The duty of care in the UK bank-customer relationship: An analysis of the recent regulatory developments

by Martin Berkeley

Abstract: This article explores how stakeholders in financial relationships owe duties of care – not only as already established by regulation and case law, but also because of the impact they can have on individuals, businesses and the economy as a whole. Recognition of the current suboptimal effectiveness of bank duties led the Financial Conduct Authority to initiate a review of bank duties. In analysing this, it is argued that large banks owe a special duty of care as they receive state support which can create moral hazard and they also can cause catastrophic damage to the economy and there follows a discussion of potential new duties. It is further argued that there is room for moral obligations in financial relationships.

 

Summary: 1. Introduction – 2. The FCA consultation – 3. Response to the consultation. – 4. Is there room for morals in finance?

 

1. Duties of care between banks and other financial institutions tend to be thought of as unidirectional in that duties are owed to customers by banks. This is of course over simplistic and customers also owe duties, albeit narrower, to their banks; for example the duty not to draw cheques so as to facilitate fraud or forgery.[1] While the drawing of cheques may sound archaic, the principle of not using banking facilities recklessly or for fraudulent purposes holds, though perhaps it is easier to understand more simply as the duty to operate a bank account honestly.

Similarly, the duty to inform a bank of any suspected fraud as soon as feasibly possible has taken on new urgency given the pace and apparent proliferation of financial crime committed electronically.[2] These customer duties have been used by banks to argue that customers should have taken more care with their banking facilities and should have informed the bank earlier of suspected fraudulent activity.[3] Cynically, this may be seen as an attempt to hold customers responsible for losses by a bank. Of course, customer behaviour is not always simple and raises the question as to whether the same uniform standard should be applied to an internet savvy millennial, as opposed to an octogenarian with only limited understanding of electronic commerce.

Despite being commercial organisations, banks do not operate in a moral vacuum. There are both external laws and rules as well as expectations placed upon them as well as by their own corporate culture. An example of when a bank neglects its core values and allows its moral compass to drift is when the former Barclays Bank Chief Executive Bob Diamond appeared before the HM Treasury Select Committee and was asked by John Mann MP if he: ‘could remind me of the three founding principles of the Quakers who set up Barclays? ^[4]’ Mr Diamond was unable to assist Mr Mann who reminded the former Barclays CEO the founders of Barclays’ values could be summarised, with some irony as ‘honesty, integrity and plain dealing’.^[5] This would seem a good starting point for any New Duty.

 

2. The Financial Conduct Authority (FCA) recognising the importance of bank duties and accepting that all was not well with them, undertook a consultation exercise in 2018 questioning whether any ‘New Duty’ was required of banks. The term ‘New Duty’ was used to encompass a number of potential outcomes.

Initiating the exercise, the FCA issued the document: ‘Discussion Paper on a duty of care and potential alternative approaches’,^[6] in which it outlined its concerns and the range of views in respect of the duties of financial institutions. Specifically, the following questions were asked of consultees:

• Do you believe there is a gap in the FCA’s existing regulatory framework that could be addressed by introducing a New Duty, whether through a duty of care or other change(s)?
• What might a New Duty for firms in financial services do to enhance positive behaviour and conduct from firms in the financial services market, and incentivise good consumer outcomes?
• How would a New Duty increase our effectiveness in preventing and tackling harm and achieving good outcomes for consumers? Do you believe that the way we regulate results in a gap that a New Duty would address?
• Should the FCA reconsider whether breaches of the Principles should give rise to a private right for damages in court? Or should breaching a New Duty give this right?
• Do you believe that a New Duty would be more effective in preventing harm and would therefore mean that redress would need to be relied on less?

The consultation process took the format of workshops hosted by the FCA which were attended by interested parties. Parties then subsequently could make written submissions. The FCA has thus far issued an interim response reflecting the broad scope of responses.[7]

3. Given the long history, extensive nature of the explanations and supporting material in respect of expected duties as expressed in the FCA’s PRIN and the recent FCA’s consultation exercise suggests that the current duties are insufficient or ineffective. Alternatively, they have been not been enacted, interpreted or enforced effectively by both banks and regulators. The recent financial crises, mis-selling scandals and the seemingly increasing workload of redress organisations (the FCA’s apparently caseload is apparent at record levels),^[8] suggest that whatever duties already exist, are not functioning as intended or being adequately enforced, lending weight to the view that perhaps action of some sort is needed to achieve the desired standards.

