The Courts

1
The Courts involvement in the Regulation of
Financial MarketsTimothy Dutton QC James
McClelland (Fountain Court Chambers)Part I the
PPI judicial review its wider regulatory
significance
2
The Decision

• R. (on the application of British Bankers
  Association) v Financial Services Authority
  2011 EWHC 999 (Admin) (Ouseley J).
• Court rejected the BBAs claim to quash an FSA
  Policy Statement (PS 10/12) and FOS online
  guidance.
• The Policy Statement had introduced amendments to
  the DISP section of the FSA Handbook which
  provided for the handling of PPI complaints.

3
Why it matters

• Now the leading authority on how the Courts will
  approach the relationship between high-level
  rules and specific rules within a regulatory
  system.
• Its relevance is not limited to PPI.
• Not even limited to FSMA regulation.

4
Structure of this Presentation

• Part I Regulatory framework
• Part II The dispute
• Part III Conclusions wider significance

5
Part I Regulatory framework
6
The different categories of Rules (R)

• High-level Standards
• e.g. the Principles of Business.
• Business Standards
• e.g. the Conduct of Business Rules.

7
Principles of Business (PRIN)

• Types of Rule (R), expressed as being
• a general statement of the fundamental
  obligations of firms under the regulatory system
  (PRIN 1.1.2G).
• Eleven in total (cf Ten Commandments).
• 1. Integrity A firm must conduct its business
  with integrity.
• 6. Customers interests A firm must pay due
  regard to the interests of its customers and
  treat them fairly.
• 7. Communications with clients A firm must pay
  due regard to the information needs of its
  clients, and communicate information to them in a
  way which is clear, fair and not misleading.

8
The Principles are not actionable by private
persons

• s.150 FSMA.
• (1) A contravention by an authorised person of a
  rule is actionable at the suit of a private
  person who suffers loss as a result of the
  contravention, subject to the defences and other
  incidents applying to actions for breach of
  statutory duty.
• (2) If rules so provide, subsection (1) does not
  apply to contravention of a specified provision
  of those rules. .
• PRIN 3.4.4R
• A contravention of the rules in PRIN does not
  give rise to a right of action by a private
  person under section 150 of the Act (and each of
  those rules is specified under section 150(2) of
  the Act as a provision giving rise to no such
  right of action).

9
Conduct of Business Rules COB

• For insurance ICOBS (previously ICOB).
• Granular rules specifying particular
  requirements.
• Detailed rather than general.
• Prescriptive rather than normative.
• For example
• Chapter 4 of ICOB Advising and selling
  standards.
• Chapter 5 of ICOB Product disclosure.

10
DISP Complaints Handling under the Handbook

• DISP Dispute Resolution Complaints.
• Two limbs
• Firms obligations to handle and determine
  complaints by customers (DISP Chapter 1)
• FOS jurisdiction to make binding determinations
  where complaints not resolved by firms (DISP
  Chapter 2).

11
Complaints handling by firms(a) The Core
Obligation

• Core obligation under DISP 1.4.1R, whereby a firm
  must investigate complaints
• competently, diligently and impartially assess
  fairlywhether the complaint should be upheld
  and what redress may be appropriate
  taking into account all relevant factors .
• re. fairly is this procedural or substantive?
  (see below).

12
Complaints handling by firms (b) Root cause
analysis

• a respondent must put in place
  appropriate management controls and take
  reasonable steps to ensure that in handling
  complaints it identifies and remedies any
  recurring or systemic problems, for example, by
• analysing the causes of individual complaints so
  as to identify root causes common to types of
  complaint
• considering whether such root causes may also
  affect other processes or products, including
  those not directly complained of and
• correcting, where reasonable to do so, such root
  causes. (DISP 1.3.3R)

13
Complaints handling by firms - reaching out to
non-consumers -

• Guidance indicates that firms should consider
  reaching out to non-complainants
• A firm should have regard to Principle 6
  (Customers' interests) when it identifies
  problems, root causes or compliance failures and
  consider whether it ought to act on its own
  initiative with regard to the position of
  customers who may have suffered detriment from,
  or been potentially disadvantaged by such
  factors, but who have not complained. (DISP
  1.3.5G)
• Deleted on 1 September 2011 but v. similar
  provision in new DISP 1.3.6G.

14
Part II The Dispute
15
Background to the Dispute

• By mid-2008 tens of thousands of complaints being
  presented to FOS.
• Those complaints were, necessarily, first
  considered and rejected by firms.
• The overwhelming majority were then upheld by
  FOS.
• Serious concern (on both sides) that firms and
  the FOS were approaching complaints differently
• FOS was overtly assessing compliance with both
  the ICOB/ICOBS and the Principles.
• Banks (it appears)were applying ICOB/ICOBS alone.

