Documents: 09/07/2003 - A submission to the House of Lords Select Committee by Alex Henney 9 July '03 - A submission to the House of Lords Select Committee on the accountability of the Financial Services Authority in general, and of the accountability of the government and of the Parliamentary Ombudsman regarding The Equitable debacle, Alex Henney, Chairman, Equitable Members' Action Group (EMAG)
These objectives are developed in sections 3-6 of the Act. 2. The FSA should be 1) self accountable in the sense that it reports in public on its own activities, 2) accountable to Parliament, and 3) accountable to the financial customers on behalf of whom it regulates the financial services industry and who indirectly pay for its costs through their charges. Finally we look at the issue of what appears to be an attempt by the government to delay accountability for regulatory failure regarding The Equitable debacle. SELF ACCOUNTABILITY 3. The FSA publishes a great volume of consultation and information papers. A highlight of its self accountability was the report which the FSA's Director of Internal Audit, Mr. Ronnie Baird, prepared at the request of the government, titled "Report of the Financial Services Authority on the Review of the Regulation of The Equitable Life Assurance Society from 1 January 1999 to 8 December 2000" (the Baird Report), which Her Majesty's Government is Submitting as Evidence to the Inquiry Conducted by Lord Penrose, The Stationery Office, 16 October 2001. We have no view beyond this seemingly comprehensive and detailed document (which was produced in unusual circumstances) as to the comprehensiveness and objectivity of the documents the FSA prepares which review aspects of its performance, nor of its Annual Report. ACCOUNTABILITY TO PARLIAMENT 4. Although the Treasury Select Committee has acted vigorously on a number of occasions in investigating the activities of the FSA, the National Audit Office is precluded from investigating it under the National Audit Act 1983, which empowers it to undertake efficiency studies and of government departments and various specified public bodies, and the Parliamentary Ombudsman is precluded from investigating it for maladministration after 30 November 2001 when the FSA assumed its full powers. Prior to that date it acted as agent to the Treasury on a Senior Level Agreement, and its prudential regulation came within the scope of the Parliamentary Ombudsman's powers. Members of Parliament have referred some 530 cases to the Parliamentary Ombudsman relating to The Equitable. On 16 October 2001 the Baird Report was published, and this provided the Parliamentary Ombudsman with prima facie evidence of maladministration. He decided to examine the prudential regulation 1 of The Equitable over the period 1 January 1999 to 8 December 2000 through a representative test case. The report is being published on 1 July 2003. 5. The FSA is not properly accountable to Parliament. We recommend that the National Audit Office should be empowered to undertake efficiency studies of the FSA, and that the Parliamentary Ombudsman should be empowered to investigate it for maladministration. ACCOUNTABILITY TO FINANCIAL CUSTOMERS 6. We consider two types of accountability to customers, 1) for conduct of business regulation, and 2) legal liability for loss caused by the negligence of the FSA in prudential regulation. The FSA's performance and accountability for conduct of business decisions 7. In 1998 the FSA de facto took over responsibility for conduct of business regulation. It did nothing to investigate or protect new policyholders joining The Equitable. In 1998-99, after Equitable was attracting media criticism over its handling of policies with guaranteed annuity options, FSA files contain a minute asking "whether there is anything we should be doing in order to fulfil our regulatory obligations or at least justify our stance"2 . Another asks: "Is there at least enough for a meeting?" A third asks: "Is there anything we should be doing on this? I knew we were going to about a year ago (my delay)." The FSA's performance of doing nothing was disgraceful, and it should be held to account. But, as we shall show, there is no effective means for customers to achieve this and seek redress for the FSA's negligence of their interests. 8. We suspect that this inept performance is due in part to the composition of the board of the FSA, which, according to the Consumers' Association submission to the Committee3, is dominated by industry interests. It includes four members of the Financial Services Executive, while of the current 11 non-executive board members, over half are representatives or employees of financial service firms and one is a representative of the Bank of England. Of the remainder, two have non-financial services backgrounds and only one is a representative of a consumer organisation (National Consumer Council). This means that consumer representation is very much in a minority on the board. Furthermore:-
