The Bonfire of the Regulations - Why the Financial Services Act 1986 failed to control the City.

I have said repeatedly that the City of London is an organised criminal enterprise that owes no allegiances to anyone but itself.

I have made that assertion by applying the accepted definitions of organised crime to the way in which business is conducted within the Square Mile, and by extrapolating from the outcomes.

This blog is the first in a short series of articles looking at the history of the regulation of the financial sector, and why it is always doomed to fail!

William Chambliss, the American criminologist once said;

"...One of the reasons we fail to understand business crime is because we put crime into a category that is separate from normal business. Much crime does not fit into a separate category. It is primarily a business activity..."

Examining the activities of a recognisably-defined 'organised crime'  (OC) family, such as the Gambino or the Lucchese family in New York, one is immediately struck by the essential business-like nature of the enterprise.  To some extent, the same could have been said of British criminal families, like the Krays, the Richardsons, the Nashes, or the Tibbs families, to name but a few. The core group of the family has been traditionally made up of people who are bound by common ties of ethnicity, blood links, and a common culture. Their ambitions are to run a variety of business enterprises, all of which may serve to support the other elements of the profit-making operations.

In many of the more well-researched American cases, they have traditionally offered access to commodities and services which were demanded by the public more generally,  but marginalised by contemporary 'straight' society, alcohol in the early days, later drug trafficking, prostitution, counterfeit products; or services which were effectively closed to their constituents by the straight world, such as financial lending to borrowers of limited or no means, which became known as 'loansharking'.

Such 'criminalised' businesses were supported by many other, 'straight' business enterprises, food supply services, restaurants, clothing industry products, garbage hauling, etc, indeed, many OC enterprises operate among other functions, as legitimate front companies through whom the profits from the illicit enterprises are laundered.

What has traditionally differentiated these OC groups from their straight world counterparts, is their residual willingness to resort to means of 'self-help' to settle commercial  disputes, finding the judicious use of a sawn-off shotgun or machine pistol to be far more efficacious than spending vast sums of money on lawyers and litigation.

When we come to make comparisons between such OC enterprises and their counterparts in the straight world of the City of London, once we drill down beneath the very thin veneer of utmost respectability with which the City cloaks itself, there is in fact, very little to provide any great sense of differentiation between the two enterprises. Indeed, one gets to marvel at the levels of similarity.

I will confess, it has taken me a long time to overcome my natural reluctance to view the City as anything other than an entity of utmost probity and transparent ethical standards. Like you, I was brought up to believe that the City was a vital element in the British economic infrastructure, and was part of our enviable ability to engage directly with the rest of the commercial world. I fondly remember watching films and Pathe News reels when the received diction of Mr Cholmondley-Warner would extol the virtues of Threadneedle or Throgmorton Street.

I genuinely used to believe that the City was there to facilitate GB plc's financial and economic well-being, in the same way as the National Health Service looked after our bodies, the police, our safety, the teachers, our education and the church, our souls! It was only when I was at the Fraud Squad, and I started to engage with City institutions, (and then only when I could get past the Praetorian guard of the City's own police force, who jealously obstructed our every attempt to conduct our own enquiries within their bailiwick), that I began to see the place in a different light, and began to realise that the City owed a duty to no-one but itself and its private members.

Today, with the  examples of the recent criminal scandals still raw in our memories, I have started to examine the financial sector, and to try and understand why the regulatory agencies, the early SIB and the alphabet soup of self-regulating organisations (SROs), and the FSA, failed so dismally to control the Square Mile; and try and identify why the FCA will fare no better in the future.

I have come to this difficult conclusion as a result of observing how the financial sector has repeatedly and efficiently managed to survive every scandal, every allegation of fraud and financial crime, every money laundering allegation, but without one member of its upper circle ever having been prosecuted or brought low through the criminal justice process.

I have come to the conclusion that the City is indeed so powerful and all-embracing, that they are indeed, a protected species, that even the Government is frightened of its threats to migrate from its present home, if its members or its customs and practices are impacted too heavily by the civil power. I believe that the City has the means, through its many avenues and back channels, to let Government know what it will and what it will not put up with, and to make it clear to Government that if it harbors any ambitions to continue to be in receipt of the 11% or thereabouts of GDP that the City contributes every year to its coffers, it had better do the City's bidding, and keep its nose out of the Square Mile's affairs.

"...Leave us alone, and don't ask too many awkward questions..." is the way of the Square Mile, and Government does just that!

So, what was the means by which the City achieved this level of hegemony, became so powerful that it could resist even the most intrusive investigations and survive?

"...Go where you will, in business parts, or meet who you like of businessmen, it is - and has been for the last three years - the same story and the same lament. Dishonesty, untruth, and what may, in plain English, be termed mercantile swindling within the limits of the law, exists on all sides and on every quarter…"

For many years the City had been able to operate with virtually no regulatory oversight whatsoever, as this quote from Temple Bar Magazine, of 1866 identifies.. The impetus for reform only really began to gain momentum in the early 1980s as the result of a series of scandals within the fabric of the City of London, scandals so bad, they attracted significant publicity.

During this period, it became abundantly clear that the existing machinery of City self-regulation had proved to be wholly ineffectual in providing the necessary degree of regulatory control. 

When discussing the constraints previously placed upon the activities of City practitioners, Professor Gower, the architect of the Financial Services Act 1986, later stated;

"...It is not easy to detect any rationale for the choice of one method rather than another. All one can perhaps say is that the practice has been to avoid any form of regulation until some scandal has shown it cannot be avoided and then to choose statutory Government  regulation, unless there is a traditional self-regulatory agency in existence to which the task may be left..."

