The Voice of Private Client Compliance and Regulation
NEWS
• FCA’s AIFMD reporting software ready at last• BVI and Cayman suffering sanctions lag• Bitcoin companies fleeing NY to IoM• UK’s appeal against EU bonus cap founders• PEPwatch: ‘get Putin’s friends’ campaign underway… and more
ARTICLES
• Should single family offices worry about the AIFMD?• How to make the ‘social media opportunity’ compliant• Directors’ duties in a third-party fraud• Q&A with an American AML guru• New York court shields overseas PEP assets … and more
INSIDEWealth Briefing, in association with Appway and with support from the accountancy firm of KPMG, recently undertook a global survey of wealth managers’ attitudes to the compliance during the onboarding process for private clients. The results are inside.
These reforms stem from recommendations that the Parliamen-tary Commission on Banking Standards included in its final report, which it entitled ‘changing banking for good.’ The Financial Services (Banking Reform) Act 2013 also gave the Treasury the power to ex-tend the reforms to cover the UK branches of foreign credit institu-tions (i.e. banks) and investment firms. This power is exercisable by statutory instrument (using the affirmative procedure) and the Treasury is required to consult the regulators, organisations which represent interests substantially affected by the proposals and any other persons it considers appropriate before starting the Parlia-mentary process. The consultation period closes on 30 January.
The effect of the order, if it is passed, would be to make foreign financial firms that have a branch in the UK and are credit institu-tions or investment firms designated by the Prudential Regulation Authority into ‘relevant authorised persons’ for the purposes of Part V of the Financial Services and Markets Act 2000. The order, according to HM Treasury, will not be designed to expose a senior manager in such a branch to any liability to the new offence relat-ing to a decision causing a financial institution to fail set out in s36 Banking Reform Act.
The regime includes a ‘presumption of responsibility’ so that senior managers can be held to account when a bank fails to comply with regulatory requirements in their area of responsibility and they failed to take reasonable steps to prevent or stop the contravention. It also mandates statements of responsibility, setting out the aspects of the bank’s business for which a senior manager is responsible; a ‘register of approved persons’ that the Financial Conduct Authority is required to keep that the names of all senior managers and details of regulatory action that anyone has taken against them; a requirement for every bank to verify that someone is ‘fit and proper’ to do a job within its walls before asking the FCA to approve him; an annual assessment by every bank to see whether there are any grounds on which a regulator might seek to withdraw its approval of a senior manager and, if so, to notify the regulator of those grounds; the need for every bank to verify someone’s ‘fitness and propriety’ before giving him a ‘significant harm’ job, and annually thereafter; powers for the PRA and FCA to make enforceable rules of conduct for all employees, however lowly, at the relevant banks; a requirement for banks to notify the appropriate regu-lators when they take formal disciplinary action against any employees (an immense generator of paperwork); and a requirement for banks to notify all employees of the rules of conduct that apply to them.
FOREIGN BANKS IN LONDON TO SUBMIT TO STRINGENT SENIOR MANAGERS’ REGIMEHM Treasury is now consulting interested parties about its plans to extend its ‘senior managers and certification regime’ (SM&CR), as introduced by Part 4 of the Financial Services (Banking Reform) Act 2013, to senior managers at the British branches of foreign banks for the first time.
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US REGULATION
Q: What do US regulators tend to look for when they visit a firm?
A: They look at what work you should be doing as a compliance officer and the kind of people to whom you delegate stuff. If the regulators find that you have delegated things to an unregistered designated manager and unqualified people, it says how much you care about compliance. It will bring trouble to your firm. That’s what they look for first. They also think that your advertising is ex-tremely important. They will look to see whether it gives people a good idea about what you really do. This is something they are bound to hold you to.
If FINRA, the Financial Industry Regulatory Authority, contacts you about some information they want and you provide it late, this is not going to bode well. They’ll become very unhappy. Communica-tion with regulators is very important. They look at detail. If you’ve been sanctioned by a regulator and you’re not that big a firm, for instance if you’re in the second year of business and you have a fine, this is not good. Your reputation is all you’re going on because it’s intellectual property and the people in this business know each other.
Q: What tips do you have for organising an AML programme?
A: The act [of money-laundering] itself is international. You must look for red flags. You should send off a suspicious activity report [to the Financial Crimes Enforcement Network or FinCEN] even if it’s a small suspicion. Firms should do this but often don’t, because they don’t want their customers to be deemed suspicious by anybody.
Q: Can a US compliance officer be sent to jail for not reporting, in the same way that a British money-laundering reporting officer can be?
A: No, and he won’t be prosecuted for preparing a bad AML pro-gramme either. He’ll probably be relieved of his duties. He could be prosecuted for aiding and abetting – I have seen compliance of-ficers being indicted recently by the Securities and Exchange Com-mission, which has its own court. The penalties are light and there are not many such cases in the US.
Interestingly, I heard of a survey where they asked high-net-worth individuals with accounts with $100,000+ or their own internal brokers the question “would you like to see more regulation?” The answer was yes, surprisingly. And they wanted to impose jail time on compliance officers who were guilty of aiding and abetting and even for bad AML programmes.
Q: What regulators have you dealt with?
A: The National Association of Securities Dealers and the member regulation, enforcement and arbitration operations of the New York Stock Exchange, which merged in 2007 to make FINRA. They were self-regulatory organisations and so is FINRA today. Its job is to un-
burden the SEC from its duty to perform various tasks. It cannot put anyone in jail. I think the SEC can press federal charges and it can’t. FINRA has become a smaller SEC with a chip on its shoulder because it lacks enforcement powers. It gets none of the glory and does all of the investigative work. They don’t ‘have any handcuffs.’
Q: Are examiners educationally sub-normal, as everybody likes to say?
A: I think we have to do a case-by-case evaluation. They certainly come over as arrogant. They really teach their investigators and au-ditors to be very thorough. They are reputed not to be the sharpest tool in the shed. I think they created it themselves but I think it’s unfounded. I always found the audit very thorough. I know that’s not everybody’s opinion. People do often think ‘here comes the dummy’ and they certainly aren’t very approachable. However, when they latch onto something, it’s like a shark.
Q: What’s the best way of knowing how to deal with the regulators?
A: When you make friends at the regulators, that’s when you get the gold. It’s rare [for consultants to make friends with people who work at reguatory bodies]. Cordium has somebody at FINRA. I have two!
Q: Are they cagey about what they tell you?
A: No. They say to me that they have two reasons for telling me things about their work: (a) it helps them to do their jobs more easily and (b) I’m fighting the good fight. One of them said to me “you’re pre-empting any problems before we get there, and that’s good. You’re making our jobs easier. We want to see firms doing the right thing.” I’ve often blown a whistle as well.
Q: What other differences are there between the SEC and FINRA?
A: The examiners are salaried and those salaries have to be paid for but any profits that FINRA makes get disseminated back to the brokerage firms [something that does not happen in the UK]. The SEC is different. If you work for them you get more benefits because you are working for the US Government. There are problems there, though, as the legislative branch has been imposing budgetary cuts since the credit crunch, so it’s a double-edged sword. Some people have not had a raise in salary in a year. And when the SEC comes in to do an audit, you have less time to prepare and more people come. FINRA typically sends one person.
Q: When the SEC site presents a message from ‘the staff’, what does that mean? Surely everybody there is a staff-member.
A: These are the people who deal with the information on the site, i.e. the public relations people. It’s really another way of saying ‘this is what’s going on’.
A FINANCIAL CRIME COMPLIANCE GURU SPEAKS FROM ACROSS THE PONDChris Hamblin of Compliance Matters recently interviewed John Donegan, the vice-president of broker-dealer and AML consulting in Cordium’s New York office. Among many other things, he is an anti-money-laundering expert and an authority on US suitability rules and the securities frauds to which many HNW clients succumb.
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US REGULATION
Q: For years, compliance experts in the UK have been wondering why lawyers keep going into the SEC, out into private practice and back in again, while British regulators tend not to. What stops them is the fact that they can earn three times as much in private practice as they do as regulators. I heard that it’s illegal in the US for law firms to pay the salaries of their alumni as they go back for another stint as regulators but they get round this by (illegally) promising to ‘see them right’ after 3 years of not earning very much and that it’s worth it for the law firms because they get early warning of what’s coming next. What are your thoughts about that?
A: Yes, it’s the revolving door. Matt Taibbi, the journalist, has ex-plained this. Lawyers from investment banks are writing the laws they intend to break. The revolving door creates a monstrosity. ‘Too big to fail’ exists because of corporate cronyism. They’ve taken this job in private practice to lobby the very people who are regulating their firms. I’d love to believe it’s not happening, but it is.
