Banking Reform Act: Issues for litigators

The Financial Services (Banking Reform) Act 2013 (the Act) received Royal Assent on 18 December 2013 and the British government announced that it was "the biggest reform to the UK banking sector in a generation".

Much has been written about the introduction of the ringfence that will separate retail banking from investment banking, the bail-in tool and the creation of a new regulator for the payments system, but what does the Act mean for litigators and those with a contentious regulatory practice?

New regime for senior managers

The Parliamentary Commission on Banking Standards (PCBS) recommended a new senior persons regime to replace the Significant Influence Function element of the Approved Persons Regime. The PCBS identified two key purposes for creating the new regime: first, to encourage greater clarity of responsibilities and improved corporate governance within banks; and, secondly, to establish beyond doubt individual responsibility in order to provide a sound basis for the regulators to impose remedial requirements or to take enforcement action where serious problems occur.

Key features of the new regime

The Senior Managers Regime will apply to UK banks, building societies, credit unions and PRA-regulated investment firms who have permission to deal as principal.

Reverse burden of proof

The reversal of the burden of proof, as set out in the new ss66A(6) and 66B(6) of the Financial Services and Markets Act 2000 (FSMA), is one of the more controversial provisions in the Act. The new provision provides that a person who was a senior manager in relation to a relevant authorised person at the time of the contravention occurring or continuing, and was responsible for the management of any of the authorised person's activities in relation to the contravention, is not guilty of misconduct if he satisfies the Financial Conduct Authority (FCA) or Prudential Regulation Authority (PRA) that he has taken such steps as a person in his position could reasonably have been expected to take to avoid the contravention occurring or continuing. As such it is for the person accused of misconduct to prove that he is not guilty of misconduct; the burden of proof is not on the FCA or PRA. This could lead to the FCA commencing significantly more cases against senior managers given that this reversal could potentially mean that much less of the FCA's resource will be required at the outset of the investigation.

Additional responsibility on senior managers

There will be mandatory statements of responsibility for senior managers to specify more clearly the areas of the business they have oversight of. This will assist the FCA in identifying to a greater extent the individual(s) with responsibility for the relevant parts of a firm where failings have been identified. There will also be provision for time-limited/conditional approvals of senior bankers, and regulators will be able to make conduct rules for senior managers.

Not just senior managers

A significant change under the Act is to expand the FCA's remit beyond approved persons to include employees of "relevant authorised persons". A "relevant authorised person" is defined as a deposit-taking institution, or an investment firm which deals in investments as principal and carries out activity regulated by the PRA. This is a fundamental change to the existing regime and could lead to enforcement action against a much larger group of individuals. The FCA has stated that it intends to issue a consultation on the scope of this change and the senior managers regime later this year.

Limitation period extended

Another key change is the extension of the limitation period from three years to six years during which the FCA or PRA can impose a penalty on someone who has performed a controlled function without approval.

New criminal offence

During a House of Commons debate on 11 December 2013, the Financial Secretary to the Treasury set out the rationale behind introducing a new criminal offence relating to a decision which causes a UK financial institution to fail.

He said: "The introduction of this offence means that…those who bring down their bank by making thoroughly unreasonable decisions can be held accountable for their actions…In line with the commission's recommendations, the new offence will be applicable only to individuals who are covered by the senior managers regime…The maximum sentence for the new offence will be seven years in prison and/or an unlimited fine. That reflects the seriousness that the Government and society more broadly, places on ensuring that our financial institutions are managed in a way that does not recklessly endanger the economy or the public purse".

The offence

A person commits an offence if, at a time when he is a senior manager in relation to a UK financial institution (broadly banks and building societies, but not insurers or credit unions):

he takes (or agrees to the taking of) a decision by or on behalf of that financial institution as to the way in which it (or a member within its group) conducts business or fails to take such steps as he could have done to prevent that decision being taken;
he is aware, at the time the decision is made, of a risk that the implementation of the decision may cause the financial institution (or a member of its group) to fail;
he behaves, in all the circumstances, in a way that falls far below what could reasonably be expected of a person in his position in relation to the taking of the decision; and
the implementation of the decision causes the failure of the financial institution (or that of a member of its group).

Note that the offence requires actual knowledge of the risk – it will not be sufficient that the manager in question ought to have known of such a risk.

The penalty

Nevertheless, the stakes are high. A person convicted of this offence is liable:

on summary conviction (in England and Wales), to imprisonment for a term not exceeding 12 months (or six months if the offence was committed before the commencement of s154(1) of the Criminal Justice Act 2003), or a fine, or both; and
on indictment, to imprisonment for a term not exceeding seven years, or a fine, or both.

Comment

The changes summarised above will have a fundamental impact on senior managers and on a much wider group of employees who have previously not fallen under the scrutiny of the regulator. The new regime for senior managers and the new criminal offence are expected to be implemented in mid-2015. The FCA and PRA will refine how the senior managers regime will take shape throughout the course of this year. Although we await the details of these, enforcement cases are likely to be brought against individuals more frequently and with a higher success rate.