Corporate governance as a contraption of the FSA's accountability

An exegesis of the Combined Code

The Authors

Olu Omoyele, Financial Services Authority, London, UK

Acknowledgements

The theme of this paper is drawn from the author's LL.M Master of Laws research, conducted at the School of Law, King's College, University of London, with reference to which the author gratefully acknowledge the supervision provided by Professor Eva Lomnicka.

Abstract

Purpose – Owing to the tremendously vast and unprecedented nature of the directly-conferred statutory powers of the Financial Services Authority (FSA) (under the Financial Services and Markets Act (FSMA) 2000), there is need for ample accountability on its part. The paper aims to discuss the situation.

Design/methodology/approach – A critical analysis of the Combined Code on corporate governance. The paper argues in favour of obliging the FSA to adopt the Code as a way of making it accountable.

Findings – It is desirable that the FSA be accountable and that this can best be done via the imposition of corporate governance principles. The paper includes a suggestion of election of the FSA's governing board.

Practical implications – The wider re-drafting (and construction), by Parliament, of section 7 is the most attractive mode of enforcing corporate governance as an accountability mechanism. This is so, as it will give it far greater force than at present by creating a mandatory regime to bind the FSA in this respect. What is required, therefore, is an amendment of s. 7 of the FSMA 2000 to establish a better accountability method to be imposed on the FSA.

Originality/value – The paper proposes, for the first time, the use of corporate governance (especially the Combined Code) to ensure the accountability of the FSA. The paper is valuable to academics, postgraduate research students and legal practitioners in the area of financial services regulation, corporate law and general public body accountability. It is also useful for those interested incorporate governance and the Combined Code on corporate governance.

Article Type:

Conceptual paper

Keyword(s):

Financial services; Financial management; Corporate governance; United Kingdom.

Journal:

Journal of Financial Crime

Volume:

15

Number:

1

Year:

2008

pp:

82-103

Copyright ©

Emerald Group Publishing Limited

ISSN:

1359-0790

Following the recent National Audit Office (NAO) report on its audit of the Financial Services Authority (FSA), the issue of its accountability as a regulator has again been thrust into the headlines. This paper proposes the adoption of corporate governance principles as a mechanism of ensuring the accountability of the FSA. It does this via an exegesis of the Combined Code on Corporate Governance in this context. The article will commence on the premise that there is a pressing need for ample accountability on the part of the FSA particularly in view of its overwhelming powers under the Financial Services and Markets Act (FSMA) 2000. That is, this need derives from the tremendously vast and unprecedented nature of its directly-conferred statutory powers. The Authority's status as the single financial regulator means that the need for adequate accountability cannot be over-emphasised. This is more so now as it moves towards becoming a more principles-based regulator.

Background

The need for the accountability of the FSA arises almost innately out of the unprecedented nature of its powers. The first thing to note is that the FSA is a private company discharging what are essentially public functions. The fact that quite colossal[1] powers have been conferred on a body corporate inevitably raises a few concerns. The FSA is the all conquering body in relation to (virtually) anything financial in the UK, and so there is the suggestion that the Authority is both the judge and the jury thereby raising concerns about accountability. In this respect, an academic declared that, “arguably the Act creates the most powerful regulatory body for financial services anywhere in the world” (Taylor, 2000).

The FSA, via the FSMA 2000, is responsible for regulating insurance, banking as well as investment business in the UK. It regulates both the prudential (i.e. capital adequacy requirements) and conduct of business aspects of financial services. It is as a result of the enormous and vast nature of its powers that ample accountability is needed. The powers of the FSA can be broadly divided into legislative[2], investigative[3], disciplinary[4] and prosecuting powers[5].

The necessity for the regulation of the regulator, as it were, stems further from the need to protect the industry as well as the public from a potential collapse of the regulatory regime or of the finance industry as a result of long-term or institutionalised poor regulation. The cumulative effect of the ineffective regulation could be fatal to the industry in years to come if sufficient checks and balances are not put into place to prevent it.

In this age of global business, an ever growing information media and high-profile financial scandals with far reaching economic vibrations, the need for accountable regulation is superseded perhaps only by the desire for competent regulation. However, in the UK, this arguably differing emphasis is even less apparent due to the unique nature of its financial services regulator as a non-governmental organisation discharging what are essentially very public functions; more so, being a private company, albeit a non-profit making one.

Shortcoming of the existing accountability mechanisms

There are mechanisms already put in place to aid the FSA's accountability. The most important ones are: the regulatory objectives[6], parliamentary accountability[7], stakeholder accountability[8] and specific challenges to FSA decisions[9]. It is apparent, however, from a detailed examination of these existing accountability mechanisms (details of which is beyond the scope of this paper) that they do not go far enough to ensure the FSA's accountability. Proportionality is perhaps the key. The unprecedented nature and scope of the FSA's powers necessitates that stronger accountability mechanisms be devised to counter maladministration, abuse of power as well as promote public confidence in the regulator, especially, being a single regulator. The exemption from liability in damages further makes the development of adequate accountability mechanisms pivotal to the effective operation of the regulatory regime.

The proposition in this paper is that a novel, yet subtle, notion in the FSMA represents a potential method of adequate accountability. That concept is corporate governance and it is therefore the subject matter of the critical examination subsequent.

Corporate governance

Introduction

As a result of the separation of ownership and control in large corporations coupled with various high-profile corporate scandals with global vibrations, the need for the imposition of governance principles on such corporations has been exacerbated. The Combined Code on corporate governance[10] was designed primarily therefore for profit-making public companies with large assortments of shareholders.

