Banking misconduct and SMEs: protection for small businesses?

By Dr Holly Powley, Lecturer in Law, and Prof Keith Stanton, Professor of Law (University of Bristol Law School).

By Dean Hochman

The Royal Bank of Scotland (RBS) has been placed under the spotlight with regards to its treatment of small and medium sized enterprises (SMEs) that experienced financial difficulties and were referred to its Global Restructuring Group (GRG). The Financial Conduct Authority (FCA), heavily criticised for its failure to publish the full report of an investigation into the business practices within RBS’s GRG has, in the last fortnight, released an interim summary of the report. The report itself makes for an uncomfortable read, highlighting serious issues with regards to the treatment of SMEs within RBS, amid allegations that it was this treatment that led to the failure of these SMEs, detrimentally affecting the livelihood of those involved with the businesses as a result.

This episode serves to highlight the lack of options available to SME customers who feel that they have been mistreated by their bank. Despite the FCA now indicating that they will take steps to extend the scope of the Financial Ombudsman Service (FOS) to enable SME access to the service, there are still questions about the scope of the regulatory regime and its applicability to SMEs. As will be demonstrated, the structure of the regime itself has, thus far, operated to exclude SMEs from access to redress. This blog will analyse the current position for SMEs and will assess the viability of potential reform to the FOS. 

RBS and GRG: what happened to SMEs?

GRG dealt with RBS’s SME customers in financial difficulty. SMEs in financial distress would be transferred to the GRG unit, with the intention that the GRG unit would assist with the restructuring of the business in order to facilitate a return to financial health. Despite this objective, there were suggestions that RBS was ‘engineering a business into default’ in order to move the business into GRG, where the bank would potentially be able to profit from any additional charges levied for lending products and services. Allegations of mistreatment of SMEs transferred to GRG are widespread, with accusations ranging from complaints that the interest charges on GRG products were too high for the struggling SME to survive, through to the suggestion that GRG forced SMEs in the unit into bankruptcy in order to benefit from the SME’s assets. The increased costs of the products SMEs were required to access through GRG restricted the ability of firms in difficulty to leave the unit. These allegations originated from a report completed by Dr Lawrence Tomlinson, entitled ‘Banks’ Lending Practices: Treatment of Businesses in distress’, published in November 2013.

In light of these accusations, the FCA commissioned a ‘skilled person’s report’, using powers contained within s.166 Financial Services and Markets Act 2000 (FSMA 2000), to investigate the activities within GRG. Promontory Financial Group (UK) Limited were appointed to conduct the investigation and produce the report as an independent party. The completed s.166 report was presented to the FCA in November 2016. In the face of significant public pressure, the FCA has now published an ‘Interim summary’ of the report. This document makes for a difficult read. The ‘key review findings’ state that ‘the independent review found that there had been widespread inappropriate treatment of SME customers by RBS’, although it did not find evidence that RBS had sought to engineer the transfer of SME customers to GRG. In assessing whether GRG actions did distress viable businesses, however, the interim summary highlights that, of the 207 firms assessed for the purposes of the report, 34% from this sample were clearly not viable, yet, of the remaining firms, 92% experienced ‘some inappropriate actions in the handling of their case’. The report also found that 16% of the ‘potentially viable cases’ (equating to 11% of all firms sampled) ‘did experience inappropriate actions by RBS that, in all the circumstances of the case, were likely to have resulted in material financial distress (beyond that which the business would have experienced in any event)’. These statistics indicate the extent of the inappropriate treatment of SMEs within GRG. Only one in ten businesses referred to GRG exited the turnaround unit.

Why hasn’t the FCA taken action?

The FCA has been faced with heavy criticism as to its failure to take action in relation to the poor practices at GRG. Reports published in 2013 indicated the existence of problems at GRG, and, further, the FCA has had the full s.166 report since November 2016. The FCA has sought to justify its lack of action by indicating that RBS’s dissent (see also RBS’s response to the Treasury Committee regarding GRG) to the contents of the report required it to undertake an assessment of the results of the s.166 report before they could proceed with any investigation, but has now stated that they are assessing whether further action is required. Interestingly, in an evidence session with the Treasury Committee, Andrew Bailey (the FCA’s Chief Executive Officer) did caution against the assumption that this would centre around a fine, emphasising the existence of other enforcement measures. One must, therefore, be cautious as to the action that the FCA will take in this regard, particularly as the FCA has sought to emphasise that ‘commercial lending activity is largely unregulated in the UK, and there are no “conduct of business” rules against which to assess GRG’s treatment of SME customers’. This appears to indicate that any enforcement action the FCA might decide to pursue would have to be based upon the FCA’s broad, high level Principles for Businesses, rather than any specific rules contained within its Handbook.

