Financial Services Regulation Update 18 June 2008

Updated June 2008

Note these items are presented as news bulletins only. If you want help or more information contact Suzanne MacDonald.

1. Chancellor announces new Financial Services Authority (FSA) Chairman

Alistair Darling, the Chancellor of the Exchequer, has announced that Lord Adair Turner has been appointed as the new FSA Chairman. Lord Turner will succeed the current FSA Chairman, Sir Callum MacCarthy, when he steps down from the role on 22 September 2008.

The appointment of Lord Turner is for a five year term. To facilitate Parliamentary scrutiny, the appointment is subject to a pre-commencement hearing by the Treasury Select Committee.

Commenting on Lord Turner's appointment, the Chancellor said: "I am delighted to appoint Adair Turner as Chairman of the FSA. His wide-ranging expertise will be invaluable in driving forward the FSA's objectives to maintain confidence in the financial system, promote public understanding of it, protect consumers and reduce financial crime."

2. Hector Sants: principles-based regulation and the lessons from the sub-prime crisis

In a speech to the Securities and Investments Institute Annual Conference, Hector Sants, Chief Executive of the FSA, commented on how the FSA is responding to the recent market turmoil and the impact of these events on the FSA's supervisory regime:

• Increased supervisory attention will focus on the requirement for firms to maintain adequate capital and ensure they undertake adequate stress and scenario testing.
• Does senior management understand the circumstances under which their firms would fail and are they comfortable that the risk is acceptable?
• FSA supervisors will be focusing their attention on the competence of senior management, who should be able to justify their actions with reference to the outcomes they are seeking to achieve.
• The FSA continues to monitor markets carefully and liaise with key market participants to inform itself of market events and their implications. The FSA is looking at the increase in firms' funding risk and has been collecting information on firm's liquidity arrangements and funding plans.
• Those firms that have remained focused on the high level outcomes for their business are faring better than those who did not. Recent events have not undermined the FSA's commitment to principles-based regulation.
• Compensation structures present a risk. Employees and shareholders must share in the upside and the downside, for example by using clawback and the increased use of share options. But quantum of remuneration is not a regulatory matter.
• Where supervisory remediation programmes cannot achieve the right results the FSA will use enforcement action to change behaviour in the industry.

3. Treating Customers Fairly (TCF): FSA review of 'wake up' packs

Sarah Wilson, Director and Insurance Sector Leader of the FSA, made a speech to the Institute of Economic Affairs about 'The future of life assurance: managing the risks'. She commented on the findings of the FSA's review of the quality of 'wake-up' packs (the literature provided to those approaching retirement) and the alleged delays of some providers in transferring open market option funds. The FSA found that 40% of insurers still have substantial work to comply with regulatory requirements. Key problems identified were: (i) failure to explain the potential advantages of exercising the Open Market Option; (ii) insufficient prominence of important information; and (iii) failure to use guaranteed rates in default annuity illustrations. The FSA will publish full feedback in July 2008.

TLT can help with reviews of all your customer-facing literature.

4. FSA fines

4.1 Thinc: £900k for sub-prime mortgage business breaches
Thinc Group Limited (TGL), a large IFA group, has been fined £900,000 for inadequate risk management and compliance systems in its sub-prime mortgage business, and inadequate records of advice to customers on the suitability of sub-prime mortgages.

Breaches by the firm during the relevant period (1 January 2006 to 30 September 2007) relating to the sale of sub-prime mortgages included failure to obtain adequate financial information before advising and providing some customers with a 'Record of Suitability' letter that did not correspond to the product advised or sold. TGL also failed to demonstrate (i) that customers' credit histories justified the sale of a sub-prime mortgage; (ii) why that particular product matched the customer's needs and circumstances; or (iii) that it had considered the affordability of the sub-prime mortgage contract.

Other factors were the vulnerability of TGL's customers and the failure of TGL to implement effective remedial action to improve sales practices and regulatory compliance generally after an FSA thematic visit.

TLT notes that this large fine was imposed even though the FSA has not determined that the firm missold sub-prime mortgages and there had been few complaints

4.2 Woolworths: £350k - for breach of the Disclosure Rules and Listing Principles
Disclosure and Transparency rule (DTR) 2.2.1 requires that an issuer must notify the market of any inside information which directly concerns the issuer as soon as possible through a regulatory information service..

Listing Principle 4 (see LR 7.2.1) provides that a listed company must communicate information to holders and potential holders of its listed equity securities in such a way as to avoid the creation or continuation of a false market in such listed securities.

