Opening Statement by Chairman - Joint Oireachtas Committee on Economic Regulatory Affairs

Thank you Chairman and members of the Committee for the invitation to meet with you today. I am joined by my colleagues, Acting Chief Executive and Consumer Director, Mary O’Dea, George Treacy, the Head of Legal and Consumer departments and Donncha Connolly, Deputy Head of Domestic Credit Institutions.

I have already written to you, Chairman, on certain matters regarding the evidence presented to your committee two weeks ago by the former Head of Group Internal Audit in AIB, Mr Eugene McErlean. I believe it is very important that we put on the record today the facts regarding the allegations made by Mr McErlean. In this statement I will address the roles and powers of the various regulatory authorities during the period in question, from 2001 to 2004, and the regulatory responses to the issues under discussion. I will also outline current developments in regulation, in particular the changes we have made in response to the pressing issues which have arisen in the continuing financial markets crisis and also in relation to corporate governance issues.

Key Facts

Mr McErlean made serious allegations that have been the subject of much comment. In particular he claimed that

1. ‘The Financial Regulator knew about overcharging in AIB in 2001, conducted its own investigation in 2002 and failed to act to protect consumers’;
2. ‘In 2005, the Financial Regulator failed to inform an Oireachtas committee about its investigation and in fact gave the false impression that they were unaware of overcharging until 2004;’
3. He also raised issues relating to Goodbody Stockbrokers and trading in AIB shares.

I would like to deal with each of the above three claims.

1. First, I will address Mr McErlean’s claim that – ‘the Financial Regulator knew about overcharging in AIB in 2001, conducted its own investigation in 2002 and failed to act to protect consumers.’

The Financial Regulator did not exist in 2001. For the period up to 1 May 2003 the Central Bank was the prudential supervisor for banks and the Office of the Director of Consumer Affairs (ODCA) had responsibility for approval and monitoring of bank charges. The Financial Regulator took over these responsibilities when it was set up on 1 May 2003.

Nevertheless, let me put the facts on record here today.

In April 2001, before the Financial Regulator was established, and following reports in the media of overcharging by AIB in relation to certain customers, the Central Bank called in AIB and sought explanations to establish the facts and ascertain the steps that AIB was taking to address the matter. The area to which this issue related was administration time charges. This process involved meetings with AIB, which included Group Compliance and Group Internal Audit. The Central Bank made it clear to AIB that it expected AIB internal audit to investigate fully this overcharging matter to determine whether there was an administration time overcharging issue across branches and to provide it with the findings of its work as soon as these were available. Regular contact by the Central Bank with AIB on this issue continued from April 2001 up to the conclusion of this matter at end-February 2003. As part of this process AIB was instructed by the Central Bank to report the matter to the Office of the Director of Consumer Affairs, which had specific responsibility for the regulation of bank charges at that time.

Having heard Mr McErlean’s evidence at your meeting of 24 March, members might question the size of the final figure on the administration time overcharging issue. I would like to clarify the facts for the Committee.

Central Bank records show that initial work on administration time charging was completed by AIB Internal Audit in mid-2001 based on a sample of branches. These records show that there was an issue regarding overcharging for administration management time in respect of business customers. Internal audit did not quantify the amounts involved at that time. The only figure we are aware of that matches any amount raised before the Committee, is that in the first half of 2002, Mr McErlean included a figure in his legal claim against AIB for failing to properly record in their 2001 accounts the potential liability, arising from overcharging and estimated by him at that time to be in the region of €50 to €75 million. Notwithstanding that Mr McErlean subsequently settled his legal claim with AIB, the matters raised were pursued by the Central Bank. In Mr McErlean’s testimony to this Committee he stated clearly that in relation to the claim of a figure of €50- €75 million for this overcharging issue, that he did not know the exact position. To restate, let me emphasise this we have no understanding of the basis of Mr McErlean’s ‘guesstimate’ and no such amount was offered in any internal audit report. Indeed, the gross revenue, as distinct from the amount of overcharging, which was generated by this administration time charge by AIB was confirmed in an AIB Internal Audit report to be €30.4m over the period 1996-2001.

The detailed work on the administration time charging issue was progressed by AIB in 2002 and concluded in the second half of 2002 by which time Mr McErlean, was no longer working in AIB.

