Compliance code cracker: GAM, Greensill and conflicts of interest — multiple regulatory failures

In a final notice which reveals details of many conflicts of interest-related regulatory failures, the Financial Conduct Authority (FCA) has imposed a fine of £9,103,523 on London-based asset manager, GAM International Management Ltd (GIML). GIML is a subsidiary of GAM (UK) Ltd, which is a UK subsidiary of GAM Holding AG.

The FCA refers to "GAM" as being the GAM group of companies; "GAM UK Group" as GAM (UK) Ltd and its subsidiaries, GAM International Management Ltd, GAM London Ltd and GAM Sterling Management Ltd. "Compliance" refers to the compliance function of GAM UK Group.

The FCA took action in respect of breaches of Principle 2 of the Principles for Businesses between November 28, 2014 and October 25, 2017 (period 1) and Principle 8 between October 20, 2016 and March 8, 2018 (period 2). GIML internal documentation identified the three lines of defence model as a control to identify and manage conflicts of interest matters, it said.

Many of the problems had originated at the board/first line of defence level with Timothy Haywood, a GIML board member and investment director who held the CF1 (director) and CF30 (customer) controlled functions. The FCA also took action against Haywood (discussed here).

FSA report on conflicts of interest and asset managers

In the GIML case the FCA referenced legacy-regulator the Financial Services Authority's (FSA) 2012 report on conflicts between asset managers and their customers. In this report, the FSA had required asset managers to provide a written attestation stating that their arrangements were sufficient to ensure that they managed conflicts of interest effectively and in compliance with FSA rules.

An attestation had been provided by the GIML chief executive officer (CEO), but the FCA said it had become incorrect within two years.

The FSA also said it had found that many firms had failed to establish an adequate framework for identifying and managing conflicts of interest. In the final notice for GIML, the FCA said that, during period 1, it had failed to ensure that its systems and controls for the identification, management and prevention of conflicts of interest had operated effectively.

The FCA said that, during period 2, it had failed to adequately control the conflicts of interest arising out of three investments. Two of these funds — the Laufer 1 and SCF Funds (discussed here) — related to Greensill Capital (UK) Ltd (discussed further here, here, here, here and here).

The FCA found that, during period 1, GIML's conflicts of interest framework was deficient in that the GAM UK Ltd conflicts of interest committee (COI committee), established in December 2012, had failed to meet between November 2014 and October 2017.

It also found that GIML had failed to sufficiently promote the identity and role of the COI committee and its chair, the COI officer. The GIML board of directors had had only limited discussion of conflicts of interest, and GIML had produced only one internal audit report on conflicts of interest.

Conflicts of interest log and matrix

In addition, the FCA said that GIML's COI log was a list of potential conflicts of interest created to ensure that they were adequately considered and managed, and that during period 1, a COI matrix had been created. This had set out more comprehensively the nature of potential conflicts of interests that might be encountered by GIML, along with a summary of the relevant controls in place to address such conflicts, and details as to who the owner of the controls were.

Both systems addressed personal account dealing, and the log addressed cross trades, but not other categories of conflicts relevant in the case.

The FCA also said that compliance at GIML maintained two registers recording potential conflicts of interest in respect of employees — one in relation to employees' personal relationships, and the other in relation to employees' external directorships. The registers did not, however, record corporate conflicts arising from business relationships.

The FCA said that GAM used a compliance software platform as one of the primary systems and controls to identify and manage conflicts of interest. It said that, during period 1, employees had been able to log compliance information, including any actual or potential breaches of the COI policies, directly into this platform, thus enabling the information to be reviewed by compliance, which was responsible for dealing with breaches of the COI policies.

Compliance failed to identify significant deficiencies

The FCA said that, as part of its monitoring plan, compliance carried out an annual review of the COI policies and the conflicts of interest matrix. During period 1, however, compliance had failed to identify significant deficiencies in the implementation of the conflicts of interest framework, such as the failure of the COI committee to meet for three years and the lack of awareness among GIML staff of the COI officer.

Furthermore, it said, notwithstanding the requirement in the COI policies that actual or potential conflicts of interest be escalated to the COI officer, in practice, such matters were escalated to compliance.

The FCA concluded that, during period 1, GIML had failed to ensure that its systems and controls for the identification, management and prevention of conflicts of interest had operated effectively and GIML was, therefore, in breach of Principle 2.

Principle 8 requires a firm to manage conflicts of interest fairly, both between itself and its customers and between different customers. The FCA said that, during period 2, GIML had failed to manage fairly conflict of interest issues arising from three investments — the Laufer 1 investment, the SCF Fund (as noted above, both related to Greensill and are discussed further here) and the Avenir notes.

