Comments from ACCA to HM Treasury, September 2012.
ACCA welcomes the opportunity to comment on this consultation. We share the concern expressed by the chairman of the FSA as regards why no members of the board or senior management of RBS have been found legally responsible for the failure of RBS and faced sanction, and agree that if action cannot be taken under the existing rules then the rules should be changed for future reference. We also agree with the point made by Lord Turner that banks and their directors should be expected to observe standards that are more demanding in some respects than those which apply to companies generally. It will be key to the future survival and growth of a stable banking sector that those appointed to govern banks have the right skills, background and qualifications to properly assess the risks facing banks and formulate appropriate and effective strategies to manage those risks.
The banking industry has seen a number of high profile cases of management and governance failures in recent years. The reasons behind these will continue to be debated for years to come, but in the short term action is needed to attempt to restore trust in that system. Care must be taken though to avoid knee jerk reactions and the creation of new offences which will be so complex to enforce that they are never prosecuted.
The global reach of any such measures must also be considered. Incidents such as the difficulties faced by HSBC in controlling the AML procedures of its Mexican acquisitions, or the ‘wire stripping’ activities undertaken in respect of US transactions by Standard Chartered, could result in the removal or prosecution of individuals in the UK on the basis of events which have occurred overseas – and equally, the changes in behaviour of the UK based boards of these multinational banks would have an impact far beyond the UK. It is vital that any measures act to improve the decisions made by banks, rather than deterring able individuals from even attempting to manage them.
With that in mind, ACCA supports the proposals to introduce a rebuttable presumption that any individual who manages one failing bank is not suitable to manage others, and also a limited introduction of criminal sanctions for recklessness in the execution of directorial duties.
1. What are your views on the proposal to introduce a rebuttable presumption along the lines set out in paragraph 3.11 that the directors of a failed bank are not suitable to hold senior executive positions in other financial institutions?
We strongly support the controlling persons regime operated by the FSA and see it as being integral to the process of bringing about high standards of business conduct within the finance industry, The G20 said in 2009 that ‘strengthened regulation must promote propriety, integrity and transparency’, and our own 2009 report ‘The Future of Financial Regulation’, in making the point that effective regulation needed to be seen as being about more than rules and procedures, argued that regulatory authorities should take reasonable steps to ensure that regulated entities possess the skills and experience, at all levels of the business, necessary to protect the interests of their stakeholders, and that ethics-based corporate cultures, led from the top, should be actively encouraged in this context.
We would not like to see this regime develop to a point of rigour where capable individuals were deterred from taking senior positions within banks. But it is reasonable within the context of that process for all relevant considerations to be systematically taken into account by the authorities, and the special place which banks occupy within the economy and society, as argued in the FSA report, to justify specific account to be made of an individual’s involvement in a bank which has ‘failed’.
The rebuttable presumption mechanism deals directly with a number of the difficulties currently facing regulators faced with establishing whether certain individuals within a collegiate board may or may not be suitable persons to act in a position of control over a bank.
Perhaps more importantly in the long term it should also generate a strong incentive effect on directors of banks to always ensure that should their bank fail, they will be in a position to demonstrate that they are in fact worthy of continuing their chosen career. This added incentive may in itself be enough to ensure that absent the most catastrophic series of external events, bank failures become far less likely, as each individual has a direct interest in ensuring that no action is taken in their name which might be seen to have caused the failure. If each board member has a direct interest in being able to positively prove that they were opposed to any unduly reckless behaviour on the part of the bank, the likelihood of that behaviour taking place is massively reduced. Without the ‘rebuttable presumption’, it would be open to a director to claim after the event that they had opposed the suspect transactions, but had no specific evidence to back up their assertions; once the rebuttable presumption process is in place then the onus will be on the director to prove the assertion.
2. What are your views on the possible supporting measures discussed in this chapter aimed at clarifying management responsibilities and changing the regulatory duties of bank directors?
The various failures of the RBS board, as set out in the FSA report, indicate that in a number of ways the directors of RBS appear to have failed to comply with their statutory responsibilities towards their shareholders. In particular, they do not appear to have been effective in weighing up the likely long-term consequences of their decisions, the impact of the company’s operations on the community (in this case the national community) and the desirability of the bank maintaining a reputation for high standards of business conduct. It must also be questioned whether the company's directors achieved the standard of skill and care which the law demands of them.
