Enforcing legislation in a complex financial environment
29 June 2016
I recently returned to NZ from a long stint in the UK, having most recently come from what many might say is the dark side - an Investment Bank that certainly had its fair share of conduct issues and enforcement actions. In Auckland, it feels very different and yet very similar in that many of the issues that we grapple with are the same issues facing other jurisdictions.
The title that I was given to talk to you today about is “Enforcing legislation in a complex financial environment”. I thought it interesting the way that title is phrased – ‘Enforcing Legislation in a Complex Financial Environment’ – I am sure that you are all very interested in how we at the FMA enforce legislation, but I hope that you are even more interested in how you might ‘Comply with Legislation in a Complex Financial Environment’. No doubt some of the other speakers will offer their thoughts on this, but it is perhaps a good place for me to start today, with a few opening comments.
The FMA is of course an enforcement agency. We have a clear enforcement mandate, and we have dedicated enforcement resources, both in terms of people and funding. One of the teams that I oversee is staffed by litigators and dedicated to the appropriate deployment of our enforcement capabilities. However, to state the obvious, Compliance negates enforcement, and it is far better for all concerned that there is a focus on compliance rather than enforcement - ideally you’re dealing with our supervision teams rather than interacting with the investigators and enforcement lawyers. And when I say compliance here, I mean outcomes for customers rather than a tick box approach.
So what will we be looking for?
Conduct is what the FMC Act says on the tin, and it follows that we will be very interested in any conduct that is a threat to markets operating fairly, efficiently or transparently. Such behaviour directly impacts the confident and informed participation of businesses, investors and consumers in our markets.
Our main focus is ensuring that regulated businesses and individuals:
- Are demonstrably delivering the outcomes their customers want and expect;
- Have designed processes, systems and governance with that goal in mind;
- Can clearly articulate and evidence that there is an appropriate alignment of customer and business interests; and
- Are appropriately disclosing to investors and the public what is required to meet their regulatory obligations.
If firms aren’t able to demonstrate that they are doing these things, and if we are concerned that such firms don’t have customers’ interests at the centre of their thinking, we’ll regard them as posing a higher potential risk, with a greater potential for causing customer detriment. It follows that we will pay more attention to that firm.
Demonstrating compliance with black letter law is necessary, and presents a minimum baseline. But experience tells us that achieving good conduct, or good outcomes, is not done simply by creating and seeking compliance with detailed legislation, or indeed detailed internal compliance policies.
What happens in a highly prescriptive, highly rules based environment, is that people refer and then defer to the rules, and often take a view that is it isn’t specifically prohibited, it must be ok. Put bluntly, people stop thinking for themselves and abdicate responsibility for their decisions. For example if it isn’t a conflict that is identified in a conflict policy it must be ok. And of course you can never legislate for every particular circumstance or situation.
Nor is it appropriate to think that senior management, compliance and risk departments, or indeed the FMA as a regulator can or should be omnipresent. Ultimately, individuals make decisions, influenced by the environment they inhabit. We need to create an environment where - faced with a choice - individuals make the right decision.
So whilst firms and individuals might start by asking whether they ‘can’ do something (i.e. is it ‘legal’), that shouldn‘t be the be all and end all. They should also ask themselves whether they ‘should’ be undertaking a particular course of action. Part of a conduct orientated philosophy involves this shift from “Can we” to “Should we”. And this is also where culture comes in – because part of what culture is, is what you do when there are no rules to guide you. It’s the stuff that happens when no-one is looking. It’s your default position – it’s a set of practices, beliefs, even biases that drive our decisions and actions.
The message here is that in order to comply rather than be faced with potential enforcement, get conduct and culture right. And a comment here to the legal practitioners in the room, unfortunately the enthusiasm with which lawyers have facilitated or even driven the exploitation of loopholes and technicalities in legislative drafting was apparent during the GFC. This did the industry and the legal profession no credit. I can’t personally comment on the practises in NZ at that time, but it was certainly prevalent in London and New York.
I think we have been pretty clear and consistent on this, but it is worth reiterating, that the FMA does not prescribe culture. We are not the culture police. A firm sets its own culture – we think that culture is set and influenced by the tone from the top, but we are also cognisant that people’s role models are not necessarily the CEO or the Chairman.
Their role models may be their line managers, team leaders, and successful colleagues. Employees will judge the firm’s values by who they see rewarded – whether financially, or in terms of reputation or promotion. They’ll also look to see what is tolerated, what people turn a blind eye to.
