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Legal and Conduct Risk in the Financial Markets, 3rd Edition by McCormick, Roger; Stears, Chris (22nd March 2018)

Part I The General Context, 5 The Lawmaker, the Regulator, and Current Preoccupations

Roger Mccormick, Chris Stears

From: Legal and Conduct Risk in the Financial Markets (3rd Edition)

Roger McCormick, Chris Stears

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2015. All Rights Reserved. Subscriber: null; date: 01 April 2020

Credit risk — Financial stability — Regulators

(p. 55) The Lawmaker, the Regulator, and Current Preoccupations

We will have grown up, I think, as a society when we stop blaming the regulator for the failure of a bank.1

For centuries, alchemy has been the basis of our system of money and banking.2

5.01  There is no perfect commercial legal system and even an advanced and finely tuned body of laws requires ‘repairs and maintenance’ on a continuous basis. (This is one of the arguments against calls for more codification of the common law.) It is not realistic to expect all the necessary changes to come about as a result of case law. The legislature (Parliament) is the principal source of new law (other than ‘soft law’,3 which emanates from regulatory authorities and elsewhere at an alarming rate). Legislative changes do not come without risk and they very frequently introduce an element of uncertainty, at least for an initial period until the markets have adjusted to the change and some degree of stability of interpretation has been achieved. However, the imperative for London is for the law to ‘keep up’ not only in order to reflect the changing nature of market transactions and (unless inappropriate) recognize their validity but also to ensure that the regulatory framework keeps pace with changing risk profiles. We need to avoid the creation of ‘a mismatch between the expectation of the law and modern commercial reality’.4 The lawmaker’s job is never finished or complete. If one of the objectives of law is to serve the interests of society, this objective will always be a moving target. The sections of society principally affected by what we loosely call (p. 56) ‘financial law’ are in a state of virtually constant change and so the demands of the legal system are also constantly changing.

5.02  Regulators also have a key role in developing enforceable rules and standards.5 The regulator’s job appears, at times, to be a truly thankless task. There is a probability, not a possibility, that any financial misdemeanour by a regulated body will be blamed on the regulator. On the other hand, we seem to be very quick to criticize regulators for being over-zealous if they impose fines or other penalties when shortcomings are detected. And of course the responsibility for the ‘red tape’ and general cost of ‘bureaucracy’ associated with compliance is laid at the regulators’ door as well. We seem, in recent years, to have made a habit of changing our regulatory bodies, and their powers and scope of activities, with every perceived ‘failure’ of any significance. Prior to the creation of the new ‘Twin Peaks’ system of regulation in the UK,6 there was no shortage of critics of the preceding ‘tripartite’ regulatory system who wanted to see more power given (in effect, returned) to the Bank of England. But the replacement regulators, the PRA and the FCA, seem to be subjected to as much criticism from the discontented as the bodies they have replaced.7 Regulators are, in any event, an easy target for politicians who wish to distance themselves from responsibility for ‘failures’ and for a financial press that is quick to criticize those perceived to be in a position of authority. Sometimes it seems that they cannot win.

5.03  Legal risk will always be present in the financial markets. It can be controlled and managed, but it cannot be eradicated (although certain specific legal risks can sometimes be removed, eg, by legislation or by contractual restructuring). Hardly a week goes by without there being some mention of legal risk (whether or not by name) in the financial pages of the press. One issue of the Financial Times chosen (p. 57) at random prior to the publication of the first edition of this book8 contained articles on the following:

  1. (1)  Sir Peter Middleton, formerly the Chairman of Barclays Bank, was interviewed in connection with his new role as the Chairman for the Centre for Effective Dispute Resolution. In the course of the interview he described some of the advantages of mediation over traditional litigation:

it’s a lot cheaper … the hidden costs of litigation are much greater than you think, particularly the amount of management time it takes up. If you invite a QC along to give you his view of a case, it takes up half a day. The courts give you an answer, but it’s a long, tortuous process and lacks flexibility. The other thing that’s hugely important is the confidentiality of the process. In a court case you never know what is going to come out that had nothing to do with the case.