Relevance of corporate governance vis-à-vis a financial regulator

The rationale for the employment of corporate governance provisions as a way of ensuring the FSA's answerability is submitted to be three-fold. Firstly, the status of the FSA as the single regulator with unprecedented powers and yet limited statutory accountability is a persuasive enough point in convincing one to research some credible alternative mechanisms of making it accountable. This is so as an unaccountable financial service regulator is a ticking time bomb just waiting to explode. In other words, the result of some unfortunate market conditions coupled with incompetent or negligent regulation, is bound to be catastrophic to the health of the financial service industry and, consequently, investors. That is not to say that an unaccountable regulator is bound to be incompetent in its duties, however, the absence of sufficient and credible answerability to external persons means that the possibility and even probability of negligence is enormous. Negligence, if left unchecked has the potential of deteriorating into abject incompetence.

Secondly, s. 7 of the FSMA provides:

In managing its affairs, the Authority must have regard to such generally accepted principles of good corporate governance as it is reasonable to regard as applicable to it.

The provision above indicates a new way of viewing the FSA and, in turn, provides a novel way of making it accountable. The proposition is that the FSA should follow similar practices as imposed on public companies in the dispensation of its regulatory duties, e.g. by following recommendations of the Combined Code[11]. To complement this, the FSMA clearly favours the appointment of non-executive directors[12]. The criticism of s. 7 is the fact that the test whilst an objective one only requires the FSA to adhere to those principles of good corporate governance if it is reasonably applicable to it. However, it can be argued that the section should either be widely construed or, alternatively, it should be altered to give it greater force. Essentially, due to the disparity in the FSA's powers to accountability ratio, a different (perhaps radical) but less political method of accountability is needed. The proposition here is that corporate governance can serve as the ultimate apparatus in ensuring that much-needed accountability is afforded to the UK's single and quite unconventionally powerful financial regulator.

It is true, of course, that s. 7, in requiring the FSA to have regard to generally accepted principles of good corporate governance, does not go as far as requiring that the FSA must adhere to the Combined Code. This is so even though the latter would be considered as being a generally accepted code on corporate governance since s. 7 adds the words “as it is reasonable to regard as applicable to it”. This clearly diminishes the compulsory nature of any impact that the provision may otherwise have had on the regulator. However, it is contended that the very mention of it coupled with the absence of other credible existing accountability mechanisms, as mentioned above, necessitates that greater value and applicability be annexed to s. 7 so as to make the FSA answerable for its actions and overtly accountable.

Finally, that other facet of contemporary macro business, globalisation, is submitted as an additional reason for promulgating the utilisation of corporate governance as an accountability mechanism. This is so, as the FSA regulates the financial service industry nationally in the UK; and those industries that are being regulated form part of the global economy, since regulated firms are usually part of multinational groups of companies. In this light, two academics considered that:

… [I]ssues of wider public and political concern are being handled by regulators, who are, in effect, the nationally-based of a wider transnational business system (Black and Muchlinski, 1998).

That is, the FSA's regulatory practices whilst limited legally by national boundaries do, nevertheless, have international economic and political consequences. Such global vibrations mean that greater transparency is required not only in respect of the UK public but essentially the whole world as a confederate economy. With such far-reaching effects in mind, the need for competent regulation of the regulator becomes unavoidable. The rationale being not to regulate the regulator per se but instead to make sure that the regulator is carrying out its regulatory functions properly and in the interests of both market participants and the general public as well. To this effect, Black and Muchlinski (1998) added that:

It may be essential for good governance and public responsiveness for these bodies to be subjected to scrutiny not just by market players but by the wider public to ensure that proper regulation of markets is actually taking place.

In essence, it is not just the players in the markets who have an interest in the proper regulation of the market; the wider public do as well. After all, the latter represent the largest contributors to the various investment funds utilised by institutional investors.

The increasing liberalisation of capital markets and the regulatory structure necessarily means that less political influence is exercised over the regulator. The advantage being that volatile political influences are not exerted upon an otherwise stable financial service regulator. The disadvantage, on the other hand, is that there is loss of any meaningful parliamentary accountability, notwithstanding the FSA's duty to report annually to Parliament. The abolition of the delegation model[13] which ensured ultimate ministerial responsibility means now that such responsibility must be replaced with accountability. That accountability, it is argued, is not sufficiently catered for under the FSMA 2000. It is submitted as a consequence, therefore, that corporate governance principles as applicable to public companies be imposed on the FSA in a manner far more rigorous than purported by s. 7 of the Act.

It is true that the underlying rationale for the imposition of corporate governance principles on public companies is shareholder protection. The requirements of transparency, such as the disclosure of directors' remuneration, are aimed at ensuring that shareholders are kept fully informed of matters relating to how their resources are utilised by their company. Admittedly, the suggested application of such principles to a regulator undoubtedly is a contentious one. Therefore, corporate governance does not appear overtly to be a particularly strong mechanism of accountability of the FSA. There are two reasons for this. Firstly, as stated above, the corporate governance principles as applicable to listed public companies are aimed primarily at shareholder protection. The FSA, however, is a company limited by guarantee and not shares and so has no shareholders. The argument so raised is that in the absence of shareholders, there is no justification for the application of extensive corporate governance principles to the FSA. Nevertheless, it is submitted that since the premise for protecting shareholders of a public company is because as stakeholders they are vulnerable to the incompetence or malpractices of the directors, the same analogy applies to the regulator. That is, since practitioners, consumers as well as the general public are all in one respect or the other stakeholders in the financial health of the country, they are necessarily also stakeholders in its regulation and, effectively, the regulator. They are, therefore, greatly interested in its diligent regulation and, effectively, in a sufficiently accountable regulator.

