Hidden depths

Professional indemnity insurance is vital for individuals who manage Financial Services Authority-regulated firms, especially in an environment where the punishment for misconduct can be costly. Vicky Fisher reports on how fines levied so far are only the tip of the iceberg

"In a regulated market it is necessary that the most serious breaches of regulations are punished appropriately and that the lessons that emerge are evident to the market as a whole."

This statement appears in the Financial Services Authority 2004/5 Annual Report. The FSA's objectives as an enforcer are clear: punish offenders and publicise the results.

The FSA has also stated that its focus will be not only on the institutions that it regulates but also on the individuals who manage them. Just under two years ago the FSA announced its intention to concentrate on the responsibility and accountability of senior managers within regulated firms and it has been true to its word.

High profile scalps

In recent weeks, the press has reported several high profile scalps taken by the FSA - both corporate and individual. In one case regarding hedge fund GLG Partners and its star trader, Philippe Jabre, the FSA panel recommended fines of £750,000 each in response to alleged insider trading in February 2005. Mr Jabre is appealing the FSA's decision.

Earlier this year, the FSA also levied a fine of £6.4m from Deutche Bank for market misconduct and failing to conduct its business with due care, diligence and skill. It personally fined David Maslen, Deutche Bank's former head of cash trading, a further £350,000 in relation to the same offence.

However, in seeking to establish corporate guilt and target those with individual responsibility, the FSA does not only concentrate its resources on the big City firms. Within small to medium-sized firms it is often easier for the regulator to identify and target an individual "controlling mind" to bear personal responsibility for the acts and omissions of the entity.

The ambit of the FSA's enforcement actions taken in 2004/5 were wide-ranging, from mis-selling of products and breaches of the listing rules to market abuse, insider dealing and the failure to design and implement internal systems and controls. Keeping an eye on these areas may well be more difficult for smaller firms where there are fewer senior managers to share the responsibility.

In a letter to the Joint Money Laundering Steering Group on 10 April, the FSA again stated its intention to focus on the responsibility of the individual. "Senior managers are the key to anti-money laundering, and it is they who must take responsibility for their firms' systems and controls," the letter stated.

This rhetoric is backed by the FSA's recent enforcement action in the case of Investment Services UK. This small bond broker helped its clients to open bank accounts so that they could participate in bond trades.

However, ISUK failed to provide adequate information to the bank about these new customers. As a consequence, a small number of individuals were able to operate anonymous accounts and £8m entered the UK banking system without the bank knowing the identity of its customers or the sources of the funds.

After a three-year investigation, the FSA fined ISUK £175,000. The FSA also took action against ISUK's managing director fining him £30,000 for his personal failure to implement adequate anti-money laundering systems and controls.

By targeting both the entity and the individual, the FSA is using the well-known strategy of divide and conquer. This strategy increases the legal costs for those involved, as the firm and the manager will usually need to be separately represented. It also increases the likelihood that problems will come to light when the entity and the individual seek to shift responsibility to the other to save their own necks.

In 2004/5, the FSA conducted 79 investigations with enforcement proceedings ensuing. Enforcement notices were issued against 19 individuals and the sanctions imposed on individual managers included prohibitions, cancellations or variations of permission and personal fines ranging from £1000 to £290,000.

Also in 2004/5, 121 investigations were concluded by the FSA without the eventual use of its enforcement powers. In other words, 121 further firms or individuals were investigated and either given private warnings, vindicated or the cases against them dropped.

The total number of investigations concluded by the FSA in 2004/5 was 200 and this number is likely to grow. In most, if not all cases any fines levied represent only the 'tip of the iceberg' as the firms and/or managers involved have incurred considerable legal fees responding to the FSA and mounting their defence.

Insurance cover

Neither companies nor individuals are allowed to insure against fines levied by a regulator. They can, however, take out insurance to cover their legal costs in dealing with regulatory investigation.

These policies cover actions by the FSA and the Department of Trade and Industry and any costs sought by these institutions from the insured. The policy also pays financial compensation to witnesses who sacrifice precious time to give evidence on behalf of the insured.

In a climate where the FSA is determined to prove it is an effective regulator by making examples, the peace of mind provided by such a policy can be priceless.

- Vicky Fisher is professional indemnity legal adviser at Markel.

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