UK FSA Skilled Persons Appointments, Contributed by Alison McHaffie, CMS Cameron McKenna LLP
The Financial Services Authority (FSA) has the power to require a firm to provide a report by a Skilled Person, and may use this power to support both its supervision and enforcement functions. The FSA is making increasing use of this power at significant cost to firms: in 2009-2010 the total costs to firms of these reports was £32.2 million, with each report costing the firm involved between £1,795 and £4 million. The FSA has made it very clear that it will continue this outsourcing of the investigative process, as they seek to develop a significantly more interventionist supervisory regime with a lower tolerance for consumer detriment.
Under the new regulatory regime, the number and scope of Skilled Person appointments is expected to increase further. The UK Government intends to extend the regime with specific new powers in the Financial Services Bill for the new Prudential Regulation Authority (PRA) and Financial Conduct Authority, as well as for the Bank of England. These will provide a specific power for Skilled Person appointments to deal with recovery and resolution planning. They will also apply to more firms including issuers under the UK Listing Authority (UKLA) regime, as well as recognised investment exchanges (RIEs) and recognised clearing houses (RCHs). The PRA insurance team has already warned that it may make even more use of these powers than FSA.
Whatever the FSA may say in its Enforcement Guide and other statements, experience shows that it appoints a Skilled Person where two criteria are met. The first is that there is an apparent serious breach of technical rules. Secondly, that the FSA does not have sufficient confidence in management, in particular risk management, to investigate and resolve the matter satisfactorily themselves.
Initially a firm should try to satisfy the FSA that the appointment of a Skilled Person is unnecessary. The FSA will normally contact the firm to discuss the issues before finalising its decision to require a Skilled Person report and this provides an opportunity for a discussion with the FSA as to why an alternative means of obtaining the information would be better. This can be done by satisfying the FSA on what may be termed the “three dimensions” of the issue that has arisen:
- The firm has notified the FSA promptly and in a manner giving confidence that it has properly scoped the issue;
- The firm has advised the FSA as to what remedial action is required, giving a clear timetable; and
- The firm has made clear that senior management will lead on the necessary remedial work, and that the key focus is that customers are not disadvantaged.
This approach is intended to reassure the FSA that senior management is in command of the situation. Sometimes it is necessary to support this approach with an offer by the firm to commission their own report. This is preferable to the formal “section 166 appointment”1 as the firm retains control and, in some circumstances, it is possible to ensure that the report is also protected by legal privilege which would not be the case with a Skilled Person report.
Making the Appointment
Where the FSA proceeds with the appointment, it will usually allow the firm to choose the Skilled Person. The FSA sometimes requires firms to prepare a shortlist of three and then makes a choice, justifying its selection. On other occasions the FSA requires the firm to make a choice from its own list of two or three firms. In either case, the firm should scope the appointment (recognising that the FSA has the final say) and interview possible appointees, gauging their attitude to the task, experience and qualifications and meeting the staff who will be running the project (and not just the overall “client partner”).
The Skilled Person Process
Where the FSA perseveres with the proposed appointment, there are four elements to managing a Skilled Person investigation. These are to:
- Agree the terms of reference;
- Manage the investigation effectively, so that the Skilled Person does not form an incorrect or unfair view of the matter under investigation;
- Review the draft report, seeking amendments as to findings of fact, judgements and conclusions; and
- Prepare a management response to the final report, together with any remedial actions that are required.
Agreeing Terms of Reference
While the FSA will typically prepare and insist on the adoption of its scope, there are a number of areas where a firm should protect its position. These include:
- The period under review. This should not extend back too far, nor should it continue after system changes or procedural enhancements were adopted.
- How the Skilled Person is to work. If a selection of files is to be reviewed, systems interrogated or staff interviewed, then the basis and method of this work should be clearly stated.
- The criteria. Whether the Skilled Person is reviewing records of retail sales, client money, equity execution, governance structures or financial resources, the scope of the appointment should clearly state the standard of review. For example “the Skilled Person shall review equity trades between 1 and 7 July for compliance with PRIN2 2, SYSC3 4 and COBS4 11” is preferable to “the Skilled Person shall perform an examination of current processes around the sales process” or “a past business review of derivatives trading identifying customer detriment.” These latter examples are loosely worded and will enable the Skilled Person to judge not just against the rules but against wide concepts such as good industry practice, its view of a notional ideal position, as well as FSA guidance and material set out in consultation papers and Dear CEO letters.
- The focus. The scope should ideally state that the Skilled Person is reviewing for material divergence from the stated standard (for example PRIN 2, SYSC 4 and COBS 11) and is required to identify where in consequence a customer has suffered or been exposed to the risk of material disadvantage. This formulation is intended to ensure that the Skilled Person does not produce an endless list of minor and potential faults, but instead concentrates on real customer disadvantage.
- The remedy. Where the Skilled Person is required to advise on redress, the formula should be stated in the scope at this stage, if possible, rather than left to later determination by the FSA.
