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The New Rules on Regulatory References

Posted on 31 January 2017

Trends from Suspicious Transaction Reports

The FCA and PRA have now published final rules regarding regulatory references for banks and insurers subject to the Senior Managers' and Certification Regime ("SMCR"). The new rules will come into force on 7 March 2017 (the date on which the certification regime comes fully into effect).

Whilst regulatory references may be thought to be a relatively insignificant aspect of the wider reform brought about by SMCR, the new rules have the potential to impact significantly on individuals and firms. We set out below both the reforms and some of the ways in which these different interests may be affected.

The genesis of the new rules was the perceived threat, developed in the 2015 Fair and Effective Markets Review of so-called "rolling bad apples"; employees allowed to leave an authorised firm under a cloud, yet able to take employment at another authorised firm because of inadequate references being requested or provided.

Against that backdrop, the new rules seek to bring about standardisation to the content of references sought and requested for candidates for the following roles: Senior Management Function holders, certified staff and so-called "notified NEDs" (namely NED's who are not pre-approved to perform any Senior Management Functions). For dual regulated roles, only one reference need be sought –the standard form template for FCA and PRA references is the same.

Key changes brought about by the FCA and PRA rules are as follows:

  • Firms subject to the new rules must take "reasonable steps" (which is not defined), to obtain compliant references from the candidate's current employer and anyone who has employed the candidate in the last 6 years.
  • Where the requested firm is also subject to the new rules, the requesting firm must request information in the standard form template (at SYSC 22 Annex 1R). The requested firm is under a mirroring obligation to provide this information.
  • The standard form template information includes mandatory information about the following in the 6 years preceding the reference request (including any period between the request and the reference itself):
    • Whether the requested firm concluded that the individual was not fit and proper and separately whether any disciplinary action resulted.
    • Whether disciplinary action was taken against an individual for breach of "individual conduct requirements" (such as Code of Conduct breaches).
  • The standard form template also requests any information relevant to the assessment of fitness and propriety occurring in the 6 years prior to the reference request, occurring between the reference request and the reference, or occurring at any time if it is "serious misconduct" (the meaning of which is elaborated upon in guidance). This "catch-all" requirement generated significant comment from respondents to the consultation, concerned at its uncertainty.
  • The PRA has noted that information provided under the "catch-all" section might include information in mitigation of mandatory disclosures, or events that did not formally result in disciplinary action or a finding that the individual was not fit and proper.
  • Where the requested firm is not subject to the new rules (e.g. it is subject to the Approved Persons' Regime), the requesting firm must request all information relevant to an assessment of fitness and propriety, occurring in the 6 years prior to the reference, occurring between the request and the reference, or occurring at any time if it is "serious misconduct" (see above). The standard form template need not be used. It is likely that such references will be less detailed than those provided in the standard form template and will be similar to the kinds of regulatory references provided at present.
  • In certain circumstances, a firm subject to the new rules must update a reference that it has given. This applies if it becomes aware of matters that would have caused it to draft the standard form template reference differently. Additionally, references must also be updated if the firm has since giving the reference reached new conclusions on fitness and propriety or taken action for breach of "individual conduct requirements" of a type that are "significant" to the assessment of fitness and propriety and which would have otherwise been disclosed in the reference.
  • There is specific guidance clarifying that these rules do not create per se a duty to investigate alleged misconduct by a former employee, but the FCA unsurprisingly notes that there may clearly be circumstances in which this is prudent (SYSC 22.5.18G).
  • Responding to concerns expressed in consultation about potential unfairness, the FCA clarifies the continuing existence of a common law duty on the requested firm to exercise due skill and care in the preparation of the reference (SYSC 22.5.4.G(1)). It goes on to note that fairness will normally require a firm to give an employee the chance to comment on allegations/issues covered in a reference, although it anticipates that this would commonly be done as part of a disciplinary process and that the absence of consultation does not prevent the allegation/issue being mentioned.

These new rules look set to heighten the significance of references for firms and individuals alike. Firms for example will need to implement systems, not only to ensure that proper references are taken up when hiring, but also to ensure that information is retained in order that they can give accurate references in relation to former employees that left the firm up to 6 years ago. Further, under the new regime, firms may find themselves less able in disciplinary situations to duck the issue of whether individuals are fit and proper or have committed Code of Conduct breaches. If so, we can see that potentially leading to increased enforcement actions against individuals. Whatever the case, the rolling 6 year coverage period may make the regulatory reference more like a provenance documents for individuals, hanging over their heads for years to come, bringing increased litigation risk for firms.

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