Natalia Chumak and Rory Spillman published in Financier Worldwide

By Signature Litigation
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Signature Litigation

Natalia Chumak and Rory Spillman published in Financier Worldwide following Promoting individual responsibility in banking and the potential for conflicts.

The financial crisis of 2008-09 and the investigations that followed have prompted regulators to review the underlying culture and the internal operations of financial institutions. The Parliamentary Commission on Banking Standards concluded in its report ‘Changing banking for good’, released in June 2013, that many bankers, particularly at a more senior level, have been allowed to operate with little personal accountability, suggesting that when things went wrong, individuals claimed ignorance or hid behind collective decision-making leaving often little realistic probability of enforcing action against senior individuals.

The Financial Services (Banking Reforms) Act 2013 introduces amendments to the Financial Services and Markets Act 2000 reflecting a number of the recommendations of the Commission and requiring changes to the regulatory framework. The FCA’s and PRA’s joint consultation paper ‘Strengthening accountability in banking: a new regulatory framework for individuals’, issued in July 2014, builds on the recommendations of the Commission and implements the changes required by the Financial Services (Banking Reforms) Act 2013.

The new framework has the potential to produce serious conflicts of interest within senior management and between senior management and the financial institutions within which they work. Senior managers are soon to face the burden of having to prove that they took all reasonable steps in their role and a new criminal offence of reckless misconduct.

The framework

The new framework is currently intended to apply to UK incorporated banks, building societies, credit unions and PRA-designated investment firms. However, the Treasury has indicated that it may extend its application to non-UK incorporated banks that conduct business through a branch within the UK.

The proposals are divided into three main areas: the senior managers’ regime; the certification regime; and the conduct rules. This article focuses on the first and the third of these proposals.

The senior managers’ regime (SMR)

The SMR replaces the previous concepts of ‘significant influence functions’ and ‘controlled function’ within the current regime with a senior management function (to be jointly managed as a single regime by both the PRA and the FCA). It is currently proposed that the SMR will apply to those individuals that are members of the relevant firm’s executive committee and those responsible for key business areas or that exercise significant influence over the relevant firm’s decision making whether or not they are employed by the relevant firm.

The proposals outline a list of 18 responsibilities that are to be allocated to individuals at the senior level of relevant firms. These responsibilities largely correlate with the existing ‘control functions’. In addition to the 18 responsibilities listed, the FCA has indicated that in the event that an individual has overall responsibility for any of the 27 ‘key functions’ listed within the proposals, then that individual will also be subject to the SMR. The effect of this proposal is to broaden the application of the SMR.

Before taking on a senior management role the individual must obtain approval from the appropriate regulator, which will require a written and agreed (between the relevant firm and the individual) statement of responsibility setting out the scope of that individual’s responsibility. Relevant firms will also be required to prepare and provide to the regulators a responsibilities map setting out the firm’s management and governance arrangements (including responsibilities of the senior managers).

In the event that a person with a senior manager role leaves his or her post, they will be required to provide a ‘handover certificate’ informing the incoming senior manager of all relevant issues. It is worth noting here that the new Conduct Rules that specifically apply to senior managers appear to include a duty to whistle-blow. Conduct rule ‘SM4’ requires senior managers to “disclose appropriately any information of which the FCA or PRA would reasonably expect notice”. In the context of the handover certificates, the outgoing senior manager will be conscious to ensure that the certificate is carefully drafted whilst the incoming senior manager will likely take the opportunity to bring to the authorities’ attention any possible discrepancy.

It is likely that the statements of responsibility and, to a lesser extent, the responsibilities map and handover certificate will be subject to substantial negotiation by those holding the positions of senior management. This is particularly so in light of two significant amendments to the enforcement regime.

The first is the presumption of responsibility (the reversal of the burden of proof in civil matters). This means that a senior manager is presumed to be responsible for a contravention, and may be held personally accountable and face individual sanctions unless they can demonstrate that they took reasonable steps to prevent, stop or remedy the relevant breach. For the reversal of the burden of proof to be engaged, the regulator must establish (on a balance of probabilities) that: (i) the firm contravened a relevant rule; (ii) the person was a senior manager at the time of the contravention; and (iii) the senior manager was responsible for managing the relevant part of the business in which the contravention occurred.

