Coutts Fined £6.3m for AIG Fund Failures

Jack Humphrey, Regulatory journalist
November 09, 2011 /

The Financial Services Authority (FSA) has fined Coutts & Company (Coutts) £6.3 million for failings in connection with the sale of the AIG Enhanced Variable Rate Fund.

Between 3 December 2003 and 15 September 2008 Coutts sold the Fund to 427 high net worth customers, with investments totalling £1.45 billion. The Fund invested in financial and money market instruments but unlike a standard money market fund, it sought to deliver an enhanced return by investing a material proportion of the Fund’s assets in asset backed securities and floating rate notes.

During the financial crisis of 2007 and 2008, the market values of some of the assets in the Fund fell below their book values. On 15 September 2008 Lehman Brothers applied for Chapter 11 bankruptcy protection in the US and AIG’s share price then fell sharply and suddenly.

A large number of investors sought to withdraw their investments and there was a run on the Fund. As a result the Fund was suspended with customers prevented from immediately withdrawing all of their investment 5.

On 14 June 2011, the FSA sent a letter to the wealth management industry following a review of the suitability of client portfolios in a sample of firms in the sector. As part of the review, the FSA identified significant, widespread failings.

The FSA considers suitability a key area of risk in the wealth management industry and firms in this sector are seeing, and will continue to see, an ongoing and increasing focus on these issues.

At the time of the Fund’s suspension on 15 September 2008 247 Coutts customers had £748 million invested in the Fund. These customers were subsequently permitted to withdraw 50% of the full value of their investment (capital plus accrued interest).

On 14 December 2008 customers were given the opportunity to withdraw the remaining 50% but for less than its value on that date (a 13.5% reduction in the value of their entire accrued investment).

Alternatively, customers were given the option of transferring that 50% into a Protected Recovery Fund (PRF) which guaranteed that customers would get back this proportion of their investment in full if they kept their money in the PRF until 1 July 2012.

The vast majority of customers chose the PRF option which meant they have not earned any investment return on this proportion of their investment since 14 December 2008. Eight customers chose not to enter the PRF and suffered a 13.5% reduction in the value of their entire investment as at 14 December 2008.

There were a number of serious failings in the way the Fund was sold. In particular, Coutts generally informed customers that the Fund was a cash fund which invested in money market instruments and could be seen as an alternative to a bank or building society account.

However, a significant proportion of the Fund’s assets did not meet this description and customers may have misunderstood the true position about the risks they were assuming.

Coutts also failed to have an adequate sales process in place for the Fund. Advisers were given inadequate training about the risks and features of the Fund. Nor did Coutts’ sales documentation accurately or adequately describe the Fund and its risks.

Coutts allegedly recommended the Fund to some customers even though it may have exposed them to more capital risk than they appeared willing to accept. Many customers were advised to invest a large proportion of their overall assets in the Fund while there is a risk that their investments were not appropriately diversified.

Additionally, Coutts failed to respond appropriately to the changing market conditions in late 2007 and during 2008 when there was a greater risk of the Fund suspending redemptions and of customers suffering a loss. Despite having been aware of these issues affecting the Fund, Coutts failed to make the necessary changes to the way in which it sold the Fund, and did not ensure that advisers who sought to reassure existing customers inquiring about their investment in the Fund provided a fair explanation of the risks.

The FSA added that Coutts failed to properly deal with questions raised from December 2007 around its past sales of the Fund, including about whether it had explained the Fund’s risks to customers adequately and whether their investments were appropriately diversified; and failed to undertake an effective compliance review of its sales of the Fund after the Fund was suspended and customers complained. The review failed to adequately address suitability and disclosure issues and was not completed in a timely manner.

As a consequence of the above failings, Coutts’ customers were exposed to an unacceptable risk of an unsuitable sale of the Fund over the sales period in breach of FSA Principle 9.

Coutts agreed to settle at an early stage entitling it to a 30% discount on its fine. Were it not for this discount, the FSA would have imposed a financial penalty of £9 million on Coutts.

Coutts has also agreed to carry out a past business review, overseen by an independent third party in relation to all customers who remained invested at 15 September 2008 and will compensate all customers who have suffered a loss as a result of its failings.

 

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