Q: What would you do to remedy the situation?
A: I would create a ‘regulator watchdog’ which examines the regu-lators for propriety. We have the Committee of 70, a political watch-dog group and research and election information source for the Philadelphia metropolitan area. They make sure that everything is going the way it should, so I’d have a separate watchdog like that. Second, I’d say that if you’re with the regulator, you can’t go and take a position with regulated people. The revolving door should be shut.
I love my industry. Despite these problems, we’re doing great things and making markets as fair as they can be.
Q: You must have witnessed a lot of securities fraud against high-net-worth people. In the US, for an individual to be considered an accredited investor, he must have a net worth of at least $1 million not including the value of his primary residence. Then he’s permit-ted to invest in certain types of highly risky investments such as seed money, hedge funds and private placements, but they aren’t all sophisticated enough to be allowed to do that, are they? Elvis, for example, was a HNW individual who was very good at music but finance wasn’t his field of expertise and he was constantly
being ripped off by the card-sharp who managed him, who was himself terrible at handling money. You could argue that Elvis was a vulnerable HNW and that there are many like him today.
A: Yes, if you have the wherewithal to create wealth, you can still be vulnerable. HNWs are the most common victims of fraud, espe-cially the elder ones. These are the ones we need to protect. It’s all about suitability. FINRA is going to ask firms for proof of suitability. It’s coming up in a year. It’s the CARDS (Comprehensive Automated Risk Data System) initiative and it’s for everybody, but especially HNWs. CARDS will involve account reporting requirements that would allow FINRA to collect, on a standardised, automated and regular basis, account information, as well as account activity and security identification information that a firm maintains as part of its books and records. It will allow FINRA to run analyses that identify ‘red flags’ to do with sales practice misconduct. The $1m [threshold] should be moved to $3-5 million. Also, you shouldn’t be allowed to sell a 90-year-old a variable annuity that has a death feature!
“FINRA is going to ask firms for proof of suitability. It’s coming up in a year”SEC and FINRA suitability rules are numerous. When an HNW in-dividual comes to a securities house, you must ask ‘why weren’t they handling their own accounts and wealth?’ They’re coming to a financial planner because they don’t know what to do. I dislike the term ‘HNW’ and like the term ‘accredited investors.’ The SEC and FINRA do have an HNW category and they regulate them more lightly but every bit of advertising you want to do to senior citizens has to go by FINRA. If you are doing it, you’ll get a visit every year. A lot of people prey on these people. It is a mistake to treat someone as an HNW, unless he’s been trading options all his life. They still try! You can even receive an SEC reward for stopping a fraudster, although not if you’re a compliance person, because then you’re just doing your job.
* Compliance Matters hopes to interview John Donegan further in future. He can be reached at [email protected]
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The financial services industry has been criticised in the past for being slow to take advantage of social media, but uncertainty re-garding regulation and the perceived riskiness of it all has led to a degree of cautiousness. It can also be argued that although social media may have a place in large institutions such as banks that have the structure and financial resources to follow an effective strat-egy and also manage compliance and business risk, the value and return on investment for smaller financial firms is less clear.
The Financial Conduct Authority’s recent consultation paper [GC14/6 Social Media and Customer Communications] may seek to make existing rules surrounding social media promotions a little clearer, but the rules are so uncompromising and rigid that it is dif-ficult to create a promotion that works well from a marketing per-spective. Any contravention of financial promotion rules can result in a criminal offence that carries up to two years imprisonment and an unlimited fine, so it is of paramount importance for every firm that wants to be involved to decipher the rules and consider how it can take advantage of social media platforms to drum up business while also remaining compliant.
THE PROPOSED RULES: COMPLICATED STUFF
Firms can take some comfort in the fact that the FCA has not pro-duced its guidance consultation paper in response to any particular non-compliance in this area and we have yet to see any enforcement action or fines. However, any firms that are hoping for a ‘how-to’ guide that teaches them how to slip social media into their strategy compliantly are going to be sorely disappointed. Firms are expected to digest the rules to do with financial promotions and consider how these apply to social media. Anyone that has read the FCA’s so-called handbook will know that this can be complicated stuff.
What is clear from the ‘guidance consultation’ is that all financial promotions, even those with stringent word/character limits, are governed by the same rules set out in the handbook. The overriding financial promotions rule is that communications have to be ‘fair, clear and not misleading’ and that customers ought to be receiving products and services that perform in the way they have been led to expect.
THE PROTECTION OF HNWS
The FCA is most concerned with ensuring that firms are putting cus-tomers at the heart of their business practices and that the market operates in a way that promotes fair competition.
Financial products and services are often complex, containing con-cepts, terminology and structures that most consumers do not come across everyday. This is why it is especially important in finan-cial services for information to be clear and understandable and for promotions not to be misleading. The FCA’s ultimate aim is to raise
standards to empower consumers to make decisions they can feel confident about.
Before a firm decides how to promote a new product or service through advertising, it is important for it to select the appropriate target market and then design the product or service for it, rather than the other way around. It is wise to conduct market research to find out the needs of designated target groups to ensure that it reaches the consumers for which it was meant and, crucially, not those for whom it is not suitable.
The regulator suggests using software that enables advertisers to target particular consumer groups precisely. Many social media platforms hold valuable demographic information that firms can use to target their promotional and/or advertising efforts. Although this ‘manages the risk’ somewhat, firms should also be aware of the limitations of this method, such as limited options for criteria and the likelihood that they will be seen by people who are not being targeted. In order to manage this risk further, firms should ensure that each advert is clear and provides enough information to allow the intended target to work out whether or not it would meet his needs or circumstances.
INVITATIONS AND INDUCEMENTS
The financial promotions rules apply where there is an element of persuasion in the content. According to the FCA, “...any form of com-munication (including through social media) is capable of being a fi-nancial promotion, depending on whether it includes an invitation or an inducement to engage in financial activity” and applies to invest-ments, mortgages, insurance, banking and consumer credit. Some examples are obviously persuasively worded; many are less clear.
Consider the following Twitter examples which provide a signpost to a website containing a financial promotion:
Example A: ABC Mortgages – ‘To see our current mortgage offers click here: [link]’
Example B: ABC Mortgages – ‘To see our great mortgage offers click here: [link]’
Example C: ABC Mortgages – ‘We have the best mortgage offers in the UK. Click here to take advantage now! [link]’
Only example A is compliant as it is simply a factual signpost to the company’s mortgage offers and does not contain any inducement to engage. The other two contain persuasive language that requires an accompanying risk warning such as: ‘Your home may be repos-sessed if you do not keep up repayments on your mortgage. Early repayment charges may applicable’. The promoter could do this by including a link to a website with a disclosure notice; this would
HOW TO TAKE ADVANTAGE OF THE ‘SOCIAL MEDIA OPPORTUNITY’ WHILE REMAINING COMPLIANTTen years on from the advent of Facebook and with platforms such as Twitter, Google+ and YouTube looming large in terms of active user numbers, social media has gone beyond a fad or a phase and has become a habit for many people. Ian Stott, the client services director at the Consulting Consortium in the City of London, provides us with a very comprehensive set of tips.
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PROMOTIONS
keep things within the 140 character limit. However, as can be seen, examples B and C have different levels of persuasiveness, with B not seeming particularly compelling. Companies ought to consider the ways in which they use language and should put themselves in the shoes of the consumer. They should say: “Does this incite me to engage in investment activity?” The rule of thumb is that if it is a mere statement of fact containing no emotive language, it should not be viewed as a promotion.
This does not mean that firms are not allowed to promote products and services; it just means that they have to carry the associated risk warnings so that a consumer who views only that promotion is supplied with the necessary information regarding both the pros and cons of a product or service.
TIPS FOR FIRMS
1. Have a strong strategy before commencingThe FCA ‘guidance consultation paper’ sets out a number of wider expectations for firms that undertake promotional activity on social media, including the requirement to have a clear process in place for signing off digital communications and the ability to keep ad-equate records of communications across social media channels.
Because of the regulator’s focus on all aspects of a firm’s behav-iour on social media, it is important to establish clear guidelines to govern the creation of content, the approval process, consumer interaction and monitoring. It is important to do this in conjunction with measurable goals and targets for the activity, whether in terms of growth or interaction. By doing all this prior to taking any action, firms find it far easier to monitor the success of their efforts and adapt them as their relationships with their customers develop.
