My Lords, last night at 6.39 pm, the detailed impact assessment for the senior managers and certification regime that is part of the Bill appeared in my inbox. At 6.41, it was withdrawn and, at 6.42, it or some version of it was sent again. This was all a bit confusing. But the real problem is timing. It is simply not acceptable to send us an important impact assessment the night before we debate the matter. I have not been able to give this impact assessment anything but the briefest of glances. We need more time to review and think about the contents, but we can now do that only on Report. When we agree the SM&CR issue on Report, could the discussion be held under Committee stages rules? Perhaps the Minister could nod agreement or write to me nodding agreement with that proposal.
Part 2 introduces two very significant changes. It scraps the reverse burden of proof regime for relevant authorised persons, which are defined in the Treasury briefing note as banks, building societies, credit unions and PRA-regulated investment firms. The Bill replaces the reverse burden of proof with a test requiring the regulator to prove misconduct, which is the position we were in before, during and for five years after the crash. In this period, and under that test, no senior manager was jailed and financial misconduct did not cease. The Bill extends this new regulatory regime to all sectors of the financial services industry.
The sections of the Bill that deal with these matters are very complex. I am sure the Minister will say that this amendment has technical defects, and I am certain that he would be right about that. However, we are in Committee and this is a probing amendment. I hope that the intention of the amendment is clear. It does not challenge the extension of a new, less onerous SM&C regime to the wider financial services industry. It seeks to preserve the existing SM&C regime for those currently classified as relevant authorised persons. That is, it seeks to preserve the reverse burden of proof regime for banks, building societies and PRA-regulated investment firms. This would create a two-tier regulatory system. It would allow the regulatory regimes to be proportionate to the risks involved. Those institutions that did, and still can, threaten our financial system would be subject to a tougher regime, but those who cannot or are on the balance of probability unlikely to would be subject to the new lighter regime proposed in the Bill.
In an article in the Evening Standard on 15 October, the highly respected City journalist Anthony Hilton made the case for such a two-tier system, writing that,
“all banks, insurers and securities houses are not all equal in the damage they can do; some are much more equal than others. By extension, rules and regulations designed to impose mild restraint on the giants of the industry can amount to damaging overkill when applied to the typical smaller firm. The answer is a two-tier system of prudential regulation whereby those firms with the potential to put the system at risk are subject to much more intrusive supervision … Guy Jubb, global head of Governance and Stewardship at Standard Life Investments, has suggested something similar for his world”.
A two-tier system is what this amendment seeks to create.
There was considerable anxiety at Second Reading about the Bill’s abolition of the reverse burden of proof regime. In his reply and in subsequent correspondence, the Minister set out the reasons for this reversal. The first is that since the Government propose to extend the regime to all financial services, in the interests of fairness and regulatory coherence it would be vital that the regime be rolled out consistently across the industry. He said:
“it would clearly not be proportionate to apply the reverse burden of proof across the financial sector, including to the small organisations that will now make up the majority of firms which will come under the regime, and which pose more limited risks to market integrity and consumer outcomes”.—[Official Report, 26/10/15; col. 1081.]
The Minister singled out credit unions as an example of the kind of small firm that would suffer disproportionately under the reverse burden of proof regime, which I remind the Committee has not yet come into force. Here, I entirely agree with the Minister. Credit unions should never have been in the category of relevant authorised persons in the first place and should be removed. However, I disagree with all the other aspects of the Minister’s argument. It entirely ignores the different risk potentials of the major institutions and the about-to-be newly regulated firms, except to say that it would not be fair to impose the stricter regime on the whole sector. It would not be fair, but the stricter regime for relevant authorised persons was made law for all the good and necessary reasons advanced by the Parliamentary Commission on Banking
Standards and accepted by Parliament and the Government. These good and necessary reasons, well rehearsed at Second Reading, are still entirely valid. The facts have not changed. The reverse burden of proof is still needed.