16
FSA Policy Statement 10/12(August 2010)

• Amended DISP, by inserting a new Appendix 3,
  entitled Handling Payment Protection Insurance
  complaints.
• The amendments may be sub-divided into five main
  elements
• Guidance on the assessment of complaints in order
  to identify whether a breach or failing had
  occurred (DISP App 3.2).
• Guidance on the approach to considering evidence
  (DISP App 3.3).
• Guidance on root cause analysis (DISP App 3.4).
• Evidential provisions on determining the effect
  of a breach or failing (DISP App 3.6).
• Evidential provisions on the approach to redress
  (DISP App 3.7).
• The most controversial were (1) and (3).

17
Re. (1) Guidance on the assessment of
complaints

• FSA annexed to the Policy Statement an Open
  Letter.
• This purported to remind firms of the appropriate
  standards by setting out a list of 15 common
  failings which occurred in the sale of PPI
  policies.
• In formulating these common failings (which the
  banks characterised as standards) the FSA
  relied not just upon ICOB/ICOBS but also the
  Principles.

18
Re. (3) Guidance on root cause analysis

• Amplified the guidance provided at DISP 1.3.3R.
• Provided that a firm should consider whether the
  complaints disclosed a root cause and if so,
• consider whether it ought to act with regard to
  the position of non-complainants and
• If so, take appropriate and proportionate
  measures to ensure that those customers were
  given appropriate redress or a proper opportunity
  to obtain it
• In particular by considering whether it was fair
  and reasonable to undertake proactively a redress
  or remediation exercise, which might include
  contacting customers who have not complained.

19
BBAs Grounds of Review

• Can be distilled into three grounds
• The s.404 argument (against FSA only)
• The no obligations argument
• The exhaustion argument.

20
(1) The s.404 argument

• A challenge to the root cause analysis
  component of the PS.
• s.404 FSMA provided a statutory procedure for
  ordering past business reviews and the payment of
  redress to non-complainants.
• This was hedged in by protections for industry
  in particular
• it required Treasury consent and
• it was limited to requiring redress for legally
  actionable failures (and therefore not breaches
  of Principles).
• BBA argued that by the Guidance on root cause
  analysis, the PS was seeking to circumvent
  statutory limitations on s.404.
• Rejected - Guidance was non-mandatory.

21
(2) The no obligations argument

• Alleged an error of law because, when formulating
  the common failings, the FSA treated the
  Principles as giving rise to obligations towards
  customers.
• The effect of PRIN 3.4.4R and s.150(2) FSMA was
  to prevent the Principles imposing any
  obligations as between firms and customers.
• s.150(2) was therefore
• not just a procedural bar on court proceedings,
  but
• a substantive limitation upon obligations being
  owed to consumers.

22
Court rejected the no obligations argument

• S.150(2) did no more than provide that rules
  could disapply s.150(1). (If rules so provide,
  subsection (1) does not apply to contravention of
  a specified provision of those rules.)
• And s.150(1) itself merely provided consumers
  with a statutory right of action. (A
  contravention by an authorised person of a rule
  is actionable at the suit of a private person who
  suffers loss as a result of the contravention,
  subject to the defences and other incidents
  applying to actions for breach of statutory
  duty.)
• The effect of PRIN 3.4.4R was therefore simply
  to disapply a statutory right of action that
  would otherwise arise. It had no wider effect.

23
Wider significance of the rejection of the no
obligations argument

• Three points.
• Reasoning logically applies not just to
  Principles but to all Handbook Rules that are
  non-actionable - they remain relevant to DISP.
• Whenever complaints under DISP are considered,
  the Principles need to be brought into account.
• Firms must apply the same approach when assessing
  complaints internally under DISP 1.4R, as the FOS
  would under its compulsory jurisdiction.

24
Wider significance of the rejection of the no
obligations argument (contd)

• Firms had argued that DISP 1.4.1R was merely
  procedural and did not identify standards by
  which to assess complaints.
• (NB DISP 1.4.1R competently, diligently and
  impartially assess fairlywhether the complaint
  should be upheld and what redress may be
  appropriate taking into account all relevant
  factors ).
• However, Judge held that
• when firms have to decide complaints, before
  they can go to the Ombudsman, they have to apply
  in reality and for fair complaints handling, the
  same approach as the Ombudsman would.
• Significant because, if firms fail to do so, they
  will not only be rejecting a complaint which FOS
  will uphold but be in breach of their own
  regulatory obligations.

25
(3) The exhaustion argument

• Even if Principles could be treated as creating
  obligations to customers, they could not be
  relied upon to augment or contradict ICOB/ICOBS.
• This was because ICOB/ICOBS were promulgated by
  the FSA to occupy the field and to crystallise
  the Principles in insurance sales.
• The FSA could not then resort to the Principles
  to amplify and extend ICOB/ICOBS.

26
The exhaustion argument in practice ICOB
5.3.1R vs Common Failing 15ICOB 5.3.1R

• ICOB 5.3.1R required that in an oral sale, firms
  had to provide the customer with a Policy
  Summary containing (amongst other things) notice
  of any significant and unusual exclusions or
  limitations.
• And
• draw the attention of the retail customer
  orally to the importance of reading the policy
  summary, and in particular the section of the
  policy summary on significant and unusual
  exclusions or limitations.

