In contrast to the volume of other materials the FSA manages to produce, “Dear CEO” letters are relatively rare.
Usually addressed to CEOs of particular types of financial services business, these letters highlight deep-seated concerns the FSA has about particular issues in an industry area.
Recent “Dear CEO” letters have been sent to wealth managers, mortgage lenders and administrators and firms holding client money, highlighting issues about suitability, arrears handling and the compliant segregation of client money, among other things.
Not all “Dear CEO” letters are for information only – more recently, many require a response to be given by the CEO to confirm the contents have been read and understood and others to confirm that the firm is operating in compliance with regulatory rules.
The FSA’s trend towards requiring the CEO to respond in such a way that would, if required by a consumer contract, be regarded by the FSA’s Unfair Terms Team as an unlawful “enforced declaration” as it provides the FSA with traction to pursue senior management if compliance failings are later found in the areas highlighted.
This reflects the FSA’s continued focus on senior management responsibility and helps its enforcement teams overcome difficulties apportioning blame on individuals when there is an unclear division of responsibility in a firm.
“Dear CEO” letters are, for many CEOs, a classic Catch-22.
Naturally, there is only one real choice about how to respond, which is to confirm compliance. But in complex organisations, many CEOs will not have the time to access and personally assess the underlying information to satisfy themselves that the response they are effectively required to give to the FSA is complete and accurate in all respects.
It seems reasonable, there-fore, for a CEO to rely on his or her compliance team to deliver such a response and that is what appears to have happened in the FSA’s recent Towry Investment Management case.
The Towry case is interesting for a number of reasons. It demonstrates once again that failures to adhere to the client assets sourcebook are extremely costly for firms.
The FSA reports that Towry held an average of £50.6m of client money at any one time and using the FSA’s fining formula for Cass breaches (representing 1 per cent of the average client money at risk), the applicable fine would have been £506,000 (before any discount). This same formula was used to calculate the biggest fine ever issued by the FSA, of £33.6m, to JP Morgan Securities in 2010.
Another interesting facet of the Towry case is that the FSA found a breach of principle 11. This is the high-level principle that requires a firm to “deal with its regulators in an open and co-operative way, and…disclose to the FSA appropriately anything relating to the firm of which the FSA would reasonably expect notice”. Of itself, another Catch-22.
It has previously been rare for the FSA to find principle 11 breaches but a few recent examples show that this principle should not be forgotten.
The fine of Goldman Sachs International in 2010 is perhaps the best example, where GSI failed to disclose to the FSA that it was being investigated by the SEC in the US.
In the Towry case, the FSA determined that there had been a breach of principle 11 because Towry had “failed to undertake adequate enquiries” before replying to a “Dear CEO” letter to say it was compliant with the FSA’s Cass rules and because Towry did not disclose “appropriately” breaches of Cass requirements.
As part of a thematic visit in November 2010, some months after the Dear CEO response confirming compliance had been given by the firm, the FSA itself discovered Cass breaches at Towry and the disciplinary action followed.
Clearly, client money remains a high priority for the FSA, following the issues uncovered after the collapse of Lehman in 2008 and continued financial instability. But the Towry case also reminds firms of the importance of handling “Dear CEO” letters with great care and the all-encompassing duty to self-report under principle 11.
Mark Pritchard is a lawyer in the financial services regulatory team at solicitors TLT