Lehman Brothers Ruling Stumbles FSA Probes Into Client Accounts

It appears that investigations by the UK FSA regulator into how spread betting providers segregate client monies have stumbled onto a wall in the aftermath of the Lehman Brothers Holdings Inc.’s bankruptcy due to a ruling involving the investment bank’s European arm.

In the past few months the FSA had been inspecting whether investment companies were properly separating client funds following the 2009 collapse of Lehman Brothers. The investigators found two companies in breach of the regulations and now face a ban or a fine, however the investigations have been hindered by a December ruling over the administration of Lehman’s European unit, which stated that the Financial Services Authority rules were ‘patently inconsistent and flawed.’

‘The judgment is a huge embarrassment to them and may throw into doubt whether their current investigations run their full course,’ said Darren Fox, an administrative lawyer at Simmons & Simmons LLP who is acting on behalf of clients of Lehman’s European section involved in the case who didn’t have their funds properly segregated.

The FSA warned firms in March about the need for segregation of client monies after the failure of Lehman Brothers, which affected world markets negatively. Creditors have since filed for some $830 billion of claims and financial regulators are trying to sort the intricacies of how monies were transferred around the group’s diverse units.

Companies that are found in breach are liable for fines and/or individual (s) involved may be banned. The Financial Services Authority was about the publish a report in October after finalising its investigations which were initiated in March 2009. The report which was published today found that investment companies and insurance brokers had an unsatisfactory track record on segregation of client money account and were not always storing the necessary documentation. In particular two companies are now being investigated while another has already had its assets frozen while others were forced to commission independent reviews, according to the Financial Services Authority.

Joseph Eyre, an FSA spokesman stated that at the time of the Lehman Brothers bankruptcy it was the regulator’s practice to depend on auditors confirming that companies complied with FSA regulations on client monies. The FSA’s more active approach to supervision means that the regulator now doesn’t have to rely on auditors signing off the papers. ‘We have increased our supervision of firms that have permission to hold client money and now conduct more extensive reviews of auditors’ client money reports.’

The FSA stated in a March circulatory letter that it would investigate records showing that client monies is deposited in separate accounts. The regulator further stated that it had already found sufficient evidence that certain companies weren’t following the regulations on paper trails for client’s assets. In a letter dated January 19 and circulated today to the heads of insurance brokers and investment companies, the regulator detailed cases of poor segregation and unsatisfactory storing of records. The regulator has also emphasized to spread betting providers about the need to properly segregate client monies.

‘What the Financial Service Authority is really interested in is to do with senior management and the organization of these systems,’ said Steven Francis, a former FSA enforcement officer who is now acting as a regulatory lawyer at Reynolds Porter Chamberlain LLP. ‘In practice, directors are so important that they delegate almost everything, especially in a technical area like this. So how do directors retain control?’

The December ruling in the case of the failure of Lehman Brothers International Europe established that the bank had failed to segregate ‘great sums’ of client monies from house accounts, as required by the Financial Service Authority. Clients that should have had their money deposited into separate accounts, and didn’t, cannot claim money from the pool of client funds administered by PricewaterhouseCoopers, Lehman’s bankruptcy administrator, Justice Michael Briggs said.

Michael Briggs was also quoted as saying that the Financial Service Authority’s current regulations were unclear and don’t help in a case that is very complex. The Financial Services Authority’s rulebook ‘is patently inconsistent and flawed in certain significant respects, and while the court aims to make full and practical sense of any clause which it is called upon to interpret, its task remains interpretation rather than improvement,’ Briggs added. Until the Financial Services Authority clarifies its regulations, the ruling may help firms challenge any shortcomings the regulator makes in its inspections, the lawyers said.

The FSA now intends to consult on changes to parts of its rules, specifically about transfer arrangements and on companies keeping appropriate reserves that could serve to top up client-money accounts if needed. The financial regulator will publish proposals later in the year, it said. ‘It is simply not acceptable that some companies are not ensuring that clients get the full protection’, Sally Dewar, the FSA’s risk manager, said today. ‘We have pointed out our worries to companies and will be following up these concerns with further inspections this year.’

Tags: FSA

This entry was posted on Friday, January 22nd, 2010 at 5:39 pm and is filed under Industry News. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.