December 8, 2011, by Adrian Mateo
Why do we punish financial services firms?
It was announced on 5th December 2011 that HSBC Bank was to be fined £10.5 million by the Financial Services Authority (FSA) for unsuitable investment advice provided by its subsidiary NHFA, which resulted in the mis-selling of investment bonds to thousands of elderly and disabled customers. The details of the case have been widely reported, and it is interesting to view it from the perspective of this question: why, precisely, do we punish?
Theories of punishment offer several possible answers. Perhaps the most obvious answer is that we punish to deter. We punish individual firms to stop them engaging in similar conduct in future (individual deterrence) and to prevent other firms doing likewise (general deterrence). In practice, punishment often takes the form of a financial penalty, but such penalties are sometimes viewed as inadequate deterrents. Rational, profit-focused firms may consider that it is worth taking the risk of contravening the law because (a) they are unlikely to be apprehended and punished, and (b) even if they are, any penalty is likely to be low. It is notable, however, that HSBC’s £10.5m fine is the highest ever imposed in such a case. Furthermore, the FSA has placed great emphasis on its increased willingness to impose penalties as part of its policy of “credible deterrence”.
A second answer is that we punish to rehabilitate. It may be hard to conceive of firms being rehabilitated through punishment in the way that individuals might be, although it is possible to imagine a firm genuinely re-evaluating its culture following punishment in an exceptional case. However, if we interpret rehabilitation more broadly it appears less fanciful. Regulatory breaches sometimes occur through supervisory failures rather than intentional wrongdoing. To the extent that enforcement action ensures these failures are addressed, the action may be argued to be rehabilitative. Perhaps a better way of describing such grounds for punishment is restorative. Recent regulatory scholarship has emphasised theories of “restorative justice” and this has received a sympathetic ear from the Coalition. Professor Andrew Ashworth, while arguing that restorative theories are based on a premise similar to rehabilitation, suggests that they are not theories of punishment, but arguments that penalties should move away from punishment and towards restitution and reparation. While the fine imposed on HSBC is not likely to achieve restoration, the firm seems likely to pay around £30 million in compensation as part of the past business review and redress programme that it initiated.
Finally, punishment may be imposed in order to ensure just deserts. Punishment is thus seen as a form of retribution, reflecting the wrongdoing in a proportionate way, rather than (necessarily) seeking to influence future conduct. Firms are punished because they deserve to be, rather than because it is likely to produce a particular result.
One interesting point to consider is not what the punishment does, but what the revealing of the punishment does. I was recently funded by the Arts and Humanities Research Council to investigate the issue of “reputational sanctioning”. I examined how enforcers (such as the FSA) can use negative publicity to achieve particular objectives. Publicising penalties can play a number of roles. First, it can help consumer decision making, by ensuring that consumers have information that might affect their choices. Secondly, it can operate as a penalty, particularly in the form of a deterrent. It may be that the real “sting” for HSBC is not in the specific fine imposed, nor even in the compensation it will pay out, but in the reputational damage created. Sometimes this is harsh. Where an enforcer relies, in effect, upon the market to impose the penalty, there is a danger that it operates as what Professor John Coffee described as “something of a loose cannon”. But there is little doubt that it can have a deterrent effect.
It will interesting to try to judge the impact of the fine, and the publication of its details on HSBC. Paradoxically, HSBC might even get some positive publicity from the action. The FSA’s Final Notice recognises the “significant level of co-operation” offered by the firm and the Authority’s Director of Enforcement of Financial Crime recognised that the firm had “taken steps to do the right thing”.
There is scope for further research on why and how we punish firms. The penalty, and details of the penalty can have significant impacts and need to be studied with care.
Peter Cartwright (Professor of Consumer Protection Law, School of Law and Integrating Global Society Research Lead for Finance and Society)
It is very interesting to serve this issue as guide and avoidance to the beginners who are starting to established a financial services firms. And yet punishment maybe the result of the issuance of the service.