Secondly, the wording of s. 7 itself suggests it to be a weak provision not aimed at being an effective mechanism of ensuring the FSA's accountability. A probable solution to this is to construe s. 7 widely via some form of judicial engineering. Whilst some may argue that this amounts to judge-made law, it is submitted that this kind of manoeuvring is not alien to English law as it happens all the time in the courts wherever senior judges deem it to be in the public's interest or necessary in order to stay in sync with the changing times[14]. Alternatively, s. 7 can be amended by Parliament so as to give it greater force. The advantage of this is that Parliament is able, with considerable precision, to stipulate what categories of good corporate governance principles must be followed by the FSA. This should mean that the existing principles applied to public companies may be refined and altered accordingly so as to adapt them to suit a regulator like the FSA.

The corporate governance principles to be considered include the requirement of Annual Report, Annual Public Meeting (APM), and the Combined Code on corporate governance.

Annual report

FSMA, Schedule 1, para. 10:

At least once a year the Authority must make a report to the Treasury on:

  1. (a) the discharge of its functions;
  2. (b) the extent to which, in its opinion, the regulatory objectives have been met;
  3. (c) its consideration of the matters mentioned in s. 2(3); and
  4. (d) such other matters as the Treasury may from time to time direct.

The FSA has a statutory duty to report to the Treasury annually thereby effecting some degree of parliamentary accountability, notwithstanding the abolition of the delegation model. Statute dictates that the FSA must report to what extent it has discharged its regulatory functions. That is, a statement must be made as to the FSA's utility of its vast powers ranging from prosecutory to legislative powers.

The initial reaction to this requirement is that it is equivalent to the requirement on companies to file annual report and accounts with Companies House. Although private companies may dispense with this requirement, public companies must always file such report and accounts on an annual basis. The obligation on public companies goes further to require the filing of interim accounts as well.

In addition, a subjective account of the extent to which it has met the regulatory objectives articulated by Parliament in s. 2(2) of FSMA[15] is required. The suggestion is that those objectives which were created to serve as a yardstick against which the FSA's performance can be measured will also be used to somehow ensure that it is in fact an accountable body. In requiring that it reports on how it has met them, statute has provided a way for the Treasury and Parliament to scrutinise the performance of the FSA on a continuing basis.

Para. 10(3) of Sch. 1 obligates the Treasury to lay a copy of the annual report before Parliament including copies of other documents, for instance, the non-executive committee's report. It becomes apparent, therefore, that whilst direct accountability to Parliament was extinguished by the FSMA, there does remain, in that legislation, a more oblique mechanism of parliamentary accountability[16]. The obligation on the FSA in this respect is a prime example of a corporate governance principle, albeit a subtle one, being used to make it answerable in some way to the Treasury.

Annual public meeting

FSMA, Sch. 1, para. 11:

Not later than three months after making a report under para. 10, the Authority must hold a public meeting (“the annual meeting”) for the purposes of enabling that report to be considered.

The FSA, though not a public company, is obliged to hold an APM to facilitate the discussion of the contents of its annual report. This is tantamount to a public company's obligation to hold an Annual General Meeting (AGM). It would appear, therefore, that the use of corporate governance mechanisms in the context of the FSA despite not being a public company has its roots somewhat curiously in the FSMA. In aiding accountability, such a meeting would enable the market as well as concerned members of the public make representations of their views about the FSA's regulation of the financial services sector.

Para. 11(4) of Sch. 1 states that the FSA must give reasonable notice of the meeting. It will be suggested later under the Combined Code that this should be 20 working days which is equivalent to the requirement on public companies. Such corporate governance principles must be applied to the FSA to aid its accountability particularly in view of its limited statutory accountability[17].

In conclusion, the obligation to hold an APM is another example of a corporate governance notion, albeit another rather subtle one, being employed, via the FSMA to effect some answerability on the part of the FSA. Therefore, there is arguably some scope for researching for a fuller employment of corporate governance as a possibly effective mechanism of accountability. Next, the Combined Code on corporate governance is critically analysed in order to ascertain whether its provisions are at all suitable to a regulator such as the FSA.

The Combined Code on corporate governance

The layout of the Combined Code

The Combined Code on corporate governance is divided into two main sections. The first relates to companies and the other to institutional shareholders. The larger of the two, dealing with companies, is subdivided into four parts, namely:

  1. Part A – Directors.
  2. Part B – Remuneration.
  3. Part C – Accountability and audit.
  4. Part D – Relations with shareholders.

There are three schedules annexed to the Combined Code providing more detailed guidance in respect of the provisions of the Code[18]. Each topic or subject area starts off with the Main Principle followed by Supporting Principles and more importantly, the Code Provisions. The examination of corporate governance, next, shall for ease of understanding and logic follow the pattern of the Combined Code.

Directors

Main Principle A.1 states:

Every company should be headed by an effective board, which is collectively responsible for the success of the company.

Here, the Supporting Principles explain that the board should ensure that the necessary financial and human resources are put in place for the company to meet its objectives and also to review the performance of its management. In addition, the board of directors should set the company's values and standards. It is apparent immediately that the human agents of a company are solely responsible for determining the company's movement as they devise the various strategies which combine to take the company as a whole in one direction or the other. The importance of the board of directors in helping to shape a company's destiny, as it were, should, therefore, not be underestimated. The unitary nature of the board's responsibility is so that incompetence or rather culpability for it cannot be transferred so easily via delegation. This should serve to remind directors that they must act collectively and objectively and, more importantly, in the best interests of the company and in essence its owners, the shareholders. The considerable importance of board decisions, therefore, is the basis for the requirement of scrutiny by another group of directors known as the non-executive directors[19]. Their role, inter alia, is to “constructively challenge and help develop proposals on strategy”[20]. In fulfilling its leadership role, Code Provision A.1.1 requires that the board of directors meet sufficiently regularly to effectively discharge its duties.

