Cable may tie down Goodwin, despite his eluding the FSA’s net; Turner and Sants call for smaller holes

21 September 2012

In response to the October 2008 failure of RBS, news reports suggest that Vince Cable MP, Secretary of State for Business, Innovation and Skills, may apply for an order to disqualify Fred Goodwin from being able to hold any future directorship of a UK company.

This is in contrast to the FSA’s much criticised report of December 2011 which concluded that there was ‘not sufficient evidence to bring enforcement actions’ against Goodwin and his senior colleagues.

The FSA report concluded that Goodwin and the RBS board were ‘ultimately responsible’  for making poor decisions which, in the context of the financial crisis, caused the failure of RBS.   However, the errors and poor decisions that the FSA was able to identify did not justify enforcement action under their rules and guidelines.  As the report states, ‘errors of commercial judgement are not in themselves sanctionable’.

The report considered the investigation into whether Goodwin and the RBS management had acted in compliance with FSA guidelines and found no evidence that they had not.  One area the report discusses is whether Goodwin, in his role as CEO, delegated responsibility to appropriate board members in the manner required by the FSA guidelines.  APER guidance outlines the need for ‘clear and effective delegation and reporting lines’, (APER 4.6.11 G).  Despite questioning the quality of Goodwin’s judgement when making certain decisions, the FSA were unable to find any rules or guidelines which had been broken during the failure of RBS, and thus concluded they would be unable to sanction him.

The inability of the FSA to take enforcement action against Goodwin has attracted criticism. This may intensify if Cable is able successfully to apply for his disqualification.  If the reports are accurate, Cable would likely apply to the court for a disqualification order against Goodwin under Section 8 of the Company Directors Disqualification Act 1986.  This requires the Secretary of State to be satisfied – on the basis of investigative material – that disqualification is ‘expedient in the public interest’.  The court would then have to be satisfied that Goodwin’s previous conduct makes him ‘unfit to be concerned in the management of a company’.  The broader language of this Act, in comparison to the FSA’s detailed rules and guidance, may go some way to explaining the potential for action against Goodwin.

The ‘investigative material’ upon which Cable might base his decision could – interestingly – be the very materials obtained and considered by the FSA.  Investigative material explicitly includes a report made under sections 167, 168, 169 or 284 FSMA, as well as information or documents obtained via sections 165, 171, 172, 173 or 175.  If the case, it will clearly highlight the discrepancy between the two regimes, and provide further ammunition to those who call for greater powers for the financial regulator.

When the FSA report was published in December 2011, Lord Adair Turner, Chairman of the FSA, anticipating criticism of the Authority’s inability to take any action against Goodwin, suggested alternative approaches that could be taken in the future. One option he mooted was an ‘automatic incentives based approach’ which would ensure that executives and boards faced immediate consequences for the failure of banks.  More dramatically, he suggested a ‘strict liability approach’ which would make executives and board members personally responsible for the adverse effects of poor decisions. This approach would establish rules which would ‘automatically ban senior executives and directors of failing banks from future positions of responsibility in financial services’; a punishment which echoes the actions Cable may be poised to take.  Lord Turner acknowledged the potential controversy of the option – recognising the ‘complex legal issues’ it would involve and noting the potential for injustice.

In his last speech as CEO of the FSA, Hector Sants opined on ‘Delivering effective corporate governance: the financial regulators role’ and supported the idea of “a presumption that if you are on the board of a bank that fails then you should not be allowed to carry out that role in the future. The onus should be on the individual to demonstrate otherwise“.

If Cable is able to secure Goodwin’s disqualification, it is likely to intensify pressure for reform.  This may include something akin to the strict liability approach Lord Turner outlined.  However, such an approach – punishing individuals for honest mistakes which, with the benefit of hindsight, did not work out commercially – could sit in contrast to the objective of the PRA.  As currently drafted in the Financial Services Bill, this is simply: ‘promoting the safety and soundness of PRA-authorised persons’.  In pursuing that objective, the PRA is not to seek to ensure that firms do not fail, but will be ‘seeking to minimise the adverse effect that the failure of a PRA-authorised person could be expected to have on the stability of the UK financial system.’

What motivation would there be for directors to admit fault and work to secure the orderly wind down of their firm if they are faced at the same time with an automatic disqualification from further employment?  We will have to wait and see what powers the Treasury proposes, but if too strict, as noted by Lord Turner, it might ‘discourage some high quality and high integrity people’ from working in regulated firms.

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