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The conflict in the FSA investigating itself

Most professionals whose job it is to advise or to make arrangements for others will come across occasions when their duty to a client conflicts with an interest that they themselves have in the transaction.

Some conflicts of interest are obvious and easily avoided but others are less so. But it is important to recognise the conflict when it arises and to deal with it properly.

The duty to avoid conflicts of interest is deeply embedded in the law. An IFA acts for his or her client in respect of transactions carried out on behalf of the client. In other words, the IFA is the agent for the client.

The relationship of principal and agent is one of trust and confidence and the law describes such a relationship as a “fiduciary” one. The law imposes on the agent a duty so that the principal is entitled to the single-minded loyalty of the agent. One of the consequences of that duty of loyalty is that the agent must always act in good faith towards the principal, he must not make a secret profit out of his position and he must not put himself in a position where his duty to the principal conflicts with his own interests.

If he finds himself in the position where there is such a conflict which cannot be avoided, the agent must disclose it fully and get the principal’s fully informed consent. Without that consent, the agent must not act in the transaction.

A common conflict of interest occurs when the agent takes a secret commission paid by the other party to the transaction with the principal.

Thus, in the days before the compulsory disclosure of commission, it was common for an insurance intermediary to take a commission paid by the insurance company when arranging an insurance contract between his client and the insurance company.

The intermediary could reasonably say that the client knew or should have known that the intermediary was being remunerated with a commission paid by the insurance company but the client would often not know how much the commission was. Thus, the FSA’s rules on commission disclosure simply back up what the law requires anyway.

Conflicts also arise in other ways. There are, unfortunately, many cases in which a solicitor has acted in breach of his or her duty of trust and confidence owed to a client by ignoring the conflict of interest that arose in the circumstances.

In a case that the House of Lords described in 2005 as “particularly shocking”, a firm of solicitors acted for both the buyer and the seller in a property deal. The seller, Mr Hilton, was a small property developer. The buyer, a Mr Bromage, had recently been released from prison for a number of offences, one of which involved fraudulent trading and nine others related to obtaining credit whilst an undischarged bankrupt. The firm of solicitors knew of Mr Bromage’s convictions and prison sentence because it had acted for him in the criminal proceedings.

Both parties instructed the firm to act for them and the deal was negotiated in the solicitors’ offices. The deal involved Mr Hilton building six flats on a site, and Mr Bromage buying them as each was completed. The firm arranged the bank loan that Mr Hilton needed to fund the building work. He also wanted a cash deposit of £35,000 from Mr Bromage. The firm then negotiated the deposit down to £25,000 and lent the money to Mr Bromage.

As Lord Walker said in giving judgment: “Mr Hilton was not told that his own solicitors were advancing the entire deposit to a convicted fraudster so as to clothe him with the appearance of a man of substance.”

In due course, after the flats had been built, Mr Bromage refused to complete the purchase. Mr Hilton asked the solicitors to take steps to rescind the contract.

At that point, the solicitors told Mr Hilton that there was a conflict of interest, that they should not have acted, and advised him to consult another firm of solicitors.

The transaction ruined Mr Hilton and it was 15 years before the case got to the House of Lords and he got judgment in his favour.

Lord Walker went on to say: “The solicitor’s duty of single-minded loyalty to his client very frequently makes it professionally improper and a breach of his duty to act for two clients with conflicting interests in the transaction in hand.”

In this case, the solicitors had irreconcilable duties to each client. They owed Mr Bromage a duty not to disclose his criminal past and they owed Mr Hilton a duty to tell him the facts about Mr Bromage’s past and the fact that they had a personal financial interest in the transaction, having lent Mr Bromage the money for the deposit. In the circumstances, the only proper thing they could have done was to refuse to act for Mr Hilton when he first approached them.

The House of Lords ordered that the damages suffered by Mr Hilton should be assessed by a judge if they could not be agreed. Lord Walker ended by saying: “But it is now 15 years since Mr Hilton suffered a grievous wrong for which he has not been compensated. For the good name of the solicitors’ profession, his compensation should be agreed, on a generous scale, without further delay”.

As Lord Millett said in a different case which reached the House of Lords: “A fiduciary cannot act at the same time both for and against the same client…his disqualification has nothing to do with the confidentiality of client information. It is based on the inescapable conflict of interest which is inherent in the situation.”

Not all cases are about such clear conflicts. The conflict can be subtle and those involved do not always find it easy to spot. Where there has been concern that the FSA has not acquitted itself well in relation to a high-profile failure, the regulator has itself carried out an internal investigation into its own performance and then published the conclusions.

The investigations it carried out in relation to the closure to new business of Equitable Life in 2000 and the investigation into the failure of Northern Rock are examples.

But there is an inescapable conflict of interest in any situation in which a public body seeks to investigate its own alleged wrongdoing or failure to perform properly.

Those investigations cannot be relied on to the same extent that they could have been if they had been carried out by a truly disinterested and respected outsider. How do we know whether or not every point has been properly considered and investigated?

For a long time before the establishment of the independent police complaints commission, the police used to investigate complaints against themselves. The public did not accept the results.

By the same token, investigations into the failures of the FSA should be fully investigated by a truly independent body reporting to, for example, Parliament.

Peter Hamilton is a barrister specialising in financial services at 4 Pump Court

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Comments

There are 14 comments at the moment, we would love to hear your opinion too.

  1. By the same token, investigations into the failures of the FSA should be fully investigated by a truly independent body reporting to, for example, Parliament.

    That will never happen, given that FSMA 2000 gives the FSA is more power than Parliament.