- The timetable and reporting process. The FSA will normally specify a time limit within which it expects the Skilled Person to deliver the report and may provide for regular or interim reports to be made. The timetable should be reasonable and allow the firm sufficient time to review and respond to drafts.
Managing an Investigation
It is important that a firm remains firmly in charge of the process throughout the appointment. Steps that firms can take include the following:
- Appoint a project team led by a senior manager to co-ordinate the firm’s co-operation with the Skilled Person.
- When documents are provided to the Skilled Person, ensure that they are in good order and accompanied by a clear explanation.
- When staff are to be interviewed, ensure that they are thoroughly prepared and briefed, accompanied to interview and a note taken. Any inconsistencies or misunderstandings can in this way be swiftly identified and remedied.
- Resisting “scope creep.” While a firm cannot prevent a Skilled Person from widening the scope of its report at the FSA’s request, or if it detects further issues, a firm must be vigilant in keeping the Skilled Person within the bounds of its appointment. A question to be asking at each point is: “how does this fit within the agreed scope?”
- Keeping abreast of developments. The firm must maintain a continual dialogue with the Skilled Person, seeking weekly updates and understanding its concerns and gauging its reaction and, if adverse, seeking to address it. The firm must ensure that it is the first to hear “bad news,” and not the FSA.
- Receiving preliminary drafts. The firm should insist on receiving early drafts of all work streams so that it has an adequate opportunity to review and respond to work in progress. This will enable it to identify problems such as misinterpretation of data, unfavourable assumptions, biased sampling, and scope creep. The Skilled Person should also agree to consider and provide a reasoned response to the firm’s comments on its preliminary drafts. Waiting for the draft overall report is usually waiting too long.
Additionally, it is important to maintain a dialogue with the FSA. The Skilled Person will be required to make regular reports to the FSA, and the firm must also ensure that it has open communications with the regulator. In this way it can seek to maintain “symmetry of information” as between it, the Skilled Person and the FSA. The FSA also expects firms normally to be informed about the passage of information, and the Skilled Person would usually be expected to keep the firm apprised of any communication between it and FSA. However, in practice this requirement is often overlooked by the Skilled Person and the FSA. Where this is not done, the risk is that the Skilled Person and the FSA together form an adverse view that is only communicated to the firm when it has become a settled opinion and the consequent remedial or enforcement steps all but determined.
Dealing with a Draft Report
While a firm should have sought to influence the drafting throughout the process, the period between production of a draft report and its finalisation offers a key tactical opportunity for influencing the process and controlling its future direction. It is necessary for a firm to be very alert to the risks of poor execution, over-zealous extension of remit, judgemental findings and conclusions overly influenced by the FSA rather than the Skilled Person’s judgement. The following steps should be followed:
- Check that the Skilled Person has not exceeded its terms of reference.
- Review for factual accuracy.
- Review for representativeness of sampling. Where a period has been selected for review, or certain transactions chosen for scrutiny, the firm should review to ensure that any conclusions drawn are truly representative of the underlying position.
- Check that judgements are sustainable. In many cases a Skilled Person will form a view based on what it considers to be good industry practice, or will make its own interpretation of FSA rules or guidance. In other cases a Skilled Person may misunderstand the sales process, overlook or misinterpret disclosure documents or reach an incorrect view on an individual sale.
- Ensure that extrapolations are fully grounded. Findings about the adequacy of senior management systems and controls, suitability of sales or overall governance, are likely to be derived from case reviews.
- Check that the conclusions are sustainable. The Skilled Person’s conclusions and recommendations should be soundly based on the facts, take full account of both the FSA’s requirements and good industry practice, and be realistic.
Management Response & Remedial Action
The issue of the final report is often not the end of the regulatory process for the firm. Often the scope of the appointment requires the firm to produce a management response to the issues identified and may require or expect the firm to take additional remedial action or carry out a past business review (PBR). If there is the possibility of a referral to enforcement, the management response will also be of vital importance for defending and/or limiting the extent of any enforcement action. The FSA will often seek to rely on the Skilled Person report as its investigation. The firm’s position can be protected if it:
- Drafts the management response so that it is fair and robust, and recognises any areas for improvement or where there have been failings but also addresses any areas where the findings are unjustified or unfair and sets out the action the firm has or will be taking;
- Prepares for follow up meetings with the FSA; and
- Scopes and carries out (or appoints another party to assist in) remedial action and/or any PBR to ensure it is reasonable and fair and in keeping with the firm’s regulatory responsibilities.
Alison McHaffie is a partner in the London office of CMS Cameron McKenna. Alison specialises in advising financial institutions on all types of regulatory contentious matters, including FSA investigations and enforcement actions, dealing with skilled persons appointments and handling commercial disputes and large scale litigation arising out of the provision of financial services. Telephone: +44 (0) 20 7367 2785; E-mail: Alison.firstname.lastname@example.org.
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