In application to the financial regulator, the FSA board does meet regularly in view of its status as a body corporate[21]. The diverse nature of the FSA's functions ranging from disciplinary to prosecutory powers means that the board must pay particular attention to its allocation of both financial and human resources to expedite its functions. Therefore, it would appear as though the fundamental nature of a public company's board is not dissimilar to that of the FSA. In light of this, perhaps other provisions aimed primarily at public companies may yet prove to be capable of relevance to a regulator such as the FSA.

Main Principle A.2 obliges that there be a clear division of responsibilities between the chairman and the chief executive so as to ensure that unfettered powers of decision-making are not concentrated in one individual. The intention is to maintain appropriate balance within the board of directors. Such balance is further stressed via Main Principle A.3 which provides that the board should have a balance of executive and non-executive directors so as to avoid domination of decision-making by those with a direct stake in the company[22]. Independence of directors is also of paramount importance. This is not only relevant as per non-executive directors but also in respect of who may be appointed onto the board in the first instance[23]. In addition, A.3.3 requires the appointment of one of the independent non-executive directors to act as the senior independent director and whose main role is to serve as a point of contact for disgruntled shareholders[24].

The application of A.2 to the board of the FSA should achieve the same aim intended for public companies, i.e. that appropriate division of powers and responsibilities be effected amongst the board so as to create an effective leadership structure[25]. The result of this should be that more diverse views are represented within the policy-formulating forum of the FSA. As stakeholder protection is the ultimate aim of the promulgation of corporate governance in this context, A.3 should ensure sufficient independence of non-executive directors which again is directed at reducing the likelihood of over-domination of board decisions by the executive directors and in particular the chairman and the chief executive.

A.4 relating to the appointments of directors to the board is largely irrelevant here as the government, via Treasury, appoints the directors of the FSA. Treasury should itself, of course, comply with the provisions of the Combined Code in terms of ensuring transparency in its appointment procedures. It should also make certain that appointments are made on merit and set against objective criteria. As far as the FSA is concerned, Code Provision A.4.4 provides that the terms and conditions of appointment of non-executive directors should be made available for inspection by the public[26]. A.5.1 obligates the chairman to ensure that new directors are given a full induction. This measure should mean that newly-appointed non-executive directors are closely familiarised with the FSA's workload and policies. In addition, major players in the market should be permitted to meet with those directors so as to ensure that there is a healthy rapport between the regulator and the regulated. Note, also, A.4.5 as regards to conflict of interest which stipulates that the board should not agree to a full time executive director taking on more than one non-executive directorship (or chairmanship) of a FTSE 100 company. In relation to the FSA, it should be provided that an executive director may not take on a non-executive directorship in any company or perhaps any FTSE 350 company. The greater level of obligation submitted to be placed on the Authority's directors is in view of its status as a regulator and thereby with greater socio-political responsibilities than ordinary companies limited by shares. Another reason for it is to avoid possible conflicts of interests between an FSA director and a regulated firm of which he is a non-executive director.

A more significant provision, however, is A.5.2 which provides that directors, especially non-executive directors should be allowed to access independent professional advice, where they deem it necessary, at the company's expense. In view of the complexities of the various financial services regulated by the FSA, as well as their ever-evolving nature, it may be necessary that those non-executive directors have access to continuing education, as it were, in those areas in which they may deem it vital to the proper discharge of their functions. This should, theoretically at least, lead to such directors having greater expertise and so delivering a greater service to the market and the wider public as a whole.

The board of the FSA should carry out self-evaluation on a continuing or periodical basis. This contention, influenced by A.6[27], is aimed at allowing the FSA board to review itself and if necessary make changes to its policies. This will hopefully increase competency levels and also serve as an incentive to the FSA in its desire to deter the Treasury from exercising its residual power to instigate reviews into the FSA. The application of this provision should go beyond the board's direct performance in that it should include an annual review into the performance of senior management who in turn should evaluate the departmental staff of the FSA. This is essential since the FSA, post-FSMA, is now a much bigger organisation logistically employing a vast amount of personnel who carry out diverse functions in regulating the insurance, banking and investment services[28]. As provided by the Supporting Principle to A.6, the chairman should act on the results of the performance evaluation by addressing the weaknesses of the board and, where deemed appropriate, propose new members to be appointed to the board. This will enable the board leader to mend any deficiencies that may be present on the board of the FSA on an ongoing basis. Supporting Principle A.6 goes on to say that the chairman, where he deems it appropriate, should seek the resignation of directors. Whilst this is expected to be a measure of last resort, it is hoped that the chairman of the FSA recognises the importance of this provision in maintaining a competent and independent FSA board.

Indirect parliamentary influence over the FSA via Treasury determination of its executive board composition notwithstanding, all directors should be subjected to re-appointment at reasonably regular intervals, in compliance with Main Principle A.7 of the Combined Code[29]. This is to ensure freshness of views as represented on the board. Particular attention is paid here to non-executive directors since their role is vital to the notion of accountability. Code Provision A.7.2, inter alia, states that:

Any term beyond six years (e.g. two three-year terms) for a non-executive director should be subject to particularly rigorous review, and should take into account the need for progressive refreshing of the board.

In a perpetually changing world such as the financial services industry, being up-to-date with the market is essential especially for an organisation that has the task of regulating the whole industry. This covers not just only occurrences in the UK but also developments outside the UK and in particular those emanating from the major financial centres across the globe. Therefore, wide ranging expertise should be demanded of the non-executive directors of the FSA in which case, there is the need to regularly refresh its composition.