Without an efficient banking system commerce would effectively stop, payments would not take place and trade would be reduced to little more than barter, at least in the short term. It is manifest given the vital nature of the financial system that stakeholders who can impact the orderly function have obligations to run stable and efficient services as well as wider of duties of care to customers and others.

In the days of the traditional City of London, the principle of ‘dictum meum pactum’ (my word is my bond, which is still the motto of the London Stock Exchange)[9] was understood by all counterparties and a bank’s duty to a client was implicit and understood by counterparties as a quasi-moral obligation. Breach of this moral code would be seen as acting in an ‘ungentlemanly’ manner and would lead to swift rebuke by colleagues and peers. The fear of shaming and shunning may have also acted as a ‘moral brake’ on the worst excesses of the financial system. That being said, a rose-tinted view of the City is to ignore many of the problems that historically existed or became apparent after the ‘Big Bang’ deregulation. The Big Bang also lead to significant cultural and economic changes to the UK banking sector, a slew of new regulations were introduced, some of these originating in the UK’s membership of the EU, for example Principle Based Regulation and more recently the Markets in Financial Instruments Directive II(MiFID II).[10]

The FCA’s Principles for Business (PRIN) aims to capture the duties expected of market participants succinctly. Following the Lamfalussy process the more detailed Conduct of Business Rules (COBS) are an intelligent ‘colouring in’ of the regulatory intentions.^[11] Furthermore, guidance by the regulator, speeches, advice notes, voluntary codes and even soft law guidance on conduct all add weight, clarity and direction to the regulator’s view of what duties are owed, by whom and in what circumstances.^[12]

While any bank duties would ideally apply to all stakeholders in the financial markets, certain institutions should perhaps have a higher standard required of them. For example, Global Systemically Important Banks (G-SIB)^[13] receive state subsidies being ‘too big to fail’. This creating moral hazard.  Does this support create an obligation to behave in a responsible fashion given the impact of their potential failure (though mitigated through bail out)? Simply put, if a bank is state subsidised it could be argued that they owe a higher/greater duty to ‘UK Plc’. Conversely, smaller financial institutions or IFAs do not receive similar state support and it would seem unreasonable to expect the same high level of duties as per G-SIB institutions.

The approach in the Netherlands is illustrative: the Dutch Supreme Court (Hoge Raad) has taken the view that banks have special duty of care due to their social function. (maatschappelijke functie).^[14] This duty of care applies in any contractual relationship between bank & client – credit, payments and even extends to market making activities such as IPOs. The duty can apply to both retail and professional customers as well as unconnected but impacted third parties. G-SIB banks have to balance interests of all parties in their decision-making processes. Recent case law is clarifying the duty of care towards semi-public institutions in the Netherlands. Much of case law based on the impact of derivative transactions and the impact they have had on business and the economy as a whole.

Given the damage a G-SIB can do not only to the national, but also the global economy it is manifest that they owe duties beyond that of a ‘simple’ domestic bank. However, a ‘simple’ bank can also have a profound impact on the economy, a risk that can be amplified through contagion, the run on Northern Rock being an example. At a more personal level, bad investment advice can have a devastating effect on an individual, business or their family. The duty of a financial adviser as an intimate advisory business is more akin to that of a lawyer or doctor and their client/patient. This is reinforced in recent case law By Mr Justice Kerr in O’Hare and another v Coutts & Co [2016].^[15] While a financial advisor action may not be life threatening as is the medical arena, it can be similarly life changing. In summary, duties are owed as a general principle, but there are institutions whose impact can be so profound they arguably should hold a special duty of care.

If the FCA concluded that there was a need to construct a New Duty or restate existing ones more clearly, any such expected duties would ideally make the expected behaviours unequivocally clear and also how they would be measured and quantified. During the consultation meetings, some banks argued that new duties may be ‘too complex’ or ‘difficult’ for bankers to understand. Financial transactions are complex, so understanding a simple principle such as too effectively ‘do the right thing’ should not be a challenge.

