What do you need to do?
The board of each asset management firm is required to consider the firm’s conflicts policy and procedures in light of the issues raised in the “Dear CEO” letter. If appropriate, the board is then required to pass a resolution that it is satisfied the firm’s arrangements are sufficient to ensure that conflicts of interest are managed effectively and in compliance with FSA rules.
The CEO must subsequently sign an attestation to this effect and send it to the FSA by 28 February 2013. It would be unwise for a firm to respond without having undertaken a full assessment as we know from current experience that FSA will follow up on a "clean" reply where defects are later detected.
What should the review entail?
We consider that before the firm responds it should review:
- its existing conflicts policy to ensure that it is effective and up to date;
- the frontline business arrangements for identifying, and designing controls around, conflicts of interest including the processes, personnel, training and support provided;
- the role of Compliance, Legal and Internal Audit in identifying and monitoring conflicts;
- culture around conflicts within the firm, including a review of training provided to staff; and
- how senior management receive and act on information about conflicts, and set and communicate the standards for the firm.
What does FSA expect in relation to conflicts of interest?
The FSA has two fundamental requirements in relation to the identification and management of conflicts. The first, at Principle level, requires that a firm manage conflicts fairly both between itself and its customers and between a customer and another customer. The second, contained in SYSC, reflects the requirements of MiFID (and is little altered by the prospective MiFID II). In summary it requires that a firm;
- Identifies and records conflicts between it and its customers, and between its customers, that entail a material risk of damage to customers’ interests;
- takes reasonable steps to prevent conflicts from causing a material risk of damage to a customers’ interests, or must otherwise disclose the conflict so that the customer can take an informed decision; and
- has an effective and proportionate policy to identify and manage conflicts.
The FSA expects firms to be able to demonstrate that the principles and rules are embedded in their businesses and that they are taken into account when considering new products, processes or business models. Boards should regularly review their practices to ensure compliance with these requirements.
What were the key issues identified by the FSA?
The FSA’s letter also addresses these specific areas where it wishes firms to reaffirm their controls:
- management and controls around purchase of research and trade execution services, including oversight of commission payments;
- ensuring equal access to all suitable investment opportunities;
- inducements and the management of gifts and entertainment;
- personal dealing by employees; and
- allocation of the cost of errors between the firm and customers.
Other areas a firm should review (although not mentioned by the FSA) are the potential conflicts arising from remuneration arrangements (which could lead to inappropriate investment), the aggregation of trades and fund manager directed orders.
What are the consequences of your response to the “Dear CEO” letter?
Firms should be very careful before providing the requisite confirmation – which is effectively a warranty of your compliance. The FSA followed a very similar course of action in respects of its client assets and money (CASS) compliance review, where it required firms to provide a written confirmation that the firm was in compliance with its CASS obligations. Having received the replies, the FSA followed up with further reviews, and where a firm was found to have wrongly confirmed they were in compliance with its CASS obligations, the FSA took significant enforcement action.
The FSA is planning a second round of thematic visits on conflicts of interest, informed by the responses to the “Dear CEO” letter. The FSA’s previous thematic review gave rise to a number of letters asking firms to justify their approach to conflicts and some s166 skilled persons reviews and may result in enforcement action against firms in the more serious cases. We note that there are a number of final notices in which a Dear CEO letter is referenced as part of the background to the action.
How can we help?
We are familiar with how a fund manager operates, how conflicts arise and how they can be addressed without imposing unrealistic and unnecessary burdens on the business. We would be pleased to have a discussion with you about the letter and your situation if that would be helpful.
We have extensive current experience in assisting asset managers on regulatory matters and have recently performed conflicts reviews for a clearing bank, retail and wholesale fund managers, a UK broker dealer and a complex family office.
We can assist a firm's CEO in reviewing the business and in compiling the audit trail that will justify a "clean" response, or otherwise the basis of a limited "Principle 11" notification to FSA of problems identified. We have on many occasions assisted firms in reporting problems to FSA in such a way that FSA has allowed management to resolve the issue without recourse to appointing a skilled person or taking enforcement action.