SIR CALLUM MCCARTHY, MR HECTOR SANTS AND MS MARGARET COLE

6 MAY 2008

  Q100  Mr Dunne: Do you think there should be greater transparency in identifying bank positions throughout the course of the year rather than simply on balance sheet dates?

  Sir Callum McCarthy: I find that quite a difficult judgment to make, because I think that the problem in a way is making sure that there is information that is comprehensible and actually usable, and I have some doubts, if these were a daily marking of positions and publication of those positions, whether the amount of data would simply flood the market and be unusable. One of the real problems at the moment is, if you look at the length of annual reports of the major institutions, you get a huge amount of data. It is not clear how much information you manage to extract from all that data, and I think the proposal you make might have that problem.

  Q101  Mr Dunne: Similarly, do you take the same view over reports by banks of breaches of their capital adequacy positions?

  Sir Callum McCarthy: I think that it depends very much on the circumstances of any breach, for the reasons that Hector began to discuss in answer to an earlier question.

  Mr Sants: It would not necessarily be right to say that all such breaches were important. I think you need to give proper consideration to the facts involved and the type of remedial action which would be taken.

  Q102  Mr Dunne: Because it only transpired that Northern Rock was in breach of its capital adequacy when they published their accounts some nine months later, and it was apparent from your report into your own investigations that the flurry of meetings which suddenly took place with Northern Rock happened about ten days after they had reported that breach to you; so you reacted, obviously, with relatively the appropriate speed at that point; but I note from your report that you did not regard it as sufficiently serious for it to change any of the status of the monitoring of the bank, despite the fact that they were in breach of their capital adequacy regime. Is this a fairly common thing to happen with major banks that they breach capital adequacy, or is it very unusual?

  Mr Sants: As I mentioned before, I am reluctant to give you precise data. I will give consideration to what we can say to the point. I come back to my earlier remarks, that whatever we do has to be in the best interests of the stability of that institution and if we judge that appropriate remedial action is in place, then it seems to me that that is a reasonable framework under which to operate, but we will come back to it a bit more with whatever we feel appropriate to reveal with regard to how often this occurs.

  Chairman: I think Margaret Cole, is eager to go on to market abuse questions, Philip.

  Q103  Mr Dunne: Thank you, Chairman. The Chairman touched on this in his remarks at the beginning. Ms Cole, you have helpfully provided us with a schedule setting out the apparent reduction in informed price movements from regular announcements over recent years of apparently a failure of the systems proportion of informed price movement on the back of takeover activity. Could you elaborate a little bit more on that and, in particular, set that in the context of how that compares with other countries?

  Ms Cole: Yes. As to the latter question, I think we are the only regulator that publishes a survey of this nature. Indeed, we believe that demonstrates our commitment to transparency and trying to assess the scale of the problem. So I do not think I can give you a direct comparison with other countries. Certainly it is the case that we regard what is shown by these figures as a serious problem.

  Q104  Mr Dunne: Could you tell us what you are going to do about it?

  Ms Cole: Yes, I can. We recognise that we need to do more to address the issue of market abuse and insider dealing. We certainly need to bring more cases—that is why we are in the process of preparing cases and why we have carried out a major upgrade to the skills of the staff in the enforcement division. Clearly, what I cannot tell you about is the detail of cases which are going through the system, but we do have a number of cases which are in the course of being prepared either for criminal prosecutions or for the civil process. We would expect those cases to flow through the system during the course of this year and next year.

  Q105  Mr Dunne: You have said in your memorandum to us that it is difficult to extrapolate from these figures the idea that all of the price movements reflect insider illegal activity, insider trading, because there are lots of other reasons why movements might have occurred. I think the public perception, however, is that this suggests that roughly 30% of takeovers involve insider dealing and that is the way it has been characterised in some of the media. If that is not the case, I think that is a very unfortunate consequence of this transparency. Are you able to provide any explanation? You have said you are taking action in a number of cases. Can you try and elaborate a little bit more on what proportion of the 28.7% of cases you regard as being suspicious?