9. On a number of occasions EMAG has asked the FSA to instruct The Equitable to provide information about various aspects of The Equitable's financial situation and of the manner in which it treats policyholders, see Annex 1. (Note that the questions should be seen within the context that the Equitable was a mutual not a proprietary company). But the reply by Mr. Tiner, Managing Director of the FSA, was most unhelpful see Annex 2, and is at variance with the FSA's regulatory objectives spelt out in S4(2)(b) and S5(2)(c) of the FSMA. They lay upon the FSA "so far as reasonably possible", a duty of ensuring consumers have "appropriate" and "accurate" information. It appears to us that the FSA has endorsed a conscious policy pursued by the board of The Equitable to provide policyholders with minimal information about the financial circumstances of The Equitable in order first to encourage them through fear, uncertainty, and doubt coupled with a promise of better things to come (they are still to come) to sign up to the Compromise Settlement under S425 of the Companies Act that was published in December 2001. The second reason for providing minimal information was that at times the board seemed to wish to avoid (non-annuitant) policyholders leaving in too great numbers too rapidly. The consequence of the policy or providing minimal information has been to deprive non-annuitant members of the financial information which would have assisted them in making a more informed decision whether to stay with The Equitable or to leave5. 10. We are not surprised that the Consumers' Association (CA) wrote "the Financial Services Authority operates within…closed culture, which often denies consumers and consumer organisations such as CA access to information on the grounds of market sensitivities. CA appreciates the need to protect genuinely sensitive market information, but we are particularly concerned that the current very restrictive provisions of the Financial Services and Markets Act, without a public interest test, is a significant barrier to enforcing both corporate and regulatory accountability". 11. More profoundly, as the behaviour of the FSA after the House of Lords decision on 20 July 2000 regarding The Equitable highlighted, there is an inherent conflict of interest between the FSA's responsibility to maintain orderly markets and its responsibility to protect consumers. The Lords' decision rendered illegal the board's approach to setting differential terminal bonuses for policyholders who had (and exercised) a guaranteed annuity option, and other policyholders. The decision not only resulted in a shift in value of some £1.6bn from policyholders without guarantees to those with guarantees, it increased the level of guarantees in the fund. This significantly weakened what was already a weak fund whose solvency margin according to the Government Actuary's Department was "thin" at the end of 1999, and was propped up by financial engineering6. 12. The FSA allowed The Equitable to stay open for new business as it attempted to sell the business. The FSA clearly did not understand how weak the fund was (the Government Actuary's Department did not complete its scrutiny report for 1999 until November 2000, four months after the House of Lords' decision). It did not work out that other life assurance companies were not going to bale out Equitable policyholders by paying billions for its "badwill". The FSA's decision allowed investors to continue to join a fund that was fragile and uncertain. People were invited to invest their money on the implicit prospectus that, if The Equitable can find a buyer, then they may have reasonable expectations. If not, they would be in a mess - and they were as the adjudications published on 22 May 2003 on five lead late-joiner cases by the Financial Ombudsman's Service shows7. The episode brings out in extreme form the inherent conflict in the FSA's objectives between preserving market confidence (however undeserved), which appears to have been its overriding priority and will generally prevail - and definitely did in this case - versus that of protecting consumers. Given the lack of redress available to individual consumers of financial services under English law (see next section), the FSA is not accountable to consumers for its conduct of business decisions. We recommend that responsibility for conduct of business regulation is removed from the FSA, and the Financial Ombudsman Service is set up as an independent agency. Legal liability of the FSA to consumers for negligent regulation 13. By S.19(1) of Schedule 1 to the FSMA "Neither the Authority nor any person who is, or is acting as, a member, officer, or member of staff of the Authority is to be liable in damages for anything done or omitted in the discharge, or purported discharge, of the Authority's functions". Prima facie this immunity appears to protect it from negligence of the type it exhibited with regards to The Equitable, because under English law it can only be sued for misfeasance of public office, which is far too high a hurdle to jump. 14. I have already touched on the FSA's negligence in its conduct of business regulation, but it was also negligent in its prudential regulation. The FSA assumed responsibility for the prudential regulation of life assurers at the beginning of 1999, so it had a year and a half to get its act together for any possible decision by the House of Lords on the legality of the board's approach to setting differential terminal bonuses. But did it? The Baird Report observed that "There is no documentary evidence that the FSA analysed the consequences, at this stage of The Equitable Life failing to find a buyer or requested information from Equitable Life on this "worst case" scenario". It also observed "We believe that closer and more informed scrutiny, at an earlier stage, of the financial implications of the possible outcomes of the Court case, which had been foreseen in the scenario planning, would have given the regulator more time to reflect on how to react appropriately to any courses of action proposed or taken by The Equitable in response to any ruling of the Court". The effect of this decision was that many people put money into The Equitable over the period 21 July to 7 December 2001 (after which The Equitable closed to new business), and consequently lost money. 