The way forward – suggestion of election of the FSA board

In conclusion, it is submitted that the FSA board should be elected by the industry. There are two reasons for this proposition. Firstly, there is the need to combat the risk of undue political influence on the FSA as a result of the Treasury appointment of its board. The fact that politicians are answerable to the electorate via elections is often perceived to be a determinant factor in their decision-making particularly when such an election is imminent. The result is that politicians are by their very nature prone to knee-jerk reactions and attempts at quick fixes. This is because public perception is viewed with considerable reverence in the political world. Such idiosyncratic tendency is decidedly unsuitable for application to a financial services regulator. It would be improper, therefore, that the latter be susceptible to the volatile caprice of holders of political office. Also, a government's economic policies might influence its expectation of the financial regulator, over whose board of directors it can certainly exercise a considerable degree of indirect influence.

Secondly, the need for better stakeholder accountability means that the industry should play a greater part in shaping its governance structure. A simple way to do this would be to elect the members of the FSA's board. As a compromise to the present system, Treasury can, perhaps, nominate a group of people as contenders for FSA directorships or, alternatively, interested persons with suitable credentials can make applications, and then the industry votes on them. The logic here is that the industry should be instrumental in choosing the composition of the board of the body charged with its regulation. In any case, not only does the industry pay for its own regulation, but it is also concerned with the competent regulation of the market. It is, after all, in the interest of the industry that it is properly regulated and be seen to be so. It is submitted that the adoption of this proposition would create the ultimate stakeholder accountability.

Remuneration

The remuneration aspect of s. 1, i.e. part B is a more difficult argument to promulgate in the context of this research. That is, the provisions contained in part B of the Combined Code are less applicable to a regulator[30]. This is due to the link created in it between directors' remuneration and corporate performance. In the first instance, corporate performance can be measured through profit, the calculation of which is significantly scientific and, therefore, precise. The FSA, though a body corporate, is not a profit-making organisation and so, syllogistically speaking, directors' remuneration cannot be linked to profits because there are none. Secondly, linking performance of some sort to remuneration is unlikely to be considered desirable in the context of a regulator such as the FSA.

There are two reasons for the supposition above. First, in a diverse organisation such as the FSA, one with various departments and staff, measuring the performance of individual directors or even the board as a whole is an unenviable task. It is impossible to attribute successful regulation of the financial services industry to the work of an individual director and/or the board. Secondly, there is the question of ethics. It would not appear ethical that the directors of a regulator be enticed with performance-related remuneration packages as it may only serve to corrupt the exercise of their powers and, as a consequence, undermine the functions of the FSA.

Notwithstanding the above, Main Principle B.1 also provides that:

Levels of remuneration should be sufficient to attract, retain and motivate directors of the quality required to run the company successfully…

This might yet be relevant to the FSA in view of the level of expertise needed within the FSA to enable it competently to perform its regulatory functions. It should be borne in mind that the financial services industry is a rather complex one that is always evolving as more complex products and mechanisms are developed continually. Therefore, successfully regulating the various elements of the industry requires “inside knowledge” as it were. In essence, the FSA needs people from within the industry itself who have a sound grasp of its particular idiosyncrasies to execute the increasingly numerous duties and functions of the FSA. As a result, the FSA will need to offer sufficient levels of remuneration in order to attract and retain and, to a lesser extent, motivate those it chooses to employ[31]. In any case, as Main Principle B.1 provides, there should be a formal and transparent procedure for developing policy on executive remuneration. Remuneration, as Code Provision B.2.1 stipulates, should be determined by a remuneration committee which should itself be made up of solely independent non-executive directors. This is clearly aimed at providing independent assessment of remuneration packages. In reality, as Sch. 1, para. 4(3) (c) dictates, the non-executive committee of the FSA does determine the remuneration of the chairman and other members of the executive board[32].

Accountability and audit

The financial reporting and audit provisions contained in part C of s. 1 of the Combined Code are very much applicable to a regulator such as the FSA. Main Principle C.1 states:

The board should present a balanced and understandable assessment of the company's position and prospects.

The Supporting Principle to it explains that the latter extends, inter alia, to information required to be presented by statute. That is, the FSA, in preparing its annual report as required by para. 10 of Sch. 1, should be compelled to present such information in a balanced and understandable manner. This provision should be used to compel the FSA to have adequate regard to the accuracy and viability of the information it disseminates to Parliament, the market and to the public.

Main Principle C.2 states:

The board should maintain a sound system of internal control to safeguard shareholders' investment and the company's assets.

In the absence of shareholders, the FSA should, nevertheless, have to maintain such a system of internal control as a way of safeguarding the interests of stakeholders. The latter, it is needless to say, have a vested interest in the proper regulation of the industry in order to keep infringers of rules in line. Also, proper regulation and particularly visible manifestation of it should boost market confidence which in turn should aid the attractiveness of the products and services being traded in the various markets. In compliance with Code Provision C.2.1, the FSA board should conduct an annual review of the company's system of internal controls and report to the market that it has done so. Basically, a compliance system should be set up to aid the flow of information within the FSA hierarchy. In the USA, for instance, in respect of internal controls, executive certification (that they are responsible for setting up a compliance system to ensure, inter alia, that material information reaches them) is required[33]. Erica Beecher-Monas[34], however, expressed doubts as to the effectiveness of such compliance programmes since it provides directors with the incentive to shift locus of liability down the corporate ladder[35]. A further concern was that it may also lead to companies making cosmetic rather than real changes[35]. In any case, she argued, Enron had a well-structured internal compliance programme which the board ignored, and so it did not deter such extensive corporate fraud which ultimately led to the downfall of the one time US energy giant[35].

The most significant provisions of part C are detailed in C.3: Audit Committee and Auditors. But first, it is submitted that the FSA should be made to include in its annual report, a financial statement detailing how it has utilised the money it has taken in through authorisation and fines and how much remains in its purse. Recall that para. 10(4) of Sch. 1 to the FSMA provide that Treasury may require the FSA to comply with any provisions of the Companies Act 1985 about accounts and their audit which would not normally apply to it. Therefore, the submission here is essentially that such requirements be made compulsory and so not dependent on the Treasury's discretion.