  1. (2)  The FSA was being challenged by Legal & General (the insurance company) in relation to a £1.1 million fine levied on it for ‘alleged endowment mis-selling’. The hearing was expected to take six weeks, before the Financial Services and Markets Tribunal. In a summary of the case, the FSA alleged that endowment policies known as ‘with profits flexible mortgage plans’ were ‘sold to customers for whom they were not suitable, either because they were not prepared to take the risk of a shortfall at maturity or because they did not properly understand that risk’. These allegations were denied by Legal & General.9

  2. (p. 58) (3)  A US lawyer was reported as representing clients ‘who suffered under the brutal apartheid regime’ in South Africa and bringing claims on their behalf under the 18th century US law known as the Alien Tort Claims Act. The article reported that this legislation is now ‘increasingly used as a means of holding multinationals to account in the U.S. courts for human rights abuses committed abroad’. The defendants were reported as including UK banks, NatWest, Barclays, and Standard Chartered.

5.04  The above three articles feature three different facets of legal risk. The first relates to some of the more obvious problems associated with litigation, including the amount of time it takes and the possibility of unwelcome ‘surprises’ emerging from the proceedings and consequent unflattering (and possibly damaging) media coverage. The second relates to the hazards of selling (or ‘mis-selling’) complex (or relatively complex) products in the consumer market, and the third relates to the growing unease associated with certain kinds of US class actions which, apparently, may have little if anything to do with the USA itself but nevertheless expose international companies (including banks) to very large financial claims which some may feel are of a somewhat nebulous nature.

5.05  Another, randomly selected, issue of a US newspaper10 featured articles on the following:

  • •  The firm of accountants, KPMG LLP, ‘agreed to pay $22.5 million to settle charges brought by the Securities and Exchange Commission in connection with the … audits of Xerox Corp. from 1997 through 2000’. The SEC said this was the largest ever payment they had received from an audit firm. According to the SEC, Xerox had been overstating its results in order to bolster its share price. (Xerox itself and six of its former senior executives had also paid penalties and/or disgorged profits totalling around US$32 million.) According to the newspaper: ‘The SEC said that KPMG “wilfully aided and abetted Xerox’s violations of the anti-fraud, reporting, record-keeping and internal controls provisions of the federal securities laws”. Among other things, the SEC noted that KPMG removed its audit partner after Xerox complained about his actions in the 1999 audit; ignored warnings from international KPMG officers about Xerox’s accounting practices; and failed to inform Xerox’s board or audit committee of concerns KPMG partners had about the company’s accounting.’ As part of the settlement, KPMG agreed to take certain remedial measures, including reviewing any change in assignment of an audit partner, establishing whistle-blower channels within the firm and retaining a consultant to check its policies and certify to the SEC in two years’ time as to the changes still being in effect.

  • (p. 59) •  The US Supreme Court ‘reined in’ securities fraud class action litigation with a ruling that plaintiffs alleging losses (due to falls in share prices) because of misrepresentation by a company’s management ‘must show that the lies were to blame’. Justice Stephen Breyer delivered an opinion which, although it accepted that, ‘The securities statutes seek to maintain public confidence in the marketplace … by deterring fraud’ partly by enabling private civil actions, did not accept that such laws were intended ‘to provide investors with broad insurance against market losses’. It would be necessary to show economic loss ‘that misrepresentations actually cause’. One commentator observed: ‘The Fantasyland damage numbers that plaintiffs are thinking about are now out the windows and plaintiffs are going to have to be much more realistic even where there is a stock decline.’

