The Courts’ involvement in the Regulation of Financial Markets Timothy Dutton QC & James McClelland (Fountain Court Chambers) Part I: the PPI judicial review & its wider regulatory significance The Decision • R. (on the application of British Bankers’ Association) v Financial Services Authority  EWHC 999 (Admin) (Ouseley J). • Court rejected the BBA’s claim to quash an FSA Policy Statement (PS 10/12) and FOS online guidance. • The Policy Statement had introduced amendments to the “DISP” section of the FSA Handbook which provided for the handling of PPI complaints. Why it matters • Now the leading authority on how the Courts will approach the relationship between highlevel rules and specific rules within a regulatory system. • Its relevance is not limited to PPI. • Not even limited to FSMA regulation. Structure of this Presentation Part I: Regulatory framework Part II: The dispute Part III: Conclusions & wider significance Part I: Regulatory framework The different categories of Rules (“R”) • “High-level Standards” – e.g. the Principles of Business. • “Business Standards” – e.g. the Conduct of Business Rules. Principles of Business (PRIN) • Types of Rule (“R”), expressed as being: – a “general statement of the fundamental obligations of firms under the regulatory system” (PRIN 1.1.2G). • Eleven in total (cf Ten Commandments). – 1. Integrity: A firm must conduct its business with integrity. – 6. Customers’ interests: A firm must pay due regard to the interests of its customers and treat them fairly. – 7. Communications with clients: A firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading. The Principles are not actionable by private persons • s.150 FSMA. – (1) A contravention by an authorised person of a rule is actionable at the suit of a private person who suffers loss as a result of the contravention, subject to the defences and other incidents applying to actions for breach of statutory duty. – (2) If rules so provide, subsection (1) does not apply to contravention of a specified provision of those rules. [….] • PRIN 3.4.4R A contravention of the rules in PRIN does not give rise to a right of action by a private person under section 150 of the Act (and each of those rules is specified under section 150(2) of the Act as a provision giving rise to no such right of action). Conduct of Business Rules “COB” • For insurance “ICOBS” (previously “ICOB”). • Granular rules specifying particular requirements. • Detailed rather than general. • Prescriptive rather than normative. • For example – Chapter 4 of ICOB “Advising and selling standards”. – Chapter 5 of ICOB “Product disclosure”. DISP: Complaints Handling under the Handbook • “DISP”: Dispute Resolution: Complaints. • Two limbs: (1) Firms’ obligations to handle and determine complaints by customers (DISP Chapter 1); (2) FOS jurisdiction to make binding determinations where complaints not resolved by firms (DISP Chapter 2). Complaints handling by firms (a) The Core Obligation • Core obligation under DISP 1.4.1R, whereby a firm must investigate complaints: – “competently, diligently and impartially; assess fairly…whether the complaint should be upheld [and] what … redress … may be appropriate … taking into account all relevant factors … ”. – re. “fairly” – is this procedural or substantive? (see below). Complaints handling by firms (b) Root cause analysis “[…] a respondent must put in place appropriate management controls and take reasonable steps to ensure that in handling complaints it identifies and remedies any recurring or systemic problems, for example, by: • analysing the causes of individual complaints so as to identify root causes common to types of complaint; • considering whether such root causes may also affect other processes or products, including those not directly complained of; and • correcting, where reasonable to do so, such root causes.” (DISP 1.3.3R) Complaints handling by firms - “reaching out” to non-consumers • Guidance indicates that firms should consider reaching out to non-complainants: – “A firm should have regard to Principle 6 (Customers' interests) when it identifies problems, root causes or compliance failures and consider whether it ought to act on its own initiative with regard to the position of customers who may have suffered detriment from, or been potentially disadvantaged by such factors, but who have not complained”. (DISP 1.3.5G) • [Deleted on 1 September 2011 but v. similar provision in new DISP 1.3.6G.] Part II: The Dispute Background to the Dispute • By mid-2008 tens of thousands of complaints being presented to FOS. • Those complaints were, necessarily, first considered and rejected by firms. • The overwhelming majority were then upheld by FOS. • Serious concern (on both sides) that firms and the FOS were approaching complaints differently: – FOS was overtly assessing compliance with both the ICOB/ICOBS and the Principles. – Banks (it appears)were applying ICOB/ICOBS alone. FSA Policy Statement 10/12 (August 2010) • Amended DISP, by inserting a new Appendix 3, entitled “Handling Payment Protection Insurance complaints”. • The amendments may be sub-divided into five main elements: (1) Guidance on the assessment of complaints in order to identify whether a “breach or failing” had occurred (DISP App 3.2). (2) Guidance on the approach to considering evidence (DISP App 3.3). (3) Guidance on root cause analysis (DISP App 3.4). (4) Evidential provisions on determining the effect of a breach or failing (DISP App 3.6). (5) Evidential provisions on