The FSA found Woolworths to be in breach of both of these rules.

4.3 Chepstow Financial Services £10.5k
Chepstow Financial Services has been fined for failures in the sales process used for self certification mortgages. The FSA found the broker relied too heavily on customers' declarations that they could afford the loan rather than carrying out an assessment of affordability. Consequently his business was more at risk of being used to commit mortgage fraud.

5. In the news: Credit Reference Agencies (CRAs)

Regulatory pressure on CRAs is mounting. Follow the link on the right for a briefing.

6. National Strategy for Financial capability: FSA's May newsletter

Highlights: the Parent’s Guide to Money, the 'Moneymadeclear' mortgages campaign and the Treasury’s announcement that the FSA will lead on Thoresen's recommendation of a 'Pathfinder' to deliver a UK-wide Money Guidance service.

7. Information Commissioner: watchdog gets new teeth

The power to fine
The UK's data protection regulator has gained significant new powers to impose fines. The newly enacted Criminal Justice and Immigration Act (CJIA) 2008 amends the Data Protection Act 1998 (DPA) to give the Information Commissioner (IC) the power to impose substantial fines on any organisation which "deliberately" or "recklessly" commits a serious breach of the DPA. This is enabling legislation, ie these powers can now be granted but they are not in effect yet. The effective date has not yet been set.

The IC will be expected to issue guidance that sets out the circumstances in which he would consider it appropriate to issue a fine, and how he will determine the amount of the fine. Before issuing notice of a fine, the commissioner will be required to issue a notice of intent to fine, which will specify a timeframe for making any representations that contest the proposed penalty. Payments that the IC receives will be paid into the Consolidated Fund and will not be retained by his office.

More powers?
The CJIA stops short of making serious breaches of the data protection legislation a criminal offence, as the House of Lords had proposed in an earlier draft of the legislation. The IC strongly favoured the creation of a criminal offence for serious breaches and it remains to be seen whether this will continue to be pursued. The IC is unlikely to abandon his previous request for extended audit powers, coupled with a Sarbanes-Oxley style requirement for company executives to certify their information security procedures.

8. Bank overdraft charges and fairness

In April 2008 in the case of OFT v Abbey National Plc & Others (see item 4, TLT FSR Update 16 May 2008) the High Court found that the unfairness rules of the Unfair Terms in Consumer Contract Regulations 1999, can be applied to assess unarranged overdraft charges in personal current accounts.

At the subsequent Case Management Conference, Mr Justice Andrew Smith gave the Banks permission to appeal this finding. The Appeal will be heard during Autumn 2008.

The Judgement relates to relevant terms in current agreements between the Banks and customers and is restricted to those terms that were considered by the Court. There will be a further hearing on 7, 8 and 9 July 2008 to determine whether the relevant terms in the Banks basic and historic personal current account contracts can also be assessed for fairness under the Unfair Terms in Consumer Contract Regulations (Regulations).

The Office of Fair Trading (OFT) has committed to deciding whether or not unauthorised overdraft charges are fair, and, if necessary, how much compensation customers should receive, during the second week in July 2008. If the Banks dispute the OFT's decision, the banks and the OFT have agreed to return to court before Christmas 2008 to settle this issue.

Subsequent Appeals by either side are possible so the case could continue into 2009.

9. New consumer protection and business protection regulations

On 26 May 2008, the following regulations came into force:

9.1 The Consumer Protection from Unfair Trading Regulations 2008 (CPRs)
The CPRs implement the Unfair Commercial Practices Directive (2005/29/EC) in the UK.

The Directive aims to: ban pressure selling and misleading marketing; harmonise member states' rules on unfair commercial practices; clarify consumers' rights and give them the same protection, whether they buy from the shop around the corner or from a website of a company based in another member state; and facilitate cross-border trade by establishing EU-wide rules against aggressive or misleading business-to-consumer marketing.

The FSA's regulatory approach and Handbook already address unfair commercial practices by firms regulated by the FSA. The FSA will have injunctive powers under the Regulations, but is more likely in practice to use its powers under the Financial Services and Markets Act (FSMA) when taking action against firms.

9.2 The Business Protection from Misleading Marketing Regulations 2008 (BPRs)
Amongst other things, the BPRs implement in the UK the Consolidated Directive on Misleading and Comparative Advertising, which replaces and consolidates previous European legislation in this area. The BPR defines misleading business advertising and prohibits advertising which misleads any person acting in the course of business. It also sets criteria for comparative advertising to adhere to.

