FSA Will Hold Eexecutives Personally Responsible for Poor Risk Management & Controls

Corporate Failures: Executives and Their Advisors Are Held Personally Responsible and Face Fines as well as Prosecution

Regulators have to become harsher in light of the financial crisis – they are inflicting some very serious penalties for wrong doings – could you be the next one considered not “fit or proper?”

In an attempt to avert the financial crisis of the recent past, regulators are becoming firmer – and with this, grave penalties have been brought down on not just the institutions, but personally on the firms’ executives themselves.

While the penalties of late may seem to be somewhat harsh, they do tend to provide a loud and clear warning to financial company executives that the regulators are watching and in so doing, are moving forward with repercussions on those who do not have set systems of control in place for monitoring their institutions’ transactions. Today, Risk Managers could be the most loved people in these firms. Ignore them at your own peril!

More Than Just a Slap on the Wrist

In the UK today, the FSA (Financial Services Authority) is clear – they will hold executives personally accountable and will enforce with significant penalties as is evidenced by a spate of recent high profile fines. Just some of these include:

  • Martin Russell Lafrance, a former mortgage director at General Finance Centre, was personally fined by the FSA for failing to ensure that reasonable checks were taken in order to properly verify the accuracy of the information that was provided by customers on their mortgage applications. In one such instance, an applicant stated an income of £ 450,000 when he in fact earned £ 24,000. Without using proper systems and controls, Lafrance was also found to have failed in adequately supervising and monitoring his staff in performing their roles properly and diligently. In an additional notice, the FSA determined that Lafrance was not considered to be a “fit and proper” person to perform any controlled function that involves exercising significant influence in relation to any type of regulated activity that is carried on by any authorized person due to his “lack of capability and competence.”
  • Mark Joseph Laurenti of Independent Mortgage Advisory Service Limited was recently slapped with a fine of £ 14,000 for repeatedly submitting mortgage applications that contained customer information that was incorrect. Because the FSA determined that Laurenti did not implement the proper systems and controls for risk management in his firm, he was solely held responsible for these actions.
  • Former finance director George McGregor of Royal Liver Assurance has been banned and fined in the sum of £ 109,000 for his part in the entering into of contracts that provided benefits to a former employee. The executive had also sanctioned unauthorized payments.
  • JC Flowers’ UK chief executive Ravi Shankar Sinha has been fined £ 2.9 million and is banned from trading based on his obtaining of nearly £ 1.5 million via a fictitious invoicing scheme. While half of this fine is based upon the return of the ill gotten funds, the other half represents punitive damages – as well as sends a very clear message from the FSA on the seriousness of controlling risk management as well as having proper systems in place for doing so.
  • Even the queen’s bank, Coutts Bank, was recently fined the sum of £ 8.75 million for its failure to maintain effective controls in order to prevent the laundering of money as well as its neglect in monitoring high-risk clients’ accounts.

The penalties that are being imposed, however, are not just restricted to the FSA, nor are they only brought down upon company executives as there have also been numerous auditors who have given way to punishment as well.

In a related instance, top auditor PricewaterhouseCoopers was also fined – this time, a record £1.4 million – for wrongly informing local regulators that clients’ funds were being kept safe by JPMorgan Securities when in fact amounts that ranged from $1.9 billion and $23 billion of these clients’ money was actually being held in accounts that were unsegregated and would have been at risk for loss if the lender had at some point become insolvent.

In comparison to related issues in the United States, however, the UK FSA may be watching closely for some tips. For instance, Countrywide Financial Corporation, a home mortgage lender, was ordered to pay $335 million to settle allegations that the company overcharged certain customers who were struggling to keep their homes during the recent mortgage crisis there.

And, to add fuel to the fire, President Barak Obama is calling for even bigger penalties for fighting financial related crime. In a recent speech, Obama called for a strengthened oversight and accountability of financial firms by increasing the penalties the can be imposed – including criminal charges. This followed a proposal by the chairwoman of the United States Securities and Exchange Commission to increase the civil penalties for companies that are in violation of the U.S. securities laws. All of this leads to the U.S. taking a much harsher look at financial company infractions – at least for now.

In light of the U.S.’s stance, one of the biggest questions that comes to mind is whether or not the FSA is bold enough to prosecute or impose even tougher penalties on the executives in the U.K. who are “guilty” of infractions there. And if so, will the auditors on whom the regulators rely also be implicated in any or all of these crimes?

The answer to this could be somewhat blurred in the aftermath of the departure of former FSA head Margaret Cole, a h3 proponent of the enforcement process. Provided that her successor has the same – or more – clout, in conjunction with the FSA’s merger with the Bank of England – financial service executives could be headed for even tighter scrutiny and even more stringent penalties.

Who is Really At Fault?

In any case, although the fines – and the infractions – may seem mind boggling, the truth is that in many cases, the responsible executives were not even aware of what was going on in the day to day businesses that they were running.

The fault does not lie totally with these individuals, however, it does in essence point to the fact that the institutions they were in charge of did not have the correct level of systems and controls in place, probably didn’t take enterprise risk management seriously, and failed to embed a risk aware culture.

With that in mind, how can executives better keep their finger on the pulse of what is happening in their respective business operations? The answer lies in implementing of effective risk management and controls via the proper systems. In other words, take your Risk Manager seriously.

Are You Fit and Proper?

While many of these penalized executives were – or are – part of larger organizations, the fact still remains that it is up to these individuals to see that systems and controls are not just put in place but also implemented as they were meant to be. If this is not successfully taken on, then these individuals run the very real risk of being in opposition to what is becoming one of the most important pieces of the Solvency II initiative.

One such requirement in this juncture is abiding by the Solvency II “fit and proper” requirements for those who are involved in key functions with regard to financial related transactions. These individuals will be required to meet the following characteristics:

  • Their knowledge, experience, and other professional qualifications will enable them to manage in a sound and prudent manner;
  • They possess proper integrity and are of good repute.

In addition, with regard to undertakings that involve insurance and reinsurance, supervisory authorities shall be notified of any changes in the identity of those individuals who will be effectively running the undertaking or are responsible for other key functions.

These rules are applicable not just to executives and upper management personnel in the organizations, but to any and all individuals who are essentially running the operation. These can include those who are involved in the areas of compliance, actuarial functions, and internal audit employees.

In ensuring that all of the individuals in these roles are considered to be fit and proper, the organizations should be required to have documented policies in place for accessing their qualifications. In this regard, insurers should be able to effectively demonstrate that they have sufficient expertise or at the very least, have the ability to access such expertise when needed.

The Moral of the Story is…

While nobody knows exactly what the future holds, it is possible that the fines – and possibly even more harsh penalties such as prison sentences for non-complying executives as is done in the U.S. – could continue.

In any case, it would appear that the ultimate message from the FSA is that no longer can executives take a lax view on managing risks and putting into place the proper systems and controls – otherwise, the penalties, as well as the ultimate responsibility, will fall personally on these individuals.

The key, then, is to ensure that not only are systems put into place, but that they are followed to the letter in all transactions. In addition, whereas Risk Management was previously seen as hampering commercial progress, it today should be seen as much more a guideline to “stay out of jail” – a road map of sorts that can keep both companies and those that manage them in line with the new and tighter regulatory requirements going forward.

It stands to reason, then, that the ultimate bottom line lies in financial executives pinpointing where they need tighter controls within their respective organizations and then following these methods to the letter. Certainly one way of making sure they are headed down the correct path is to stay in close ties with their Risk Managers and to strictly adhere to the recommended processes. Otherwise, these execs could be taking a very large gamble.

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