  • •  Mr Ronald Perelman was reported to be suing the investment bank, Morgan Stanley, in connection with a transaction where the bank had advised a company (Sunbeam) to whom Mr Perelman sold his interest in a company called Coleman Inc (partly in consideration for shares in Sunbeam). Although Morgan Stanley had advised Mr Perelman on earlier deals and Mr Perelman apparently had great confidence in them (seeing their ‘stamp of approval’ on Sunbeam as significant), Mr Perelman was not the bank’s client in the Sunbeam deal. Not long after the transaction was completed, ‘Sunbeam became engulfed in an accounting scandal, driving down the value of Mr Perelman’s stock. His suit cuts to the heart of a key issue facing Wall Street: What is the responsibility of an investment banker in identifying problems at a client, and to whom is the underwriter responsible.’ Morgan Stanley had, it was reported, set aside US$360 million to cover the potential costs of the court action.11

5.06  These reports focus, not surprisingly, on litigation, or adverse claims risk (and some cover what we would now call conduct risk). They feature issues which are recurrent themes in both the USA and the UK, such as the liability of auditors, the level of fines (and on whom they are imposed), the responsibilities of advisers (especially in relation to conflicts of interest, real or imagined), and, more generally, the legal consequences of corporate fraud for parties other than the primary actors themselves. Class actions are, to date, a concern that is peculiar to the USA, although, as indicated in one of the articles mentioned earlier, it seems that the effect of US class actions can certainly be felt beyond US borders and are of increasing concern to banks in London.

(p. 60) 5.07  The Financial Crisis, of course, affected the financial news agenda in a dramatic fashion. But legal risk underlies many of the stories that are reported and much of the commentary. A short time prior to the publication of the second edition of this book, the Financial Times of 7 May 2009 carried items on the following:

  • •  Expected changes in EU regulations (which will require implementation at national level by October 2010) will ‘force institutions to retain at least 5 per cent of the securitised products that they originate and sell to give them a direct interest in assessing the products’ riskiness’. The article notes that banks will have to set aside more capital to cover these ‘risky products’ and that there are other proposals ‘in the pipeline’ including measures ‘intended to make the market in derivatives that are not traded through exchanges more transparent, and to establish centralised clearing to make these instruments less risky’.12

  • •  Banks ‘game the system’ of rules designed to ensure capital adequacy, as embodied in Basel II, by using various devices to exploit certain aspects of the rules that are described as ‘two decades of financial engineering’ and ‘regulatory arbitrage’ as well as ‘insurance wizardry’. The author notes that although ‘stress tests’ that the US government has recently imposed on banks will require some of them to raise very large amounts of new capital there is an ‘absurdity’ that those banks are ‘by Basel standards, in rude health’.13

  • •  We should be less willing to ‘keep insolvent banks afloat’, notwithstanding the systemic risks that they entail. ‘Trillions of dollars have been thrown at the system, just so that we can avoid the natural process of creative destruction that would take down these institutions’ creditors. Why shouldn’t the creditors bear the losses?’ The article acknowledges the systemic risk problem and the need to protect depositors but the authors evidently feel that a way should be found to let commercial creditors suffer the discipline of failure and that ‘for capitalism to move forward it is time for a little orderly creative destruction.’14

  • •  In a joint operation with the police, the FSA ‘swooped’ on ‘an alleged £28m fraud’ in an operation described as ‘part of a probe that involved law enforcement authorities across Europe’. The alleged fraud was thought to be a ‘boiler room scam’. This involves ‘cold-calling investors and selling them shares in companies that later prove to be non-existent or worth virtually nothing.’ Losses suffered by the victims of such frauds are estimated by the police to run to several hundred million pounds a year. Police also say that the Financial Crisis has prompted more victims to come forward; this may be due to increased fraudulent activity, better publicity for the actions of the authorities or more rigorous checking of portfolios by investors. A lawyer was quoted as saying, ‘This is another example of the FSA showing its teeth …’ (p. 61) The article concluded with the observation that: ‘The FSA’s latest action also sounds a note of warning to companies that process funds relating to boiler rooms. Fox Hayes, a now defunct Leeds-based law firm, was fined almost £1m earlier this year for its involvement in overseas share scams in which investors lost £21m.’15

