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Effective Enforcement – Changing The

October 12, 2009

Effective Enforcement - Changing The

Despite grandstanding galore from politicians, there is a growing unease at the paucity of substantial change in the aftermath of the financial crisis. Nowhere does this resonate more than in the field of enforcement, where talks of US-style powers to prosecute alleged wrongdoers in financial services appear to have been dashed.

The general public are not fools. Weak and superficial exercises in chastisement are no replacement for considered and mature discussions between Westminster and the City about the best ways to lead the economy out of the dire mess in which it finds itself. In this way, we must start to look at solid proposals that will make a lasting change to the workings and culture of our financial system. Only then will the banking fraternity earn the public trust so crucial to any economic resurgence.

Two areas at which I suggest we look urgently are the remit of the Serious Fraud Office (SFO) and the related idea of deterrence.

Deterrence is a vital ingredient in any effective financial system. It broadly comes in two forms: the deterrence of losing ground to ones rivals in a competitive market and the deterrence of punishment by a credible judicial or regulatory body, when personal greed or the desire to triumph over one’s competitors leads to anti-competitive practice, fraudulent activity or exploitation.

As financial services stands, deterrence is dangerously lacking. As I have said before, the single best form of regulation is open competition. However in the current landscape – here for some time to come – of large, part-nationalised banks, competition has fallen away. It is the main reason for the rapid return to super profitability, and the awarding of huge bonuses, by some in this sector. Banks have become ‘too big to fail’, many smaller institutions have either collapsed or been swallowed up by larger banks and a large portion of the risk that remains is guaranteed by the taxpayer. In addition to this sweeping away of competition, we have a fraud-busting body in the SFO that for too long lacked either clout or respect from those in financial services.

Operational since 1988, the SFO is responsible for the detection, investigation and prosecution of serious fraud cases in England, Wales and Northern Ireland (‘serious’ involves sums of £1 million upwards). While operationally independent, the SFO comes within the remit of the Attorney General and is given the power to bring criminal prosecutions directly. The Financial Services Authority, by contrast, is able to impose civil sanctions and launch criminal cases on matters such as market abuse, in tandem with the City of London Police and Crown Prosecution Service.

The SFO has regularly been criticised for its low conviction rate, a reputation worsened by a series of high profile cases that have placed the organisation in a poor light. Notably, the organisation was humiliated after it dropped the Al Yamamah investigation into BAE Systems’ arms deals with Saudi Arabia in 2006 under pressure from the government. Small wonder it has continued to have BAE’s overseas activities in its sights. More recently still, it has come under fire for refusing to pursue criminal charges against the Phoenix Four consortium following their purchase of MG Rover.

Its most costly investigation, however, was Operation Holbein that looked at an alleged pharmaceuticals cartel designed to defraud the NHS. The investigation eventually collapsed after running up a bill of £25 million to the taxpayer. It was this case in particular that raised serious questions about the SFO’s ability and role in tackling large, complex investigations. A review of the organisation followed that suggested there was a culture of buckpassing and a lack of internal focus and skill.

Lawyers continue to lament the difficulties associated with securing convictions for fraud, especially given the collapse of highly complex jury trials. It is for this reason that many feel that the introduction of a system of plea bargaining similar to that in the USA would not work – nobody will risk blowing the whistle or turning themselves in when the likelihood of a successful prosecution is so slim.

The SFO’s problems are not necessarily of personnel. Speaking to experts in this field, I believe that one of the organisation’s main problems is in finding cases to investigate. Indeed it is only when the police or Attorney General have firm cause to believe that a criminal act has occurred that the SFO is permitted to get involved. When a case does get underway, its prosecutors routinely face months battling defence lawyers before they can get to trial. The defence has a strong incentive to engage in a war of attrition in order to derail a prosecution on legal technicalities.

As such, we face the task of reforming the financial services system and inculcating in the minds of its participants a sense of right and wrong, with an umpire (the SFO) that lacks the tools – or market respect – to do its job properly.

This contrasts sharply with the experience of the United States. For some time, the City has been lagging far behind New York in pursuing, charging and convicting white-collar criminals. From 2003-2007, the SFO’s conviction rate stood at 61%, which is dwarfed by the 92% obtained by the Manhattan District Attorney’s Office.

The differences in our systems are fourfold:

  • The whistleblower culture (bringing with it immunities) is far stronger in the US. Regulation 10 (A) of the Securities Exchange Act, for example, puts especial duties on accountants and other professional advisers to report any suspicions. Once such rules are in place here and begin to be used, over time a new culture of responsibility will naturally develop.
  • Criminal liability at the corporate level is stronger in America and applies to misfeasance by employees in the US. In the UK it applies only to directors.
  • The power of ‘deferred’ prosecution in the US has no UK equivalent. This mechanism allows prosecutors to resolve criminal changes by the imposition of substantial financial penalties so long as the future conduct of the company involved is agreed upon.
  • Finally, in the UK only the FSA can impose a financial penalty on a company. The SFO cannot. This separation of powers in tackling white-collar fraud has contributed to a sense that those committing corporate misfeasance are ‘getting away with it’.

So how does the UK learn from the experience of the United States and make the SFO an effective player in the policing of a robust financial services industry embracing the fresh culture that the general public rightly demands?

I believe we should give serious thought to reappraising the role of the Serious Fraud Office by adopting key elements of the US system. First and foremost it should target competition policy, which has been largely bypassed as a result of action taken to stop the haemorrhaging of the financial system over the past year.

Later this month I shall be posting a follow-up article that outlines precisely how we should go about this task. Getting this key issue right must form a crucial pillar in a credible financial system for the future. As the global landscape of financial services changes, so too must the enforcement of its rules; public trust cannot otherwise be restored and we shall all then be the poorer.