Senior Managers and Certification Regime: the first year in practice
7 March 2017 marked the first anniversary of the UK Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) Senior Managers and Certification Regime (the SMCR). This article examines how firms have managed some of the challenges introduced by the SMCR.
Conduct and performance issues
A key driving force behind the SMCR is reinforcing firms’ responsibilities when it comes to individual accountability. Over the last year, firms have been turned into mini-regulators with responsibility for assessing the fitness and propriety of employees falling within the Certification Regime on at least an annual basis. Firms have also been reminded that they must ensure that their candidates for Senior Manager roles have been assessed as being fit and proper before their applications for approval are submitted to the FCA or the PRA.
Fitness and propriety are not new concepts for regulated firms. However, many firms have found that taking the lead in assessing fitness and propriety in practice has proved more challenging than they expected. For example, firms have had to adapt their existing recruitment, promotion, appraisal, disciplinary and remuneration processes in order to incorporate formal fitness and propriety assessments.
There is no one-size-fits-all approach in this area. However, a number of firms have established panels to oversee conduct and performance issues that require consideration to be given as to whether an employee is fit and proper, and whether he or she has breached the regulators’ Codes of Conduct (the Conduct Rules). These panels help to ensure that the appropriate degree of regulatory context is taken into account when considering these questions.
The last year has not proved straightforward, even for firms that established robust processes for assessing fitness and propriety and breaches of the Conduct Rules.
In some cases, firms have been confident when concluding whether issues meant that employees were no longer fit and proper or had breached the Conduct Rules. However, a number of other instances have been less clear-cut. There is a significant grey area in this area, especially where conduct may have been, for example, inadvertent, due to a lack of training, a one-off incident, or characterised as more of a performance issue rather than misconduct.
A decision that an employee has breached the Conduct Rules triggers a range of reporting obligations that must be undertaken by the firm within specified time limits. The same applies to any change to the ‘fit and proper’ status of a Senior Manager. None of these reporting obligations removes or alters firms’ self-reporting obligations under FCA Principle 11 or PRA Fundamental Rule 7.
However, regulatory references are a specific form of reporting obligation that have captured firms’ attention over the past few months. Regulatory references are not a new invention. However, more detailed rules relating to regulatory references came into force on 7 March 2017. These new rules require firms to confirm, among other things, if an employee, who is taking up a role falling within the SMCR at another firm, has been found not to be fit and proper or if disciplinary action has been taken against the employee for not being fit and proper or for breaching the Conduct Rules. Firms will also be required to include any other information that may be relevant to the assessment of an employee’s fitness and propriety. Firms are now to update regulatory references (if provided after 7 March 2017) if anything subsequently comes to light that alters the substance of the original reference. As a result, new-style regulatory references mean that the stakes are much higher when it comes to firms’ decisions about whether employees are fit and proper or whether they have breached the Conduct Rules. These decisions can follow an individual around through a regulatory reference for up to six years, or indefinitely if they concern serious matters.
Risk of employee claims
Unsurprisingly, firms have not taken lightly their responsibilities when it comes to making assessments in relation to fitness and propriety and Conduct Rule breaches. Not only do firms wish to avoid unnecessarily harming the future career prospects of an employee by giving an impaired regulatory reference, they are also mindful of the possible raft of employment claims from disgruntled former employees who receive impaired references. These could include claims for post-termination victimisation, negligent misstatement or career losses totalling very significant sums. In order to mitigate the risk of these claims, most firms will offer employees or former employees the right to reply to the substance of any qualifications that they propose to include in original and updated regulatory references.
Despite these risks, firms need to remain aware of the letter and spirit of the new regulatory reference rules. The government and the regulators have made it clear that firms hold the key when it comes to helping to stop people who are not fit and proper moving around the industry from firm to firm, and that regulatory references are the means by which firms can do this. Firms’ processes for gathering the information for regulatory references will need to be suitably thorough, including when responsibility for compiling references is outsourced to other group entities or third party firms.
The vast majority of regulatory references given by firms under the new rules will be non contentious. However, firms need to think long and hard about the smaller number of impaired regulatory references that they will have to provide. Likewise, those with responsibility for handling litigation, investigations, grievances and complaints must be alert to the possibility that issues arising in relation to the conduct or performance of former employees may trigger the need for previous regulatory references to be updated.
Last year saw a significant drop in the levels of financial penalties imposed by the FCA, from just over GBP 905.2 million in 2015 to just over GBP 22.2 million in 2016. The FCA has been keen to emphasise that this is not a sign that the FCA has gone soft, but rather that it represents a shift in enforcement dynamic as a result of the start of the SMCR in March 2016.
The FCA clearly remains committed to its long-standing objective of holding individuals to account. While the SMCR does not give the FCA any new tools to make enforcement action against individuals easier, the FCA is likely to treat enforcement against individuals as a priority, rather than an afterthought, as has sometimes been the case. However, more enforcement action against individuals is likely to result in more FCA decisions being contested and referred to the Regulatory Decisions Committee and the Upper Tribunal. Under new rules that came into force on 1 March 2017, individuals are permitted to refer a proposed FCA enforcement decision straight to the Upper Tribunal, without first going through the FCA’s usual enforcement settlement process. This dynamic may also affect firms’ willingness to settle their own FCA enforcement investigations, especially if parallel investigations into their Senior Managers remain on-going.
The FCA and the PRA may choose to take enforcement action against Senior Managers, Certified Persons and those who will be subject to the Conduct Rules from 7 March 2017 in some circumstances. However, this will not always be the case. The SMCR requires firms to take responsibility for tackling employee conduct issues. In particular, firms must assess and, where necessary, report breaches of the Conduct Rules committed by their employees, as well as findings that any of their Senior Managers or Certified Persons are not fit and proper to perform their roles.
The first year of the SMCR being in force may not have been straightforward for some firms. However, there were always going to be teething issues as firms’ processes and policies bedded down. Market standards are continuing to emerge in relation to how the SMCR operates in practice and, as new issues arise, those policies and processes will continue to be tested.
This case summary is part of the Allen & Overy Legal & Regulatory Risk Note, a quarterly publication. For more information please contact Karen Birch – email@example.com, or tel +44 20 3088 3710.