Compliance Officer Questions & Answers (Client Money, Cobs, Tcf)

Can client money be mixed with the firm's money?

No. The FSA rules does not permit a firm to place client money with a bank under the firm's name, the money must be segregated into a client pool account.

For some non-Mifid business professional clients may opt out and can consent for their money to be held under the firm's name.   Client money rules may also not apply to regulated collective investment schemes but only for non-Mifid business like Pensions.

For Mifid business, instances where a firm can hold client money in the firm's name are:

- if the firm is a bank holding a bank deposit(CASS 7.1.8);

- if it is a DVP transaction within one business day(CASS 7.2.8);

- where the firm acts as principal and have paid for securities in advance(CASS 7.2.9);

- if money has been transferred to the firm as collateral (CASS 7.2.3).

Are firms liable if the bank holding the client money collapses?

To increase the security of the client money, firms use several banks, not just one single bank. Firms also use due diligence to choose the type of Bank. The aim of holding client money on trust is to protect the client in the event of the failure of the firm, or a third party at which the money may be held. In such circumstances, the general creditors should not be able to make claims on client money as it will not form part of the firm's or third party's  assets in event of failure.  As trustee of the account firms have a fiduciary duty to take good care of the client money. But the firm will not be liable in the event of default by any Bank with whom deposit is placed.

If a Bank should become insolvent, then a firm will be responsible for making all effort to recover the client money.  This will depend on the compensation scheme of the country in which the Bank is based. Whatever the firm manages to recover should be distributed pro rata to the all clients in the fund.

If there is a shortfall, the clients may have to sue the firm and can only succeed if they can show that the firm have been negligent in placing their money with that Bank. CASS 7.9.16 -  When client money is transferred to a third party, a firm continues to owe fiduciary duties to the client. Whether a firm is liable for a shortfall in client money caused by a third party failure will depend on whether it has complied with its duty of care as agent or trustee.

Can I place client money with any bank I wish?

Client money must be placed in an approved bank

Approved bank is defined as follows:

"(except in COLL and CIS) (in relation to a bank account opened by a firm):

(a) if the account is opened at a branch in the United Kingdom:

(i) the Bank of England; or

(ii) the central bank of a member state of the OECD; or

(iii) a bank; or

(iv) a building society 39 ; or

(v) a bank which is supervised by the central bank or other banking regulator of a member state of the OECD; or

(b) if the account is opened elsewhere:

(i) a bank in (a); or

(ii) a credit institution established in an EEA State other than the United Kingdom and duly authorised by the relevant Home State regulator; or

(iii) a bank which is regulated in the Isle of Man or the Channel Islands; or

(c) a bank supervised by the South African Reserve Bank; or

(d) any other bank that:

(i) is subject to regulation by a national banking regulator;

(ii) is required to provide audited accounts;

(iii) has minimum net assets of £5 million (or its equivalent in any other currency at the relevant time) and has a surplus revenue over expenditure for the last two financial years; and

(iv) has an annual audit report which is not materially qualified. (in COLL and CIS) any person falling within (a-c). "

Do firms need to hold PII cover?

 Firms regarded as a 'personal investment firms'  are required to hold PII cover.  They are mainly firms that do mortgage or general insurance business.  Some BIPRU firms also do mortgage & general insurance business, so they will need to have PII cover.

 Firms that are purely a BIPRU firm are not required to hold PII cover but can still hold PII just as a matter of good practice not because the rules require it. PII cover may be useful for firms to cover low frequency high severity losses or claims for giving bad advice to client.

Can I market and sell funds?

 To promote or market a fund to retail customers, the fund must be a recognised fund register with the FSA.

 A firm's scope of permission must allow them to recommend and make arrangement for persons to "buy or sell contractually based investments".

 The firm has to produce a Key features document saying how to join the fund and how to leave the fund etc (to go to clients with the prospectus). The firm is obliged to provide a key facts document showing whose product are offered and commission and charges.

 The firm must check the marketing material to ensure it is clear, fair and not misleading.

 The firm must put in all the relevant risk warnings about past performance of the funds etc.

 Suitability and appropriateness should be recorded.

 TCF must be covered in terms of staff product knowledge to spot inconsistencies, ambiguities or potential unfairness in the product literature and complaints procedures should be in place.