2. Be aware of what is being reposted and/or sharedReposting, either through ‘sharing’ on sites like Facebook or Linke-dIn, or ‘retweeting’ on Twitter, is also a regulated act which the FCA will approach in two ways:
(i) If the recipient of a communication (client/ prospect etc.) shares a firm’s message on social media, the firm remains responsibile for the compliance of the message because it is the original commu-nicator. Deliberations about whether the message would remain compliant if it were to end up in front of a non-intended audience should take place at both the content-creation and approval stages.
(ii) If a firm retweets a customer’s tweet, the responsibility for en-suring compliance still lies with the firm, even though it was not the originator of the content. It is natural to want to share positive reviews with the wider network, and to a certain extent firms still can, as long as the original message is compliant with the financial promotion rules.
Consider the two examples below:
Example A: Customer 1 - ‘Everyone should check out Adviser D, he just got me a 450% return on my investment!’
Example B: Customer 2 – ‘Thanks for the brilliant service today, Adviser E. You really helped make my options clearer!’
While Customer 1 has every right to express his satisfaction with his investment in this way, if the firm were to share this with its follower-base it would be in contravention of the FCA’s financial promotion rules because the wording would call for a risk warning and the regulator would also see it as an inducement to engage in
financial activity. The second example is not an inducement to en-gage in financial activity and it would be ‘compliant’ to share this in the eyes of the regulator.
3. Put sturdy systems and controls in placeOne of the root causes of firms making non-compliant financial promotions is an absence of appropriate systems and controls that ensure adequate oversight. Firms should have a compulsory com-pliance department sign-off process in place to stop themselves from promoting things in a way that does not comply with the rules.
4. Ensure that everyone involved is aware of the rulesIt is imperative that all staff, whatever their jobs or functions, should comprehend the implications of not adhering to the rules and have a clear understanding of the firm’s policies for signing promotions off.
VIABILITY FOR SMALL BUSINESSES
Although certain financial service companies, notably retail banks and price comparison websites, have managed to build a significant online and social media presence, such operations can seem unat-tainable to small businesses that are always struggling to maintain profitability within an increasingly strict regulatory regime and a changing consumer landscape.
The regulator will not like it if a firms spreads it resources thinly in key areas such as compliance to make way for better use of social media and it does not make good business sense in any case. So what are smaller firms to do? They must focus on the most appro-priate channel or channels.
HOW TO FOCUS
Not every social media channel is suitable for every type of busi-ness and a firm with few resources is generally likely to have greater success if it uses a single channel effectively than if it tries to under-take a small amount of activity across a range of media that may not be appropriate for either it or its target audience.
It is important for firms to understand how their customers or tar-get markets use each social media channel before deciding if it is the most effective way of communicating with them.
‘PROCESS’ IS THE NAME OF THE GAME
Social media can be a fantastic way in which financial services firms of all sizes talk to and maintain relationships with their customers (and potential customers) as long as their financial and personnel resources permit it. However, firms need to be aware of, and ad-here to, the strict regulations that govern advertising and promo-tional communications.
Firms can present regulators with evidence that they are deter-mined to provide their consumers with “clear, fair and not mis-leading” communications in relation to financial promotions by ensuring that the processes by which they deal with social media, particularly the sign-off and monitoring processes that the FCA re-quires, are robust. All companies should be mindful that to disre-gard the FCA’s rules may is to court enforcement action.
* The Consulting Consortium, or TCC as it likes to be known, has been supporting businesses in the compliance and regulatory sectors for more than thirteen years. Its consultants can be reached at www.theconsultingconsortium.com or on +44 (0) 20 3008 6020.
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FCA PUNISHES RBS AND OTHERS FOR MAJOR IT BREAKDOWN IN 2012The UK’s Financial Conduct Authority has fined Royal Bank of Scotland – parent of private bank Coutts – National Westminster Bank and Ulster Bank a total of £42 million ($65.7 million) for IT failures that took place in June 2012 and prevented more than 6½ million clients from using services such as ATMs or paying their mortgages.
The Prudential Regulation Authority, which supervises banks in terms of preventing risks to the financial system, also fined the banks a total of £14 million in a separate exercise.
“The FCA has taken this action against the banks for failing to put in place resilient IT systems which could withstand, or mini-mise the risk of, IT failures,” the FCA said in a press release. It went on to say that the IT incident was caused by a software com-patibility problem, the underlying cause being the banks’ failure to erect adequate systems and controls to identify and man-age their exposure to IT risks.
The IT failure affected clients in the UK for several weeks, preventing people from withdrawing or depositing money, mak-ing timely mortgage payments or getting cash when abroad. Other problems in-cluded the application of incorrect credit and debit interest by banks to customers’ accounts and the production of inaccurate bank statements. Some organisations were unable to meet their payroll commitments or finalise their audited accounts.
On 17 June 2012 Technology Services (the banks’ group centralised IT function) upgraded the software that processed updates to customers’ accounts over-night. When it noticed problems with the upgrade it decided to uninstall it without first testing the consequences of that ac-tion. Technology Services did not realise, however, that the upgraded software was not compatible with the previous version. This caused the IT incident that disrupted customers’ ability to use banking facilities on 20 June 2012.
“The incident was not the result of the banks’ failure to make a sufficient invest-ment in its IT infrastructure. The RBS
Group spends over £1 billion annually to maintain IT infrastructure. The FCA ac-knowledges that since the IT incident the banks have taken significant steps to ad-dress the failings in their IT systems and controls,” said the FCA.
The fine is significant for another reason: this is the first time that the FCA and the Prudential Regulation Authority have tak-en joint enforcement action. The banks agreed to settle at an early stage of the investigation and therefore qualified for a 30% ‘stage 1’ (total capitulation up-front) discount.
IRANIAN SANCTIONS: HARSHER FOR BRITISH OVERSEAS TERRITORIES?The current and continuing thaw in rela-tions between the West and Islamic Re-public of Iran is leading to a relaxation of the United Nations ‘Iranian sanctions re-gime’, but offshore jurisdictions appear to have been left out of the loop.
US Secretary of State John Kerry has stopped off in Paris to co-ordinate his ap-proach to Iran with the French on his way to a crucial round of negotiations in Vienna on the matter. A final deal is not yet in sight but a further thawing of relations seems inevitable.
Aki Corsoni-Husain, the head of regulatory law at the global law firm of Harneys, told Compliance Matters: “The position of the offshore world in this is not entirely posi-tive. Last year the Obama government had a meeting with Iran to reach a commitment on their nuclear programme. The quid pro quo of this accommodation is a relaxation of sanctions to a certain extent and this has been happening. For some reason, though, these have not been implemented in the United Kingdom’s overseas colonies through the usual Orders in Council.
“In the overseas colonies the anti-Iran re-gime has been technically stricter than in the UK and European Union. Under EU leg-islation you are prohibited from transfer-ring money to any Iranian over the sum of €10,000 without notifying the authorities.
“That’s up to the value of €400,000 in the UK/EU. It was €40,000. Above that upper
limit, you have to go to the authorities and get a licence. In the Cayman Islands and the British Virgin Islands, it’s still €40,000.”
The offshore law firm of Harneys and Brown Rudnick LLP is orchestrating a live webcast to discuss the matter on 10 December at 14:00 Greenwich Mean Time.
COURT SIGNALS DISMISSAL OF UK’S APPEAL AGAINST EU BONUS CAP
Niilo Jääskinen, one of the European Court of Justice’s nine advocate generals, has made a crucial pronouncement against the UK’s bid to overturn the EU ‘bonus cap’ in his court. Although this ‘opinion’, as it is called, is not legally binding, commenta-tors are taking this as a devastating blow against the British initiative. The British Broadcasting Corporation describes it as a ‘clear lead’ to the other judges.
Last year, HM Government went to the Eu-ropean Court to fight against the EU’s deci-sion to cap the bonuses that bankers were to receive in future. Its arguments were that the new rules were framed hastily as a ‘knee-jerk reaction’ to the banking crisis that was, and is still, engulfing the world, and that they would have a deleterious effect on ‘responsibility.’
One respected compliance guru told Com-pliance Matters: “In this country we rely very heavily on invisible exports. Without financial services we really are a broken country. So we have to pay for the best minds and if they don’t come here they’ll go to Singapore or Hong Kong! Every one of us negotiates the best position that we can for our contract. If you make it punitive, you just get brain-drain away from the UK.”
GABRIEL CREAKS INTO ACTION FOR AIFMD REPORTINGThe UK’s Financial Conduct Authority has now opened GABRIEL, its online reporting portal, to submissions to be made under the Alternative Investment Fund Manag-ers Directive.
