The Gazette 1987

GAZETTE

JULY/AUGUST 1987

Criticisms Inevitably, the Gower Report and the legislation based on it remains highly controversial. It had to try to strike a balance between the demands of the securities industry to remain self-regulatory and the necessity of imposing a statutory framework on that industry. Most of the controversy centres around these two issues. One of the most serious criticisms levelled at the new system has come from Sir John Nott, a former Cabinet Minister, and now Chairman of Lazards, a leading London-based Merchant Bank. In his view, the City was un- wise to promote the concept of practitioner-based regulation and the Bank of England even more so. He argues that when the next downturn in the market arrives firms will inevitably go bankrupt and no one is going to distinguish politically between bankruptcy and fraud. The blame will descend on the City self-regulators and most certainly on the Bank of England for failing to police the system. He feels that the City, and especially the Bank of England, have played into Government's hands and placed themselves in an exposed position. Another criticism suggests that legislation based on the Gower Report does not tackle the sweep- ing changes which occurred in the City after Big Bang (deregulation). In recent months, "insider dealing" scandals have shed further doubts on the ability of the City to regulate itself, especially in the deregulated market. A U.K. Labour Party document published in March of this year argues that the City needs to be brought under at least the same standards of supervision and legal restrictions as other areas of business life — a view shared by many outside the City, including Dr. David Owen the U.K. Social Democratic Party Leader, who believes that independent out- siders, rather than City insiders, should be made a majority on the S.I.B. The central issue here is that practitioner-based regulation is naturally suspect of using its powers to discriminate in favour of itself or against those offering in- novation' or uncomfortable competition. Self-regulation is traditionally argued as being tighter than a legalistic code. It sets

Big Bang we were subject to the regulations of the Federated Stock Exchange of the United Kingdom and Ireland (of which we were members) and relied on it to act as an effective regulatory body. With the expansion of the role of members of the Stock Exchange, we are now in a situation in which we continue to operate under a set of rules which are no longer comprehensive and have failed either to introduce regulation ourselves to fill the gap, or to adopt any of the new U.K. rules. By failing to introduce a proper statutory framework, we in Ireland are placing ourselves in an ex- tremely vulnerable position. There is a high risk that we will attract into this country business which enshrines practices no longer ad- missible in strictly regulated markets. This will rapidly act to reduce the credibility and standing of the Irish market. The lack of regulation is particularly important in the light of the proposed new financial centre on Custom House Quay. If we are to be competitive in this area, it is likely that further deregulation will have to be introduced into the Irish finance industry, albeit in a form designed to suit the needs of the smaller Irish market. While dual capacity is permiss ible in the case of equities, it has not developed to any great extent. Dual capacity in the case of gilts has not been accepted by the Irish Authorities, following the refusal of the Depart- ment of Finance to allow gilt brokers to become "ma r k et makers". Effectively, we are now in an exposed position and the onus is on the Irish Authorities to take urgent steps to remedy the situation. The introduction of full deregulation without a supporting regulatory framework would be a sure formula for chaos. It is thus useful to examine in more detail the background to the changes which have occurred in the U.K. and the type of framework the authorities there have decided to implement. The Prevention of Fraud (Invest- ments) Act 1958 in the U.K. is bas- ed on pre-war legislation. The rapid changes in the securities industry since then have rendered that Act obsolete, a fact amply illustrated by its failure to protect investors in the wake of a string of investment scandals. The public outcry follow-

ing the failure of two investment firms in particular, finally prompted the U.K. government to act on in- vestor protection. In July 1981, Professor James Gower of Southampton University was com- missioned by the U.K. Government to lead an investigation into in- vestor protection in England. The investigation was to operate within the following terms of reference: — (a) to consider the statutory pro- tection now required by (i) private and (ii) business in- vestors in securities and other property, including investors through unit trusts and open- ended investment companies operating in the United Kingdom; (b) to consider the need for statutory control of dealers in securities investment con- sultants and investment managers, and (c) to advise on the need for new legislation. Published in 1984, the Gower Report was highly critical of ex- isting investor protection and of the restrictive practices enshrined in the Stock Exchange. The Report proposed that the Prevention of Fraud (Investment) Act 1958 be repealed and replaced by a new In- vestor Protection Act. Everyone engaged in the investment business (defined in the widest terms) would have to register either direct with a government body or with an approved self- regulatory agency, which would have to comply with specified con- ditions. In its initial form, the Report proposed the establishment of an independent commission to watch over the new system. This latter proposal was met by strong opposition from the City which had, by tradition, been self- regulatory and operated largely under "club rules". In the event, and largely due to rearguard action by the Bank of England, the pro- posed commission was replaced by a private City body known as the Securities and Investment Board (S.I.B.). Essentially, the Gower Report settled for self-regulation within a statutory framework. The Report eventually formed the basis of the Financial Services Act, which recently passed through the final stages of Parliament, but has not yet been brought into effect.

178