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The art of inflicting pain

Financial Times: Lombard: The art of inflicting pain

“A lively debate on the subject has ensued since the Financial Services Authority, the City policeman, fined Royal Dutch/Shell a record £17m for market abuse”

By Martin Dickson

Published: September 10 2004

How hard should you hit financial wrongdoers in their pockets, and what is the point of such fines anyway?

A lively debate on the subject has ensued since the Financial Services Authority, the City policeman, fined Royal Dutch/Shell a record £17m for market abuse – over the mis-statement of its proved oil reserves and breach of the quoted company listing rules, which demand the timely disclosure of price-sensitive information.

The fine was over four times the largest previously levied by the FSA, but fell far short of the £66m the company paid in the US to settle with the Securities and Exchange Commission. Some argued that the fine was not high enough, relative to the seriousness of the offence and the US action; others that it was too high, since the FSA would be doubly hurting the real victims of the abuse, namely Shell’s shareholders.

This week John Tiner, the FSA’s chief executive, waded into the discussion, declaring that the purpose of fines was to change behaviour by sending a strong message to the management of the company concerned; by attracting publicity that adversely affected the company’s reputation; and by sending a signal to the market generally.

As for shareholders, it was right they should suffer a bit when the management failed in its duties, just as they would if executives made bad business decisions. This could lead to healthy pressure for management change. Yet at the same time, he added, investors should not suffer too much.

There is a reasonable logic to these lines of argument. Certainly, it is hard to claim that shareholders in Shell, which made £2bn of net profit in the last quarter alone, were significantly hurt by the size of the FSA fine or that from the SEC. Anyway, the American one – unlike the UK’s – will be used to compensate shareholders, which partly helps explain the transatlantic divide.

But the FSA approach has potential flaws. First, if you pursue publicity for its own sake, this could imply ever increasing fines, since it takes the word “record” to keep the interest of the press.

Second, I do not believe the general level of fines against City institutions – particularly wholesale ones that will not be too concerned about public opinion – are sufficiently high to act as much of a deterrent. Unless they hit the bottom line, they may simply be shrugged off as a cost of doing business.

Third, it is individual managers who err, not institutions, and it should be a more effective deterrent to target them for fines as much as their employers. The FSA says it is moving in this very direction, though it has yet to produce much tangible evidence in the form of fines. However, this is a very delicate area, since the last thing it needs to do is make City managers – ever more concerned about the regulator’s tendency to 20-20 hindsight – become excessively cautious.

And if setting the level of penalties is hard in the case of companies, it is no less so when it comes to individuals. What do you take into account? Their personal wealth? Their status? Their profits from a piece of insider dealing?

So far the FSA has fined only five individuals: three employees, for market abuse, and two chief executives, for breaches of the listing rules. Two things stand out. First, with the smallest fine £1,000 and the largest £45,000, the penalties, like those for companies, look too small to be much of a deterrent.

Second, it is hard to detect much of a coherent pattern in the punishment. Wealth does not seem a factor – though in one case an individual’s lack of financial resources was weighed in the balance; nor does there appear any obvious relationship to ill-gotten gains or position in a company. But the FSA’s thinking may be muddied by its willingness to cut the penalty if the accused co-operates.

This is an art not a science and it would not be wise to follow the inflexibility of America’s system of carefully tiered fines. But if the FSA is going to be whacking individuals more frequently, it needs a more publicly defensible framework for its various gradations of pain.

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