On 18 December 2014, HM Treasury published a final report following the review that it has undertaken of enforcement decision-making processes at the FCA and the PRA.

Although the final report indicates that "there seems to be no desire for fundamental reform" of the FCA and PRA's enforcement processes, it does set out a number of recommendations as to how these processes may be improved. Overall, these recommendations appear to be helpful and are designed to encourage the FCA and the PRA to be more transparent in their enforcement decision-making processes.

However, the way in which HM Treasury has drafted its recommendations allows the FCA and the PRA a great deal of flexibility in terms of how they address and implement them. As a result, the way in which the FCA and the PRA implement HM Treasury's recommendations will determine how helpful they prove to be in practice.

On 6 May 2014, the Chancellor of the Exchequer announced that HM Treasury would undertake a review of the enforcement decision-making processes followed by the FCA and the PRA. The purpose of this review was to consider whether the institutional arrangements and processes that the FCA and the PRA have in place in relation to their enforcement processes strike an appropriate balance between fairness, transparency and efficiency. As a preliminary step, HM Treasury issued a call for evidence (which is similar to a consultation process). As part of this call for evidence, HM Treasury invited interested parties to provide responses to a number of questions about the enforcement processes followed by the FCA and the PRA. Responses to these questions had to be submitted by 4 July 2014.

HM Treasury’s final report

On 18 December 2014, having considered the information received in response to the call for evidence, HM Treasury published its final report entitled "Review of enforcement decision-making at the financial services regulators: final report". The final report sets out HM Treasury's findings in relation to the FCA and PRA enforcement processes, as well as 39 recommendations as to how these processes may be improved. These findings and recommendations are split into the following categories:

• Referring cases to enforcement.
• Co-operation between the FCA and the PRA.
• Subjects’ understanding of FCA and PRA enforcement investigations and the ability to make representations.
• The settlement process.
• Decision-making in contested enforcement cases.

In addition to the recommendations made, the final report contains a number of references to the FCA’s proposed review of its penalties policy, which is due to commence in early 2015.

HM Treasury’s findings and recommendations

HM Treasury's final report sets out 39 recommendations as to how the enforcement processes followed by the FCA and the PRA may be improved. In addition to this, the final report also sets out a considerable amount of commentary as to the rationale for these recommendations. Each of the areas considered by HM Treasury in its final report are set out below, along with an overview of HM Treasury's findings and recommendations.

Referring cases to enforcement

HM Treasury acknowledged that deciding which cases are selected for referral to FCA and PRA Enforcement is an important process, especially given that the FCA and the PRA have limited resources and cannot investigate all matters which are brought to their attention. Various responses to HM Treasury's call for evidence suggested that there is a "sense of arbitrariness or unfairness on the part of subjects about case selection by the FCA". This is by no means a new sentiment: the FSA's Enforcement Process Review in 2005 noted that "The combination of more resources being devoted to priority areas and the application to enforcement of the FSA’s risk based approach may give rise to an external perception of unfairness or rough justice."

As part of the current review, HM Treasury has considered how best to ensure that the arrangements by the FCA and the PRA lead to the "right" case selection decisions to be made. As a result, HM Treasury's recommendations on this topic are intended to "optimise the use of enforcement to safeguard consumers and markets, and to provide assurances to subjects, as far as possible, that the wide discretion afforded to the regulators is exercised appropriately". HM Treasury's recommendations regarding referring cases to enforcement may be summarised as follows:

• The purposes of enforcement action (HM Treasury Recommendations 1 and 2). The FCA and the PRA should each publish referral criteria which explicitly consider whether an enforcement investigation, as opposed to an alternative regulatory response, is the right course of action in the circumstances. In addition, HM Treasury recommended that the FCA should provide further examples of cases where a firm's response to a breach of regulatory requirements has been a factor in deciding not to take enforcement action against it.

• Identifying the "right" regulatory response (HM Treasury Recommendations (3, 4 and 5). In order to help ensure that the "right" decisions are taken about when to begin investigations and when to use supervisory tools, HM Treasury said that the FCA and PRA referral decision-making frameworks should promote consideration of alternative regulatory responses. Matters should only be referred to enforcement where that is considered to be the appropriate regulatory response and consistency of approach to referral decision-making by each regulator. HM Treasury also recognised that identifying the "right" regulatory response to an issue requires a range of expert enforcement and supervision views and that the FCA and PRA's frameworks should take this into account.