10. Financial Ombudsman Service (FOS) 2007/08 annual review

The Review outlines the activities and role of the FOS during the 2007/08 financial year, presenting information and statistics on the volume of consumer enquiries, complaints and cases with which it has been engaged. For the first time, the Review includes more detailed comparative data about the uphold rates for complaints across the different financial products and sectors covered by the FOS.

During the relevant period, the FOS:

• Experienced a 30% annual increase in the level of consumer enquiries and new complaints handled.
• Saw the level of mortgage and banking disputes more than triple and the level of insurance disputes double (largely as a result of a rapid increase in complaints regarding unauthorised overdraft charges and payment protection insurance). Complaints about mortgage endowments fell by 70%.
• Settled 99,699 disputes, 50% of which related to six of the UK's largest financial services groups (which broadly reflects their retail market share).

Publication of the Review follows publication in April 2008 of the recommendations of the independent review of the FOS carried out by the Lord Hunt of Wirral (Hunt Review). The FOS is currently considering the Hunt Review's recommendations on accessibility and transparency. In the Review, Walter Merricks, Chief Ombudsman, comments that the recommendations "add up to a bold agenda for change - one that will take time to implement, but which ... will deliver an ombudsman service fit for the changing world we see ahead".

For further information on the Hunt Review see our May Update.

11. Court of appeal says FOS case fees where complaint is dismissed are not unfair

(Item 8 in TLT FSR Update for 20 March 2008 refers)
In March, the County Court declared it unfair for advisers to pay a FOS case fee if the finding was against the complainant. The FOS appealed, and the appeal has now been upheld.

A FOS spokesman says: "The FOS is pleased that the Court of Appeal has provided clarification on this issue. It affected everyone which is why it was important this clarification was given."

The advisers who brought the original case must now decide if they wish to appeal.

12. Compliance with new financial promotion regime in Conduct of Business Sourcebook (COBS)

COBS imposes a new, simplified financial promotion regime. The new regime encourages firms to use high-level principles as the basis for considering communications with customers and potential customers.

FSA has been tracking three key areas of risk posed by the new financial promotion regime:

• Balance and understandability.
• Past performance.
• Direct offer.

The FSA believes there has not yet been what it terms "a seismic shift" (though clearly it was hoping there should have been) in the creation and development of financial promotions for retail customers. Standards have been maintained since 1 November 2007 and the FSA has identified evidence of good practice and the raising of standards but some firms are taking only cautious, limited advantage of the new regime.

Firms' compliance with the new financial promotion regime in respect of retail business is one of the FSA's current supervisory priorities

TLT can help with the development and approval of your financial promotions.

13. The FSA reminds firms of KFD improvement deadlines

In September 2007, the FSA published a report on good and poor practice in Key Features Documents (KFDs), making clear its intention to ensure firms improve their KFDs. Since then, FSA supervisors have been in discussion with firms whose KFDs were assessed as poor or ineffective, and, in November 2008, the FSA will revisit some of the KFDs in its original sample.

Andrew Sykes, Head of FSA's Investment Policy and Unfair Contract Terms department, made the following points in a recent speech. KFDs must:

• Be focused on the decision to buy (or not to buy).
• Stand out in sales packs.
• Use concise plain language supported by good presentation.
• Be clearly developed with customer capability and needs in mind.

Mr Sykes notes that the FSA expects firms to be able to achieve this on their own, commenting that it is "not normally a regulator's job to give lessons on presentation and plain English" and that essentially what is required is that firms "put the same effort and expertise into the KFD as into [their] marketing materials".

He reminded firms that the FSA has linked its KFD improvement deadlines to its Treating Customers Fairly (TCF) deadlines, since disclosure material is an important part of firms' TCF obligations. Firms can therefore expect greater KFD scrutiny from supervisors as the December 2008 TCF deadline approaches. If the FSA has concerns in respect of a firm's KFDs, it will raise them and will expect the firm to take prompt action.

TLT can help with the redevelopment of KFDs to meet the new regime.

14. TCF and fairness of terms in consumer contracts

The FSA has published a report entitled, 'Fairness of terms in consumer contracts: a visible factor in firms treating their customers fairly'

In addition to their regulatory obligation to treat customers fairly, firms are legally obliged to have fair terms in their standard consumer contracts under the Unfair Terms in Consumer Contracts Regulations 1999 (Regulations). The FSA has power under the Regulations to challenge firms using such unfair terms.