Both before and since the duties were codified in the Act, there has been a degree of scepticism about whether the new rules have the potential to lead to enhanced standards of conduct in practice, given that they can only be enforced by the company’s shareholders. We agree that it is inadequate that there is no standard regulatory machinery for assessing the performance of directors, especially of banks, against these expectations. We would therefore propose that the new supporting measures should adopt, or at least be based on, the duties of directors as set out in the Companies Act.
While some measure of clarity on the duties and responsibilities expected of directors will always be welcome, there are arguments in favour of avoiding an over-prescriptive regulatory regime.
We would also suggest this represents an opportunity to take into account the company’s commitment to the letter and spirit of the code on corporate governance.
Incidents such as the Standard Chartered ‘wire-stripping’ affair have highlighted the extent to which regulatory compliance has in some cases come to be seen as a game, and the level of formalistic ‘box ticking’ which some individuals would apparently regard as a suitable response to such regulation. Although the type of director who would indulge in such practices is almost by definition not the sort of director who is envisaged by as ‘suitable’ by these proposals, or in a wider context by the principles set out in the recent Kay review into the equity markets, it is nevertheless the case that if the system is set up in such a way that an individual can be certain of being ‘suitable’ by being able to follow a clearly defined set of rules then there is always the risk that they will sail as close to the wind as they deem possible, regardless of whether this is a safe course. The wider the band of grey around acceptable vs unacceptable behaviour, the greater will be the need for directors to use their own discretion to ensure that they are as far away as possible from the whole danger zone.
While such uncertainty is inherently inefficient, it is nevertheless the case when dealing with institutions of the importance of banks that this is the lesser of two evils. The consequences of a single major bank failure would far outweigh the net societal impact of being forced to operate in a slightly more prudent manner under principles based set of duties than might be the case if duties were reduced to a simple list of boxes to tick.
3. What are your views on extending criminal sanctions to cover managerial misconduct by bank directors?
There are strong arguments both for and against the proposal. ACCA agrees with the analysis that banks are in a unique position among businesses in having a business model which relies upon trust rather than measurable delivery of goods or services. Being in a situation where criminals have been allowed to control banks would tend to erode that trust. Implementing laws specifically to deal with the incidence of criminality at the highest levels of the banking system might be seen as an acknowledgement that other measures have failed, and will continue to fail, and so the further deterrent is needed.
There is of course a very clear deterrent effect of a criminal record, and criminal sanctions. However, under the proposals, these sanctions would apply only to individuals who are already (by definition) unfit to be directors of banks. At an individual level they will already have been punished by the loss of their status and their career. Under current EU regulations they are also likely to have forfeited elements of their pay and may also have been subject to other regulatory financial penalties. Moreover, by removal from the management chain of the bank, the public and wider economy will have been protected from future damage done by them in that role. Any further punishment of the individual might be seen to be unnecessary to meet the direct policy issue at hand.
Given the acknowledged difficulties in formulating and prosecuting the proposed offences, the lack of direct justification for them and the potential wider harmful side effects on confidence in the banking industry, it might appear that the call for criminal sanctions against bank directors is an example of ‘knee jerk’ legislation, which will with the benefit of hindsight come to be seen as unnecessary. The individuals who have provoked the calls for, and should perhaps have been caught by, such measures have escaped free of criminal sanction. Given the other measures already in contemplation, if these are properly formulated there should be no need for further criminal sanctions in the future.
However, if sanctions are to exist, then there is a body of economic evidence which suggests that mere financial penalties do not have the disincentive effect required. If levied upon the banks themselves then they will have the effect of weakening the banks own financial position, thereby eroding trust in it; the very opposite of what the measures would hope to achieve. If imposed upon the individuals there are a number of potential weaknesses in the system. Many employers will offer to indemnify their employees for fines incurred in carrying out the bank’s business. If the level of fine is set at a level which is realistic for an individual it will not materially affect the bank itself (and if it did, it would be subject to the arguments put forward above against damaging the bank’s financial position). Even if the individual were expected to fund the fine themselves, the class of individuals likely to be subject to any such punishment would by definition be financially literate, motivated and well resourced to protect their own interests. There is a significant risk that they would be able to misrepresent their own wealth in such a way as to significantly dilute the impact of any monetary penalty upon them, either by transferring or hiding their assets from the authorities.