• Transparency of enforcement activities (HM Treasury Recommendations 6, 7 and 8). HM Treasury highlighted transparency as a significant issue which was raised by many respondents to its call for evidence. Accordingly, the need for greater transparency during FCA and PRA enforcement investigations is a prominent theme in HM Treasury's final report. In particular, HM Treasury recommended that the FCA and the PRA should continue to publish information about their enforcement activities and that they should also consider ways in which this reporting could be enhanced. For example, HM Treasury seemed supportive of the idea that the FCA should state in its annual report what enforcement action it has taken in priority areas and that the FCA should also indicate why certain firms are referred to enforcement following thematic reviews and others are not.

Co-operation between the FCA and the PRA

HM Treasury considered communications and co-operation between the FCA and the PRA in an enforcement context as part of its review:

• FCA/PRA consultation (HM Treasury Recommendations 9 and 10). Although HM Treasury acknowledged that the Memorandum of Understanding requires the FCA and the PRA to consult with each other to some extent in relation to enforcement matters, it identified several possible areas for improvement. For example, HM Treasury recommended that updates between the FCA and the PRA in relation to enforcement investigations should include representations from both regulators’ enforcement and supervision teams in order to promote symmetry of information between them.

• Joint investigations (HM Treasury Recommendations 11, 12 and 13). Joint investigations carried out by the FCA and the PRA have, to date, been relatively rare. As a result, there is little public guidance as to how such joint investigations will operate in practice. With this in mind, HM Treasury encouraged the FCA and the PRA to publish more guidance as to how they will conduct joint investigations and deal with decision-making in contested joint enforcement cases. However, HM Treasury recognised that the regulators may wish to develop their experience of and approach to such investigations before doing so.
• FCA/PRA co-operation (HM Treasury Recommendation 14). HM Treasury recommended that the FCA publishes more information about how it co-operates with the PRA in a similar way to how the FCA already publishes information about its co-operation with international regulators.
• PRA guidance (HM Treasury Recommendation 15). HM Treasury noted that the PRA has published very little information about how it conducts or intends to conduct enforcement investigations. This is in contrast to the considerable amount of information that the FCA has published on this topic. As a result, HM Treasury recommended that the PRA should develop its own guidance on its enforcement policy and process. We anticipate that any such guidance will draw heavily on the FCA's Enforcement Guide (EG).

The recommendations made by HM Treasury in relation to co-operation between the FCA and the PRA may help to address continuing concerns in the industry regarding the way in which the FCA and the PRA communicate and co-operate with each other, especially in relation to enforcement investigations.

Subjects' understanding of FCA and PRA enforcement investigations and the ability to make representations

When addressing this topic, HM Treasury recognised the obvious tension between investigators and subjects at the outset of and throughout enforcement investigations regarding information-sharing. On the one hand, the subject of an enforcement investigation will want as much information as possible about the reasons for the investigation as well information about the regulator's preliminary thoughts and possible findings against them. However, on the other hand, the regulator may be reluctant to be forthcoming with their preliminary thoughts and findings for fear of committing themselves to a particular position prior to considering all relevant evidence, or in some way prejudicing their investigation. This tension can often prove challenging for subjects of enforcement investigations, particularly if they wish to engage in a constructive dialogue with the FCA or the PRA during the course of investigations.

HM Treasury focused on the following key areas in its final report:

• Initial notice of investigation (HM Treasury Recommendation 16). Little information tends to be provided to subjects at the outset of enforcement investigations. In its final report, HM Treasury recognised that the nature of an investigation, the complexity of the issues and how quickly investigators are appointed will, amongst other factors, determine the extent to which regulators can describe suspected misconduct and the scope of an investigation at the outset. However, in order to enhance transparency, HM Treasury said that it would be helpful for the regulators to explain in writing at the outset of investigations the reasons why a matter has been referred to enforcement, with reference to their respective referral criteria. This is information that the FCA and the PRA should have to hand as a result of its decision to refer a matter to enforcement. Although this additional information may provide helpful confirmation for subjects of enforcement investigations, it is unlikely that the referral criteria relied on by the FCA or the PRA in order to refer a specific case to enforcement will come as a surprise to firms, especially to those who have previous experience of FCA and/or PRA enforcement investigations.
• Scoping meetings (HM Treasury Recommendations 17 and 18). In its final report, HM Treasury indicated that the subjects of investigations should be encouraged to indicate whether they accept part or all of the alleged wrongdoing at the scoping meeting or otherwise at an early stage and that the FCA and the PRA should consider incentivising subjects to do so. HM Treasury concluded that this approach may help to narrow disputed issues at an early stage and thereby allow investigations to proceed more efficiently. However, if this recommendation is to work effectively in practice when implemented by the regulators, it will be important for the FCA and the PRA to explain how they intend to characterise a subject's alleged conduct in any findings made against them at an earlier stage in their investigations. This will require the FCA and the PRA to provide considerably more information than they do at present about the nature, scope and focus of their case so that subjects of investigations can make informed decisions as to whether they wish to accept any or some of the allegations against them at a much earlier stage.
• Involvement of Supervision (HM Treasury Recommendations 19, 20 and 21). Respondents to HM Treasury's call for evidence requested greater co-ordination between the regulators' Enforcement and Supervision Divisions. This is an understandable request given the fact that firms' supervisors tend to be aware of and have greater exposure to particular markets and businesses and also sometimes have greater visibility of other projects that their firms are working on.
• Periodic updates throughout investigations (HM Treasury Recommendation 22). Enforcement investigations are often lengthy, especially in complex cases. HM Treasury's call for evidence specifically asked for views as to whether regular progress meetings should be offered to subjects. The final report stated that there was an "overwhelming consensus" that periodic updates should be provided and recognised that it is important that subjects of investigations (especially where the subject is an individual) are kept apprised of the progress of investigations, where appropriate. HM Treasury recommended that the regulators should provide updates to subjects of investigations at least once a quarter and that the subject should be able to request that these updates take the form of in person meetings. Although the FCA is open to having regular update meetings in most cases, HM Treasury's recommendation may help to promote discipline on the part of investigators and will help to ensure that investigations proceed more efficiently.
• Constructive dialogue during investigations (HM Treasury Recommendation 23). HM Treasury found that "there is some force to the argument that investigators and subjects should engage substantively on particular issues well in advance of settlement negotiations beginning". However, the degree to which this is possible will depend on the issue and case in question. In order to promote constructive dialogue during enforcement investigations, HM Treasury indicated that steps should be taken on the part of both the regulators and subjects of investigations. For example, HM Treasury suggested that earlier engagement and involvement of senior staff (from both the regulators and firms under investigation) may facilitate constructive dialogue during enforcement investigations. HM Treasury has noted that such conduct may also fall within what the FCA terms "co-operation" for the purposes of allowing additional discounts under its penalties policy. In order to help clarify this point, HM Treasury has suggested that the FCA should consider providing more examples of what it will consider to be "co-operation" in the context of enforcement investigations during the FCA's review of its penalties policy (which is due to commence in early 2015).
• Time limits for responding to preliminary investigation reports and warning notices (HM Treasury Recommendation 24). HM Treasury's call for evidence invited views as to whether the time limits for responding to preliminary investigation reports (PIRs) (typically 28 days) and warning notices (typically 14 days) are sufficient. In general, respondents were satisfied with these time limits. However, respondents felt that being given 28 days to respond to a PIR is often insufficient and disproportionate in complex cases which have involved lengthy investigations. This issue may, of course, be mitigated if subjects have a better understanding of the case against them prior to the receipt of a PIR (which is the focus of a number of other recommendations made by HM Treasury). HM Treasury recommended that the FCA and the PRA publish factors that they may consider relevant to an application for extending the period given to a subject to respond to a PIR or to a warning notice.

Settlement process

The majority of enforcement investigations are settled. As a result, the settlement process is an important one to both subjects of enforcement investigations and the regulators. Accordingly, a number of elements of HM Treasury's call for evidence and final report focused on the settlement process.

Most of HM Treasury's findings and recommendations focus on Stage 1 of the FCA's settlement process. Stage 1 is meant to begin once investigators have a clear understanding of the nature and scale of the misconduct, and communicate that understanding to the subject of the investigation, together with their assessment of the appropriate sanction. The FCA and the PRA tend to regard 28 days as a reasonable Stage 1 period. A 30% early settlement discount will be applied to any proposed financial penalty if a case settles during Stage 1.

