Government plans to sanction directors of failed banks are flawed

Responding to the Treasury consultation last year on sanctioning the directors of failed banks, the Law Society voiced concerns that a recklessness offence is difficult to translate into law. The measures proposed in the original consultation – and similar measures proposed by the Parliamentary Commission on Banking Standards – raise significant legal and practical difficulties.

The proposed offence would cover reckless misconduct in the management of a bank by a senior person. The government’s recognition of the need to make the offence compliant with the European Convention on Human Rights is welcome. The potential breadth of the proposed offence, however, raises concerns about legal certainty and proportionality. The use of recklessness as the basis of the offence means that prosecutors, and then a jury, will have to decide, possibly years after a business decision was made, whether or not it was reckless when it was made.

Banking inevitably involves taking risks, and business decisions require the exercise of forward-looking judgements. The commercial environment is unpredictable and, while a decision may seem reckless in retrospect, at the time it was taken it may have been a perfectly reasonable course of action. A risk may not have been foreseeable. Even if it was, it may have been reasonable to take the view that it was an insignificant risk, or one that it was reasonable for the business to take.

The purpose of introducing a criminal offence is to make businesses more risk-averse. The prospect of a custodial sentence seems likely to make business leaders reluctant to make bold but legitimate decisions, lest they be deemed reckless with many years of hindsight. Inevitably, company decisions will become slower, more time-consuming and conservative, with the taking of external advice a routine precaution. The introduction of an offence based on a test of recklessness risks stultifying the making of business decisions and casting a long shadow of doubt over every business decision well into the future. This may inhibit growth.

The knock-on effect of all this may also be that the prospect of criminal liability could deter experienced, well-qualified candidates from taking senior positions. This could leave struggling banks facing a vacuum of quality leadership at a time when they most need it, precipitating a quicker, perhaps more significant, bank failure.

Moreover, the additional rights conferred on the defence in criminal cases would restrict the publication of reports on the conduct in question, even though there will be a legitimate public interest in transparency, in the bringing of civil claims, and in the exercise of regulatory powers by the regulator. This is unlikely to sit well with many who feel the punishment of ‘reckless’ individuals should be as swift as possible and aired in public. What is the alternative? We already have regulatory remedies – recently reinforced – which do not produce the unfortunate and unintended consequences of this proposed offence.

The Society set out these legal, practical and broader economic concerns and made the case for more effective use of the existing broad range of powers of UK regulators to hold financial institutions to account. It would be quicker, more transparent and more effective for the authorities to use existing powers to impose unlimited fines, to order disgorgement of profits, and to impose prohibition orders on individuals, thus ensuring irresponsible individuals pay an appropriate penalty and are not permitted to continue working in the industry.

Karen Anderson is a partner, financial services regulation at Herbert Smith Freehills and a member of the Law Society’s Banking Reform Working Group