This approach would make sense. The FCA have 11 high level Principles for Businesses that regulated institutions are expected to comply with, providing broad statements of values on issues such as customer treatment (Principle 6: ‘A firm must pay due regard to the interests of its customers and treat them fairly’; Principle 7: ‘A firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading’) and on the way the business is conducted by the regulated institution (Principle 2: ‘A firm must conduct its business with due skill, care and diligence’; Principle 3: ‘A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems’). The statements provided in the interim summary indicate there is a possibility of the FCA considering that at least one of these principles has been breached given the outcomes the FCA expects firms to achieve in relation to this Principle – a breach of Principle 6 is apparent from the statement that ‘the independent review found that there had been widespread inappropriate treatment of SME customers by RBS’, although the report also details instances of misconduct that could potentially justify action under any of the Principles stated here.

The FCA taking action in relation to an issue that does not relate to a breach of the rules contained within its Handbook but where the behaviour is clearly an unacceptable breach of the Principles is not without precedent: this is the approach utilised by the FCA to fine the institutions involved in the LIBOR fixing scandal. Yet, for a regulator that has stated it intends to take a ‘proactive’ approach to its oversight of the financial sector (as previously discussed here), it is concerning that the FCA does not have rules in its Handbook that deal with enhancing protection for SMEs. This appears to be an oversight, given that there have been several indications of problems in the small business sector: the interest rate hedging product (IRHP) misselling to SMEs being an example of this. The GRG episode, again, highlights that the FCA has not anticipated misconduct issues in the banking industry. The FCA is, to some extent, fortunate that the Principles for Businesses exist to enable it to fall back on these broad provisions in instances of misconduct. Whilst the FCA cannot create rules to cover every possible circumstance of misconduct (to do so would risk confusing what is already a complicated regulatory regime), the warning bells of problems in relation to bank treatment of SMEs have been ringing for some time.

Even if the FCA does take action on the basis of the Principles, any fine (or otherwise) levied on RBS would not provide the businesses affected by GRG’s actions with compensation. The FCA does have scope to create bespoke redress schemes to require firms to pay compensation to affected consumers. However, this is a reactive mechanism that does not enable individuals to gain redress in relation to problems that the FCA does not take action on. RBS have now proposed to set up their own redress scheme for ‘eligible SME customers’. Nonetheless, given the findings of the s.166 report, it is understandable that affected SMEs might not have confidence in this scheme.

SMEs and redress: the options

This episode has highlighted the difficulties for SMEs seeking redress for poor treatment by their bank. That SMEs are businesses, rather than retail consumers, and further, that lending activity in relation to their business is deemed to fall within the commercial lending sphere, dramatically reduces the regulatory protections available to SMEs when compared with retail banking customers.

Retail banking consumers have access to the Financial Ombudsman Service (FOS), a free alternative dispute resolution scheme for consumers who experience difficulties with their financial services institution. The FOS operates as an alternative to the legal system, enabling consumers who have a complaint about their bank to avoid the time, expense and expertise required to bring a claim to court. The FOS does not require complainants to have legal representation, and does not require them to attend the FOS to make their complaint – they only need to provide the FOS with the relevant information. Further, the FOS has a very wide discretion when assessing complaints and making a determination as to whether the complaint should be upheld or not. S.228(2) FSMA 2000 states that the ombudsman can make a decision on the basis of what is ‘in their opinion, fair and reasonable in all the circumstances of the case’. This also means that the ombudsman does not necessarily have to reach a decision that accords with the common law, and that the ombudsman has the scope to consider a broad range of materials when assessing the complaint itself (including the provisions in the FCA’s Handbook, industry practice and guidance). The FOS therefore provides valuable consumer protection, removing costs for those who have a valid complaint and allowing a degree of flexibility, taking into account a broad range of factors when assessing the actions of the bank and the consumer involved.