The FSA has carried out a project which amongst other things measured awareness of, and compliance with, the Regulations in the financial services industry and reviewed the FSA's use of the Regulations in securing an appropriate level of consumer protection.

The Report informs firms of the FSA's findings and sets out examples of good and bad practice relating to the fairness of terms in consumer contracts.

Many firms whose contracts were reviewed by the FSA still have unfair terms in them. Unfair contract terms can be evidence that firms are not treating their customers fairly. Firms are required to demonstrate to themselves and the FSA that they are consistently treating their customers fairly by December 2008.

Firms should therefore take urgent action to review and amend their terms as necessary and ensure that they have systems and controls in place to ensure the fairness of their consumer contracts on a continual basis.

TLT can help to review and draft customer product conditions to ensure compliance with the Regulations.

15. Competition Commission publishes provisional findings of PPI review

As reported in previous Updates, Payment Protection Insurance (PPI) has been a matter of FSA scrutiny and investigation by the Competition Commission (CC). The CC has now published a report of its provisional findings identifying competition issues in the PPI market which result in consumer detriment.

The CC is consulting on a wide range of proposals, including prohibiting selling PPI at credit point of sale, and within a fixed period from the sale; imposing a cap on the price of PPI for a limited period; and requiring details on third parties producing PPI comparative information.

The FSA may have to amend the Insurance Conduct of Business sourcebook (ICOBS) rules for PPI firms to reflect the CC's final decisions. The FSA would be expected to formally consult on any proposed amendments to its rules.

These proposals are only open for consultation until 30 June 2008.

TLT says: firms in the PPI market should review the CC report and raise concerns with the CC.

TLT can help to ensure the compliance of your PPI products, practices and procedures.

16. FSA view of revised Tripartite arrangements

The Tripartite Authorities (the FSA, the Bank of England (BoE) and Her Majesty's Treasury (HMT)) proposed changes to the current arrangements in January 2008. Callum McCarthy, FSA Chairman, has commented on how the FSA envisages the improved arrangements would work for any bank during three scenarios:

In normal conditions: Supervision will remain with the FSA. The BoE will be able to access information the FSA collects from banks as part of the integrated regulatory reporting regime. The FSA will take the views of the BoE and HMT into account in determining what information is normally collected from banks. If the BoE requires more information, the FSA should collect it so banks face only one information-gathering body.

There may be occasions where a BoE representative joins the FSA on a bank visit.

When a bank faces difficulties: The BoE may have discussions directly with the bank to ensure it fully understands the firm's position. The FSA will share information collected from the bank, and its judgement of the bank's position, with BoE, HMT and the Financial Services Compensation Scheme (FSCS).

When the special resolution regime is invoked (that is, the regime that would allow banks to fail in an orderly manner): The FSA should be the body that judges whether a bank in difficulty is able to continue to meet the FSA's threshold conditions. Any alternative to this would weaken the FSA's authority and lead to confusion. However, the FSA should not run a bank once it enters the regime, as its role should be confined to regulation.

Consultation on the Banking Reform Bill is ongoing with a further publication expected from the Authorities soon, with legislation following in October.

17. CCA reforms: LRA to give effect to original policy intention

A number of issues have arisen as a direct or indirect consequence of the way the Consumer Credit Act (CCA) 2006 has amended the CCA 1974. The Department for Business Enterprise & Regulatory Reform (BERR) consulted on a proposed Legislative Reform Order (LRO) to effect corrective measures designed to achieve the original policy intention of each of the relevant legislative provisions. The proposals have received widespread support and so BERR has decided to proceed. The Legislative Reform (Consumer Credit) Order 2008 (a draft of which was included in the consultation) will amend the CCA 1974 to:

• Exempt buy-to-let lending from regulation under the CCA 1974.
• Clarify the position on the giving of statements for fixed-sum credit agreements.
• Provide definitions of "payments" for the purpose of issuing notices of sums in arrears.

TLT can help with compliance with CCA requirements.

18. JP Morgan Chase Bank & Others v Springwell Navigation Corporation

The High Court's Judgment in the above has just been handed down. This Judgment will be of particular interest to those marketing higher risk/emerging markets investment portfolios who need to know when their action may constitute 'advice'.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at June 2008. Specific advice should be sought for specific cases; we cannot be held responsible for any action (or decision not to take action) made in reliance upon the content of this publication.
 

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