UK FSA Dear CEO Letter to Investment Firms Faults Compliance with Principle on Protecting Client Assets

The UK Financial Services Authority has sent a Dear CEO letter and report to the chief executive officers of major insurance brokers and investment firms which hold money or assets on behalf of clients, drawing their attention to the FSA’s concerns over the handling of client money and assets. In the letter, the CEOs were asked to confirm that their firms are in compliance with their obligation to protect client money and assets.

The letter and report were sent to the CEOs of all insurance brokers and investment firms which are supervised by the FSA on a relationship managed basis and which are able to hold client money or assets. Other firms which have the ability to hold or control client money and assets will be provided with a link to the letter and report via a regulatory update sent to small firms.

Under FSA Principle No. 10, a firm is required to arrange adequate protection for client assets when it is responsible for them. In the FSA’s view, there is still a significant amount of work to be done in order for firms to ensure that the assets and money of their clients is adequately protected. According to Sally Dewar, FSA Managing Director for Risk, the client asset rules are a key protection for consumers, and firms must ensure that consumers get the appropriate protection. The FSA said that the protection of client assets will continue to be a top regulatory priority in 2010.

The letter follows up on a Dear Compliance Officer letter sent to firms in March 2009, which explained the obligations a firm has to protect client money and assets and set out the FSA’s intention to conduct further firm visits during 2009.

Subsequently, the FSA visited a range of firms and found a number of failings. As a result, the FSA decided to write to chief executives with an accompanying report containing details of visit findings, and highlighting some of the weaknesses discovered, including inadequate management oversight and control, unclear arrangements for the segregation and diversification of clients’ money; and incomplete or inaccurate recordkeeping. The FSA has already taken measures against a number of the firms that it visited, including referring two firms to enforcement, freezing a firm’s assets and commissioning skilled persons reports.

With regard to investment firms, the FSA found limited due diligence of banks and money market funds that were used to hold client money, with the firms typically relying on the credit rating of the institution used. In addition, firms failed to adequately explain the rationale for using a particular bank or fund. The FSA emphasized that simply looking at the credit rating of a bank or fund is not proper due diligence. The FSA said that adequate due diligence would involve assessing a bank or fund’s market reputation and market practices, as well as risk diversification.

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