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boundaries of responsibility in financial services

speech at the Financial Services Research Forum by Walter Merricks, chief ombudsman

7 November 2006

It is a pleasure to be attending this Research Forum for the first time, and I congratulate you on having struck on such an intriguing theme for the conference - the boundaries of responsibilities in financial services.

Before tackling the heart of it, there is a bugbear of mine that I'd like to share with you. It is about the wider topic of research in financial services - or lack of it - and in particular, the paucity of independent academic studies. Just looking at the attendance list for today tells me something stark - academic delegates are in a tiny minority.

As you may know, I am a lawyer who has a policy and regulatory background. But I have also been an academic, helping to initiate and oversee research programmes. I have been used to the abundance of both scholarly criticism and academic research in the legal world. Large well-established academic law departments prepare generations of students with both practical knowledge and a historically-based theoretical perspective - as a foundation for practice, business or other careers.

So when I came to the financial services world some ten years ago, I looked for the standard textbooks, the research library, the quarterly journals, the historical texts that would show me the development of this field. I found a rather smaller shelf-full than I had expected. For instance, I looked for what I assumed would be the standard work on the Pensions Review. As far as I can see, the position is still that no one has yet written a critical study of this major event in the life of the industry.

Yesterday I attended the launch of a Nuffield Inquiry into Empirical Legal Research, on whose advisory committee I served. The Inquiry draws attention to the need to develop the next generation of academic researchers into the operation of the law and the legal system. It looked at the role of the Economic and Social Research Council (ESRC) and the other funding councils - and how undergraduate, postgraduate, post-doctoral and inter-disciplinary studies can be fostered. In financial services we can only dream about the notion that people would be concerned about the next generation of researchers, when the present generation is itself so sparse.

I hope I do no disservice to the achievements of those in this room, and elsewhere in the professional institutes, who have sought to develop academic research. But by comparison with other fields of study - in economics, health, behavioural science and, indeed, other fields of national social importance - the financial services research field looks pitifully under-resourced. It is perhaps understandable that the research councils assume that this relatively wealthy industry does not need too much public money to support research - which points the finger in another direction.

My guess is that this dearth of a cohesive and critical research community, interacting with senior industry practitioners, contributes to the oft-noted failure of the industry to learn from the lessons of the past. So I have a message about responsibility with which I guess most of you will concur - that a mature and confident industry has a duty to foster and support independent research, to share externally company research - and so to help create a recognisable, authoritative and respected research community.

intermediaries

I hope I am not trespassing too far on the territory of today's other speakers, if I say a little about providers and intermediaries. One of the first things that astonishes a lawyer looking at the boundaries of responsibilities, is the position of financial intermediaries - whether in the insurance, mortgage or investment markets - who can apparently claim to be acting as agent for the provider and the consumer at the same time and have responsibilities to both. In no other field of agency law is this permissible. And one struggles to see whether intermediaries get anything from their clients that can amount to consideration in law, given that intermediaries are generally remunerated by (sometimes undisclosed) commission from providers.

Outside the financial services field, all fiduciary agents are obliged to disclose any commission they receive. But even under the FSA's Insurance Conduct of Business Rules (ICOB), the requirement is for intermediaries to disclose commission to commercial, not retail, customers. And only when they ask about it. The fact that these market practices are so well entrenched has caused the courts some problems. And the regulatory rules have to work around them.

This ought to engender some cause for thought as to why the basic legal principles about the boundaries of responsibilities have had to be distorted so substantially in our field. Are these legal principles just out of date? Or are the market practices themselves fundamentally flawed?

The FSA has recently set out some challenging thoughts on these issues. In September it published a discussion paper on the responsibilities of providers and distributors. I find the word "distribution" used in this context telling in itself - suggesting a warehouse-full of ready-made manufactured products searching for the most efficient method of delivery: rail or road? 44-ton truck or "white van" man? The paper's aim, it said, was to help improve confidence and efficiency in "the combined distribution effort". This suggests a common objective of shifting quantities of product to passive end-users, rather than an environment in which exacting and astute professional advisers are selecting only the products they think are any good.

However, the intriguing question to lawyers is the issue that the FSA paper seeks to address - the respective responsibilities between providers, intermediaries and consumers in a triangular set of relationships. How far can intermediaries make providers liable to consumers, if the latter have been badly advised on the basis of faulty information from the provider? Or in legal language, how far does the law see a duty of care on the provider towards the intermediary or the consumer?

It came as something of a surprise two years ago that the case of Seymour v Ockwell seemed to have been the first in which this issue had been tested. The court found no duty on the provider direct to the consumer; it maintained that the intermediary was fully liable to the consumer; but it made the provider pay two-thirds of the intermediary's liability to the consumer. I'm not sure I feel proud of the law's contribution to the advancement of knowledge here. I don't think the right conclusion to draw is that providers need only get their products about two thirds right - or that intermediaries need only bother to read one third of the product material before recommending it. But if that isn't the right conclusion, I'm not sure what is.

Last week Clive Briault from the FSA set out the scope and priorities for FSA's review of retail distribution. His analysis of the flaws in the market is wide-ranging and has a different emphasis. And while his approach is an economic rather than a legal one, the conclusion is much the same as mine. He asks why financial intermediaries are not seen as other professionals, such as solicitors, accountants and surveyors, to whom consumers seem willing to pay significant fees. Perhaps the answer lies in the clearer fiduciary duties that these professionals have - to act exclusively in their clients' best interests, and to deal more openly with situations where conflicts arise. And so it is not surprising that commission is on his hit list of priorities for attention.

complaints and dispute resolution

The Financial Ombudsman Service is here to resolve disputes, and we operate as an alternative to the courts for consumers. We are, indeed, often seen as part of the "alternative dispute resolution" (or ADR) scene - although I would maintain that for most consumers we are the mainstream, and that the costly and complex court system is the unloved alternative. So you might expect me to say something about our responsibilities in this area.

