Herbert Smith Freehills Kramer Podcasts
Herbert Smith Freehills Kramer Podcasts
FSR Brief EP13: Alternative routes to resolution
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The ways in which regulators respond when things go wrong is continuing to evolve. In this episode of the FSR Brief, Jon Ford, Michael Tan and Eva Barbosa discuss the Financial Conduct Authority's ("FCA") Enforcement Watch 2, including consumer duty investigations and the continued use of assertive supervision alongside/ in lieu of enforcement, the Financial Reporting Council's ("FRC") changes to its Audit Enforcement Procedure to introduce new routes to resolution, including an Early Admissions Process, and the latest case brought by the Prudential Regulation Authority using the Early Account Scheme. They share insights into these different approaches and consider whether there may be learnings that could be shared across regulators.
See here our blogs on the changes to the FRC's Audit Enforcement Procedure and the FCA's Enforcement Watch 2.
Welcome And Three Regulatory Updates
Jon FordHello, all, and welcome to episode 13 of the FSR Brief. I'm John Ford, a partner in the contentious FSR practice at HSF Kramer, and I'm joined by Michael Tan, a senior associate in the same team.
Eva BarbosaAnd Eva Barbosa, a junior associate in the same team.
Jon FordAnd today, look, we've been away for a little while, so we're going to give you three topics for the price of one. We're going to cover the FCA's latest enforcement watch, so that's enforcement watch two. We're going to cover the FRC's audit enforcement procedure, and the PRA's latest final notice in relation to HDI Global using the early account scheme.
FCA Consumer Duty Enforcement Signals
Jon FordSo let's start off with the FCA enforcement watch. Two points to take from it, really. One, in relation to an update on its enforcement in relation to the consumer duty. After a period of forbearance, they have 11 open investigations and they give you some details in relation to that. And two, and slightly oddly, for an enforcement watch update, they give you more detail in relation to what they call their assertive supervisory interventions. There have been 382 over the last financial year. And the enforcement watch gives you a list of some of what that means for some of those firms that have been on the receiving end of what can be quite um draconian supervisory action taken using the FCA's regulatory toolkit.
Michael TanSo, John, starting then with the consumer duty, what can firms take away from the second enforcement watch? Does it provide the kinds of details that will be helpful to firms to understand how to comply?
Jon FordMichael, look, I think it depends on which level one is looking at the enforcement watch. And a high level, yes, you can take some uh information in relation to it. It gives you some uh ideas of the themes of things that they are looking at, both from the aspect of the consumer duty and in particular looking at issues of fair value, which we know is an issue that um firms have been uh working hard to grapple with as they implemented their um procedures in relation to the consumer duty. It also gives you a flavor of where their open operations are, so where are they enforcing? Um there is a various investigations we're told in relation to the insurance sector. There are a number or two at least of uh public enforcement action taken against CMCs, and then they give some flavour in relation to wealth management and peer-to-peer lending platforms. So at that level, you at a high level, you do get some insight. But when you get into the detail, or I should say, really the detail is lacking, other than saying we're looking at, for example, operational failings and weaknesses in customer support, or operational and oversight failures, i.e., when you get into the detail, quite hard to understand what actually is going on or what went wrong, or allegedly what went wrong.
Michael TanSo I guess we'll have to wait for the final notices to get those uh further details. I guess though, these will be the extreme end, won't they?
Jon FordYeah, as ever. Look, when you get the final notices finally come through. And look, maybe some of these won't end up in final notices. In some ways, actually, they could be the most interesting cases that you'd want to know more details about. But yeah, what tends to end in final notices are the more extreme or egregious breaches of uh of these sort of principles or outcome-based regulation as the consumer duty is. What would be interesting, and I think helpful for the industry as a whole, is actually, as I say, some of those more um edge cases or ones that don't end up in um published enforcement action and understanding what were the potential concerns there, what did firms just about do right, and some of the guidance that could be issued around that, you know, some of that good practice, bad practice. That helps, I think.
Michael TanSome guidance then for the editor of Enforcement Watch 3 as to what would be helpful. As always, we're happy to give our suggestions, Michael.
Assertive Supervision And VREC Fallout
Michael TanTurning then to uh supervision, what do we learn from the Enforcement Watch 2?
