Suitability and systems: UK FSA fines wealth management firm as further thematic review work continues

• investment committees;
• house models for asset allocation and / or stock selection;
• an approved security list;
• guidelines on what are suitable investments within the risk appetites chosen by the client;
• computer systems which monitor adherence to clients’ investment restrictions, and, where applicable, investment objectives and risk appetites;
• periodic sample peer reviews of clients’ portfolios by senior management and / or other investment managers; and
• exception reporting of client portfolios and stock / asset allocations outside certain tolerances reviewed within the fund management teams and Compliance.

Firms should consider the adequacy and effectiveness of their front office controls and other processes in the light of the weaknesses highlighted in this notice, so as to ensure the suitability of investment decisions and the retention of appropriate documents.

The FSA took the view in the Savoy case that the absence of front office controls and the firm’s reliance on individual investment managers to ensure the suitability of advice, made it even more important that there should have been clear and adequate recording of the basis of investment decisions made on clients’ files and the investment advice given.

The FSA also found examples of investment managers failing to comply with such documented procedures as were in place, such as the investment risk categorisations in Savoy’s standard client agreement form, and identified one investment manager who adopted an investment risk categorisation methodology based on that used at his previous firm.

During the relevant period, Savoy undertook five separate suitability reviews (through Group Compliance and external compliance consultants), which covered areas such as documentation, file quality, portfolio management, disclosure and suitability, the results of which were provided to senior management.   Although a Suitability Working Group was established, introducing minimum standards for client file content, and reviewing and rewriting suitability and appropriateness policies, issues reported to senior managers were not always progressed on a timely basis.

Indeed, the skilled person that the FSA required Savoy to appoint in November 2011 identified a sample of cases where such issues had in fact been closed off on the firm’s outstanding actions database, but which did not appear to have been satisfactorily addressed.

Although the skilled person ultimately assessed that only 4 customers should receive redress, its review of a sample of Savoy files had found that 12 files (23%) showed a high risk of unsuitability, and displayed the following weaknesses:

• poor quality KYC information obtained from clients, missing key information such as outgoings and liabilities, ability to withstand loss, details of income and assets;
• vague categorisation of clients’ assets or income open to wide margins of error, with examples of both gross income and net worth being widely categorised, between £0 and £50,000 and £0 and £500,000 respectively;
• out of date fact find information, which was not relevant to the client’s current financial circumstances or investment objectives, and failures to update the information annually as required by the firm’s Compliance Manual;
• some investment managers using a risk categorisation methodology that was not recognised by Savoy and inappropriately conflicted with the firm’s own client risk profiling documentation;
• investment allocations were made that did not accord with the client’s expectations and/or match the client’s ATR, with no clear rationale recorded on the client’s file;
• absence of clear rationale recorded for investment allocations on discretionary management client files; and
• a heavy concentration in a small number of securities and/or a lack of diversification within discretionary and managed advisory client portfolios, again without record of any clear explanation of why this was suitable for the client.

This case provides a further illustration of the FSA's focus on the ability of firms to evidence that they have properly identified and recorded client needs, but also of the importance of monitoring the effectiveness of controls implemented to ensure compliance.  Firms should also note that the FSA was critical of the fact that few (if any) client files complied with Savoy’s internal standards on client file content which had been introduced in August 2011, and of the failure of certain senior managers to implement remedial action in respect of deficiencies identified in client files in internal reviews in a timely fashion.