In the face of these arguments, the prospect of a criminal offence punishable by a term of imprisonment would offer a number of advantages. It would be far harder for the individual to transfer or reduce the impact of the sentence. The sentence would have a far more meaningful impact on the individuals. Loss of money, while unpleasant, is potentially transitory and can be reversed. Loss of freedom is irreversible; the time spent incarcerated can never be replaced. Individuals who have reached board level in a bank will undoubtedly know the value of time, and the prospect of its loss is likely to motivate them more than mere financial imposition. Moreover from the perspective of the state the punishment is more easily enforced and more clearly measureable. The signal sent to the public is far stronger, and more readily understandable, than a fine.
On the basis that banks should be treated differently, and given the wider consequences of bank ‘failures’ we would support the principle of providing for criminal sanctions for directors of failed banks. The underlying policy rationale of such sanctions should be to deter imprudent behaviour, and both the offences and the sanctions should be formulated with this in mind.
4. What are your views on the possible formulations of a criminal offence discussed in this chapter?
Strict liability: ACCA is in agreement with the consultation paper’s assessment that introducing a strict liability offence of ‘being in charge of a failing bank’ would cause more harm than it might prevent.
The ‘strict liability’ situation is in any event covered by the proposed rebuttable presumption mechanism. Once an individual is unable to rebut the presumption of unsuitability to manage a bank then there is almost by definition a prima facie case to answer of de facto negligence/incompetence or worse in connection with the management of the bank.
Negligence or incompetence: While it is true that other regulatory sanctions may be available in the case of negligence or incompetence, the deterrent effect of a criminal prosecution may, as discussed above, be far stronger than that of a regulatory infraction. It is unlikely of course that the prosecuting authority would consider the extra difficulties of undertaking a criminal prosecution in all but the most egregious of cases; however, it is in precisely those cases where public opinion would suggest that the deterrent effect of a jail sentence is most needed. If enacted purely for its deterrent qualities then the legislation would of course suffer from the difficulty that if 100% successful it would never actually be invoked. However, if the mechanisms and processes are to be put in place for an offence of recklessness in relation to the management of a bank, these would translate across equally to enforcement of an offence of negligence in relation to management of a bank.
Having the option of criminal sanction of the most extreme cases of negligence would also ensure a continuity of available remedies for those who have failed the initial test of proving themselves suitable to run a bank. Knowledge that failure to rebut the presumption of unsuitability would almost certainly result in further regulatory action, and that whether negligence or reckless the individual might be subject to a criminal sanction, ie jail time, would enhance the deterrent effect.
Set against these considerations are the points that negligence is more typically a civil matter and that incompetence is not usually considered to be an offence in itself. Indeed there are grounds to argue that appointment of an incompetent director to the board is a matter reflecting more upon the appointment and approval process, and the fitness of those people running it, than it is on the individual themselves. Confirming the precise scope and definition of any offence of negligence or incompetence would be an essential but challenging process. The marginal deterrent effect of the extra offence may be questionable given the existing incentives for the appointment of competent directors, and the requirement of them to act diligently. Given the relative costs and marginal benefits of attempting to implement a criminal offence of negligence as against the existing civil sanctions, ACCA is not convinced that developing such an offence would represent an effective use of resources.
Recklessness: It is perhaps symptomatic of wider problems in the banking system that the concept of a director either wanting or being able to behave recklessly is even worthy of specific legislation. If the probity of a bank is truly based upon public trust in that bank, and the directors properly recognise and act upon that reliance, then there should never be a situation where directors might even consider acting recklessly.
However, it is undeniable that on the evidence currently publicly available there might at least be a case to consider in respect of the operations of a number of banks. Unthinkable though this may have been in decades past, some sanction is clearly needed, and the prospect of a significant term of imprisonment in addition to the termination of their career and financial sanction would be an appropriate reflection of the seriousness of such behaviour, and its potential impact on wider society. The costs of mounting such a prosecution would, as the consultation acknowledges, be significant. The risks of allowing it to go unpunished would however be even greater.
Provided it can be framed in a way that would facilitate prosecutions, recklessness would be an appropriate test given that it could serve the public policy aim of deterring the sort of excessive risk taking that was so damaging in the case of RBS and other banks. Again, the measures could benefit from being grounded in the codified statement of directors’ responsibilities that are set out in the Companies Act.