Jon FordLook, so this is a recurring story and one that we have been covering for a while, Michael, in terms of the opportunities and the change in priorities for the FCA in relation to using their supervisory powers. But um I detect a sense of glee as the FCA goes and lists the number of um or examples of supervisory action it's taken. So I think it lists about nine or ten of the 382 interventions they've undertaken. Some of it perhaps one wouldn't uh uh quibble about in terms of you know, there may be issues in relation to, you know, there's been conflicts of interest, for example, on in areas where perhaps the the um FCA wants to intervene quickly to be able to put restrictions on firms, but uh on on other areas, it's uh slightly concerning, I think, in terms of what they call out. So, one example they give is where they had concerns in relation to whether a firm was delivering fair value to um consumers and actively monitoring consumer outcomes. So you've got concerns in relation to those, as I've already said, they can be quite hard things to grapple with as you're implementing the consumer duty. But as a consequence of those concerns, they invited a fund manager to sign up to a VREC, restricting it from accepting new investors or additional investor capital, or launching or managing new funds, or taking fees, or charges and expenses, i.e., doing anything that that uh fund manager would want to do. And surprise, surprise, that firm is now in liquidation. So it just shows you what the um quite uh quite draconian effects can have of those um supervisory interventions and what damage that can do to firms, and therefore the great care you should be having when you're in engagement with the uh regulators, with the FCA in relation to these types of issues. Because actually, if you're gonna have a an alternative between going down a V rank, which potentially makes you go into you know liquidation versus enforcement, you know, all firms would accept enforcement. And the the final thing one should take from all of this is it's not actually an either-or. Um it is pretty clear that of the FCA, and you know, we've seen this on a number of cases that we deal with, that they'll take both um supervisory interventions and assertive intervention, and take enforcement in relation to the to what they can see or that what they are perceiving may be harm that's been caused in the past. So both a forward-looking restrictions and a backward-looking enforcement. So you can have um the worst of both worlds, as it were.
Michael TanI guess what you don't really see in Enforcement Watch 2, although that's not to say it doesn't happen regularly, is how the FCA approach constructive engagement where there isn't the aggressive or assertive use of supervisory tools, but rather they're focused on remediation and helping a firm to get back on the right track.
Jon FordYeah, that's right, Michael. That's certainly not one that is advertised in Enforcement Watch 2, although obviously there are things that the FCA can do in that sphere, and indeed firms would be far more uh welcome of it. But
FRC Expands Audit Resolution Routes
Jon Fordum I think a good segue to our next topic in relation to the Financial Reporting Council's updates to its audit enforcement procedure, which I understand ever does go further than just enforcement.
Eva BarbosaYes, that's right. It's about expanding the Financial Reporting Council, the FRC's offering in terms of its routes to resolution, and it spans um both ends of the spectrum, so supervision and enforcement. To summarise the changes introduced by the audit enforcement procedure. Last um month the uh procedure um and accompanying guidance was published and it's in fact effective from July 2026. And previously, so before this month, we had two routes to resolution available under the FRC's audit enforcement procedure or AEP. Firstly, constructive engagement, which is a remediation-based route to resolution, and secondly, the enforcement investigation under part four of the AEP. With the updates to the AEP, there are now two new additional routes to resolution: the published constructive engagement, or PCE, and the Accelerated Procedure, or AP, and also a new voluntary cooperation mechanism as part of the investigation procedure, which is called the early admissions process, or the AEP, not to be confused with the early account scheme of the PRA, although we'll later draw some parallels.
Michael TanThanks for that, Eva. That's a helpful overview. So, what's the difference between constructive engagement and the new PCE route to resolution?
Eva BarbosaThe substance of the routes are the same. The entry will identify the statutory audit firm, which is a subject of the PCE, and summarise the issue that is subject to PCE. The second uh key difference is that the FRC may announce, by way of a press notice, a matter that has been referred to PCE and the outcome of that matter. So you can see here that the FRC is leveraging the deterrence effect of publication in a route which broadly falls under its supervision tools. The third difference is that the FRC may recover the costs of PCE from statutory auditors and statutory audit firms. Slightly smaller point there.
Jon FordThanks, Eva. So perhaps moving then more onto the enforcement side, Michael, could you give us an overview between the and you know, the distinction between the accelerated procedure and the early admissions process?
