More CASS casualties
Recent announcements regarding Towry Investment Management Limited and MF Global UK confirm the protection of client money and custody assets remains one of the FSA's top priorities.
In September, the FSA fined Towry £494,000 for client money breaches (Principle 10) and providing misleading information to the FSA (Principle 11). The fine resulted from Towry's response to a Dear CEO letter from the FSA in which it said it was fully compliant with CASS.
However, following a thematic visit undertaken by the FSA in November 2010, it became apparent that this was not the case. It was found that Towry had failed to:
(i) perform client money calculations and reconciliations accurately or in a timely manner;
(ii) maintain adequate records to enable it to distinguish accurately, and without delay, client money held for one client from client money held for any other client and, to the extent that Towry did not remove excess funding from its client money accounts, from Towry's own funds; and
(iii) ensure the client money was properly segregated from Towry's money by funding any shortfalls of client money from Towry's bank account to the client money accounts or withdrawing any excess of client money from the client money bank accounts to Towry's bank account as appropriate.
The FSA considered Towry's failings to be serious for a number of reasons. First, the CASS failings took place over a period of more than nine years. Secondly, Towry's failings could have placed client money at risk of potential diminution, loss or delay in distribution if Towry had become insolvent (it did not and its clients did not actually suffer any loss as a result of the failings). Thirdly, Towry failed to identify the failings itself and they only came to light during the FSA's thematic visit in November 2010. Fourthly, Towry failed fully and appropriately to disclose CASS related failings to the FSA.
As well as Towry's actions being in breach of the CASS rules, the FSA stated the Towry's actions were particularly serious because there was a high level of awareness in the financial services industry at the time of the importance of handling client money properly given the collapse of Lehman Brothers in September 2008. The FSA stressed that Dear CEO letters (like the one to which Towry had responded) are an important regulatory tool used by the FSA on important issues which require firms to treat them with particular care.
Following hot on the heels of Towry, at the end of October, MF Global UK was the first company to enter into special administration by court order. The Special Administration Regime came into effect in February 2011 and sets the objectives of ensuring the return of client assets as soon as practicable, ensuring timely engagement with market infrastructure bodies and the authorities, and either rescuing the firm as a going concern or winding it up in the best interests of the creditors.
The Chicago Mercantile Exchange's (CME) Chief Executive, Craig Donohue, stated that, "CME has determined MF Global is not in compliance with CTFC [Commodities and Futures Trading Commission] and CME customer segregation requirements". As is the case under the FSA's client asset rules, the CME's and CFTC's rules require companies to hold client assets separately from those belonging to the company. The FSA has not made any comment. It is not yet clear whether there have been any breaches of the CASS rules or whether the breaches alleged by the U.S. authorities have been to the detriment of any clients.
The Towry case highlights the continued importance of firms ensuring they have adequate systems and controls in place to comply with the FSA's CASS rules. In addition, the case serves as a reminder to firms that responding to Dear CEO letters should not be undertaken lightly. As far as MF Global UK is concerned, we await further developments. However, it would be alarming if it were found that a firm of MF Global UK's size had failed to comply with basic segregation requirements of the FSA's client money rules after all the FSA's high publicity work in this area.