Senior managers and certification regime: the first year

The first anniversary of the Financial Conduct Authority and Prudential Regulation Authority’s senior managers and certification regime is fast approaching. After a lengthy consultation process, the regime came into force on 7 March 2016. Since this date, firms have had to manage the operation of the new regime in practice, as well as the challenges the new regime has brought with it.

Robbie Sinclair and Sarah Hitchins, Allen & Overy LLP

The first anniversary of the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) senior managers and certification regime (the regime) is fast approaching. After a lengthy consultation process, the regime came into force on 7 March 2016. Since this date, firms have had to manage the operation of the new regime in practice, as well as the challenges the new regime has brought with it.

Conduct and performance issues

A key driving force behind the new regime is reinforcing firms' responsibilities when it comes to individual accountability. For the last year, firms have been turned into mini-regulators with responsibility for assessing the fitness and propriety of employees falling within the certification regime on at least an annual basis (see Briefing "Senior managers and certification regime: food for thought for in-house lawyers ( "). Firms have also been reminded that they must ensure that their candidates for senior manager roles have been assessed as being fit and proper before their applications for approval are submitted to the FCA or the PRA.

No one-size-fits-all process. Fitness and propriety is not a new concept for regulated firms. However, many firms have found that taking the lead in assessing fitness and propriety in practice has proved more challenging than they expected. For example, firms have had to adapt their existing recruitment, promotion, appraisal, disciplinary and remuneration processes in order to incorporate formal fitness and propriety assessments.

Firms have put in place processes to ensure that they can demonstrate that consideration has been given to these issues when conduct or performance issues arise in relation to senior managers and certified persons. Firms will be expanding the application of these processes from 7 March 2017, as the FCA's Code of Conduct (the Code) will apply to a much broader population of employees from this date.

There is no one-size-fits-all approach in this area. However, a number of firms have established panels to oversee conduct and performance issues that require consideration to be given as to whether an employee is fit and proper, and whether he has breached the Code. These panels help to ensure that the appropriate degree of regulatory context is taken into account when considering these questions.

No bright lines. The last year has not proved straightforward, even for firms that established robust processes for assessing fitness and propriety and breaches of the Code.

In some cases, firms have been confident when concluding whether issues meant that employees were no longer fit and proper or had breached the Code. However, a number of other instances have been less clear cut. There is a significant grey area in this space, especially where conduct may have been, for example, inadvertent, due to a lack of training, a one-off incident, or characterised as a more of a performance issue, rather than misconduct.

Unfortunately, there are no bright lines that firms, industry bodies, advisers or the regulators can draw. Cases need to be considered on their own facts in accordance with the firm's policies and risk appetite. In some cases, external advice may be required. However, firms should take steps to ensure that decisions are consistent and are capable of standing up to external scrutiny, whether by the regulators or by an employment tribunal, which may be a difficult balance to strike.

Firms have experienced further difficulties when implicated employees have resigned before, or mid-way through, their disciplinary processes. Although this tactic on the part of employees is not a new one, since the inception of the regime many firms appear to be more resolved to continue with their disciplinary processes and willing to reach conclusions on fitness and propriety and Code breaches in an employee's absence. These decisions have consequences for firms' reporting obligations, even in relation to employees who are no longer employed.

Reporting obligations

A decision that an employee has breached the Code triggers a range of reporting obligations that must be undertaken by the firm within specified time limits. The same applies to decisions taken in relation to senior managers that may change their status as fit and proper. Of course, none of these reporting obligations remove or alter firms' self-reporting obligations under FCA Principle 11 or PRA Fundamental Rule 7. However, a specific form of reporting obligation has captured firms' attention over the past few months.

Regulatory references

Regulatory references are nothing new: the FCA's Supervision Sourcebook requires a firm to provide, on request, all relevant information of which it is aware in respect of individuals taking up approved roles at other firms (SUP 10A.15.1R). However, more detailed rules relating to regulatory references come into force on 7 March 2017 (see News brief "Regulatory references: haunted by the past ( ").

These new rules will require firms to confirm, among other things, if an employee who is taking up a senior manager or certified role at another firm has been found not to be fit and proper or if they have been found to have breached the Code. Firms will also be required to set out any other information that may be relevant to the assessment of an employee's fitness and propriety. In addition, firms will be obliged to update regulatory references given on or after 7 March 2017 if anything subsequently comes to light that would have altered the substance of the original reference. As a result, new-style regulatory references mean that the stakes are much higher when it comes to firms' decisions about whether employees are fit and proper or whether they have breached the Code. These decisions can follow an individual around through a regulatory reference for up to six years, or indefinitely if they concern serious matters.