The FSA has laid out regulatory requirements on firms to investigate complaints. And only when those complaints can't be resolved do we step in. Then the Financial Services and Markets Act stipulates our role. Unlike some of the other legislation that sets up tribunals, our law sets out the basis on which we are to decide cases - "what is, in the opinion on the ombudsman, fair and reasonable in all the circumstances". This may sound as if it could result in a free-for-all, given that we have over thirty ombudsmen at the Financial Ombudsman Service! But I see it as my responsibility to ensure that our decisions are as consistent as possible.

Just for comparison, it is worth recording that, in 2005, judges in English and Welsh county courts heard around 70,000 disputed civil claims. The average time between issue of proceedings and hearing was a year. There are no statistics on how much these disputes cost to resolve. The extent to which the decisions reached in county courts are consistent remains to be researched.

In the same period, the Financial Ombudsman Service resolved 105,000 disputed claims about financial services brought by English and Welsh consumers (together with a further 14,000 for Scottish consumers). Most of these were resolved in under six months. The service to consumers is free, and the average cost of our resolving those disputes was £433 per case (charged to the financial industry). While the issue of consistency can be tricky to pin down when you're talking about individual cases each judged on their own particular facts and merits, we have extensive internal audit procedures and quality control mechanisms in place.

So what are the boundaries of our responsibility? Some are simply stated, in terms of the products and activities where we can investigate complaints. For example, we can't at present look at complaints about provision of consumer credit by non FSA-regulated firms - although this will change next April. We can look at complaints about insurance companies made by their policyholders, but not by third parties (of which there are many). Our maximum financial award is £100,000. Although there is no upper limit on the value of the subject matter of a complaint to the ombudsman, the courts have ruled that we are entitled to reject claims that, because of their size, would more appropriately be dealt with in court.

Of course, the ombudsman service only comes into play after a consumer has made a complaint to a firm. And firms have clear responsibilities under the FSA rules to investigate complaints. Despite heavy emphasis by the FSA on complaints handling as part of its "Treating Customers Fairly" initiative, the picture that we see is that the standard of complaints handling is variable to say the least.

In particular, the rules require firms to ensure that they handle complaints consistently - and that they identify and remedy recurring or systemic problems. As I point out in the latest edition of ombudsman news (issue 57), we are now receiving large number of complaints about banking default charges. We have learned that some firms, when faced with a complaint, first respond by saying the charges are justified. If the customer presses the point and threatens to refer the matter to us, they are offered a write-off of half of the charges. If the customer issues court proceedings (as Which? is urging them to do), or actually refers the matter to us, the whole of the charges are written off. I'll just repeat what the rule says: handle complaints consistently and remedy recurring problems. And it doesn't require a researcher to explain what that means.

But I would be interested to hear how much research is devoted inside firms to the analysis of complaints - to see the extent to which complaints are handled consistently, and where issues recur, to see what is done about them.

Concerns are sometimes raised about the "fair and reasonable" jurisdiction of the ombudsman; about the "highly geared" impact that a single decision of ours can have across a large book of business or a number of different firms; and about the fact that there is no right of appeal. I should stress that we are very much aware that our decisions can have a wide impact - and we are mindful of the responsibility that comes with these powers.

We are conscious that if the potential impact on firms can be great, then by the same measure, the potential detriment to consumers may have been just as significant - and we do not shrink from difficult decisions. However, we have put in place arrangements agreed with the industry and the FSA for handling cases that might have wider implications and these are being applied in appropriate cases.

John Howard of the Financial Services Consumer Panel has touched on the responsibilities of consumers and firms. I don't propose to step into the controversy about how far caveat emptor ("let the buyer beware") is a valid maxim - except to point out how incongruous it is with the entire thrust of most financial services marketing. "Welcome to the XYZ company - the one you can trust with your money. Customers should beware."

In trying to set out the standard by which investors should be treated, I always liked the way that Professor Jim Gower expressed it in the early 1980s in his report on investor protection:

... that people had a right to make fools of themselves, but not to be made fools of.

While the ombudsman service is required to decide what we believe is "fair and reasonable", our starting point in resolving disputes between consumers and firms is the legal position. We look at terms and conditions and apply contractual principles and principles derived from civil liability for negligence. There are underlying duties of care that professional advisers owe to their customers, and we apply these. Firms offering financial products without advice generally don't have duties of care to their customers - it is up to customers to decide what they want.

There are two - or perhaps three - main areas where the law cannot be a complete guide. First, insurance consumer law is widely regarded as out of date. Indeed, the Law Commission has recently produced a paper proposing reforms and suggesting the adoption of some of the solutions that the ombudsman applies. Second - or perhaps this is just part of my first point - as a result of our existence, so few cases ever go to court that the law has not had a chance to develop in the way one might expect. So we might have to infer from legal developments in other fields where the law would now be in financial services, had it had the opportunity to develop in the normal way.

And lastly, there are the cases we handle at the ombudsman service that would defy any court - where the incompetence of a consumer in handling his or her own affairs is matched, or even exceeded, by the hopeless maladministration of the firm; where negligence and contributory negligence seem to out-do each other. I am thinking up a suitable Latin maxim we could use to describe our approach - roughly translated, it might say: "when both sides have cocked up, we take the middle road".

conclusion

I am not sure that I have entirely stuck to my brief. But I hope this collection of thoughts from the ombudsman will have given you some food for thought.

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