  Ms Cole: I agree with you. I think we have sought to explain why these figures are not necessarily indicative of insider dealing cases because there are many reasons why the price of shares might move ahead of an announcement. We have provided you with some information, I believe, that suggests that we would certainly expect 10% movement without there being any misuse of inside information. That clearly brings the overall figure down to below 20%. We still think that figure is too high.

  Mr Sants: You should also add into that that the statistic is probably not accurate to more than about 5%, so, effectively, something of the order of magnitude of 15% would be taken out of the equation. You are right, it is unfortunate that despite our best efforts to explain this, the media continue to report it in many cases, not in all cases, in a way which sometimes gives the wrong impression of what this data is designed to do, but we remain of the opinion that it is important to try to have some sort of objective measure here and it is important to enable us to focus on our basic objective, which is improving market quality. It is not the number of cases that matters here, it is improving the quality of the market. It is logically true that if there were no insider dealing you would not have any cases: so you obviously cannot have a case target, you need a target improving market quality.

  Q106  Mr Dunne: Even if there was no insider dealing, it would be quite possible for a significant price movement in many takeover target companies to occur?

  Mr Sants: More than possible, it is highly likely probable.

  Q107  Mr Dunne: Which is why I think some of the comments you have just made about the quantification, perhaps it would be helpful if you could elaborate in future public announcements, make that point clearer than you have to date, because otherwise it does give potentially quite a misleading impression.

  Ms Cole: I think we have tried to make that clear in the latest Market Watch publication. I will certainly have a look again on that subject.

  Q108  Mr Love: Sir Callum, does the City of London take market abuse seriously enough?

  Sir Callum McCarthy: I would say, no, I do not think it does. One of our ambitions is to get it to take it more seriously, and that is why we are determined both to put in the resources within the FSA and to get the additional powers that we believe are going to be necessary to really establish what we are after, which is credible deterrence.

  Q109  Mr Love: Mr Sants, is the FSA independent enough from its contributing member firms to be able to deal with this problem adequately?

  Mr Sants: Yes.

  Q110  Mr Love: Let me go on to talk about the recent controversy over telephone taping, where it would appear, according to The FT, which most people consider to be the in-house magazine of the City, they called it "a climb down" that you had moved from three years to six months in terms of telephone taping and that you did not include mobile phones. Does that show the sort of independence and robust action that we need at the present time?

  Mr Sants: I think that newspaper report was a misrepresentation of the facts with regard to what had happened with regard to our consultation process. Let us just take a look at the facts here. First of all, telephone taping is already common practice in the City, the motivation here being, particularly for the large firms, to deal with trading errors and other related matters. Something in the order of about 80% of all the dealing telephones in the City are already taped. Reflective of our determination to deliver a clearer message with regard to market abuse, we thought it reasonable to take advantage of the introduction of MiFID, though this is not a specific MiFID requirement, to take a look at making a clear rule with regard to telephone taping because of the benefits we believe that brings to our fight against market abuse. Given our regulatory framework, that introducing a rule requires a discussion process and requires a cost-benefit analysis to be done. It is a very difficult issue, doing a cost-benefit analysis with regard to telephone taping, partially because technology is changing all the time and partially because of the difficulty, in fact, of getting accurate information from the firms. We had in our initial process quite a lot of contradictory views as to how expensive this process was. So we put out a proposal to try and flush through that debate and get a clear understanding of the cost of introducing taping. We have now done that and come up with a sensible proposition. Six months is more than adequate for our purposes and we are very happy with where the proposals have ended up. With regard to mobile telephones, it is clearly the case people use mobile telephones and, as technology improves and, therefore, the cost, potentially, of addressing the taping of mobile telephones comes down, we will return to the point, but at the moment, under our statutory obligations, it was not possible for us to push through that measure and, indeed, technically I think may well have been very difficult in any case.

  Q111  Mr Love: It was reported to the newspapers that this was a matter of cost, and the institutions have said this was not as expensive as you say on a cost-benefit analysis. Sir Callum, does that send the right message to the City: "Yes, of course we will step down, we are completely independent, we want to send signals to the City of serious market abuse is"? Did that send the right signal?

