Monday, 24 September 2018

The Dynamics of Financial Penalties

In response to the news that KPMG has ‘rejected’ the size of the fine given to it by the Financial Reporting Council (FRC), today’s post will discuss some of the dynamics of financial penalties. We have analysed the FRC a number of times in Financial Regulation Matters, and it will be important to assess whether the recent pressure being heaped upon the regulator has had the effect of changing the dynamic within that particular regulatory sector. However, it will be worth looking into the issue of financial penalties moreover, to ascertain whether they are considered effective enough, and if so then why that may be.

The news story that initiated today’s post can be found in The Times, and runs under the headline ‘KPMG rejects size of misconduct fine’. The fine is based upon the auditor’s performance when auditing BNY Mellon, and specifically in relation to its recent £126 million fine from the FCA regarding the mixing of institutional and client assets. KPMG has admitted that it had fallen short of ‘the standards set for auditors’, but that it was rejecting the fine because it felt the fine was too high. At first glance, and especially when one views the headline, it seems to be remarkable that the auditor would have the gall to ‘reject’ the fine, and further still even be in the position to do so. After the performance of auditors in other high-profile cases like the collapse of Carillion, it is easy to see why such a headline would cause widespread consternation and further distrust in the capacity of auditors to perform at an adequate level. However, there may be other issues at play rather than the obvious one.

The reality of the situation is that KPMG has the right to reject the fine within the current regulatory framework, and has plenty of reasons for doing so. The first is that the issue will be now be escalated to an independent tribunal, and other auditors have seen their fines reduced by similar tribunals only very recently. The second issue is that, relatively speaking, the fine really may have been ‘too high’. The word relative is important here, however. Regular readers of Financial Regulation Matters will know that very rarely, if ever, will a fine be considered ‘too high’ by this blog, but for the auditors and their relationship to the FRC, this may very well be the case. Very rarely will the FRC’s fines exceed £10 million, and whilst we do not know the size of the fine in this instance with KPMG, it is likely that it is near that £10 million figure. That is, of course, speculation, but there is a reason for that speculation, and it is likely the reason that KPMG would have decided to challenge this fine and, in all likelihood, win a reduction via the tribunal. The FRC has come under increasing pressure from MPs to toughen up, which has been received by the FRC as an indicator that its fines need to be increased (rather than look at alternative forms of punishment, for example). As a result, there is a potential that the FRC is exceeding the limits of its regulatory dynamic with the firms that it is exceptionally close with, although this is all relative still. If that is the case, and more auditors reject the fines given to them by the FRC, then there is a real potential for the FRC to be facing a critical juncture in its future. In reality, can the regulator maintain any sense of authority, authority which it struggles to maintain anyway, if the regulated entities, en masse, reject its decisions? If the tribunals put forward lesser fines, then that may essentially destroy any credibility the regulator has with its regulated entities, as it has very little outside of that sector. Yet, should the regulated entities even be allowed to accept or reject a punishment given to it?

Professor Cartwright discusses this very issue of ‘credible deterrence’, in relation to financial penalties in particular, and put forwards some very thought-provoking points. Within Cartwright’s chapter he discusses how traditional corporate crime theories focus on the usage of financial sanction to deter negative behaviour and encourage positive behaviour, but the question for us is the effect of financial sanctioning on the regulator themselves. Whenever a regulator imposes a fine upon one of its regulatory subjects, it is essentially extending its authority to impose such fines. For some regulators this action is enshrined, and can rarely be questioned, but for others it is part of a process, or a ‘game’ within which both sides battle for what, for them, constitutes a victory. For the regulated it may involve ‘settling’ or negotiating down a fine so that the fine is palatable for it and its members (RBS and its recent fine from the U.S. DoJ comes to mind), or for the regulator it may be that it needs to signal to stakeholders, which may constitute politicians and/or the public, that it is taking the appropriate action against a wrongdoer. All of this is fairly well understood and is admittedly basic, but what happens when that regulator does not have the authority? It is likely that we are seeing the answer to that question play out in front of us with the FRC and its current politics-inspired approach to regulating. Perhaps the major issue with the FRC is that it is becoming a very reactionary body, which is a result of its incredibly lax approach in the past. Perhaps it is simply too late for the regulator to ‘toughen up’ on the orders of politicians, as it either has no authority to do so, or the dynamics of the regulatory arenas within which it operates simply do not allow for such heavy-handed tactics to be employed.


Yet, there are a number of issues with those last few statements. The ‘toughening up’ that has been called for, and the ‘toughening up’ that has seen KPMG reject the recent fine, is only a very slight increase on the levels of fines in the past – the difference between £1 or £2 million and £10 million, to a firm with revenues of £2 billion, is negligible. It is arguable that KPMG and their oligopolistic are themselves disciplining the regulator, but that is a very dangerous approach. It is dangerous because whilst it is very difficult to make a case for the FRC continuing, its demise would bring about uncertainty within the regulatory framework – what happens if a new, fundamentally tougher and more removed regulator is put in its place? The effect of this would indeed be felt by the auditors, particularly as in the UK the opposition parties are calling for the break-up of their industry – the development of a tougher regulator could move the needle fundamentally in that direction. Nevertheless, for the FRC, KPMG’s rejection of its fine may well prove to be a turning point for its ultimate future, and if another oligopolistic members rejects a future fine then it is not outside of the realms of possibility that the FRC as we know it will not be able to survive such insolence.

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