The end of the tunnel – litigation and regulatory challenges in financial services

Legal Business teamed up with Simmons & Simmons to discover how financial institutions are coping with the twin threats of regulation and litigation, and assess whether the end is in sight.

If there was ever any doubt about what might be in store for the Volkswagen Group following its recent emissions scandal, a glance at the banking industry over the last five years offers a sobering clue.

It is nearly seven years since many banks were deemed too big to fail during the financial crisis of 2008 and 2009. The price of being rescued, and for bringing the global economy to its knees, was regulation on a scale never previously experienced. In the wake of this increased regulatory oversight, a series of mis-selling and rate manipulation scandals have cost the banking industry billions of pounds in fines, civil settlements and legal fees. Only now, some years later, is there even the slightest expectation that the worst is in the past, or at the very least out in the public domain.

‘There was obviously a massive and sudden increase in the number of regulatory investigations and litigation, but now we’re at a steady state in terms of volume,’ says one in-house lawyer at a major bank. ‘The very large cases are known and those that haven’t quite made the public forum are known. I would be surprised if there is any more of the bring-the-house-down litigation, like Libor and Forex, the real mega-cases.’

Top ten FCA and FSA fines
Rank	Fine value	Institution	Reason	Date	Bank legal adviser
1	£284,432,000	Barclays	Failure to control FX trading business	20/05/2015	Clifford Chance
2	£233,814,000	UBS	Failure to control FX trading business	11/11/2014	Gibson, Dunn & Crutcher
3	£226,800,000	Deutsche Bank	For Libor-related misconduct and misleading the regulator	23/04/2015	Slaughter and May
4	£225,575,000	Citibank	Failure to control its FX trading business	11/11/2014	Allen & Overy
5	£222,166,000	JPMorgan Chase	Failure to control its FX trading business	11/11/2014	Slaughter and May
6	£217,000,000	The Royal Bank of Scotland	Failure to control its FX trading business	11/11/2014	Linklaters
7	£216,363,000	HSBC	Failure to control its FX trading business	11/11/2014	Cleary Gottlieb Steen & Hamilton
8	£160,000,000	UBS	For Libor-related misconduct	19/12/2012	Gibson, Dunn & Crutcher
9	£137,610,000	JPMorgan Chase	For serious failings relating to its ‘London Whale’ trades	18/09/2013	Sullivan & Cromwell
10	£126,000,000	The Bank of New York Mellon	Failure to comply with custody rules	15/04/2015	Allen & Overy
Source: FCA

To better understand the financial industry’s current attitude towards regulation and litigation, Legal Business teamed up with Simmons & Simmons to survey senior in-house disputes and regulatory lawyers at major banks, asset managers, hedge funds and other financial institutions. We also interviewed senior general counsel (GCs), barristers and high court judges to find out where they feel regulation and litigation are headed, and what sort of infrastructure and mechanisms have been put in place to better manage these risks.

Peak fines

For financial institutions, unquestionably, the burden of regulation and litigation will remain heavy for the foreseeable future. Eighty-eight percent of respondents to the survey have been involved in a formal dispute since 2013 (when we last surveyed the in-house banking litigation community), while 68% have experienced a regulatory investigation. This is illustrated by the growth in UK civil claims involving major financial institutions, and the larger fines handed out by the Financial Conduct Authority (FCA) and its predecessor the Financial Services Authority (FSA) (see ‘Ten years of FCA and FSA fines’ and ‘Significant litigation involving major financial institutions’ below).

For litigation, the number of claims involving financial institutions climbed from 95 in 2008 to 192 claims in 2014. The contrast in regulatory fines is greater still: in 2007, the FSA handed out £5.3m in fines, just 0.36% of the £1.47bn that the FCA issued in 2014. Fines for 2015 currently stand at £826.9m, which includes a record fine of £284m given to Barclays for ‘failing to control business practices in its foreign exchange (FX) business’.

Barclays’ annual reports illustrate the growing significance of its various regulatory and legal proceedings. In 2007 they merited a page and a half in the ‘Notes to the Financial Statements’. By 2014, coverage had ballooned to over 11 pages, plus a significant mention in the chief executive’s review. The notes included a £5.2bn provision against the cost of payment protection insurance (PPI) redress; £1.5bn for ‘Interest Rate Hedging Product redress’; and £1.25bn held for ‘ongoing investigations’ and ‘litigation relating to Foreign Exchange’. According to a Reuters report published in May, 20 of the world’s largest banks have paid £151.7bn in fines and compensation since 2008. Roughly 60% was linked to mis-sold mortgages in the US, while nearly 20% was linked to the mis-selling of insurance products in the UK, such as PPI.

