Financial regulation: Senior Managers Regime

Six months after introducing the Senior Managers Regime, the Financial Conduct Authority has released a package of further measures. Here I look at aspects of the FCA’s consultation paper on the duty of responsibility; its discussion paper on the inclusion of the legal function; and its final rules on regulatory references.

Duty of responsibility

The FCA’s draft guidance on the operation of the ‘duty of responsibility’ (the guidance) is deliberately high-level, recognising that the steps reasonably expected of a senior manager will vary from case to case.

The FCA can take action against a senior manager where there has been a contravention by the firm; the senior manager was responsible for the management of any of the firm’s activities in relation to the contravention; and the senior manager did not take reasonable steps to avoid the contravention.

Unsurprisingly, a senior manager’s statement of responsibilities and the firm’s management responsibilities map will be taken into account when determining which of a firm’s activities a senior manager was responsible for. Reassuringly, however, the guidance recognises that these documents will not be determinative and that regard must be had to the individual’s ‘actual role and responsibilities in the firm’.

Indeed, statements of responsibilities are by definition so short and high-level that it is questionable how much value they will add. Given the inherent complexity involved in the day-to-day management of a bank, the devil will inevitably be in the detail.

FCA chief executive Andrew Bailey has said that the regulator had in some cases ‘seen evidence of overlapping or unclear allocation of responsibilities’. Despite this, the guidance acknowledges the relevance of ‘[t]he relationship between the SMF [senior management function] manager’s responsibilities and the responsibilities of other SMF managers in the firm (including any joint responsibilities or matrix management structures)’.

Issues may arise, for example, where responsibility for part of the business flows up to a senior manager through their direct reports, who are themselves senior managers. It seems possible then that senior managers lower down the pecking order will be more exposed to enforcement action than their superiors, which is surely not what the regime set out to achieve.

It is perhaps unsurprising that the guidance does not differ significantly from the FCA’s previous draft guidance on the ‘presumption of responsibility’.  Although the controversial reversed burden of proof was abandoned last year, in reality any senior manager subject to an enforcement action will need to show the reasonable steps they took. While the guidance will be of some assistance, senior managers will be playing close attention to the first enforcement actions of this type.

Inclusion of the legal function

An FCA discussion paper outlines the arguments for and against including a firm’s legal function within the regime.

The arguments against inclusion are interrelated and reflect those voiced by banking industry bodies and the Law Society.

First, if the head of the legal function is a solicitor, they are already subject to professional conduct regulations imposed by the Solicitors Regulation Authority. Including the legal function would double the regulatory burden and put at risk the lawyer’s existing professional obligations, most notably that they must not allow their independence to be compromised.

Second, the head of legal performs a crucial independent advisory function: counselling a firm and its senior management on legal risk. Including the legal function would place a lawyer’s interests in conflict with those of their employer. Were the FCA to bring a personal enforcement action, the head of legal would be compelled to protect their personal position under the regime while being obliged to act in the best interests of the firm. This would compromise their ability to provide independent advice.

Third, legal professional privilege (LPP) may be prejudiced. If the head of legal needed to demonstrate reasonable steps, the only practical way to do so would be to rely on privileged material. In addition to undermining a fundamental protection, this would place the lawyer in an awkward position as any LPP belongs to the company and is for it alone to waive.

While the FCA’s discussion paper strives for neutrality, it advances rebuttals to each argument:

Far from doubling the regulatory burden on solicitors, the FCA’s Individual Conduct Rules and Senior Manager Conduct Rules are consistent with, and largely mirror, the SRA’s Principles.

There is no requirement that the general counsel, or indeed any other lawyer, be allocated overall responsibility for the legal function. Firms retain complete discretion as to who should be allocated responsibility.

It is the management of the legal function (that is, the provision of training, internal controls and allocation of resources) that bring it within the regime, not the quality of specific legal advice. The FCA contends that it can supervise a firm’s legal function without recourse to privileged material, and indeed that it is prevented by statute from requiring its disclosure.

The FCA’s approach to privilege is not entirely consistent with the draft guidance on the duty of responsibility. This indicates that the FCA will look at the substance of a senior manager’s actions and decisions as well as the management process behind them.  Factors relevant to reasonable steps include whether the senior manager ‘exercised reasonable care when considering the information available to them’ and ‘reached a reasonable conclusion on which to act’. For lawyers, the very essence of whether they have acted reasonably may be tied up in the detail of their advice.

Regulatory references

The FCA’s final rules on ‘regulatory references’ (a mandatory form of employment reference) clarify what information firms are required to share when recruiting key roles. The rules aim to prevent the ‘recycling’ of individuals with poor conduct records between firms. However, individuals may be the subject of damning references, potentially years after the alleged events, which they have had no meaningful opportunity to contest.

From March, banks and insurers will have to comply with the new rules in respect of all candidates being recruited into senior management functions, controlled functions or significant harm functions.

They will be required to seek references from all previous employers in the last six years, irrespective of the type of firm or whether it is itself FCA-regulated; to provide references in response to requests from authorised firms, which must include certain specified disclosures as well as any other information a firm reasonably considers to be relevant; and to provide an updated reference to an individual’s current employer, if new relevant information comes to light in the six years following the individual’s departure. All firms on the receiving end of references must take them into account as part of their ongoing obligation to assess the fitness and propriety of relevant employees.

Few would dispute that individuals guilty of misconduct should be prevented from wiping the slate clean each time they move on, and to that extent the new rules are welcomed. It is nevertheless crucial, given the potential consequences for individuals, that the process for providing references be fair. In response to the FCA’s consultation on these rules, one of the concerns raised was the need for former employees to be afforded a ‘right to reply’.

The FCA has now included guidance stating, among other things, that ‘fairness may require a firm to have given an employee an opportunity to comment on the allegation if it is included in an update to a reference’. Clearly, where an individual is the subject of an updated reference following departure from a firm, there will be no opportunity for the new information to be tested through a formal disciplinary process.

Even if a former employee is contacted and invited to comment on the information before the reference is updated, lapse of time and a lack of access to relevant material may restrict their ability to meaningfully engage. Moreover, unlike a current employee undergoing a disciplinary process, a former employee may not have the benefit of third-party funding for legal fees.

While firms will be acutely aware of employment law obligations, there is a danger that those tasked with updating references will err on the side of inclusion and disclose information that has not been subject to a robust verification process – information that the receiving firm is then required to take into account in assessing fitness and propriety. 

At a time when firms are increasingly shouldering responsibility for the fitness and propriety of those they employ, the balancing of regulatory obligations against duties of fairness is an unenviable task.

Elly Proudlock, WilmerHale. Lloyd Firth also of WilmerHale co-authored this article