Mis-sellers of financial products should note that the Financial Services Authority is consulting on plans to create a more transparent framework for calculating financial penalties. Up to 20% of relevant income could be at stake, reports Zoe Hare.
Topic: Financial services
Who: Financial Services Authority
When: 6 July 2009
Where: UK
Law stated as at: 27 August 2009
What happened:
On 6 July 2009, the FSA published a consultation paper detailing its plans to create a more consistent and transparent framework for calculating financial penalties. The main driver behind the change to the regime is the repeated complaints about the standards of authorised firms, in particular that the levels of mis-selling to consumers and market misconduct are not improving.
However, the FSA has also commented in its consultation paper that there are 3 further reasons for proposing the change: (i) to be more transparent in the way penalties are set; (ii) to aid consistency in penalty-setting; and (iii) to increase the level of penalties which are imposed.
The FSA considers that its revised framework will address these concerns and be a credible deterrence against misconduct, thus raising standards.
Five steps and three objectives
The new framework will consist of 5 steps which are based on three key objectives, namely: disgorgement, discipline and deterrence. The 5 steps are:
1. removing any profits made;
2. setting a figure to reflect the nature, impact and seriousness of the breach;
3. considering any aggravating and mitigating factors;
4. achieving the appropriate deterrent effect; and
5. applying any settlement discount.
Removing any profits made ensures that a person does not benefit from a breach. However removing profits is dependent on the ability to identify a benefit which derived directly from the breach and being able to quantify that benefit.
Steps 2 and 3 reflect the second objective, discipline. It is at this stage that the FSA will determine the level of the penalty. However, the method for calculating the figure varies depending on the type and nature of the case. The FSA has separated cases into three categories: (i) cases against firms; (ii) non-market abuse cases against individuals; and (iii) market abuse cases against individuals. The FSA calculates the figure as follows:
1. Cases against firms – 0%, 5%, 10%, 15% or 20% of the firm's pre-tax income over the period of the breach from the product or business area to which the breach relates.
2. Non-market abuse cases against individuals – 0%, 10%, 20%, 30% or 40% of the individual's relevant income, i.e. gross benefits from the relevant employment in connection with which the breach occurred, for the period of the breach.
3. Market abuse cases against individuals – the greater of:
(a) 40% of the gross amount of all benefits received from the individual's employment in the 12 months preceding the market abuse;
(b) twice the profit made or loss avoided by the individual as a direct result of the market abuse; and
(c) £100,000.
The figure established by the FSA may then be adjusted if there are any mitigating or aggravating circumstances, in accordance with step 3. Furthermore, as set out above, steps 4 and 5 provide that the FSA may increase the penalty if it concludes that it does not have sufficient deterrent effect, and may also apply a discount if the firm or individual settles early.
Why this matters:
As asserted by Margaret Cole, director of enforcement at the FSA:
"These proposals are an important step in pushing forward our ethos of credible deterrence. By hitting companies and individuals in the pocket where it hurts, the fines will be a stark warning to others on what they can expect to pay for flouting our rules. Moving to this new framework will enable our enforcement policy to continue making a real difference to consumers and to changing behaviour in the financial services sector."
The new regime allows firms and individuals to establish in advance an estimate of the penalty imposed for breach of the FSA's rules. For example, if a firm severely breaches the rules on financial promotions, it is likely that the FSA would impose a penalty of between 10% and 20% of the firm's relevant income.
By setting out the levels to be imposed, the FSA has made the process more transparent. However, it has also increased the deterrent effect of penalties as in some cases fines may treble in size from their current level.
The new regime is yet to be implemented as it is still in the consultation stage. The FSA's consultation closes on 21 October 2009, after which a policy statement will be published detailing the final agreed framework. It therefore remains to be seen whether industry feedback will support or reject the new regime.