United Kingdom
United Kingdom
BVI/Cayman Islands
United Kingdom/Europe
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As reported often in these web-pages, the regulators’ IT people have been dragging their feet for a long time in this area, and not just in the UK. It is to be hoped that the new reporting lines work properly.
The changes introduce five new data items: managers’ reports [AIF001]; fund reports [AIF002]; capital adequacy re-ports for collective portfolio management firms [FIN066]; capital adequacy reports for collective portfolio management in-vestment firms subject to the FCA’s pru-dential ‘sourcebook’ (rulebook, really) for investment firms, otherwise known as IFPRU [FIN067]; and capital adequacy reports for collective portfolio manage-ment firms subject to the prudential sourcebook for banks, building societies and investment firms, otherwise known as BIPRU [FIN068].
The European Securities and Markets Au-thority (ESMA) published its final guide-lines on the reporting obligations for alter-native investment fund managers (AIFMs) recently and dictated a reporting deadline of 8th October, which came and went while the FCA put the finishing touches to GABRIEL. The guidelines can be found in every language from Bulgarian to Swedish at: http://www.esma.europa.eu/content/Guidelines-reporting-obligations-under-Articles-33d-and-241-2-and-4-AIFMD-0
Reporting ‘dos and don’ts’ for Annex IV
The FCA recently came out with some in-formation to do with the reporting of An-nex IV transparency information for ‘full-scope’ UK AIFMs, small authorised UK AIFMs and small registered UK AIFMs. Any firm that is managing and, where rele-vant, marketing an alternative investment fund (AIF) that is a fund-of-funds, feeder AIF and/or umbrella AIF, should report in-formation in respect of those AIFs accord-ing to ESMA’s note entitled “Guidelines on reporting obligations under Articles 3(3)(d) and 24(1), (2) and (4) of the AIFMD.”
AIFMs should treat feeder AIFs of the same master fund individually. They should not aggregate all the information on feeder AIFs of the same master(s) in a single report. AIFMs should not aggre-gate master-feeder structures in a single report (i.e. one report gathering all the information on feeder AIFs and their mas-ter AIF(s)). By the same token, when re-porting information about an AIF that is a fund-of-funds, AIFMs should not look through to the holdings of the underly-ing funds in which the AIF invests. When
the firm in question reports information about an AIF that takes the form of an umbrella AIF with several compartments or sub-funds, AIF-specific information should be reported at the level of the compartments or sub-funds.
On its information sheet the FCA says it expects GABRIEL to be available for AIFMD transparency reporting on Mon-day 20 October. AIFMs must report trans-parency information using the AIF001 and AIF002 reports which they must submit via GABRIEL, the FCA’s online regulatory reporting system.
LAWSKY’S ‘BITLICENCE’ DRIVING FIRMS OFF TO IOMJulia Tourianski, the director of the ‘Bit-coin independence’ project that empha-sises the virtual currency’s worth to in-dividual freedom, reports that the New York Department of Financial Services’ Bitlicence is failing to attract takers. She recently told the press: “The regulatory agencies in New York want to introduce the licence. They gave themselves 45 days to review and submit corrections to the proposed licence. As I was saying before they brought it up, it’s a choke-hold on the start-ups and anyone willing to deal in Bitcoin in New York.”
When asked why she thought that the New York regulators worked for the banks, she said: “Because the banks are exempt-ed from the Bitlicence. I think Coinbase [a popular Bitcoin buying and selling centre] is one of the only companies that’s staying and complying with it. Everyone else is off to the Isle of Man...they’re leaving. New York is going to be isolated, not only are all the businesses going to leave but the businesses that do leave will not be able to interact with anybody in New York in regard to Bitcoin because they’ll be held liable - that’s how far-reaching the law is. So they’re going to reject customers from New York.”
Whereas New York’s regulation of Bitcoin is stifling, the Isle of Man’s is ‘light touch,’ aimed only at providing ‘legal certainty.’ Other nations, such as Bangladesh and Bolivia, have banned it.
An Isle of Man company called TGBEX Ltd, which claims to be the world’s first and
only producer of high-quality physical bit-coins, has just launched its business in the United Kingdom.
Co-founder John Middleton, a committee member of the Manx Digital Currency As-sociation and the Isle of Man Branch of the Institute of Chartered Secretaries & Ad-ministrators, a director of the Isle of Man Fiduciary Freeport Trust Company and also the CEO of Garigus Limited, the first com-pany in the world with shares funded in Bitcoin, said: “Our coins are produced by generating private keys offline and by en-graving the keys onto the coins, which are then secured, loaded with bitcoin and all records of private keys destroyed. Security of the bitcoin keys is paramount to our cus-tomers, so each coin is engraved via a CAM process to reduce the likelihood of human error and each coin is checked and signed off on the certificate and order form. The whole process is overseen and we have procedures in place to prevent the theft, or loss of private keys.
“The Isle of Man is an ideal location. The ability to have a chat (and a coffee!) with the data protection department, or meet the FSC at a week’s notice, just wouldn’t be possible anywhere else.”
TGBEX engrave public and private keys onto the obverse of the coins, with the private key covered by a holographic se-curity sticker in an undisclosed location. Their website is at www.tgbex.com
RUSSIAN PEP UNDER SCRUTINY FROM FEDSGennady Timchenko, an ultra-high-net-worth friend of Russian president Vladimir Putin’s, is apparently to be the first subject of a criminal investigation that stems from the US sanctions drive against Russia.
Timchenko is the founder of Gunvor Group, a commodities trading firm that he alleg-edly used as a conduit for the proceeds of crime, forcing it to purchase oil from the Russian oil firm of Rosneft and selling it on. The US Attorney’s Office for the Eastern Dis-trict of New York is leading the investigation, according to reports. Besides Gunvor, Timchenko also has shares in Novatek, the Russian ‘gas giant’ that is second only to Gazprom, and Sibur, Russia’s largest chemical manufacturer.
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AIFMD
The AIFMD is the biggest development in the fund management industry in recent times and all its requirements became directly applicable from July 2014. The ‘family office’ exemption does not apply to multi-family offices.
WHAT DOES THE AIFMD DO?
The AIFMD makes managers of alternative investment funds (AIFMs), and the funds themselves (‘AIFs’) subject to regulation that is consis-tent throughout the European Union. It is expected to make the EU’s financial sector more stable and allow EU authorities to regulate the larger hedge funds and private equity groups more intensely.
Any entity that manages a collective investment scheme which is not a UCITS is likely to be an AIFM managing AIFs for the purpose of the AIFMD. Given the extremely broad definition of AIFs, single family investment vehicles and offices are specifically exempted from the AIFMD in circumstances where “the investment [is] in an undertaking by a member of a group of persons connected by a close familial relationship …”
Recital 7 to the AIFMD provides a carve-out which applies to single family offices that do not accept external capital: “family office ve-hicles which invest the private wealth of investors without raising external capital should not be considered to be AIFs in accordance with this directive.”
In other words, the AIFMD should not affect a single-family office if that office deals exclusively within that single family. However, if a single-family office enters into an investment alongside other investors (where no such family relationship(s) exists) that office could come within the AIFMD’s remit. This is true even if the family office would not usually consider itself to be a multi-family office. Any such arrangement could be viewed as a collective investment scheme and the raising of capital from third party sources within the scope of the AIFMD. If there is a structure that can be construed as a collective investment scheme (i.e. a pooling of capital with a view to generating a return), it could be considered an AIF and thus governed by the AIFMD. This could still capture those single family offices that believe themselves to deal exclusively for ‘family and friend’ investors.
The key areas of regulation under the AIFMD include:• more onerous reporting and disclosure obligations, for both regulators and investors• various governance and conduct-of-business standards requirements above and beyond those that national regulators already impose• new rules to govern the use of prime brokers and depositories/ custodians• a requirement for managers to retain regulatory capital that is based explicitly on assets under management• new remuneration-related obligations
WHAT DOES THIS MEAN FOR SINGLE- AND MULTI-FAMILY OFFICES?
Costs under the AIFMD will increase for both single-family and multi-family offices, which must now either ensure that they obey the AIFMD or that they do not fall into its orbit. In view of the fact that they are bound to pass compliance costs on to the end user, funds in the EU are likely to become more expensive for their inves-tors. This is a key issue for family businesses and the people who run family offices that invest in such funds.
FAMILY OFFICES BASED OUTSIDE THE EU
One additional group that is exempt from the full repercussions of the AIFMD are AIFMs that market AIFs to EU investors through national private placement regimes. Most of the managers that fall within this category are based outside the EU so this would apply to non-EU family offices seeking to raise capital from EU investors. To do so, a non-EU manager must comply with requirements set by national private placement regimes, which may vary. For example, regulations 57, 58 and 59 of the UK Alternative Investment Fund Managers Regu-lations 2013, requires managers using the national private placement regime in the UK to notify the FCA and demonstrate that the regime by which the AIF is regulated meets international standards.