  • •  Frederic Oudea was appointed as successor to Daniel Bouton as executive chair man of Societe Generale. The catalyst for Bouton’s resignation was described as the award of a ‘generous package of stock options’ the previous month but Bouton had also said that he had decided to resign because of repeated attacks on him in the media during the period since the ‘Jerome Kerviel trading scandal’.16

  • •  There were also stories on (i) ‘shareholder revolts’ over bonuses and salary increases proposed for executives at Provident Financial and over the performance of Ken Lewis, the chief executive of Bank of America, who had been forced to resign as chairman of the bank the previous week and who, it was felt, might lose his remaining position because of shareholder disquiet over the bank’s ongoing need for new capital and (ii) the award of a ‘£9.8m pension pot’ to Gordon Pell ‘the last remaining executive director from Sir Fred Goodwin’s tenure at Royal Bank of Scotland’ on his retirement from that bank. It was suggested that ‘the payment is likely to ignite further controversy’.

5.08  The post-Financial Crisis themes are not so different from those in the pre-Financial Crisis period but the Financial Crisis added various new twists to the complaints about, for example, banks ‘gaming the system’ and the use of ‘innovation’ for this purpose and the generosity that boards of directors appeared to show towards senior executives. Banks are, in the post-Financial Crisis world, regarded not only as responsible for all the woes that have come with the Financial Crisis but are also judged to have been staffed by individuals who seemed able to ignore any constraints that a reasonably rigorous corporate governance system might have been expected to impose. Bonus and pension arrangements became subject to intense media scrutiny, not least because many of the banks in question were only kept afloat during the Financial Crisis by very large injections of ‘taxpayers’ money’. The ‘revenge’ for the perceived shortcomings of the banks and their executives is taking a number of forms. One of them is an increased willingness to fire executives when they disappoint (or even sue them)17 and this often follows so-called ‘shareholder revolts’.

(p. 62) 5.09  It is important for the risk management function to develop and maintain a keen sense of when legal risk is likely to be present. This needs to be coupled with an awareness of when the risk is likely to be material. Andrew Whittaker, then General Counsel of the FSA, in a paper published in 2003, identified four circumstances when legal risk ‘is particularly likely to be high’.18 These are:

  1. (1)  where the legal risk challenges the firm’s business model or business practices;

  2. (2)  where it leads to large or uncertain liabilities;

  3. (3)  where it impacts across the industry as a whole rather than being confined to a single institution; and

  4. (4)  where it crystallizes rapidly.

5.10  But have we become obsessive about risk? The Financial Crisis seems only to have intensified a social trend that was already well established. Observers have commented that we seem to have become more preoccupied with risk, and risk management, than might be good for us.19 At government level, for example, public procurement policy has for some time been dominated by the Private Finance Initiative,20 which is in turn justified in very large part by its perceived effect of ‘transferring risk’ from public to private sector. The FCA/FSA itself frequently used to refer to its ‘risk-based’ approach to regulation21 and, apart from its annual business plan, also produces a ‘Financial Risk Outlook’ each year. At the level of private enterprise, we see that many companies now have a ‘Chief Risk Officer’ as well as a Chief Financial Officer, Chief Executive Officer, etc.

5.11  The preoccupation affects all walks of life (and seems to go hand-in-hand with the ‘compensation culture’). For example, in the context of running a school, (p. 63) head teachers find that they are now severely constrained in relation to activities such as field trips, which require detailed risk assessments to be carried out beforehand. One senses that there is a great deal of second guessing and wisdom after the event involved if, heaven forbid, any accident should occur. One head teacher has complained that ‘so far as organising trips is concerned, our increasingly risk-averse, bureaucratic and lawyer-plagued culture means that many children are already being deprived of opportunities’.22

