Out-Law Analysis | 10 Feb 2015 | 3:37 pm | 5 min. read
Although the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) will not have the same powers to prosecute insurance managers criminally for misconduct as are about to be introduced in the banking industry, both regimes will result in senior individuals being held increasingly responsible for failings by their firms. This may well lead to an increase in prosecutions by the Serious Fraud Office (SFO) and similar criminal investigatory bodies, even where the regulators' powers are limited.
Ever since the financial crisis of 2008, when regulators were criticised by politicians and the public for their perceived failure to hold anybody personally responsible, the FCA has ramped up enforcement action against individuals. Just last November, the FCA issued fines and industry bans against three former senior directors with insurer Swinton after holding them responsible for a sales culture within the company that, one year previously, had cost it over £7 million in fines. Fines issued by the FCA this financial year are already at £1.39 billion - a substantial increase from the not insignificant £425m total issued in 2013/14.
The regulators have been clear that their new regime for insurers should not be identical to that for banks, given the differences in industry business models and the level of risk each poses to overall financial stability. Some of the changes, including a "fit and proper" test for senior managers at large firms, also come from the EU, whose Solvency II regulatory regime is due to come into force on 1 January 2016. However, the consultations make it clear that the PRA is looking for "suitable alignment" of the conduct standards for individuals at both insurers and banks.
Therefore, it is worth looking to the banking senior managers' regime to give some indication of what these proposals might contain. Near-final rules are due shortly ahead of the banking regime itself coming into force from mid-2015. Under the new banking regime, senior managers' functions will be outlined by the PRA and FCA, with prescribed responsibilities being allocated by firms dependent upon each manager's function. Statements of responsibility will have to be prepared by firms setting out precisely each individual's responsibilities, who reports to them and how they will go about their day to day role.
The banking regime will work in conjunction with the new criminal offence under section 36 of the Banking Reform Act, which covers a member of senior management being involved in a decision or failing to be involved in a decision which they should have been which leads to the failure of that bank or financial institution. Whether the criteria of that offence will ever be met or whether it will ever be in the public interest to prosecute, it is certainly an indication of the intention to criminalise aspects of senior management conduct.
Within the banking senior manager's regime are provisions for remuneration, including both claw back and deferral. There are minimum amounts which must be deferred for no less than seven years, with claw back being allowed for a period of a minimum of seven years from the time in which any award was given. These extremely lengthy provisions are aimed at ensuring that individuals are able to account for a significant period of time after any events take place.
The new Senior Insurance Manager's Regime (SIMR) will apply to senior managers who are running insurance companies, or who have responsibility for certain 'key functions'. The regulator will look more closely at those applying for these roles because it believes that a higher hurdle to entry is more resource effective than seeking to remove individuals due to any subsequent misconduct. However, this new regime will not entirely replace the existing 'approved persons' regime, which will continue for those who are not senior insurance managers. This already sets it apart from the new rules for bankers, which will replace the existing regime entirely. The PRA is currently consulting on which insurance roles should fall under which regime.
Clearly defined responsibilities will be allocated to those who are subject to the new regime, in the same way as proposed for those in the banking industry. Whilst there will not be a similar 'presumption of responsibility', the regulator will still likely start form the position that where an individual takes responsibility for an area or an activity then that individual will be the first to face questions in relation to perceived failures in that area. There is no criminal offence within the current insurance proposals similar to that within the banking regime, but there are new conduct rules that will be put in place by the FCA which will apply only to those captured by the SIMR or significant influence function holders.
As part of the requirements, the PRA will identify the core responsibilities that they believe those individuals should take. They include fitness and propriety, developing the firm's culture and standards, embedding that culture and those standards in the day to day management of the firm, producing financial information, regulatory reporting, oversight of capital and liquidity, development of the firm's business model and training. Towards the end of the list is ensuring and maintaining the independence, integrity and effectiveness of the firm's whistle blowing procedures - an indication of how whistle blowing is becoming increasingly important within the regulatory sphere.
Again, the regulators do not really have the same powers over insurers' remuneration as they do over bankers' remuneration. However, what is almost inevitable is that when regulators visit firms as part of their supervisory relationship or investigations the regulator will examine how senior management are remunerated and how this incentivises them to ensure that they are complying with their responsibilities. It may well be a less formal process than that adopted in the banking regime, but deferral and claw back policies may help firms to demonstrate compliance in this regard.
All of this stems from a desire for increased accountability and transparency within the financial services sector, on behalf of both regulators and government. As well as enabling regulators to hold those within the industry accountable, this new approach will make it clearer how the industry and its institutions work, what its aims are and who holds responsibility.
While we may not be looking at increased criminalisation of senior management conduct within the insurance regime in quite the same way as we are in the banking regime, it appears quite clear that there is a push towards holding senior management responsible for any misconduct, criminal or otherwise, even if the FCA and PRA are themselves unable to prosecute. It is certainly worth keeping an eye on what is happening in the banking regime, as this will provide a signpost as to what it likely to happen within the insurance sector.
Michael Ruck is a financial regulatory enforcement expert at Pinsent Masons, the law firm behind Out-Law.com