The FSA has published a ‘Dear CEO’ Letter which summarizes its findings from thematic reviews assessing the arrangements for managing conflicts of interest at asset management firms.
The FSA’s findings highlighted that not only had many firms failed to establish an adequate framework for identifying and managing conflicts of interest, but there were also breaches of the FSA rules and Principles. The FSA found that the attitude of senior management towards customers correlated to how well, or poorly, firms dealt with conflicts.
Due to the seriousness of the issues and the widespread nature across the population of firms reviewed, the FSA decided that it needed to not only communicate its findings to the wider asset management sector but to take action to ensure firms are complying with the various rules on conflicts of interest. Those asset managers that receive a hard copy of the letter are required to complete an ‘attestation’ confirming that their arrangements are sufficient to ensure that the firm manages conflicts of interest effectively and in compliance with the FSA rules. All other asset managers should consider the paper fully and review their arrangements in light of the FSA’s findings.
Asset managers who receive a hard copy must complete and return the ‘attestation’ by 28 February 2013.
Who will this impact?
Although targeted at asset managers, some of the key messages contained within the letter will be of interest to all firms when reviewing their arrangements for managing conflicts of interest.
The Board, or equivalent, need to consider the paper and what it means to their firm. Firms need to assess their arrangements for managing conflicts of interest in light of the FSA’s findings. Where necessary, firms should implement changes to strengthen their controls for managing conflicts. The Board needs to review the firm’s position and, for those that receive the hard copy letter, complete the ‘attestation’.
When completing the ‘attestation’, firms should be mindful that the FSA has taken enforcement action for a breach of Principle 11 (Relations with regulators) against a firm that confirmed their CASS arrangements were sufficient in response to a Dear CEO letter, only for the FSA to find that this was not the case. Therefore, it is important that the Board is satisfied that the arrangements for managing conflicts within the firm are robust before the attestation is completed.
Firms need to consider the FSA’s findings which fell into the following six areas:
1. How firms identified and controlled conflicts of interest
Once again, the FSA has highlighted the importance of senior management setting the tone, and has noted the strong correlation between a firm’s culture and its ability to recognize conflicts of interest.
It is clear that conflicts should not be seen purely as a compliance matter. The FSA noted that the involvement of both compliance and business lines in not only designing control frameworks but in the monitoring of conflicts proved more effective.
2. How firms managed the purchase of research and trade execution services on behalf of customers
The FSA commented that only a few firms visited exercised the same standards of control over payments for research and execution services as they did for payments made with their own funds. Examples of good and poor practices in this area are noted in the paper.
Specific mention of COBS 11.6.3R and the use of dealing commission is made, with the FSA noting that few governing bodies regularly reviewed this area, that various firms were using commissions to pay for goods or services and were unable to demonstrate whether the goods or services were eligible under the FSA’s guidance and evidential provisions. In addition, some firms did not comply with the disclosure requirements relating to commission payments. The FSA found that those firms with strong controls over commissions were better able to demonstrate control over the execution of customer orders.
3. How firms managed gifts and entertainment
The FSA found that most firms visited did not give proper consideration to how their duty to act in their customers’ best interest could be compromised by accepting gifts or entertainment. Examples of good practice include: imposing limits on not only the value of individual gifts or events but on the frequency with which multiple gifts/events can be accepted within a certain time period; valuing a gift/event based on the cost incurred by the provider or the market value, not the face price; and extending the policy to frequent low-level entertainment, not just occasional expensive events. Good practice for controls included requiring both line management and compliance to approve gifts and entertainment.
4. Ensuring customers have equal access to all suitable investment opportunities
Whilst the FSA found most firms allocated trades fairly, there were examples of poor practice in this area which firms should consider. Similarly, most firms had controls in place to ensure cross trades were beneficial for both customers and executed at a fair price, but again there were examples of poor practice in this area including firms failing to record the rationale for cross trades. Firms should also consider the enforcement action that the FSA took against a firm for conflicts relating to cross trades between funds.
5. How firms managed personal account dealing (PAD) by employees
Examples of good practice in this area included: explaining to employees the conflicts created by PAD; setting out clear procedures; setting restrictions; monitoring PAD and regularly reviewing the policy to ensure it remained appropriate. An example of poor practice included exempting senior management from aspects of the PAD policy without a valid reason.
6. How firms allocated the cost of errors between themselves and their customers
When considering this area the FSA noted that a number of firms, mostly hedge fund managers, were too reliant on contractual limitations to avoid liability for the cost of errors other than in the case of gross negligence. It also found that some firms used these clauses to avoid not only reporting the errors to customers but even collating information about the costs of errors to customers. The FSA noted that firms should consider if repeatedly making the same or similar errors might in itself amount to gross negligence. Various examples of good practice have been noted, including encouraging staff to admit errors rather than conceal them.