Managing conflicts of interest in asset management: key takeaways from recent FCA fines

The notice to Mr Haywood also provides insight with respect to the importance of complying with gifts and entertainment policies.

The final notices show that the FCA is particularly concerned that, when making investment decisions for customers, asset managers should not let conflicts of interest interfere with their obligations to customers.

Failings in relation to conflicts of interest may arise in two ways:

• Systems and controls failings. These occur when systems and controls do not operate effectively to ensure the identification, management and prevention of conflicts of interest. A systems and controls failing may constitute a breach of Principle 2 of the FCA’s Principles for Businesses

• Failure to adequately control conflicts of interest arising out of specific investments. A failure to control conflicts may constitute a breach of Principle 8 of the FCA’s Principles for Businesses.

We will look at each of these points in turn below, following which we will consider the FCA’s notice to Mr Haywood and, in particular, his failures with respect to GAM’s gifts and entertainment policy.

Systems and controls failings

The key elements of GAM’s systems and controls for managing conflicts included:

• A Conflicts of Interest Committee

• A Conflicts of Interest Officer

• A board of directors

• An internal audit function

During the period set out in the final notice, the FCA identified the following failures of GAM:

• GAM’s Conflicts of Interest Committee had failed to meet for three years.

• The identity and role of GAM’s Conflicts of Interest Officer had not been made clear to its staff.

• GAM’s board of directors had only had limited discussions concerning conflicts of interest, despite having responsibility both for establishing effective conflict of interest frameworks and for overseeing the identification and management of conflicts.

• GAM’s internal audit function had very limited oversight with respect to conflicts of interest, and only produced one report on conflicts, which had not identified any issues.

We have identified the following key takeaways with respect to the FCA’s notice on systems and controls failures:

• Conflicts of Interest Committee: Firms should ensure that their Conflicts of Interest Committee is made up of appropriate members, taking into account levels of seniority and covering the major areas of the firm’s business. Firms should consider taking steps to raise staff awareness of the existence and role of the Conflicts of Interest Committee.

• Conflicts of Interest Officer: Firms should ensure that their staff are aware of the existence and role of its Conflicts of Interest Officer.

• Conflicts of interest register/log/matrix: Firms should make sure that their conflicts of interest register/log/matrix covers the whole range of conflict scenarios. It is not enough to just cover personal account dealing and cross-trades, but matters such as personal relationships, external directorships and business relationships should also be included.

• Compliance function: Compliance teams should have effective oversight of the implementation of conflict of interest systems and controls.

• Internal audit function: Firms should consider the appropriate frequency and quality of the reviews conducted by its internal audit team with respect to conflicts of interest systems and controls.

Failure to control conflicts of interest arising out of specific investments

The GAM final notice identifies three instances in which there had been failure to adequately control conflicts of interest. We set out a summary of the key points below.

	Investment Scenario	Potential Conflicts of Interest	Failure to Manage Conflicts
Investment 1	GAM invested own-managed funds in assets originated by a joint venture business partner, where the investment manager with responsibility for making the investment also managed the day-to-day relationship with the joint venture business partner.	GAM was potentially incentivised to assist the joint venture business partner rather than act in the best interests of clients. This risk was exacerbated by the offer of three potential financial incentives for the benefit of GAM, despite the fact that no incentive was taken up. These incentives included: A “fee ramp”, which guaranteed the amounts that GAM would earn from its management of specific supply chain finance funds An “equity warrant” over the business partner’s shares A “first and last look” arrangement which allowed GAM the first opportunity to launch further funds investing in the business partner’s originated assets	GAM failed to: Conduct any documented process to consider the risk of potential conflicts of interest Disclose potential conflicts of interest to clients Comply with its conflicts of interest policies concerning the escalation of conflict issues to its Conflicts of Interest Officer, Conflicts of Interest Committee, board of directors or compliance team
Investment 2	GAM launched a co-branded fund with its joint venture business partner, involving cross-trading between clients.	Cross-trading was identified in GAM’s conflicts of interest policies as a category of activity which could lead to a conflict of interest between clients.	As was the case with Investment 1, the potential conflict of interest was not escalated per the conflicts of interest policy. There was also an additional failure to verify cross-trades in accordance with GAMs’ Cross Trade Policy and to assess and confirm that the cross-trades delivered financial benefit to the initial purchaser.
Investment 3	Scenario 1 The investment by GAM of own-managed funds in certain notes (which aimed to profit from arbitrage in credit market) for which GAM was also the arranger without being separately remunerated for arranger role. Scenario 2 The investment director responsible for the investment in the notes personally co-invested in the notes himself a few days following GAM’s investment with prior approval from GAM’s compliance team.	Although GAM’s compliance team found no conflict with respect to the investment described in Scenario 2, the FCA noted that the compliance team failed to identify whether the investment of funds could have been influenced by the investment director’s personal financial interests.	GAM’s Conflicts of Interest Committee and board of directors failed to consider Scenario 1. There was a failure to identify the potential conflict in Scenario 2 when the compliance team was considering (and subsequently approving) the investment director’s co-investment. Upon the potential conflict in Scenario 2 being identified following the investment director’s investment, it was not considered or managed expeditiously. The Conflicts of Interest Committee considered the matter one year following the investment, with the board of directors considering the matter two months after the Conflicts of Interest Committee. The matter was finally resolved two years after investment was made.

