UK: Skilled Persons Reports: Changes To The Regime In 2013

Skilled persons reports are one of a range of investigation powers the Financial Services Authority (FSA) has at its disposal. Over the years, the FSA has used this tool with increasing frequency and the costs for firms associated with such reports can be significant. While this power will remain under the new financial services regulatory regime which is expected to go live on 1 April 2013, certain amendments have been proposed which firms should be aware of.

Currently, section 166 of the Financial Services and Markets Act 2000 (FSMA) provides the FSA with the power to require a regulated firm or individual to commission a report by a skilled person. More particularly, section 166 provides that:

• The FSA may, by notice in writing, require an authorised firm to provide it with a report on any matter about which the FSA has required or could require the provision of information or production of documents under section 165 of FSMA. Section 165 provides wide powers to require information from authorised persons subject to the requirement that the FSA may only require information and documents "...reasonably required in connection with the exercise by the Authority of functions conferred on it by or under..." FSMA
• The FSA may require the report to be in such form as may be specified in the notice
• The person appointed to make a report must be a person (a) nominated or approved by the FSA; and (b) appearing to the FSA to have the skills necessary to make a report on the matter concerned The cost of the skilled persons report falls to the firm.

FSA guidance

While it is one of the FSA's powers of investigation, skilled persons reports can be used in both supervisory and enforcement contexts. The FSA has stated that it uses skilled persons reports "to obtain an independent view of aspects of a firm's activities that cause [the FSA] concern." The FSA's existing guidance on the use of skilled persons reports can be found in the Supervision Sourcebook (SUP) of the FSA Handbook. The guidance states that the FSA may use its section 166 power:

• For diagnostic purposes, to identify, assess and measure risks
• For monitoring purposes, to track the development of identified risks, wherever these arise
• In the context of preventative action, to limit or reduce identified risks and so prevent them from crystallising or increasing
• For remedial action, to respond to risks when they have crystallised

Past statistics

Frequency: The frequency with which the FSA has utilised skilled persons reports has increased steadily over the past 10 years. In 2002/2003, the FSA used its section 166 power in 31 cases but, by 2011/12, the number had risen to 111 cases.

Cost: while the 31 reports commissioned in 2002/2003 were estimated to have cost in aggregate £10.75 million (with the cost per report ranging from £13,000 to £4 million), in 2011/12, the estimated aggregate cost had increased to £31.2 million (with the cost per report ranging from £2,975 to £3 million).

Summary statistics (2002 to 2012)

Subject matter: While the issues addressed by skilled persons reports can vary widely, they have in the past been used to consider:

• Client money and client asset arrangements –– Past business reviews and quality of advice
• Controls over data security and controls to prevent money laundering
• Accuracy of regulatory financial and transactional reporting
• Adequacy of systems and controls, corporate governance, senior management, compliance and risk management arrangements
• Treating customers fairly
• Capital adequacy
• Market abuse

Outcomes: Skilled persons reports can result in a range of different outcomes including consumer redress programmes following confirmation of poor sales practices or advice failings, or the implementation of enhanced systems and controls and governance structures following the identification of weaknesses. Enforcement action may also follow. By the same token, skilled persons reports may serve to ally regulatory concerns about the scope or severity of a particular issue.

Identity of skilled persons: In response to a number of requests made in late 2010 under the Freedom of Information Act 2000 (FoIA), the FSA released some further information about its use of skilled persons reports. The information revealed (albeit not unsurprisingly) that it is often the "Big 4" accountants who are engaged to undertake skilled persons reports, though smaller accountants firms and compliance consultants undertake a fair proportion.

Size and nature of target firms: The FoIA disclosures also revealed that, for the 88 skilled persons reports commissioned during 2009/2010, they were evenly spread between large UK institutions (e.g. retail and wholesale banks and life insurers), medium-sized institutions and small firms (including financial advisers and intermediaries). However, for the preceding two years, there was a heavier use of section 166 powers in relation to medium to small firms. As to sector focus, the FoIA disclosures indicate that the power has been most heavily used between 2006 and 2010 in relation to financial advisors and intermediaries, followed closely by life insurers.

Proposed changes

It is generally expected that the number of skilled persons reports will continue to rise, particularly in light of the recent publication of the FSA's Consultation Paper entitled 'Regulatory Reform: PRA and FCA regimes relating to aspects of authorisation and supervision' ("Paper") in September 2012. The Paper sets out proposed changes to the current FSA Handbook which will align it in readiness for the new, separate rulebooks on conduct and prudential regulation due to be released next year. Amongst the changes are amendments to the regulatory powers relating to skilled persons reports.