Michael TanYeah, of
Accelerated Procedure And Early Admissions
Michael Tancourse, John. So I think really the distinction here is about how much information the FRC feels it has. The accelerated procedure is used where the FRC determines that it has enough information to become to be able to come to a view on what breaches there have been. And it might have got that information through various means. It could have got it through regular reporting, it could have got it through self-reporting, um, it could have used some of its powers to gather some of the information. But the key point is it has the information available to it to be able to come to an early view. It will then put its position to the respondent and say, look, the accelerated procedure is an available route here. Are you willing to accept that our position or not? And the respondent will have the option of saying no, we would rather fight this or go through the investigation process, or saying, no, okay, we're willing to accept your position. Let's enter into settlement discussions immediately. If the FRC feels it doesn't have sufficient information, well, then it goes into traditional investigation mode. The alternative that's now been introduced through the EAP is similar to the PRA EAS scheme. The respondent can indicate to the FRC that it's interested in offering up an early account of what went wrong. That will obviously have advantages to the FRC in being able to speed up its investigation if a fulsome and candid account is provided by the respondent. And that allows for early resolution to the investigation by the respondent offering up various admissions. The key with both of these, the AP and the EAP, is the amount of discount on offer to the respondent if they agree to either of these procedures. The key is up to 60% discount is available if you are using the AP or the EAP with the FRC.
Jon FordSo there can be a significant upside to the firm if they use one of these routes to get to a resolution of the enforcement.
Michael TanThat that's right, John. So it's 25% for cooperation and up to 35% for early settlement. Excellent.
Jon FordAnd so look, what are the overall views from us and from the industry in terms of these new alternative routes?
Michael TanOverwhelmingly positive, I would say. They've been warmly received. Um, I think for a long time the industry felt that the FRC's toolkit was in need of modernisation. Obviously, ARGA was on the cards for what seemed like the longest time ever. That's finally been taken off the table. But this modernization of the toolkit is warmly welcomed. I think there has always been the options of having a supervisory alternative to enforcement, um, not least through constructive engagement. But you can see the FRC has been creative in trying to think of different ways to bring disputes to resolution as quickly as possible.
Jon FordEva, is there anything else that firms should be thinking about in terms of these different routes?
Eva BarbosaYes. Um ultimately firms should think about what's more appropriate for them in the particular circumstances. For instance, with the AEP, firms should be mindful of certain strategic considerations. They'll be expected to make admissions on an open basis and waive legal privilege over potentially adverse material generated during the self-review, which may be subsequently relied on by the FRC if the matters end up proceeding to a full investigation. So firms should think about the risk of follow-on litigation. And there are associated risks with embarking on the AEP when firms do not know the full extent and nature of potential breaches at the outset.
Michael TanAnd I'm guessing similar considerations will apply to the accelerated procedure where you know the firms having to sign up to admissions of breaches outlined by the FRC at an early stage, uh, which clearly will carry a risk of follow-on litigation.
Jon FordThanks, Eva and Michael. That that's really helpful. Um, what do we learn? Regulators love a three-letter uh acronym. But actually, these um changes by the FRC have given firms different options, different routes, but as always, one has to think about the wider context in terms of what is the most beneficial route to try and go down.
Michael TanI think that's right, John. And I I mean a key difference here in the FRC context as compared to financial services is within financial services there are statutory powers that the regulators can use to order um redress or organise or arrange redress, whereas the FRC don't have similar powers. And so the risk of follow-on litigation, you know, is different.
Jon FordYeah. No, no, that is an interesting contrast.
PRA HDI Global Early Account Case
Jon FordWell, Michael, that does take us now back to the financial services regulators and to the PRA, and the latest example of their use of the early account scheme, or should I say a firm's use of the early account scheme by HDI Global.
Michael TanMichael, could you perhaps give us an overview? Yeah, that's that's right, John. So I think the reason why this case is interesting is because you can compare it and contrast it to the UK insurance case, which was the first case that used the EAS scheme, and it gives some guidance and details as to what's required under the EEAS to fully benefit from the settlement discount. So, just some headline points on the facts of the HDI case. Here, the PRA found breaches of Fundamental Rule 2 and Fundamental Rule 6 and imposed a penalty of 4.165 million. And it essentially boiled down to failures by HDI to give correct information when reporting FSCS liabilities to the PRA and when reporting data to the FCA for the purposes of calculating the firm's FSCS levy. That incorrect submission of information persisted over an extensive period of time and continued even after issues with the accuracy of the data were first identified. So just to give you some idea of the kinds of misreporting, in 2023, HDI submitted FSCS liabilities for the year ending 2022 of 20.39 million, when in fact the corrected figure was closer to 200 million. And at least on 11 occasions between February 2022 and June 2024, HDI submitted materially inaccurate figures to the regulators in response to supervisory requests for by the PRA in annual submissions to the SCA and in the course of making further incorrect submissions when it was trying to remediate the figures it had already provided.