The European Securities and Markets Authority (‘ESMA’) will review the way the national private placement regimes work in 2015. Euro-pean authorities may have to issue EU marketing passports to non-EU managers as a result. It is expected that all the national private placement regimes will be abolished in a full review of the AIFMD that is timed for 2018.
WHAT SHOULD FAMILY OFFICES DO?
• Family offices should review their structures to ensure they definitely do not manage AIFs and are not inadvertently breaching the AIFMD.• When a family office deals with a small amount of external capital, it should ask itself whether or not the trade-off between having access to that capital and the extra costs of complying with the AIFMD regime continues to make economic sense.• When a family offices is close to the €100 million threshold and manages AIFs that accept external capital, it should consider whether it is prepared to run the risk of going over various thresholds and whether it is prepared to comply with the full scope of the AIFMD if so. If not, it may wish to consider redeeming units, or restructuring its operations by closing AIFs to stay beneath this €100 million threshold. Alternatively, the family office could convert AIFs into managed accounts, which are not subject to the AIFMD.• When family offices deal with external capital and expect to fall into the small AIFM regime, they should consider whether their current reporting capabilities will enable them to provide the information that they will have to report annually. Family offices
SHOULD SINGLE FAMILY OFFICES BE BOTHERED ABOUT THE AIFMD?Many were relieved to see that single family offices were one of the groups specifically exempt from the Alternative Fund Managers Directive. Despite this, the AIFMD may still have unexpected consequences for single family businesses or, at least, for family single offices that manage the wealth generated by large single family businesses. Kirsten Lapham, an associate at the global law firm of Withers, has the answers.
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LIABILITY FOR DIRECTORS
should consider whether they will need additional services from existing ‘third party’ providers, or whether new providers will be required to enable compliance.
* Kirsten Lapham is an associate at Withers. She can be reached on +44 (0)20 7597 6812 or at [email protected]
The case involved a claim by Group Seven Limited for fraud in relation to a ‘fantasy investment’ of €100 million. One of the defendants al-leged that the company’s directors had breached their duties by fall-ing for the scam and should be liable in part for the company’s loss.
Although this case was decided under Maltese law, the High Court’s conclusion that the two directors were in breach of duty is worthy of note. Directors in this situation could face personal liability to the company for losses caused by fraud perpetrated by third parties.
“The senior in-house legal counsel had no idea what the investments were”FACTUAL CIRCUMSTANCES
In each case concerning an alleged failure to comply with directors’ duties codified in the Companies Act 2006, the particular facts will be paramount. In this case, a number of factors were relevant including:
• the patent absurdity of the fraud perpetrated on the company which, amongst other things, promised returns of €1.3 billion on an investment of €100 million over a period of 13 months and which the fraudsters claimed was backed by the Federal Reserve in Washington releasing Medium Term Notes at a discount of up to 20% from face value to special, ‘selected’ projects of which it approved, thereby allowing the recipients to make an almost immediate profit (to be split with the Federal Reserve);• the level of secrecy that the fraudsters had encouraged, thereby closing off investigation into the preposterous nature of the ‘investment’ or the shadowy group of people who would be involved in the ‘investment’ – an unknown and credential-free ‘Tier 1’ authorised trader of the Federal Reserve; an unknown and unheard-of group called the 786 Group in Washington; the Committee of 300; the Illuminati; and finally a trading ‘platform’ operated by the Vatican and the Royal House of Aragon;• the credit of €100 million of the company’s money to an account over which the company surrendered control and had no security, the purposes of which were deliberately concealed from the bank where the account was held and operated; and
• the side-lining of the company’s chief financial officer, who reviewed initial proposals relating to the scheme and was extremely sceptical from the outset, from the decision-making process.
DIRECTORS’ CONDUCT
The court found that the two directors, one of whom was also group legal counsel, were in particular responsible for the company’s in-volvement in the fraudulent scheme. Their conduct was heavily criticised and the comments below give a flavour of the judge’s attitude.“It is impossible to overstate the level of incompetence demonstrat-ed by [the group legal counsel’s] evidence at this trial. He did no checks on the background of these people trying to sell this transac-tion to him...He discovered nothing about the details of the transac-tions...He accepted without challenge anything they said. Finally, in October 2011, he signed away control of €100 million, despite being required never to agree to anything like that...He took comfort from documents that were meaningless...If he were uncertain as to the law, he should have obtained advice from somebody else. That is what one would expect of a senior in-house legal counsel who might have knowledge of generalities, but would not necessarily have knowledge of specifics. It is plain that he had no idea what the in-vestments were, but was content to accept the vague descriptions provided by the defendants and fell into the trap of believing in the secrecy of everything.”
The two directors were, in the judge’s view, “thoroughly taken in” rather than “dishonestly complicit” in the fraudulent scheme, and committed the company’s funds in a “ridiculous and reckless” way. He concluded that it was clear that they had been in breach of their duty as directors to exercise reasonable skill and care, but he did not think they had been in breach of their fiduciary duty.
POTENTIAL CONSEQUENCES FOR DIRECTORS
If a director has breached a fiduciary duty, he must restore the dis-sipated assets even if it is possible that the company would have suf-fered the same loss without the breach. By contrast, as in this case, if a director has breached his duty to exercise reasonable care and skill, but not his fiduciary duties, the court will consider what may have
DIRECTORS’ DUTIES IN A THIRD PARTY FRAUD: A FRESH COMPLIANCE HEADACHE IN THE MAKINGMary Erb of the British law firm of Fieldfisher grapples with a recent English judgment in which the High Court held that two directors who were taken in by a substantial fraud were in breach of their duty to their company. Not only does this open the door to civil liability for directors - possibly compliance directors - at banks in the event of fraud; it might make them liable for compliance failures that lead to other disasters.
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LIABILITY FOR DIRECTORS
happened without the director’s breach and whether the loss would still have occurred in any event. The director may still be liable to compensate the company, to the extent that the loss suffered can be shown to have been caused by his breach.
In the case of a fraud perpetrated on the company by a third party, directors who have been shown to be in breach of their duty to exer-cise reasonable care and skill may still be liable for the whole amount of loss suffered by the company as a result of the fraud, despite the malevolent involvement of the fraudster. In 2009, the Court of Ap-peal held in Lexi Holdings plc v Luqman that two non-executive di-rectors who knew of another director’s previous dishonest conduct, and did nothing about it, were liable to the company for the third director’s fraud. The reasoning was that the fraud could not have taken place but for the non-executive directors’ failure to exercise reasonable care and skill.
CLOSING CONSIDERATIONS
The courts have acknowledged, in cases concerning directors’ duties, that business activity undertaken by company directors necessarily involves a certain amount of risk and that too hard an attitude on the part of the courts to directors’ conduct may reduce the appetite of directors for appointments, or ‘chill’ that risk-taking business activity beyond a point which is healthy for a company.
It is therefore worth noting that a director may be protected from liability in the case of breach of duty by seeking relief from the court on the grounds that he acted honestly, reasonably and that it is fair
in all circumstances of the case to relieve him of liability (in full or in part). Another possible avenue to protect a director is the ratification by the company of his conduct, or the company may have in place a policy of directors’ and officers’ (D&O) insurance which may cover the relevant liability.
This case illustrates that directors must be vigilant against the pos-sibility of the company becoming a victim of fraud. They may be in breach of duty (and risk personal liability to compensate the com-pany) if the company is victim to fraud and they failed to spot a scam which a reasonably diligent person, with the general knowledge, skill and experience that would be expected of a director in their position (and the general knowledge, skill and experience that they actually have), would have spotted.
OTHER POTENTIAL CONSEQUENCES
If this ruling gains general currency, compliance directors (not to mention COOs and CEOs) at banks may find themselves being found liable for such things as not spotting the fact that their underlings were illegally fixing rates such as Libor, or colluding in obvious ex-amples of bribery by the company’s third-party contractors. There is an appeal outstanding on this matter so it will come before the courts again, so nobody should rely on the case at this present stage. Watch this space.
* Mary Erb is a Partner in Fieldfisher’s Corporate Group in Manchester. She can be reached on +44 (0)161 835 8018 or at [email protected]
A recent joke doing the rounds goes like this: if a busload of tabloid journalists and a busload of bankers were to drive over a cliff, which would hit the bottom first? The answer is ‘who cares’?
