All adds up: Considerations and calculations behind eye-watering admin penalties

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The staggering increase in the frequency and quantum of administrative penalties makes it clear that the Regulators are taking no prisoners in executing their mandates to enhance market integrity and to fulfil their strategic objectives to act decisively and visibly against misconduct – especially since the Financial Action Task Force (FATF) greylisted South Africa at its February 2023 Plenary meetings.

The 2024 Regulatory Actions Report (Report) acknowledges the change in approach of the Regulators and states that

…there has also been a significant increase in the value of penalties imposed for AML/CFT contraventions as illustrated by the R16m penalty on Ashburton Fund Managers. The substantial increase in the value of administrative penalties is primarily due to the FSCA’s approach to enhancing effective deterrence.

Whilst the Report also states that the Regulators "strives to be fair, objective and consistent in applying its enforcement powers", these penalties have often induced a sense of shock. Regulated institutions have raised concerns about how the quantum of such fines was determined, and the fairness and consistency of consequential fines.

How Regulators determine and impose administrative penalties

In terms of section 167 of the Financial Sector Regulation Act, 2017 (FSR Act), the Regulator responsible for overseeing the relevant financial sector law that has been breached, may impose an administrative penalty on the offending person or regulated institution (collectively the Regulated Entity). The FSR Act distinguishes between factors that the Regulators must consider and may consider in determining the appropriate administrative penalty.

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Factors that the Regulators must consider include (1) deterrence (2) the degree of cooperation by the Regulated Entity and (3) submissions made by the Regulated Entity, including mitigating factors submitted by the Regulated Entity.

The factors that may be taken into account include:

1. the nature, duration, seriousness and extent of the contravention,
   
2. loss or damage suffered as a result of the misconduct,
   
3. the extent of any financial or commercial benefits to the Regulated Entity,
   
4. previous contraventions by the Regulated Entity of financial sector laws,
   
5. the effect of the misconduct on the financial system and financial stability,
   
6. the effect of the proposed penalty on financial stability, and
   
7. the extent to which the conduct was deliberate or reckless.
   

Similarly, section 45C of the Financial Intelligence Centre Act, 2001 (FIC Act) empowers the Financial Intelligence Centre (FIC) or the PA (as a supervisory body) to impose an administrative sanction on an accountable institution for, amongst other things, failing to comply with the FIC Act.

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It sets out the factors which the FIC/PA must consider in imposing the appropriate sanction which includes:

1. the nature, duration, seriousness and extent of the relevant non-compliance;

2. previous compliance with any laws;
   
3. remedial steps taken by the institution or person to prevent a recurrence of the non-compliance;
   
4. any steps taken or to be taken against the institution or person by another supervisory body; or a voluntary association of which the institution or person is a member; and
   
5. any other relevant factor, including mitigating factors.
   

Although the FSR Act and the FIC Act appear well-meaning insofar as they give certainty and guidance to the Regulators and the public concerning the determination of administrative penalties, the question remains - what do these factors really mean and how are they considered, and by the Regulators when they arrive at a quantum that they consider reflects an appropriate and fair administrative penalty?

This quagmire has also been raised by the Financial Services Tribunal (FST). In FSCA v Jooste for example, where the FST was requested to reconsider the administrative penalty imposed by the FSCA, the FST (referring to section 167 of the FSR Act) held that

…this is a rather perplexing mixed-bag provision because it does not take account of how penalties, which require the exercise of a value judgment, are logically determined…Why it should differ from the list in sec 45C of the Financial Intelligence Centre Act 38 of 2001 is anyone's guess. One would, for instance, have expected that the nature and seriousness of the contravention (which falls under (b)) would have been prominent under (a).

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How the factors must be considered and applied to arrive at an administrative penalty

The relevant authorities emphasise that the Regulators should not approach the determination of an administrative penalty as a mechanical exercise, where the factors to be taken into account are considered and applied in a tick-box fashion (example: Jooste v FSCA and Bryte Advisors v FSCA).

Specifically, in MET Collective Investments v FSCA (MetCI) the FST held that the

mechanical checklists in determining any sanction, administrative or criminal, are problematic. Ticking the box of each element does not mean that the correct weight was attached to the element or that result is necessarily “appropriate”, which is the ultimate measure. Why, for instance, the Legislature thought it wise to place “the nature, duration, seriousness and extent of the contravention” under “may” and not “must” is anyone’s guess since it is the logical starting point of the consideration of any penalty under any system. Eventually, the “appropriate” penalty, having regard to the deterrence factor, can only be assessed after consideration of all the relevant facts, whether aggravating or extenuating.

The FST judgment in MetCI is considered to be the magnus opus when it comes to the approach that must be applied by the Regulators in how to weigh up indicative factors to determine the appropriate penalty.

In MetCI, the FST was tasked with reconsidering an administrative penalty of R100m, which had been imposed by the FSCA in terms of section 167 of the FSR Act.

