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The chief executive of Britain’s Financial Services Authority, John Tiner, summoned the CEOs of 21 financial institutions to meet at midnight on March 2, 2004, at the agency’s Canary Wharf headquarters. Tiner believed, according to various press reports, that the corporations, including the British brokerage arms of UBS AG and HSBC Holdings plc, had misled “mum-and-dad” investors about the riskiness of a group of funds known as split capital investment trusts. Tiner’s agency had spent the previous two years sifting through tens of thousands of taped phone conversations and e-mails from the companies. Tiner laid out his findings at the midnight meeting. Then he reportedly gave the companies two weeks to admit culpability for “mis-selling” these financial products (which operate by investing their money in other publicly traded companies), and come up with about $672 million to compensate shareholders. But Britain’s financiers let the deadline pass. In mid-March 2004, a fund manager at one of the targeted companies boasted to the Financial Times: “The FSA said two weeks ago: ‘Take it or leave it.’ The industry said: ‘We’ll leave it.’ ” Nine months later, the FSA accepted a settlement of about $370 million from 18 of the 21 firms, without any admission of wrongdoing. (Investigations of the nonsettling firms are ongoing.) In a press release, the FSA said the settlement was “ in the best interest of investors” because, given the case’s complexity, there was no guarantee that protracted litigation would yield a settlement in their favor. Fairly or unfairly, Tiner was mocked by London’s press as a tin-pot Eliot Spitzer. On paper, the Financial Services Authority is the world’s burliest financial watchdog. Born in December 2001, it combines the powers of the Securities and Exchange Commission with those of state insurance boards, state attorneys general, the Commodity Futures Trading Commission, the Office of the Comptroller of the Currency, and the Federal Reserve Board. The FSA can levy fines and penalties, and, ultimately, take away a company’s right to list a stock or even do business in London. The agency’s reach extends to multinationals too. Twenty-four of the 100 largest American corporations trade on the London Stock Exchange, from Altria Group Inc., and The Boeing Co. to United Technologies Corp. and Verizon Communications Inc. As regulatory master of the globe’s second financial center, Tiner should by all rights be the equal of Spitzer, the New York State attorney general who’s taken on the U.S. banking and insurance industries. But a number of factors have hobbled Tiner and his group. The FSA has primitive information technology and a small number of enforcement lawyers: 100, compared to the SEC’s 1,200. Perhaps just as important, the FSA operates in a legal and business culture that is unaccustomed to hefty fines or large judicial awards. Tiner failed to cow the financiers at his infamous midnight meeting, industry watchers say, because their companies’ stock prices didn’t plunge afterward. Tiner and the FSA are being challenged on other fronts too. Two parties have recently gone to court to contest the agency’s actions. The Surrey-based Legal & General Assurance Society Ltd. has battled the FSA to a draw in a case involving risky financial instruments. And Sir Philip Watts, ex-chairman of the Royal Dutch/Shell Group of Companies, based in London and The Hague, challenged the FSA after it fined Shell for overestimating its oil reserves. Still, the FSA shouldn’t be counted out yet. It’s only a few years old, and despite these high-profile challenges, most of its actions haven’t been questioned. And, say observers, it’s unfair to expect the FSA to emulate the American way of securities enforcement. “The FSA are still light-years behind Spitzer,” says Eva Heffernan of DLA Piper Rudnick Gray Cary, who has worked on both sides of the Atlantic. “What they are is [more] aggressive compared to their predecessors.” In the old, pre-FSA, days, Britain relied on a system of “chaps regulating chaps.” The chaps who ostensibly did the regulating were spread among several trade groups: the Personal Investment Authority, the Investment Management Regulatory Organisation, and the Securities and Futures Authority. The Bank of England kept an eye on banks. In the absence of subpoena power, it was said that the ultimate sanction was a “raised eyebrow” by the Bank of England’s governor. However, the 1995 collapse of Barings Bank showed that that system didn’t work. Creating a