Strategic priorities
Changing tack a bit, the FMA’s Strategic Priorities drives our decision making process. We are constantly thinking about whether and how something connects to these priorities. If you want to look at something through our eyes – then have this in mind. These are the areas that we are interested in: Capital market growth and integrity; Sales and Advice; Investor Decision Making; Effective Frontline Regulators; FMA Efficiency and Effectiveness; Conflicted Conduct; and Governance and Culture.
In situations where our expectations in these areas are not met, we are more likely to feel justified in expending resource.
As I mentioned earlier, we have a law enforcement capability within the regulator – we can execute search warrants, we can bring civil or criminal proceedings. We can also utilise softer tools – warnings, administration orders and the like.
Our tools range from what we term regulatory and legislative tools, through to more traditional enforcement tools. We think that all of these tools are valuable in encouraging compliance with regulatory or legislative requirements. As I’ve mentioned, we have specific litigation funding and a team of feisty litigators that like nothing better than a good old knock about in the courts. The public (and therefore the media) like to see a bit of blood in the streets every now and then – quite understandably they want a regulator with teeth who’s not afraid to get into a scrap. However enforcement via the courts is not necessarily where we, or presumably you and your clients, want to be.
That is not to say we will shy away from enforcement through the courts if this is necessary. Sometimes litigation will be the best deterrent, it may offer the best form of punishment, and be the appropriate way of obtaining compensation for victims. In such circumstances, it may well represent the best way of achieving our regulatory objectives. But it is just one of the available tools.
Tools available to us
Administrative Orders - These include Stop Orders, Prohibition Orders and Infringement Notices. These can be used without an order from the court. Direction Orders - You may have seen that we recently issued our first Direction Order under the FMC Act. We ordered an FX educator (and I use that term lightly) to change its marketing material and provide a copy of the direction order to its clients. This type of tool can be used when we are satisfied that a person or company has breached, or is likely to breach, certain provisions of the FMC Act.
- Stop Order - We can issue Stop Orders in a variety of circumstances such as Distribution of offer documents; Acceptance of monies; Supply of Financial Services; and Distribution of any offer communication or advertisement.
- Infringement Notices - these are a mechanism to punish offences by requiring payment of an infringement fee. Carrying a maximum fine of up to $50K these provide a quick and effective deterrent to non-compliance.
- Enforceable Undertakings - entering into enforceable undertakings can include undertakings to pay compensation to any person, or pay an amount to the FMA in lieu of a pecuniary penalty. We’ve used enforceable undertakings in a variety of circumstances – to stop an individual providing advice, receiving money, and as part of the settlements reached with respect to interest rate swaps.
- Court Ordered administrative actions - These tools enable us to apply to the Courts for a variety of Orders, including to remedy problems with debt security or registered schemes, Banning Orders (directors/promoters), injunctions and asset protection orders.
We also have step in rights under s34, and of course a range of criminal and civil liability orders.
It’s not my intention today to take you through all of these tools in detail, but rather to highlight that there is a range of ways in which we can respond to particular circumstances – a range of options for enforcing legislation in this complex financial environment.
The role of enforcement
Enforcement is just one of the ways in which we regulate, and how we decide to intervene depends upon a range of factors. Escalating levels of liability are available to ensure that the response is proportionate to the contravention. I emphasise again, that it is when compliance fails and when the risk of harm to consumers or markets hit elevated levels, that enforcement action comes into play.
So what’s the process? How does a matter end up in Enforcement?
FMA investigations
Matters can come to our attention through a variety of channels, including internal FMA teams; Frontline regulators; members of the public/investors/participants; legal advisers; other government agencies such as Police, SFO, ComCom, Reserve Bank and Treasury.
We will make initial inquiries to evaluate whether a matter warrants investigation – considering conduct and whether a lesser form of intervention could deal with conduct, FMA strategic priorities, FMA resources and the likely scope and complexity.
After weighing up those matters, we’ll decide whether to formally investigate. If so we will then:
- Gather evidence – including compelling information under s25
- Evaluate evidence
- Assess whether there are reasonable grounds to believe contravention.
I know that many of you are familiar with the FMA’s s25 information gathering powers. These are very broad powers to require documents and information, require persons to give evidence orally or in writing. It is an offence not to comply, carrying a maximum fine of $300,000.
Appreciate significance - We recognise that our notices are a powerful tool, they’re a statutory notice with criminal consequences for non-compliance. They are not used lightly and we have robust processes in place around our decision making to use these tools. We expect them to be treated seriously.
Privilege – We are aware that privilege may exist in material requested – if this is the case talk to us about ways to protect that information and observe confidentiality.