15. The FSA then sat on its hands and failed to try to mitigate the obviously flawed nature of the House of Lords' decision. The case on behalf of policyholders who did not have guaranteed annuity options was not well put, and one of the judges has commented: "If the case had been put differently, and we had known the true facts, the outcome might have been different." Instead of taking action the FSA signed up to the flawed compromise proposed by The Equitable's new board, which was detrimental to the interests of the policyholders who did not have guaranteed annuity options. If the Financial Ombudsman's adjudication on five test cases of people who invested after legal proceedings commenced and withdrew before the Compromise8 stands up to The Equitable's appeal, then policyholders who did not take the FSA's advice to sign-up to the compromise endorsed by the FSA, but left The Equitable, will have fared better than those who stayed and signed the compromise. After a decade of regulatory inaction, the FSA did not come clean but papered over the cracks. Annuitants and policyholders without guaranteed annuity options therefore paid dearly for following the FSA's endorsement. 16. Under English law, policyholders have no hope of holding the FSA to account for negligence, but as explained in Annex 3 there are prospects that the evolving interpretation of the European Union Banking and Insurance Directives may lead to the FSA and (previously) the Insurance Directorate of the Department of Trade and Industry and then the Treasury being held liable to policyholders for losses resulting from their negligence. 18. We recommend that the FSA and an independent Financial Ombudsman Service are made liable when due to their negligence consumers of financial services lose some or all of the value of their deposits, investments, or policies THE ATTEMPT BY THE GOVERNMENT TO DELAY ACCOUNTABILITY FOR REGULATORY FAILURE REGARDING THE EQUITABLE 19. The Insurance Directorate of the Department of Trade and Industry was responsible for the prudential regulation of life assurers until 1998, when responsibility was passed to the Treasury (along with the personnel) as an interim step before passing responsibility (and most of the personnel) to the FSA on an agency basis through a service level agreement on 1 January 1999. On 1 December 2001 the FSA assumed full responsibility and powers in its own right. Until 27 April 2001, when the 23 staff concerned with the regulation of life assurers were transferred to the FSA, the Government Actuary's Department (GAD) was responsible for providing the DTI/Treasury Insurance Directorate and then the FSA with actuarial advice and in particular for undertaking annual scrutiny reports of life assurance companies. "A case study in serial regulatory failure by the government and its agent, the Financial Services Authority", one of our submissions to The Penrose Inquiry which we have provided to the Clerk to the Committee, conveys our view about the incompetence of the government as regulator. 20. On 31 August 2001, nine months after The Equitable has closed to new business, under pressure from concern expressed in the press and by various Members of Parliament, the Treasury set up an Inquiry by Lord Justice Penrose with broad terms of reference9, which perhaps involve writing a post-war history book of the life assurance industry and The Equitable. The Inquiry is not a statutory inquiry, it reports to the Treasury and it does not analyse culpability. We have met with Lord Penrose and his colleagues, and have no doubt about his wish to report thoroughly and objectively into the history of The Equitable debacle. We are, however, skeptical - if not cynical - about the motives of the Treasury in setting such broad and time consuming terms of reference. Originally it was suggested that Penrose would report by the end of 2002, now he hopes to complete his report by mid summer 2003, which will be more than three years after the House of Lords ruling that led to the demise of The Equitable. When will the Treasury publish it? How much will The Treasury edit on grounds of so called "confidentiality" to delete criticisms of regulatory failures? Was the Inquiry an attempt to delay and thereby defuse the anger of approaching million policyholders, the loss of their homes by some, and the reduction of the incomes of 50,000 with-profits (more aptly titled "with-losses") by 25% starting this February? Is this an "establishment cover up"? At very least for members of The Equitable who die in period before action (if any) is taken on Penrose's report, justice delayed is definitely justice denied. 21. We contrast the dilatory performance of the government and the slowness of its inquiry, with that of the Australian government and its inquiry into "The Failure of HIH Insurance"10. The HIH was a very large general insurance company and a life assurer which was placed in provisional liquidation on 15 March 2001, and formal winding-up orders were made on 27 August 2001, when the deficiency of the group was estimated to be between Aus$3.6bn and $5.3bn. A judge was appointed to inquire into the collapse on 29 August 2001 (not a delay of nine months as was the case for the Equitable Life), and he reported in April 2003, just over two years from the date of provisional liquidation. Furthermore the inquiry analysed culpability, and fifty six possible breaches of the law have been referred to the Australian Securities and Investments Commission and the Director of Public Prosecutions. Annex 1 Edited version of a letter from Alex Henney to John Tiner titled "A complaint regarding the lack of information provided by the Equitable to its members" dated 12 November 2002 requesting the FSA help policyholders to get information from The Equitable
Annex 2 Edited version of a letter from John Tiner to Alex Henney dated 10 January 2003 refusing to help policyholders I will start by working through the points in your letter of 12 November and the numbering below refers to the paragraph numbering in that letter.
