Over the years, the UK financial services sector has paid significant compensation for misconduct in the sales of financial products, amounts that can be material to a firm’s financial statements.

Arguably the most famous scandal relates to sales of payment protection insurance (PPI). At least 45 million policies were sold from the 1970s – the majority between 1990 and 2010 – and the industry paid compensation of around £40bn between 2011 and 2019. 

PPI is by no means unique. Other recent and significant misconduct cases include sales of interest rate hedging products to SMEs, unsuitable defined benefit pension transfer advice following the introduction of pension freedoms in 2015 and the LIBOR fixing by many leading financial institutions.

More recently, in January this year, the Financial Conduct Authority (FCA) announced it would investigate whether there is historical evidence of widespread misconduct in the motor finance market. And in February, the FCA asked firms to suspend sales of guaranteed asset protection (GAP) insurance and make changes to the product, following concerns that it was not providing fair value to consumers.

Misconduct causes 

Misconduct can arise at all stages of a product lifecycle and may arise in multiple ways for the same product.

The design of the product may not be appropriate perhaps due to excessive charges (such as high interest rates, fees, or premiums) or exclusions (for example, that prevent a claim under an insurance policy). Some insurance products may have inherent (albeit unintended) biases, such as the post code lottery, which can lead to certain consumers – often minorities or more vulnerable customers – being prejudiced against.

Meanwhile, sales and distribution channels might encourage consumers to purchase products they do not need, that are not appropriate to their circumstance, or are too expensive. Or poor customer service can mean that products and services are poorly explained or not explained at all. 

Conflicts of interests, such as discretionary or large commissions, can incentivise aggressive selling tactics or non-disclosure of material facts, which mislead consumers into purchasing products. 

There is also the potential for misconduct to lead to misconduct. Claims management companies have emerged to push claims and take a large proportion of any compensation. This can be a lucrative business that incentivises aggressive sales tactics and disproportionate charges.

Firms’ complaints procedures may also treat consumers unfairly. For example, complaints may be arbitrarily rejected, insufficient resources might mean there is insufficient investigation, or complicated procedures might be designed to delay or deter the complainant.

Misconduct claim time lags

Claims of misconduct can arise years after the event as establishing whether misconduct actually took place and the appropriate level of redress can take time. PPI is a case in point. Sold for the best part of 20 years from the early 1990s, PPI mis-selling only hit public consciousness in the mid-2000s, while significant provisions and payments took even longer to emerge.

Establishing whether misconduct has occurred can be subjective. The standards against which to measure misconduct may have evolved over time; with older cases, there are fewer rules and less clarity around acceptable standards. 

There may initially be a lack of awareness by consumers to make a claim or firms’ procedures may discourage claims. Publicity surrounding successful court cases or claims management companies can also increase awareness and encourage consumers to make claims.

Claims may traverse both the firms’ and the financial ombudsman or the courts’ complaints processes before there is resolution. Court cases can be prolonged and firms may contest any findings against them or the actions of the FCA, which will add to the time to resolve the issues. The regulatory processes may also be slow to identify a systemic misconduct issue and put in place processes to deal with the issue.

Final costs can be significant

While individual compensation payments are typically very small relative to large UK banks’ capital, in aggregate the redress can become significant when there has been significant sales volumes. Perceptions of good product profitability can also lead to aggressive sales tactics driving up sales volumes, which also increase the risk of misconduct.

Beyond compensation, the costs to the industry include regulatory fines and the administrative and legal costs of investigating the claims and implementing remedial actions. After the first three free cases, the FOS charges £650 per case and lawyers do not come cheap. 

Potential provisions may be subject to high estimation uncertainty. What constitutes misconduct might be subjective as there may not be clear regulatory guidance or precedent and standards may have changed.

At the same time, it might not be clear which products are affected and over what period. For example, a failed distribution platform may affect multiple products, even if there is only hard evidence of mis-selling for certain products.

The regulatory response

Over the past 20 years, the Financial Services Authority – and now the FCA – have developed and evolved conduct regulation, often in response to misconduct cases, to make it more stringent, both in terms of the underlying policy and the FCA’s enforcement of the policy. 

The FCA’s Consumer Duty is the latest iteration of the UK’s conduct regulation and came into force on 31 July 2023. It requires that firms must act in good faith towards retail customers, avoid foreseeable harm, enable and support customers to pursue their financial objectives, and products and services must deliver fair price and value.

The PPI example highlights the need for the FCA to act quickly when there is a possibility of significant and widespread misconduct or bring certainty to the market when systemic misconduct is shown not to exist. 

However, growing regulation and the new Consumer Duty in particular, may add to the subjectivity and complexity of requirements, potentially and perversely increasing the future risk that firms fail to treat customers fairly. We are yet to see the implications of the concerted move to principles-based regulation, which underpins the Consumer Duty, and how future non-compliance is determined and how this intersects with misconduct claims. 

The conduct of firms in response to future misconduct claims may also change. For example, the potential cost of investigating claims may incentivise early settlement. For example, following a High Court ruling in 2011, the larger banks made ‘goodwill’ payments to PPI complainants to deal with the large volume of claims. 

Misconduct on the horizon

It seems unlikely that the risk of systemic misconduct will disappear as new products and services are developed, and given delivery channels designed to generate profits at the lowest cost. The use of AI across all the stages of a product lifecycle, cryptoassets, and ‘green’ assets are three areas where the potential risk is perhaps greatest. 

Products and services can be complex, and many individuals will not fully understand their operation or effect. The monies involved mean the potential for significant conflicts will remain. 

A longer version of this article was published by the ICAEW Financial Services Faculty.

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