidance say?
The presumption of responsibility means that the FCA or PRA will no longer have to prove that a senior manager was personally responsible for a regulatory breach. Instead, senior managers will be required to satisfy the regulator that they took "reasonable steps" to prevent, stop or remedy regulatory breaches that took place in their areas of responsibility.
Responses to an initial consultation paper on the senior managers' regime, published in July 2014, asked the FCA for further guidance, particularly in relation to the circumstances in which the FCA would seek to apply the presumption, the scope of its application and the meaning of reasonable steps which the senior manager should take in order to rebut the presumption of responsibility. The new consultation paper sets out lists to provide for when a senior manager is guilty of misconduct and the circumstances in which the presumption would apply in Appendix 2.
It will be interesting to see how the FCA interprets the "reasonable steps" test in the future, given the historic variance on the issue. The most striking example came in 2010, where the Upper Tribunal disagreed with the then FSA and held that John Pottage could not reasonably have been expected to react any earlier or proactively identify problems when neither his own risk and compliance specialists, nor the FSA, had spotted that the warning signals merited a wider review.
The draft guidance states that the FCA would be able to take action against an SMF manager where there had been, or had continued to be, a breach of a relevant requirement by the firm; where that SMF manager was responsible for the management of any of the firm's activities in relation to which that breach occurred at the time of the breach; and where the SMF manager is unable to satisfy the FCA that they had taken "such steps as a person in their position could reasonably be expected to take" to avoid the breach.
It then goes on to provide a non-exhaustive list of factors that the FCA would be expected to consider. These range from the role and responsibilities of the SMF manager and the nature, scale and complexity of the firm's business; to whether the SMF manager "acted in accordance with their statutory, common law and equitable obligations" including those in the Companies Act and the UK Corporate Governance Code, where applicable.
The "reasonable steps" test would also apply to any delegation of responsibilities by an SMF manager, covering both the delegation itself and the steps taken to ensure that the person to whom the task was delegated was "an appropriate person, with the necessary capacity, competence, knowledge, seniority or skill". It would also cover the manager's duty to ensure clear and effective reporting lines in relation to the activities for which they were responsible, and to ensure an "orderly transition" when another person took over their senior management function.
General changes to the senior management regime in the March paper
The nature of the concerns raised by respondents to the July 2014 consultation paper was widespread. As well as the need for further clarification on the steps expected of senior managers under the presumption of responsibility, they included: the timescale required for implementation; the inclusion of some particular senior management functions including NEDs; and the regulators' approach to allocation of responsibilities generally. In relation to the certification regime, issues raised included: concerns about the increased responsibilities on firms for overseeing the fitness and propriety of staff and the lack of the regulator's input in such decisions; and the proportionality of the new regimes for smaller firms.
The FCA considered that feedback and tweaked some of its proposals. In the main, the scope of those who fall within the regime was limited somewhat to address the concerns in regard to NEDs. The FCA announced in February that the regime would only apply to NEDs with key areas of specific responsibility: board chairs, senior independent directors and chairs of key committees.
Addressing the proportionality issue, the FCA has now made it clear that smaller firms with less complex business models and governance arrangements can submit less complex 'responsibility maps'. The FCA intends to further consider whether it could provide examples of simplified templates for smaller firms, and will make an announcement in the coming months.
Elena Elia is a financial regulation and enforcement expert at Pinsent Masons, the law firm behind Out-Law.com.