There are limitations as to who can use the FOS. For a complaint to be considered, the complainant needs to be an ‘eligible complainant’. Eligible complainants are restricted to individuals, micro-businesses (defined as an institution with less than 10 employees and an annual turnover of 2 million euros or less) and charities. As at November 2016, there were 5.5 million businesses in the UK, with 5.4 million of those businesses being classed as SMEs. Of the 5.4 million SMEs, 5.3 million of those are deemed to be ‘micro-businesses’. These businesses will, therefore, fall within the FOS’ remit. However, that still leaves approximately 100,000 SMEs who do not have recourse to the complaints scheme, and who will have to pursue any claim through the legal system. The cost implications of this, particularly when a business has experienced financial difficulties, make this option unattractive.

Even if the business can bring itself within the scope of the FOS’ eligibility rules through its designation as a ‘micro-business’, the FOS only has the power to award compensation of up to £150,000. In the event the business does not fall within the FOS’s remit, or the claim is valued at over £150,000, the only option available for a business to gain redress is to pursue a claim in the courts. However, this option is not free from difficulty. A claim under s.138D FSMA 2000 for a breach of a rule in the FCA’s Handbook will be barred by the fact that such an action is only available to ‘private persons’ (Reg 3(1) Financial Services and Markets Act 2000 (Rights of Action) Regulations 2001). In addition, even if this restriction were to be removed, an SME would need to establish that a rule has actually been breached, if they are to avail themselves of s.138D. This, in itself, is problematic: as indicated above in relation to the FCA’s interim summary of the s.166 report, some areas of banking, such as commercial lending, currently fall outside of the provisions in the Handbook – meaning that there are no rules for banks to break when engaging in lending activity with SMEs.

The position changes slightly for micro-businesses, who fall within the definition of ‘banking customer’ within BCOBS (the Banking Conduct of Business Sourcebook; the definition is contained in BCOBS 5.1.1R). BCOBS 5.1.1.R requires a bank to provide a service to a customer (including a micro-business) which is ‘prompt, efficient and fair.’ However, as BCOBS 1.1.1R states, the rules and guidance contained within BCOBS only apply in relation to ‘the activity of accepting deposits’. The issues experienced by SMEs dealing with GRG did not relate to the activity of accepting deposits, but instead commercial lending and restructuring services. Overall, therefore, it is unlikely that, in the RBS GRG scenario, there will be a breach of a rule on which an SME can ground a claim without substantial revision to the FCA Handbook.

The impact of this is that a claim in negligence, with all of the associated difficulties, is often the only litigation option for SMEs who wish to bring a claim against their bank.

How to resolve the problem for SMEs

The analysis above has demonstrated the difficulties SMEs face in gaining redress when they have been subject to bank misconduct. Bringing a claim through the courts is costly and time-consuming, and is unlikely to be successful. The FOS, whilst open to a wider range of businesses through its incorporation of micro-businesses introduces difficulties in terms of the compensation it can award. The FCA, in its interim report, has acknowledged this problem stating that ‘the work highlighted a gap in support for smaller businesses with genuine grievances about business banking conduct issues that could benefit from impartial assessment and quick resolution’. However, the FCA has been aware of this difficulty for some time, having published a discussion paper in November 2015 outlining their approach to SMEs and mooting the possibility of extension of the FOS to enable it to receive complaints from a wider group of companies. This was in response to concerns raised by the Parliamentary Commission on Banking Standards in 2013, and by the Treasury Committee, in March 2015.

In evidence to the Treasury Committee on 31st October 2017, Andrew Bailey indicated that the FCA will consult on extending the scope of the FOS, to enable it to receive complaints from a broader range of businesses and increase the maximum compensation the FOS can award. On the face of it, this seems to be a sensible suggestion if, as he indicates, there is no possibility at this time of introducing by means of legislation a formal scheme to handle such problems. Increasing the amount the FOS can award as compensation will reduce the number of micro-businesses whose claims fall outside of the FOS because of their value, and extending the number of businesses the scheme applies to will reduce those in the ‘small and medium’ bracket who fall outside of the scheme altogether but are unlikely to be able to afford sufficient legal representation if pursuing a claim against a bank in court.