Unsurprisingly, firms have not taken lightly their responsibilities when it comes to making these assessments. Not only do firms wish to avoid unnecessarily harming the future career prospects of an employee by giving a qualified regulatory reference, they are also mindful of the possible raft of employment claims that they may face from disgruntled former employees who receive qualified references. These could include claims for post-termination victimisation, negligent misstatement or career losses totalling very significant sums. In order to mitigate the risk of these claims, most firms are going to offer employees or former employees the right to reply to the substance of any qualifications that they propose to include in original and updated regulatory references.

Despite these risks, firms need to remain aware of the letter and spirit of the new regulatory reference rules. The government and the regulators have made it clear that firms hold the key when it comes to helping to stop people who are not fit and proper moving around the industry from firm to firm, and that regulatory references are the means by which firms can do this. Firms' processes for gathering the information that will go into regulatory references will need to be suitably thorough, including when responsibility for compiling references is outsourced to other group entities or third-party firms.

The vast majority of regulatory references given by firms from 7 March 2017 will be non-contentious. However, firms need to think long and hard about the smaller number of qualified regulatory references that they will have to provide. Likewise, those with responsibility for handling litigation, investigations, grievances and complaints must be alert to the possibility that issues arising in relation to the conduct or performance of former employees may trigger the need for previous regulatory references to be updated.

Transitions between senior managers

Most transitions between senior managers have run smoothly. Handovers are completed on a timely basis, and successors are identified swiftly and put forward to the FCA or the PRA for approval shortly afterwards. However, things do not always go to plan. Some firms have experienced challenges when trying to co-ordinate handovers where a senior manager is leaving in difficult circumstances. Certain firms have found these challenges easier to overcome than others. For example, some firms have made the completion of handovers a contractual requirement for their senior managers or a factor that will affect the release of any deferred compensation.

The regulators have also taken a strict approach to their respective 12-week rules, which permit an individual to perform a senior manager function for no more than 12 weeks in a consecutive 12-month period without being approved to perform that senior manager function. The regulators' rules stipulate that this rule should only be relied on in temporary or unforeseen circumstances, and the regulators have stuck firmly to this approach in practice. As a result, it is very important for firms to have robust succession planning in place, even if that means that there is an employee who can cover a senior manager function on a temporary basis while a permanent replacement is identified. However, if that temporary appointment looks likely to last for more than 12 weeks in a consecutive 12-week period, firms must apply promptly to the relevant regulator to have the individual filling that appointment approved as a senior manager.

Firms will also need to be able to submit Form As and accompanying documents for new senior manager candidates, as well as draft statements of responsibilities and revised draft management responsibilities maps to the regulators in short order. This should be relatively straightforward where a new or temporary senior manager will be fulfilling the same role and responsibilities as his predecessor. Where changes need to be made or there are delays in finding a candidate to fill a senior manager vacancy, firms may be best served to open a dialogue with the regulators at a very early stage in the process so that they are made aware of, and kept updated about, the situation.

Enforcement appetite

Last year saw a significant drop in the levels of financial penalties imposed by the FCA, from just over £905.2 million in 2015 to just over £22.2 million in 2016. The FCA has been keen to emphasise that this is not a sign that the FCA has gone soft, but rather that it represents a shift in enforcement dynamic as a result of the start of the regime in March 2016.

The FCA clearly remains committed to its long-standing objective of holding individuals to account. While the regime does not give the FCA any new tools to make taking enforcement action against individuals easier, the FCA is likely to treat enforcement against individuals as a priority, rather than an afterthought as has sometimes been the case. However, more enforcement action against individuals is likely to result in more FCA decisions being contested and referred to its Regulatory Decisions Committee and the Upper Tribunal. Under new rules that came into force on 1 March 2017, individuals are permitted to refer a proposed FCA enforcement decision straight to the Upper Tribunal, without first going through the FCA's usual enforcement settlement process. This dynamic may also affect firms' willingness to settle their own FCA enforcement investigations, especially if parallel investigations into their senior managers remain ongoing.

The FCA and the PRA may choose to take enforcement action against senior managers, certified persons and those who will be subject to the Code from 7 March 2017 in some circumstances. However, this will not always be the case. The new regime requires firms to take responsibility for tackling employee conduct issues. In particular, firms must assess and, where necessary, report breaches of the Code committed by their employees, as well as findings that any of their senior managers or certified persons are not fit and proper to perform their roles.

Next steps

The first year of the regime being in force may not have been straightforward for some firms. However, there were always going to be teething issues as firms' processes and policies bedded down. Market standards are continuing to emerge in relation to how the regime operates in practice and, as new issues arise, those policies and processes will continue to be tested.

Robbie Sinclair is a senior associate in the Employment team, and Sarah Hitchins is a senior associate in the Contentious Regulatory team, at Allen & Overy LLP.

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