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6 Law & Fin. Mkt. Rev. 1 (2012)

handle is hein.journals/lawfinancmr6 and id is 1 raw text is: Editorial The FSA Board Report on RBS: enforcement and law reform The recently published FSA report on the collapse of the Royal Bank of Scotland (RBS) fills in some of the detail surrounding the collapse of the bank and provides some valu- able insight into the reasoning that underlies the absence of enforcement action on the part of the FSA. It also provides a useful update on the manner in which supervision of banks is evolving in the wake of the financial crisis. However, it leaves unresolved the apparent compliance conundrum which is encompassed in the first question which the report is intended to address: Why has no one in the top management of RBS been found legally responsible for the failure and faced FSA sanction? Implicit in the question is an expecta- tion that a failure on the scale of RBS must be inextricably linked with breaches of regulatory rules, for if that is not the case the rules are of little or no value in preventing such outcomes. The answer ultimately given in the report is that there was no prospect of success in FSA enforcement action because the relevant conduct of directors and senior inanag- ers of RBS could not be shown to be in breach of the rules. However, in recognition of the fact that such a conclusion simply deflects attention back to the role of regulatory rules, the FSA goes on to ask whether if action cannot be taken under the existing rules, should not the rules be changed for the future? In particular, the FSA canvasses two reforms. The first is that some form of strict liability be applied to directors and senior managers for the adverse consequences of poor decisions, making it more likely that a bank failure such as that of RBS would be followed by successful enforce- ment actions, including fines and bans. That approach was followed by the Joint Parliamentary Committee in its report on the draft Financial Services Bill on the basis that it would strike a different balance between risk and return.2 The second proposed reform is that major takeover bids made by banks should require regulatory approval in the light of the potential risks that are posed by a bid (such as that made by the RBS-led consortium for ABN AMRO) that goes wrong. Each reform option is considered in turn below. Strict liability for bank directors and senior managers Strict liability is a regulatory strategy that works well when parties subject to the liability are able to take precautions to reduce harm and to engage appropriately in activities that may cause harm. For that reason it has been employed in regulatory regimes relating to consumer protection (such as product safety and food safety) and environmental protec- tion. Underlying the application of strict liability in those regimes is the premise that the parties subject to strict liability have the capacity to control the risks to which their custom- ers and society are exposed. The salient question for banks is whether that premise holds true with respect to the risks that arise from banking activities. It is certainly the case that banks can control credit and market risk as well as liquidity risk and thereby limit the probability of their own failure. Strict liability for directors and senior managers might well encourage further caution and thereby limit the risk of failure of a single institution but it is not clear that strict liability can contribute effectively to the control of systemic risk. One reason is that since systemic risk arises from the interconnections within the banking system, it is difficult for an individual institution to put in place measures which will prevent or mitigate systemic risk. Indeed, that conclusion forms much of the basis for regula- tory intervention because it ultimately leads to the conclusion that, even during times when it is particularly strong, market discipline cannot be relied on to control systernic risk. Making directors and senior managers responsible for bad outcomes would not help to prevent systemic risk because strict liability is an ex post remedy which, although it may act as a general deterrent against risk-taking, cannot facilitate the taking of cx ante precautions. Thus, the underlying policy of strict liabil- ity to encourage the taking of preventative measures is not directly applicable to systemic risk in the banking sector. In that sense strict liability cannot support banking regulation in a manner similar to that in which it operates in other regula- tory regimes. Front the alternative perspective of the promotion of accountability of bank directors and senior managers to share- holders, strict liability may have some initial appeal, especially since the balance of risk and reward has become so heavily skewed towards the former in recent years.Thus, an argument may be made that the traditionally protective approach of corporate law towards the liability of directors is not appro- priate in a context in which the balance between risk and reward has moved so far away from the norm. On that basis, strict liability within the FSA regulatory regime (and in par- ticular SYSC and APER) may be viewed as an appropriate response to a corporate law framework that retains its protec- tive policy even in the face of spectacular business failure. However, several objections may be made to that approach. One is that the balance between risk and reward may be better resolved through further development in the disclosure regime for remuneration and appropriate action on the part of institutional investors.4 Another is that strict liability may exacerbate the boundary problem' as between the regu- lated and shadow banking sectors, encouraging movement out of the regulated sector and thus potentially limiting the role of regulators in promoting financial stability. Finally, and perhaps most persuasively, strict liability would undermine the legitimacy of regulators holding individuals to account by removing the link between fault and personal responsibil- ity. Without that link, personal responsibility (in the form of Law1i and Finania Ma rkets Review January 2012

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