The Calm Before the Storm?

Things have been quiet of late on the Connaught front. Back in July we all heard that the FCA offered to mediate negotiations between ‘the parties involved’; it subsequently emerged that the regulator had set a deadline of 31 October for agreement to be reached. Since then, we’ve heard nothing.

While we await the outcome of that process, one of the Action Group’s UK representatives has been asked to contribute to a paper about the FCA, produced by the Bully Banks pressure group. Bully Banks represents the directors and shareholders of small and medium-sized businesses (SMEs) that have fallen victim to bank mis-selling. To date it has been concerned principally with getting justice for those mis-sold interest rate hedging products, known as ‘swaps’, by the major High Street banks.

Bully Banks and the Action Group have a lot in common: both represent victims of misconduct by large regulated firms and are hoping that the FCA will achieve redress for them. Both harbor concerns that their losses would not have been incurred in the first place if the FCA had been on the ball, and fear that the FCA is, on occasion, inclined to protect the big players in the industry from their customers, when in fact it should be doing the opposite.

In short, we are both worried that the FCA, and its predecessor the FSA, may have fallen victim of regulatory capture. In Bully Banks’ case, witness the way in which mis-selling of swaps continued for years with little or no attempt to stop it, the banks’ series of successes in lobbying the regulator to water down and delay the eventual redress scheme, and the departures of senior figures involved in the scheme’s implementation to well-paid roles in the banks that were among the worst offenders.

Connaught investors, too, have grave concerns. Why was Capita Financial Managers allowed to continue to look after billions of pounds worth of funds when its systems and procedures were known to be so flawed following the discovery of huge losses in the Arch Cru funds? Why was it not made to strengthen its balance sheet, or increase its insurance cover, so it would have the capacity to meet future claims? What did the FSA know about Capita’s concerns about the Fund when it handed over the operator role to Blue Gate? Why did it not call in the police after George Patellis blew the whistle in January 2011?

Why, when investors finally became aware of what had happened in 2012 and started contacting their MPs and the relevant Ministers, did the FCA spend the next 12 months systematically mis-briefing politicians about its actions in relation to the Fund, the cause of investors’ losses and its capacity to achieve resolution? And why has nothing yet been done about the fact that Capita’s half-year results, issued the week after the negotiations were announced, contained forward-looking statements suggesting that everything looked rosy, whereas in fact we know the company faces a payout that could result in the suspension of its dividend? Policing the transparency of quoted companies’ announcements to the market is also the responsibility of the FCA.

Regulatory capture is only one possible explanation; there may be others, and we stress it is possible that the FCA is a robust and effective regulator that is not inappropriately close to to Capita and the banks – the organisations, coincidentally, who fund the supervisory body by means of a mandatory levy.

But it can do no harm for victims of financial services misconduct to compare notes and provide the regulator, and the politicians who ultimately created the organisation and the law it is responsible for enforcing, with constructive criticism and helpful suggestions on how regulation can be improved.

In this spirit, we and Bully Banks have jointly produced a discussion paper covering how the FCA might better protect itself from the risk of regulatory capture; it can be viewed here. If you have any suggestions on anything we’ve missed or ways the document might be improved, please email us.

As you would expect, we have gathered an extensive dossier on how the FSA/FCA has conducted itself in relation to the Fund. Even if the current negotiations result in our losses being made good by the firm whose spectacular negligence and extensive systemic failures made them possible, and whose senior management knew about the Fund’s failings but chose to conceal them from us, or if the FCA achieves the same goal by issuing a restitution order, we recognise that we have an obligation to work constructively with the team currently leading the regulator, to ensure that similar problems cannot happen in the future.

In the event that the current process results in a similar fudge to the Arch Cru redress scheme (a token contribution from Capita) and the swaps one (less than a third of the earmarked money paid out to date) or if the regulator refuses to engage with us to reform itself, the collaborative approach will have to be replaced with a more confrontational one. In that eventuality, our plan is to hand the dossier to the media and politicians and ask them to replace the FCA with a new organisation, with a different remit, governance regime and senior team. Given the length of the charge sheet, we would be surprised if the organisation survived in its current form, so our role would be to work with politicians to design the replacement regulator and consult on the kinds of people that should be in positions of influence within it.

We hope that we and Bully Banks are worrying unnecessarily about the FCA having been captured by vested interests. The negotiations currently underway will serve as a litmus test of its good faith, and the respect or contempt in which it is held by Capita. If the FCA threatens Capita with removal of permissions from every regulated subsidiary – a prudent step, given that they all share a common parent that was willing to conceal evidence of serious wrongdoing from investors, leave a subsidiary chronically undercapitalised and uninsured and publicly threaten to tip it into administration if faced with a restitution order – and if the Capita realises it will go through with the threat, we will get what we want. And what would Capita get it return? Perhaps the right to sell those subsidiaries, rather than have to close them down; possibly even the right to continue trading them, albeit with stronger balance sheets and insurance and very much closer supervision.

But even if the ugly rumours about regulatory capture are well founded, we would like to think that the organisational instinct in favor of self-preservation will trump the desire to protect its client group in the industry, Capita included, and that the regulator will therefore ensure that Capita pays up, if only to save the FCA’s institutional skin.

More news as we have it!