The second is a new criminal offence of ‘reckless management’ which relates “to a decision causing a financial institution to fail”. The offence is said to be pursued in cases only involving the most serious of failings, such as where a bank failed with substantial cost to the taxpayer or serious harm to customers.

Although the regulators note that the offence is only to be applied when an institution fails and that this is expected to be rare, the maximum sentence following conviction of seven years imprisonment and/or an unlimited fine will certainly cause those in the position of senior managers to take heed and it has reportedly resulted in at-least two HSBC non-executives threatening to resign.

Conduct rules

The new conduct rules intend to replace what is currently the Statements of Principle within the FCA Handbook and are intended to be wider in scope and apply to all individuals within relevant firms who are in a position to have an impact on the regulators’ respective objectives (rather than just those subject to the current ‘Approved Persons’ regime). The conduct rules are to have a much more far reaching application which will require substantial education and training within the relevant firms.

The regulators currently propose that the conduct rules should apply to all bank staff save for those expressly listed in an exhaustive list. This list is very limited and is confined to positions of low responsibility, for example, vending machine staff.

The new conduct rules are also intended to apply to unregulated activities. This is specifically intended to prevent an event similar to that of the LIBOR fixing scandal where the relevant activity was unregulated.

The new rules place obligations on relevant firms to educate and provide training to employees in relation to the new rules and to notify the regulators when they are aware of or suspect a breach or if they have taken disciplinary action. Such obligations will be relevant to those senior managers whose responsibilities include training and education and who are under duty to whistle-blow.

Potential conflicts

The new framework gives rise to the potential for conflicts within senior management and between senior management and the relevant firm. Senior managers who ultimately act for and on behalf of the firm will also have to protect their own position.

For example, the proposed concept of the reversal of the burden of proof may put senior managers in a more difficult position where the relevant firm has admitted liability as part of a settlement deal which would make the senior manager presumed to be liable unless he proves he has taken all reasonable steps to prevent the relevant contravention. Further, in light of the introduction of the deferred prosecution agreements earlier this year, firms are able to settle allegations of criminal activity without being prosecuted. However, individuals do not have the benefit of this regime. Therefore, a senior manager could find themselves in a position where their firm has agreed to enter into a DPA possibly leaving the senior manager to face their own criminal liability battle which, if he fails, may result in seven years imprisonment and/or an unlimited fine. The terms of such a DPA may even require the financial institution to assist the authorities in furthering its investigation into particular individuals.


It is possible that going forward, as a result of the likely conflicts, relevant firms may be less willing to settle regulatory actions early when this would leave their senior managers exposed. However, the reality is that these conflicts will exist from the very beginning of the role as senior manager and will not arise only in the event of an investigation. It is therefore important that relevant firms take proactive steps now to ensure appropriate regimes and safeguards are in place. This will require substantial collaboration between the HR and in-house legal departments in preparing the relevant paperwork, implementing the new procedures and regularly reviewing the progress.

Senior managers should take specialist independent legal advice from the outset in relation to their proposed responsibilities and intermittent advice throughout (to create a paper trail of responsible decision making). Both parties need to ensure that they receive strategic advice which would allow them to plan a few steps ahead and put appropriate measures in place in the event there is a future investigation or litigation.

The new proposed regulation is well intended and, if managed properly, will assist in creating a more responsible and transparent structure in the management of financial institutions. The downside is that it is likely to result in an increase in costs to the relevant firms (at least at the outset) and, potentially, in an increase in the remuneration expected of those in the position of senior managers in the market in order to offset the potential risks (notwithstanding the remuneration proposals contained in the FCA’s and PRA’s related joint consultation paper) . However, if managed inefficiently, the new regulation will result in substantially higher costs and an additional layer of bureaucracy and an element of “watching one’s own back” within management, leading to a de-compartmentalised management.


The consultation closed on 31 October 2014. The finalised policy statements and guidance with implementation timetable are expected in late 2014 or early 2015. It is proposed that the period between publishing the final policy and adopting rules to implement the framework could be between six and 12 months.

 Read the original article here.

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