There are three main changes set out in the Financial Services Bill in relation to the use of reports by skilled persons. These are:

RIEs: The first of these changes will bring into the regulator's scope, for the first time, RIEs (and entities related to RIEs). This new use of power is expected to assist the regulators to assess whether exchanges are meeting their recognition requirements.

Cost: The second change is perhaps the one that is the most 'headline-grabbing', despite being foreshadowed in early drafts of the Financial Services Bill. Appointing a skilled person under the current rules involves the FSA making a request to the firm concerned to either nominate a skilled person (for the regulator's consideration and agreement) or the FSA can nominate a skilled person. However, it is now proposed that the regulator (i.e. the FCA or the PRA as successors to the FSA) can (in addition to the current mechanism for appointment which will remain), appoint the skilled person directly to conduct the work. There is no power of veto under the current section 166 of the Financial Services Bill which implies that the regulator may still be able to appoint a skilled person even if the firm were to object to the appointment of that particular person. However, in practice it will be important for the skilled person to have a good working relationship with the firm, as well as with the regulator, so the regulator would be unwise to ignore any well-founded objections.

Costs estimates: A new rule will be created to allow the regulator to levy a fee on the firm to recoup the costs of producing the skilled persons report in these circumstances and the FSA has said that the firm will be "provided with an indication of the costs expected to be incurred by the appointment of the Skilled Person, before the work begins". The accuracy of these initial costs estimates will be of concern to firms, particularly as it is unclear whether the firms will be allowed any involvement in fee negotiations in circumstances where the regulator is contracting directly with the skilled person, despite the firm having to ultimately foot the bill for the appointment. In practice, the firm may be able to raise objections as regards costs if it considers that these will be unacceptably high based on early indications, however there is no specific guidance available on this point.

For information gathering: The third change is a new regulatory power under section 166A to appoint a skilled person specifically to gather and update information. This will be used in situations where such information could be beneficial for the regulator to have, for example, in the controlled winding down of a financial institution or as part of a recovery plan, or for ensuring that the remedy of a serious regulatory breach is carried out effectively. This is a new and different application of the section 166 power and one could see it being used significantly in future.

Publication of report data: Finally, it is of note that the regulator will now publish, on a quarterly basis, details of the number of skilled persons reports commissioned and the firm business types which are the subject of the reports. Indeed, the FSA has already published this data for the first quarter of 2012/2013 and, in that period, 23 skilled persons reports were commissioned, seven of which related to banks or building societies.

New Skilled Person Panel

A further key (and practical) change to the current skilled persons regime is the new, formal procurement process recently announced by the FSA in order to create a "Skilled Persons Panel". While this change is in part due to a need for the FSA to comply with new EU Procurement Directives (EPD), it is said that this will allow the FSA's successors to have more control in the selection process, with improved due diligence on the skill sets of persons carrying out the reports and the ability to apply a more consistent methodology for approving and appointing those persons.

Skilled persons will be assessed for selection to the Panel during the tender process by their specific experience against certain categories including client assets, conduct, financial crime, data & IT and prudential (insurance). It is intended that the Panel will also be split with reference to the likely cost of the skilled persons reports. This is because compliance with the EPD will be required for reports which cost over €200,000 and, consequently a two-tier Panel is to be created with differing provisions for those skilled persons who undertake reports above the EPD threshold (who will be required to sign a four-year framework agreement) and those below the EPD threshold.

Once the Panel is in place (currently expected to be by March 2013), regulated firms will be expected to select a skilled person from the official Panel (where the request is raised in the usual way by the regulator). Where the FCA or PRA appoint a skilled person directly, under their new powers, they will have ultimate control and choice over the selection of a person from the Panel, as in any other contractual context.

Conclusion

On the assumption that the proposed changes to the skilled persons regime survive Parliamentary scrutiny, they should make firms pause for thought as the underlying rationale for the changes is to alter the balance even further in favour of the regulator. Not only will firms be required to select skilled persons from a panel prevetted by the regulator, it also appears that, in certain situations, they will have limited influence over issues of cost. These proposals are yet another example of the new regulators' intention to be more pro-active and pre-emptive, and recent publications regarding the new regulatory authorities have made it clear that the PRA and the FCA will make increased use of skilled persons reports in pursuit of their regulatory objectives.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.