Defending Financial Institutions in Italian Sanctioning Proceedings — Part 3
I threw the kitchen sink at him but he went to the bathroom and got his tub
(Andy Roddick after having lost the Wimbledon final to Roger Federer in 2004)
This is the last in a three-part series on the issue of how defending financial institutions in the context of sanctioning proceedings brought by regulators in Italy.
After having looked at certain preliminary procedural and organizational matters and at how to coordinate the defenses between the various individuals involved, this post will discuss how to structure the content and the merits of the defenses.
Preparing the defenses requires a careful balancing between various trade-offs.
In short, you have to defend yourself, but maybe… not too much.
Here is why.
1. The defenses are still part of the administrative phase. They will be assessed by the regulator, i.e. the same institution which has initiated the proceeding.
True, in the last ten to fifteen years the procedural rules have been changed to avoid the drawbacks stemming from the old framework, where the same office which had initiated the proceeding would decide on the defenses, with the obvious ensuing situations of conflicts of interest. Under the current legal framework the office in charge of assessing the defenses is not the same which drafted and filed the charges. It may indeed happen that as a result of the defenses the final decision deviates from the initial approach embedded in the letter of charges. Even in those cases where such deviation occurs, however, it is rarely a radical deviation (e.g. the initial charges may be mitigated, e.g. by dropping some charges or issuing lower sanctions).
As a consequence, you should expect some level of inertia on the part of the regulator: The final decision will in most instances mirror the content of letter of charges, no matter what you write in your defenses.
Some of the arguments you are going to table during this phase, then, may become relevant in subsequent phases (in court, that is), rather than in the context of the proceeding itself.
2. As I have argued elsewhere, financial institutions and regulators play a repeated game. The relationship specifically connected to the sanctioning proceeding must be read and handled in the more general context of the entire nexus of relationships in place with the regulator.
If this sounds cynical, this is because it is cynical. Yet this is the reality of the facts: In responding to the charges you have to factor also the consequences that your response may have on the broader relationship with the Regulator.
3. Sanctions are a supervisory tool: Regulators will look at the entire set of circumstances and at the general conduct of the institution and not at the specific charges in isolation. The very same conduct may yield very different consequences, depending on the overall level of compliance of the institution with the regulatory framework.
I am aware that this statement is debatable from the theoretical standpoint (if there is a breach there has to be a sanction, the argument goes). Yet experience tells that in taking decisions on sanctions, regulators routinely take into account the overall level of compliance of the institution.
4. Decisions by the regulator may be appealed in Court. In preparing the defenses you will need to also look further on the horizon and bear in mind that what you write may be assessed by a court of law if you are sanctioned and you decide to appeal.
Mix all the above strategic constraints and you may want to follow this rules of thumb.
Firstly, do not throw a kitchen sink at the regulator, lest, like Andy Roddick, you may end up receiving in return a bath thub (I am not a big tennis fan, I am more the ski-kind-of-guy, as you may know by now, I owe this quote to my colleague Felice Azzollini, who firstly used it discussing defensive strategies with a client, driving this quote into the toolbox of our team).
Clients sometimes wish to argue– to take an extreme version which I have actually heard — that the Regulators’ officers inspecting the bank know nothing of how banks are run and understood nothing of what they were analyzing. Whether this may or may not be true, quite simply, doesn’t matter. What matters is what the reaction of the regulator when you file the defenses is. Aggressive stances may prove ineffective and may deteriorate the relationship with the regulator.
Secondly, fast forward for a later stage, when you want to file an appeal in court against the decision which has issued the sanctions. In filing an appeal you will eventually consider filing arguments which can be distinguished, with a major simplification, between (i) procedural arguments: For example that charges were filed too late, beyond the term set out by the law and (ii) arguments relating to the merits of the charges (say, the regulator has deemed that the bank was using tainted data for the calculations of the LGD). Judges must be expected to react differently to these two classes of arguments, for the quite simple reason that procedural and strictly legal arguments will more easily resonate with a judge and are easier to grasp and assess than facts which entail a technical, prudential, assessment (picture a judge trying to assess whether the data used by the bank to calculate the LGD were indeed tainted or not): Judges must be expected to defer to the regulators the assessment of the merits, which are frequently outside their comfort zone.
Now let’s go back to the administrative phase. You may want to raise procedural issues only if these are bullet proof, as these imply a wrongdoing by the regulator and may be difficult to digest for the latter. If you have procedural arguments, you will most likely prefer to only hint at them, and save them for the judicial phase.
Thirdly, in relations to the merits, should you just challenge the charges and argue that the latter were unfounded? As anticipated, if you are too aggressive you might end up receiving a bath tub in return. A wiser strategy, at least based on my experience, might be to defend yourself, challenging the merits of the arguments made by the Regulators, but trying to build also on a logic of cooperation. The optimal strategy will vary case by case, but, in general, one should consider (a) putting the alleged breaches in a wider context and trying to downplay the relevance of the charges (for example if the charges mention specific episodes of breaches, one may try to show that those breaches were in fact only a tiny fraction, when compared to the universe of all similar occurrences) and (b) reassuring the regulator that the bank will further reinforce its internal control mechanisms so that they can prevent the situations which have been criticized by the Regulator from occurring again.
Point (b) is particularly relevant. When I discuss this point with clients I feel at times that they are uncomfortable with using these kind of arguments: The objection will typically be that they do not want to acknowledge to any wrongdoing. Of course I see the point and agree to it.
The point is, however, that committing to further reinforcing the internal control systems is very different from committing to cure a deficiency. The former does not imply an admission of responsibility, while still showing that the bank is willing to acknowledge the views of the regulator and to act on the basis of that input.