However, there are important questions that need to be considered if the FCA is to embark upon an approach that will be capable of operating as an effective mechanism for addressing SME mistreatment. Compensation limits will need to be set carefully – it will be a balancing act to ensure that any extension will truly capture the problematic cases whilst ensuring that the increase does not reduce the efficiency of the FOS or lead to an overwhelming number of complex cases that the FOS does not have the expertise to resolve. Raising the limit to £200,000, or £250,000, for example, is still unlikely to encapsulate the majority of the complaints relating to GRG: a much higher limit will need to be introduced for the reforms to be effective. Yet, an increased limit is also likely to reflect the increased complexity in these forms of complaint. This, in turn, poses questions in terms of the expertise of FOS staff and of its ability to deal with such complaints in a relatively fast and informal manner. Given the complexities involved with calculating the appropriate compensation and questions surrounding consequential loss in complex cases featuring damage to businesses (the contentious IRHP compensation scheme has demonstrated the difficulties that can arise), it is questionable whether it is more appropriate for such complaints to be dealt with by a court.

Additionally, it needs to be considered whether businesses or banks will be happy with such complex complaints being dealt with under a scheme that has such wide discretion in terms of the factors that can be taken into account when the FOS is determining whether or not to uphold any complaint. As highlighted above, the FOS has the ability to subjectively determine what is ‘fair and reasonable’ in all the circumstances of the case. This makes it difficult to predict what the outcome of a complaint might be, particularly as the FOS can reach a decision that is at odds with the common law. This will clearly have implications for commercial certainty, and it might be that affected businesses are uncomfortable with their rights being determined on the basis of such discretionary criterion. This needs to be taken into account in any extension of the ombudsman scheme.

This is not to say that an alternative dispute resolution service for business customers will not work. It is to say that the potential problems involved in extending a scheme designed to deal with relatively simple disputes predominantly between retail consumers and their financial institution to protect SMEs should not be underrated. The creation of a specialised business ombudsman scheme for SMEs affected by dealings with their bank or other financial institution might be an alternative that could be considered. A dedicated business service, either separate to, or as a division of, the FOS would ensure that SMEs have access to an alternative dispute resolution service whilst also ensuring that the complaints are being dealt with by individuals with the appropriate level of expertise and understanding of the complexity of the claim. Dividing the business consumer service from the retail consumer service would also mean that the business element would be able to create a more bespoke service, better suited to business complaints than the current FOS. It is likely that, for reform to be effective, a complaints service for business consumers will need to have different characteristics to the FOS as it currently stands.

A further option for the FCA to pursue might be a revision of the rules contained within its Handbook. The FCA have already indicated that they will be engaging in a review of the rules and guidance contained within their Handbook. It is unlikely that such a review will take place before the Brexit negotiations have been completed, yet changes to the scope and application of the rules could have significant benefits for SMEs. Further, the introduction of rules designed to protect SME customers in their relationship with their bank would not be a significant extension on the current situation: certain Handbook provisions already apply to micro-businesses (see, for example, the discussion above in relation to the provisions in BCOBS), and the FCA have previously stated that they take a ‘tiered approach’ to determining appropriate levels of protection. As the FCA state (p.18), ‘For most SMEs, purchasing financial services and pursuing claims or complaints are not core business operations. They are reliant on advice when they can afford to pay for it; when they cannot, they rely on non-expert, time-poor individuals without relevant industry or product expertise.’

For any change in Handbook rules to provide an effective compensation remedy, s.138D FSMA 2000 would also have to be reformed to enable non-private persons to bring a claim under it. The FCA have stated (in a much broader context) in their GRG report that they would be willing to engage with Parliament on reform in this area. However, in Bailey’s evidence session on 31st October 2017, it appeared that Parliamentary action on this issue is unlikely at this time.

Conclusion

The regime applicable to SMEs in the UK now appears to be rather archaic. The number of businesses in the UK has increased by 59% between 2000 and 2016. However, the legal protection available to SMEs does not appear to have changed significantly. The traditional justification for a lower level of protection for businesses revolves around the expertise within the business, and the fact that businesses have had a stronger bargaining position than consumers. However, as accepted by the FCA, this is not always the case. Businesses, particularly those that do not deal with financial products and services on a regular basis, can find themselves in a vulnerable position when dealing with financial institutions. Yet, the current regulatory framework fails to recognise the importance of ensuring that SMEs are not mistreated in these dealings. The extension of the FOS to enable more business access to the complaints scheme might be a step towards mitigating the impact of the regulatory regime. Unfortunately, though, it is unlikely to be capable of resolving the number of complex disputes that can arise in the SME-bank context. An alternative might be the creation of a separate mechanism to deal with disputes between SME customers and their financial services provider. A thorough review of the regulatory regime itself is required if SMEs are to be provided with routes that offer viable access to justice.

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