Dead man walking: The FSA’s aggressive stance with financial services firms
LONDON, Sept. 20 (Business Law Currents) – If the death sentence of the UK’s Financial Services Authority (FSA) was to earn a last request then it may well have been to introduce a new era of aggressive enforcement as it prepares to hand over power to the Financial Conduct Authority (FCA).
It may have slept through the worst financial crisis in living memory and be about to be put to death but this seems to have only invigorated the FSA in its enforcement actions, as it introduces increasingly tough measures on financial firms. Dead man walking? Perhaps. But beware of those boots, as the FSA toughens up its enforcement actions.
Recent weeks and months have seen the FSA break new ground on its enforcement action as it becomes an increasingly intrusive regulator. Introducing new enforcement tricks as well as seeking ever harsher punishments the FSA gives a reflection of possible things to come.
Amongst the new tricks the FSA stands poised to introduce are so called “health warnings”- public statements on financial products that the FSA regards as risky. Causing controversy for their ability to shame firms into producing simpler financial products, the FSA has already indicated that it intends to level some health warnings at complex structured products – a move that may see less innovation amongst financial firms.
Structured products are a form of debt offering with an embedded derivative component. In layman’s terms; a formula written into the notes that refers to an underlying asset. This formula then adjusts the size of payments made to noteholders as the value of the underlying asset fluctuates. Typically structured notes reflect the underlying movements of individual shares or groups of shares (e.g., an index) although in theory there are no limits on what the notes might be linked to.
Structured products have become popular amongst banks for their ability to generate returns in an era of low bond yields and erratic stock markets. Investec recently issued £190,000 of notes under a £4 billion Zebra Capital Plans Retail Structured Products Programme which promises to pay a return calculated on the performance of the FTSE 100 index but without the danger of any decline that investing in the same shares would carry.
Structured products are also not limited to the UK either and are frequently international in their focus. For those interested in China, Standard Chartered recently issued 10 million USD China Market Access Product Warrants in London that are linked to the common A stock of Chongqing Road & Bridge Co scheduled to mature on 4 September 2012.
For more information on structured products please see Business Law Currents article: Denouncing Derivatives: SEC Warns of Global Debt Disaster
Health warnings are the latest initiative to spring from a greater focus from the FSA on financial products rather than on firms and the claims they make. The FSA has increasingly taken a closer look at product regulation as it seeks to weed out those financial instruments that it believes could prove systemically dangerous.
According to Margaret Cole, interim managing director of business conduct, the FSA increasingly looks for “minutes of product approval meetings and there are examples where we [the FSA] have told a firm to go back and add features to a product to bring about greater comfort [on the FSA’s part]”.
Historically the focus of the FSA has been on supervising firms and moderating product advertising not on the development of products themselves. More recently, however, the FSA has sought to pay greater attention to product approval, stepping into a process that it was not previously integral to.
Health warnings precede reported new powers for the FSA’s replacement agency; the FCA, that will give the regulator the power to ban products entirely for a temporary period. The FCA may even look at imposing price caps on fees and charges, particularly where firms appear to be making excessive profits.
The move comes in the wake of FSA failures even after the financial crisis to prevent payment protection insurance (PPI) from being massively oversold to customers that may cost banks as much as £6 billion pounds in compensation. For more information on PPI please see Business Law Currents article: UK Banks Payment Protection Insurance Compensation in Focus.
As well as new enforcement tactics, the FSA has also made increasingly more robust use of its existing powers. Seeking injunctions and imposing harsh penalties on those that incur its wrath, it has sometimes stood at odds with the legal establishment.
Recently the FSA won an interim injunction in the English High Court to freeze the assets of several investment firms and traders it says have manipulated share prices on UK trading platforms. According to the FSA, Da Vinci Invest Ltd, a UK-registered Swiss-based fund and Swift Trade, a Canadian day-trading firm, engaged in “layering”, a practice of submitting multiple orders to create the impression of liquidity whilst intending to trade in the opposite direction. Typically a trader might place a number or orders to buy in the hope of increasing a stock’s price. The trader will then sell its stock and cancel its buy orders, taking advantage of the ability to sell at an inflated price.
The injunction freezes £1.1 million in assets and precedes either the conclusion of the FSA’s investigation or the court case against the firms.
The FSA’s new aggressive approach to enforcement hit a road block recently, however, when the courts overturned its previously harsh punishment of one metal trader.
Refusing the FSA’s request to either fine or prohibit Jason Geddis from trading, the courts ruled that only public censor was appropriate for what appeared to be a lack of care rather than deliberate market manipulation. The court criticized the FSA for building a case around market abuse when in fact the reality appears to have been rather more mundane. The court noted that the rules concerning surrounding trading on the London Metal Exchange were not as clear as they should have been and that Geddis had acted quickly and appropriately upon discovering that he had caused unusual market volatility.
With the FSA, and in all likelihood its successor, embarking on a new era of aggressive enforcement it remains to be seen whether it will be successful in stamping out financial folly or whether it might simply make firms down trodden.
(This article was first published by ThomsonReuters’ Business Law Currents, a leading provider of legal analysis and news on governance, transactions and legal risk. Visit Business Law Currents online at http://currents.westlawbusiness.com. )