The clampdown continues apace

A month after JP Morgan agreed to pay regulators $920m in settlements for the so-called ‘London Whale’ trading scandal, it faces a potential record $13bn fine to settle investigations into its mortgage-backed securities. If agreed to, the settlement marks the latest in a long line of massive financial penalties.

Last year GlaxoSmithKline was hit with a $3bn settlement for marketing irregularities, while Johnson and Johnson paid out $1.1bn – also over marketing issues in the US.

And following the Gulf of Mexico oil disaster in 2010, BP has faced a series of potential fines and compensation claims that could run into tens of billions of dollars.

But are these huge fines just the price of doing business for large corporates? Or will they really serve to change the culture and risk management procedures of other companies by sending out a strong warning signal?

Vedanvi Business and Risk Consultancy managing director Jay Tikam believes regulators are now hitting back after the global economic downturn and the failure of Basel II.

He cites a 2013 US Government Accountability Office report putting the cost of the financial crisis to the US economy at $22trn and the Bank of England talking of £7.4trn of lost output.

Tikam also points to Financial Services Authority (FSA) penalties increasing year on year from £66m in 2011 to £337m between January and September 2013. (From April 2013 the penalties were issued by the Financial Conduct Authority (FCA), which replaced the FSA.)

He says: “Regulators allowed themselves to be manipulated into a light-touch approach. Amid severe criticism, they are now retaliating by moving to seize back and assert their powers.

“To rectify bad behaviours, enforcement action heated up. The regulator today, at least in the US and UK, is increasingly intrusive, aggressive and will not hesitate to wield its powers by issuing severe penalties, as in the case of JP Morgan. They are sending out a message that they mean business.

“Fines are not only being levied on firms but also individuals in their personal capacity for gross failure, negligence or misconduct.

“The regulators have achieved their intended desire, to rouse fear within the financial community in an attempt to clean up, hopefully once and for all.”

BDO LLP Financial Services Risk Advisory partner David Morrey says the increasing regulatory fines in the UK, US and Europe could see more corporates relocate parts of their businesses to Asia, where regulation is less stringent.

He says: “Being a multinational bank won’t stop you getting fined at the end of the day, but you don’t have to worry about the FCA doing a dawn raid on your premises in Shanghai because it doesn’t have any authority there.”

The fine line

He too believes a greater number of fines are going to be levied and says: “These things tend not to happen in isolation. If one company in one market gets hit for something, and if that means the regulator has got a sniff of an issue and made some money out of it, that will encourage them to look for others.

“So it is important to keep track of what is happening to others and doing a thorough ‘could this happen to us?’ piece.

“It is easy to say we have good policies and training, but you need to get a team out going through everything, confirming at every level of detail and looking at it all as the regulator would do.”

He adds: “Are regulators using risk management failings as a way of getting money out of companies? There is undoubtedly a punitive element to fines, or ‘agreed’ settlements, especially in the US, but increasingly in other countries.

“At one level, being fined by a government/regulatory sector that has shown itself to be extremely poor at managing its own risks is a bit hard to take.

“At another level, big banks in particular benefit hugely from implicit or explicit government guarantees and the high regulatory burden discourages their smaller competition – in that sense the fines can be seen as a reasonable price for them to pay for their privileged status.

“Where this becomes more interesting, and much harder to justify, is where politicians take the same approach to fining for risk management failings in the non-banking world.”

Mills & Reeve law firm partner Virginia Hickley says that since 2008 UK legislation has been tightened with the structural changes made to the FSA, effectively splitting it into two distinct entities.

She adds that in the UK the Financial Services Compensation Scheme can order advisers to pay compensation to investors who have suffered a loss, while the award limit for compensation from the Financial Ombudsman Service has increased from £100,000 to £150,000.

Hickley explains: “After each of the two recessions, there was a huge spike in litigation. As a result, the regulator has taken a tougher stance to try to avert another scandal about the delay in payments – offering more advice and guidance on how to claim and making sure that compensation is paid quickly. They have effectively become the new threat to financial institutions and advisers.

“The regulator really wants to show that it is clamping down on bad financial practices as well as giving much-needed money to the chancellor. The regulatory regime is set to get tougher and tougher.”

Chase Information Technology Services chief technology officer Nigel Cannings develops systems to analyse employee activity in financial firms, such as phone calls, email and instant messaging (IM). He says: “There is enormous pressure to get results on a trading floor, driven by a strong bonus culture and competitive team building. Few people actively set out to infringe rules, but there, pushing the boundaries of what is an acceptable part of everyday life.

Financial consequences of toeing the line

“There is an increased emphasis on proactive monitoring of transactions by regulators, and an increasing systemisation of some of the more exotic markets.

“There is a real need to have human input in the compliance process, and to drive that by a mixture of purely random sampling of data and transactions, and the use of systems that are designed to look for unusual patterns of behaviour across structured and unstructured data sets, such as the ubiquitous telephone and IM conversations that take place constantly between traders.”

US search firm Recommind’s director of market development Nick Patience believes regulation is now eating into the profits of corporates. He says: “Failure to meet compliance requirements has now become a major source of operational risk and a growing financial burden, as massive fines for non-compliance have been and will continue to be assessed against institutions.

“Some firms have been taking major measures to improve internal controls so that they can comply with new and changing regulations, hiring extra employees and setting aside vast sums of money to the effort.”

He adds: “Through the best of today’s analytics and data management technologies, leading firms will achieve ongoing compliance even as the rules change and fluctuate as they are certain to do through the remainder of this decade.”

But Dun & Bradstreet product marketing leader, financial institutions, Paul Westcott believes there is hope and is seeing many companies now taking a closer look at their complete supply chain on a single-entity level because they don’t understand the information swimming inside the ‘silos’.

He says: “The regulators are genuinely looking to work with financial institutions much more post the crisis than perhaps they did before. It feels like the regulator is working to understand what is achievable by the financial institution, and the financial institution wants clarity on what the regulator is actually looking for.”