This article was originally written for and featured in Compliance Monitor.
The case against the directors of the now defunct mortgage and loan brokerage firm, Black & White Group Ltd, is the latest chapter in the on-going PPI mis-selling saga. The case serves as an important reminder of the FSA’s mantra that firms must put customers, not profit, at the heart of their business.
Black & White advised on and arranged mortgage contracts and associated insurance, including Payment Protection Insurance (PPI), using a panel of around 20 mortgage lenders. Many of its customers were particularly vulnerable, having low or impaired credit ratings.
An investigation by the Financial Services Authority into the practices of the brokerage firm following concerns raised by a whistleblower in 2008, found troubling results.
The RDC in review
The FSA uncovered a “sales-driven” culture created by the former chairman, Christopher Ollerenshaw, and chief executive, Thomas Reeh, which placed undue focus on maximising profits. Advisors, driven by an incentive scheme which meant that greater commission could be earned by selling single premium PPI policies over regular premium policies, sold single premium policies to their customers without having due regard to their suitability.
Reeh told his sales advisors, “a simple message. If you can’t fit a lump sum into the frame or it’s not appropriate… then get a monthly policy at the very least. Every little helps and we are missing dozens of these every month…”
Pressure was also levied on advisers to sell products offered by one particular lender, Money Partners Limited (MPL) without properly considering their customers’ needs. MPL had also provided Black & White a £1 million loan. The FSA found that when the brokerage firm began to struggle to make the repayments on the loan, it offset its repayments against the commissions it earned from its increased sales of MPL products. This, the FSA said, created a significant conflict of interest.
The regulator also held that the directors failed to ensure that the brokerage firm had adequate compliance systems and did not provide the FSA with timely information regarding the firm’s capital adequacy provision.
In August 2010, the FSA found the directors in breach of Principle 1 and Principle 7 of the Statement of Principles for Approved Persons and knowingly concerned in Black & White’s breach of Principle 6 of the Principles of Business. It imposed prohibition orders prohibiting both Ollerenshaw and Reeh from performing regulated activities on the grounds that they were not “fit and proper” persons. It also fined Ollerenshaw £70,000 and Reeh £50,000; Childs would have been fined £50,000, had he not been declared bankrupt in 2009. At the same time, the FSA censured Black & White for operating in a manner that created a high risk of unsuitable sales, stating that it would have imposed a fine of £2.2 million had the firm not been liquidated in 2008.
Ollerenshaw and Reeh challenged the FSA and submitted references to the Upper Tribunal. They argued that the FSA had failed to prove that the customers had suffered any loss in relation to PPI sales and that, in fact, they had legitimately advised customers to choose MPL products due to MPL’s speed and efficiency. They also emphasised that any failures in financial reporting ought to be viewed in light of their relative inexperience in the financial services sector and in view of the progress that Black & White had made in this area.
While the tribunal accepted the overwhelming majority of the FSA’s case against the directors, it found that the FSA had “fallen short” of all the allegations it had made. First, the FSA’s file review, which had been conducted in order to show that customers were committed to MPL products when other more suitable products were available, was fundamentally flawed and could not be relied upon. Second, the tribunal found that although there were shortcomings in relation to compliance at the brokerage firm, this needed to be considered in light of the “considerable” achievements of Reeh in “bringing in a coherent regime of Compliance”.
As a consequence, and highlighting the fact that neither director had financially benefited from their breaches given the subsequent liquidation of Black & White, the tribunal significantly reduced the financial penalty imposed on Reeh to £10,000 and on Ollerenshaw to £50,000. The tribunal also directed that it did not consider the prohibition order on Reeh was appropriate. Interestingly, the tribunal appeared to focus primarily on the impact of the prohibition order on Reeh rather than the potential risk he posed to customers. It stated that Reeh, who had “failed to appreciate” his duties at the time, has since rebuilt a successful career in the financial services sector in Australia and to impose the order and a higher penalty would have the effect of “bringing this fresh start to an end” and result in “potential hardship… on his young family”. By contrast, the tribunal directed that the imposition of a prohibition order on Ollerenshaw, who was regarded as the “man in charge” of Black & White, was appropriate on the basis that he was “out of his depth” in modern financial services regulation.
A clear message to financial services firms
The concern that inappropriately structured incentive schemes in the financial sector can lead to poor sales practices is not, of course, new. The case against the Black & White directors sits alongside a series of enforcement actions relating to the mis-selling of retail products dating back to 2008, as well as the recent publication of guidance from the FSA following its thematic review into the risks to customers from financial incentives offered to sales staff.
This case sends an unambiguous message from the regulator: firms need to take action now to determine what type of action they are “inciting” in their sales staff. Is it to get the best deal for the customer or the best deal for the person or firm selling the product? If it is the latter, they will face enforcement action. The regulator will pay short shrift to firms and senior managers who encourage staff to focus on profits over suitability, although it appears from this case that there may be circumstances where credit will be given to those who are relatively inexperienced in the financial services sector.
The FSA is keen to encourage a return to the culture of viewing customers as people to serve and advise, rather than as people to sell to. As Martin Wheatley has said, the FSA, and in future the FCA, “intend to change this culture of viewing consumers simply as sales targets… This will be part of the ongoing improvements we make to regulation as we seek to make markets work well and give people a fair deal.”
This leaves firms facing a difficult challenge in terms of how they can remunerate their sales staff going forward. A move away from rewarding volume of sales represents a marked change from the way financial services firms have operated in recent times – a change that will not only require a significant transformation of culture, but also a significant amount of investment in areas such as technology, HR and risk management. Investment that, for example, small and medium sized firms can little afford. Such a change will also no doubt affect profitability. Nevertheless, in order to satisfy the regulator that they are carrying out their business in a way that ensures consumers get a fair deal, financial services firms need to act now to ensure that consumers are at the heart of their business.