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Turning Tides in FCA SMCR Enforcement: Easier Targets, Non-Financial Misconduct, Changing Priorities

In Short

The Situation: The Financial Conduct Authority ("FCA") is extending the Senior Managers and Certification Regime ("SMCR") to FCA solo-regulated firms on 9 December 2019 and has also released a number of statements in relation to non-financial misconduct which apply to all SMCR regulated firms.

The Result: FCA enforcement action in relation to SMCR is likely to increase from its current subdued levels, with solo-regulated firms and non-financial misconduct the most likely focus for regulatory attention.

Looking Ahead: Firms and individuals who fall within the scope of SMCR will need to rapidly move on from an implementation or project management mind-set and focus on pro-active compliance, particularly in relation to non-financial misconduct.

Background

Following the financial crisis, there was tremendous pressure for greater personal accountability and action against senior staff at financial institutions. As a result, SMCR was introduced in the UK for banks, building societies, and PRA-designated investment firms in 2016. The purpose of establishing SMCR was to provide laws, rules, and processes designed to improve governance and make key individuals accountable at such firms.

However, despite the original political impetus which brought about its introduction, FCA enforcement action stemming from SMCR has been relatively low since the regime was introduced in 2016. As of August 2019, of the 19 FCA investigations using SMCR powers, there has been only one successful enforcement action (against James Staley, the Chief Executive of Barclays). This has led some to question whether SMCR will actually bring about the higher levels of FCA enforcement action that were originally anticipated.

The tide, however, does appear to be turning. An analysis of the current regulatory landscape of SMCR suggests that FCA enforcement action in connection with the regime will be on the rise.

Easier Targets?

On 9 December 2019, SMCR will be extended to virtually all FCA solo-regulated firms to ensure that there is individual accountability right across the UK financial services industry. Solo-regulated firms are regulated solely by the FCA and not the Prudential Regulation Authority ("PRA"), and include regulated fund and asset managers, investment firms, and insurance intermediaries. Although these firms will be able to draw on the lessons learned by firms already subject to SMCR (such as banks and insurers), it is expected that enforcement levels, and the success rates of such enforcement action, could rise significantly as a result.

The extension of the SMCR will bring approximately 47,000 more firms within the regime. These numbers alone suggest that an increase in investigations and successful prosecutions is inevitable. However, it is worth noting that the extension will also bring far smaller and potentially less sophisticated firms within scope. The inclusion of smaller firms to the regime is likely to increase successful enforcement levels as:

  • These firms will potentially have less sophisticated governance procedures in place, meaning that they are potentially a larger source of breaches;
  • It will be far easier for the FCA to identify decision-making processes in relation to these smaller firms when investigating breaches, which will translate into more successful enforcement actions against such firms and their staff; and
  • These firms will have fewer resources at their disposal to fight any enforcement action.

Non-Financial Misconduct

Non-financial misconduct is currently a significant area of supervisory focus for the FCA. It has been the subject of speeches made by FCA executives and of correspondence between Megan Butler, in her capacity as the Director of Investment, Wholesale and Specialist Supervision at the FCA, and a UK Parliamentary Committee. The type of conduct that falls within non-financial misconduct includes sexual misconduct, sexual harassment, discrimination, and bullying. The FCA has made very clear that non-financial misconduct falls within the scope of its regulatory framework and SMCR. 

Under SMCR, non-financial misconduct can impact the fitness and propriety assessment relevant to obtaining a regulated role and amount to breaches of the ongoing Conduct Rules. Ms Butler stated in a letter addressed to the Chair of the Women and Equalities Parliamentary Committee that "there have been instances where either we or a firm we supervise have found an individual not to be fit and proper on the basis of their 'non-financial' conduct, with the consequence that they were unable to be take up or else continue in their role"

This sentiment has been echoed by other senior individuals in the FCA. Christopher Woolard, Executive Director of Strategy and Competition at the FCA has stated that: "in [the FCA's] judgement, the way a senior manager approaches issues around diversity may be relevant to our assessment of their competence and character…the way firms handle non-financial misconduct, including allegations of sexual misconduct, is potentially relevant to our assessment of that firm, in the same way that their handling of insider dealing, market manipulation or any other misconduct is. This is a message industry needs to hear".

Ms Butler also states in her letter that sexual harassment and other non-financial misconduct committed by individuals, who are within the scope of SMCR, can amount to a breach of the Conduct Rules, specifically Individual Conduct Rule 2.1.1 which requires individuals to act with integrity. Furthermore, where such a breach of the Conduct Rules occurs at a level below senior management, senior managers are still potentially at risk if they fail to disclose such a breach to the FCA. This is because the FCA has recently made clear that under Senior Manager Conduct Rule 4, senior managers must disclose information about non-financial misconduct which amounts to a breach of the Conduct Rules to the FCA.

Another way in which the FCA's recent focus on non-financial misconduct is creating regulatory risk for senior managers can be seen in the context of whistleblowing. Ms Butler stated in her letter that the FCA expects firms to have appropriate internal whistleblowing and complaints processes in place. Where the whistleblowing procedures in place in relation to such issues are found to be inadequate, the FCA may argue that the senior manager who has responsibility for those procedures should face regulatory action.

FCA enforcement related to non-financial misconduct therefore seems to be set to rise. Even within the last 12 months, the number of cases of such misconduct reported to the FCA has hugely increased (in 2018 the FCA received 64 disclosures from whistle-blowers relating to non-financial misconduct, up from 20 in 2017).

From Implementation to Enforcement

The FCA is aware that implementing SMCR is a significant undertaking for firms. To ease the implementation process, the FCA has granted all solo-regulated firms a 12-month transitional period from 9 December 2019 within which to complete the first round of annual assessments in relation to the Certification Regime. During the transitional period, firms may also complete internal training in relation to the Conduct Rules for staff other than senior managers and certification staff. From this we can infer that the FCA is more concerned, at least for the time being, with the proper implementation of SMCR than with ensuring immediate compliance.

However, the end of the transitional period should be seen by firms as a warning that the FCA is set to move on from viewing SMCR (and its extension to FCA solo-regulated firms) as a regime in its implementation stage. Firms should anticipate that the FCA, at that point, will increasingly seek to use its resources to carry out enforcement action as a means of ensuring compliance with SMCR. At this point, to paraphrase a famous financier, when the tide goes out, firms will need to ensure that they aren't swimming naked.

Three Key Takeaways

  1. Whilst enforcement activity stemming from SMCR has so far been more subdued than was initially expected, changes in the regulatory landscape mean that firms should expect SMCR based enforcement action to increase.
  2. We expect that the key drivers of increased FCA enforcement action will be (i) the extension of SMCR to solo-regulated firms; (ii) the FCA's clear intent to use SMCR to tackle non-financial misconduct as well as financial misconduct; and (iii) the inevitable shift in the FCA's focus from SMCR implementation to enforcement.
  3. Firms need to move their SMCR projects from implementation to proactive compliance. 

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