• Early notification of Stage 1 (HM Treasury Recommendation 25). A number of respondents to HM Treasury's call for evidence expressed views that 28 days is typically too short a period for Stage 1, especially in cases where there are complex issues that need to be discussed and negotiated. 28 days can also prove to be too short a period for firms that need to mobilise various internal decision-making processes which are required in order to authorise a settlement. As HM Treasury noted, these difficulties are often compounded where subjects of investigations do not have a detailed understanding of the FCA’s case theory in advance of receiving settlement papers at the outset of Stage 1. In addition to recommending that firms should be given at least 28 days' notice of the commencement of Stage 1, HM Treasury has also recommended that preliminary without prejudice settlement meetings before the commencement of Stage 1 are to be encouraged (see next bullet). These recommendations may assist subjects of investigations to prepare for the Stage 1 process.
• Pre-Stage 1 preliminary "without prejudice" meetings (HM Treasury Recommendations 26 and 27). In certain cases, the FCA will have one or more preliminary meetings with subjects on a "without prejudice" basis in the period leading up to the commencement of Stage 1. These meetings are typically useful opportunities for investigators to set out their preliminary findings and for subjects to understand the FCA's position on key issues. As HM Treasury noted in its final report, these meetings are consistent with the aim of encouraging a constructive dialogue between the FCA and those under investigation and promoting early settlement. With this in mind, HM Treasury has recommended that preliminary without prejudice meetings between the regulators and subjects of investigations are held prior to the commencement of Stage 1. These preliminary meetings have the potential to be helpful to the settlement process. For example, they may help the FCA to better understand the position of the person under investigation and, if appropriate, allow the subject of an investigation to outline the basis upon which they may be willing to settle the matter at an early stage.
• Information provided at Stage 1 (HM Treasury Recommendations 28 and 29). The FCA and the PRA are required to allow subjects of investigations to access evidence that is relied on and evidence which may undermine their case when a warning notice is issued (section 394, Financial Services and Markets Act 2000 (FSMA). HM Treasury noted in its final report that in most cases firms and individuals will already be in possession of the key evidence relating to their cases in advance of Stage 1. However, to the extent that they are not, HM Treasury said that it is "critical" that such documents are provided to subjects at Stage 1.
• Extending Stage 1 (HM Treasury Recommendation 30). HM Treasury believes that a Stage 1 period of 28 days will remain sufficient in the majority of cases. This is, in part, due to HM Treasury’s belief that a number of its recommendations (particularly relating to periodic updates and preliminary without prejudice meetings) will help ensure that subjects have a better understanding of the regulators’ views prior to Stage 1 and, as a result, will help with the early identification of fundamental issues in dispute. However, HM Treasury also recognised that it is important that extensions to the Stage 1 period are granted where they are warranted.
• Making representations during settlement negotiations (HM Treasury Recommendation 31). A common theme in responses to HM Treasury's call for evidence was that FCA investigators can sometimes appear to be unwilling to revisit their findings on material issues, or their assessment of penalty, even in the face of cogent and persuasive representations as to why they should do so. In addition, some responses to HM Treasury's call for evidence argued that investigators are reluctant to return to Settlement Decision Makers (who will have approved the parameters of the settlement) because by doing so they are conceding to FCA senior management that they were initially "wrong". Taking these arguments into account, HM Treasury emphasised that the regulators' approach to settling enforcement cases "must not simply be to secure the best possible terms, but to achieve the right regulatory outcome. The regulators will need to consider the many purposes of taking meaningful and proportionate enforcement action, including achieving "credible deterrence"". HM Treasury also emphasised the importance of subjects being assured that representations they make during the settlement process are given due consideration by the regulators. HM Treasury suggested that this may be achieved by more senior staff at the FCA (but not Settlement Decision Makers) attending settlement meetings.
• Settlement discounts (HM Treasury Recommendation 32). As is set out above, to encourage early settlement of enforcement investigations, the FCA and the PRA operate similar, graduated discount schemes which reduce the financial penalty payable. The discounts granted range from 0% to 30% and the amount the discount given in a particular case depends on the stage at which settlement is agreed. The earlier settlement is agreed, the higher the early settlement discount granted. In its final report, HM Treasury suggested that this graduated discount scheme may not optimise settlement prospects. This is because the 30% discount for a settlement during Stage 1 should serve as a significant incentive to subjects to accept wrongdoing at an early stage, but the fixed 20% and 10% thresholds may temper that incentive. As a result, HM Treasury has invited the FCA and the PRA to reconsider the availability of early settlement discounts after the expiry of Stage 1, other than on a discretionary basis.
• On-going settlement review (HM Treasury Recommendation 33). Given the significance of the settlement process in enforcement investigations, HM Treasury has stated that the regulators’ settlement processes must continue to function properly by ensuring fairness for subjects and achieving the right regulatory outcomes. As a result, HM Treasury has suggested that the FCA's Regulatory Decisions Committee (RDC) and the PRA's Decision Making Committees (see Decision-making in contested enforcement cases below) may play roles in periodically reviewing the regulators' settlement processes following the conclusion of settled enforcement cases.