the approach to redress (DISP App 3.7). • The most controversial were (1) and (3). Re. (1): Guidance on the assessment of complaints • FSA annexed to the Policy Statement an “Open Letter”. • This purported to remind firms of the appropriate standards by setting out a list of 15 “common failings” which occurred in the sale of PPI policies. • In formulating these “common failings” (which the banks characterised as “standards”) the FSA relied not just upon ICOB/ICOBS but also the Principles. Re. (3): Guidance on root cause analysis • Amplified the guidance provided at DISP 1.3.3R. • Provided that a firm should consider whether the complaints disclosed a “root cause”; and if so, – consider whether it ought to act with regard to the position of non-complainants; and – If so, take “appropriate and proportionate measures to ensure that those customers were given appropriate redress or a proper opportunity to obtain it”; – In particular by considering whether it was fair and reasonable to undertake proactively a redress or remediation exercise, which might include contacting customers who have not complained. BBA’s Grounds of Review • Can be distilled into three grounds: (1) The “s.404 argument” (against FSA only); (2) The “no obligations” argument; (3) The “exhaustion” argument. (1) The s.404 argument • A challenge to the “root cause analysis” component of the PS. • s.404 FSMA provided a statutory procedure for ordering past business reviews and the payment of redress to noncomplainants. • This was hedged in by protections for industry; in particular – it required Treasury consent; and – it was limited to requiring redress for legally actionable failures (and therefore not breaches of Principles). • BBA argued that by the Guidance on root cause analysis, the PS was seeking to circumvent statutory limitations on s.404. • Rejected - Guidance was non-mandatory. (2) The “no obligations” argument • Alleged an error of law because, when formulating the “common failings”, the FSA treated the Principles as giving rise to obligations towards customers. • The effect of PRIN 3.4.4R and s.150(2) FSMA was to prevent the Principles imposing any obligations as between firms and customers. • s.150(2) was therefore – not just a procedural bar on court proceedings, but – a substantive limitation upon obligations being owed to consumers. Court rejected the “no obligations argument” • S.150(2) did no more than provide that rules could disapply s.150(1). (“If rules so provide, subsection (1) does not apply to contravention of a specified provision of those rules.”) • And s.150(1) itself merely provided consumers with a statutory right of action. (“A contravention by an authorised person of a rule is actionable at the suit of a private person who suffers loss as a result of the contravention, subject to the defences and other incidents applying to actions for breach of statutory duty.”) • The effect of PRIN 3.4.4R was therefore simply to disapply a statutory right of action that would otherwise arise. It had no wider effect. Wider significance of the rejection of the “no obligations” argument • Three points. (1) Reasoning logically applies not just to Principles but to all Handbook Rules that are non-actionable - they remain relevant to DISP. (2) Whenever complaints under DISP are considered, the Principles need to be brought into account. (3) Firms must apply the same approach when assessing complaints internally under DISP 1.4R, as the FOS would under its compulsory jurisdiction. Wider significance of the rejection of the “no obligations” argument (contd) • Firms had argued that DISP 1.4.1R was merely procedural and did not identify standards by which to assess complaints. – (NB DISP 1.4.1R: “competently, diligently and impartially; assess fairly…whether the complaint should be upheld [and] what … redress … may be appropriate … taking into account all relevant factors … ”). • However, Judge held that: • “[…] when firms have to decide complaints, before they can go to the Ombudsman, they have to apply in reality and for fair complaints handling, the same approach as the Ombudsman would.” • Significant because, if firms fail to do so, they will not only be rejecting a complaint which FOS will uphold but be in breach of their own regulatory obligations. (3) The “exhaustion” argument • Even if Principles could be treated as creating obligations to customers, they could not be relied upon to augment or contradict ICOB/ICOBS. • This was because ICOB/ICOBS were promulgated by the FSA “to occupy the field” and to crystallise the Principles in insurance sales. • The FSA could not then resort to the Principles to amplify and extend ICOB/ICOBS. The “exhaustion argument” in practice: ICOB 5.3.1R vs Common Failing 15 ICOB 5.3.1R • ICOB 5.3.1R required that in an oral sale, firms had to provide the customer with a “Policy Summary” containing (amongst other things) notice of any “significant and unusual exclusions or limitations”. • And: – “[…] draw the attention of the retail customer orally to the importance of reading the policy summary, and in particular the section of the policy summary on significant and unusual exclusions or limitations.” ICOB 5.3.1R vs Common Failing 15 Common Failing 15 • • “[…] In sales primarily conducted orally, it was not enough just to provide important information in writing. So, we have found it to be a failing where there was not a fair presentation of the information during the sales discussion, by, for example: – giving an oral explanation; or – specifically drawing the customer’s attention to the information on a computer screen or in a document and giving the customer time to read and consider it. In addition, the requirement to pay due regard to a customer’s information needs and communicate information in a clear, fair and not misleading way required the firm to provide balanced information when making reference to a policy’s main characteristics (whether orally or in writing). So, we have found it to be a failing if, where the firm described the benefits of the policy orally, it did not also provide an adequate description of the corresponding limitations and exclusions in a way that was clear, fair and not misleading, for example orally. Further, ICOBS requires that, if a firm provides information orally during a sales dialogue with a customer on a main characteristic of a policy, it must do so for all the policy’s main characteristics.” ICOB 5.3.1R vs Common Failing 15 The BBA’s argument • BBA said that the requirements of ICOB 5 were only that significant terms appear in the Policy Summary and there be an oral signpost; • Common failing 15 required firms to specifically draw customers’ attention to the significant terms (e.g. refund terms) and give them consumer time to read them. • This created inconsistency with the ICOB requirements. Judge’s reasoning on the “exhaustion” argument in general • The Principles were best understood as the “ever present substrata to which the specific rules are added”: – The Principles always had to be complied with. – Specific rules did not supplant them and could not contradict them. – They were but specific applications of the Principles to the particular requirements they cover. – “The general notion that the specific rules can exhaust the application of the Principles is inappropriate. It cannot be an error of law for the Principles to augment specific rules.” (para. 162). • The real question was not whether specific rules exhausted general ones, but whether they excluded them – This would require the Court to accept that a breach of the Principles might go un-redressed, even though a specific rule has been complied with. – The FSA had not, by ICOB/ICOBS, created a comprehensive code. – Such a code could be circumvented unfairly, or contain provisions which were not apt for the many and varied sales circumstances which could arise. Judge’s specific reasoning on Common Failing 15 • Ouseley J. accepted that it went further than the specific rules. • But it did not contradict them – note why he concluded that there was no contradiction: – “[…] it requires nothing to be done that specific rules forbid, or omitted which they require.” [para. 174] – “The specific rules are silent on the topic of how oral presentations should be conducted” [para. 176] – “There can be no contradiction of the specific rules unless they are construed as the exhaustive expression of all obligations. There is no justification for such a construction in the absence of clear wording giving effect to a clear purpose or intention of such an outcome. The overarching or underlying Principles are simply being applied where the rules do not cover the point.” [para. 176] Part III: Conclusions & Wider Significance What conclusions can be drawn from the Judge’s reasoning on “Exhaustion”? • There appear to be only 3 circumstances in which specific rules will limit the application of the Principles: (1) If the Principles are said to require something to be done which the rules actually forbid. (2) Conversely, if the Principles are said to require something to be omitted which the rules require must be done. (3) If the Principles contain an additional requirement in circumstances in which the specific rules should be construed as the exhaustive expression of all obligations; but such a construction will only be justified if there is “clear wording giving effect to a clear purpose or intention of such an outcome”. Direct Consequences for industry • • Upstream consequences (when planning their systems and operations): – Firms cannot treat the specific rules as reflecting the limits of their duties to customers. – This remains true even if they are operating in an area governed by detailed and highly prescriptive rules. – The open-textured provisions require a degree of flexibility and responsiveness (rather than a “tick box” mentality). – Given that firms engaged in selling mass consumer products target economies of scale and consistency of customer-treatment through “tickbox” operations, this creates tensions (and costs) in implementation. Downstream consequences (when handling complaints): – Firms must consider the Principles and apply the same assessment of reasonableness as the FOS. – They cannot take refuge in asking whether or not the customer has a cause of action. Wider Regulatory Significance • This is a judicial vindication of the “Principles based” approach to regulation which the FSA had been pursuing for a number of years. • The FSA has emphasised that it expects that principles of fairness, to be embedded throughout a firm’s operations and within its culture. • In firms with tens of thousands of employees (Lloyds Banking Group has over 100,000), this is easier said than done. • The development within FSMA Regulation of the sorts of expectations of professional responsibility and “client” (as opposed to “customer”) care historically associated with the professional disciplines (cf medicine and law). • The tension is to what extent these requirements are scaleable.