Avenir notes and the role of compliance

The FCA said that in March 2017, GIML invested in the Avenir Pass Through Notes (Avenir notes), a credit market arbitrage product for which GAM was to be the named "arranger". A special purpose vehicle (SPV), Avenir, had been created to purchase the notes and offset GIML's exposure.

In its 2012 paper, the FSA said it had found variable standards among firms in terms of controls over employees dealing for their personal accounts (PAD). It said that firms with good controls took care to: explain to employees the conflicts of interest created by PA trading; set out clear procedures; and impose significant restrictions, such as an expectation that staff would trade only as long-term investors, with minimum holding periods and maximum trading frequencies.

It also said that those firms monitored PA trading activity, and focused attention on staff conducting extensive personal trading or judged to be in particularly sensitive client portfolio handling roles. Good practice involved a governance committee overseeing personal trading activity and reviewing all aspects of the policy to ensure it remained appropriate. One example of poor practice arose where a firm exempted senior staff from some of the firm's PA trading rules, without good reason.

With regards to the Avenir notes the equity holder of the SPV (called "owner A") was owned by an investment director at GIML and an external individual. Owner A was permitted to invest equity in the SPV while GIML-managed funds purchased the bonds issued out of the Avenir notes.

As an equity owner, owner A would experience any loss arising from the investment first. The FCA said that both owner A and investment director B had made investments in the Avenir structure. GIML invested 21,116,000 euros of GIML-managed funds in the Avenir notes on March 24, 2017.

Personal investment and erroneous prior approval from compliance

The FCA said that, having received prior approval from compliance, investment director B had made a personal investment of 200,000 euros in the structure of the Avenir investment. It also said that there was, therefore, a risk that the investment by GIML-managed funds could be influenced by investment director B's personal financial interests.

This, it said, had created a created a conflict of interest between a GIML employee and GIML's clients. In its approval, however, compliance had "erroneously noted that it was comfortable that there was no conflict of interest", the FCA said.

There were two conflicts arising from the notes according to the FCA: GIML's investment of client funds into a product of which it was to be named the arranger; and in relation to investment director B's personal investment. The conflicts were not, however, identified by GIML until April 2017, after GIML had invested client funds in the notes and compliance had approved investment director B's request to invest, and he had invested.

A senior member of compliance and the COI committee

At that late stage, the FCA said, a senior member of compliance had suggested that those two conflicts of interest should be considered by the COI committee. Investment director B's investment in the structure was not, however, considered by the committee until March 8, 2018, almost one year after it had taken place.

The matter was also considered by the GAM (UK) Ltd board of directors on March 13, 2018, and subsequently on May 21, 2018. The GAM (UK) Ltd board advised that consideration should be given to how best to recover GIML's investment. The Avenir notes were disposed of on July 12, 2019, making a loss of 1,445,302 euros.

The conflict relating to GAM's role as arranger was not, however, considered by the COI committee or by the GIML or GAM (UK) Ltd boards.

SCF Funds and cross trading

The FCA said that the SCF Fund was a co-branded fund launched by GIML and Greensill in June 2016 with two share classes (the A and B classes). Investment director A (Haywood, discussed further here), was a co-portfolio manager of the SCF Fund while also managing the relationship between GIML and Greensill.

The FCA also said that a further class of the SCF Fund, the C class, was launched in July 2017 for the benefit of a customer, company B. GIML had used approximately £423 million of customers' money in GIML-managed funds as the initial purchasers of asset-backed securities linked to company B's receivables, with the intention that it would deliver a financial return to those clients.

The C class subsequently purchased those securities from the initial purchasers (B cross trades). The FCA said this comprised "cross trading", which was identified within the COI policies as potentially leading to a conflict of interest between customers. The B cross trades, therefore, had presented a potential conflict for GIML between the interests of one of its clients, company B, and its other clients.

In its 2012 paper, the FSA said that some firms were unable to show that cross trading between customers was always in the interests of both customers. It also said that in some cases it had found that investment staff failed to record reasons for cross trades between customers or conflicts of interest between asset managers and their customers. It also said that, where reasons had been recorded, senior management had failed to carry out any meaningful review of them.

In the case of the SCF Fund, the FCA found that the potential conflict between the interests of one of GIML's clients, company B, and other GIML clients should have been escalated. The operation of the C class of the SCF Fund was not, however, escalated to the COI committee, the COI officer, the GIML board of directors, compliance, or to investment director A's line manager.

Furthermore, it said GIML had failed to verify that all the B cross trades were correctly tagged as cross trades on GAM's order management system, and that an adequate rationale for the B cross trades had been recorded on the system.

https://podcasts.apple.com/gb/podcast/compliance-clarified-podcast-by-thomson-reuters-regulatory/id1548510826

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