The Audit Committee

A public company is required to establish an Audit Committee of at least three who should all be independent non-executive directors. In addition, as C.3.1 points out, the board should ensure at least one member of such a committee has recent and relevant financial experience. The FSA has in fact established an Audit Committee as required under Sch. 1, para. 4(3)(a)&(b). The role of the Audit Committee includes, inter alia, reviewing the question of whether the FSA's internal financial controls secure the proper conduct of its financial affairs[36]. In this regards, the Smith Guidance provides some helpful guidance as to the internal audit process. For instance, para. 4.1 state that “the audit committee should review the significant financial reporting issues and judgements made in connection with the preparation of the company's financial statements”. It is vital that the FSA, prior to the publication of its annual report (which as previously argued should contain a financial statement detailing the use of its resources) be opportuned to review the significant financial reporting issues vis-à-vis its financial statements.

The responsibility for the preparation of complete and accurate financial statements and financial reporting disclosures should, of course, lay with the board as a whole and not the Audit Committee[37]. The Audit Committee should, however, review the clarity and completeness of disclosures in the financial statements and also consider whether the disclosures made are set properly in context[37].

Para. 4.3 of the Smith Guidance provide that if the Audit Committee is not satisfied with any aspect of the proposed financial statement, it should report such views to the board. The board then has the opportunity of redressing any deficiencies in the statement prior to the external auditors' audit and in any event, prior to the publication to the market as well as submission of the annual report to Treasury for Parliamentary scrutiny.

The Audit Committee's functions should extend, as para. 4.4 suggests, to the review of related information presented with the financial statements[38] as well as other company statements requiring board approval[39]. In this respect, the FSA's Audit Committee should be tasked with reviewing such matters as corporate governance statements as per, for instance, audit.

The Smith Guidance also quite helpfully addresses the issue of whistle-blowing[40]. Para. 4.8 states that the Audit Committee should carry out review of the company's arrangements enabling staff raise concerns of possible improprieties in financial reporting matters or otherwise confidentially[41]. The Audit Committee of the FSA should be charged with ensuring that such arrangements are in place and in such a manner that affords and guarantees a proportionate and independent investigation of such matters and where necessary for follow up actions. This is particularly useful in the context of the FSA due to its multi-disciplinary nature in regulating very diverse yet distinct areas of financial services. The vast range of regulated activities as regulated by the FSA necessarily means that it is helpful to have such a confidential mechanism of raising concerns of impropriety, particularly by middle and lower level staff.

In reality, the FSA does in fact have an internal audit function[42], as it should, and the Audit Committee should monitor and review its effectiveness. In this regard, an irrelevant point in para. 4.9 states that in the absence of an internal audit function, the Audit Committee should annually assess whether one is needed and if so, make a recommendation to the board.

The Audit Committee should ensure that adequate resources are made available to the internal audit function. It should also make sure that the latter has access to such information as necessary for the fulfilment of its role[43]. In reviewing the work of the internal audit function, para. 4.12 outline certain functions that the Audit Committee should carry out. These range from meeting with the heads of internal audit at least once annually (without the presence of management) to ensuring that the internal auditor has direct access to the chairman of the board, etc.[44].

On of the more influential powers of the Audit Committee is that its approval must be obtained for the appointment or termination of appointment of the board of the internal audit function[45]. This level of scrutiny as well as powers of the Audit Committee is so that the Committee plays a pivotal role in the establishment and continued supervision of a company's corporate governance techniques. For the FSA, it will achieve this as well as create a necessary multi-faceted hierarchical system even within the internal audit mechanism of the regulatory body. The FSA, therefore, would have sufficient information and time in getting things done in the appropriate manner before submitting to an external auditor. It can be viewed as an additional chance for the FSA to redress matters internally on its own terms prior to further scrutiny by the external auditor.

The external auditor

The FSA does employ external auditors to review its accounts and internal audit review statements. One must recall that the FSA is funded by the industry and that as a result, the utilisation of its resources should be scrutinised so as to aid market confidence in it as the regulator. In addition to monitoring the internal audit function, the Audit Committee is also responsible for overseeing the FSA's relations with the external auditors[46]. As a result, it should recommend the appointment; reappointment and removal of the external auditors. For want of transparency, in the event that the board rejects such recommendation, it should include the latter and its reasons for rejecting it in its annual report[47]. For the FSA, this should enable Parliament scrutinise such a rejection by the board and decide if it was appropriate or not. The selection process for the appointment of new external auditors should be overseen by the Audit Committee and it should also assess the qualification, expertise, resources and independence of the external auditor on an annual basis[48].

The Audit Committee should approve the terms of engagement and the remuneration to be paid to the external auditor and in any case satisfy itself as to the appropriateness of the external auditor's level of remuneration[49]. The Audit Committee should secure the independence of external auditors, i.e. that no family, financial or employment ties exist that may impair the auditors' judgement or independence. Please note also that ethical guidelines of the accounting profession should be borne in mind in respect of the company's employment of the external auditor's former employees.

In the event that the external auditor is to provide other non-audit services for the FSA, para. 4.25 provide that the Audit Committee should ensure that the provision of such services does not adversely impact on the external auditor's independence or objectivity. In the USA, the Sarbanes-Oxley Act contains an outright ban for accountants on performing certain kinds of non-audit service, e.g. building and managing financial information systems, legal services, etc. In addition, those wishing to perform non-audit work falling outside of those categories must obtain prior approval by the company's Audit Committee (Alexander, 2002). The rationale for this stems from the impact that the rather cosy relationship between companies and their external auditors had in some of the high-profile corporate scandals recently experienced in the USA.