Any New Duty could reduce the regulatory burden as in an ideal world as a high-level principle should suffice in showing the desired behaviours, without detailed rules explaining exactly what is acceptable or not, though example case studies may be helpful. Finally, avoiding mis-selling or market damaging event by adhering to any New Duty should result in less redress payments, fines or litigation costs. Similarly, bankers and financial advisors are often heard to complain that they are not respected or seen as a ‘proper’ profession. Subscription and adherence to a code of conduct, as well as professional censure as per a professional banking tribunal, akin to other professional bodies, such as the General Medical Council for doctors or the Solicitors’ Regulation Authority for lawyers, may help in raising standards in the industry and increasing the levels of respect afforded to bankers and financial advisors. In the Netherlands a banker’s oath has been introduced which aims to professionalise financial services and reduce misdemeanours.[16]

To this end, the introduction of the FCA’s Senior Manager Certification Regime (SM&CR), aimed to ‘raise the standards of governance, increase individual accountability and help restore confidence in the banking sector’.[17] Though this was initially aimed at senior levels within the banking industry, the approach will have application at the level of individual advisers as it is extended across the financial services industry.[18]

The SM&CR had its origins in the UK Parliamentary Commission on Banking Standards (PCBS), which considered the professional standards and culture in the UK banking sector with the aim of improving standards in banking and restoring public trust in the industry. The PCBS recommended ‘making individual responsibility in banking a reality, especially at the most senior levels’, as it believed that senior bankers had operated without culpability and with little real chance of being penalised or sanctioned. The PCBS also was of the view that senior bankers would hide behind collective decision-making or claim ignorance of events that happened on their watch. Without individuals as well as institutions having New Duties imposed on them, there is a risk of blaming the bank rather than those who actually potentially breached the standard.

The SM&CR has its flaws: the terminology implies that it only applies to senior staff and the recent decisions such as the perceived soft treatment of Jes Staley of Barclays,^[19] do little to inspire confidence in the effectiveness of the SM&CR or its future enforcement. Furthermore, the effectiveness of SM&CR type regulation is questionable, not only because banks may ‘game’ systems, but also the use of judicial devices such as Deferred Prosecution Agreements give the appearance of letting errant bankers ‘get away’ with a crime. Even if a duty is owed and it is breached it is unenforced.

Any New Duty also needs to extend to the pre-sales processes and product design. Customers often believe they are owed a duty and/or they are being advised – much as in the doctor/patient or lawyer/client relationship. If this is not the case, this needs to be made explicitly clear up front and the bank needs to ensure the client understands this. The current simplistic contractual interpretation of the bank/customer relationship is at odds with reality experienced by many non-professional customers.^[20] The use of contractual estoppel to limit liability and non-reliance clauses reduce the position of a customer to little more than a junior party to a transaction. However, the consequences of that transaction can be profound. The point that external advice is available is also to an extent specious, as it may not realistically be available or the situation may be so constructed by bank that the customer has no realistic opportunity to take external advice, if it even were available.

It is pointless to have any standards or duties if they are unenforceable, ineffective or inconsistently applied. The FCA’s high level Principles (PRIN) are effectively unenforceable by anyone but the regulator and Section 138D of FSMA is only actionable by private persons, leaving many small enterprises unprotected. It would be straightforward for HM Treasury to redefine the meaning of ‘private person’ within FSMA 2000 (Rights of Actions) Regulations 2001.^[21] Furthermore, any high-level New Duty needs to be enforceable by all stakeholders. That may be customers, regulators or even affected third parties. This last category is important: suppose a bank’s activities seriously damage the UK economy, for example causing a failure of the payment system – arguably damaged parties should have the right of redress, as is the case in The Netherlands.

As others have noted, banks are well funded in terms of their litigation budgets and can pick or choose which cases to settle or litigate.^[22] Simply put, weak cases will be litigated and the fear of precedent encourages confidential settlement, thereby stifling the exposure of wrong doing and keeping it effectively hidden from the regulator. The concept of a financial services tribunal has been raised by some parties.[23] How this would be structured and operate is unclear at this stage, however if it could have the effect of removing the ability for confidential settlement, as per perhaps the FOS model – this may help matters. If a special tribunal is binding, and public would help, also this would reduce the inequality of arms between customers and firms.

The regulator has a role to play as well in any New Duty. In addition to enforcement of the New Duty, it has a duty as parastatal to not only fulfil its objectives, but also be more transparent in its dealing with banks and in publishing decisions. The current system of reporting misdemeanours is inadequate and there is apparently a belief that there is no point in reporting poor conduct to the FCA as there is little or no feedback and that nothing may actually be done. This negative perception of the regulator allows firms to breach PRIN and COBS with apparent impunity.

What could a New Duty look like? In short to do the right thing. To treat customers as one would wish one’s own parents to be treated, though this obviously needs to be formalised more eloquently. The bank customer relationship is a contractual one but given the importance and implications of when things go wrong, and the ongoing failures despite the regulations already in place, the need for a New Duty is overwhelming.

