Why do regulators fail to regulate?

Seal of the U.S. Securities and Exchange Commi...

Seal of the U.S. Securities and Exchange Commission. (Photo credit: Wikipedia)

When people hear about regulators failing to spot problems, they often think the regulators are incompetent.  The headlines around these cases present a picture of regulators unwilling, unable, or unprepared to do their jobs.  Even though regulators may have flaws, what the headlines miss is the pressure that regulators face from the industry they regulate.  When a bad report comes through, it is rare that the offending company accepts the report. Instead, like in sports, they start arguing with the umpire to change the result.  Even if they do not change the result, they know they are “softening up” the regulator for the next visit.  We can see this in sports such as football (soccer), basketball or baseball where managers play “mind games” with referees and umpires by questioning their decisions. They put the referee’s performance in the spotlight and not their own team’s performance.  In extreme cases, we can see the players “hounding” or “mobbing” the referee.

The same approach happens in the corporate world.  There are many techniques. Some are subtle and some are overt.  For example, the industry may hire former regulators to lobby the politicians who control the regulators.  At the same time, they may hire former regulators to find out the best ways to influence the regulator.  The former regulatory officer will know the system, know the people, and know the issues.  Alternatively, they may use overt pressure such as public campaigns or, in extreme situations, lawsuits against the regulator.  In some cases a company, or an industry group, may blend both actions by lobbying the politicians who have legislative control over the regulator.  In some cases, it is not unheard of for a company to use personal information against the regulators.

An extreme example of this approach could be considered the way the Audit Commission in the United Kingdom was abolished.  The Audit Commission, the main regulator for local government, was often painted as ineffective or out of control. The new coalition government disbanded the regulator when they assumed control.  They promised to arrange a different form of regulation in its place.  By abolishing it, they send a subtle, but chilling, message to other regulators.  If you push too hard, you may be abolished.  The regulator will realize they have to protect themselves politically.  However, the more political they become, the less independent the regulator will be because they will have to take sides to survive.

In the United States, we can see the strong political pressure on the regulators. Congress is putting pressure on the Securities Exchange Commission and the Commodity Futures Trading Commission as they attempt to regulate the financial industry regarding derivatives. The derivatives were unregulated and their excessive use contributed to the financial crisis of 2008. The banks and commodity firms have been using lobbying firms to exert direct pressure on these regulators.  The danger then is that the regulators will start to “work with” the industry they are trying to regulate.  They will be “captured” as described in the term regulatory capture, which seems endemic in the American regulatory framework.

When the regulator is under overt, public pressure, it will have an effect on the frontline staff. Despite their best efforts, regulators will find it difficult to resist the pressure.  Human nature tells us that people react to this pressure to find ways to remove it or reduce it.  As such, their approach to difficult cases will be weakened.  The staff know the headlines and they carry that into their work, even if only sub-consciously.  Even the most experienced regulator will find it difficult to push borderline cases, or take on powerful targets, when the political pressure is clear.  What is less well known is that the same pressure can exist institutionally beyond the headlines.  An organisation can resist institutional pressure from the companies if they have a strong Chief Executive and a strong organisational culture.  In addition to these strengths, they also need to connect to their stakeholders.

The regulator’s stakeholders, their ultimate audience, can help them to resist the pressure.  In most cases, the audience or the stakeholder for a regulatory is another institutional body. For example, Parliament or Congress may be the main stakeholder or audience for government regulators.  For institutional bodies, lobbyists and other methods can be used to influence the regulators.  Instead of attacking the regulator directly, they go to their boss.  In other cases, it may be the public.  When it is the public, it is harder for the companies and organisations being regulated to influence them in the same way.  However, it can be done by using the media to present a picture of the regulator to the public.

In some cases, the regulatory framework may prove problematic by its own nature. Financial regulators face a particularly difficult task because there is a strong belief that markets can regulate themselves through openness and competition.  The laissez-faire attitude is strongly entrenched and that means the regulators face an immediate uphill battle.  Although the logic is not sound, it is clear and seductive.  The market, between sellers and buyers, will regulate itself, as their respective interests will ensure the market creates regulations to protect and promote those interests.

If we look at a number of regulators in the UK, we can see how they confront these problems, how they have responded, and whether they can succeed. The regulators that have been in the news recently are Care Quality Commission (CQC) and the Information Commissioner’s Office (ICO) and the Financial Services Authority (FSA).[1]  Although other regulators could have been considered, all three have similarities that allow us to understand the issues. What connects them though is they have been put under intense pressure, as regulators, by the bodies they regulate and their statutory supervisors.  Their response has been mixed.  The CQC and the FSA are struggling and the ICO appears, relatively speaking, to have responded best to the pressure.