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In considering the factors set out in section 167 of the FSR Act, the FST enunciated the following principles:

• Deterrence as a factor is not the overriding consideration. What is overriding is the appropriateness of the penalty, which means that it must be balanced, proportionate and fair.
• Deterrence is not a self-standing determinant but "must" be "considered" in conjunction with the degree to which the person has cooperated with the regulator in relation to the contravention; and any submissions by, or on behalf of, the person relevant to the matter, including mitigating factors referred to in those submissions.
• In relation to "cooperation", this factor relates to assessing the facts. It can never be expected for a Regulated Entity to simply roll over and submit, so the fact that a Regulated Entity does not plead guilty in the first instance, does not mean that they did not cooperate.
• The extent of the loss is a material – very material - factor in determining an appropriate penalty because it relates to the "nature, duration, seriousness and extent of the contravention", but it cannot be decisive.

The FIC Appeal Board (FICAB) have made similar pronunciations in terms of how the Regulators (should) consider and apply the relevant criteria and factors in the FIC Act to determine an appropriate administrative penalty. In Mercedes Benz Lifestyle Centre v FIC, the FIC explained how and at what stage the factors mentioned in section 45C (2) are weighed:

[The] list implies, as one would have expected, that the emphasis is on the nature, duration, seriousness and the extent of the relevant non-compliance. Items (b) and (c) may, depending on the fact, be either aggravating or mitigating. The last item on the list (e) includes aggravating and mitigating circumstances. It is under this item, where moral culpability or its degree is taken into account. It may be aggravating or mitigating. ...fault or blameworthiness is not a requirement for the imposition of a sanction – transgression is the statutory jurisdictional fact. The degree of blameworthiness is a factor which may be taken into account in determining what an appropriate sanction would be in the circumstances of the case.

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In several cases, the FICAB has highlighted the following important principles:

• An administrative sanction cannot be avoided merely because non-compliance was rectified after the fact. Addressing non-compliance after misconduct does not prevent the imposition of sanctions. Furthermore, legal precedent holds that rectifying non-compliance after the issuance of inspection reports has no bearing on the consideration of sanctions, as the FIC Act addresses non-compliance at the time of inspection. A transgression remains a transgression, regardless of subsequent rectification, and must still be subject to sanction.
• The obligations of the Regulated Entity exist irrespective of the risk rating of its clients and/or products, and this risk rating is not considered as a relevant factor under section 45C(2) of the FIC Act.

Moreover, and specifically in relation to FIC penalties, it appears that in addition to the section 45C(2) sanctioning criteria to be taken into account, the FIC also has an unpublished guide document called the Financial Sanctioning Criteria (the FIC Sanctioning Manual) which seems to set out certain baseline penalties.

In Mit Mak Motors v FIC, the FIC, commenting on its use of the FIC Sanctioning Manual, stated that the guideline is not to be applied mechanically and that the "guidelines are there to assist the FIC in calculating the quantum of the financial penalty but only after the degree of culpability has been established".

Similarly, in Hyde Park Auto v FIC the FIC indicated that the FIC Sanctioning Manual is "...a useful tool to ensure more or less equal treatment of those who are subject to a sanction having failed to comply with registration or reporting obligations".

This view was endorsed by the High Court in Harlyn Trading International (Pty) Ltd v Financial Intelligence Centre and another which stated that "the guidelines are therefore designed to achieve proportionality between the ultimate penalty and the extent of non-compliance".

The mystery remains

Although section 167 of the FSR Act and section 45C of the FIC Act prescribe various factors which the Regulators may or must take into account when deciding on an appropriate administrative sanction, and although judgments have provided further guidance as to how these factors should be approached and applied, how administrative penalties are decided can still come across as subjective and vague to those outside the Regulators' chambers.

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To uncloak the mysteries of administrative penalties, consideration should be given to legislative reform to provide more detailed and substantive fining factors to serve as guidelines for Regulators when deciding on an appropriate penalty. Perhaps the FSCA can take some guidance from its international counterparts in this regard.

For example, the United Kingdom's Financial Conduct Authority (FCA) explicitly details the steps to determine penalties imposed on Regulated Entities in its Decision Procedure and Penalties Manual. Section 6.5A.2 of the Manual details how the FCA considers the seriousness of the breach to arrive at an appropriate financial penalty and includes considering the revenue generated by a Regulated Entity, cross-referenced to a scale of the level of breach. The various aspects of the breach are then further detailed under section 6.5A.5 of the Manual .

Although enforcement is an important function to ensure market integrity and stability in the South African financial sector, the Regulators risk being perceived as simply "being seen to be regulating" by imposing seemingly subjective administrative penalties.

It may be that the Regulators already have a more detailed (although unpublished) guidance manual in play, but the opaqueness of the Regulators' conduct in imposing penalties remains a perceived cloak of invisibility for regulated entities, which affects market confidence.