This article was written for and first featured in Compliance Monitor
Track and field athlete Dwain Chambers would ostensibly appear to have very little in common with Yohichi Kumagai, the former executive chairman and managing director of the London branch of the Japanese insurer Mitsui Sumitomo (“MSIEu”). However, they have both been the recipients of lifetime bans in their respective fields. But, whilst Dwain Chambers recently had his ban overturned, leaving him free to compete in this summer’s Olympics, the Financial Services Authority (“FSA”) has made it “crystal clear” that Mr Kumagai is not fit and proper to perform regulated activities, with the effect that he will never work again in the City of London (or indeed the UK) in the financial services sector. Mr Kumagai was also personally fined £119,303 and MSIEu was fined £3.35 million by the FSA. Perhaps a fairer comparison is John Pottage, who held a comparable senior management position to Mr Kumagai at UBS Wealth Management. The FSA similarly tried to fine Mr Pottage personally after “serious flaws in the control environment” were discovered, but the fine of £100,000 was overturned by the Upper Tribunal.
The publication of the final notice against Mr Kumagai and MSIEu on 8 May 2012 will have caused great consternation amongst senior management, particularly those who are overseeing a firm’s expansion, as many of the factors which led to Mr Kumagai’s fall from grace arose from the fact that he was responsible for the Japanese’s parent company’s growth into non-Japanese client business in Europe and the Middle East. This decision is significant for working out which operational areas need particular attention in such circumstances.
Breach of Principles for Business
MSIEu was held to have breached Principle Three of the FSA’s Principles for Businesses by failing to take reasonable care to organise and control its affairs responsibly and effectively. Mr Kumagai was held to have breached the Statements of Principle Five and Seven of the FSA’s Statements of Principles and Code of Practice for appointed persons by failing to take reasonable steps to make sure that the business of the firm for which he was responsible as a significant influence holder was organised so that it could be controlled effectively and comply with the relevant regulatory standards.
The Final Notice identifies the following factors as being of key importance. When regulated firms and those in senior management positions carry out their periodic reviews of areas of risk, they should be aware that the following issues caused serious concern to the FSA.
· A strong, effective and skilled board and senior personnel.
· Proper management information.
· Capital adequacy.
The FSA identified that the board of MSIEu board and its senior personnel lacked the requisite skill and experience not only of the underlying non-Japanese underwriting business but also of the UK regulatory system. That failure was laid at Mr Kumagai’s feet as this was clearly his responsibility as part of his Chief Executive function. In addition, the FSA found that Mr Kumagai failed to ensure that critical posts within the organisation were filled with appropriately skilled individuals. The fact that an insurance business did not have a Chief Underwriting Officer came in for specific criticism by the FSA, as did the fact that other pivotal roles remained unfilled or filled only on an interim basis. The danger with having too few and/or inexperienced staff at that level is that systemic risks can go unnoticed and unchallenged.
Although MSIEu had tried to implement an underwriting and claims IT system to standardise business processes across all branches, it had failed to do so adequately (despite reporting to the FSA that it had). Mr Kumagai was held to have taken insufficient steps to ensure that those members of staff to whom the task of implementing the IT system had been delegated were up to the job. The result of not having a suitable IT system in place was that the senior management, the finance function and auditors did not have access to up-to-date financial information. In particular, it meant that the amount of reserves that MSIEu ought to have been holding in order meet all future claims could not be calculated properly and led to deficiencies in the reserves.
MSiEu failed to hold sufficient capital to meet the FSA’s ICG requirements. ICG stands for “Individual Capital Guidance and is the amount and quality of capital that the FSA thinks that a firm should hold at all times based on an ongoing assessment by a firm of its capital resources undertaken as part of an assessment of the adequacy of the firm’s overall financial resources.
When Mr Kumagai became aware of MSIEu’s capital shortfall, he sought to form a business plan to ensure that the firm regained the required capital adequacy.
The adequacy or inadequacy of a firm’s capital can be seen both as an area for constant monitoring in its own right, but also as a consequence of weak management and poor management information systems. MSIEu was fortunate enough to have well-resourced parent company which was able to inject funds into it. For less fortunate firms, a skilled and experienced board which is able to make tough decisions quickly and which has all the relevant information at its disposal can, theoretically, anticipate issues such as capital inadequacy.
Why Mr Kumagai?
It is easy to imagine Mr Kumagai comparing himself to John Pottage and feeling as though he has been singled out. Mr Pottage was the first individual senior management to be fined (£100,000) by the FSA for failing adequately to supervise his own team. At the same time, UBS Wealth Management (Mr Pottage’s employer) was fined £10 million (which was reduced to £8 million). However, on appeal to the Upper Tribunal, Mr Pottage was cleared of committing any misconduct. The Upper Tribunal held that: “the actions Mr Pottage in fact took prior to July 2007 to deal with the operational and compliance issues as they arose were reasonable steps.” Mr Pottage still works at UBS.
There appear, therefore, to be two main reasons why Mr Kumagai was dealt with so severely (although the penalty seems to the writer to be modest relative to Mr Kumagai’s position). First, his management (or failure to manage) were inadequate, as a matter of fact, for riskiness, size and complexity of his organisation. He failed to assess the level and nature of the controls required to support MSIEu’s expansation of the non-Japanese client business. He did not supervise and oversee an effective governance structure. He did not ensure that MSIEu was managing its capital adequately. He failed to satisfy himself that the management information received by the senior management team and auditors was adequate to judge whether MSIEu was in compliance with regulatory requirements and standards. In addition, he permitted the continued the expansion of the non-Japanese client business without giving due consideration to the FSA’s message that the expansion strategy would require careful oversight and focused oversight fro the board and that this would rely on good systems and controls.
The second reason is the change in the attitude of the FSA itself. The FSA has gone from being reactive to events to attempting to circumvent financial crises before they happen. There was no great disaster at Mitsui Sumitomo; however, the way in which Mr Kumagai was managing the firm meant that it was foreseeable that something could have occurred which would have caused severe loss to policyholders.
After the Upper Tribunal published its decision on Mr Pottage’s appeal, Tracy McDermott of the FSA was quoted as saying: “we have always recognised that pursuing disciplinary action against senior management in large firms is very challenging. But we also believe strongly that senior management must take responsibility for the businesses they run.”
Whereas five or six years ago, Mr Kumagai might not have been made an example of in this way, there was been a real sea-change at the FSA, which will be continued by the Financial Conduct Authority and Prudential Regulation Authority in 2013.
In the press release accompanying the Final Notice, Tracy McDermott stated: “senior management must take responsibility for the firms that they run. Kumagai failed to respond adequately to the changing risks facing his business even after they had been pointed out by the FSA. If those who hold senior positions in financial services firms had had any doubt about how seriously we view their regulatory responsibilities this fine and ban should make our position crystal clear.
“The failures by Kumagai and the firm have result in significant sanctions for both him and MSIEu. The FSA requires firms to have effective corporate governance and controls. They must adapt these appropriately to reflect changes in their risk profile, especially growth into new areas.”
Senior Management beware!
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