Aviva Investors Global Services Ltd has been fined £17,607,000 for what the Final Notice describes as systems and controls failings which led to its failure to manage conflicts of interest fairly. If it had not been for a combination of the traditional 30% ‘Stage 1’ discount and mitigating factors (the firm’s prompt compensation exercise and open and cooperative manner) the fine would have been closer to £34m.
Although the Final Notice advises breaches of Principle 3 (Management and Control) and Principle 8 (Conflicts of Interest), arguably at the heart of the problem was the firm’s failure to ensure compliance with COBS 11.3 (‘Client order handling’) and COBS 11.5 (‘Record keeping: client orders and transactions’).
COBS 11.3.2 requires client orders to be promptly recorded and allocated whilst the requirements of COBS 11.5.2 include the need to record the name or designation of the client immediately after executing a client order.
As is sometimes the case with asset management firms, Aviva’s managers were responsible for the management of several portfolios which paid differing levels of performance fees – the Final Notice advises the fees could range from 20% (a Hedge Fund) to nil (certain traditional Long-Only Funds). Given that at least half of these performance fees were paid to the traders there was an obvious conflict of interest where these funds were trading in the same instruments. It is interesting to note that during the nearly eight year period in question, £27.4m was paid to certain traders as a result of Hedge Fund performance. Furthermore Aviva found evidence of delayed booking and improper allocation of trades by two former traders which led to the firm paying compensation of £132m to eight funds that may have been adversely impacted as a result of poor controls.
Although Aviva did recognise the potential conflict to the extent that it was duly noted in its Conflict Log, it failed to manage the inherent conflict; whilst SYSC 10.1.6 concerns the need to record conflicts, the effect of SYSC 10.1.7 is to require firms to manage such conflicts to prevent them from giving rise to a risk of damage to the interests of a firm’s clients.
Compliance with COBS 11.3.2 and 11.5.2, particularly with reference to the ‘promptly’ and ‘immediately’ aspects, is an effective way of eliminating the danger of ‘cherry picking’ in which a trader could wait until the end of the day before allocating deals to ensure that those securities which had benefitted from favourable intraday price movements end up in the funds paying the highest performance fees. Aviva did have policies in place for the prompt allocation of trades but did not have the business controls in place (the so called ’first line of defence’) to ensure compliance e.g. the process, as opposed to the policies, did not require traders to record the intended allocation prior to booking the trade and lack of readily available data meant that delays in the booking and allocation of trades intraday could go undetected.
Aviva’s monitoring and oversight (‘second line of defence’) came in for criticism with inadequate compliance monitoring which was no doubt exacerbated by Compliance being under-resourced and lacking the ‘credibility and respect’ to provide robust challenge. The firm’s Internal Audit function (‘third line of defence’ – which for those firms that do not have such a function can also be read to include independent assurance) also demonstrated weaknesses that meant identified issues were not addressed in a timely or effective manner.
Although perhaps of less relevance to smaller asset managers with the one client, we would recommend that those firms subject to COBS 11 review the findings in the Final Notice and compare them to their own practices. In particular it is worth bearing in mind that whilst one can have ‘a policy’ in place, it is important not to overlook the importance of the ‘three lines of defence’ i.e. to have the business controls in place and adequate compliance monitoring. It is appreciated that many firms may not have the luxury of an Internal Audit function, although Complyport clients will have the benefit of our independent review during our on-site visits.
