Does the Financial Services Authority’s (FSA) public censure of broker Steven Davis for misconduct signal a new determination by the regulator to punish mortgage companies that fail compliance procedures? Or is it simply just a headline-grabbing ‘warning shot’ designed to make the industry sit-up and take notice?
Davis, chief executive of Essential Mortgages Limited (EML), is the first senior manager of a mortgage firm to be disciplined since the FSA took over regulation of the industry. He was the subject of a ‘Statement of Misconduct’ published by the FSA last month, after the regulator found that he had fallen ‘below acceptable standards in the way he carried out his duties as a director of his firm.’ The statement also said: “His misconduct led to considerable consumer detriment.”
The regulator found that the ASU policies of around 350 of EML’s clients, worth £500,000 in insurance cover, were not put on risk because the firm had failed to pay the premiums to the insurance company. Instead the premiums were banked and ended up being used to pay EML’s own costs and liabilities. Although passing on the premiums to insurers was the job of EML’s accounts clerk, the FSA took the view that Davis was at fault because he was the director responsible for overseeing the accounts function.
In publishing the Misconduct Statement, the FSA said that the case would have normally ‘merited a significant financial penalty’ against Davis. However, as EML went into liquidation in January last year, the FSA said it believed Davis was unable to pay such a financial penalty and that even forcing him to pay a smaller fine would have had an adverse impact on his ability to pay his creditors.
EML’s permission to carry out regulated activities was cancelled in October 2005, at the request of the firm’s liquidators. However, there is nothing to stop Davis returning to the mortgage industry and re-applying for regulatory status. A spokesperson for the FSA said: “If Davis applied to be regulated in the future then we would make a judgement based entirely on its own merits, and this Statement of Misconduct would form part of his records for consideration.”
Softly, softly
Rob Griffiths, associate director of the Association of Mortgage Intermediaries (AMI), says that although he believes the FSA would have acted before against mortgage companies on any case of major fraud or negligence, he feels that the FSA has taken a ‘softly, softly’ approach up until now. He explains: “For the first year and a half of regulation, the FSA has given the industry fair chance to bed down. It has worked with firms and allowed them time to sort themselves out if they have not been complying as they should. The FSA has very much taken an educational and informative role.”
Griffith says that although the Davis case may mark a shift in the way the regulator deals with non-compliance, he feels it is unlikely that the FSA will suddenly start taking serious action in relation to issues such as Financial Promotions, an area that has always been controversial among brokers and is still mired in confusion.
Instead Griffiths believes the FSA will crack down on those companies whose actions have caused, or could potentially cause problems for customers. He says: “In the Davis case, his responsibility has been lacking in key areas. It is a serious misconduct and where the FSA finds misconduct it is its duty to act. Where it has seen consumer detriment, it must take action. I am sure we will see more firms taken through enforcement action over the next 12 months.”
Griffiths say brokers only have to look at the areas that the FSA has previously carried out thematic work to get an indication as to which subjects and issues the regulator is likely to be focus on, areas such as disclosure and ‘Treating Customers Fairly’ (TCF). “The FSA has undertaken two major reviews and given examples of what it believes to be good and bad practice,” he explains. “If firms are still found wanting in those areas when the FSA revisits them, then the FSA will take action.”
One of the most important aspects of the Davis case, according to Griffiths, is that although the firm deemed the root cause of the problem to be an ‘administrative error’ in a system handled by a junior member of the organisation, the FSA decided the buck ultimately stopped at the top.
“This case is a good example of the importance the FSA places on the responsibility of senior management,” Griffiths says. “The responsibility of senior managers is key. Senior managers need to get a grip on what’s happening in their firm. Firms should be aware of their responsibilities towards regulation and if not they should revisit the rulebook and ensure their compliance is robust. The FSA and AMI are here to provide firms with guidance if they are unsure as to their responsibilities.”
Senior management emphasis
AMI’s view is reinforced by the FSA’s own comments when publishing its statement regarding Davis. Jonathan Phelan, FSA head of retail enforcement, said: “Senior managers of authorised firms should take note that the FSA will hold them to account where they fail to act appropriately when carrying out their regulatory responsibilities.”
Phelan continued: “The failures in this firm could have been avoided if the director had taken reasonable care to organise and control the accounting functions of the business. This case is very serious because customers who placed their trust in the firm to put in place their insurance policies were exposed to considerable risk.”
Many in the industry see the emphasis on the responsibilities of senior directors as part of the FSA’s shift away from a rigid rulebook regime to a more principles-based approach, as personified by TCF. The TCF ethos says that good practice should become engrained in an organisation’s culture, but it must also start from the top down.