Relations with regulated persons and other stakeholders

Part D of the Combined Code which deals with a company's relations with its shareholders is sub-divided into two further parts. The first part addresses dialogue with institutional shareholders whilst the second deals with the constructive use of the AGM. Main Principle D.1 states:

There should be a dialogue with shareholders based on the mutual understanding of objectives. The board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place.

It is clear that public companies must actively seek the views of shareholders as they are the owners of the companies. It is only prudent that those shareholders, particularly the institutional investors, who form the largest shareholders, are given the opportunity to contribute their opinions to the business and running of the company.

Since, the equalisation of shareholder protection (in the case of public companies limited by shares) with stakeholder protection (in the case of a regulator such as the FSA) is the basis of this paper's promulgation of corporate governance as an accountability mechanism, the importance of such dialogue between the FSA and the regulated industries and consumers cannot be over-emphasised. This, therefore, fits in tandem with stakeholder accountability as discussed in the preceding chapter. The requirement of such dialogue with the industry and the public, notwithstanding the Practitioner and Consumer Panels, is justified on the ground that the composition of the Panels is determined by the FSA itself. This, it is argued, weakens the accountability mechanism intended by Parliament.

The Supporting Principles provide that the board should keep in touch with the opinions of shareholders (or in this case, stakeholders), in the most practical and efficient ways. Therefore, the FSA board should ensure that sufficient contact with stakeholder representatives (via the Panels) is maintained so as to understand and consider their respective issues and concerns. The Panel system advanced by the FSMA provides for consultation with the two Panels and that the FSA must have regard to those views as expressed by the Panels. Whilst simply requiring that the FSA have regards to it does not go far enough in respect of FSMA, the combination of the requirement that the FSA give reasons for disagreeing with the Panels and the requirement of dialogue in the Combined Code (especially if adopted as argued by this essay) should make it a much stronger provision. The adoption of corporate governance as a major accountability mechanism should go a long way to removing the rather weak and almost voluntary nature of the FSMA provision in this respect.

According to Code Provision D.1.1, the chairman has the responsibility for ensuring that the views of shareholders are communicated to the board as a whole. Such specific placing of responsibility should ensure that the FSA chairman at any given point in time gives sufficient credence to this provision in making sure that the entire board is made aware of the views of stakeholders. D.1.1 goes further to require that the chairman discusses governance and strategy with major shareholders. Again, in application to the FSA, it would mean that the latter is forced to dialogue with the stakeholder Panels in an attempt to reaching constructive conclusions and, where appropriate, compromise with them.

Non-executive directors of the FSA should have the opportunity of attending meetings with the Panels and in any case be obliged to do so if requested by either Panel. As a way of further strengthening such constructive dialogue, the senior independent non-executive director should attend sufficient meetings with a range of practitioner and consumer groups apart from the two Panels. That should ensure that the FSA gets an even broader perspective of the diverse views held in the industry, notwithstanding those already represented on the two stakeholder Panels.

In aid of transparency, the FSA board should state in its annual report the steps taken to facilitate effective dialogue between stakeholders and the board members, especially the non-executive arm of it. The requirement of such compulsory disclosure, as influenced by Code Provision D.1.2, should add to the board realisation that it must in fact effect such dialogue in the first place.

The latter aspect of part D dealing with the company's AGM requires that “the board should use the AGM to communicate with investors and to encourage their participation”[50]. In essence, if adopted as part of the corporate governance mechanism of accountability, this provision should ensure that the FSA has annual meetings with not only industry players but also interested members of the general public as well. The APM serves as a useful forum for the open discussion of major FSA matters and proposed actions. Such discussion ensuring that the FSA board are made aware of the views held both publicly and within the industry, thereby, going beyond those already known through the Panels' consultative process[51].

D.2 has four Code Provisions of which the first two are inapplicable to the FSA as they deal with proxy voting rights and company resolutions at an AGM. The other two, however, are applicable. D.2.3 provides that the chairman arrange for the attendance of all directors and also for the availability of the chairmen of the various board committees at the AGM to answer questions. In relating this to the context at hand, FSA directors do attend the APM but it is submitted that the FSA should ensure not only the attendance of all its 16 directors but also the availability and preparation of the chairmen of the Audit and Remuneration Committees as well as the deputy chairman who is also the lead non-executive director, to answer questions posed by those attending the APM. Again, the intention is to facilitate greater dialogue between the FSA, the industry as well as the public as a whole.

Code Provision D.2.4 relates to the sending of the Notice of the AGM to shareholders at least 20 working days before the meeting. Here, the FSA should be required to do two things. The first is to send such notice to the two Panels and, secondly, to place an advertisement of the APM is a minimum of two national newspapers, giving at least 20 working days' notice. Note that the FSA does these.

Conclusively, the requirement of compulsory communication with the regulated industry and consumers is decidedly advantageous in helping the FSA form a better understanding of the industry it regulates and especially help it be aware of the industry's views vis-à-vis regulation. A point of greater significance, however, is that it renders the FSA accountable to the industry itself both in terms of having to consult via the two stakeholder Panels and conducting a two-way conversation with it and the public at the APM.

Section 2 of the Combined Code

S. 2 of the Combined Code relating to institutional shareholders provides guidance to them in relation to dialogue with companies and evaluation of companies' governance disclosures and making considered use of their votes. It is, therefore, apparent that this is irrelevant to the FSA but only partly so. The fact remains that the stakeholders, i.e. the industry and consumers should dialogue with the FSA and also evaluate the latter's governance disclosures and arrangements. However, it is contended that an extensive discussion of this area is not necessary here since the stakeholder Panels have their own internal guidelines as to their relationship and dialogue with the FSA via consultation. The evaluation of governance arrangements should be inherent in those.

