The dilemma of disclosure

With state regulation just round the corner, there can be little doubt that the industry needs the credibility that this will bring. Company failures in the insurance sector are perceived to be even more damning than in other business arenas.

The reputation of insurers and brokers alike was dented by the high-profile insolvency of Independent Insurance, and later by that of broker Ward Evans, but will the advent of the Financial Services Authority as regulator avoid such instances in the future? Many argue that there will never be sufficient FSA visits to make the system foolproof. The issue therefore arises of whether there should be a channel for what have become known as whistle-blowers.

Whistle-blowing refers to when an employee becomes aware of malpractice in a firm and reports it, either to the firm or to the authorities. While the regulator has undoubted influence, firms eager to run bona fide businesses should instil in staff that they would take any allegation of malpractice very seriously. Employees should be encouraged to raise concerns internally, initially to a director, and be advised that they would not be penalised and their confidentiality would be respected. In the event that staff felt that they should report their concerns to the authorities, the Public Interest Disclosure Act would give them protection.

One of the main concerns with the application process for FSA regulation is that if, among other things, acceptance is designed to protect individuals and small businesses, high-street brokers should be subject to more rigorous testing. Brokerages with a turnover of less than £1m have not needed to produce the regulatory business plans that larger businesses have had to. In essence, the application form is one where simple yes/no answers are all that is required.

It is also highly unlikely that these firms will attract a visit from the regulators in the early years of the new regime. How then will retail clients - who are the most likely customers of high-street brokers - be any better protected than they are today? Whistle-blowers could certainly have an influence on the regulators in alerting them to potential problem firms.

It should be noted that general insurance will have the same rules as IFAs and it is essential that staff be given the same advice. If an employee has disclosed their worry internally and are concerned by the lack of response, or if they felt unable to talk to anyone internally for whatever reason, they can contact the FSA. The act protects them if they contact the FSA where they satisfy the test for speaking to their employer, they reasonably believe the information and any allegations in it are substantially true and they reasonably believe the FSA is responsible for the issue in question.

Whistle-blowing was introduced to the financial services sector in May 2002, with some 276 disclosures being made in the first year. The most recent figures show that, of these, 80 have been resolved, 102 were not progressed and 94 were awaiting resolution. Of those resolved, 18% resulted in FSA authorisation being withdrawn. Interestingly, some 42% of those cases not progressed found no regulatory issues identified. In the subsequent six months to October 2003, the number of disclosures dropped quite dramatically.

Only 109 were reported, some 20% down on the previous period. It could therefore be argued that the initial impact has lost some of its impetus.

The categories of disclosure cover the areas of compliance, fraud and dishonesty, insider dealing, solvency, training and competence, unauthorised activity, administration, fitness of individual and market conduct, among others. While some amendments will be made for general insurance, the same areas will be covered.

Market confidence

In 2002, FSA managing director Carol Sergeant told conference delegates that: 'The whistle-blowing initiative is good news for the firms we regulate, for those working in the industry and for us as regulators." She went on to explain that it was good news for firms in that whistle-blowing procedures and the decision to encourage workers to sound the alarm internally in the first instance meant that senior management would be the first, and not the last, to know about potential problems. It was good news for workers, as they had protection and confidentiality, and it was good news for the FSA as valuable information could be sourced, helping to protect consumers, reduce financial crime and maintain market confidence.

Alan Johnson, Minister of State for Employment at the Department of Trade, addressing the same conference said: "The Public Interest Disclosure Act provides an essential framework protecting workers who blow the whistle responsibly. I welcome initiatives that build on that framework. The FSA's guidance on internal whistle-blowing procedures will help promote greater openness in the workplace, which is the underlying aim of the Act," (see box below).

Prevention rather than cure

While there is positive progress, what can not be ascertained is how many employees will have the courage to actually use the facility. It is far more likely that whistles will be blown after a catastrophe than beforehand. This may identify what went wrong, but would be far more useful as prevention rather than cure.

After the collapse of Independent, many former employees, fresh with the news that their shares were worth nothing, their jobs were lost and their final payroll had failed, agreed to blow whistles, suggesting that the firm's senior management was guilty of fraud and total mismanagement.

It is unlikely that many of these people would have taken steps to point this out prior to the company's failure. The same could be said of Ward Evans. A lot of people allegedly knew an awful lot, but little was made official.

Perhaps whistle-blowing should not just be the responsibility of the workforce. There are many other bodies that are privy to information that could be of great use to the FSA. In the case of Independent, the auditors, bankers and actuaries had every opportunity to uncover information, but all concerned seemed to give a clean bill of health. It raises the question of whether firms should be allowed to appoint their own policemen as the relationship between a principal and auditor can be very cosy. When fees for accounting services are vastly higher than those for audit services, and both are payable to the same supplier, one could ask just how many of the difficult questions have been adequately answered.

There were massive allegations following the collapse of Independent that the accounts for a number of years were totally inaccurate. This raises the issue of whether anyone could or should have blown a whistle.

Three years on, little has actually been resolved. The one certainty is that the vast majority of those whose livelihoods were affected, are still suffering relative financial hardship.

Clients, while being philosophical, have long memories, and the industry still bears the scars. Most staff who wanted to have been able to find new jobs, but there are still those who will not employ former Independent personnel, choosing to lay some of the blame at the wrong doorsteps. It is incomprehensible to most that the main perpetrators have still not faced up to the responsibilities of their actions. If whistle-blowing can go only a tiny way to prevent a recurrence of probably the worst incident in the industry for many years, then it is definitely worth a try.

Insurers could keep a watch on brokers as accounts departments must be capable of recognising consistently bad payers. The problem is that every insurer files papers once payment has been made. It would make sense for offices to share more information with one another as anomalies could then be identified more easily.

So, will whistle-blowing solve anything? Regular reporting of information will undoubtedly help identify problem areas. The danger is that, if there is financial crime taking place, the reporting is unlikely to be honest.

Whistle-blowing is probably the best way of uncovering criminal activity, providing staff can see through the firewalls. It is also important that the same staff have the courage to take action and that they are doing so for the right reasons. Disgruntled staff being spiteful could waste a lot of valuable time both for the FSA and the firm.

It is fair to say, however, that most brokers would welcome improved market confidence and would like to be proud of their profession. Anything that facilitates this cannot come quickly enough.

THE FSA AND THE PUBLIC INTEREST DISCLOSURE ACT

Further information about this can be found on the FSA website at www.fsa.gov.uk/whistle/

The dedicated whistle-blowing telephone number is 020 7066 9200, and the email address whistle@fsa.gov.uk. The Public Interest Disclosure Act came into force on 2 July 1999. It amends the Employment Rights Act 1996 and creates a framework for whistle-blowers across private and public sectors. It protects workers who meet the tests laid down in the Act for making disclosures of certain information in the public interest by allowing such individuals to bring a legal claim in respect of victimisation. The act defines a 'qualifying disclosure' as one made in good faith, of information that, in the reasonable belief of the worker making the disclosure, tends to show that one or more of the following has been committed, is being committed or is likely to be committed:

- A criminal offence

- A failure to comply with any legal obligation

- A miscarriage of justice

- The placing of the health and safety of any individual in danger

- Damage to the environment

- Deliberate concealment relating to any of the above.