Regulatory Action: Shock and Awe | Expert opinions

We often see regulatory action against various financial entities after the regulator has “checked their books.” Recent regulatory actions include restrictions on accepting deposits, opening new accounts through online banking channels, issuing co-branded cards, launching new mobile products and managing public debt issues. These actions reflect regulators’ commitment to maintaining financial stability, fair markets and ensuring regulatory compliance. However, investors view such actions with shock and awe because they directly affect them.

Another sector that is subject to periodic inspections and regulatory action is pharmaceutical companies exporting to the US. Here, inspections are conducted by the U.S. Food and Drug Administration (FDA) to assess compliance of regulated facilities with applicable laws and regulations, such as the Food, Drug and Cosmetic Act and various other related statutes, to ensure safety and quality of medicines.

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Unlike financial sector reviews and audits, which are year-round, U.S. Food and Drug Administration inspections are conducted every few years with an element of surprise as to their timing. FDA investigators arrive on site and present a “notice of inspection,” or Form 482. They then examine the manufacturing process, review relevant records, and collect samples. At the conclusion of the inspection, comments, called Form 483, are provided to guide corrective action. This gives the facility the opportunity to take voluntary remedial action and prevent it from happening again. In extreme cases, the FDA may recommend withdrawing the drug from the market or preventing its export to the US.

As with financial inspections, Form 483 remains confidential between the regulator and the entity being inspected. But there are two varieties that I know of. As with the financial sector regulator, FDA inspections are initially confidential. But the FDA reviews the findings, the company’s responses and other data and typically classifies its findings within 90 days into three categories — (i) no indicated action when there are no significant issues; (ii) indicated voluntary actions when minor problems requiring correction are identified; and (iii) indicated official action when serious violations requiring enforcement action are identified. The classification is publicly disclosed.

Two, under the Freedom of Information Act, individuals may request FDA 483 for a fee. FDA removes confidential commercial information before releasing a document. Unfortunately, there is no time commitment, and people have been known to wait up to two years to access this information. This redacted file is then uploaded to the FDA website and can be freely accessed by all stakeholders, including investors. I’ve simplified it, but it’s a broad protocol.

Regulators work to ensure patient safety, fair treatment of borrowers and compliance with rules. Their actions, even if perceived as somewhat extreme, help them maintain the integrity of the industry they regulate. However, there is no escaping the fact that major regulatory decisions impact a variety of stakeholders and may have unintended consequences. To give just one example: admonishing a bank that its systems are vulnerable could lead to an increase in cyberattacks. This does not mean that regulators should overlook shortcomings, but there must be a way to involve investors and other interested parties in this exchange.

Currently, when an entity receives information from the regulator, it discloses a summary to the stock exchange. If the action is punitive, investors feel hurt and then argue that the action is reflexive, even as the discussion continues.

So should the FDA first grant a grace period when serious violations are observed? It’s hard to argue, considering life and health are at stake, so I’ll focus on the financial sector, where changes can be relatively easy. Given that inspections are often ongoing, public disclosure of information only after receiving the “final” letter causes serious market disruption, especially if the actions are also serious. Disclosure and updates regarding communications between them should be encouraged. While it can be argued that disclosing such information for the first time could lead to market volatility, timely and meaningful disclosure in some form would better prepare the market.

Additionally, financial regulators should consider classifying their regulatory communications based on the nature and severity of the findings. They may publish a summary of findings and ultimately the entire audit report or encourage regulated entities to do so. An annual or semi-annual summary of inspection findings, without naming specific entities, will also help inform regulatory expectations. They should also highlight best practices they have observed. This will provide stakeholders with the information they want and all regulated entities with clear indicators of improvement.

The author works at Institutional Investor Advisory Services India Ltd. The views are personal. X: AmitTandon_In