At first glance, the proposed new system of City regulation called 'practitioner-based, self-regulation' introduced by the Financial Services Act 1986, and applying legally-backed re-regulation to an exercise in de-regulation, appeared to contain a fundamental paradox: the system, while being essentially market-influenced and non-governmental in function, incorporated a considerable degree of statutory underpinning, the very last thing the financial sector wanted to accept.

The Securities and Investments Board, (SIB) described as 'an unprecedented body', was a perfect example of the kind of new agency being introduced. It possessed wide powers to investigate alleged breaches of criminal and regulatory provisions, to call for evidence and to bring prosecutions, in exactly the same way as only the statutory agencies and more importantly, the police, had hitherto had the power so to do. The SIB was unusual however because it was not a statutory agency, but a company, limited by guarantee.

Professor Gower realised that the City establishment would be very reluctant to recognise the proposed changes and that attempting to introduce an American-SEC style body would not be 'practical politics'.  Indeed, the proposed legislation was widely resented and led to considerable friction between the Conservative government and the various sectors of the City, who saw the new proposals as an entirely unwarranted intrusion into their traditional hegemony.

Once it realised however that direct opposition to the legislation was fruitless, commercial pragmatism quickly reasserted itself. The City Establishment recognised that too public a degree of controversy generated by overt antagonism to legislation would potentially provide a threat to its own autonomy, and possibly undermine its traditionally perceived position of being wholly supportive of the agencies of control.

In 1992, as part of my thesis for the award of my Master of Arts degree at Exeter University, I had observed;

"...This traditional position of the City was deliberately inculcated to give the abiding impression to any outsider that the City was a complete supporter of all the control mechanisms that Government cared to introduce, a law-abiding, ethical establishment entity..."

"...As a classic example, when dealing with the issue of Insider Trading, a common practice which had underpinned the foundation of the entire fortunes of the entire stockbroking community since time immemorial, the City Panel on Take-Overs and Mergers issued a statement on insider dealing as far back as February 1973, with the full support of the Stock Exchange and the then Governor of the Bank of England..."

"...It proposed that insider dealing should be a specific criminal offence...which should be properly enforced by the Police...and the Police should be given statutory powers to investigate the beneficial ownership of securities..."

"...This encouragement for the provision of investigative powers to the Police (by which they meant the City Police), was merely part of the traditional posture of support for law enforcement which the City has always been keen to be observed to adopt..."

"...It provides the City with a dual benefit because it enables the financial sector to be perceived to be high-profiled in its support for law enforcement, thus perpetuating its required image of absolute probity and utmost good faith, while resting secure in the knowledge that those same agents of the State deputed to investigate and regulate its activities, are so ineffectual and their reputation for concerted action so poor, that they are unlikely to be able to do little more than conduct the most cursory examination of any allegations of misconduct..."

"...By continuing a policy of encouraging the same agencies to be granted ever-increased powers, the egregious sector knows that it is simply facilitating an increased dilution of investigatory effectiveness...."

Yet again, when confronted by the Financial Services Bill, the City therefore reverted to its traditional defensive posture of closing ranks and started preparing instead to undertake a policy of passive resistance, first with a view to marginalising the legislation, and then, by supplying a wide variety of City practitioners to the various boards, committees, sub-groups, working parties and review teams, ultimately becoming responsible for its administration, and thereby, rendering it wholly ineffectual!

The paramount need was to retain self-regulation, a technique for which Professor Gower would later shrewdly observe 'the City believes it has a genius'. This need became an article of faith for those who opposed the introduction of a wider degree of financial regulation.

The appearance of being a willing co-participant in the regime of financial regulation; the provision of members for the various committees and sub-committees; contributing to the ever increasing degree of bureaucratisation and thus generally being observed to undertake a 'responsible' approach towards the public administration of the new policies, ensured that enforcement of the new regulatory provisions would in fact be made more difficult than politically envisaged, and in reality, wholly worthless.

The City establishment succeeded in emasculating the intentions of the Financial Services Act 1986, even before it got off the ground, and rendered its intentions irrelevant.

It was further able to minimalise the effects of the legislative intentions of Parliament by employing men and women in the new compliance role who, in the early days, were totally imbued with the cultural appreciation of the primacy of the 'commercial' ethic of their masters. 

These people were expected to be capable of undertaking the proposed compliance role, but without engaging in too close an approximation of a policing function. They were expected to know how to behave without having to be schooled in the issue, and what business practices should be treated as in the paramount interests of their employers. Almost inevitably, they were recruited primarily from within the ranks of those who had worked in the financial sector for many years, and who were thus, well versed in the mores and norms of the sector. These experienced old hands, in their turn, have schooled the newcomers to the compliance function, thus maintaining the hegemony of their financial masters, and ensuring that the internal compliance function recognises the limits of its role within the profit-making nexus!

The SIB, from the beginning, showed little interest in enforcement. The chairman himself was reported in the press as stating; "I am a regulator, a watchdog and a policeman in that order." It was widely rumoured that the SIB was most reluctant to recruit personnel who showed any sign of being "enforcement minded" and instructed  its head hunters accordingly..Dr Barry Rider of Cambridge University put it thus;

"...It would seem there is little alarm on the part of those who have been systematically abusing  the system..."

In this way, the City saw off the most ambitious plans to provide a regulatory edifice which it was hoped would bring the UK into line with the regime extant in the USA. Before the ink was dry on the Statute Book, the legislation was stumbling along, blinded and toothless, all its important functions being overseen by City Insiders.

Just as with its successor, the FSA, we should not be surprised when the lead regulator proves to be utterly toothless and supine, when its leading functionaries are a bunch of passed-over bankers.

As with the SIB, the City was able to see off the FSA, and we shall look at some more reasons in the next edition of this blog!