Coutts & Co. Fined 6.3 Million Pounds for Suitability of Advice Failings
Sarah Jane Leake | Bloomberg Law
The Financial Services Authority (FSA) has fined Coutts & Co., the private bank that counts the Queen among its clients, £6.3 million for failing to take reasonable care to ensure the suitability of its advice in connection with the sale of an AIG fund (Fund).
The bank’s co-operation with the FSA, together with its willingness to settle at an early stage in the investigation, enabled it to benefit from a 30 percent reduction. Without this discount, the FSA would have fined Coutts £9 million.
While the Fund invested in financial and money market instruments, unlike a standard money market fund, it sought to deliver an enhanced return by investing a sizeable proportion of its assets in asset backed securities (ABS),1 floating rate notes,2 and assets with terms to maturity of between three and five years.3
This investment strategy sought to smooth out fluctuations in the market value of the Fund’s assets in order to deliver higher returns to customers than available on a typical bank deposit account. However, during the financial crisis, the market values of some of the assets in the Fund fell below their book values.
On 15 September 2008, the day Lehman Brothers filed for Chapter 11 bankruptcy protection in the U.S., AIG’s share price fell suddenly. In consequence, a large number of investors sought to withdraw their investments and there was a run on the Fund. As the Fund was unable to meet all withdrawal requests immediately, withdrawals were suspended and the Fund was closed to new investors. At the time of the suspension, 247 Coutts customers had a total of £748 million invested in the Fund.
Existing customers were subsequently permitted to withdraw 50 percent of their investment, realising its full accrued value. They have been allowed to withdraw the remaining 50 percent since 14 December, though not for its full value (representing a 13.5 percent reduction in the accrued value of their whole investment at this time). While customers were promised that they would get back this proportion of their investment in full if they kept their money in a special “protected recovery fund” (PR Fund) until July 2012, those who took advantage of this offer could not access their money in the meantime and lost the opportunity to earn an investment return. While Coutts sought to address this issue by offering a loan to investors of up to the amount held in the PR Fund, it attracts interest at 1 percent over the Bank of England base rate.
Upon investigation, the FSA identified a number of serious failings in the way the Fund was sold. These are outlined below.
— Inadequate Sales Processes
The bank failed to provide adequate staff training on the Fund. While some written guidance was made available, Coutts relied on advisers seeking out more detailed, yet potentially important, information for themselves. Customer file notes indicate that many advisers underestimated the nature of the risks associated with the Fund and, in consequence, failed to articulate them appropriately to customers. Moreover, the bank’s sales documentation failed to adequately or accurately describe the Fund’s risks. Its suitability letters, used to record its recommendation of the Fund, were potentially unclear and misleading. In particular, it described the Fund as a “cash” product that could be seen as “an alternative to traditional bank and building society deposits,” whereas a sizeable proportion of the Fund’s assets did not meet this description. As a result, customers may have misunderstood the true position of the risks they were assuming.
— Unsuitable Sales
Analysis of sales files indicates that Coutts made a material number of unsuitable sales. The bank is found to have recommended the Fund to several customers even though it may have exposed them to more risk than they appeared willing to accept. Moreover, it failed to appropriately advise customers with competing investment objectives (high returns v limited risk appetite) and make them aware of the trade-off between the Fund’s risks and returns. It also advised a number of customers to invest a significant proportion of their total assets in the Fund (in many cases up to 100 percent, often comprising millions of pounds), with the risk that their investments were not appropriately diversified.
— Changing Market Conditions
In the FSA’s view, Coutts failed to respond to the volatile market conditions of 2007/8 in an appropriate fashion. Despite its awareness of issues affecting the Fund (e.g., widespread media speculation about AIG’s financial stability) that were likely to increase the risk of a run on the Fund, Coutts, ultimately, failed to mitigate this risk and, furthermore, the risk of a suspension of the Fund. Moreover, Coutts failed to make substantive changes to the way in which the Fund was sold, nor did it seek to provide existing customers with a fair and balanced explanation of the increased level of risk associated with the Fund. In essence, the bank failed to take adequate steps to protect its customers’ interests.
— Investigating Past Sales
From December 2007, a number of questions arose within the firm as to whether it had explained the Fund’s risks adequately to its customers, and whether customers’ portfolios were suitably diversified. The FSA found that Coutts failed to take prompt and effective action to address the queries raised and, notably, never undertook a review of past files to determine whether the Fund’s risks had been adequately articulated to customers.
— Compliance Review
The bank received complaints from 38 percent of customers who were invested in the Fund at the time of the suspension.
Coutts consequently carried out a compliance review of its sales of the Fund to customers who remained invested in the Fund at the time of the suspension. The FSA, however, found this review to be inadequate – it failed to address suitability and disclosure issues and was not completed in a timely manner.
Pursuant to section 206(1) of the Financial Services and Markets Act 2000, the FSA may, where it considers that an FSA-authorised firm has breached a regulatory requirement, fine that firm in an amount it considers appropriate. In this regard, the FSA must take into account the relevant provisions of the FSA Handbook.
In view of the above failings, the FSA concluded that Coutts “failed to take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who was entitled to reply upon its judgement.” This amounts to a breach of Principle 9 of the FSA’s Principles of Businesses.4
When determining the level of financial penalty, the FSA took into consideration the seriousness of the breach. Overall, Coutts’ failings put 427 customers’ investments, totalling £1.45 billion over the period, at risk. Moreover, Coutts holds a competitive position in the market, and, in the FSA’s view, its practices should set an example to others in the sector. The FSA hopes that the size of the fine will deter other firms from similarly contravening the regulatory regime, and, in effect, promote higher standards of regulatory conduct.
Coutts has agreed to undertake a past business review in relation to all of its sales of the Fund to those who remained invested at the time of the suspension. Where sales are found to have been unsuitable, redress will be paid.
Commenting on the action, Tracey McDermott, acting director of enforcement and financial crime at the FSA, stressed that suitability remains a key area of risk in the wealth management industry. Firms are urged to pay heed to the Dear CEO letter circulated earlier this year,5 highlighting significant widespread failings in this area and providing a number of suggestions for improvement. For the sake of best practice, firms should regularly assess the suitability of their client files and, where appropriate, provide redress to those who may have suffered detriment, or been potentially disadvantaged, as a result of the firm’s non-compliance with the regulatory system.
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