The tools required to achieve the outcomes of a New Duty may already exist. The transition from COB to COBS under MiFID in 2007, abandoned the requirement to give best advice, but the general duty of loyalty is still a requirement under MiFID II and potentially may fulfil the intentions of any New Duty.^[24] This would also be a simple route in terms of legislation as no changes would be required, but just enforcement of existing regulation.^[25]

It is my view that a New Duty is needed, but more difficult questions are what should this new duty look like, and who should decide this, also how is ‘buy in’ and compliance to be ensured? Would a meaningful oath for bankers (along the lines of the Hippocratic oath) help? Perhaps fitness to practice or disciplinary tribunals such as found in many other professions have a place as well.

 

4. Bank/customer duties are primarily grounded in law, but do the interpretations reflect the reality of the client/adviser relationship? Financial services are essentially based on trust and the interaction between a customer and adviser is normally (and perhaps naïvely) one of confidence and trust. Financial institutions often market themselves as ‘trusted advisers’, but the reality is different – it is a commercial arrangement. It is axiomatic that humans are irrational, and the profit motive can cause a financial advisor to be less than fulsome in their risk disclosures or even deceitful. This is where hence financial regulation based on principles should be aids to interpretation of more detailed rules. This raises the wider question as to whether there is room for moral values, perhaps expressed as fairness in financial services. [26]

The FCA requires in its Principles for Business for firms (and by extension their employees) to act with integrity as well as having due regard for their customers interests.[27] It would appear that the FCA consultation is recognition that these basic concepts are not functioning as intended. Even with the extensive regulations that have developed it seems these concepts do not work in reality as is also evidenced by continued mis-selling scandals. Even where an adviser’s conscience may suggest a course of action over another, which is less good for the customer, the pressure of targets and commercial reality make the idea of an equitable approach to regulation less than realistic. Awrey et al believe that with changes to the corporate governance and incentive programmes within firms, the limits of law and regulation may be overcome.[28]

Borg and Hooker take the view that relationship between firms and customers is a ultimately a moral issue, arguing that banks have a wider social responsibility, and suggesting the pro-bono model found in the legal profession as an admirable way of utilising their skills in a positive fashion rather than just deploying financial assets as part of their Corporate Social Responsibility programmes.[29] Such an approach could help rebuild trust by connecting with the wider public. Their suggestion that errant bankers should undertake a type of public remedial training to ‘improve their moral sensitivity’, is interesting, but the commercial realities of the financial advice industry risk that this would become just another ‘tick box’ exercise.[30] Hudson argues the concept of unconscionability in equity should be seen as measuring what ought to have occurred and creating just outcomes. [31]

The Treating the Customer Fairly (TCF) regime was introduced by the FCA’s predecessor in 2006,[32] with the aim of improving customer outcomes. The initiative extended to not only how customers were treated but also how products were designed and sold. Essentially it sought to make customers central to financial services firms and their transactions. The concept of fairness is of course elastic and subjective. Notably the TCF approach is not based on any new rules but the correct application of existing rules as outlined in PRIN and COBS. While this is not the same as a moral approach to finance it should be seen as an attempt to change banking culture but given its existence of nearly one and half decades, and the persistence of issues, its effectiveness should be questioned.

It seems that there is a role for change in the culture and ethics of financial services. The concepts of trust, integrity and ‘doing the right thing’ are to some extent woven into the regulatory framework, but with limited effectiveness. However, balancing these with the transactional nature of financial services and realities of making a profit as is not straightforward. It may be aspirational, but the ethical and moral aspects of finance should be borne in mind by regulators, advisers, lawyers and their impact on customers when designing regulatory systems and judging their effectiveness.[33] The leadership of banks and other financial institutions should also regularly check that their moral compasses have not drifted like the hapless Mr Diamonds appear to have done.

Author

Martin Berkeley is Director of Corvinus Capital, guest lecturer at the Alliance Business School Manchester, ESCP, University of Reading Law School and module tutor for the University of London Global MBA. Email: martin.berkeley@corvinuscapital.com

[1] See London Joint Stock Bank Ltd v Macmillan [1918] AC777

[2] The key principles outlined in Greenwood v Martins Bank Ltd [1933] AC51 are just as relevant to modern banking problems

[3] The case of Hing Cotton Mill Ltd v Liu Chong Hing Bank Ltd [1986] AC 80, raised the possibility of customers owing wider duties to banks, but this rejected on appeal

^[4] Evidence by Barclays Bank CEO Bob Diamond to HM Treasury Select Committee – 4 July 2012

^[5] See https://www.home.barclays/about-barclays/history/our-quaker-roots.html.

