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Stop the spying

Money Marketing reported on November 6 that the FSA had lost an appeal to the Information Tribunal regarding a disclosure order by the Information Commissioner. This order required the FSA to disclose the names of seven firms it had criticised concerning the quality of their advice about equity-release schemes and follow-on investments.

The FSA had obtained the information about the firms’ advice in the course of a mystery-shopping exercise. As a result, in May 2005, the FSA issued a press release which set out its concerns about the suitability of the advice. The FSA refused a request under the Freedom of Information Act to disclose the names of all the firms which had been the subject of the mystery shopping and the names of the seven firms it had investigated in relation to subsequent investment advice.

The Information Commissioner ruled that the FSA must disclose the names of the seven firms and the findings it had made. The FSA has now appealed to the High Court.

The FSA maintains that it would be wrong to disclose the names of the firms because the evidence from the mystery-shopping exercise may not truly reflect the firms’ market practices and naming them may increase unjustified complaints against those firms.

Further, those seven firms could maintain that they have not been treated equally when compared with their competitors who were not included in the mystery- shopping exercise. The results of the exercise were released in May 2005, more than three years ago, and so are now probably out of date. That case exemplifies some of the concerns about mystery shopping.

In essence, mystery shopping involves the FSA operating in a covert manner and actively deceiving the firms it approaches. There is, therefore, an important question – is it ever appropriate for the FSA, as regulator, to use such a technique?

It is significant that the FSA seeks appropriate authority for its mystery-shopping exercises under the Regulation of Investigatory Powers Act 2000. This act regulates the wholly excep-tional undercover activities of the security forces, such as MI5, the police and other arms of the executive such as the Revenue and Customs. Those activities include the interception of communications between, and the covert investigation of, those suspected of damaging the national interest by, for example, affecting the security or the economic well-being of the UK.

It seems a wholly disproportionate use of those powers to carry out research into the activities of firms carrying on business lawfully in the UK. This may well expose the FSA to a public law challenge.

The unfairness extends to other aspects of mystery shopping. Take the case of IFAs who are subjected to such an exercise. Some IFAs charge on a fee basis.

If the FSA sends a mystery shopper to such an IFA, the shopper pays the fee but other IFAs will be remunerated on a commission basis. Since the shopper will withdraw before the IFA will have earned any commission, the shopper does not pay anything – no doubt because if the shopper offered a fee, he or she would have to admit to mystery shopping.

So the IFA gets nothing, even though the firm will have done the same amount of work as the IFA that charged a fee. That is not fair as between the two firms.

Further, however, it is not proportionate as between the firm relying on commission and the FSA. The FSA has no intention of recompensing the IFA for its time and effort but the IFA is being misled into thinking that it will earn commission if the shopper, posing as a genuine client, accepts the solution presented.

But there is a reasonable legal argument that the IFA could recover damages from the FSA for breach of an implied term that the client has the genuine intention of giving serious consideration to the solution with a view to accepting it.

In addition, the IFA could protect itself from the loss of commission in such situations by a suitably drafted condition in its standard terms of business. But the deception remains.

It feels wrong for the regulator to be behaving in this way. So it is instructive to see how the FSA seeks to justify mystery shopping.

It maintains that mystery shopping is used to help it protect consumers. In its guide to mystery shopping, the FSA says the practice is a long-established research technique used extensively to measure the quality of service provided. But without describing how others use mystery shopping, including the extent of the burden imposed on the unsuspecting retailer or trader, this is an unconvincing comparison. There is a substantial difference between what is reasonably to be expected of a national regulator compared with a commercial organisation.

The FSA says many big financial services providers use mystery shopping to research their competitors and their own sales staff, to improve customer services and to help ensure they are treating their customers fairly.

Again, relying on what firms do is no justification for how the regulator should behave. Certainly, there is a substantial difference between a firm checking on the performance of its own staff on the one hand, and, on the other, what the regulator does in relation to a firm which is subject to its regulatory regime.

In the case of a firm checking up on its own staff, it has presumably decided that the benefits of the exercise are worth the cost of employing the mystery shopper, the wasted efforts of the sales staff and the other overheads incurred. But the IFA has been tricked into undertaking work which it would not have willingly have done if it had known the true facts.

The FSA says that it uses mystery shopping for either of two reasons. The first is to carry out research in an area that has been identified as potentially high risk.

The second is in circumstances where it already has concerns about compliance and wants to confirm and identify key issues so it can conduct more focused supervisory work.

The FSA says it would not choose to conduct mystery shopping speculatively, on the off-chance that it might discover problems.

But unless the FSA restricts its efforts to those specific firms about which it has positive information, it is inevitable that, from the point of view of other firms, the visit by the mystery shopper is speculative and made on the off-chance that the visit might throw up something. That does not appear to be either fair or proportionate or, indeed, appropriate in our society.

In its guide, the FSA addresses the question of proportionality. It says it takes steps to ensure the mystery shopping “is conducted in a way that is proportionate to what we are trying to achieve”. The way that firms are selected depends on the nature of the market being investigated. Sometimes, for example, it selects a mixture of small and big firms. But that is a judgement on proportionality made purely from the FSA’s own point of view. It has no regard to the effect on the firms selected. From an individual firm’s point of view, especially in the case of a small firm, the selection will not be proportionate.

The FSA does not make public the details of the firms concerned in any mystery- shopping exercise it undertakes. That at least is fair. But the FSA puts the value of mystery shopping no higher than “invaluable feedback to share with firms”. That result does not justify the active and intrusive deception involved. The FSA should abandon mystery shopping.

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