Do I need to disclose any trade I execute to the regulators?

Trades executed in certain recognised venues need to be reported to the FSA on a daily basis. This enables the regulator to assess whether a firm is conducting business outside its scope of permission to use to detect market abuse.

 Under the FSA Disclosure and Transparency Rules a shareholder must disclose any shareholding of a listed company in UK which is over 3% and every subsequent 1% holding thereafter. This is also required under the Companies Act 2006 which imposes the obligation on the shareholders to make the disclosure. 

Under the Takeover Code, disclosure to the Takeover Panel is required if we execute a trade which leads to a person acquiring 1% of shares of a quoted company in UK in a takeover situation. This is to protect shareholders in event of mergers and acquisition. The stockbroker may make the disclosure using the prescribed forms.

Can I recategorise a retail client into a professional client?

 To do so the client must meet certain criteria set by FSA in terms of experience and capability and demonstrate a willingness to be treated as an elective professional client despite the protection that they will lose as a consequence.

 To be upgraded they must also satisfy certain quantitative assessment.   They should meet at least two of the following:

 (a)  the client has carried out transactions, in significant size, on the relevant market at an average frequency of 10 per quarter over the previous four quarters;

(b)  the size of the client's financial instrument portfolio, defined as including cash deposits and financial instruments, exceeds EUR 500,000;

(c)  the client works or has worked in the financial sector for at least one year in a professional position, which requires knowledge of the transactions or services envisaged.

How can I show that we are TCF compliant?

 Have your gap analysis to hand

Articulate and document your TCF policy and objective

Provide TCF staff training

Review and document your Financial promotions procedures and approval process

Review and document your complaints procedures and complaint management system

Review and document your advice and selling procedures suitability, appropriateness, best execution

Review and document the Training & Competence Scheme, files and Recruitment procedure

Obtain Staff feedback on TCF.

Obtain Client feedback and Client survey on TCF

Management information to be delivered to senior management

Compliance monitoring should be ongoing.

 As I have a duty of confidentiality to my clients, can I disclose their information to regulators?

 Client's information should always be treated as confidential provided that such information is not already in the public domain.  It should only be disclosed where required by law or if requested by any regulatory authority or exchange having control or jurisdiction over the firm , to investigate or prevent fraud or other illegal activity, and also if it is in the public interest to disclose such information.

 You can get your clients to warrant that they will not enter into a transaction/s or take any other action which might result in market manipulation and money laundering or fraud and if they enter into a transaction which is the subject of any enquiry or cancellation by a regulatory authority, they will co-operate with the firm and promptly supply information in connection with the enquiry.

 Does a firm have to disclose any spread it makes when dealing on own account?

 COBS 16 requires disclosure of  a total sum of the commissions and expenses charged and, where the retail client so requests, an itemised breakdown, including, where relevant, the amount of any mark-up or mark-down imposed by the firm or its associate where the firm or associate acted as principal in executing the transaction, and the firm owes a duty of best execution to the client

 The rationale for the disclosure is to prevent any potential client detriment and balance of information (See Policy Statement 07/14). 

 So on a contract note the firm may state any settlement fee and state that "A mark-up (i.e is the difference between the price we take position and the price we execute the transaction) can range between 20% to 60%.  The firm is not obliged to provide you with an itemised breakdown of mark up unless you specifically request it".

 On best execution, where the execution factor is Price, the firm have to keep a record of the different prices offered in the different execution venues considered and show that the firm selected the execution venue that provided the best price for the client

 To cover conflict of interest the terms may state:

 "in exceptional circumstances deal as principal for its own account by selling to you or buying from you the investment concerned and therefore make a profit (or loss) or take a mark-up, mark-down or credit for our or its own account..................... you agree that we and any relevant associated company may provide the relevant services despite any such interest and that we are not required to account to you for any income, gain, profit, benefit or other advantage arising from doing so provided that we do not contravene the FSA Rules."

Please note that this publication is provided for information purposes only: it is not intended to be a comprehensive or complete statement of the law or of the legal and regulatory requirement or to constitute legal advice.  Readers should take legal advice before applying the information contained in this publication to specific issues or transactions.