October 21, 2021

Volume XI, Number 294

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FCA Imposes £17.6 Million Fine on Investment Adviser for Mismanagement of Conflicts of Interest

On February 24, 2015, the UK Financial Conduct Authority (FCA) imposed a £17.6 million fine on a UK institutional investment adviser (UK Adviser) for failing to fairly manage conflicts of interest among the UK Adviser's side-by-side managed funds. This enforcement action highlights the FCA's increasing focus on the handling of conflicts of interest by investment advisers.

Summary

According to the FCA's final notice, the UK Adviser employed a side-by-side management strategy from 2005 to 2013 whereby funds that paid differing levels of performance fees were managed by the same trading desk. This compensation structure created an incentive for the trading desk to favor funds with higher performance fees through a practice of "cherry picking." While the UK Adviser had a general policy of requiring trades to be allocated in a timely manner, weaknesses in the UK Adviser's systems and controls allowed traders to delay the allocation of executed trades for several hours without detection and to assess the performance of the trades before making such allocations. As a result, traders were able to enhance the performance of funds with higher performance fees by allocating favorable trades to these funds and less favorable trades to funds with lower performance fees.

In 2013, the UK Adviser discovered evidence of the improper trade allocations and self-reported its findings to the FCA. It also provided £132 million in compensation to funds that may have been adversely impacted.

Based on the foregoing, the FCA concluded that the UK Adviser had breached Principle 3 and Principle 8 of the FCA's Principles of Businesses, which require an investment adviser to (i) take reasonable care to organize and control its affairs effectively with adequate risk management systems and (ii) manage conflicts of interest fairly between itself and its customers, and between customers and other clients. Among other things, the FCA found that the UK Adviser failed to adopt and implement policies and procedures that address the specific risks associated with side-by-side management.  It also found that although the UK Adviser was able to detect certain weaknesses in its systems and controls through internal audits, it did not take sufficient steps to ensure that the weaknesses were remedied. As a penalty for these breaches, the FCA imposed a £17.6 million fine on the UK Adviser.

Implications

This enforcement action signals the importance of a robust control environment with effective policies for managing conflicts of interest and detecting and correcting violations, particularly for investment advisers that manage funds on a side-by-side basis. Investment advisers that are based in the UK or have operations in the UK should review their policies and procedures to establish that they meet the standards set forth in the FCA's final notice as well as its Principles for Business and other related rules. Investment advisers should also be aware that the US Securities and Exchange Commission has sanctioned investment advisers in the past for mismanagement of side-by-side funds and requires that investment advisers disclose side-by-side management arrangements and the associated conflicts in the investment advisers' regulatory filings and client brochures (including in Part 2A of the investment advisers' Form ADV).

© 2021 Proskauer Rose LLP. National Law Review, Volume V, Number 73
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About this Author

Robert G Leonard, Proskauer Rose Law Firm, Private Investment Attorney
Partner

Robert G. Leonard is a Partner in the Hedge Funds Group. For more than 25 years Rob has been structuring, organizing and representing hedge funds, funds of funds and other private investment funds (both domestic and offshore) and investment advisers.

212-969-3355
Michael F Mavrides, Proskauer Rose Law Firm, Private Investment Attorney
Partner

Michael F. Mavrides is a Partner in the Hedge Funds Group. Mike focuses his practice on representing domestic and offshore hedge funds, funds of funds and other private investment funds, including private equity and real estate investment funds. He regularly advises funds and their managers on a wide variety of issues, including formation and structuring, seed capital, anchor capital and other strategic arrangements, placement agency, solicitation and other marketing arrangements, succession planning, separately managed accounts, and all types of portfolio management, trading and...

212-969-3670
Christopher M Wells, Proskauer Rose Law Firm, Private Investment Attorney
Partner

Christopher M. Wells is a Partner and head of the Hedge Funds Group. Chris advises hedge funds, funds of funds and other pooled investment vehicles and their managers on all aspects of fund formation, operations and compliance.

212-969-3600
Howard Beber, Tax Attorney, Proskauer Rose Law Firm
Partner

Howard J. Beber is a partner in the Corporate Department and co-head of the Private Funds Group, which is recognized by Chambers GlobalChambers USA and US Legal 500. His practice focuses on representing private equity funds and institutional investors on a broad range of issues including fund formations, secondary transactions and portfolio investments. 

Howard is actively involved in all stages of fund formation and fund sponsor representation, counseling on terms and marketing strategy, preparing offering documents...

617-526-9754
Sarah K Cherry, Tax Attorney, Proskauer Rose Law Firm
Partner

Sarah K. Cherry is a Partner in the Corporate Department and a member of the Private Investment Funds Group. Her practice is focused on the representation of U.S. and non-U.S. private equity funds and managers in capital formation, regulatory compliance and operational issues. Sarah also regularly represents institutional investors and funds-of-funds in their investments in U.S. and non-U.S. private equity funds both in primary and secondary transactions. In addition, Sarah advises clients in relation to internal general partner dynamics and management company issues.

617-526-9769
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