Decision-making in contested enforcement cases

The FCA and the PRA deal with decision-making in contested enforcement cases in different ways:

• The FCA has the RDC, which deals with contested disciplinary cases. In general, respondents to HM Treasury's call for evidence were supportive of the FCA's RDC framework and called for it to be retained. HM Treasury made a recommendation in its final report to this effect.
• The PRA deals with contested disciplinary cases in Decision Making Committees which are usually comprised of PRA executives. The constituent decision-makers will vary depending on the issues in question, with the most significant decisions being taken by the PRA Board (excluding the FCA CEO) sitting as a decision-making committee.

In addition, the subjects of enforcement action may refer their case to the Tax and Chancery Chamber of the Upper Tribunal (an independent tribunal) if they wish to challenge the regulators' decisions.

• Internal decision-making in contested cases (HM Treasury Recommendation 34). Overall, respondents to HM Treasury's call for evidence were supportive of the RDC framework and found that it provides "an appropriate level of objectivity, independence, legal expertise and industry experience". However, responses to the call for evidence suggested that the PRA's decision-making structure for contested enforcement cases may not offer the same level of functional independence as the FCA's RDC or the same perception of objectivity required for enforcement decision-making in contested cases. As a result, HM Treasury recommended that the PRA should establish a functionally independent Decision Making Committee, composed of independent members, to handle contested enforcement cases. Previously, the Parliamentary Commission on Banking Standards (PCBS) had suggested that a separate decision-making committee should be created that has the jurisdiction to consider both FCA and PRA enforcement cases. HM Treasury rejected this idea and said that co-ordination between the FCA and the PRA in relation to enforcement matters does not necessarily require a joint enforcement decision-making committee.
• Access to the Upper Tribunal (HM Treasury Recommendation 35). All those subject to decisions of the FCA and the PRA in enforcement matters have the right to refer these decisions to the Upper Tribunal. HM Treasury described the role of the Upper Tribunal in its final report as "a critical safeguard on FCA and PRA decision-making in all enforcement cases" and added that it "guarantees compliance with Article 6 of the European Convention on Human Rights". In addition, HM Treasury recognised that in some cases the subject may wish to challenge an adverse regulatory decision against them before the Upper Tribunal without first going through the various FCA or PRA internal decision-making procedures. As a result, HM Treasury recommended that the FCA and the PRA implement a new expedited procedure which will allow subjects of enforcement investigations to skip their internal decision-making processes after the issuance of a warning notice and proceed straight to the Upper Tribunal. As firms often choose not to pursue enforcement matters to the Upper Tribunal it is unlikely that many firms will make use of this new expedited route to the Upper Tribunal. However, where current or former employees of a firm are under investigation, it is possible that these individuals may opt to refer their cases directly to the Upper Tribunal. This may result in concurrent enforcement cases against firms and individuals into the same alleged fact patterns operating on very different timetables and also increases the risk that information about such cases may come into the public domain at an earlier stage via the Upper Tribunal process.
• Performance: accountability and efficiency (HM Treasury Recommendations 36, 37, 38 and 39). HM Treasury also recommended that the RDC, and potentially the PRA's new Decision Making Committee, should report annually on their performance and noted that the Treasury Select Committee may consider requiring future Chairs of these committees to appear before it. In its final report, HM Treasury also appeared to support the fact that the RDC process may be improved, but indicated that it intends to leave the details of how the RDC process may be improved to the FCA.

What next?

The FCA and the PRA are expected to publish their own consultation papers or policy statements regarding how they intend to implement HM Treasury's recommendations. It is likely that this will take place in 2015, but neither the FCA nor the PRA have given any further indication in relation to timing of next steps.

In the meantime, although HM Treasury's recommendations are not legally binding on the FCA or the PRA, they may still provide firms and individuals who are currently subject to enforcement investigations with some ammunition to supplement their arguments for greater transparency about the allegations they are facing. In the longer term, HM Treasury's recommendations indicate that there is at least a prospect of a more transparent and more consistent approach from both the FCA and the PRA towards enforcement investigations than is currently the case. However, the extent of any changes to the current enforcement processes at the regulators will depend on how the FCA and the PRA interpret and implement HM Treasury's recommendations in practice.

Key sources

• HM Treasury final report: final report (December 2014) and related press release.
• HM Treasury call for evidence: call for evidence (May 2014), including the terms of reference for its review (at Annex A), and related press release.

This article first appeared on Practical Law and is published with the permission of the publishers.