While the pressure remains high, there is a subtle difference between the volumes of claims and regulatory investigations that our 86 respondents expect to see, and expected costs. While 41% percent expect to see civil claims grow, only 18% are allocating more funds to forthcoming litigation costs and settlements. Similarly, while 35% expect the number of regulatory investigations they are involved in to grow, only 18% are allocating more funds towards regulatory fines. This in part reflects a view that, given levels were very high to start with, the overall value of fines and settlements can only go down. This can already be seen with PPI settlements, where FCA-reported payouts to customers were down to £300.5m in August, the lowest monthly figure since September 2011. Now that the FCA has announced a deadline of 2018 for PPI settlements, the end is quite literally in sight.

‘I would be surprised if the FCA’s total fines for 2016 are as high as the totals for 2015 or 2014,’ says Robert Turner, head of Simmons & Simmons’ international financial markets litigation group. ‘There may be a higher number of fines, but without something dramatic in the market place, it seems unlikely these numbers will be as high. We’d probably all know about it by now if there was going to be something on the same scale.’

‘A rapport’

The internal legal and regulatory infrastructure that the banks and financial institutions have is also considerably larger and more sophisticated than only a few years ago (see ‘Banking on trouble’ above). Thirty-one per cent of respondents’ in-house teams have grown in the last two years, while 50% are unchanged. That financial institutions have seriously invested in these areas has gone some way to improving their relationship with the regulators.

Annual PPI refunds and compensation
Year	Refunds and compensation
2015 (to August)	£3.02bn
2014	£4.474bn
2013	£5.259bn
2012	£6.281bn
2011	£2.134bn
TOTAL	£21.168bn
Source: FCA

Ten years of FCA and FSA fines
Year	Total fines
2015 (to date)	£826.9m
2014	£1,471.4m
2013	£474.3m
2012	£311.6m
2011	£66.1m
2010	£89.2m
2009	£35m
2008	£22.7m
2007	£5.3m
2006	£13.3m
Source: FCA

‘A lot of the banks are very sophisticated about how they deal with internal issues now and their infrastructure for dealing with things, and the FCA’s confidence in them dealing with things is probably higher than it used to be,’ says Marc Thorley, a financial markets litigation partner at Simmons. ‘A number of the banks have become efficient in doing their own internal investigations.’

‘We have a very well-defined and well-understood escalation process within the organisation,’ says Joanna Day, director of legal services at Santander UK. ‘We really believe in being transparent and upfront with the regulator, and if we didn’t, we would be in breach of regulatory principles.’

‘The key challenge in terms of our relationship with the regulators is to keep a relationship based on trust and clarity,’ says Dominique Bourrinet, group GC at Société Générale. ‘We really put a lot of emphasis on making that relationship as streamlined as possible. For that purpose, we have built up a team dedicated to co-ordinating with our main regulators, so that we can answer their queries on a timely basis and really feel it is a working relationship.’

The greater investment in staff that the FCA has made into its supervision department has also helped. ‘Its teams have racked up considerably, so they are now able to deal with the volume of work they have got on their plate,’ says one GC. ‘There is more consistency among the individuals, so you do have a rapport. Let’s not underestimate the importance of that. We now feel as though we’re being given a fair hearing and I get the sense that there is a lot more co-operation on each side.’

Held to account

The rhetoric coming from the Treasury and the regulators is also softening. In a recent speech at Mansion House, the FCA’s acting chief executive Tracey McDermott said: ‘The intensity and volume of regulatory activity over recent years is not sustainable, for regulators or for the industry. We are often told that boards are now spending the majority of their time on regulatory matters. This cannot be in anyone’s interests.’

The most dramatic example of this softer approach was the recent watering down of the Senior Managers Regime (SMR), which is hitting banks in March 2016 to increase the individual accountability of senior managers. Initially the SMR had a ‘presumption of responsibility’, where senior bankers had to prove that they took such steps as a person in their position could reasonably be expected to take to prevent regulatory breaches. This reverse burden of proof has now been dropped and the regulator will now have to prove that the senior bankers failed to ‘prevent regulatory breaches in the areas of the firm for which they are responsible’.

‘I would describe it as a major u-turn by the government,’ says Richard Sims, a contentious regulatory partner at Simmons, who previously worked for three years in the enforcement division of the FSA. ‘That is obviously very welcome news to the sector and more widely.’

