Criminal liability for senior bankers

Publication | October 2014

Banking Reform Legislation

The UK Financial Services (Banking Reform) Act 2013 marks a turning point in financial regulation in the United Kingdom. Among many other features, the introduction of criminal liability for senior bank management in the case of bank failure emphasises the notion of personal responsibility for reckless decision-making. This article examines the new offence and makes some practical recommendations on steps financial institutions can take to manage investigations which may lead to prosecution under the new offence.

On December 18, 2013 the UK Financial Services (Banking Reform) Act 2013 (the ‘Act’) received Royal Assent. The Act updates the regulatory regime for banking in the UK. Its many innovations reflect the often competing choices facing the legislators – the desire to prevent another financial crash has to be balanced against the importance of maintaining London’s status as a global financial centre, unfettered by unnecessary constraints. Among the many changes introduced by the law, one of the most significant, in scope and symbolism, is the introduction of a criminal penalty for bankers whose ‘reckless’ decisions are found to have caused a bank’s failure.

The backdrop to the introduction of the new legislation was the widespread belief that the 2008 financial meltdown was caused by negligent failures in bank governance. In response to calls for a complete overhaul of the regulatory regime for banks, two commissions were set up by the UK government between 2010 and 2012: the Independent Commission on Banking and the Parliamentary Commission on Banking Standards (the ‘PCBS’). Both were extremely critical of the regulatory regime in place and recommended a raft of changes to rectify what the PCBS report referred to as ‘profound lapses of banking standards’. One recurring feature of their reports was a criticism of the lack of attribution of individual guilt for the bank failures. In other words, the commissions saw the financial meltdown as having stemmed as much from the failure of individuals to make properly considered decisions as from systemic failures. This recognition echoed calls from regulators for new prosecutorial tools. As far back as 2011, Richard Alderman, the then director of the Serious Fraud Office commented that there was the need to introduce ‘some kind of offence of being involved with recklessly running or being involved in the running of a financial institution’. With that in mind, a central theme of the PCBS’s final report in June 2013 was ‘to make individual responsibility in banking a reality’ and among other things, it stated that that there was ‘a strong case in principle for a new criminal offence of reckless misconduct in the management of a bank’. The report added that such an offence would provide regulators with a tool to prosecute the most egregious of failings, ‘such as where a bank failed with substantial costs to the taxpayer, lasting consequences for the financial system, or serious harm to customers.’

Nuts and bolts of the new penalty

Simply put, the new regime is aimed at deterring senior management from reckless decision making. ‘Senior management’ is defined as a person who carries out a specific function (as per section 37(7) and (8) of the Act) at a UK incorporated bank, investment bank or a building society. The crime of ‘reckless misconduct’ in managing a bank has three constituent elements:

  • the manager’s decision, whether active or passive, caused the failure of the financial institution in question (for the purpose of this section, ‘decision’ has been broadly defined to include a failure to prevent a decision)
  • at the time the decision was taken, the manager was aware of the risk that such a decision might cause the failure of the financial institution (or its group companies)
  • the manager’s conduct was ‘far below’ the reasonable standard expected from a person in such a position.

Proceedings in respect of this offence may be instituted by the Financial Conduct Authority (the ‘FCA’), the Prudential Regulation Authority (the ‘PRA’), the Secretary of State or the Director of Public Prosecutions. Moreover, under section 38(4), if proceedings are instituted by the FCA or the PRA they must comply with any conditions imposed by the Treasury in this respect. A successful conviction could lead to the individual being imprisoned for up to seven years and/ or fined an unlimited amount.

The implications of a prosecution are therefore very serious for the individuals concerned. However, the drafting of the Act raises questions about the likelihood of a successful conviction since the Act delineates an extremely narrow category of behaviour that is required to be proved. To be found guilty of the offence, the person’s decision must have ‘caused’ the bank’s failure, they must have ‘been aware’ that their action could cause the failure of a bank or any of its group companies and their behaviour must have fallen ‘far below’ reasonably expected standards. How these issues will be interpreted will only become clear at the judicial stage. For example, the government argued during the Parliamentary debates on the bill that ‘causing’ the bank’s failure should be understood as having significantly contributed to the failure. However, this interpretation is unsupported by a plain reading of the Act.

Practically speaking, whilst the financial institution employer of an individual subject to an investigation for this offence would, by definition, have failed, there is likely to be a continuing entity. The management of this entity will need to be alive to the problems posed by an investigation. Separately, it is noteworthy that the offence seeks to cast a wide net by making the management of a financial institution potentially liable for the failure of any of its group companies. Therefore, even if the entity at the top of the corporate tree is alive and flourishing, the collapse of a small subsidiary could still lead to potential exposure.

Practical impact of the new criminal offence

In examining a potential offence under this section, investigating authorities are likely to require a high degree of access to the financial institution and its records. The interference of an ongoing investigation may prove to be a significant burden for the institution in question. Some of these problems are:

Breadth of the investigation: In the absence of any available guidance on what ‘causing’ a bank’s failure might mean and given that the cause of the failure will not usually be clear, we assume an investigating authority would wish to review almost every senior management decision taken over the relevant period. This could raise difficulties for an institution which does not have proper records of its major decisions and where many decisions may have been taken

Interference with the continuing institution’s daily functioning: An investigation may be a drain on management time, particularly if the financial institution does not have good record-keeping practices and transparent decision-making processes

Potential cause of management conflict: By its very nature, the new offence criminalises individuals’ actions by holding them responsible for having caused the bank’s failure. However, decision-making in large institutions is frequently a collaborative process with inputs from various stakeholders. An investigation of this sort would be likely to take place many months or years after the decision itself and may cause conflict and dissension among the continuing management.

As an investigation may be triggered months or years after the allegedly culpable decision was taken it is important that detailed records are kept of the decision making processes followed. Any financial institution which considers its record keeping procedures to be inadequate should consider strengthening them now.

There is a risk that the offence may prompt senior management to take overly cautious and defensive decisions. Banks may have to institute clear processes to ensure that the quality of decision-making is not affected while similarly ensuring that the time taken to make decisions is not unduly lengthened.

Conclusion

There is much criticism of the likely ineffectiveness of this offence and the significant hurdles for the regulators to overcome in successfully prosecuting under this provision. For example, a prosecutor may struggle to prove that a financial institution collapsed because of mis-management as opposed to the cause being one of many other outside forces (e.g. fluctuations in interest rates or exchange rates; inter-bank illiquidity; changes in government policy; or a combination of these factors). However, even if a prosecution may ultimately fail, any financial institution (or its successor) which is investigated for the offence is likely be put under a great strain by the investigation.

On July 9, 2014 The Financial Services (Banking Reform) Act 2013 (Commencement No. 5) Order 2014 was issued, which enables the PRA and FCA to begin consulting on this offence and the other provisions under the Act concerning conduct of persons in financial sector services. The consultation process is unlikely to be completed before the end of this year. The offence is therefore likely to come into force by early 2015.

In the meantime, the presence of this new offence on the statute books should lead cautious financial institutions to re-examine their decision making processes, to ensure they comply with the highest standards of transparency.

The Government clearly hopes that the offence will work alongside the other provisions of the Act and the new Senior Persons Regime to effect a fundamental change in the nature of decision-making in financial institutions (even though some may argue such a change had already occurred). As the government noted in its response to the PCBS report, ‘bank directors must maintain an awareness of their responsibility to safeguard the security and stability of their firm. […] changes to introduce new criminal sanctions for recklessness will further sharpen directors’ focus on their personal responsibilities and duties in respect of the firm.’


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Neil O'May

Neil O'May

London