This work was subject to verification procedures undertaken by AIB internal audit. This verification process by AIB internal audit was considered by the Central Bank to be an essential control in providing assurances that the guidelines for identification and refund of affected customers, were adhered to by AIB branches. The conclusion by AIB internal audit, (which was advised to the Central Bank at the time) was that while some minor issues were identified and addressed, the refunding of administration time charges was completed in accordance with the guidelines that had been issued by AIB management.

AIB advised that the initial sample of branches and business units tested by internal audit had been selected for testing because their recorded level of administration time charges were above the norm. This could form the basis of why, ultimately, the amount of overcharging finally identified when it carried out its more detailed review was not as widespread or significant as initially envisaged. In summary, the wider audit established that the administration time overcharging issue was not as widespread as the initial branch sample testing undertaken by AIB internal audit in 2001 may have indicated. The actual figure only emerged once the detailed programme of work was completed. The final figure for refunds by AIB to its customers amounted to €255,000 and this figure was notified by AIB to the ODCA in February 2003 which welcomed the fact that the matter had been concluded and customers refunded. The administration time charge itself was abolished by AIB in 2001.

Having provided this detailed information, I would ask that the committee recognise the importance of distinguishing clearly between matters that Mr McErlean discussed with the Central Bank in 2002 and subsequent foreign exchange overcharging issues that were first brought to the attention of the Financial Regulator by a whistleblower in 2004. The overcharging matters discussed with Mr McErlean in 2002 were known to the Central Bank from 2001 and were investigated and concluded in February 2003, as I have set out. The other matters only became known in 2004. This is a critically important distinction.

2. I would now like to deal with the second allegation namely that is that ‘in 2005, the Financial Regulator failed to inform an Oireachtas committee about its investigation and in fact gave the false impression that they were unaware of overcharging until 2004.’

By way of background, one of the reasons for the establishment of the new consumer focused regulator was a series of failures in consumer and customer related banking issues, such as those detailed in the High Court Inspector’s Report into National Irish Bank. Before our establishment, the then consumer regulator, the Director of Consumer Affairs had emphasised the need for new consumer powers. On our establishment the legislative emphasis putting the consumer at the centre of financial regulation, was evidenced by the fact that the Consumer Director position was a statutory one with a place on the Regulatory Authority (Board).

In April 2004, a whistleblower brought to the attention of the Financial Regulator an entirely different and separate AIB charging issue, mainly in relation to foreign exchange rates. This issue had not been reported to, and was not known by, the regulatory authorities before 2004. As distinct from the 2001 overcharging issues which related to management time overcharging, the issue reported by the whistleblower in 2004, related to charging customers beyond what was approved under the Consumer Credit Act. As the 2004 allegations of overcharging by AIB were investigated, serious allegations emerged of a cover up at AIB and the Financial Regulator decided to widen the investigation to cover all other major charges. These investigations were reported on publicly, including to the Joint Committee on Finance and Public Service, and resulted in repayments of more than €65m by AIB.

The investigation ordered by the Financial Regulator, was carried out by Deloitte and independently verified by a former Comptroller and Auditor General, Lauri McDonnell. At that time the Financial Regulator had no powers to sanction. We could not publish the Deloitte report as this would be in breach of our legal powers. The Financial Regulator has taken a lot of criticism from the media and from other quarters on the question of secrecy. Our confidentiality requirements restrict our ability to disclose information to third parties. Let me put this on the record, we must operate within the law – if the law is changed and we are permitted to make additional disclosure, then of course we would do so. Both ourselves and previous regulators should not be blamed for what is in essence is compliance with the law. We did publish two reports which contained as much detailed information as we were permitted to disclose. Key findings included that AIB had failed to notify regulators in relation to foreign exchange charges over a prolonged period despite having a number of opportunities to do so; and AIB had weak controls in relation to monitoring customer charges. Escalation procedures at AIB had not worked effectively and its compliance function was insufficiently resourced to monitor customer charges.

I would also like to assure the committee that since our establishment, reflecting our mandate with a strong emphasis on consumer protection, we have given a high priority to consumer charging issues. Our investigations were wide ranging across the banking and insurance industry. These examinations into overcharging concluded in 2007, and of the total amount of over €180million recovered, overcharging by banks accounted for €136 million with a total of 469 separate charging issues. AIB has refunded its own customers over €65 million. Sanctions could not be imposed as these matters predated our sanctioning powers.

