The thorny issue of handling client money is still causing problems and the FSA is threatening to crack down hard on firms that persist in getting it wrong. It is time to read the guidance and get straightened out. Jonathan Drake and Linda O'Tooles explain
The handling of client monies will be one of the Financial Services Authority's highest priorities for the coming year. There are two reasons: firstly, principle 10 of the authority's Principles for Business requires firms to arrange adequate protection for client assets when it is responsible for them. Secondly, the FSA is keen that firms meet the requirements of principle 6 - to "pay due regard to the interests of its customers and treat them fairly".
In a series of recent reviews, some of the most serious shortcomings identified include failures by firms to perform client money calculations, or performing calculations incorrectly; failure to keep track of money held by third parties; failure to observe trust law and thus potentially risk the trust-account status of client money; and failure to inform customers of how their money is being handled.
Firms that fail to meet client money requirements may find they will be shut down, fined, or expend considerable effort attempting to convince the FSA that they should be allowed to stay in business.
In the light of the latest guidance from the FSA, entitled Guide to Client Money for General Insurance Intermediaries, intermediaries would do well to undertake a detailed review of all their pre-existing arrangements, particularly where third-party business partners or appointed representatives are involved.
Client money calculations must be done as often as necessary but a minimum of every 25 business days, using the firm's own accounting records, as these are the most up to date figures. Within 10 business days of the calculation, a firm must have reconciled its own records with its bank-account records.
Client money held by third parties must be included in the calculation until confirmation has been received that the transaction in question is complete, as should the client money the firm estimates is still due from third parties.
The FSA says that firms often fail to include balances held with third parties, and do not account for uncleared cheques and debit or credit card cancellation periods. It is imperative these balances are accounted for in the firm's broking and general ledger systems and tally with the balances used for the client money calculation.
Generally, when passing client money to a third party, firms should exercise appropriate skill, care and judgement in selecting firms to do business with.
There can be several links in a chain between a client and the insurer, all of which are responsible for arranging adequate protection of client money when it is with them. Retail customers must be notified in writing if the money may be transferred to a third party - but a firm need only notify them once and this can be done in a firm's terms of business agreement or other client agreement.
Trust law is pivotal to the way firms operate their client money accounts. By law, a firm holding money under a statutory or non-statutory trust is held to have a fiduciary duty to its client.
Firms are responsible to their clients for client money until it reaches the insurer, or someone who receives that money for and on behalf of the insurer. Once the insurer receives the client's premium, the fiduciary duty to the client in trust law is discharged. Firms should be aware they may be held accountable to their clients if they do not demonstrate that they have correctly discharged this fiduciary duty.
Only one firm has a relationship and duty to the client. This is why a firm will keep its fiduciary responsibilities to its client even if the client's money is working its way through a number of intermediaries. Consequently, it is paramount that intermediaries ensure their Toba arrangements with third parties cover this.
The FSA's recent reviews also revealed that firms are not telling customers how they are holding their client monies (for example, whether as agent for the insurer or client); nor are they specifying what money they hold.
Firms should state in their Toba or client agreement whether they can only receive premiums as an agent or whether they can also receive and hold claims money and/or premium refunds, and they should also specify who benefits from interest earned on client bank accounts.
Interpretation of the client money rules in chapter 5 of the Client Assets Sourcebook continues to cause confusion; the FSA's new guide is, therefore, a welcome plain-English approach to interpreting it. Brokers are encouraged to utilise the guide as a tool but the FSA emphasises that the guide will not be updated each time the rules change, and so should not be read as a substitute for the rules.
Firms must ensure there are robust procedures in place for handling of client monies and demonstrate that they have control over what they and their representative third parties do. Enforcement action is guaranteed for those firms where significant non-compliance remains.
As Julian Adams, head of wholesale insurance firms at the FSA, says, the regulator will "consider taking enforcement action against any firm where we see wilful non-compliance or an inability to handle customers' money in line with our requirements".
Jonathan Drake is a partner, and Linda O'Tooles a solicitor in the corporate insurance group at Clyde and Co.
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