27
ICOB 5.3.1R vs Common Failing 15Common Failing 15

• In sales primarily conducted orally, it was
  not enough just to provide important information
  in writing. So, we have found it to be a failing
  where there was not a fair presentation of the
  information during the sales discussion, by, for
  example
• giving an oral explanation or
• specifically drawing the customers attention to
  the information on a computer screen or in a
  document and giving the customer time to read and
  consider it.
• In addition, the requirement to pay due regard to
  a customers information needs and communicate
  information in a clear, fair and not misleading
  way required the firm to provide balanced
  information when making reference to a policys
  main characteristics (whether orally or in
  writing). So, we have found it to be a failing
  if, where the firm described the benefits of the
  policy orally, it did not also provide an
  adequate description of the corresponding
  limitations and exclusions in a way that was
  clear, fair and not misleading, for example
  orally. Further, ICOBS requires that, if a firm
  provides information orally during a sales
  dialogue with a customer on a main characteristic
  of a policy, it must do so for all the policys
  main characteristics.

28
ICOB 5.3.1R vs Common Failing 15The BBAs
argument

• BBA said that the requirements of ICOB 5 were
  only that significant terms appear in the Policy
  Summary and there be an oral signpost
• Common failing 15 required firms to specifically
  draw customers attention to the significant
  terms (e.g. refund terms) and give them consumer
  time to read them.
• This created inconsistency with the ICOB
  requirements.

29
Judges reasoning on the exhaustion argument
in general

• The Principles were best understood as the ever
  present substrata to which the specific rules are
  added
• The Principles always had to be complied with.
• Specific rules did not supplant them and could
  not contradict them.
• They were but specific applications of the
  Principles to the particular requirements they
  cover.
• The general notion that the specific rules can
  exhaust the application of the Principles is
  inappropriate. It cannot be an error of law for
  the Principles to augment specific rules. (para.
  162).
• The real question was not whether specific rules
  exhausted general ones, but whether they excluded
  them
• This would require the Court to accept that a
  breach of the Principles might go un-redressed,
  even though a specific rule has been complied
  with.
• The FSA had not, by ICOB/ICOBS, created a
  comprehensive code.
• Such a code could be circumvented unfairly, or
  contain provisions which were not apt for the
  many and varied sales circumstances which could
  arise.

30
Judges specific reasoning on Common Failing 15

• Ouseley J. accepted that it went further than the
  specific rules.
• But it did not contradict them note why he
  concluded that there was no contradiction
• it requires nothing to be done that specific
  rules forbid, or omitted which they require.
  para. 174
• The specific rules are silent on the topic of
  how oral presentations should be conducted
  para. 176
• There can be no contradiction of the specific
  rules unless they are construed as the exhaustive
  expression of all obligations. There is no
  justification for such a construction in the
  absence of clear wording giving effect to a clear
  purpose or intention of such an outcome. The
  overarching or underlying Principles are simply
  being applied where the rules do not cover the
  point. para. 176

31
Part III Conclusions Wider Significance
32
What conclusions can be drawn from the Judges
reasoning on Exhaustion?

• There appear to be only 3 circumstances in which
  specific rules will limit the application of the
  Principles
• If the Principles are said to require something
  to be done which the rules actually forbid.
• Conversely, if the Principles are said to require
  something to be omitted which the rules require
  must be done.
• If the Principles contain an additional
  requirement in circumstances in which the
  specific rules should be construed as the
  exhaustive expression of all obligations but
  such a construction will only be justified if
  there is clear wording giving effect to a clear
  purpose or intention of such an outcome.

33
Direct Consequences for industry

• Upstream consequences (when planning their
  systems and operations)
• Firms cannot treat the specific rules as
  reflecting the limits of their duties to
  customers.
• This remains true even if they are operating in
  an area governed by detailed and highly
  prescriptive rules.
• The open-textured provisions require a degree of
  flexibility and responsiveness (rather than a
  tick box mentality).
• Given that firms engaged in selling mass consumer
  products target economies of scale and
  consistency of customer-treatment through
  tick-box operations, this creates tensions (and
  costs) in implementation.
• Downstream consequences (when handling
  complaints)
• Firms must consider the Principles and apply the
  same assessment of reasonableness as the FOS.
• They cannot take refuge in asking whether or not
  the customer has a cause of action.

34
Wider Regulatory Significance

• This is a judicial vindication of the Principles
  based approach to regulation which the FSA had
  been pursuing for a number of years.
• The FSA has emphasised that it expects that
  principles of fairness, to be embedded throughout
  a firms operations and within its culture.
• In firms with tens of thousands of employees
  (Lloyds Banking Group has over 100,000), this is
  easier said than done.
• The development within FSMA Regulation of the
  sorts of expectations of professional
  responsibility and client (as opposed to
  customer) care historically associated with the
  professional disciplines (cf medicine and law).
• The tension is to what extent these requirements
  are scaleable.