Interviews - Section 25 notices will typically set out the following information (same for suspects and witnesses):
- Right to be accompanied by a lawyer at the interview
- General purpose of the interview
- General factual subject matter
- We will generally attempt to engage with regards to suitability of dates and timing, and offer flexibility where possible. We will take action for non-compliance where appropriate.
Questions in advance / further disclosure -There is no requirement for the FMA to set out a full list of the questions to be asked in advance of the interview, nor is there a requirement to provide further disclosure of the case against a suspect. Indeed doing this may affect the integrity of the investigation process.
However, the FMA invites interviewees and their lawyers to engage with us in relation to information that will assist the interview to operate more effectively. If we are in a position to provide information without prejudicing the investigation process, then we will consider doing so.
Talk to us
We are open to conversations about how we use our powers, and we encourage you or your clients to engage with us early if you have queries.
To assist us, we expect market participants to comply with notices we issue, and to provide information to us in an accessible and orderly fashion. We have seen responses to section 25 notices where the information provided is incomplete, scrambled and/or difficult to access. This inevitably adds time and cost to the investigation process, and can result in delays as further resources must be dedicated to deciphering the response.
To the extent that your clients wish to provide clarification or context, or indeed to point us to any particularly relevant documents included in a response, we encourage you to do so.
Confidentiality Orders - The confidentiality of our investigations is very important to the FMA and we don’t issue as a matter of course, but think about the appropriateness in each case.
The reasons we use Confidentiality Orders is to protect the integrity of the interview process, as people can’t share either the information they gave during an interview or the questions they were asked in the interview to others in order to ‘get the story straight’. They also provide a protection for those who are the subject of the interview, as there is a legal basis for resisting the inquiries of employers or other parties (including subsequent interviewees) who may ask for information.
Also protect the companies concerned – against information getting into the market that could be damaging to reputation. Again, we are happy to engage and discuss the nature and scope of confidentiality orders.
Search Warrants – are a tool that we can and do exercise.
So how do we decide what action to take?
Enforcement documentation
We’ll shortly be updating a suite of enforcement related documents, which we hope will encourage and facilitate greater awareness of the tools available to us and how we go about using them. These include Model Litigant Policy, Crown Law’s Prosecution Guidelines and, in more detail, the following:
Regulatory Response Guidelines - We will shortly be publishing our Regulatory Response Guidelines, which describe our approach to conduct that contravenes the regulatory regime. The Guidelines outline our response options, and the factors that we may take into account when deciding on an appropriate regulatory response.
As a risk based regulator, we focus our resources on conduct that we think poses the most significant risk to achieving our objectives. And we want to proactive, with the timely and proportionate use of appropriate regulatory tools. To achieve this we need to:
- Consider the benefit and burden of our proposed approach, so that we apply a proportionate response that will most effectively address the problem,
- Work in a fair, consistent and transparent manner with participants
The criteria we’ll consider when determining the appropriate response include, amongst other things:
- Consideration of our Strategic Priorities
- Seriousness of the Conduct for example.
- Market Impact or Detriment
- Public Interest
- Deterrence
- Education
- Maintenance of law/justice
- Compensation - Is compensation appropriate and what outcome best achieves that.
Co-operation Policy - Our co-operation Policy will outline the circumstances in which the FMA might exercise its discretion to take a lower level regulatory response or no action at all, against an individual or business in exchange for information and full, continuing and complete co-operation. On brief note here –co-operation does not equal fulfilling your legal or regulatory obligations. Complying with a s25 notice, for example, is not co-operation in that sense.
Enforcement Policy - The Regulatory Response Guidelines will be supplemented by our Enforcement Policy, which sets out our approach to enforcement, including commentary on the publication of enforcement actions, our approach to the use of criminal powers – which are reserved for the most egregious and serious misconduct.
I should also mention that clarification of the law can be an important factor in determining whether issuing proceedings is appropriate - it may be necessary for us to test the boundaries of the law for the overall benefit of all market participants. Accordingly, we may take "grey area" cases in order to provide clarity to the market.
Use of s34 powers - this is the power to stand in the shoes of another and exercise that person’s rights to take action against a third party. I understand that this power was the subject of many submissions during consultation on the draft legislation. However, Parliament chose to maintain it to give us the ability to pursue actions that for various reasons others may not be able to.
As such, we will use these powers in accordance with Parliament's intention as and when the appropriate cases present themselves.
Matters we are unlikely to enforce
No doubt you may be interested in those situations where we might not take enforcement action.
