The Financial Services Authority fined the private bank Coutts—the wholly owned subsidiary of the Royal Bank of Scotland (RSB) — £6.3m for the manner in which sold investments to clients. Its one of the largest penalties ever levied on a company by the FSA.
The fine signals the culmination of unpleasant events, which begin on July 10, 2011, when RSB received notification from the FSA of the investigation into the sale activities by Coutts advisers as it relate to the sale of two financial products– the AIG Enhanced Variable Rate Fund and AIG Life Premier Access Bond and Premier Bond.
The FSA also found infractions related to the in-house compliance review process covering those sales.
Coutts & Co sold the Fund for the issuer ALICO (American Life Insurance Company), a wholly owned subsidiary of insurance and financial giant AIG. Between December 2003 and September 2008, 427 persons invested £1.45bn in the Funds.
ALICO invested some money in commercial paper, bank deposits and certificate of deposits. The company also purchased asset–based securities, such as residential and commercial mortgage bonds, floating rate notes and other assets with 3 to 5 year maturity dates.
Financial Crisis Led to Falling Book Value
When the global financial crisis occurred in late 2007 to 2008, the market value of many assets held in the Fund dropped below book value. In addition, media accounts of AIG’s financial problems persist. ALICO started liquidating assets and increased its overnight cash position.
When Lehman Brother filed an application for Chapter 11 bankruptcy protection, on September 15, 2008, the value of AIG’s stock plummeted. This caused a run on the Fund. ALICO could not meet all of the requests for withdrawal. To avoid having to liquidate long-term assets, at a substantial discount to raise the necessary cash, ALICO suspended withdrawals and closed the Fund to new clients.
Eventually, ALICO allowed customers to withdraw 50% of their investments, at full-accrued value. However, as of December 14, 2008, customers could only withdraw the remaining 50% of assets—at less than full accrued value — a 13.5% loss. Customers who elect to transfer the remaining 50% to a recovery fund can access the capital in July 2012, but will only recover the principal invested.
Investment Mis selling by Coutts
What FSA Alleges
The FSA writes in its complaint that Coutts failure to take the necessary steps to gain a thorough understanding of the Fund it sold to customers, especially the features and risk. In their failure to know their product, Coutts committed several other investment violations, including breaches as listed below:
Failure to have an adequate sales process in place for the Fund – The bank failed to put the appropriate sales process in place for the Fund including failure to determine if the producer was suitable for Coutts clients. The bank did not have an established sales process. Materials contained inaccurate, unclear and misleading information without the appropriate explanation given to customers.
Inadequate training and guidance for advisers – Coutts advisers received inadequate training and lack “product specific” training and did not have a clear understanding of the most important attributes of the Fund. They failed to explain to customers the risks associated with the Funds or present suitable alternatives to meet investors’ risk tolerance.
Inadequate compliance sales review – The firm’s compliance review procedures have defects because it failed to address serious issues uncovered about previous sales activities. Coutts did not perform the sales process review until after suspension of the Fund activities on 15 September 2008 and began receiving complaints. The firm completed the compliance reviews in October 2008 and July 2009—well past the due dates.
Failings in relation to risk to capital – Client in this Fund sought a short-term investment for capital or an investment, which offered a cash alternative, but offered a “higher rate of return than a bank or building society account.” The Fund recommended by Coutts advisers had the potential for high returns, but exposed clients to more risk
The FSA states in the filing documents, Coutts’ breaches, though serious, fail to constitute “misconduct, deliberate or reckless” behaviour. However, Coutts & Co violated a basic rule of the FSA’s handbook, Principle 9, which states:
“A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment.”
Tracey McDermott, the FSA’s acting director of enforcement and financial crime said, “It is imperative that firms also ensure that clients understand the nature of the product they are buying and the risks it involves.
By moving to settle the matter in the initial stages of the Financial Services Authority’s (FSA) investigation, Coutts received a 30% discount– on what would have otherwise been a £9 million financial penalty.
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