5.12  Concern about the perception that there is ‘for every injury someone to blame’ prompted the then Lord Chancellor, Lord Falconer, to issue a statement on 10 November 2004, which was very widely (and sympathetically) reported, decrying the growth of highly speculative litigation and the misuse of ‘Conditional Fee Arrangements’ and demanding that ‘we must break the cycle’. The statement (which was largely concerned with personal injury claims but is nevertheless clear evidence of the extremely litigious climate that now affects all businesses) was accompanied by the threat that ‘if the claims management sector does not put its own house in order we will consider how new formal regulation could be introduced’. The theme was taken up by the then Prime Minister, Tony Blair, in a speech reported by The Times on 27 May 2005:

The Prime Minister called for new laws yesterday to demolish the myth of the compensation culture and rein in ambulance-chasing companies. Britain was in danger of developing a disproportionate concern about risks, Tony Blair said … The perception of the ‘so-called compensation culture’ had the adverse effect, causing public bodies and others to act in ‘highly risk-averse ways’, he said. Too often the knee-jerk response from public bodies was to do everything to avoid blame in a ‘something must be done’ culture. ‘In the end, risk is inescapable,’ Mr. Blair said. ‘Government cannot eliminate all risk. But too often our reflex as a society is to regulate and to introduce new rules … If we start to believe that every possible problem must be avoided at all costs we end up with a mindset that says that nothing good should happen in case it leads to something bad. Irrational decisions should not be made through fear of litigation. Rather, there should be a commonsense culture, not a compensation culture.23

(p. 64) 5.13  Most would agree with these sentiments. If entrepreneurs (including banks) are to maintain an appropriate appetite for risk, how are they to cope with this claims culture (or, as described by a former Lord Chancellor, ‘have a go’ culture) which walks hand-in-hand with a general risk-averse mentality? The regulators must obviously allow that entrepreneurs can take risks; but they must ‘manage’ them. In the post-Financial Crisis world, banks are now also told that they must refrain from taking ‘undue risks’—a concept that owes a great deal to hindsight rather than genuine, objective analysis. This ties into the ongoing governance debate.24

5.14  Risk management is not the same as risk avoidance. It follows that risk management systems are not designed to ensure that risks never materialize and losses never ensue. However, in the aftermath of accidents and disasters of any kind, as well as events that cause purely financial loss, we have developed an unfortunate tendency to assume that there must have been something wrong with the risk management function for such an event to have occurred. The same can be said for the regulatory system itself. If a bank fails, we assume automatically that there has been a ‘regulatory failure’. (In each case, someone must be found to take the blame.) The spotlight on risk management procedures (and regulation) thus grows more and more intense. As Nugee and Persaud point out:25 ‘Risk management is a great business. But it almost seems that the more vigilant we are and the more safeguards we build into accounting rules, bank stress tests and contingency reserve funds the more new risks emerge. There is evidence that the adoption of risk management practices in institutional investment in the 1990s has increased, not reduced, volatility in financial markets.’

5.15  Some feel that risk management is now somewhat overrated as a science or set of skills. However, one result of the Crises will surely be that risk management, as a growing science, discipline or even profession will be with us for the foreseeable future.

5.16  Similar sentiments are encountered in relation to ‘consumerist’ trends in society. A degree of scepticism may indeed be healthy but, as Callum McCarthy, the then Chairman of the FSA, pointed out, those who make the argument that:

… regulatory concern for consumer protection purposes is overdone … tend to forget the scale of past problems: pensions mis-selling has involved compensation payments of £11.5 billion; the losses associated with split capital trusts—depending on how they are calculated—are variously estimated to amount to between £650–£900 million for the zero dividend preference share holders; precipice bonds mis-selling—a recent event—has so far involved compensation of over £150 million and is very far from finished.26

(p. 65) 5.17  It is not immediately obvious why the fact that very large sums have been paid in compensation is a complete answer to the suggestion that perhaps we are making it too easy to make allegations and claims that lead to such a result. However, the legal risk management function has, of course, to deal with the ‘consumerist’ regulator as a fact of life.

