24 February 2015
The FCA has imposed a financial penalty of £17.6m on Aviva Investors Global Services Limited for systems and controls failings which led to a failure to manage conflicts of interests fairly1.
Aviva operated a side-by-side management strategy in its Fixed Income division whereby different funds were managed by the same desk. The difficulty arose because the funds paid different levels of performance fees, a proportion of which was paid to the traders who managed the funds. As such, traders were incentivised to favour one fund over another. The FCA found that two former traders had been delaying allocating executed trades to a particular fund in order to see how the trade performed before deciding which fund to allocate the trade to, in a process referred to as "cherry picking".
Aviva operated a "three lines of defence" model of risk management, but primarily relied on the first line of defence, the business itself, to identify, assess and manage risk. The FCA found that this was deficient in a number of respects, including: (a) a lack of clear demarcation between the business itself and compliance; (b) a failure to implement controls to manage the conflicts of interest risk; (c) a lack of systems to require the contemporaneous recording of the intended allocation of trades; (d) insufficiencies in the management information required; and (e) a culture heavily focused on performance to the detriment of risk awareness and compliance. The FCA also found that the second line of defence (compliance) had been under resourced and lacking the necessary skills and experience and, being based on manual sampling of trades, was insufficiently comprehensive. Further, the FCA found that the third line of defence (internal audit) was insufficiently thorough and failed to follow through remedial efforts that were undertaken.
A copy of the Final Notice can be found here.
This is yet another case that concerns conflicts of interest. The incentive structures implemented by authorised firms, particularly those in respect of employees in customer facing roles, will always be a key area of regulatory scrutiny. The Aviva case highlights in particular the importance of carefully monitoring the effect of such structures and not only implementing targeted management processes, but also ensuring those processes are followed through. It is interesting in this context to note that one of the seven areas of risk focus for the FCA this year will be poor culture and controls that continue to threaten market integrity, including conflicts of interest (see elsewhere in this issue "FCA publishes its Business Plan").
The FCA was extremely complimentary about the remedial steps that Aviva had undertaken since discovering the failings. It stated in its press release that Aviva had worked with the FCA in an “exceptionally open and cooperative manner” and in the Final Notice itself that this cooperation had been “far above and beyond the level expected”. This is unusual. In addition to “committing significant resources to investigating and addressing the weaknesses in its control environment, making significant improvements, which include enhancing governance, strengthening its control framework and seeking to embed an appropriate culture under the leadership of a new management team”, Aviva paid out £132m in compensation to investors in the effected funds. In the circumstances, it is perhaps not surprising that the FCA felt able to be so effusive.
The case does highlight, therefore, an important point: that, depending on the firm’s conduct once wrongdoing has been uncovered, a Final Notice may not be quite the PR disaster for a firm that it could otherwise be. The Aviva case shows that the FCA is willing, in certain circumstances, to mitigate the negative impact of the Final Notice on a firm by highlighting clearly and prominently how the firm has sought to promptly remedy its mistakes. As in any service industry, this can go a long way to restoring consumer confidence in a firm’s brand. The positive response of the firm also contributed to making the fine itself of £17.6m, relatively modest (specifically amounting to a 40% reduction by way of mitigation for the part of the penalty that was calculated under the new regime for penalty setting). Of course, Aviva, like almost all firms that have faced the prospect of an RDC hearing over the past year, chose to settle early and thus received the standard 30% reduction in the financial penalty.
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