It is totally unacceptable that any financial institution fails to have in place strong robust control systems to identify customer issues and to ensure they are comprehensively dealt with. Banks did fail their customers by not doing this. However, I believe there has been significant progress in recent years in compliance on customer charging. While human or systems errors sometimes lead to overcharging, we now require in our statutory code all financial institutions to have procedures and systems in place to deal effectively with these and ensure that customers are properly informed and compensated. Our statutory consumer code came into full effect in 2007 and is backed up by our administrative sanctions powers.  We are not aware of any comparable consumer protection code elsewhere. Firms are now statutorily obliged to act in their clients’ best interests and to handle errors speedily and effectively. In the interests of ensuring that customers are aware of the propensity of their provider to make mistakes, institutions are required to communicate directly with their customers and to refund them with interest where they have overcharged. If they do not do this, they will be subject to sanction.

In conclusion I believe the facts I have placed before the committee shows clearly the Financial Regulator dealt with the matter of overcharging in a robust and professional way and in a way that reflected our new legislative mandate, albeit without our full powers. The amount recovered answers the allegation that the Financial Regulator was in some way taking a soft approach towards the banks.

3. I will now deal with the third allegation which concerns issues at Goodbody Stockbrokers.

In October 2001 AIB Capital Markets, in accordance with the obligations imposed in the Central Bank’s Handbook for Investment and Stockbroking firms, submitted to the Central Bank and Stock Exchange a copy of an AIB Group Internal Audit Report entitled “Special Investigation Goodbody Stockbrokers – Trading in AIB Shares” and a copy of a management letter addressed to the Internal Audit Committee of the Board of AIB. The work related to this report had been undertaken from May to September 2001.

The report stated that the arrangements that Goodbody had put in place to allow them to trade in AIB shares as a principal to facilitate meeting the needs of their clients had not operated in accordance with those previously communicated to the Central Bank and the Irish Stock Exchange which had been notified of the arrangement in July 2000. The original arrangements presented were designed to allow Goodbody, in its stockbroking role, to trade in AIB shares as a principal in compliance with the provisions of the Companies Act, 1990 which restricted trading by a company in the shares of its holding company. The practice ceased in July 2001. The Companies Acts were subsequently amended with effect from 4 August 2001 enabling Goodbody, as stockbroking subsidiary of AIB, to trade AIB shares.

The failures on the part of Goodbody to comply with the original arrangements presented to the Bank were as follows:

• The information provided in relation to the regulatory status and control of the third party account was misrepresented;
• Measures were introduced to maximize the ability of Goodbody to reclaim stamp duty arising on transactions undertaken for the third party account. In particular a further third party client incorporated in Nevis was introduced to the arrangement;
• Transactions undertaken by Goodbody between the two third party clients designed to maximize stamp duty reclaim were not undertaken on an “arms length basis” and involved clear conflicts of interest;
• High levels of operational failure in settlements and dealing resulted in Goodbody funding the third party accounts when not doing so was a key requirement of the arrangement;
• Laxity in following up on client documentation;
• Failure in compliance monitoring and controls procedures in Goodbody which did not identify and address the changes and weaknesses arising in the arrangements.

Subsequent to the submission of the report, the Central Bank met with senior personnel in AIB, as part of its examination of this matter. Ultimately significant personnel and operational changes took place in Goodbody.

The obligation at the time, in accordance with the provisions of the Criminal Justice Act, 1994, was for suspicions of money laundering identified by the Central Bank to be reported to the Gardai. We can confirm that this was done.

Summary

These are the facts regarding the 2001 management time charging issue and the Goodbody issue. In view of these facts, the suggestions and allegations made at this Committee last month that the Financial Regulator, which did not even exist at the time, was involved in a cover up, that the Financial Regulator was negligent in any way and that the Financial Regulator misled another Oireachtas Committee are absolutely absurd. We completely and utterly reject these ill informed and damaging allegations.

As I have said, I would like to outline for you some current developments in regulation and the changes we have now put in place. But before moving on to regulation, I want to set out briefly some important matters with regard to the disclosure of information:

Disclosure of Information

As was confirmed by the decision of the Data Protection Commissioner, and affirmed by the decision of Judge Linnane in the Circuit Court on 10 June 2008, the Financial Regulator provided Mr. McErlean with copies of all of the personal data to which he was entitled under the Data Protection Acts and, where documents were redacted before release, such redaction was in accordance with the Data Protection Act. These redactions related, for example, to confidential information in respect of third party individuals and entities. In this respect, the Financial Regulator had to ensure that any disclosure of information was not inconsistent with its obligations under section 33AK of the Central Bank Act 1942, EU law obligations of professional secrecy and the Data Protection Acts to any third party.

