FCA Fines Retail Investment Management Firm for Failings Relating to Fund Management

by Allen & Overy LLP
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In this report we consider the FCA’s decision to fine Invesco Asset Management Ltd and Invesco Fund Managers Ltd (together, Invesco Perpetual) £18,643,000 for failings relating to fund management and for exposing investors to greater levels of risk than they had been led to expect.

Background

Invesco Asset Management Ltd and Invesco Fund Managers Ltd (together, Invesco Perpetual) is a large fund management business that is located in the UK. As at 31 December 2013 it had assets under management totalling approximately £71 billion, of which approximately 75% were held in retail funds.

FCA’s findings

On 28 April 2014, the FCA issued a final notice (dated 24 April 2014) that set out its findings in respect of Invesco Perpetual. The FCA found that for some or all of the period May 2008 to November 2012, Invesco Perpetual breached Principles 3 (Management and control) and Principle 7 (Communications with clients) of the FCA’s Principles for Businesses (PRIN), as well as certain rules in the FCA’s Collective Investment Scheme sourcebook (COLL) in connection with its fund management activities.

Further details regarding the FCA’s findings in respect of its breaches are set out below.

Principle 3

The FCA found that Invesco Perpetual breached Principle 3 of PRIN in that it failed to take reasonable care to ensure that the systems and controls that it put in place around the front office of its fixed income business were sufficient to record trades on a timely basis to enable it to value the funds it managed accurately. It identified two issues in particular:

  • Failure to record trades on a timely basis. The FCA found that between May 2008 and May 2012, Invesco Perpetual failed to record trades in its fixed income business on a timely basis. The FCA found that this gave rise to the risk that the funds managed by Invesco Perpetual may not have been priced accurately and that investment decisions may have been made that were not appropriate for its funds.

This issue was identified by Invesco Perpetual’s internal audit function in May 2012, which established that in 2010 and 2011 Invesco Perpetual had failed to record 9% of trades executed in its fixed income business on the day they were executed (as they should have been, so as to ensure that they were taken into account when Invesco Perpetual performed daily valuations of its funds).

The FCA also found that Invesco Perpetual’s "persistent and repeated" failure to ensure that it promptly recorded trades in its systems placed its investors at an increased risk of loss as:

  • any decisions made by Invesco Perpetual’s fund managers based on the portfolio at that valuation point may have been inappropriate;
  • compliance checks would have been carried out using incomplete data; and
  • units or shares in the funds may not have been priced correctly.

The FCA identified two occasions when Invesco Perpetual paid compensation to its funds for losses of approximately £1,500 that arose from the late or incorrect input of trades.

  • Failure to monitor fund managers’ allocation of trades in respect of aggregated trades. The FCA found that Invesco Perpetual failed to put adequate controls in place until May 2012 to monitor how partially executed aggregated trades within its fixed income business were allocated.

Where a firm aggregates a client order with one or more other orders and the aggregated order is only partially executed, the FCA’s rules (specifically, 11.3.7R and 11.3.8R in the FCA's Conduct of Business sourcebook (COBS)) require that firm to allocate the related trades in accordance with its order allocation policy. Each firm must have such a policy in place. These rules are intended to help ensure that trades are allocated fairly between funds interested in the same investment opportunity and that investors in those funds, accordingly, are not disadvantaged.

The FCA concluded that Invesco Perpetual’s failure to have adequate controls relating to partially executed aggregated trades gave rise to the risk that some funds or investors in those funds could have been favoured over others, and that as a result investors may have suffered losses.

The FCA also concluded that Invesco Perpetual’s breach of Principle 3 created a risk that Invesco Perpetual would breach certain other rules set out in COLL (specifically in Chapter 6.3 of COLL, which concerns

valuation and accounting procedures).

Principle 7

The FCA found that Invesco Perpetual’s investors were exposed to increased levels of risk through its use of derivatives and consequent introduction of up to £1 billion of leverage (which represented 5% of net asset value) into its funds. However, the FCA concluded that Invesco Perpetual failed to adequately disclose the risks associated with its use of derivatives to its investors, which was in breach of the provisions set out in COLL. As a result, the FCA concluded that Invesco Perpetual had breached Principle 7 on the basis that it failed to pay due regard to the information needs of their clients, and communicated information to them in a way which is clear, fair and not misleading.

In particular, the FCA found that key investor information and simplified prospectuses that were provided to those who invested in certain Invesco Perpetual funds did not provide sufficient information about the risks associated with their investments. For example, although the full version of prospectuses produced by Invesco Perpetual referred to the fact that it was permitted to invest in derivatives on behalf of the funds, the shorter versions of these prospectuses which were provided to investors did not mention this.

The FCA concluded that Invesco Perpetual’s breach of Principle 7 meant that investors:

  • May not have been fully aware of the risks involved when investing their money.
  • Were exposed to a higher level of risk than they had been led to expect.
  • May have made investment decisions that, if they had been provided with appropriate information by Invesco Perpetual, they might not have made.

In addition, the FCA commented that Invesco Perpetual’s breach of Principle 7 may have given it an unfair advantage over its competitors, as it may have benefited from the use of additional funds from investors who would not have invested with Invesco Perpetual had it made adequate disclosures regarding the risks associated with their investments.

COLL

COLL 5.2 (General investment powers and limits for UCITS schemes) sets out a number of investment restrictions that must be followed when investing the scheme property of UCITS schemes. In the final notice issued in respect of Invesco, the FCA described these restrictions as "a very important safeguard for consumer protection".

The FCA found that Invesco Perpetual had made trades that breached the investment restrictions set out in COLL 5.2. The FCA concluded that these breaches exposed investors to greater levels of risk than they had been led to expect and resulted in certain funds being compensated in respect of losses of nearly £5.3 million.

Sanction

The FCA imposed a financial penalty of £18,643,000 on Invesco Perpetual. As the breaches by Invesco Perpetual took place both before and after 6 March 2010, the FCA applied both its old penalty regime (applicable to breaches taking place before 6 March 2010) and its current penalty regime (applicable to breaches occurring after 6 March 2010).

Under its current penalty regime the FCA follows a five-step framework when calculating a financial penalty. Interestingly in this case, the FCA reduced the financial penalty calculated in respect of Invesco Perpetual's breaches of the investment restrictions in COLL 5.2 by 50% from £25,813,069 to £12,906,534 at step 2 of its current penalties policy. The FCA explained that it considered that the original penalty calculated under the current penalties policy would have been disproportionate to Invesco Perpetual's breaches of COLL. This was because:

  • Only 16 out of approximately 405,000 executed trades had breached the COLL rules.
  • These 16 breaches were not indicative of widespread failings by Invesco Perpetual.
  • The financial penalty calculated before a deduction was applied was very high in comparison with the amount of loss caused by the COLL breaches (which was only around £5.3 million).

Comment

This case is an example of where the FCA has taken action against a firm on the basis of risks that investors were exposed to, as opposed to only taking action when investors have suffered actual detriment. Such an approach is not only consistent with the FCA’s consumer protection objective but also with the FCA’s commitment to "early intervention" in cases where it appears there is a risk that consumers may suffer detriment.

It is also interesting to observe the FCA exercising its discretion to reduce the level of financial penalty calculated in circumstances where it considers that the five-step framework under the current penalty regime would result in a disproportionately high penalty.

Final notice

Invesco Asset Management Ltd and Invesco Fund Managers Ltd.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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