Hilarious? Hardly, but it does demonstrate the contempt in which both professions are often now held. The result of this contempt has been a sharp rise in scrutiny and (for the first time in the case of British journalism) regulation for both, most recently through the Leveson Inquiry for the media industry and the Parliamentary Com-mission on Banking Standards for the banks (the latter following recent legislative change to further tighten regulation).
REGULATION V SELF-REGULATION
The outcome of these inquiries, however, could not be more differ-ent. The former makes vague demands for tighter self-regulation, backed up by the punitive Crime and Courts Act 2013, which states that any publisher who wins a libel case must nonetheless pay heavy
costs if he is not a member of the new government-approved regula-tor. The latter seems to be a more thorough affair, with the already very powerful and aggressive financial regulators (most definitely not self-regulators) being handed further powers to regulate. These make it easier to hold individuals (in particular the senior managers who run financial institutions) to account. They will also bring sweep-ing cultural change to firms in the area of ethical standards and gov-ernance, impose more ‘certification,’ introduce new ‘conduct’ stan-dards and impose tighter controls on remuneration (already among the tightest of their kind in any regulatory regime in the world).
Therein lies the big difference between regulation in the finan-cial and the media industries. The banks have the FCA; the press still has its own self-regulating successor to the Press Complaints Commission, the Independent Press Standards Organisation.
The FCA already has very big teeth indeed and likes to bare them regularly. Since its formation in April last year it has increased the
WHAT IF REBEKAH BROOKS HAD BEEN THE HEAD OF A FINANCIAL SERVICES FIRM?She “got away with Murdoch,” in the words of the UK’s top satirical magazine, but if Rebekah Brooks, the former CEO of News International, had been the CEO of a non-compliant bank, would the Parliamentary Commission on Banking Standards have been as kind to her as the jury at the Old Bailey was? Neil Herbert of HRComply has very definite views on the subject.
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LIABILITY FOR DIRECTORS
number of enforcements and bans and the values of fines to a vast degree.
And so we come to the eponymous analogy of this article – what if Rebekah Brooks had been the head of a financial services firm?
Rebekah Brooks was the editor of the News of the World when the newspaper carried out illegal phone hacking. If she had held a simi-lar post in the financial services industry could she have escaped punishment, or at the very least a massive fine? And would she be allowed to return to the industry in a similar post?
MANAGEMENT RESPONSIBILITY TO THE FORE
The financial crisis has taught us not only that the dealers and traders who were out of control; it also taught us that the senior managers at those firms failed to control them. The government’s response to this problem has been draconian.
If you listen to a speech by anyone from the FCA, it is obvious that the regulator is intent on convincing chairmen and CEOs of the im-portance of senior managers instilling a compliance culture at their firms into. In fact 2013 was almost the first year when British finan-cial regulators fined more individuals than companies.
“John Pottage of UBS was the first individual to be fined for supervising his team badly”Principle 7 of APER (the FCA’s statements of principle and code of practice for approved persons) requires an approved person to take reasonable steps to ensure that the business for which he is respon-sible complies with regulatory rules and standards. This regulation has become a source of some trepidation among the higher ech-elons of financial firms. For example, John Pottage, an employee of UBS, was the first individual to be fined by the regulator for super-vising his team badly. Although Pottage (the former CEO) had his £100,000 fine overturned by a tribunal in 2012, he nevertheless lost about four years of his life while he set about proving his innocence.
In the eyes of the FCA, wherever there is a rogue trader, there is a rogue manager who is equally culpable (unwittingly or otherwise). Unless a firm has evolved the correct policies and procedures to mitigate its ‘conduct risk’ and the rogue trader has totally ignored every order that the firm has given him, the regulator will seek ret-ribution from the senior manager also.
A NEW REGIME
The new proposed ‘regulatory framework’ FCA CP14/13 – along with a further consultation paper from the PRA CP14/14 – proposes amongst other things:• a new Senior Managers’ Regime for the most senior individuals in affected firms;• a certification regime affecting a wider population of risk-takers who could harm the firm, its customers, or markets; and• a new set of ‘conduct rules’, divided between those that apply to all non-ancillary staff within a firm and others that apply only to senior managers.
The result of this will be that senior managers will be held to ac-count for ‘conduct failings’ at the businesses they control. This is
a clear reversal of the burden of proof in the case of regulatory misconduct, with senior managers having to prove that they took reasonable steps to avoid the failings. They face up to 7 years’ im-prisonment and unlimited fines if the regulator can prove the mere existence (theirs or not) of reckless misconduct that resulted in bank failure. There will be a doubling of the time available for the regulators to take action against senior persons (from 3 to 6 years from the time of the offence). There will also be further restrictions on remuneration on top of caps that the European Union is impos-ing on so-called ‘variable remuneration.’ In short, the net is tighten-ing on senior managers who preside over firms that fail to stamp out reckless behaviour and unethical conduct.
“In the eyes of the FCA, wherever there is a rogue trader, there is a rogue manager”THE RIGHT ATMOSPHERE
It is already abundantly clear that senior managers must focus on establishing tighter governance and controls through a culture that encourages ethical conduct and compliant behaviours. This can be achieved through a mixture of training, monitoring, policy, assess-ment and appropriate remuneration structures. Senior managers must lead by example and ensure that this culture is instilled from the top down.
On this basis alone then, it is inconceivable that Rebekah Brooks would have escaped enforcement from the FCA had the News of the World been a bank.
We are constantly reminded that the FCA is now focusing on ‘outputs’ not ‘inputs’ i.e. the resultant behaviour of staff that af-fects the product, the markets and customers. A newspaper edi-tor can clearly see the ‘outputs’ of his or her staff on the pages of the newspaper before it goes to press. A senior manager of a bank cannot possibly oversee every transaction, trade or piece of advice being delivered across desks, products and international markets. It should have been a lot easier to spot the unethical practices being blatantly carried out in the News of the World.
PROMOTIONAL LITERATURE GIVES THE GAME AWAY
It is indeed the regulatory imposition of an acceptable culture on finance that makes it differ from publishing so starkly. The FCA de-mands and expects all financial institutions to instil a code of prac-tice and a culture that is acceptable. The tabloid press regulator expects no such thing.
On the subject of apologies, there could hardly be a sharper contrast between the two industries in their levels of contrition. The banking industry has bent over backwards to comply with the ever-growing demands of regulation. On the other hand, on the day of Brooks’s acquittal the sister paper of the News of the World (the redoubtable Sun) ran the headline – ‘Old Bailey Sensation – A Great Day for Red Tops’ – with a full page picture of the red-headed Ms Brooks.
Can you imagine any bank daring to thumb its nose so blatantly at the FCA in its own promotional literature?
* Neil Herbert is the founder and director of HRComply. He can be reached at +44 (0) 844 8794946
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POLITICALLY EXPOSED PERSONS
For the first time, the state’s highest court confirmed that New York common law prevents a court from freezing a civil judgment debtor’s assets held in foreign bank accounts. In Motorola Credit Corp v Standard Chartered Bank last month, the court expressly ad-opted New York’s nearly century-old “separate entity rule,” which provides that even when a bank branch is subject to personal ju-risdiction in New York, that bank’s other branches are treated as separate entities for the purpose of enforcing a judgment, putting them beyond the reach of judgment creditors.
THE KOEHLER CASE OF 2009
Motorola is a particularly noteworthy decision for the international banking community because just five years ago, in Koehler v Bank of Bermuda, the Court of Appeals eschewed the separate entity rule in favour of one bank worldwide, enabling judgment creditors to reach far beyond New York’s borders to grab debtors’ assets. Koehler held that a bank subject to personal jurisdiction in New York could be ordered to deliver assets in a foreign branch to a judg-ment creditor even if the underlying litigation, the targeted assets, and the parties themselves bore no connection to New York. In the wake of Koehler, judgment creditors worldwide flocked to New York courts as a portal through which to reach assets all over the world, demanding that banks located in the state should hand over this-or-that judgment debtor’s assets in faraway places.
With Motorola, the Court of Appeals has dramatically curtailed (and perhaps gutted) Koehler, limiting its application drastically and em-phasising the strong policy considerations favouring recognition of the separate entity rule and the significant restrictions that that long-standing doctrine (that was never discussed in Koehler specifically) places on efforts to reach foreign assets. Moreover, the strong policy arguments and considerations recognized by the Court of Appeals will undoubtedly feature in other settings where the spectre of dou-ble liability, conflicting obligations in multiple jurisdictions and inter-national comity (legal reciprocity, stopping courts in one jurisdiction from trampling on the preserves, laws or judicial decisions of anoth-er) come into play, especially in the context of international banking.