The Financial Regulator is subject, under both EU and Irish law, to strict obligations in relation to all confidential information that it receives in the course of its supervisory functions. The disclosure by the Financial Regulator, including any employee or former employee, of confidential information in breach of its obligation of professional secrecy is a criminal offence. In addition, as you have previously indicated, whilst the members of the Committee have the benefit of absolute privilege, this does not extend to witnesses appearing before you.

Regulatory system

Turning to the present, I am certain that in today’s regulatory environment, many of the issues raised by Mr McErlean would have been dealt with differently. The Financial Regulator now has powers that the Central Bank and Office of the Director of Consumer Affairs did not have at the time of the earlier charging issues at AIB and trading issues at Goodbody. We now have administrative sanction powers that mean we can, and do, name and shame firms and impose heavy fines on both firms and individuals for regulatory breaches. We can also remove people from senior positions and have moved to disqualify individuals for a period of time from the industry. We can also take market abuse actions where heretofore there was no such powers in this area, and finally we have open lines with other supervisory authorities where issues are their remit for further examination and possible prosecution.

Moving to reform of the current regulatory system, I would like to update the committee on our progress towards reforming the banking supervisory model.

Chairman, I do not have to remind this committee of the importance of confidence in its regulatory system. This is important now more than ever as we deal with the most serious global financial crisis. The worldwide system of regulation is being restructured and it is essential that a more systemic approach is taken to both national and cross border regulation. It is important that, as regulators we carry out appropriate reform to ensure the continued viability of the Irish financial sector which is a major contributor to the Irish economy. There are approximately 60,000 people employed in banks, building societies and insurance companies in Ireland1. The international financial services industry employs 26,000 of these people2. The industry is also a substantial contributor to the tax revenues of the State. As a regulator of some 13,000 financial services providers, the Financial Regulator has a critical role in ensuring that people can do business with these entities in a well regulated market.

We have intensified our supervision of banks which are under far more scrutiny than ever before. Our approach is far more intrusive, we have applied extra resources and hired in additional risk experts, increasing our on site presence in covered institutions. We have recruited 20 new additional staff to date and will be recruiting a further 20 specialists. Principles led supervision has clearly not worked effectively in recent times – not just in Ireland but across the globe - so a new approach is necessary and is in fact underway. We are focused on ensuring that where there is imprudent business practices or wrong doing, that we can identify it in a pre-emptive manner and deal with it.

We are also engaged in a number of investigations and have set up a special investigations unit to expedite these enquiries. A special enforcement unit will also be established with our new resources. We want to ensure, that there will be accountability in respect of any issues that arise such as the absence of governance, principles or appropriate practices in financial institutions. Root and branch reform has to happen, is happening and it is important for public confidence that it does happen.

Conclusion

Chairman, while the purpose of this meeting has been to provide a response to Mr McErlean’s allegations, I would like to emphasize, in conclusion, that we are fully committed to taking the necessary steps, working with our colleagues in the Central Bank, to ensure that the Irish financial system operates to the highest of standards and to the benefit of all its customers and stakeholders.

We recognize that this is a very difficult time for consumers in this country. It is essential that depositors and borrowers can continue to have confidence in their banking system so that they can carry on their normal business. As at the broader level, where changes are being introduced to tackle the serious economic challenges, so too at the regulatory level are changes taking place. For our part, as I have outlined, we have introduced new operational processes, bringing in new skills and applying new resources and new approaches as necessary in response to the environment we are in.

It has been widely acknowledged that the consumer directorate has worked extremely well for consumers and it is important that this level of consumer protection is maintained. Indeed, in our consumer role, we have today issued a statement warning lenders to treat their customers fairly when a mortgage holder contacts them to address issues before they become problematic.

The Minister for Finance announced this week the Government’s plans for reforming regulation. We very much welcome this. Along with the Central Bank, the Financial Regulator, in a joint submission to the Minister recognized that the architecture of financial regulation and supervision, both here and internationally, required broad-ranging review. The Government announcement reflects international trends by creating much closer links between financial stability and prudential supervision. In addition, the new model will allow for a much more intensive regulation of financial institutions, such as that which we have recently adopted in the regulation of financial institutions covered by the Government guarantee scheme.

We will work closely together with the Central Bank to ensure that the new arrangements are implemented speedily and smoothly.

Again, I would like to thank the Committee for this opportunity to clarify a number of issues. We are happy to take any questions you may have.