strong, unified regulator was a central aim of the “New Labour” government when it came to power in May 1997. Prime Minister Tony Blair and his chancellor of the Exchequer, Gordon Brown, unveiled their vision within two weeks of entering office. What they created is a quasi-public agency, funded by taxes on the finance sector, but answerable to Her Majesty’s Treasury. The FSA officially started work in 2001, after a long period of industry comment and Parliamentary debate. In a typical case, an FSA enforcement team presents evidence to the agency’s regulatory decisions committee, a panel of part-time outside lawyers chaired by an FSA staff lawyer. After giving the accused an opportunity to respond, the committee issues a ruling. Following an adverse decision, the defendant may appeal to the Financial Services and Markets Tribunal, an independent body that is part of the English court system. This system worked smoothly for two years, but last fall the agency faced its first serious challenge — by Legal & General in a mortgage endowments case. Mortgage endowments are complicated and risky investment vehicles. In lieu of taking out a home mortgage with a bank, a home owner borrows the money from an insurer, which invests the principal. If the insurer makes a positive return, the home owner can make a profit. If the return is negative, the homeowner owes the insurer more money. In the end, mum and dad could lose their home. In 2001 the FSA accused 25 British financial institutions of selling mortgage endowments to hundreds of thousands of homeowners who didn’t fully understand the risks. As a result of the FSA’s actions, the mortgage endowment industry agreed to pay nearly $1.3 billion to customers, according to a 2004 report by the House of Commons Treasury Committee. The lone holdout was L&G, which was fined about $2.1 million by the FSA for “mis-selling” financial products. In November 2003 L&G’s general counsel, Geoffrey Timms, filed an appeal with the Financial Services tribunal, which convened at the Royal Courts of Justice in autumn 2004. The trial turned on the FSA’s alleged laziness in gathering evidence. During its probe, the regulator had asked PricewaterhouseCoopers International Limited to study how many of L&G’s customers deserved to be compensated. PwC looked at the risk level of several homeowners who purchased mortgage endowments — including their income and education levels — without examining each sale to see if it was deceitful. PwC concluded that 60 of the 152 sample consumers they studied were vulnerable. According to court documents, PwC by its own account didn’t show that the insurer was guilty of improper sales, which required a higher standard of proof. L&G argued that the FSA, without doing its own investigation, assessed its penalties based solely on PwC’s incomplete findings. On January 18 the tribunal ruled that the FSA had failed to justify its conclusions and that “Legal & General were justified in feeling aggrieved.” It criticized the FSA for sometimes being cavalier with evidence. But the decision castigated L&G for occasionally being overly aggressive with consumers. And the judges did not stop there. In their ruling, they carefully reviewed 13 L&G sales and found that eight were improper. (L&G’s fine is to be determined at a new hearing scheduled for late April.) In the end, who won? Some see the ruling as a victory for companies. On February 2 Tiner announced that, in light of the tribunal’s decision, the FSA would thoroughly review its enforcement procedures over the next six months. (Tiner declined to be interviewed for this story.) L&G’s solicitor, David Scott, of Freshfields Bruckhaus Deringer’s London office, says: “The tribunal has proven that it’s an effective check and balance on the FSA. Now the focus is on making the internal FSA process fair.” But Barney Reynolds, head of the European financial services group at Shearman & Sterling’s London office, is more generous to the government. “I don’t think one should see the L&G ruling as a bang in the face of the FSA,” he says. “This is just the courts tussling with the FSA over the correct interpretation of their powers.” L&G’s GC Timms declined to comment. Alistair Graham, head of the London disputes group at White & Case, adds that a GC who picks a fight with a regulator must show that the benefit outweighs the cost — not only in attorneys’ fees, but in managerial distraction, damaged public image, and strained relations with the enforcement agency. According to Graham: “A lot of GCs are saying: ‘Gosh, that was a brave move, and [Timms] got away with it, but it was a close-run thing.’ ” Graham predicts that there won’t be an explosion of FSA appeals from big institutions anytime soon. The next party brave or foolish enough to take on Tiner was a man with his back to the wall. While L&G challenged the rigor of the FSA’s enforcement procedures, Sir Philip Watts is challenging its basic fairness (his appeal has yet to be heard). Trained as a seismologist, Watts served as Shell’s chairman during what was arguably the greatest seismology scandal since the eruption of Krakatoa. Between January and May 2004, Shell cut its estimated oil reserves by 23 percent, or nearly 4.5 billion barrels. Davis Polk & Wardwell — investigating on behalf of Shell’s audit committee — unearthed a compromising chain of e-mails sent by Shell’s exploration chief to Watts. The firm’s executive summary of its findings, which included some of this correspondence, was released to the public last winter. In one message, Shell’s exploration chief mused: “If I was interpreting the disclosure requirement literally (Sorbanes [sic]-Oxley Act etc.), we would have a real problem.” In another e-mail to Watts, he complained: “I am becoming sick and tired about lying about the extent of our reserves.” Two days after Davis Polk turned over its findings in March 2004, both executives resigned. On August 24, 2004, at the end of a four-month investigation, the FSA fined Shell $30 million for misleading the financial markets. Simultaneously, the SEC fined Shell $120 million. Both regulators found that Shell’s overstatements resulted from the company’s unlawful behavior, and reserved the right to sue Shell executives. Despite the rulings, the matter was far from over. Two class actions, now in the discovery phase, were soon filed in New Jersey federal court, naming Shell and its executives as defendants. “The FSA bolsters our allegations,” says plaintiffs attorney Brad Friedman, of New York-based Milberg Weiss Bershad & Shulman. On September 16 Watts appealed the FSA’s decision to the Financial Services tribunal. Although the FSA never named Watts in its notice to Shell, he argued that if an FSA action “relates to a matter which identifies” him, the statute gives him the right to see evidence and be heard. Watts was represented by former FSA official Martyn Hopper, of London’s Herbert Smith, who declined to comment; other lawyers in the field think this is a tough argument to win. Regardless of Watts’s fate, the case will be remembered as a signpost in British financial regulation. The $30 million fine levied on Shell may be modest by the standards of the SEC, which issued a total of $1.2 billion in civil fines in 2004. But the FSA’s fine was a big step in the direction of U.S.-style enforcement. It was more than quadruple the next-highest fine in FSA history, a $7.7 million fine against Credit Suisse First Boston LLC in 2002, arising out of a Japanese regulatory scandal. And it was well over double the sum of all other FSA fines last year. In 2004 the FSA issued approximately $11 million in fines against 19 other companies, and nearly $1 million against ten individuals. Invariably, the FSA comes off as timid in comparisons with America’s financial watchdogs. Consider Spitzer’s greatest coups of 2003 and 2004. His charge that Wall Street firms, like Merrill Lynch & Co., Inc., were skewing their research analysis to reward investment banking customers led to a $1.4 billion settlement in the United States with ten banks. Following those revelations, the FSA merely toughened its conflict-of-interest rules for investment banks. The discovery of market timing by investment funds led to nearly $3 billion in American settlements, as compared with nearly $10 million in Britain. But to Shearman’s Reynolds, this merely shows that the FSA chooses its battles wisely and that its highest priority is protecting consumers. The British agency has pressured financial institutions who cater to vulnerable retail consumers to disgorge large sums. It cajoled the “mortgage endowment” industry to come up with nearly $1.3 billion for homeowners, and forced fund managers to pay $370 million to individuals who purchased shares in split capital investment trusts. So far, the FSA has mostly refrained from penalizing international players, who trade mainly among themselves on the “wholesale” financial markets. And that suits Reynolds fine. “The FSA is possibly the most sophisticated regulator in the world,” he says. “It has a light touch and great rules.”

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