We will not enforce every breach that comes to our attention. Given the factors that I’ve mentioned, as you’d expect we are less likely to pursue enforcement where this is not justified in the public interest, is unlikely to further our statutory and strategic objectives, or where there are opportunities for more effective intervention.
We’re less likely to pursue matters that are one-off, isolated, or minor events relating to technical error or similar issues, particularly where these are self-identified and self-reported.
Approach to resolution
When we think about resolution we will always be guided by our regulatory objectives – what are we seeking to achieve and how do we go about doing that? Often, our regulatory objectives might be met by a non-litigation outcome - I’ve already mentioned the range of regulatory tools that we have at our disposal. Revisiting a couple of those now, Enforceable Undertakings, Compensation and Warnings for example, might be part of any resolution.
Some general observations
I looked at the likely attendees for this event and saw that it is predominantly lawyers, either in private practise, or in-house. As such it seemed like a very opportune time for me to address a good chuck of the practitioners that operate in this field.
It is no surprise that as we have all adapted to the new legislative and regulatory regime, lawyers have had a very important role to play, in interpreting new legislation, and advising as to compliance with regulatory obligation and engaging with the regulator on matters requiring clarification. At the FMA we are very aware of the critical role that lawyers play in influencing and shaping our financial services industry. We’re aware that it is often through you that we are able to engage with market participants. So you are important stakeholders for us. Certainly I see it as an important part of my role to foster that engagement and interaction between us.
Of course often we will disagree, and I am sure that we are probably in active disagreement with a number of you in this room. There is nothing wrong with that. However, I hope that your experience is that in those circumstances where we will have to agree to disagree, the FMA remains open to engagement, open to discussion and often works with you to find solutions together. And that is a core strength here in the NZ market – we are small enough that it is relatively easy to get access to decision makers, and most of us know each other.
And with that in mind, I hope you don’t mind if I share with you some of the things that made an early impression on me since I assumed this role.
Perhaps because the regime is so new, and consequently lawyers are often involved in matters, there is a danger that we can end up taking an overly legalistic approach, particularly when we have disagreements. It struck me how quickly conversations here turn to a discussion about legislation, provisions and interpretation.
Often, very little time is spent seeking to understand and address the underlying issue that the FMA are concerned about. The parties quickly turn to a legalistic discussion about duties, responsibilities or what powers the FMA may or may not have, rather than about the actual matter that has given rise to FMA’s discomfort in the first place.
So we seem to ‘lawyer up’ very quickly, which may be beneficial to the private practitioners involved, but perhaps not so much for the institution. How regulated firms react to these situations plays into how we decide to conduct what could quickly become a pointy conversation. This is often driven by advisers.
Abroad things are a little different – far less time is spent arguing about which provision might apply, rather there is a focus on understanding why a regulator might take a dim view of some particular conduct or action, and seeking to address that underlying matter.
As tempting as it may be for lawyers to revert to type, reach for the statute book and prepare for an argument, I fear sometimes this may be doing your clients a dis-service. To be crystal clear on this – how firms engage and interact with us does make a difference. Often firms will take advice from their lawyers on precisely that – and hence the importance of the role you have to play.
More often than not, an open discussion with us about the underlying matter will be far more productive for all. Certainly it is recognised overseas that the days of seeking to thread the eye of the needle in terms of what is lawful, with sharp practices or innovative legal arguments or interpretations, those days are gone – of course you need to understand the legal and regulatory environment that you operate in - but most of the businesses abroad don’t want to be constantly skirting the line, they wanted to be well inside the line.
So perhaps the most valuable advice that you could give to your clients, or to your executives, might be to ensure that you think about our regulatory priorities (we discussed these earlier), think about the matter that has given rise to the query or intervention from the FMA, and engage with the FMA about the underlying issue, rather than seek to immediately question the legal basis of our interest. In that respect, legal advisors have a very important role to play in transitioning to a conduct orientated regime.
I appreciate that taking such an approach requires some trust and confidence in the FMA that we will treat participants fairly and proportionally.
I also know that this is different to the traditional role of a lawyer – interpreting and advising on the application of the law – but it would seem to me that the best lawyers have always played a far bigger role than merely advising as to the strict interpretation of the law – they think strategically and commercially, and advise accordingly.
That skill will be an incredibly valuable asset in a conduct focused regulatory world, and at the FMA we would certainly welcome engagement with legal professionals in this manner – and I hope that we can continue to work together to promote and facilitate fair, efficient and transparent financial markets.
Thank you.
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