5.18  Whether or not the problems associated with operational risk are exaggerated, legal risk, as a component of operational risk, has played a very significant role in this context. The extreme difficulties of the Equitable Life Assurance Society27 were largely sparked off by litigation that went to the House of Lords and the case of Hazell v Hammersmith and Fulham London Borough Council28 gave rise to widespread concern as to the validity of, and the recoverability of moneys paid, in ‘swap’ transactions (ie derivative transactions) involving local government (and to some extent, building societies). As these cases show, legal risk, like many other kinds of operational risk, is one of the most difficult to deal with because it tends to be ‘low probability/high impact’. In other words, situations triggered by legal risk do not generally happen very frequently (and historical data are not very illuminating), but when they do they can cause extremely serious problems. The Giovannini Group has observed that, ‘experience suggests that financial institutions often fail to manage adequately very low probability risks of catastrophic events, which may have the nature of externalities’.29 Legal risk, and related questions such as how and why it arises and what it actually is, need to be taken seriously.

5.19  The analytical exercise involved in describing precisely what we mean by legal risk is a complex one. As with the definition of law itself, most definitions of legal risk tend to have ‘fuzzy edges’. Definitional issues and the general characteristics of legal risk are considered in some detail in Part VII of this book.30 Finding an appropriate definition is not an academic exercise. It is important for financial institutions, particularly with the new emphasis that is being placed on ‘governance’ and culture, to have a clear understanding, reflected in established procedures, of who is responsible for the management of different kinds of operational risk.

5.20  It is not practical or sensible to consider legal risk in isolation from other kinds of risk. However, the Basel II and III regulatory approach requires some degree of precision. Analysis of where the line is to be drawn is important not only for allocation of responsibility within an institution but also for developing appropriate risk management procedures. The handling of a court case in England involving, say, a claim that a spouse’s guarantee of a customer’s loan is invalid is likely to (p. 66) involve different procedures to those that may be relevant for handling an assertion that a bank’s loan or security documentation in a country where it does very little business does not conform to the local legal requirements in that country unless and until a relatively insignificant stamp tax has been paid. Certain kinds of legal claim may have precedent-setting implications for a broad range of the bank’s business whereas other legal problems may be capable of being ring-fenced to a particular country or perhaps a particular customer. Nevertheless, although there may be differences in procedure, the underlying rationale for analysis and management will be more effective if it is consistent with a coherent model which explains and identifies legal risk as a whole and contains a proven and accepted methodology for its assessment and mitigation, including a system of reporting, assessment, decision-making, and recording. Those who are faced with difficulties of the kind described in the Financial Times and Wall Street Journal articles referred to above will no doubt accept that, whatever the parameters of the legal risk concept may be, you tend to know it when you see it. The problem is: you can’t always see it coming.


1  Mervyn King, in his evidence to the Treasury Select Committee on 26 January 2010.

2  King, The End of Alchemy (Little, Brown, 2016) at p 8.

3  See para 24.51.

4  See Bamford (former Chief Executive of Financial Law Panel), ‘The Banker/Customer Relationship Fiduciary Duties and Conflict of Interest’ (paper presented to International Bar Association Committee, Berlin Conference, 24 October 1996). This paper does in fact conclude that in relation to conflict of interest and fiduciary duties ‘the courts are themselves adapting the requirements to market expectations and circumstances’.

5  In a regulator context, ‘standards’ refers to a level of fitness and proprietary, skill and care, and/or market conduct, expected of a person (whether ‘natural’ or ‘legal’) in the proper discharge of a duty or responsibility. The FCA, for example, issues ‘guidance’ alongside its various rules, which would generally be regarded as representing the ‘standard’ expected by the authority in order to comply with that rule. Outside the confines of the FCA Handbook, ‘standards’ are adopted on a voluntary basis. In a similar vein, they may pertain to matters of individual competence or extend to market practice norms. An example of this can be found in the work of the Banking Standards Board and FICC Market Standards Board (see Ch 12).