  2. Pissed Off IFA 8th April 2011 at 3:42 pm

    Seems like a role that IFAs would give their remaining arm for, most of them having already had the shirt and one arm and leg taken as result of the FSA. Let a team of small IFAs carryout an inspection of the FSA. All cynism and joking apart, IFAs would be the best qualified for this role of inspecing the FSA.

  3. And similar conflicts exist operationally within the FSCS and contribute directly to elevated levies.

    They have no incentives to be operationally efficient, or to ever reject claims – as they have no commercial consideration or reputational concerns. Most assessments are laughable tick box exercises ignoring large parts of advice/suitability, but they’re good at expending disproportional efforts focussing on legalistic concerns.

    Many advisers would be well-served asking how the FSCS’s central costs are controlled. Compensation costs, generous salaries, 35hr weeks, long holidays, good benefits, and public-sector-style sickness costs are all passed on through the levy so are guaranteed to be met – so why keep costs low?

  4. says it all no need for further comment

  5. The article puts forward an irrefutable case for independent assessment of the FSA’s activity over a number of issues. This is not a new argument, however. Latin scholars (and I’m not one) will recognise this as “Quis custodiet ipsos custodes?” which phrase actually saw the light of day quite a while back. It has lost none of its strength with the passing of time.

  6. I would like to nominate myself please for the role.

    A small salary of say ‘6’ figures and a very large bonus at the end will suffice…

    lol x

  7. There is a secondary and powerful reason to support Peter Hamilton’s argument – as above.

    It arises from the FSA investigation into RBS, and is well set out in Adair Turner’s letter last December to Andrew Tyrie at the Treasury Select Committee.

    It relates to the FSA’s granting of confidentiality to those from whom they take evidence during the investigation.

    Two extracts from that letter, worth reading:

    The legal position on publication of reports or documents generated in the course of such investigations is clear. In those cases where a decision is made not to progress with an enforcement action, we are not permitted to release them without the consent of all involved. Until now RBS has made it plain that it does not wish to provide consent. This regime – set out in FSMA and in relevant Single Market Directives – is designed both to ensure maximum flow of information, and to protect the legal rights of people under investigation.

    We would need permission from RBS (and we expect from a number of third parties in addition) to do this notwithstanding the wording within the Act which you quote in your letter drawn from Section 348 (4) (b) of FSMA. This section of the act allows the FSA to make public information but only where we do it in such way that a person can not be identified, but with the legal meaning of ‘persons’ covering firms as well as individuals. It would not therefore allow us to put out a report on RBS, as RBS would, of course, be identified.

    However, and crucially, then consider that position of of protecting the legal rights of people under investigation against the proposals published in February where the Government revealed plans to legislate to grant the Financial Conduct Authority the power to publicise warning notices against firms and individuals – not when enforcement action is to be taken but actually whilst the enforcement investigations are ongoing – with no confidentiality envisaged and more importantly with the current right to appeal to the Upper Tribunal removed.

    Powers of that magnitude exercised by a regulatory authority require to be subject to independent scrutiny – if there is to be even a semblance of justice.

  8. At least we can empathise with the Libyians, Egyptians, Syrians and any other poor sods oppressed by a dictatorial self styled judge, jury and executioner.
    Like those found guilty of war crimes further down the line, perhaps it is not vain to hope that one day the regulator will get its just desserts.

  9. When in history has the public ever ever benefitted from an orgsanisation investigating itself ? Parliament expenses ? MOD arms sales ? Police brutality ? NHS ? Ring any bells ? This farce should be stopped immediately and the FSA stripped of its self regulatory powers. It has never prevented any financial failures as evidenced by recent events, cannot prevent fraud by evidence of the never ending procession of prosecutions and fines. It is not fit for purpose !

  10. Incompetent Regulators Awards Team 8th April 2011 at 5:48 pm

    If there was a truly independent and intelligent investogation, the place would be immediately shut die to incompetency with possible recourse to individuals who have misled us all which is probably hidden behind those dodgy walls.

  11. Julian Stevens 8th April 2011 at 7:15 pm

    EVERYTHING that the FSA does should be subject to the scrutiny of a suitably empowered Regulatory Oversight Committee. The fact that the FSA is to all intents and purposes exempt from any sort of accountability to any body other than itself is an affront to what is supposed to be a democratic society.

  12. What makes it even worse is the vast sums of money that the FSA is allowed to get away with spending on these token whitewash “investigations” into its own failures, yet nobody is ever disciplined, fined, demoted or sanctioned in any way. Somehow or other, it’s always somebody else’s or some sort of “procedural” or “institutional” failure, but the buck never stops on the desk of any individual. Except, of course, in the case of Clive Briault over the failure of his department to regulate Northern Rock, and look at what his “punishment” was ~ a golden parachute with an estimated value of £612,000, all other peoples’ money of course.

    And then we hear the next round of calls from Adair Turner for more staff, more resources, more power and, as always, more money. The FSA is an unbridled monster with an insatiable appetite for everything and anyone or any body that dares to try to stand in its way……..

  13. Philip Westwood 11th April 2011 at 11:31 am

    Absolutely – I am in the crazy position where I complained to the internal FSA complaints proceedure enquiring why (in my case) they hadnt fulfilled their statutory obligations and launched an investigation into firm that was provably in breach of FSA regualtions.

    The conclusion as to why they hadnt investigated was that the FSA was incompetent and that they SHOULD have investigated.

    I fully supported the conclusion and, stupidly, expected that they would now take action.

    Sadly there is STILL no evidence of an investigation forcing me to complain again asking why, since the conclusions of my initial complaint was that an investigation should have occured, it still hasnt!!

    Going round in circles…….

  14. Would the establishment allow an independent investigation?

    The finger of blame point points where? The FSA is not independent.

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