Regulation of co-ops is going to get tougher

Given the scale of the crisis that has washed over us in recent months, it is inevitable that regulation of the sector will be reviewed. One important factor is...

Given the scale of the crisis that has washed over us in recent months, it is inevitable that regulation of the sector will be reviewed.

One important factor is the evident anger expressed by Lord Myners about responses to his proposals for reform of the Group. Whether his critics like it or not, he carries enormous political weight with the government as well as with the Labour Party, for whom he was City minister in the last administration.

Regulation of the whole co-operative sector is now likely to be significantly strengthened. The crisis at the Co-op Group added momentum to a process of regulatory reform for co-operatives that was already falling into place, but could now be reinforced. At the heart of this is an enhanced role in relation to co-operatives for the government’s main financial regulator, the Financial Conduct Authority (FCA).

Lord Myners’ evidence to the House of Commons Treasury select committee was informative – not least in terms of what we learnt about allegations about conflicts of interest within the Group. Lord Myners seemed to suggest these might soon be considered by regulators – both to examine past behaviour and to challenge any potential conflicts of interest which might one day crop up within other co-operative societies.

“The regulatory oversight of the Group is quite limited,” complained Myners. “The FCA has been given additional powers by parliament, but has yet to fully exercise these … There is a public policy question here. There are eight million members who somehow do not have any influence or control over the Group that they own … The carapace [ie the controlling structure] at the top of the Group is largely outside regulatory oversight …

“I think regulators could appoint an inspector to look at the conduct of the Group and its board of directors and its general management. It would be very sad if that was required … If the Co-op simply rejected any need for change then I think the regulator could not ignore that, any more than the banks would ignore that … If you don’t accept the need for change, it will be forced on you in any case … The nuclear option is to derecognise the ‘co-operative’ name.”

It is clear from the Myners Report on the Group that his criticisms were not simply about the corporate governance arrangements of the Group with regard to their oversight of the financial management and strategy of the business. There are also repeated references to conflicts of interest and how this relates to financial support for other organisations.

Those other bodies named in the report are the Co-operative Party, Co-operatives UK and Co-operative Press (publisher of the Co-operative News), which all have Group directors on their boards.

Myners questioned whether these alleged conflicts of interest were dealt with properly by the Group’s board and its secretariat. He did so with reference to the rules of the Group and the regulatory obligations of co-operative societies. The following text is taken from Appendix Two, section 3.3, of Myners’ report.

“First, the board must keep a register of interests and directors must disclose their interests (and declare them when relevant, even if already on the register). When a conflict is declared, non-interested directors decide whether an interested director can attend a meeting (and speak and/or vote) in relation to the matter.

“Second, the [Group’s] code of conduct also adds that directors must not profit at the expense of the Group and requires declarations of interest to be recorded in the minutes. The Review team understands that the register is maintained (although it has not been provided to the Review) but the other systems and processes are not followed at all or are followed in a very ‘amateurish’ way.

“Potential conflicts of interest are not always raised during board and subsidiary board meetings and, if raised, are frequently then ostensibly ignored in the ensuing conversation.”

My interpretation of this section of the Myners Report, when placed in context by Myners’ testimony to the Treasury Select Committee, is that the FCA may consider to what extent the Group and its directors failed to comply with the Group’s own rules and also with the key legal obligations of a co-operative society.

It might seem strange that the financial regulator should also be the regulator for the co-operative sector, but this is the result of some recent history. The Registrar of Friendly Societies – the former regulator of those co-operatives (including the Co-operative Group) registered as industrial and provident societies – was wound up in 2001 and its role transferred to the Financial Services Authority (the former financial regulator).

According to informed observers, the FSA did its job very badly. One well-placed person said: “The FSA were useless. They approved registrations for new societies without looking at the rules and they let through approvals they should not have done.”

With the creation of the FCA in place of the FSA from April last year, the regulatory function for co-ops was transferred to the FCA. But it has now also been given additional powers as a result of the Co-operative and Community Benefit Societies and Credit Unions (Investigations) Regulations 2014 – a statutory instrument introduced by ministers, rather than an act of parliament.

As a result of these new regulations, the FCA can investigate co-operatives, community benefit societies and credit unions where it believes there has been an attempt to commit fraud, to disadvantage members, or where behaviour may be improper or unlawful.

A spokesman for the FCA explains: “It allows us to require documents and information recorded in any form. But we can only exercise these powers to the extent necessary to maintain confidence in registered societies. The power we had under s48 of the Industrial and Provident Societies Act 1965 – to obtain documents and information in certain circumstances – has been replaced with a wider power to obtain information in any circumstances. Other powers in industrial and provident society legislation remain unchanged.”

According to explanatory papers, this move places regulatory oversight of co-operative and community benefit societies “on a level playing field” with companies, whose oversight is in the hands of the Department of Business, Innovation and Skills. “These powers include a requirement for the FCA to appoint an inspector if a court instructs them to do so and give the FCA power to appoint an inspector to investigate the affairs of a society. As with companies, the power would be available when it appears to the FCA that, for example, there may have been an intention to defraud creditors or the society has been conducted in a way which unfairly prejudices a group of members or for unlawful purposes.”

But the FCA does not merely have the power to consider whether societies are complying with their essential obligations; it is required by the act to do so. To quote the act, “The FCA must maintain arrangements designed to enable it to determine whether persons are complying with requirements imposed on them [by legislation]”.

These are new powers for a regulator that is itself just over a year old. Consequently, there must be uncertainty as to how those powers will be used.

However, it would be prudent for co-operative societies and credit unions to assume the powers have not just been given to the regulator as part of a tidying-up exercise to provide a theoretical equality of treatment of companies and co-operatives.

I am told that the FCA is taking its new powers and duties seriously. All co-operatives and credit unions should recognise that we may be on the verge of a stricter regulatory system. They would be well advised to take additional steps to ensure that they comply with their own rules and broader legislation.

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