^[6] FCA, Discussion Paper on a duty of care and potential alternative approaches, DP18/5 July 2018

[7] FCA, A duty of care and potential alternative approaches: summary of responses and next steps, Feedback Statement, FS19/2 April 2019

^[8] https://www.finance-disputes.co.uk/2018/09/fca-caseload-at-record-levels-despite-dropping-more-cases-than-ever/?utm_source=Squire+Patton+Boggs+-+UK+Finance+Disputes+and+Regulatory+Investigations+Blog&utm_campaign=14cebf4b17

[9] https://www.lseg.com/careers/graduate-and-internship-programmes/about-us/our-culture

[10] https://www.esma.europa.eu/policy-rules/mifid-ii-and-mifir

^[11] Alexander Lamfalussy devised this approach, the methodology was adopted in wider financial regulation in the EU, see the “Lamfalussy” report: https:// http://www.esma.europa.eu/sites/default/files/ library/2015/11/lamfalussy_report.pdf

^[12] For example, Thomas v Triodos Bank NV 2017 EWHC 314 (QB), where adherence to the British Banking Code was judged to give rise to an intermediate duty of care to explain a product beyond that not to mislead or misstate

^[13] List of global systemically important banks (G-SIBs) http://www.financialstabilityboard.org/wp- content/uploads/r_141106b.pdf

^[14] For example see Dutch Hoge Raad, NJ/1999/285, Mees Pierson/ Ten Bos, 9 January 1998

^[15] O’Hare and another v Coutts & Co [2016] EWHC 2224 (QB)

^[16] Richard Furlong, Bankers’ oaths or being nicer chaps? Banking reform in the Netherlands and the UK compared, JIBFL, No.6 (2014) 383

[17] Financial Conduct Authority, Senior Managers Regime, 5 (2016)

[18] The FCA has signalled it plans to extend the scheme to all FCA registered firms, see ‘Individual Accountability: Extending the Senior Managers & Certification Regime to all FCA firms’, FCA Consultation paper CP 17/25 (July 2017)

^[19] FT: UK Regulators criticised for fine on Barclays Chief, 20 April 2018, https://www.ft.com/content/f8a5160e-4482-11e8-803a-295c97e6fd0b

^[20] For a helpful explanation of the current state of UK case law see Gerard McMeel, ‘Every word you just said was wrong’ Holding banks to higher standards, JIBFL, No. 4 (April 2018) 218

^[21] See Lloyd Maynard, Holmcroft Properties: will a contractual phoenix rise from its ashes? JIBFL Vol. 31 No. 6 (June 2016) 358

^[22] Reputedly major banks have litigation budgets valued in billions of pounds.

[23] Richard Samuel, Tools for changing banking culture: FCA are you listening? Capital Markets Law Journal, Vol. 11, No. 2 (2016)

^[24] MiFID, Art 19(1) and MiFID II, Art 24(1)

^[25] For a fuller exploration of this, see Martin Berkeley, Do the FCA’s Principles for Business require a firm to give the best advice? JBIFL, Vol 33, Issue 4 April 2018

[26] For analysis of how the concept of ‘fairness’ is problematic for regulation see Niamh Moloney, How to Protect Investors: Lessons from the EC and UK, Cambridge University Press (2010), 219-223

[27] FCA, Principles for Business, https://www.fca.org.uk/about/principles-good-regulation

[28] Awrey, Dan and Blair, William and Kershaw, David, ‘Between Law and Markets: Is There a Role for Culture and Ethics in Financial Regulation?’ Delaware Journal of Corporate Law Vol. 38, 191 (2013)

[29] Emma Borg and Bradford Hooker, ‘Epistemic Virtues Versus Ethical Values in the Financial Services Sector’ Journal of Business Ethics, ISSN 1573-0697 (25 April 2017)

[30] Ibid.

[31] Alistair Hudson, ‘Conscience as the Organising Concept of Equity’ Canadian Journal of Comparative and Contemporary Law Vol. 2, 267 (2016).

[32] Financial Services Authority, Treating Customers Fairly – towards fair outcomes for customers. July 2006

[33] For a fuller discussion of these dilemmas see John R. Boatright ‘Trust and Integrity in Banking’ Ethical Perspectives 18, no. 4 473-489 (2011).