The Senior Managers’ Regime (SMR), due to come into force in March 2016, is the U.K. financial regulators’ response to widespread concern that bank executives were not held personally responsible for the huge losses of the financial crisis. Yet as Tracy McDermott, acting head of the Financial Conduct Authority said in a speech late last year, the SMR also aims to prevent such crises arising again. She put it like this:
[The regime] has the capacity to lead a sea-change in how U.K. Financial Services is seen by all parties. Why? Not because of how it affects ex-post enforcement. Important as this is. But because it should drive better, clearer ex-ante decisions fostered by a sense of real responsibility and clear accountability. And thus less problems in the future.
Time will tell whether the SMR, which focuses on individual responsibility, will indeed lead to fewer problems. But in the interim, it seems likely that no matter how hard executives strive to make the very best decisions, they will feel vulnerable to the risk of regulatory penalties and personal censure.
The Push for Personal Accountability
The drive toward new regulation that imposes more personal accountability is understandable given how hard it proved to be to hold any single person to account under the old regulations – a point illustrated by Andrew Green QC in his report on the regulatory failures relating to the collapse of HBOS. In that report, Green noted that under guidance from the Financial Services Authority, the regulator at the time, disciplinary action could only be taken against an individual where there was evidence of “personal culpability.” Yet he went on to observe:
“In the context of a substantial multi-divisional company such as HBOS where strategy was frequently the result of collective decision-making over an extended period of time, it was inevitably difficult to identify a particular individual whose conduct evidenced “personal culpability”.
Since the financial crisis, regulators have sought to right this shortcoming by introducing measures to ensure that there is clearer accountability among senior executives and non-executives – a process that the SMR accelerates.
For example, senior executives will now have to produce statements that outline their particular responsibilities, and they will be expected to take “reasonable steps” to prevent breaches of those responsibilities – though what is reasonable is not defined.
The Old Approach
This approach diverges in two ways from that established over many decades in the law courts when considering personal liability.
- First is the principle of collective board responsibility, which allows for decisions to be taken at board level by majority rather than as a group of individuals.
- Second is the related issue of business judgment. Judges in the U.K. and beyond have taken care not to make their own, retrospective judgments on the business decisions taken by directors. What matters is that directors act in good faith, within their authority, and that they exercise due skill and care – not whether the actual decision made was “right”. (The U.S. and Australian legal systems refer to this expressly as the Business Judgment Rule.)
The way the judge handled claims brought against the former directors of Madoff Securities International Limited, which came to trial in the U.K. in 2013, illustrates both points. Bernard Madoff had already pleaded guilty to fraud in excess of $170 billion, having operated what turned out to be the largest Ponzi scheme in history.
But claims of £33 million were then brought against directors of the financier’s London operation. The presiding judge, Mr Justice Popplewell, resisting the temptation to apply the wisdom of hindsight, exonerated the directors, finding they had not been in breach of their fiduciary duties as they had acted in what they considered to be good faith, in the company’s best interests and, importantly, that the board had come to a collective decision.
He explained his decision thus:
“A board of directors may reach a decision as to the commercial wisdom of a particular transaction by a majority. A minority director is not thereby in breach of his duty, nor is he obliged to resign and nor indeed to refuse to be party to the implementation of the decision. Part of his duty as a director acting in the interests of the company is to listen to the views of his fellow directors and to take account of them. He may legitimately defer to those views where he is persuaded that his fellow directors’ views are advanced in what they perceive to be the best interests of the company, even if he is not himself persuaded.”
“A director is not in breach of his core duty to act in what he considers in good faith to be the interests of a company merely because if left to himself he would do things differently,” (emphasis added).
The New Approach
Under SMR (i.e. in a regulatory enforcement as opposed to a civil liability context), senior managers may not be afforded such protection.
Take for example the situation of someone who holds a senior management function within a bank as head of a key business area and who sits on the board. And assume a collective board decision is made that directly affects that business area even though, left to him or herself, the manager concerned might do things differently. In a law court, provided the manager obeys the business judgment rule and abides by the principle of collective board responsibility, it is likely he or she would escape personal legal liability if things later turn sour.
By contrast, under the SMR, the regulators may still hold that person personally accountable, even if the board decision was not one he or she fully supported. In other words, the new weapons available to regulators, such as the duty of responsibility on individual managers to fulfil their personal management functions, are likely to take regulatory enforcement actions into territory left deliberately unchartered by the courts.
One can only speculate how this might have an impact on the dynamics and debate within the board, or indeed the decisions taken.
There must be a danger that the collective wisdom and experience of a group of people chosen, one hopes, for their diversity and independence, will be sacrificed or at least bent to the will of the individual board member who risks personal liability if the decision under consideration turns out badly.
Is it not also likely that board decisions will be more conservative and risk-averse, or that good executives and non-executives alike will be more cautious about taking up a board position?
Offering some reassurance to executives about the consequences of the new regime, McDermott suggested in her speech that they had nothing to fear if they followed their instinct to do what was right.
Unfortunately, when it comes to defending decisions after the event, referring to one’s instincts might not suffice.
Moreover, in the complex world of banking, one wonders whether the new regime will make it any easier for regulators to judge what the “right thing” to do was without the benefit of hindsight. Did the individual take reasonable steps to prevent breaches in their area of responsibility, or did a failure to catch the ball really hang on the actions or decisions of a single person?
Regulators may have to swat up on the geometry of motion.