In addition to learning from the failings identified by the FCA in relation to the investment scenarios set out above, other key takeaways that we have identified include:

• Documented procedures: Firms should ensure that they have documented procedures with respect to decisions to invest, and specifically in relation to the approval and operational processes used to enter investments into their systems.

• Due diligence on investments: Firms should ensure that they have documented policies or guidelines setting out the nature and extent of due diligence to be conducted on an investment before it is undertaken, including in relation to credit analysis.

• Pre- and post-trade systems and controls: Firms should consider and monitor aggregated financial exposure across portfolios or investment funds with respect to investments arranged by the same counterparty.

• Order management systems: Order management systems should have the functionality to record conflicts of interest.

• Individuals performing multiple roles: Firms should make sure that their systems and controls can address any actual or perceived issues arising from individuals performing multiple roles.

Breaches by the relevant individual approved person

Timothy Haywood, the approved person fined in connection with the failings set out above, was the Investment Director and relevant Business Unit Head at GAM. He was also the director in day-to-day contact with Greensill, the joint venture business partner.

As the breaches occurred prior to the application of the Senior Managers and Certification Regime, Mr Haywood held controlled functions CF1 and CF30 under the FCA Approved Persons Regime and was subject to the FCA’s Statements of Principle and Code of Practice for Approved Persons (“APER”) rather than the FCA’s Conduct Rules.

Mr Haywood was found to have breached APER Principle 7 by failing to take reasonable steps to ensure that the business for which he was responsible complied with the relevant requirements and standards of the regulatory system. The FCA noted that Mr Haywood annually attested to having read and understood the firm’s policies, including the firm’s conflicts of interest policy. He also attested to his responsibility as an employee and a board member with respect to conflicts of interest.

Mr Haywood was also found to have breached APER Principle 2 (i.e., failing to act with due skill, care and diligence in carrying out his accountable function) in relation to breaches of GAM’s Gift and Entertainment Policy (“G&E Policy”).

The purpose of the G&E Policy is to ensure staff do not offer or accept any gift or entertainment which might create or give the appearance of a conflict between their own interests and the duties owed to their clients. In relation to the G&E Policy, the FCA identified the following failures of Mr Haywood:

• Failed to obtain prior approval for a number of items of entertainment. This included the use of a private aircraft of an employee of Greensill for a business trip, and attendance at charity dinners.

• Accepted entertainment that was prohibited under the G&E Policy, including the use of a private aircraft of an employee of Greensill for a personal trip.

• Failed to record gifts and entertainment items in a timely fashion on the firm’s regulatory compliance software platform.

• Provided an inaccurate attestation in relation to a year in which he attested that he had declared all relevant gifts and entertainment given and received during the course of his employment.

The FCA stated in its final notice that the correct disclosure with respect to the approval or refusal of gifts and entertainment is extremely important. This is because gifts and entertainment have the potential to create conflicts of interest and influence decisions, including investment decisions.

Although Mr Haywood was not found to have been actually influenced by the gifts and entertainment he received, the risk of influence and conflict was still present. Specifically, there was a risk that Mr Haywood would have been incentivised to invest firm-managed funds in assets originated by the firm’s joint venture business partner for personal interest rather than acting in the best interest of the firm’s clients.

We have identified the following key takeaways with respect to Mr Haywood’s failings related to the G&E Policy:

• Recording of G&E: Staff should be made aware of the importance of seeking approval for gifts and entertainment and they should do so in a timely manner. Firms should also ensure that their systems capture refusals of gifts and entertainment as well as approvals.

• Attestations: Firms should remind staff of the significance of attestations and the importance in ensuring that any attestations that are given are accurate.