While the SMR has been pulled back slightly, its introduction to UK banks next year, and the wider UK financial services market in 2018, demonstrates a long-heralded shift towards greater personal accountability. This hasn’t gone unnoticed at the banks, where 96% of respondents felt that the regulatory focus on an individual’s accountability has increased.

‘The FCA has talked for years about holding senior individuals to account,’ says Sims. ‘It has expressed its frustration over not being able to take effective enforcement action against individuals as a result of the financial crisis and some of the banking failures around that. It’s only now that it is starting to feel it has the right tools in place to hold individuals to account.’

The increase in personal accountability gives the FCA a far bigger stick with which to achieve its main goal of getting banks to improve their culture.

‘There isn’t any instant fix, there has to be a cultural shift in thinking,’ says one in-house litigator. ‘It’s quite simple: bankers just need to learn and appreciate that the customer must come first. If you look at the behaviours that have driven where the banks have gotten themselves into with the loans, a lot of it is due to financial reward. The incentivisation has been wrong. If the bankers stop being selfish, and learn and appreciate that the customer should come first, that would certainly help. Cultural shift is the bottom line.’

Many in-house counsel believe the challenge is as much a behavioural issue as a legal one.

‘It’s not a legal thing, it’s not a compliance thing,’ says Day. ‘If that was your grandmother that you were selling that product to, would you be happy about recommending it to her? That kind of approach has made people aware that dealing with the regulator isn’t just something for compliance, or legal and regulatory affairs.’

‘It is clear that the more efficient our corporate culture, procedures and controls are, the better the perception that the regulators will have of our own institution,’ says Bourrinet. ‘As a general rule, it is pretty obvious that there is a big expectation from regulators that we bring the compliance into the DNA of the bank – that everybody understands how important it is to comply with the regulations.’

Keeping it civil

When it comes to the growth in civil claims aimed at the industry, much of this stems from the time it has spent under the regulatory spotlight. This is evident with the asset managers and hedge funds, where 46% and 67% of respondents respectively expect to see their claim volumes grow.

‘As regulatory enforcement attention moves to asset managers, and as regulators notch up expectations with MiFID II [Markets in Financial Instruments Directive II], the reasons for asset managers getting involved in more litigation are not hard to see,’ says Turner. ‘You can see the trend with the banks, with next year’s litigation following this year’s regulatory findings, and I would expect to see the same with the asset managers.’

For the banks, the full fallout from their Libor and FX rigging issues has yet to properly play out in the UK courts. Forty-three percent of respondents felt that benchmark manipulation and mis-selling issues will increase the volume of claims made against them. Whether these claims will succeed and what form they will take is another matter. When it comes to FX-related mis-selling claims, while there have been major group actions and settlements in the US, the success of this approach in the UK is still unknown. US claimant law firms such as Scott + Scott and Hausfeld have established themselves in the UK and made it clear that they plan to pursue FX group actions. Unsurprisingly, 67% of banks surveyed see class actions and group litigation as being a growing issue.

‘The issue is whether that is going to take off here,’ says Turner. ‘If FX-related claims, or investor claims against Volkswagen take off and are seen to succeed, then you can see that once the infrastructure is there, once the claimant bar is there and once the litigation funders are there, then self-fulfilling momentum becomes quite likely.’

The manipulation of Libor has also given extra life to interest rate swap mis-selling claims brought against the banks, such as Deutsche Bank and others v Unitech Global, which was adapted to allow for Libor rigging (see ‘A message has been sent’, pages 58-59). It remains to be seen, however, whether such cases will make it to a full-blown trial or simply settle out of court.

‘The only swaps mis-selling cases so far that have gone to trial and have got a judgment have ultimately gone in favour of the banks,’ says Richard Bunce, a banking litigation partner at Simmons. ‘There have been some bumps on the road and in interlocutory hearings recently there have been some decisions by the courts that seem claimant-friendly, allowing amendments to allow certain causes of action. Until someone is brave enough to take one of those cases all the way to trial, we’re not going to know.’

In the survey, 19% of respondents said they would only go to trial if they had no other option, while a further 47% would typically look to settle. For 42% of respondents, costs are the biggest disincentive to litigation. Only 7% see the risk of losing as a disincentive.

In the past, banks may have been inclined to settle, even when they had a good case. The reality now is that banks are forced to and willing to litigate the right cases.

Hit list

One factor that favours litigation is the high esteem in which most hold the UK court system, with 88% of respondents agreeing that the courts usually get it right. The cost and duration of such cases are, however, a disincentive and it is hoped that recent initiatives such as the October launch of the Financial List, will help address this. The List is dedicated to complex banking disputes valued at over £50m, and offers an even mix of ten specialist Chancery and Commercial Court judges all highly experienced in major financial disputes.

