FSA Fines Investment Managers for Client Money Breaches
Richard Powell | Bloomberg Law
Just six weeks after fining Towry Investment Management Ltd £494,000 for breaching its client money rules,1 the Financial Services Authority (FSA) has disciplined another firm. On this occasion, in contrast to Towry’s failure to carry out adequate internal reconciliations, investment managers, McInroy & Wood Limited (M&W), neglected to a obtain trust letter from their bankers to ensure that client money was properly identifiable in the event of the firm’s insolvency.
While the financial penalty imposed of £21,500 (before discount for early settlement) may appear modest it was calculated in accordance with the FSA’s penalty regime in force prior to 5 March 2010. If the majority of the firm’s breaches had occurred after that date, the fine would likely have been considerably greater, being calculated under a new five-stage process designed to reflect the FSA’s credible deterrence approach to enforcement.
The FSA’s Principles for Businesses (PRIN) contain general statements of fundamental regulatory obligations. In the context of client money, Principle 10, at PRIN 2.1 provides: “A Firm must arrangement adequate protection for clients’ assets when it is responsible for them.” The detail of the regime is contained in the Client Assets sourcebook (CASS). Besides Principle 10, M&W were found to have contravened CASS 7.18.1R.2 This 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 with the firm’s own money.
At the core of the client money regime is the imposition of a statutory trust on client money received and held by a firm. 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.”3 Although client money legally belongs to the firm, the beneficial ownership stays with the client.
Client Asset Unit
M&W’s failings took place against a background of increased regulatory scrutiny in this area since the financial crisis and, in particular, the collapse of Lehman Brothers, which had not properly segregated all client assets as required. As part of this initiative, the FSA’s new client assets unit arranged for firms to receive a Dear Compliance Officer Letter on 20 March 2009 and the following year, on 19 January 2010, a Dear CEO Letter together with a Client Money & Asset Report. These set out the standards supervisors expected the industry to meet.
Investigation into McInroy & Wood
M&W is an authorised firm based in Scotland that handles client money in the course of providing discretionary investment management services. From May 2006 to August 2010, it held approximately £6.5 million on behalf of 500 clients with an average balance of £666,000 across 22 client money accounts at different banks.
The FSA investigation arose out of a thematic project into the management of client money and assets which sought to ascertain whether money and assets were held safely by firms and could be returned within a reasonable time in the event of a firm’s insolvency. This is something that has conspicuously not happened with the insolvent Lehman Brothers.
The firm had used bank A to hold its off-shore client accounts until March 2006 and bank B since July 1998 for on-shore client accounts. In March 2006 M&W moved its off-shore client accounts to bank C, but, due to an oversight, did not obtain a trust letter. It told the FSA that it had later incorrectly believed that such a letter had been obtained although it did not check. The FSA was also shown an investment administration agreement between the firm and bank C but this was silent as to the trust status of the money.
Later, in 2006, the firm’s auditors advised that it did not sufficiently distinguish client accounts as such with bank C because their titles did not contain the word “designated.” The firm did not review the position because, again, it believed mistakenly that there was a trust letter in place.
Events then move to March 2009, when M&W received the FSA’s Dear Compliance Officer Letter. This caused it to carry out a review of its client money arrangements including whether trust letters were in place. However, the firm only looked at on-shore and not off-shore accounts. Later that year, the firm reviewed the suitability of bank C to hold client money but despite considering many factors it did not identify the missing trust letter.
In January 2010, the FSA Dear CEO Letter asked chief executive officers to, amongst other things, confirm that the letter and accompanying report had been considered and that the firm was complying with the rules. This specifically included trust documentation. While the firm checked the trust letter with bank B and even made amendments to the wording, no such process was carried out for bank C. The FSA was told in interview that M&W had belived the trust letter from bank B also covered accounts with bank C as they were in the same banking group and their staff spoke to the same individuals.
M&W was visited by the FSA in August 2010 as part of a thematic visit. At last, following supervisors’ requests for copies of all trust letters, the failure in respect of bank C was discovered. Remedial action was taken immediately although the first trust letter obtained was insufficiently precise not including the words “client money.” This was promptly rectified.
The FSA considers this breach to be serious for a number of reasons. Four years had passed without there being a trust letter in place for bank C and M&W had failed to identify the omission despite a number of opportunities. Moreover, protecting client money is a key regulatory priority for the FSA. Nonetheless, it was recognised that the amounts at risk were small, that no monies were actually lost, and that M&W quickly acted once it became aware of the position.
In this the latest sanction for breaching client money rules, Richard Sutcliffe, head of the FSA client asset unit, has emphasised the importance of a trust letter “as it confirms money is ring-fenced from the firm’s own assets, readily identifiable and aids the prompt return to clients.”4 This case, like the recent Towry case – where the staff inaccurately re-assured the FSA over compliance, shows that firms without adequate processes in place can expect to be sanctioned for client money failures.
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