Learning lessons from FCA action - SMR

Posted: 30th March 2015

The FCA has fined and banned two former senior executives of Martin Brokers (UK) Ltd for compliance and cultural failings at the firm.

This follows previous enforcement action against Martin; in 2014 the FCA fined Martin £630,000 for misconduct relating to the London Interbank Offered Rate (LIBOR). LIBOR manipulation is clearly one of many topics that have garnered a huge amount of attention and even more monumental fines.

We seize at the lessons from the culture and conduct of Martin and its senior management, and look at how these lessons can be echoed in the business models, strategies and governance structures of many financial services firms.

SO WHAT WENT WRONG?

Two former key figures at Martin were fined and banned from performing ‘significant influence functions’ (SIF) at financial services firms. The firm’s former chief executive, David Caplin was fined £210,000 whilst a former compliance officer, Jeremy Kraft was fined £105,000.

From this, we see the FCA is using its new ‘significant influence function’ powers to fine individuals for cultural failings within a firm. In particular, failing to recognise and prevent misconduct borne out of a culture that gave undue weight to revenue generation at the expense of promoting a culture of regulatory compliance. In the words of Georgina Philippou, Acting Director of Enforcement and Market Oversight at the FCA:

“This case and other recent SIF outcomes should serve as a warning to everyone that holds a significant influence function that if a firm’s misconduct can be attributed to cultural failings, then we expect senior management to answer for this.”

Here we take a balanced look at the essential messages behind the FCA’s actions and comments.

POOR TONE FROM THE TOP

It was the firm’s weak compliance culture that revealed Caplin’s shortcomings. The FCA found that Caplin, as CEO, allowed a culture to develop which prioritised profits to the detriment of regulatory compliance.

Kraft on the other hand, as an FCA approved Compliance Officer, did not challenge Caplin on compliance matters, and abdicated responsibility for monitoring and supervising brokers. He also failed to recognise the risks associated with its brokerage activities including the risk that brokers could collude with traders. As a result, the compliance culture was complacent, exceptionally weak, and in breach of Principle 3.

WHAT OF YOUR FREEDOM OF SPEECH POLICIES? HOW DO YOU CHECK THAT STAFF FEEL SAFE TO SPEAK OUT?

We consider a strong risk and compliance culture running through the entire organisation, as essential. Such cultures are difficult to achieve without the direct, active and demonstrable sponsorship and support of the board and senior management. The right kind of culture can also be achieved if each part of the business is actually encouraged to challenge the strategy, policies and procedures provided by senior management, without fear that this could negatively affect remuneration or employment.

With increased accountability at the feet of senior management and uplift in senior management attestations required by the FCA, we encourage firms to consider the learnings from these fines and to think about the following: 

• Do the leadership, strategic direction and priorities of your firm encourage the right behaviours and focus for senior management and employees?
• Have you considered the importance of customer feedback and the role it plays in developing your strategy, products and services?
• Could your employees stand up to or disagree with those at the top, without adversely affecting their career?
• How can risks and poor practises be identified, escalated and addressed by your firm’s ‘control environment’ and internal management information (MI), without any fear or blame?
• What of your freedom of speech policies? How do you check that staff feel safe to speak out?
• How do you know your whistleblowing processes are effective? Can you evidence that issues get fixed without anyone being blamed as a result of an escalation?
• How do you know that performance management and reward schemes are encouraging the right behaviours?

THE DECISION MAKER

Caplin was a “dominant personality” according to the FCA. He assumed de facto responsibility for overseeing and monitoring broker conduct. His authority over Martin’s small trading floor was absolute and we can only speculate that there was an imbalance of decision-making power.

It may still be the case that some organisations have the CEO as the Chair or sole authoriser of all important decisions. This may make many staff feel inhibited to make or challenge decisions. That said, this is an opportunity for firms to look at their own control equilibrium:

• Look at the balance of power at your firm – is it skewed heavily towards one or two individuals? Could empowered structures and committees that share significant responsibilities - not only across Directors, but involving the more independent supervision of the Non-Executive Directors - bring greater balance?
• With a committee, comes the need for some governance of its own. How often are these committees audited or have a ‘second line overview’ that looks at the proper execution of their responsibilities? How can you yourself be assured that they are effective and then evidence this?
• Every member of staff has an important role to play in the management and mitigation of risk within a firm. How do you know whether staff are aware of their responsibilities with regard to identifying, managing, monitoring and reporting risks?
• One of the key components of an effective governance structure is challenge throughout the structure – including at board, senior management and committee level. How do you judge the quality and effectiveness of the challenge process?

PROFITS AND ETHICS

The FCA found that the firm’s culture prioritised profits, lacked ethics and provided lavish entertainment to traders in exchange for commission income, whilst Caplin engaged employees in part by awarding brokers bonuses equal to about 30 percent of their net commissions. Financial services companies obviously exist to make money, and many reward people highly for doing so, but to avoid this affecting your customers and ultimately your firm negatively, ponder the following:

• What are the payoffs for your organisation? Are they solely profits?
• Are you also rewarding people for compliance and good practice?
• Is your reward and remuneration the root cause of why customers are being treated unfairly?

INDEPENDENT REVIEW AND ADVICE

The points made, as well as the fact that Kraft did not act on the advice of an external compliance consultancy – one which identified some serious compliance flaws at the firm – surely goes to highlights the important of such advice. External healthchecks from a firm such as Huntswood can greatly assist by giving an independent view of the regulatory health of an organisation.

In this vein, until the fundamental behaviours of staff are understood through assessing a firm’s culture, until there is traction for change from leaders, and until new behaviours are encouraged over time, we believe we will see many more poor practices and subsequent fines.