‘Financial disputes work is probably one of the busiest areas in current times and that seems likely to continue. The Financial List was a recognition of that position and the specialist nature of many of the disputes,’ says Sonia Tolaney QC of 3 Verulam Buildings, who led the List’s consultation process on behalf of the Commercial Bar.

Another important driver for the List, which at press time already had five cases on it, was the fact that ‘previously users were forced to choose to issue a case in either the Chancery Division or the Commercial Court, when in fact financial cases often straddle the two’, says Vannina Ettori, legal adviser and private secretary to the Chancellor of the High Court. ‘With the Financial List, the procedures are common and the judges who sit in the list can reliably be expected to have the right expertise for the case.’

One significant attraction is its Financial Markets Test Case Scheme, which will allow parties to resolve uncertain points of law with a hypothetical set of facts.

‘They are going to use it to resolve market issues in what they describe as “a friendly way”,’ says Craig Berry, head of litigation, commercial & private banking and capital resolution at The Royal Bank of Scotland. ‘There will be no adverse costs. It will simply be so that an issue can be put direct to the courts in a factual scenario, so that they can decide it and give the market guidance. It could be brilliant, if indeed it picks out the right issues.’

How much do you expect your institution to spend on settling conduct and litigation charges over the next two years?

A significant by-product of the List was the simultaneous launch of the Shorter and Flexible Trial Procedures pilot scheme, which is open to less complex commercial claims, where there is no need for extensive disputes over facts and less need for extensive disclosure. As with the Financial List, a key component will be the presence of a docketed judge for the entirety of the dispute.

‘The idea is that because you have a docketed trial judge managing the case from day one through to the trial, the judge is able both to review and police each procedural step taken and, as a consequence, assess the resulting legal costs on a summary basis, having given judgment,’ says Ed Crosse, a financial disputes partner at Simmons who was the solicitors’ representative on the shorter and flexible trials committee.

The pilot schemes were partly influenced by a successful fast-track procedure in the Australian commercial courts, as well as a similarly successful initiative in the UK’s Intellectual Property Enterprise Court (IPEC), which helped speed up intellectual property claims. Mr Justice Birss, who was a key driver behind the success of IPEC, is currently chair of the shorter and flexible trials committee.

‘There are significant similarities to IPEC,’ says Birss J. ‘What that court has been doing in the past five years is taking cases that you’d expect to be tried in one or two weeks and dealing with them in a day or two. Instead of coming on in a year and a half, you could get them so that they’re ready in six months. That is a critical lesson that it can be done.’

For the flexible trials scheme, lessons have also been learnt from arbitration. While the courts can’t compete with arbitral tribunals when it comes to confidentiality, the view is that the pilot scheme will prove that when parties agree, the courts can adopt the more flexible case management procedures used in arbitration.

‘If you consider arbitration, major commercial disputes are resolved in a way that can be quicker and more efficient than is sometimes the case in court,’ says Birss J. ‘In the right case I do not see why you cannot adopt similar techniques in court. It does not require parties to be any more imaginative than to think: “We can do this in arbitration, so why not in court?”’

Significant litigation involving major financial institutions: Claims issued 2008-15
Year	Number of claims
2015 (to date)	100
2014	192
2013	246
2012	152
2011	144
2010	89
2009	110
2008	95
Statistics based on information obtained from public sources by Bloomberg’s court service. Pleadings not yet available for all cases. Statistics therefore include cases identified on basis of parties’ names only. Source: Simmons & Simmons

Arbitration is one of the more popular forms of dispute resolution, with 30% planning to use it in the future, as are other more specialised forums such as PRIME Finance, a Dutch-based arbitration system set up to resolve complex derivatives and finance disputes. Mediation is also popular and Day says Santander uses it extensively for disputed commercial contracts.

Whichever route financial institutions take, demand on all of these forums will remain high. The crippling penalties might be waning, at least for those with decent internal measures in place, but new regulations will open financial institutions up to new sources of disputes. These won’t just come in the form of traditional stumbling blocks, such as fraud and mis-selling, but in new areas such as data protection and competition, which for UK-based financial institutions has come under the auspices of the FCA and its concurrent powers with the Competition and Markets Authority. And then there could be a black swan that catches everyone by surprise.

The hope is, however, that if another surprise does come, the investment into capable legal and regulatory functions will at least keep the punitive costs to a minimum. LB