The FSA also said last month that it had set a deadline of March 2007 for companies that had thus far failed to show satisfactory progress in implementing TCF to demonstrate that they were taking the initiative seriously.
The principles-based approach is welcomed by broker Danny Lovey of Essex-based The Mortgage Practitioner. “As far as interpretation of the rules is concerned you will get different answers from different people, even within the FSA,” Lovey says. “The move towards principles – towards the spirit of the rules – is much better because the wording of the rulebook is so complex.”
He continues: “I wonder if the FSA concentrates too much on the micro sometimes, rather than the macro. It has spent too much time dotting the i’s and crossing the t’s; it has spent too much time and resources on the rulebook that it’s almost unintelligible now.”
Lovey is less convinced that this first enforcement action against a senior mortgage manager is a sign of a stricter stance by the regulator. He says: “I’m not so sure this is the FSA finally getting tough, but more the case that the system for catching up with cowboys is working. If people are blatantly not following the principles as laid down by the FSA, then action needs to be taken and I am sure that most people in the industry would support the FSA in such cases.”
A raft of action?
Rob Clifford, chief executive of Mortgageforce, agrees that action should be taken against brokers where consumer detriment has occurred, but he does not believe that there are major problems among the broker community. He says: “Consumers expect a regulator to take action, but it is important to see it in the context of the whole mortgage market where less than half a per cent of customers ever have to complain.”
Clifford continues: “It is honestly very difficult for small brokers to adopt this regime, much harder than it is for lenders, for example, who have many more resources. However I don’t believe we will see a raft of small firms facing action against the FSA.”
Clifford believes that for small and medium sized brokers, it could be difficult for senior management to be aware of everything that junior staff or non-customer facing staff are actually doing. However he points out that even despite such difficulties, it is the job of senior managers to put procedures in place to ensure they can pick up on any problems that occur.
He concludes: “The reality is that senior executives have to take responsibility for regulation so they need to ensure that their systems are robust and that they have proper management in place.”
Analysis of failure
The main points of the Financial Services Authority’s (FSA) Statement of Misconduct against Steven Davis.
According to the FSA, the Accident, Sickness and Unemployment (ASU) policies of at least 350 of Essential Mortgage Limited’s (EML) clients were not placed on risk because the firm failed to pass on their insurance premiums ‘as a direct result of its inadequate systems and resources.’
This left EML’s clients without cover, estimated to be worth £500,000. According to the FSA’s Final Notice on the case, Davis was the director responsible for the firm’s accounts functions, but he had instigated a system that relied upon one full-time accounts clerk, described by EML as its ‘Accounts Department’, whose job it was to handle all financial matters, including the payment of client premiums.
The FSA said the accounts clerk was not qualified, had no specific training for her role with EML, and was not subject to any formal reporting regime or management oversight. In its notice, the FSA said the clerk would ‘prioritise payments according to urgency, taking into account the perceived importance of the creditor and urgency.’
As a result of poor systems, the FSA says the client ASU insurance premiums collected by EML were banked and used by the company to meet other costs and liabilities. Davis told the regulator that EML made ex-gratia payments to customers in response to their claims, of which, according to the accounts clerk, there may have been around six cases, although the FSA only found one such payment for £5,000 to a customer whose ASU policy had not been placed on risk.
EML sold insurance products, including ASU, on behalf of a broker who appointed a third party administrator to process the ASU policies on its behalf. The ASU policies only came on risk once a mortgage was completed, at which point the third party administrator would invoice EML.
EML had fallen into arrears in respect of premium payments to the third party administrator to the tune of £300,000 by July 2003, so an agreement was made for the firm to pay what it owed. However, in February 2004 the ASU broker changed the system so that it was down to EML to forward the customer’s application and then receive commission.
According to Davis, this change caused an ‘administrative error’ in EML’s accounts function that resulted in premium payments not being made to the third party administrator.
The accounts clerk told the FSA that she had received phone calls from EML’s customers saying they had not received their insurance policies, but she did not equate that with the possibility that their policies had not been put on risk. She could not recall telling any one of EML’s directors about these calls. In its findings the FSA said that it was not ‘asserting that the accounts clerk referred to in this notice is guilty of any misconduct.’
The failure to pay the ASU premiums contributed to EML’s already shaky financial situation, which resulted in the company’s liquidation and a Credit Voluntary Agreement in February 2005. Davis said it was he that had spotted the ‘error’ with the payment of premiums, which he then took up with the liquidator and reported to the FSA.
According to the FSA’s final notice, Davis told the regulator: “...it was a grave error,” before adding: “There were 370 odd clients affected and it’s a disaster.”
The full final notice can be found on the FSA’s website at http://www.fsa.gov.uk