BACKGROUND TO THE CASE
In 2003, the US District Court for the Southern District of New York awarded Motorola, the plaintiff, a multi-billion-dollar judgment against the Uzans, finding that they diverted for their personal ben-efit more than US$2 billion in loans that Motorola had made to a Turkish company that the family controlled. For the better part of a decade, Motorola has engaged in an international hunt for the Uzans and their assets.
In 2013, as part of Motorola’s efforts to collect on this judgment, the district court issued a restraining order (pursuant to New York and federal law) freezing the Uzans’ assets. Motorola served the restraining order on the New York branch of non-party Standard
Chartered Bank, a multinational bank headquartered in the United Kingdom. Although Standard Chartered had no Uzan assets at its New York branch, its branch in the United Arab Emirates held about US$30 million in deposits related to the Uzans. When Standard Chartered sought to freeze those assets in accordance with the re-straining order, regulatory authorities in the UAE and Jordan inter-vened and debited US$30 million in Standard Chartered’s account at the UAE Central Bank. The rationale for this action was that Stan-dard Chartered could not dishonour its obligations to repay UAE deposits to satisfy an order from a foreign court. (Motorola never attempted to domesticate its US judgment in the UAE’s courts.)
Faced with conflicting obligations and the prospect of double li-ability under US and foreign law, Standard Chartered sought relief from the district court. Standard Chartered argued that, under New York’s separate entity rule, the restraining notice Motorola served on its New York branch could not restrain assets held in another Standard Chartered branch in the UAE. Motorola responded that Koehler allowed the restraint of assets in the UAE via Standard Chartered’s New York branch. The district court found for Standard Chartered. On appeal, the US Court of Appeals for the Second Cir-cuit certified to New York’s high court the question of whether the state’s separate entity rule precludes a judgment creditor from or-dering a garnishee bank (a bank directed to surrender a debtor’s assets that are in its possession) operating branches in New York to restrain a debtor’s assets that it holds in its branches outside the United States. The Court of Appeals answered that it did.
HOW PRO-BANK POLICY CONSIDERATIONS KEPT AN OLD DOCTRINE ALIVE
In a 5–2 decision, the Court of Appeals held that “service of a re-straining notice on a garnishee bank’s New York branch is ineffective under the separate entity rule to freeze assets held in the bank’s for-eign branches.” The long-standing common law doctrine, the court held, was firmly rooted and very much alive in New York, citing state and federal decisions applying the rule for nearly a century. The court endorsed the rationale behind the separate entity rule. Acknowledg-ing the multiple amicus curiae (‘friends of the court’) submissions by sovereigns, regulators, and trade groups, the court recognized that allowing US courts to restrain assets overseas would undermine international comity.
The rule, the court held, also eliminates competing claims on the same assets and protects banks from double liability. Moreover, the rule avoids placing banks in the “difficult position of attempting to comply with the contradictory directives of multiple sovereign nations,” as Standard Chartered had faced. Finally, the court rec-ognized that directing banks to process restraint orders for foreign assets imposes an “intolerable burden” by forcing banks to identify and monitor assets in numerous foreign branches. International banks, the court held, have long relied on the benefits afforded by the separate entity rule “when deciding to open branches in New York, which in turn has played a role in shaping New York’s status
NEW YORK COURT SHIELDS OVERSEAS PEP ASSETS FROM JUDGMENT CREDITORSThe New York Court of Appeals recently issued a decision of great importance to international financial institutions and the ‘politically exposed persons’ for whom they act. In this case the PEPs were the family of media-mogul-turned-politician Cem Uzan, whom some describe as Turkey’s answer to Italian premier Silvio Berlusconi. At stake were the family’s holdings in the United Arab Emirates. Lee Armstrong and Sevan Ogulluk of the global law firm of Jones Day were involved in the case and comment on its significance here.
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GLOBAL COMPLIANCE SURVEY
as the pre-eminent commercial and financial nerve centre of the Nation and the world.”
A RETROGRADE STEP?
But what about Koehler? Just a few years ago, this same Court of Appeals held in that case that a bank subject to personal jurisdic-tion in New York could be ordered to deliver a judgment debtor’s stock certificates located in a non-US branch of the bank. The Mo-torola court rejected the argument that Koehler effectively over-ruled the separate entity rule. It noted that the parties did not raise, and the court did not address, the doctrine in that case. Moreover, the court explained, Koehler involved the repatriation of stock certificates and was therefore inapposite to the assets here.
An impassioned two-judge dissent argued that the majority opin-ion could not be reconciled with Koehler and that an ‘outmoded’
separate entity rule was now going to frustrate the collection of judgments, enable judgment debtors to evade enforcement and allow international banks to shirk their responsibilities. Against the backdrop of global “banks being held more accountable than ever for their actions vis-à-vis their customers,” the dissent described the majority opinion as a “step in the wrong direction.”
Although the precise scope of the separate entity rule in the con-text of assets held in domestic branches (as well as assets other than deposit accounts, as in Koehler) has yet to be determined, judgment creditors can no longer view New York as a collection-point for assets located all over the world.
* Lee Armstrong and Sevan Ogulluk are partners at Jones Day in New York. They can be reached on +1 212 326 8340 and +1 212 326 3977 respectively or at [email protected] and [email protected]
For this report, 211 wealth managers were surveyed during August and September 2014. Interviews to discuss the survey’s themes were carried out with 25 senior private banking and wealth management executives. The survey population came more or less equally from the UK, Switzerland, North America and the rest of the world. Half were from private banks; the rest were from a kaleidoscope of asset-management firms, wealth management firms and family offices. 61% of respondents had assets under management of more than $1 billion.
WHAT IS ONBOARDING?
In the mind of the casual observer the word ‘onboarding’ might con-jure up the image of someone coming aboard a ship, but the sur-vey claimed to use the word to describe almost the exact opposite: a never-ending series of checks and surveillance. The first page of its first section said that the term covered “all the activities neces-sary to acquire a client and keep them on a wealth manager’s books compliantly” and that it also encompassed the process of regularly reviewing clients as well as the expansion of existing relationships with the addition of new investment products or services, adding: “in this sense, onboarding underpins the entire client lifecycle, rather than being merely a ‘once and done’ task.”
All respondents were therefore kept aware at all times that they were answering questions not only about processes that always go on at the beginning of the business relationship, such as mandatory know-your-customer (KYC), anti-money-laundering (AML), risk-profiling and suitability assessments and the quizzing of the customer about service preferences, but also the process of reviewing clients regular-ly and the checking that happens when clients buy new investment products or services.
Nevertheless, and slightly confusingly, many of the questions and
paragraphs used the word ‘onboarding’ to refer only to the begin-ning of a relationship. The section on organising and orchestrating onboarding, for example, stated: “during the delicate onboarding phase, fledgling relationships are being nurtured.”
WHEN YOU SAID YOU WAS HIGH-TOUCH, WELL THAT WAS JUST A LIE
Onboarding, in its normal sense at least, is more of a worry for wealth managers than ever before. When asked how concerned they were about clients dropping out during the ‘initial onboarding process’, i.e. the conversion of a prospective customer into a real one, 29% of re-spondents said very, 42% said moderately and 29% said not at all. This suggests that a great deal of business is going by the wayside at the initial ‘KYC’ stage, although the survey did not ask about the frequency with which drop-outs occur. It did, however, mention that fewer than a quarter of firms had procedures for preventing drop-outs and even fewer had highly successful ones, with nearly half labelling their efforts at prevention as ‘not very successful.’
One respondent grappled manfully with the English language to get this point across: “Clients dropping out wasn’t so much of a concern in the past, but now there’s so much competition in the marketplace. A lot of retail and DIY players have a turbocharged ability to get people on board, so now you have clients saying ‘You’re supposed to be high-touch, but I feel that I’m getting a worse service than else-where.’” Several experts who contributed to the study said they were hearing more and more reports of clients losing interest during on-boarding (the word here, as in much of the survey, being used in the sense of ‘coming on board’).
Additional regulations have seriously impeded the average respon-dent’s ability to convert a prospect to a client quickly. More than half (52%) of them said that additional regulation had slowed conversion times down significantly or very significantly over the past five years.
ONBOARDING COMPLIANCE: THE WORLDWIDE SURVEYWealth Briefing, in association with Appway, a software company, and with support from the accountancy firm of KPMG, recently published a global survey of wealth managers’ attitudes to the com-pliance-related problems with the onboarding process for private clients. The results were illuminating.
