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Regulator homes in on individual risk managers and compliance officers

Experts say the FSA is now targeting individual risk and compliance managers and making them personally accountable for investment losses when failing to gauge or manage the risk firms take on

The UK’s Financial Services Authority (FSA) is homing in on individual risk managers and compliance officers by making them personally accountable for investment losses stemming from risky trading strategies, experts say.

They claim this comes in the wake of the regulator’s decision to fine and ban a hedge fund compliance officer for “failing to act with due skill, care and diligence” when the firm in question lost a large amount of money in the wake of the collapse of Lehman Brothers.

“The FSA policy on liability and accountability is clear,” says Rod Fletcher, head of the business crime & regulation team at Russell Jones & Walker. "The regulator says it will focus on senior management and hold them accountable for their area of responsibilities. Compliance officers could therefore find themselves in the firing line."

This month, the FSA revealed it “fined Dr Sandradee Joseph £14,000 and banned her from performing any significant influence function in regulated financial services for breaching Principle Six of the FSA’s Statements of Principle for Approved Persons”. The authority did this, it said, after she failed to “act with due skill and care” when her company Dynamic Decisions Capital Management (DDCM), a hedge fund management company based in London and Milan, lost approximately 85% of the fund’s total assets under management, in the wake of the collapse of Lehman Brothers.

“This is a first and very important precedence,” says Frederic Ponzo, managing partner at GreySpark Partners, a London-based capital markets consultancy. “Until now, the regulator would only inflict penalties if someone had sinned by action – now they show they will also go after those who sinned by omission. Not being aware of wrongdoings is not good enough an excuse for someone whose job is to control risk and compliance.”

The FSA said that after the losses incurred from the investment strategy adopted by DDCM for the fund it managed in late 2008, a senior employee at DDCM entered into a number of contracts, on behalf of investment funds managed by DDCM, for the purchase and resale of a bond (the Bond) to conceal losses.

Various investors raised concerns that the Bond was of “doubtful provenance and legitimacy”, and the DDCM’s prime broker resigned as a result of concerns.

The FSA said that “Joseph failed to consider the reasons for the prime broker resigning, and despite being aware of the investors´ concerns about the Bond she failed to properly investigate those concerns or act upon the information. In doing so, Joseph did not engage with her responsibilities as compliance officer and therefore failed to act with due skill and care. She relied wrongly on another employee of DDCM, and on her belief that external lawyers were instructed and would have acted on concerns as appropriate.”

Experts say this case proves that personal accountability is under the spotlight.

“There is greater personal and senior accountability – that’s the message the FSA has been very keen to put out there," says Fletcher. "It is not just a question of a bank being fined but it is now apparent that individuals are being held to account for the full extent of their job descriptions.

“Being global head of X could actually mean that they are responsible for events and systems within other jurisdictions across continents. Unless they can satisfy themselves that the systems and structures are organised and done in a way that is right, they do run a risk of being held to account. Senior executives therefore need to be clear about the extent of their responsibilities and these should be accurately reflected in their job descriptions.

“I don’t think the FSA will necessarily target the compliance officers at firms that have made huge losses on products or on defaults. However, there has to be a person or head of unit who performs the compliance oversight function and reports to the FSA who is accountable if systems do fail. Their role is to create a risk and compliance structure and culture that works properly. However, if authorities take the view that no appropriate system is in place, which, of course, creates greater risk to the firm, then it’s not just compliance officers but also other senior management that the FSA will hold accountable."

This could result in prosecutions in the aftermath of the collapse of MF Global, especially since it filed for bankruptcy after its heavy debt burden on sovereign debt.

“This is where a sound judgment call is required,” says Ponzo. “So far, the FSA actions are targeting fraud and the failure to detect it – not incompetence or wrong business decisions. In the case of MF Global, the regulator – and judiciary – are investigating the accounting irregularities and the non-segregation of client money. The over-leverage and the non-inclusion of rating risk (i.e. one factor of market risk in this case) are less of a consideration for the casework, although they are very important for the industry practices and from a prudential standpoint.”

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