In evidence to the Parliamentary Commission on Banking Standards in January 2013, Tracey McDermott, then director of enforcement and financial crime and now acting CEO of the FCA, stated that the inability to impose sanctions on senior executives was first and foremost due to the evidential standard required to prove their liability. She said that,
“the test for taking enforcement action is that we have to be able to establish personal culpability on the part of the individual, which means falling below the standard of reasonableness for someone in their position”.
That regime produced no convictions or charges against senior managers, and that is exactly where we will be again if we scrap the reverse burden of proof for senior managers in banks, building societies and PRA-regulated investment firms. The extension of the regulatory regime to less risky firms requires a lighter touch, but this does not imply that this same lighter touch should apply to much riskier organisations currently subject to the reverse burden of proof regime.
The Minister advanced two other reasons for removing the reverse burden of proof. The first is that, as Andrew Bailey asserted, it is leading to individuals and their advisers spending more time and resources on mitigating the risk of being held personally liable for breaches on their watch than on running their firms in a manner consistent with regulator’s objectives. This does not seem to fit with the details of last night’s impact assessment. It assesses the maximum cost benefit to large firms as 10% of current costs and as more likely to be 5%. This does not sound as though the lighter-touch regime will free much time or resources. In any case, Parliament’s intention was precisely that these people should spend more time and resources ensuring compliance with the rules. We know what happened when they did not do that. Mr Bailey went on to say that he sees the reverse burden of proof giving rise to a box-ticking mentality. Perhaps it may, but required behaviour often precedes and leads to cultural change.
Another point was raised by Mr Bailey. He said there has been noise around the reverse burden of proof that has been distracting future senior managers from complying with the spirit of other important aspects of the regime. He does not say how he knows he is not being gamed on both these points. I assume he would not deny that financial institutions attempt to game regulators and that he has been told of these things by bankers and others subject to the reverse burden of proof regime. How has he tested what he has been told? How does he guard against and discount obvious special pleading? Without this information, his arguments can have little force.
There is one other argument I have heard made, entirely understandably, about the reverse burden of proof: it runs counter to our strong legal tradition of “innocent before proved guilty”. There is ample precedent for this in law. The reverse burden of proof has been used in the Road Traffic Act 1988, the Health and
Safety at Work etc. Act 1974, the Terrorism Act, the Misuse of Drugs Act 1971, the Trade Marks Act 1994, the Criminal Justice Act 1988 and the Official Secrets Act. The House of Lords, sitting as the Law Lords, dealt with the issue in Sheldrake 2004, UKHL43. It made plain that each statutory provision must be considered on a statute-by-statute basis. The decisive factor before the courts is whether the reverse burden is necessary to ensure that the offences remain workable. Without it, these offences were not workable. That is precisely why we need, and is the justification for, the reverse burden of proof. That has been said and is the case here. This argument has not been advanced in our discussions so far, perhaps because the Minister is familiar with the current status in law of other examples of the reverse burden of proof. As noble Lords will know, the Telegraph reported on August 29 that Sir Eric Pickles is considering using the reverse burden of proof in his unexplained wealth orders, which I assume are a precursor to undeserved wealth orders.
The fact is that none of the Minister’s reasons for abandoning the reverse burden of proof stands up to scrutiny. We need the reverse burden of proof regime for systemically risky organisations for the reasons advanced by the PCBS and others. Life has not got better, financial misconduct has continued and no senior managers have been punished. The regime that makes punishment not happen is the regime, effectively, that the Bill wants to restore to banks, building societies and PRA-regulated investment firms. Our amendment is aimed at preventing that. The amendment does not interfere with the extension of the regulatory regime. It tries to retain the already approved and enacted regime for riskier, systemically dangerous firms and allow the lighter regime for those firms that are less risky and not systemically dangerous.
We need to be able to hold senior managers personally and directly accountable. As Senator Warren said:
“If large financial institutions can break the law and accumulate millions in profits and, if they get caught, settle by paying out of those profits, they do not have much incentive to follow the law”.
I beg to move.
1 pm