6  See for discussion, Ch 13.

7  As evident by the increase in complaints referred to the Financial Complaints Commissioner in the 2015–2016 financial year concerning the actions, predominantly, of the FCA (although the PRA is not without its critics). In its Annual Report 2015–2016, the Office of the Complaints Commissioner observed that factors relating to staff turnover, rising workload, and the significance of criticism and uncertainty during the year contributed to the FCA’s tendency to be defensive in the face of criticism. The Commissioner noted that ‘while the FCA continues to deal with the majority of complaints competently and fairly, I have seen examples of an unwillingness to face up to and admit shortcomings, and delays in dealing with “awkward” cases.’ In late 2014, the FCA came in for severe criticism for its mishandling of a press briefing into a proposed investigation into insurance back books which led to significant falls in the shares of leading insurers and later, in January 2016, by the Treasury Select Committee for its quiet abandonment of its banking culture review.

8  Dated 13 September 2004. The same issue also contains articles on the desire of the accountancy firms for legal limits to their liability for negligent audit work and on the European Commission’s desire to see ‘more private law suits brought against companies accused of breaching anti-trust rules, bringing Europe’s competition regime more into line with the US system’. As regards the position of accountants, the collapse of the Italian company, Parmalat gave rise, amongst other things, to a US$10bn claim (in the USA) by the company’s administrator against the company’s auditors.

9  The tribunal later upheld the FSA’s claim that there were defects in certain sales procedures but also criticized the FSA for over-reliance on relatively slender evidence as to the degree of mis-selling. In a further ruling on 26 May 2005 the tribunal cut the original fine imposed on L&G from £1.1m to £575,000, but did not allow L&G costs (which would almost certainly have been more than the fine). The tribunal also, according to the Financial Times of 27 May 2005, described the FSA investigators as having been ‘more concerned with identifying reasons for maintaining sanctions than objectively evaluating the evidence’. And it noted that the FSA’s refusal to disclose to firms what goes into its ‘case review papers’—which the Regulatory Decisions Committee sees—is ‘open to inadvertent abuse and an enemy of transparency’. Criticism in the same vein has come from the Association of British Insurers (press release of 21 April 2005) which comments that ‘The FSA must be fair, and be seen to be fair. It must demonstrate more openly that the work of the Regulatory Decisions Committee (RDC) is “independent, fair and robust”. In particular, the ABI argues that firms being investigated are entitled to know precisely what evidence has been presented about them to the RDC by FSA officials and given adequate opportunities to respond.’ The Daily Telegraph, 28 May 2005, was particularly virulent in its criticism of the FSA, commenting, ‘It’s no exaggeration to say the whole of the financial services industry was willing L&G on. Companies large and small are heartily sick of the way the FSA works, churning out more directives than the human brain can comprehend and imposing fines for laughably trivial breaches of the money-laundering rules.’ The FSA responded to the criticisms of the procedures of its RDC by making various procedural changes, announced on 19 July 2005.

10  The Wall Street Journal, 20 April 2005.

11  According to the Financial Times of 16 and 18 May 2005, Morgan Stanley have, since the date of the above article, been ordered by the Florida court to pay $604.3m in ‘compensatory’ damages and $850m in punitive damages to Mr Perelman. The judge in the case, having found evidence of ‘bad faith’ in respect of certain aspects of the bank’s handling of the case, ordered the jury to assume that Morgan Stanley ‘had aided and abetted Sunbeam to defraud Mr Perelman’. The jury are now to decide whether or not to award punitive damages. (Mr Perelman claimed $2.7bn in actual and punitive damages.) At the time of writing, the bank is expected to appeal.

12  ‘Tougher capital provisions for banks on risky products’ (Nikki Tait).

13  ‘How banks learn to play the system’ (John Gapper).