Jon FordSo, Michael, it's again an example of operational errors over an extended period of time, and indeed had a significant impact on the sort of information that was being reported to the PRA, that distinction between a 20 million to 200 million, magnitude of 10, obviously quite a different uh difference there. What do we learn from contrasting that with the previous use of the early account scheme by the PRA and what sort of discounts were an offer here and why do they why were they different?
Michael TanYeah, I mean that's that's the key bit of information, isn't it? Why was 50% available to UK insurance? Whereas only 30% was available to HDI. Well, the notice from the PRA make that pretty clear pretty quickly. HDI wasn't eligible for the early account scheme settlement discount because it did not offer up admissions on breaches. It only offered up admissions as the facts. And if you look at the UKI notice, you can see that after it provided its fulsome and candid account, it offered up admissions of breaches and facts. Because HDI didn't do so, the PRA concluded that paragraph 10.40 of its settlement procedure didn't apply. It therefore only qualified for 15% discount at step three, which is the adjustment for any mitigating factors, and the regular 30% discount at step five, which is the application of any applicable reductions for early settlement because it's settled at the discount stage of the investigation process.
Jon FordUnderstood. So there's a they missed, or there may be no strategic reason why they didn't make those emissions in terms of breaches, but because they didn't, they just weren't eligible to qualify for the 50% reduction in fine.
Michael TanThat's right. So they could have got the 15% at step three, as well as a 50% at step five, instead of just the 30% that they got at step five.
Jon FordUnderstood. But I mean, I suppose, nevertheless, there may have been benefits for HDI here in relation to having some control over the investigation and delivering the factual narrative to the regulator, albeit obviously still didn't um warrant for a significant reduction to their fine, or as much as a reduction as they could have done if they'd also offered that up with admissions in relation to breaches.
Michael TanI think that's right, John. You can you can see from the way that the PRA set out its decision making around calculating the penalty that the early account essentially just banked them the 15% under step three. Yeah. Um, and the 30%, they would have got that anyway by making uh by agreeing to settle during the discount stage. I guess, you know, speculating somewhat, but you know, the 50% that was available under the EAS, well, it's up to 50%, there may have been factors here where even if they did make admissions to breaches, they might they may still not have got the full 50%. Um one reason being the fact that it took them over a year having uh after having identified the issue to actually finally correct the position, and only after getting in an independent advisor.
Jon FordUnderstood. Thanks, Michael, and thanks ever.
Why The FCA Lacks Early Accounts
Jon FordI suppose stepping back, um, and as we look at the three different examples here, it shows the different routes that regulators are using, the different powers they may have, or trying to amend procedures that they have to try to give um ways of achieving regulatory outcomes either via enforcement or supervisory uh intervention to achieve what the regulators would say is better outcomes for the market and for consumers overall. And for firms, it also gives them different options in terms of how they can strategically engage with regulators when issues arise as well.
Michael TanI mean, calling out the elephant in the room here, John. The one major gap is why the FCA has not introduced an early account scheme equivalent. The kinds of discounts that are attractive under the EAP and the EAS are significant. Under the EAS, you're looking at up to 57.5% discount. Under the EAP, you're looking up to 60% discount. The FCA offer nothing like that. It's a maximum of 30%.
Eva BarbosaPerhaps one final learning is that despite being in different sectors, regulators can take learnings from each other's approaches.
Jon FordYeah, look, I think that's a really good point, Eva, and thanks, Michael, also, in terms of what um industry and the market as a whole can also uh gain from enforcement outcomes, which tend to give further detail in relation to what has gone wrong, what has been done to fix things. That gives further information to other regulated firms who may, you know, proactively look at their own controls, see what they can do to enhance them. So actually, the overall for the market as a whole, there's a benefit to these types of earlier account schemes or equivalents in terms of the information it uh it gives the market, which you can contrast with the information that is given in something like Enforcement Watch, which, you know, understandably is at a is at a high level, albeit one could say there's a sort of missed opportunity.
Michael TanAnd you can certainly see why the FCA probably is in a position to at least consider these alternative routes to resolution. And a more assertive approach to supervision, by its own admission, is giving it much more information by the time it enters into enforcement. And that's precisely the kinds of circumstances which would lead to an accelerated procedure which has been introduced by the FRC. If they're serious about wanting to drive down the time and resource it takes to undertake enforcement investigations, something like the EAS or EAP is exactly suited to doing that.
Key Takeaways And Closing
Jon FordWell, there you go. We end another episode of the FSR brief with a suggestion for the FCA. We wonder whether they all take it up. Well, one we can uh monitor and report on in the future. Thank you all for joining us, and till next time. See you then.