Credit Suisse Fined 5.95 Million Pounds for Systems & Control Failings
Sarah Jane Leake | Bloomberg Law
Within weeks of the High Court of England & Wales finding conduct of business failings at Credit Suisse (UK) Limited (CSUK),1 the UK Financial Services Authority (FSA) has fined the firm £5.95 million for failing to ensure the suitability of its advice to customers in relation to sales of structured capital at risk products (SCARPs).
CSUK qualified for a 30 percent discount on the fine, owing to its co-operation with the FSA throughout the course of the investigation and its agreement to settle at an early stage. Without this, the FSA would have sought to impose a fine to the tune of £8.5 million.
Structured Capital at Risk Products
While SCARPs provide a pre-determined, enhanced level of income to customers, they also, as their name suggests, expose them to significant risk – that they may lose part or all of their initial capital in the event that markets fall below a certain point. Each individual SCARP may have a different risk profile, dependant on a number of factors (e.g., term, underlying indices or equities, market conditions, etc.). It is therefore essential that, when recommending SCARPs, investment firms strive to ensure that every single SCARP is suitable for each particular customer and that the relevant customers are fully aware of the nature of risks associated with investing in SCARPs.
Between 1 January 2007 and 31 December 2009 (Relevant Period), CSUK customers invested over £1 billion in these products. However, while they were receiving income on their investments, these customers are estimated to have lost £198.2 million (it must, though, be noted that these losses were incurred during a time of unprecedented market turmoil). According to the FSA, these losses are primarily attributable to the firm’s failure to establish and maintain sufficient systems and controls for ensuring the suitability of advice provided to its customers.
The FSA’s concerns first arose during a routine supervisory visit to the firm in December 2009, which led to appointment of a skilled person pursuant to section 166 of the Financial Services and Markets Act 2000 (FSMA). The skilled person was instructed to assess the adequacy and effectiveness of CSUK’s systems and controls in place to support the suitability of recommendations given to customers, and to review a sample of the firm’s customer files to examine how these systems and controls were implemented in practice. The key findings are outlined below.
— Determination of Customers’ Attitudes to Risk
The methods used by CSUK to determine and articulate customers’ attitudes to risk were found to be inadequate. For example, many of the terms set out in the “client acceptance booklet” (CAB),2 which assisted the firm in determining a customer’s risk profile, were unlikely to have been clear to inexperienced investors (e.g., the CAB stated that an investor with medium risk has “a more pronounced appetite for risk for all or a portion of the investor’s portfolio”3). There was, therefore, a high risk that the firm may not have accurately understood the level of risk that each customer was willing to take.
Where a customer’s selected risk profile fell outside the range of risk profiles considered compatible with the stated objective, CSUK required its customers to provide their reasons. These explanations were not, however, always recorded in the CAB. As such, CSUK was, in the majority of cases, unable to demonstrate its understanding of, and the interaction between, a customer’s attitude to risk and his investment objective.
— Evidencing Suitability of Advice
Analysis of customer portfolios shows that CSUK failed to take reasonable care to satisfactorily evidence and demonstrate that its recommendations to customers were suitable, given the assets and investments held by them at the time.
Generally, the firm’s customer file notes failed to demonstrate how a customer’s overall portfolio had been construed, with reference to their investment objectives and risk profile. In just over 70 percent of the files under review, there was insufficient evidence to demonstrate that customers’ overall portfolio had been taken into consideration when determining whether SCARPs were suitable. Moreover, CSUK increased a number of customers’ risk profiles during the course of their relationship with the firm. In most cases, however, there was insufficient documentary evidence to justify why the risk profile had been amended.
— Recommending Leverage
The firm was found to have had inadequate systems and controls in place concerning the recommendation of leverage to those customers who invested in SCARPs. Where leverage to fund a transaction, the firm failed to record the rationale for recommending leverage, the appropriateness of the amount of leverage in light of individual attitudes to risk, or whether the risks associated with the use of leverage had been considered on a case-by-case basis. Moreover, there were no mechanisms in place to monitor the amount of leverage within each portfolio.
Given that leverage magnifies losses, CSUK’s failure in this regard exposed customers to significantly more risk than they might have been willing to take on.
— Issuer & Investment Concentration
While interviews conducted during investigation identified that the firm had a good understanding of the risks arising out of issuer4 and investment concentration,5 CSUK was unable to evidence that these issues had been taken into consideration when making recommendations. CSUK therefore failed to ensure that it had adequate systems and controls in place concerning levels of issuer and investment concentration within customer portfolios. This exposed customers to the risk of incurring significant losses in the event that the issuer or security in question failed.
The failings outlined above were allowed to occur and continue because, throughout the Relevant Period, CSUK’s oversight – of SCARP transactions, of compliance monitoring, and of its own staff – was substandard.
CUSK was found to have failed to monitor its staff properly, to ensure that they took sufficient care to ensure the suitability of their advice. With too many competing responsibilities, the relevant management was unable to supervise the conduct of the firm’s relationship managers.
Perhaps owing to its failure to supervise staff satisfactorily, the firm also failed to monitor transactions effectively in the context of customers’ overall portfolios. Between January and September 2009, CSUK only considered the suitability of transactions against a customer’s risk profile and investment objectives, and not against their existing portfolio of investments. While the firm had an internal evidencing tool (known as MICOS), intended to demonstrate that management had reviewed the suitability of transactions, this tool was used effectively in only 44 percent of cases.
Protecting customers is one of the FSA’s statutory objectives. Therefore, under section 206(1) FSMA, the FSA may, where it considers that an FSA-authorised firm has contravened a regulatory requirement, impose on that firm a financial penalty of such an amount as it considers appropriate. In this regard, the FSA must also take into account the relevant provisions of the FSA Handbook which in this instance includes Principle 3 of the FSA’s Principles for Businesses.6This provides that a firm must “take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems.”
In view of the above failings, the FSA concluded that CSUK was in breach of Principle 3 and, as a result, exposed its customers “to an unacceptable risk of being sold a SCARP which was unsuitable for them.”7
To the FSA, the size of the fine is justified by the seriousness of the breach. CSUK’s advice put some 623 investors’ funds, collectively £1.099 billion, at risk without their knowledge for a lengthy period of time. It also took into account the firm’s competitive position within the market – as one of the largest private banks in the country, its practices set an example to other market practitioners. In the FSA’s view, it is therefore even more important to set and follow high standards.
Since the failings were identified, CSUK has made a number of changes to its systems and controls to ensure the suitability of advice to customers. It has also examined all of its customer files to ensure that the information it holds is accurate. Moreover, the firm has agreed to undertake a past business review in relation to SCARP purchases during the Relevant Period, to ensure that its customers have not suffered a loss as a result of being advised to purchase an unsuitable product. Redress will be paid where appropriate.
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