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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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