Annex 3 Prospects that European law might render the FSA liable for losses resulting from its negligence11 There are hopes that European Law will force a change in English practice, and the FSA may become liable in tort for supervisory failures. Professor Mads Andenas12 and Dr. Duncan Fairgrieve13 argue in a recent article "Misfeasance in public office, Governmental liability, and European influences"14, that "expansion of tort liability for misfeasance in public office in the House of Lords' recent [strike out] decisions in Three Rivers District Council v Bank of England15 (which is about the Bank's obligation to regulate the bank BCCI which went into liquidation in 1991) may contribute to resolving possible conflicts with the European Convention of Human Rights. It may also reduce the differences in the protection offered under English law and EU law". The authors point out that the "BCCI operated in several member states at a stage when the coordination of banking supervision was being developed at a Community level. It is well documented that BCCI was allowed to continue its business for a long period due to coordination problems between the banking supervisors in different member states. The First Banking Directive (1977) was intended to secure non-discriminatory treatment of banks from other member states…The opening up of the banking markets in the Directive was accompanied by certain safeguards to protect the interest of depositors. Depositors were to be protected by certain supervisory measures that should be undertaken by national authorities. In particular they were to protect depositors from the problems of coordination between different national banking supervisors. This was the first step in establishing a new supervisory system in the Community". In short, although the House of Lords would not allow a claim based squarely on European law, which was one of the grounds on which the claim was based, they accepted that the claim based on misfeasance (which is an English law concept) could go forward, and they expanded the elements of this tort in the light of European law by broadening the mental elements required for this tort, and ensuring these mental elements alone (based on subjective recklessness would suffice, without the need to show specific accusations of bad faith). In France the Conseil d'Etat has held that the Commission Bancaire, the banking regulator, can be liable for damages for loss caused to investors by a collapse of a credit institution. In two decisions, the German Supreme Court has recognized that individual bank creditors including depositors represented a "protected interest", which means that depositors are protected from negligence by the regulator, and significantly another case has been referred to the European Court of Justice regarding the quantum of compensation. In Italy, Article 47 of the Italian Constitution (1948) provides that the state shall encourage and supervise saving in all its forms, and imposed a duty on the state to supervise banks in the interest of depositors. A series of recent judgments have paved the way for tort remedies against banking supervisors. The Italian Corte di Cassazione (Supreme Court) decided in two judgments that the Banca d'Italia in principle can be held liable in damages to investors and depositors for negligent supervision of banks. More recently, the Corte di Cassazione has applied the newly established damages liability to protect legitimate interests and held the securities commission Consob liable for investors' losses. Article 47 of the Italian constitution influenced the language of the Treaty of Rome, which in Article 57(2) required unanimity for the adoption of Community measures concerning the protection of savings. The authors believe that the attempt by Parliament to protect the FSA is not consistent with the EU's Banking Directives and with practice in other EU countries. The general aim of the Second Banking Directive (1989), which sets common minimum standards for banking supervision, is to ensure that a depositor putting money in a bank enjoys the same level of regulatory protection regardless of the domicile of an EU based bank. The country of domicile will be responsible for regulating the bank across the EU. Clearly there is an inconsistency if British depositors in a French, Italian or German (and Dutch, see paragraph 18) bank can sue the French, German, Italian or Dutch regulators for loss due to regulatory negligence, but French, Italian, German or Dutch depositors in a British domiciled bank cannot sue a British regulator for negligence16. Thus if The Banking Directives are interpreted as requiring that the FSA be liable for negligence to bank depositors for loss, then in like manner the Insurance Directives can be interpreted as requiring the FSA to be liable for negligence to insurance policyholders for loss. Furthermore S5(1) of the FSMA states "The protection of consumers objective is securing the appropriate degree of protection for consumers", which arguably imposes a duty of care on the FSA. In addition to the cases mentioned in the paper by Andenas and Fairgrieve, there has been a recent Dutch case (Rb. 