Reputation risk may outweigh fines in UK financial regulator enforcements (Complinet)

January 28, 2011

A man is seen behind the entrance door of the offices of the Financial Services Authority (FSA) in Canary Wharf, London, November 19, 2010By Joanne Wallen (Complinet)

Jan. 25 – British firms continue to be referred to enforcement despite the best intentions of the Financial Services Authority’s thematic reviews and credible deterrence strategies. On the one hand it looks as though the risks are considered to be worth taking. On the other, reputational damage and loss of trust for the whole industry are at stake.

Last week was overshadowed by the large fine that Barclays received for giving unsuitable investment advice to retail clients about two funds in particular. The fine was 7 million pounds, and the firm is also likely to have to pay up to 60 million pounds in redress, as well as carrying out a past business review and employing a firm of accountants to review customer files. The total cost of the enforcement action will, therefore, be significant.

Compared with the amount of investment a large firm would have to make to consolidate all its legacy systems into one, to revamp all its systems and controls throughout the entire group, to beef up its compliance team and to ensure that every member of staff was properly trained, the costs may not be so high after all.

Barclays knew about the problems well before the FSA got involved. The final notice said that it had identified concerns with the funds in question, the Aviva Global Balanced Income Fund and the Global Cautious Income Fund, early on, yet had failed to do anything about it.

More importantly, the FSA has been reminding firms about their obligations to provide “suitable” advice to clients for years. It would be inconceivable to imagine that anyone working in a compliance function at a large bank or in its senior management could have not realised that advising retired customers to put all of their funds into something that was called “balanced” or “cautious” but was actually high-risk, was non-compliant. The FSA had previously fined Park Row and RSM Tenon for very similar contraventions of the rules.

At the other end of the scale, the two partners of small IFA firm Clark Rees were apparently unaware that they were not supposed to sell unregulated collective investment schemes to unsophisticated retail investors. They had also mixed their own assets with the company’s to achieve the FSA’s capital requirements. The pair were fined and banned, and the FSA told Complinet that they had not been sufficiently up-to-speed with FSA regulation. Once again, the FSA had been warning about advising on UCIS for some time and in July last year it announced that it was taking action against several firms for mis-selling the schemes.

A third enforcement last week saw spread-betting firm City Index fined 490,000 pounds for failing to submit accurate transaction reports in respect of 60 per cent of its reportable transactions. On reading the announcement, at least two lawyers told Complinet it was barely worth commenting on, since it was simply the latest in a long line of enforcement actions for transaction reporting failures.


Ian Mason, a partner at Baker & McKenzie, told Complinet: “I can’t get too excited about another transaction reporting fine, the FSA is collecting scalps in that area like stamps in an album.” Rob Moulton, a partner at Ashurst, said: “Unfortunately it is now a little difficult to get too excited about transaction reporting fines. This is another to add to what is a growing list of institutions that have been fined for transaction reporting errors. Therefore, for a firm the size of City Index, 60 per cent errors in transaction reporting is given a fine of less than 500,000 pounds. This may be compared to Commerzbank, which was fined 595,000 pounds for an impressive 84 per cent errors, or Société Générale fined 1.575 million pounds for also managing 80 per cent errors.”

Moulton suggested that the size of the fine might have something to do with why firms were not taking more precautions. “Perhaps the fines are such that having thorough systems and controls are not cost-effective? It is hard to argue that there is now any commercial damage from such a fine, which can almost be viewed as a ‘badge of honour’,” he said.

Mason disagreed, however, and said that that kind of thinking was unlikely to be prevalent in many firms. “I do not believe that any reputable firm thinks in terms of doing a cost-benefit analysis which results in an acceptable outcome to breach FSA rules,” he told Complinet. Mason said that fines needed to be large enough to hurt, but he confirmed that the fine was only part of the cost and that the s166 skilled persons reports, consumer redress, management time and reputational implications all significantly added to the costs. “Usually the systems and controls cases are triggered by a failure such as IT, legacy systems, poor recordkeeping, failure to escalate or a combination of these rather than a deliberate intention to breach the rules.”


Bill Warren, managing director of Bill Warren Compliance, was not so sure. He told Complinet: “No doubt the costs for Barclays of the enforcement versus implementing effective systems are probably equal.” What concerned Warren was the fact that both Barclays, and RBS the previous week were fined for what largely amounted to a lack of systems and controls.

“What were the risk and compliance people doing?” Warren queried. He said that sales people needed to be “held in check by compliance” despite the idea that instilling a “treating customers fairly” culture throughout a firm was supposed to have made individuals more aware of how they should behave. As for small firms in the current economic environment, Warren reckoned many probably were “taking risks based on cost”. The risk to smaller firms was far greater, though, he suggested. If a small firm were found to be mis-selling products or giving unsuitable investment advice to customers, they would be thrown out of the industry. “It is no wonder intermediaries of all shapes and sizes are so fed up with the FSA’s perceived unfairness,” he added.

Research carried out last year by three academics at Oxford University suggested that whatever the actual cost of the fine and the accompanying redress, reputational damage cost firms even more. Global branding consultancy Interbrand last year valued Barclay’s brand at a sizeable $4.2 billion. In a report entitled: “Regulatory Sanctions and Reputational Damage in Financial Markets”, John Armour, Colin Mayer and Andrea Polo from Oxford University’s faculty of law and the Saïd Business School , found that: “Reputational sanctions are very real: their stock price impact is on average 10 times larger than the financial penalties imposed.” The report cited an article from The Times newspaper of July 7, 2009, which said: “The threat of fines from the FSA are seen as a footling expense, just another cost of doing business, no different from paying the quarterly phone bill. The embarrassment factor no longer counts for much, alas.” Yet the report’s authors said they interpreted “the fall in equity market value in excess of mandated payments as the firms’ reputational loss”.

Moreover, and consistent with Warren’s view, the report found that: “The reputational effect is proportionately greater for small firms; that it has increased in intensity since the financial crisis of mid-2007; that it is unrelated to the size of financial penalties levied; and that it spills over to the firm’s parent.” It concluded: “Reputational losses are important forms of regulatory enforcement. They dwarf regulatory penalties such that, intended or not, they are the primary consequence for a firm of a revelation of its misconduct.”

A brand consultant who did not wish to be named did not think that, overall, the FSA sanctions would do much more than to “dent” Barclays’ reputation. Given the size of the firm and the fact that the UK market consisted of so few retail banks, the reputational damage was not likely to be that great, he said. Another factor was that consumers had a degree of “snow blindness”. They had become so used to hearing about “staggering” fines for the major financial institutions and to being inappropriately sold financial products that such news meant very little to them any more.

More damaging than the risk to an individual bank’s reputation, however, was the overall effect on the banking industry. He said the UK banking industry was “fundamentally important” to the UK economy, and the more tarnished the industry’s reputation became with UK consumers and shareholders, the more likely it was that some of these businesses would disappear abroad.

Joanne Wallen ( is a correspondent for Complinet.Complinet, part of ThomsonReuters, is a leading provider of connected risk and compliance information and on-line solutions to the global financial services community. Established in 1997, Complinet serves over 100,000 industry professionals in 80+ countries. Its connected approach provides one single place to get all the relevant regulatory news, analysis, rules and developments from the region to support firms in highly regulated industries.

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