Investment managers are risking f ines, career-long bans and even jail time by unwittingly breaking compliance rules, consultants and lawyers warn, as the regulator starts to get tough.
Fund firms and asset managers responsible for millions of pounds of clients’ cash have so far been largely spared the intense scrutiny other financial professionals have got used to in the fallout from the global financial crisis.
But the Financial Services Authority (FSA) now has the industry firmly in its sights after a handful of probes uncovered shortcomings that could be more common than first feared.
“The relatively small insular world of wealth management has not always coincided with a strong culture of compliance,” Joanne Smith, chief executive of The Consulting Consortium said.
“Ignorance ... is primarily the reason behind failings, rather than deliberate neglect,” she said, predicting an uptick “in the region of 100 percent” in the volume and frequency of enforcement actions against money managers this year.
While watchdogs chased rogue traders, tax dodgers and the figure-heads of ailing banks in recent years, many investment houses allowed a relaxed attitude towards regulation to take root, the compliance advisers said.
As a result, many are oblivious to the standards they are duty-bound to uphold and penalties that apply to the companies and individuals who fall short.
Lax anti-money laundering controls, insufficient transaction reporting, poor checks on the suitability of investment recommendations and sloppy exchanges of price-sensitive information are top of the list of the compliance traps asset managers are most likely to fall into.
The FSA has demonstrated its hard-line approach following the March publication of its Retail Conduct Risk Outlook, doling out an 8.75 million pound ($14 million) fine to private bank Coutts & Company for soft-touch handling of high-risk customers.
Far smaller firms have also been censured this month, with Christchurch Investment Management and its compliance officer, David Thornberry, fined a total 38,150 pounds for mishandling client cash, with faults dating back to November 2007.
In the first action of its kind, the FSA banned Thornberry from acting as a compliance officer again after discovering that he had no formal training for the role and no awareness of the regulator’s rules for the protection of client assets, which were communicated in writing to all firms some months before.
Last June, the FSA warned wealth management chief executives to expect “increasing supervisory focus” on the sector.
But Simon Appleton, a director at regulatory consultancy Kinetic Partners, said many fund managers were unprepared for the more intrusive approach to compliance monitoring, with a daily responsibility to report all of their stocks, bonds and derivatives transactions a notable, and widespread, weakness.
He points out that only in specific cases can the manager rely on brokers to report on their behalf.
“There’s a misguided feeling out there at a lot of the buy-side firms that the rule just doesn’t apply to them because they do not view that they are the entity executing the trades.”
“The FSA has started on-site visits to buy- and sell-side firms to look at transaction reporting arrangements. That information is key for them to be able to detect market abuse. They send those reports to other European authorities and if that information is found to be inaccurate or incomplete, it would not reflect well on the FSA.”
Besides under-reporting trades that could conceal market abuses, experts said that many wealth managers and fund firms could face disciplinary action if they were asked to explain and justify the investments they select for each client.
“The FSA commenced a thematic review last year into the suitability of investment recommendations and they were shocked as to how unsuitable some of these recommended investments appeared to be for the circumstances of the clients they reviewed,” Harvey Knight, head of financial services at law firm Withers said, referring to money managers’ poor grasp of client risk appetite.
“We’ll see sooner rather than later if they (the FSA) intend to hold them to account.”
Insider dealing remains high on the list of offences the FSA wants to crack down on, as demonstrated by the 450,000 pound fine it slapped on J.P.Morgan Cazenove star banker Ian Hannam last month for passing on inside information. Hannam is appealing against the fine.
Appleton said most managers understood that trading on unpublished privileged information was a crime. But some are less aware that sharing details is also a dereliction of duty, as is failing to report the exchange of price-sensitive information gleaned in private meetings with quoted firms they invest in.
“I’ve seen people caught after a company insider made a passing mention about a takeover at their local church. The FSA was analysing trades after the event and spotted that the insider and beneficiary were from the same village,” he said.
“Improper disclosure is one of the FSA’s seven deadly sins. If you suspect someone in your firm has breached one of these, you’re obliged to file a suspicious transaction report,” Appleton added.
Nick Matthews, one of Kinetic’s specialist anti-money laundering experts, said he had some sympathy for the increasing burden on compliance officers.
But he said money managers were often guilty of prioritising turnover or business growth over compliance checks, with the Coutts’ fine indicative of the substandard controls culture the FSA wants to stamp out.
“It’s not just financial crime they need to be vigilant for, it’s the day-to-day issues too. It is not humanly possible to stay on top of every detail, it must be a team effort,” he said.