's-Gravenhage 13 June 2001, NJ 2001, 445, JOR 2001, 215 (Stichting Vie d'Or a.o./Pensioen-en Verzekeringskamer-Staat-Deloitte & Touche), which concerns a Life Insurance company whose products were marketed aggressively to rich individuals. The investments made by the company were at times risky, the accounting was not clear, and the auditors were not vigilant enough. The activities were however approved by the Dutch regulator (despite warnings from private sources). When the insurance company went into liquidation, the policyholders sued the regulator and the auditors, and won compensation from the auditors but not from the Regulator and the State. The claimants and the auditors have brought an appeal against this decision and this is now pending before the Court of Appeal of The Hague. A decision is expected to be handed down in the course of this year and it is most likely that subsequently a procedure before the Supreme Court will follow. Notes 1 The Ombudsman is not empowered to examine conduct of business regulation. [Back] 2 The quotations in paragraphs 7, 11 and 14 are from the Baird Report. The full story of regulatory incompetence by the Insurance Directorate of the Department of Trade and Industry; the Treasury; the Government Actuary's Department; and the FSA is set out in my submission to The Penrose Inquiry on behalf of The Equitable Members Action Group titled "A case study in serial regulatory failure by the government and its agent, the Financial Services Authority", which has been provided to the Clerk of the Committee. [Back] 3 Summary of the response from the Consumers' Association to the House of Lords Select Committee on the Constitution - April 2003: Accountability of Regulators to Citizens and Parliament. [Back] 4 To quote from the Revised Memorandum of Understanding between the Financial Services Authority and the Financial Ombudsman Service of July 2002:- The FSA is responsible for:
5 Information that was withheld which would have been particularly useful to members includes:-
[Back] 6 The scrutiny report for 1999 by the Government Actuary's Department stated that, as far as capital risk was concerned, at first sight the solvency position looked reasonable, but the available assets of £3,861m to cover RMM of £1,114m included a future profits implicit item of £925m, disregarded the liability to repay a subordinated loan of £346m and benefited from a reduction of almost £1.1bn in the GAO reserve from the reinsurance agreement. Without these items, the available assets would be just £1511m, a less satisfactory picture for this large fund" (para 4.59.39 of the Baird Report). [Back] 7 www.financial-ombudsman.org.uk/faq/equitable. [Back] 8 Policyholders who signed the compromise lost their right to alternative redress. [Back] 9 The terms of reference are "To enquire into the circumstances leading to the current situation of the Equitable Life Assurance Society taking account of relevant life market background; to identifying any lessons to be learnt for the conduct, administration, and regulation of the life assurance business; and to give a report thereon to Treasury Ministers". [Back] 10 www.hihroyalcom.gov.au/finalreport[Back] 11 This annex has been prepared with assistance from Professors Mads Andenas, Cees van Dam and Dr. Duncan Fairgrieve all of the British Institute of International Comparative Law. [Back] 12 Director, British Institute of International and Comparative Law, London; Senior Teaching Fellow, Institute of European and Comparative Law, and Fellow, Harris Manchester College, University of Oxford. [Back] 13 Fellow in Comparative Law, British Institute of International and Comparative Law, London; Maître de Conférences invité, Université de Paris 1, Sorbonne. [Back] 14 International Comparative Law Quarterly, Volume 51, October 2000 pp.757-780. [Back] 15 Three Rivers District Council and others v Governor and Company of the Bank of England [2000] 2 WLR 1220; Three Rivers District Council and others v Governor and Company of the Bank of England [2001] UKHL 16. [Back] 16 This situation arose with BCCI depositors in France who wanted to sue the Commission Bancaire for loss due to negligent regulation. The court ruled that the collapse of the BCCI was due to fraudulent behaviour at the group headquarters in London, and was not linked to activities in France, and consequently the Commission had not been negligent. It implicitly thus suggested that the depositors seek redress from the British regulatory authority, then the Bank of England. [Back] |