If an investment bank has uncovered evidence that a trader has deliberately mispriced positions it then faces an additional burden: informing the Financial Services Authority (FSA).

The quicker the bank informs the FSA and the more open it is, the better, but the call will often result in a fine and some kind of public censure.

The FSA will immediately want to know the scope of the problem. Was it the result of a lone individual or a group effort? Did it involve co-operation from compliance and back office staff, or where existing controls weak enough that this was not necessary?

Did it stretch across different products, divisions and geographic locations, or was it limited to a small team in one place? How long has it been going on? Is the damage limited to the bank’s own trading books or have clients also lost out?

In addition to conferring with the bank, the FSA may instigate its own investigation and can call in external accountants for support. According to Peter Hamilton, a barrister at 4 Pump Court, how rigorously the FSA examines a situation — as opposed to relying on the bank’s own analysis — will depend on how serious the matter seems and the existing relationship between the bank and regulator.

Once the FSA is satisfied it has the measure of the situation, it will turn to remedial action. Simon Hart, a partner at Reed Smith, says that sophisticated financial institutions will usually have already located the source of their problem through internal investigations and devised a plan of action, such as disciplining individuals or introducing new compliance controls. This plan can be presented to the FSA for approval, although the regulator can reserve the right to order more investigation or tougher changes where it thinks it is necessary.

With the situation under control, all eyes will turn to any possible fine. Up against the regulator, the banks begin the process on the back foot. However, there are no set penalties and any fine would likely be subject to negotiation between senior figures such as the FSA’s head of enforcement and the bank’s general counsel.

The size of the fine will depend on several factors: the nature and size of the breach; whether it involved deliberate or reckless behaviour; the size of the business at fault and how the business behaved towards the regulator after it discovered the problem.

Co-operating with the regulator and settling at the earliest possible stage will result in a 30 per cent reduction in any penalty. Mr Hart says both sides have an incentive to settle early: the bank wants to bury the issue and move on, while the FSA is keener on seeing the businesses it regulates publicly accepting their errors and making changes than it is in fighting long and costly legal battles that may ultimately bring higher penalties.

In agreeing a settlement, the bank surrenders its rights to appeal against the fine. It also acknowledges that the FSA will publish a public document, called a final notice, giving detailed particulars of mistakes the bank made.

If a bank decides that the proposed fine is unreasonable, it is free to withdraw from the talks at any point before a settlement is signed.

This will mean the FSA will continue its investigation, leading to publication of a document known as a decision notice detailing its chosen fine. Institutions are then free to challenge this at the Financial Services and Markets Tribunal. That would involve more time and expense but could eventually secure a lower fine.

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