FCA fines Lloyds TSB for financial incentives failings

Governance failings and conflicts mis-management can take many forms.

Whilst we await the outcome of its review into broker conflicts of interest, the FCA has issued its biggest ever retail conduct fine, for failings in the way employees are remunerated.

The FCA announced yesterday that it was fining Lloyds TSB Bank plc £28m for serious failings in the systems and controls governing the financial incentives it gave to sales staff in Lloyds TSB (LTSB), Halifax and Bank of Scotland branches (the Firms) for the sale of protection and investment products to customers (on an advised basis).

The fine was reduced from £35m because of early settlement. The level of the fine reflected the fact that the Firms were leading providers of protection (such as critical illness and income protection) and investment products (such as ISAs and Personal Investment Plans) to customers in the UK, having collectively sold nearly 1.1m  products during the 26 month period reviewed, earning them a combined total of £212,415,491.

The FCA acknowledges in the Final Notice, that incentives play an important role in setting the sales culture of a firm and cannot be at the expense of the fair treatment of customers.

Where firms have incentive schemes in place, there must be sufficient systems and controls to mitigate the risk of inappropriate advice or behaviour. These systems should include risk-based monitoring, focussing on the risk the adviser poses (because of the incentive) and not just the customer profile.

The high risk features of the Firms' incentive schemes included:

• Variable salaries with basic salary (and promotion) being linked to performance against sales targets – typically, advisers who achieved 138% of their sales target automatically qualified for a promotion and salary increase
• The Firms had a right to make automatic demotions to sales staff who didn't meet 90% of their targets over a nine month period (resulting in a salary decrease)
• Bonus rewards which increased substantially as sales targets were exceeded (in one case, 264% of the adviser's salary was awarded as a bonus)
• Disproportionate rewards for marginal sales (ie sales that took advisers over the bonus threshold)
• A bonus advance and claw back if certain sales targets were not met
• A bias towards the sale of protection products and larger bonuses awarded for particular products (for example, regular premium compared to lump sum) – this created a risk that advisers could persuade customers to select a product term that was longer than required
• Advisers could access their sales data on a daily basis and were provided with information which enabled them to calculate their potential bonus, should they meet their target

The file checking system was flawed in that for LTSB only data mining (based on customer characteristics) was used to identify files for verification, which resulted in some sales staff having none of their sales verified in a given month. In June 2011 this was changed to a target of one sales file manually checked per month. The Firms also assumed that any sale that had not been selected by the data mining tool for checking was a suitable sale. For example, if an adviser made 100 sales and the mining tool selected two for review, both of which failed, the adviser would receive a 98% pass. Further, the Firms should have supplemented the monitoring system with an adviser risk-based approach e.g. advisers who were close to moving up or down the salary tiers as a result of targets.

In addition, although advisers were required to meet competency standards, the system was flawed in that the standard could be met even where the Firms had identified issues with their sales and high proportions of the Firms staff received bonus payments even where a high proportion of their sales reviewed had been found to be unsuitable or potentially unsuitable (although the low number of file reviews could have triggered the high failure proportions e.g. one failing file could result in a high proportion of fails). By way of illustration, there were 229 LTSB advisers who received a bonus on one occasion when 100% of their verified sales were classified as advice fails.

The overall remuneration governance framework, and the collective failure of the management of the Firms to identify sales incentives as a key risk were considered serious failings. In the case of LTSB, senior management (and relevant committees) had responsibility for reviewing and challenging the sales plan and approving the final sales targets. The Group had a Remuneration Governance Policy that set out the governance framework around the Firms' incentive schemes, which cascaded responsibility for the design, approval and oversight of incentive schemes to the Group's Retail Division. As a result the Remuneration Committee only considered schemes at a high level, did not provide clear guidance to the business on its risk appetite for unsuitable sales to be rewarded and did not have sufficient understanding of the file failure mechanics (and therefore deficiencies). Similar criticisms were levied at senior management in the recent fines imposed against Swinton (for add-on mis-selling) and Clydesdale (for failing to adjust interest rates), where governance failings were a key factor in the Final Notices.

Learnings from the fine

• Ensure risk-based reviews are in place so that staff with higher bonus related incentives schemes have a higher proportion of file reviews. File reviews should also be increased for sales staff who have more at risk if they fail to achieve their targets
• File failings should be a red flag, remaining files should not be assumed to pass
• Do not permit bonus payments to be made in relation to files which have failed review
• Where managers are responsible for the supervision of the team's selling practices, their remuneration should not be based on adviser sale performance
• Ensure sufficient management information is set out in executive and board committee reports to enable management to understand red flags in sales patterns
• High volumes or high percentage increase in sales should be a red flag for management who should question whether the customer remains at the heart of business thinking.

This fine, the highest ever levied for retail conduct failures, is a stark reminder of the need for firms to ensure that they put the interests of the customer first and, in their sales processes, ensure that good behaviours are embedded through the right remuneration and incentive schemes.