  Sir Callum McCarthy: Given the legal requirements that we have to demonstrate that what we are doing is cost-effective, there was no other course of action that we could properly take. I think there is nobody who doubts the determination that we have to actually tackle the problem that has been a long-standing problem over decades. I think that we are tackling it with greater resolution and greater resources than has ever happened before.

  Mr Sants: To deal with the particular, if we choose to, we can ask people to retain the tapes for longer periods. The obligation this places on us is to act quickly and decisively. If we act quickly and decisively, the change in the time period will have no material affect on our ability to deliver in this area. So it is not that important a point, with due respect. What is important is that the tapes are there for at least a four to six-month period.

  Q112  Mr Love: Let us talk about quick and decisive. It is accepted, I think, across the City that there is widespread abuse. Whether that is supported in the newspapers, a quarter of all takeovers, or a fifth, or even a lesser figure, it is still very widespread. You have admitted earlier on that there are few prosecutions, even those in the pipeline. Sir Callum has just said this is a system that has been going on, market abuse has been going on, since time immemorial. Why did it take you so long to come back to the Government and say, "We need legislation to improve this situation"? Sir Callum, if you are quick and decisive, why has it taken so long?

  Sir Callum McCarthy: All I would say is this is something that we have decided to push up our list of priorities. We started doing that, I would say, about three years ago. I think since then we have, as Margaret has said, changed the enforcement team, we have reinforced it, we have spent money heavily on the technology and we are now very clearly asking the Government for further powers. I think that it shows our determination.

  Mr Sants: Mr Love, you have got a point with regard to the tariffs effect here. What we have learnt in the last year is that civil action alone is not providing sufficient deterrence, which is why we wish and intend to take more criminal prosecutions in the future. So we have learnt something here. We have learnt that our sanctioning needs to be greater to achieve the required deterrent effect.

  Q113  Mr Love: I will come back to the criminal issue in a second. Can I ask Ms Cole, you were part of a team who went to see how the SEC do it. You indicated earlier on that they do not publish any figures, but did you get any idea from your visit there about the nature of the way they go about dealing with market abuse and are they, in your view, more successful and why are they more successful?

  Ms Cole: I think there is no doubt that they have had more cases and they have more successful cases. I think one of the major reasons that came across to me from that meeting is that they have more tools with which to build the evidence to bring the cases, and the most significant tool that they have is the ability to enter into plea bargaining arrangements and immunity arrangements with co-operating witnesses, and that is not just a tool, they have a long history of that being accepted within their legal system and it is, as I am sure you know, very commonly the practice that witnesses will come forward when they are aware of an SEC investigation and will offer tangible evidence against other participants in a crime. That is not a power that we have historically had. You mentioned earlier: why has it taken so long for us to ask for it? It is not right that we have only just asked for it. We have been asking for this power for a period now of more than two years.

  Q114  Mr Love: I accept the issue about the legal powers, but would you accept that there is a difference, a very distinct difference of perception about the robust—I use that word advisedly—and rather tough way that the SEC goes about investigating market abuse in the United States than the more consensual way in which we do it in this country? Is that a contributory factor to whistle-blowing and plea bargaining that they achieve in the United States?

  Ms Cole: I would accept there is a difference in perception and I would accept that that makes a difference to people coming forward, as well as I have explained a long history, a longer history than we have had, in prosecuting cases. I think it is important to note that we have said that we accept that we need to do more in this area and that we publicly said that we need to present a tougher face all round.

  Q115  Mr Love: What action are you taking? We have heard about the action on resources strengthening the team. We know that you are going to be seeking the legal powers necessary. How do we change the culture in the FSA and, if I may say so, change the culture in the City of London to accept more that this is a criminal offence?

  Ms Cole: We are certainly taking more steps that we think are bolder investigate steps. We have started a process of early telephone interviews so that we can get on to a case of suspicious movements at a very early stage. We will use all the powers we have available to us. That is both down the criminal and the civil route. We will use and we have used our ability to obtain civil injunctions to restrain the use of the proceeds of potential market abuse, so we have looked into the various powers that we have and also into the various powers that we need and we do intend to be bolder and more resolute, if I dare use those words, about proceeding with market abuse cases and insider dealing cases.