Supporting Principle to Main Principle E.1 states that institutional shareholders should apply the principles set out in “The responsibilities of institutional shareholders and agents – statement of principles” of the Institutional Shareholders' Committee. Whilst this does not apply to the stakeholder Panels, both Panels have their own laid down guidelines as to their dealings with the FSA in fulfilling their respective statutory consultative roles.

Conclusion

Ensuing from the premise that the existing methods of conferring some sort of accountability on the FSA are not sufficient to fulfil that role, the elucidation of the corporate governance mechanism formed the focal point of the paper. The Annual Report and the APM have both been shown as corporate governance provisions already adhered to by the FSA as a result of specific references to them in the FSMA 2000. However, the adoption of the provisions of the Combined Code on corporate governance represent the main proposition of this prose, with some suggestions made as to how to improve the FSA's accountability, for instance, the suggestion of election of the FSA board.

Independent assessment of the FSA

Beyond the independent audit of the FSA's accounting information, addressed earlier under Accountability and Audit, there is also the need for a wide-ranging audit of the FSA's conduct and performance generally. This should go beyond the judgments that the Treasury can deduce from the information contained in the annual report submitted by the FSA. The aim of this is to cater for any misgivings that may exist as a result of the FSA being an independent, non-governmental body and serve as a way of maintaining confidence in its performance of its numerous functions. This, it is submitted, is an important tool of ensuring the accountability of FSA.

A welcome development in this context is that the first ever such assessment of the FSA was recently completed by the NAO (FSMA 2000, 2007). This was conducted at the invitation of the Treasury under s. 12 of the FSMA. It covered five areas: performance management; working with other regulators; international influence and representation; financial crime; and financial capability. Below is an extract from a statement published on the web site of the NAO (www.nao.org.uk/pn/06-07/0607500.htm):

“The National Audit Office found:

The NAO concluded that the FSA has done well in effectively managing the merger of 11 regulatory bodies. The FSA was commended for having created strong and effective structures but the report adds that there are, nevertheless, areas for improvement. Sir John Bourn, the Comptroller and Auditor General of the NAO, sums it up succinctly:

[T]he challenge for the FSA is now to move to the next level. It must do more to demonstrate its impact; to get a clearer understanding of how much its different activities cost; and, crucially, to streamline its processes and advice, to benefit industry and consumers[52].

Conclusion

The role and function of the FSA was radically altered by the FSMA 2000. The FSA has gone through an institutional metamorphosis having been transformed from a regulatory body solely for investment business and utilising delegated powers to the single regulator for the banking, insurance and investment business sectors with the aid of directly-conferred statutory powers. As opposed to merely being a regulatory body with disciplinary and investigative powers, it now possesses legislative and prosecutory powers as well. The FSA is the super-regulator endowed with regulating virtually the entire financial services industry in the UK, and yet it is still growing and expanding[53].

The overwhelming and, quite frankly, unprecedented nature of the FSA's functions and powers coupled with the abolition of the delegation model meant that accountability of such a powerful and influential, yet non-governmental, body was a source of considerable concern even prior to the enactment of the statute. In the aftermath of the FSMA becoming law in its entirety, that concern rages on still, understandably so. This paper, as a result, sought to argue for the adoption of one of the more novel, yet subtle, mechanisms introduced by the legislation – corporate governance.

The way forward

In the final analysis, the adoption of corporate governance as a major or the main mechanism of the FSA's accountability can take one of three forms. Firstly, the FSA can, on its own initiative, elect to adopt such rules in making it more transparent and accessible to the industry and the public as a whole. However, it is thought that the FSA, whilst not unwilling to be accountable, is unlikely to choose to adopt such a system which shall undoubtedly confer a far stricter regime on it. Secondly, some form of judicial engineering is another way of widening the application of corporate governance beyond the narrow and yet vague manner in which it is currently provided for statutorily. The fact that litigation is a prerequisite of this diminishes its attractiveness as a force for change. The fact that judicial review is unlikely to result in such an imposition (as it will be beyond it scope) is an additional reason why this method of perpetuating corporate governance in this context is even less viable than the first. Finally, therefore, the third way, legislative intervention, becomes more relevant. The wider re-drafting (and construction), by Parliament, of s. 7 is the most attractive mode of enforcing corporate governance as an accountability mechanism. This is so, as it will give it far greater force than at present by creating a mandatory regime to bind the FSA in this respect. What is required, therefore, is an amendment of s. 7 of the FSMA 2000 to establish a better accountability method to be imposed on the FSA. The great advantage of this is that Parliament is able, with considerable precision, to stipulate what categories of good corporate governance principles are to apply to the FSA. It can modify the Combined Code in respect of its application to the FSA. This is in order to tailor the applicability of the provision to suit the FSA particularly in view of the fact that those principles were designed primarily for profit-making public companies limited by shares.

In conclusion, it is not intended that corporate governance should represent the only method of accountability of the FSA but instead that it should, in conjunction with the existing methods, epitomise a fresher, more contemporary apparatus of effecting a more intrusive approach to regulatory responsibility and reliability, by encouraging transparency within the FSA. In any event, the existing mechanisms, whilst advantageous in their own right nevertheless lack adequate bite in ensuring that the FSA is sufficiently answerable to the public. Therefore, corporate governance is proposed in this paper as a better and decidedly more effective mechanism of ensuring the FSA's accountability.

References

Alexander, K. (2002), "The need for international regulation of auditors and public companies", The Company Lawyer, Vol. 23 No.11, pp.341.

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FSMA 2000 (2007), The Financial Services Authority – A Review Under Section 12 of the Financial Services and Markets Act 2000, available at: www.nao.org.uk/publications/nao_reports/06-07/0607500.pdf (accessed April 2007), .

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Corresponding author

Olu Omoyele can be contacted at: oluz@yahoo.com