COMPLIANCE MATTERS | NOVEMBER 2014 | 15
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GLOBAL COMPLIANCE SURVEY
Against this background, the survey warned, a study by ComPeer had predicted that the cost of compliance for British wealth managers was likely to total £500 million a year by 2015, a cost that would be twice as high as the firms’ direct expenses in view of the fact that onerous compliance requirements always increase opportunity costs.
WHEN COMPLIANCE MAKES ONBOARDING A LENGTHY PROCESS
When attempting to measure onboarding time-frames across the industry, the survey took both ends of the spectrum into account. Several of the world’s largest wealth managers have implemented widely-admired systems that have managed to reduce onboarding times drastically through automation and the integration of systems and data sources. At the same time, however, several of the expert contributors said they knew of wealth management firms where the onboarding process was regularly taking in excess of 41 business days, although only a small proportion of the survey participants admitted to this (5% for HNW individuals and 7% for legal entities). It was also noted that some wealth managers were so swamped by regulatory change that their onboarding processes took up to six months in complex cases.
In such extreme cases, the survey’s editorial panel of experts thought that the following factors might be responsible:
• confused/convoluted management lines (possibly between parent and subsidiaries at a local level, as well as within individual business units); • a lack of specialist market expertise to carry out KYC/AML assessments efficiently, particularly in newer markets; • the absence of an end-to-end process; • data silos and the ubiquitous issue of legacy systems (a term that the average salesmen defines as ‘any software systems that were not built by the firm that I happen to work for at the moment’) which are difficult to change and do not talk to each other efficiently.
At the most technologically advanced end of the spectrum, however, the panel thought that things were very different. One panellist said that he knew of a commercially available IT system that used all the client data stored in the institution in question and combined it with risk factors generated from the IT firm’s reference and market data, without any client data ever leaving the financial institution. He said
that the system enabled the relationship managers to monitor invest-ment suitability within portfolios ‘immediately and constantly’. It also had an AML monitoring tool for checking ‘politically exposed per-sons’ that allowed the institution to monitor client accounts and their activities around the clock so that red flags for sanctions or PEP status immediately came to light. Similar systems presumably abound, al-though they are expensive.
THE 5 WORST COMPLIANCE HEADACHES FOR WEALTH MANAGERS
This histogram shows the proportion of respondents who reported that onboarding was having a high or very high effect on their firms’ operations and systems. Figures come from this year and last.
Two-thirds of wealth managers in the survey believed that the pace and impact of regulatory change would increase over the next three years. The authors of the report believe that suitability rules, which are becoming more stringent the world over and which wealth man-agers have to consider globally, are similar to each other in spirit, even if their content varies. As a result, processes that underpin suit-ability can be said to be broadly market-neutral. This may make it easier for financial institutions to implement onboarding systems that can cope with disparate regulatory regimes and to standardise data. For the vast preponderance of firms, KYC/suitability/risk pro-files are already an integrated part of the onboarding process. The report explains that one reason for this is that “unstructured meeting notes and paper-based records could make it very difficult to avoid regulatory censure in the case of a suitability file review.”
To what extent has the time to convert a prospect to a client slowed due to additional regulation over the past ve years?
5
4
3
2
1
0
19%
5 10 15 20 25 30 35
33%
30%
13%
4%
Percentage of respondents %
Rati
ng 1
-5 (l
ow to
hig
h)
20142013
45%30%
38%
38%
48%
24%
39%
15%
33%
15%
18%
30%
36%
34%
34%
33%
31%
31%
29%
31%
27%29%
15%28%
15%28%
Proportion of respondents reporting high/very high impact on their �rm’s operations and systems comparing this year to last.
MiFID II
Suitability
UCITS V
EMIR
FATCA
Capital requirements
such as CAD 4
Dodd Frank
Control of com-mission-sharing
agreements
AIFMD
Basel 3
RDR
PRIPS
TCF
COMPLIANCE MATTERS | NOVEMBER 2014 | 16
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GLOBAL COMPLIANCE SURVEY
ADAPTING TO NEW REGULATIONS (AND INTERNAL RULES)
The frenetic pace of regulatory change in recent years has caused wealth managers to take a fairly fluid approach towards their on-boarding systems and processes. A third of the survey respondents reported that their firms had updated their onboarding procedures in the past six months, and a fifth had done so in the last month. Eight out of ten had made updates at some point in the last year.
A man from KPMG told the authors of the report that wealth manag-ers ought to modify their approach to software to take stock of the fact that things change fast: “The IT infrastructure needs to be lay-ered in such a way that new regulatory developments and associated business change requirements can be implemented effectively with minimal business disruptions and costs.
“Technology vendors can be a useful resource for wealth managers formulating strategies for keeping up with new rules internationally. They will need to centralise their regulatory competences and enrich or marry them with strong business, risk and IT knowledge. I would advise small- to mid-size organizations to strategically collaborate with globally-operating consulting and technology houses that have the depth to maintain global regulatory coverage over time.”
When asked whether KYC formed an integrated part of their firms’ onboarding processes, 89% of respondents said yes and 10% said no. When asked the same question about suitability, 82% said yes and 17% said no. When asked the same about risk profiles, 93% said yes and 6% said no. nearly a quarter of respondents said that their on-boarding systems were still entirely based on paper, with only 6% of them being exclusively digital. The remainder (70%) were a mixture of the two. Bruce Weatherill, the chairman of Clearview Publishing, disapproved of the lack of progress towards digitisation: “Part of the onboarding process is actually to serve the regulatory needs of suitability and KYC by collecting all of the client’s information in one place. If you’re doing it all on paper then all you’re really doing is storing up problems for the future because paper will get misplaced.”
At present, the survey found, full automation is a rarity. Very few wealth managers have end-to-end onboarding practices, that is to say that all the technological resources, proceses and information required to onboard a client are linked up together instead of ‘silo-bound’. Only 5% of wealth managers could so much as lay claim to running completely end-to-end onboarding processes. As one put it: “Processes like STP (straight-through-processing) and automation for filling in documents and harvesting data are being used, but I wouldn’t want to say they’re prevalent.”
ADAPTIVE QUESTIONNAIRES
Bruce Weatherill went on to observe that if a client indicates that he has children during the induction process, the RM should imme-diately ask him for their names, rather than stick to a set menu of questions and only think of asking that question days later when the moment (and the client’s mood) for completing a tedious administra-tive task may have passed. Such is the need for dynamic or adaptive questioning for KYC and other purposes, where the questionnaires adapt according to the type of client. Some firms write the need for adaptation into their onboarding questionnaires; as everywhere else in the survey, automation appears to be the driving force here.
In a section that drew a sharp distinction between ‘onboarding’ on the one hand and ‘updating KYC, risk and suitability profiles’ on the other, the survey recorded that 60% of firms’ KYC questionnaires adapted to the clients being onboarded; 60% of suitability question-naires did; and 58% of risk profile questionnaires did.
Participants also generally saw benefits in “taking a rules-based ap-proach to questionnaires,” using ‘decision trees’ to guide the RM as he asks the questions. According to the survey, close to half of wealth managers did not have a formal ‘process owner’ for onboarding – a sign that the process takes in many departments at a firm – but it said that the job invariably devolved on the RM in practical terms.
BUSINESS BENEFITS THAT ARISE FROM COMPLIANCE OPERATIONS
In a section that begins by discussing the ever-growing compliance burden’s deleterious effect on wealth managers taking on clients as quickly and painlessly as possible, the survey noted that pros-pects were being questioned at greater length and produce and were having to sign more and more types of document and then turned to the question of how to turn this into an advantage. Most respondents found it ‘tricky’ to choose only one business benefit to pursue while trying to improve the onboarding process. The second most popular option – being able to adapt to new regulations more quickly – trailed significantly behind an increase in referrals, with cost-cutting, faster access to new assets and preventing drop-outs close behind.
Diverging slightly from the official survey definition of ‘onboarding’, Anne Grim of Barclays Wealth and Investment Management said: “Onboarding is the first ‘moment of truth’ in the relationship. If it’s done poorly the client’s initial reaction to your organisation will be a negative one and so you’ll be trying to recover from a negative position.” The survey reinforced this with the observation that “On-boarding truly marks the transition between telling the client how well they will be serviced to showing them. It is therefore vital that every element inspires absolute confidence, particularly as clients tend to release their assets gradually over time.” In other words, the client is going to take the efficiency with which the wealth man-agement firm extracts compliance data from him at the beginning as a proxy for the quality of service that he can expect once the relationship has begun.
What is the main business bene�t your �rm would seek by automating/improving the client onboarding process?
Increasing referrals by providing a high-quality onboarding experience
