Legal - Client money: the FSA belatedly bares its teeth

A flurry of enforcement cases this month for breaches of the Financial Services Authority's client money rules has generated fines totalling £34m: almost as much in a few days as the FSA collected in the whole of 2009. If these penalties do not tell firms that the FSA takes such breaches seriously, nothing will.

As recent case law has emphasised, segregating client money and assets is an essential protection for clients if a firm becomes insolvent. A failure to segregate, deliberate or not, is likely to mean that clients are left having to claim along with other unsecured creditors against the insolvent company.

In the case of insurance, problems often arise where there is a chain of intermediaries passing the money from client to insurer. At any point in that chain, failure to comply with the client money rules can result in the client losing out.

Insurance brokers have the additional option of holding money as an agent of the insurer, meaning that credit risk is transferred from the client to the insurer. The FSA's Guide to Client Money for General Insurance Intermediaries sets out clearly what the options are for brokers, should there be any doubt.

Dedicated unit
One common theme that can be learnt from three of the recent FSA enforcement cases is that, where the breaches were inadvertent rather than deliberate, a significant factor was an operational change and a failure to identify the consequences in terms of compliance with client money rules. In other words, the firms understood their client money obligations but their systems and controls did not identify the problem.

Shortcomings of insurance brokers in this area were highlighted in the FSA's Client Money and Asset Report, published in January 2010. It highlighted, for example, cases of brokers with poorly worded terms of business agreements and inadequate procedures to deal with unallocated cash balances. Brokers would be well advised to review their internal controls in the light of these findings ahead of the FSA's planned review of its client money rules for insurance intermediaries early next year.

The recent fines also highlight the shortcomings of the FSA's previous regulatory approach. It was only in March last year that the FSA set up a dedicated unit to look at client money compliance in firms. In one of the recent cases, the breach lasted for seven years and put billions of pounds of clients' money at risk. And it was the bank that spotted the problem, not the FSA.

Keeping client money safe is a fundamental requirement for a system of regulation. The FSA's previous approach of trusting firms to follow the rules cannot continue.

Matthew Rutter, financial services partner, Beachcroft

Source: Professional Broking – July/August 2010