14  ‘Insolvent banks should feel market discipline’ (Matthew Richardson and Nouriel Roubini).

15  ‘FSA swoops in £28m fraud inquiry’ (Jennifer Hughes and Michael Peel). The FSA’s zeal for pursuing alleged insider traders continues, with high profile arrests becoming more and more common.

16  ‘SocGen hands chairman’s role to Oudea’ (Scherezade Daneshku).

17  Yet another story from the Financial Times of 7 May 2009 refers to ‘Cherie Blair’s first foray into the world of US corporate class action lawsuits’ (acting as a special adviser to two UK pension funds suing Royal Bank of Scotland).

18  ‘Legal Risks and the Basle Capital Accord’, presentation to International Bar Association Financial Law Seminar, Munich, 22 May 2003.

19  See especially Michael Power, ‘The Risk Management of Everything’, paper published by Demos (2004) (<http://www.demos.co.uk>): ‘… the story of operational risk characterises a new risk management in which the imperative is to make visible and manageable essentially unknowable and incalculable risks. New categories are a part of the appearance of manageability, a conceptual ‘mopping-up’ exercise involving definitions and formalisations …’ Power also observes that ‘the implementation process under the Basel 2 proposals remains controversial. Much discussion has taken place about what constitutes an operational risk “event” (actual loss, possible loss, a near miss?). Furthermore the case of Barings suggests that significant operational risk events … by their very nature … lack rich historical data sets and exist at the limits of manageability. However, a great deal of operational risk management activity in financial institutions in fact focuses on routine systems errors and malfunctions. In many cases it is as if organisational agents, faced with the task of inventing a management practice, have chosen a pragmatic path of collecting data which is collectable, rather than that which is necessarily relevant. In this way, operational risk management in reality is a kind of displacement. The burden of managing unknowable risks, a Nick Leeson, is replaced by an easier task which can be successfully reported to seniors.’

20  Now frequently referred to as ‘Public Private Partnership’.

21  This terminology was also adopted by the then Chancellor of the Exchequer, Gordon Brown, in connection with non-financial regulation as well as financial regulation: see HM Treasury announcement of 24 May 2005, launching the ‘Better Regulation Action Plan’ (which will feature a Better Regulation Bill as well as a Deregulation Bill to be presented to Parliament).

22  See Lenton, ‘Litigation, Litigation, Litigation’, The Spectator, 18 September 2004. See also speech given on 2 May 2005 (to the National Association of Headteachers) by Sir Digby Jones (the Director-General of the Confederation of British Industry) in which he said: ‘We, and especially politicians and the media, are all taking part in something of a deceit because we are teaching the next generation that risk doesn’t exist … Don’t play conkers in the playground, you might get hurt. Don’t do backstroke in the swimming pool, you might bump into somebody. Don’t take kids canoeing on a Saturday, they might put you in the slammer … Unless we educate children about risk, get them to understand it, embrace it and exploit it, then we will fail as a nation.’

23  Mr. Blair also made some remarks in this speech which appeared to be critical of the FSA. The language used was cautiously worded; ie the FSA was ‘seen as’ being ‘hugely’ inhibiting to efficient business. The FSA responded by asking Mr. Blair to substantiate his remarks. Both The Times and the Financial Times roundly condemned his comments about the FSA. In the post-Crisis world, the views expressed by Mr. Blair seem more out-of-fashion than ever, although this author, at least, remains sympathetic to his concerns about the growth of the compensation culture.

24  Para 8.92 et seq.

25  Financial Times, 17 September 2004, 19.

26  Mansion House speech, 21 September 2004.

27  This is the world’s oldest mutual insurance company; the adverse court ruling ultimately forced it to close its doors to new business. See further, the Penrose Report, March 2004, HC 290.

28  [1992] 2 AC 1; see generally Ch 20 below.

29  See the Second Giovannini Clearing and Settlement Report, 29.

30  See also Intro 1.05