UK FSA Fines Wrap Platform 3.5m Pounds for Client Money Breaches
Richard Powell | Bloomberg Law
ntegrated Financial Arrangements plc (IFA), the UK’s largest wrap provider, has become the latest firm to be disciplined by the Financial Services Authority (FSA) for client money breaches. This takes place in quick succession to recent financial penalties imposed on Towry Investment Management Ltd1 and McInroy & Wood Limited,2 both investment managers. This latest action reinforces the importance of protecting client money and its place as a key FSA regulatory priority.3
IFA operates a wrap platform, which enables independent financial advisers to place and trade their clients’ investment portfolios, for example in mutual funds, exchange-traded funds and equities, together on one administrative-friendly, tax-efficient platform. In total, as at 30 September 2011, the firm held portfolios for 94,000 retail customers with a value of approximately £10.1 billion, of which some £1 billion was in cash.
The financial penalty of £3.5 million was reduced by one-third from £5 million because of an early settlement discount. The initial sum represented 1 percent of average client money balances held on the platform, which averaged £508 million from 1 December 2001 until 30 June 2010. As was the case for Towry Investment Management and McInroy & Wood, the penalty was calculated in accordance with the FSA’s former penalty regime contained in its Decision Procedure and Penalties Manual (DEPP), which applies to misconduct taking place prior to 5 March 2010. This was because the majority of the firm’s breaches occurred prior to this date. Otherwise, the fine would likely have been much greater, being calculated under a new five-stage process, set forth at DEPP 6, designed to reflect the FSA’s policy of credible deterrence.
Client Money Contraventions
IFA contravened the FSA’s client money rules in three respects.
While IFA recorded the receipt of client monies, it did not, as it was required, perform regular client money calculations to verify if client money it had received was matched by actual client money held. Shortfalls occurred because IFA allowed clients to trade on funds of up to £50,000 received by cheque before cleared funds were available and, similarly, uncleared sales proceeds could also be used to trade. The failure to perform reconciliations meant that shortfalls in client money went unfunded by the firm and that one client’s money was used for another. According to the FSA, the shortfall during part of 2011 varied from between £1.1 million and £6.9 million.
The failure to perform regular client money calculations was in breach of the rules in the FSA’s Client Assets sourcebook (CASS). CASS 7.3.1R requires a firm to make adequate arrangements to safeguard clients’ rights and to prevent the use of client money for its own purposes. Additionally, by failing to investigate (and remedy) client money shortfalls, the firm had contravened CASS 7.6.13R, which obliged it to identify the reason for any discrepancy. More generally, IFA had breached FSA guidance at CASS 7.6.6G requiring regular internal reconciliations between client money entitlements and the amounts standing in client bank accounts.
— Trust Letters
The second contravention concerned a failure to put proper trust documentation in place to ensure that client money was properly identifiable in the event of the firm’s insolvency. This was the same breach for which McInroy & Wood Limited was disciplined. Against the background of 28 client money bank accounts:
- IFA could not show in relation to one account standing to the credit of £706 million the receipt of an acknowledgement of trust letter from the relevant bank within 20 business days of its opening or, alternatively, an immediate withdrawal of funds;
- One trust letter failed to identify the account as client money; and
- Two acknowledgement of trust letters failed to confirm that all monies were held in trust by IFA.
These matters constituted a further breach of CASS 7.3.1R, but also of CASS 7.8.1R. The latter provides that on opening an account, notice must be given to the deposit-taker asking for: (1) an acknowledgement of the monies’ trust status; and (2) confirmation that the title of the account sufficiently distinguishes it from any other accounts containing the firm’s own money.
The imposition of a statutory trust on client money received and held by a firm is fundamental to the client asset regime. The Court of Appeal in CRC Credit Fund Limited, Lehman Brothers Inc. & Ors v GLG Investments Plc Sub-Fund: European Equity Fund & Anor stated, with reference to the CASS rules, that “a firm receives and holds client money as trustee for the purposes of the client money rules and the client money . . . distribution rules.”4 It was vital, therefore, that client money bank accounts were set up on this basis.
In the context of these breaches, the FSA was also concerned about IFA’s organisational arrangements to ensure they complied with regulatory requirements. Under CASS 7.3.2R, a firm must have “adequate organisational arrangements to minimise the risk of the loss or diminution of client money . . . as a result of . . . poor administration, inadequate record-keeping or negligence.” The FSA found IFA to have breached CASS in this respect in three ways:
- Compliance: there was an absence of any monitoring of adherence to client money rules and an excessive dependence on external and internal audit reports, which proved to be erroneous.
- Governance: reflecting similar findings in other firms, there were inadequate mechanisms for gathering management information on client money risks and their proper consideration by IFA’s board.
- Policies & Procedures: IFA’s systems and controls were insufficiently documented (e.g., the finance department’s written procedures failed to properly address client money obligations).
— Principles for Businesses
Besides specific breaches of CASS, IFA also contravened two of the FSA’s Principles for Businesses (PRIN), which are general statements of fundamental regulatory obligations. These are set out at PRIN 2.1, where Principle 3 provides: “A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems,” and Principle 10 provides: “A firm must arrange adequate protection for clients’ assets when it is responsible for them.”
This latest FSA action takes place against a background of increased regulatory scrutiny over client assets since the financial crisis, most recently seen in the U.S. with the collapse of MF Global, which also failed to properly protect client assets as required. In the UK, as part of this regulatory initiative, the FSA’s client assets unit has sent firms a Dear Compliance Officer Letter on 20 March 2009 and, on 19 January 2010, a Dear CEO Letter together with a Client Money & Asset Report setting out the standards supervisors expect the industry to meet.
As if a financial penalty of £3.5 million were not enough, the FSA has also appointed a skilled person under section 166 of the Financial Services and Markets Act 2000 to review IFA’s client money procedures, for which IFA will bear the cost.5
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