All regulators rely upon their statutory authority, but this leaves them vulnerable to political influence.  Their strength is drawn from their ability to leverage their constituents to give them the freedom of action needed to succeed. Regulators need to find a way to triangulate against the pressures by connecting to their constituents.  Of the three, the ICO appears best able to leverage their constituents.  If a regulator can leverage their constituents, they can resist the pressure.  However, it does not make it disappear.


The CQC faces particular problems because of its history and its stakeholders.  The CQC was formed out of three previous regulators and has increased responsibility even though its resources are being reduced.  A recent parliamentary report makes a stark conclusion.

The Care Quality Commission (the Commission) is the independent regulator of health and adult social care in England. It was formed in 2009 from the merger of three previous regulators. It currently regulates over 21,000 care providers against 16 essential standard of quality and safety. The Commission plays an absolutely vital role in providing assurance to the public, both by ensuring appropriate quality standards and by deterring poor quality and unsafe care. The Commission takes action where it finds standards are not being met. To date, however, it has failed to fulfil this role effectively.


The claims are that the CQC was more concerned with reputation management and not transparency regarding its regulatory work. At the time, it seems to lack a strong client base for pursuing regulatory action.  The people needing protection are usually the ones least able to ask for it. The people in care are not organised, powerful, or resourceful, to influence the regulator.  By contrast, the organisations, such as care homes, or care home providers, are better placed to resist the regulator. They have the resources, the organisations, and the power, to resist regulation.

To overcome this dynamic, the CQC needs to leverage its relationship with the people in care.  To this end, the increased transparency about complaints and regulatory scores for care homes can help the CQC in its regulatory work. In effect, the transparency agenda allows the CQC to triangulate, use the clients and the system against the care homes and care home providers, in the middle. A regulator who does this well is the Information Commissioner’s Office (ICO).


The ICO has been effective in regulating the Freedom of Information Act and to a lesser degree the Data Protection Act.  An important part of the ICO’s success, despite, its limited resources, is its use of the public and political events to give it leverage.  For example, the HMRC fiasco gave the ICO increased powers. At the same time, the ICO has a system that allows it to triangulate effectively against the organisations it is regulating.  Moreover, it can resist regulatory capture, to some degree, because it is working on behalf of the public.  The public have a voice, they are increasingly aware of their rights (the ICO works to educate the public) and the work is transparent.  The weakness, though, is that the ICO does not have the institutional resources to deal with large organisations who will use the legal system to resist the regulation.  For example, the ICO faced pressure from the News of the World in large part because the threat of extended litigation. The ICO only has a budget of about £15 million, which can be less than the legal budget for some global firms


The ICO, like any good regulator, has demonstrated, largely, its prudence.  Prudence is a key skill for regulators. One regulator, by contrast, has shown a lack of prudence in its work.  The FSA has been unable to leverage its power for three main reasons.



Who are their constituents?  The question shows their challenge.  The answer is the public are their constituents.  Yet, one is hard pressed to see how the FSA connects to the public directly to the public.  They work for the public, but the connection is so vague that it is hard to gain any leverage.  Instead, they are closely involved with the organisations that they regulate.  In many cases, the FSA were embedded in the banks they regulated. In effect, they are captured by their proximity.  To a degree, the FSA has suffered from reverse triangulation.  They have staff inside the banks and they feel the pressure at that level. They face pressure through a bank’s political connections or the wider political lobbying powers of the City. The regulatory system is changing but its effectiveness will depend on their ability to resist the pressure.

At the same time, they their most powerful ally, the regulatory framework set by the government, was undermined when light touch regulation was required. The FSA is trying to catch up, with the new regulatory framework, but it destined to be superseded by a new financial regulatory body.  The Northern Rock failure, RBS failure, and now the LIBOR failure have provided an opportunity reset the regulatory framework. However, that will not be enough.  What the FSA, or what succeeds it, needs is a way to create leverage against the industry.  They have not found a way to connect to the public.  They have not found a way to use transparency to their advantage.  The CQC seem well placed to rely upon complaints in care homes or a league chart of inspections. The ICO rely upon the public and they too benefit from transparency. For the FSA, the problems seem institutional and therefore potentially intractable.  Can the FSA find a way to reverse triangulate against the banks?  Even changing the regulatory framework away from a light touch approach or philosophy will not be enough. They do not have a way to counter the continued ability of banks to game the regulatory framework and risk fines that amount to a fraction of the bank’s profits.  What they need is to find a way to create, or strengthen the direct customers of the banks.  The CQC has the people in care.  The ICO has the public.  However, who do the FSA have?  Therein we see their dilemma.


[1] The Press Complaints Commission (PCC) could be included but it cannot sanction the press. The other regulators have the statutory power to impose sanctions, which is a reason for companies and organisations to pressure them.


About lawrence serewicz

An American living and working in the UK trying to understand the American idea and explain it to others. The views in this blog are my own for better or worse.
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