  Q116  Mr Love: We will no doubt look at that in the future when you come back. Can I move on to this issue of criminal versus civil, because it is recognised, certainly I think it is recognised by our committee, how difficult it is to achieve prosecutions in this particular area. The test required for a civil prosecution is significantly lower than that required for a criminal prosecution; so at the time when you are saying to us we are having real difficulty in getting prosecutions in this area but we want to move to a situation where we are doing more criminal cases requiring a higher standard of evidence that we simply cannot get, how do we match those two things?

  Ms Cole: I think the first point here is that we think that we need to do criminal cases because we think they have a significantly greater deterrent effect on the industry than the civil cases. Of course, in civil cases we can impose unlimited penalties and we can prohibit the unregulated from the industry, but in the criminal context, obviously, what people are looking at is, the threat there is of a custodial sentence, and we think that has a significantly greater deterrent effect. So we think we need to move into the space of criminal prosecutions. That is not to say that we will not use our civil powers as well. You are right in saying that, at least theoretically, the burden of proof in a civil action is lower than for a criminal action. I would just say, however, that when we proceed with civil actions, and the process of reviewing our decision there is for the Financial Services and Markets Tribunal, the tribunal have held that there is no meaningful distinction between the burden of proof in a criminal case and the burden of proof in a civil case. That is something which I would say is very different for the SEC, who operate on a true civil burden in civil cases.

  Q117  Mr Love: Can I ask you, and perhaps others would like to comment, is not the greatest deterrent effect actually achieving prosecutions and should not your first priority be, by whatever means, to prosecute?

  Ms Cole: We do have a priority to prosecute. Where we can collect the evidence that will justify the bringing of a criminal prosecution in a suitable case, we will bring that prosecution. We have to have evidence that leads to us believe there is a reasonable prospect of conviction and we have to satisfy the public interest test. The important challenge for us is collecting the evidence which will substantiate our cases. We clearly cannot bring cases without the evidence. Insider dealing cases, as you pointed out, are uniquely difficult to bring, largely because the evidence is circumstantial. That is why it is so important to be able to get people to come forward as co-operating witnesses and give us actual direct evidence of the elements of the offence in question.

  Mr Sants: As you yourself said, some of this is about messaging. You rightly observe that historically people have questioned whether the FSA is taking this issue seriously enough. We are determined to remove that misconception, we are determined to remove the conception that somehow or other we are light touch, and, therefore, one of the key points about bringing criminal cases, where the circumstances and evidence warrant it, is to deliver the right message here that we are determined to address this issue, and any suggestion that the culture of the FSA is not determined I would reject. I have acknowledged in the earlier point on Northern Rock there is more work to do. On market abuse the issue is not the culture of the FSA. I do, however, agree with the observations made by my Chairman and by you. I think there is still a cultural problem in the City in the round, albeit not in the senior management in the larger firms.

  Q118  Mr Love: One final question if I can, Chairman. Mr Sants, you said earlier on, and I agree very strongly with it, that your role is to look after the consumer. Is it the success of the SEC in the United States that there is a perception there that the authorities look after the little guy against what is happening in some of our city institutions, and should not the FSA be concentrating more on looking after the little guy in order that we achieve more success in this area?

  Mr Sants: It is absolutely the case that we need to look after everybody. At the end of the day everybody is a beneficiary of fair markets and quality markets, and you are absolutely right, as we said in our Market Watch, insider dealing is cheating and cheating is at the expense of everybody. Everybody who has access to the stock market and every consumer should be worried about this, and we are determined to deal with it.

  Q119  Chairman: As you are aware, we will be continuing to look at that in our financial stability and transparency inquiry which has unfolded over the past few months. Could I finish on the issue of short selling and its regulation given the controversy there has been in the past? Going long on 3% or over of the total stock in a company must be disclosed to the market. Should there be a requirement for a declaration of interest from going short similar to applying and going long?

  Mr Sants: Are you specifically referring here to our discussion around CFDs or are you talking about the wider issue of going short in—