Regulators are finding new ways to compensate those who lose out as a result of firms’ failures, and it could have significant consequences for the costs of regulatory breaches.
Who pays the price? Regulators and policy makers have long contended with the question of whether enforcement fines are truly effective – if financial penalties really work. In jurisdictions such as the UK, despite the drive for individual accountability, fines against individuals remain relatively small. Those imposed on firms, meanwhile, are ultimately borne by their shareholders and the public, rarely by those actually responsible.
This year’s Global Enforcement Review shows that in the market conduct arena, the massive fines associated with abuses of Libor and FX benchmarks are now largely behind us. Whether those cases have really changed behaviors – and cultures within those firms – remains an open question, however. In this light, the concept of genuine restitution to those who lost out is attractive: If regulators can’t be confident they’re really punishing the guilty parties, they can at least stop them benefiting and try to put things right for those who have lost out.
The idea is certainly not a new one. In the UK, disgorgement is one of the three principles underpinning the FCA’s penalty regime (along with discipline and deterrence)1 and disgorgement and restitution are significant elements of many of the sanctions imposed by the SEC, FINRA and CFTC in the U.S.2 Interestingly, in SEC and FINRA cases firms actually paid out more in restitution and disgorgements in 2017 than they did in fines.
If the use of the restitution remedy is unusual in public market cases it is perhaps because of the difficulties determining exactly who has lost out and by how much as a result of the misconduct. In cases of mis-selling where investors have been matched with inappropriate financial products, it is often straight-forward to calculate their losses, and regulators frequently use this as a starting point for penalties. In other cases, such as misleading statements or market manipulation, the losses are often not so clear-cut.
Every little helps
Which is why the FCA decision against Tesco in March 2017 could prove significant. The FCA took action against the supermarket giant over its overstatement of profits in 2014.3 For the first time the regulator used its powers under the Financial Services and Markets Act to require a listed company to pay compensation for market abuse to those affected: about 10,000 retail and institutional investors who purchased Tesco shares or bonds and held them during the period between the erroneous trading update and its correction about six weeks later. The compensation, totaling about £85 million, was calculated to reimburse these buying investors for the inflated price they paid as a result of Tesco’s misstatement.
The FCA’s thinking on penalties for misconduct by listed companies has evolved over the years and changed notably with its action against oil rig services company Lamprell in 2013.4 In that case, when it penalized the company for listing rules breaches, rather than calculate the penalty according to relevant revenue as in the past, the FCA used market capitalization as a better reflection of the impact and importance of the firm to the public market.
The Tesco case takes this much further. Importantly, it demonstrates the willingness of the regulator to think creatively about compensation and act to remedy actual losses for public market investors even where they may be difficult to quantify.
Compensating a large number of investors for manipulation of LIBOR and EURIBOR was impractical. What this may mean for the financial costs of a breach in the future will depend on the particulars of the cases in question and the methodology the regulator decides to employ. The focus, however, may increasingly be where it should be: on making investors whole again.
2 https://www.finra.org/newsroom/statistics#key, https://www.cftc.gov/PressRoom/PressReleases/pr7650-17 and https://www.sec.gov/files/enforcement-annual-report-2017.pdf