4.3.2 Protecting customers’ assets
One inevitable feature of undertaking financial services transactions is that money will flow from customers to firms and back again as products are bought and sold. This creates the risk that a customer’s money or other assets can become mingled with the assets of the firm undertaking the business on the customer’s behalf – a risk that becomes very material if the firm gets into financial difficulties.
To avoid this improper treatment of customers’ money, the Client Assets Sourcebook (CASS) sets out regulations to safeguard customers’ money and to ensure that it is properly segregated from the firm’s assets. This ensures that if a firm gets into financial difficulties, customer money is not used to settle its debts. The rules apply both to money and to the financial assets (e.g. shares and securities) that are owned by customers.
The key measure to ensure compliance with CASS is that financial services firms should place customer funds into designated customer bank accounts. These have to be entirely separate from the firm’s own accounts and have to be treated as such by the firm’s bankers.
To ensure the effective management and segregation of customer funds, CASS also requires a regular reconciliation of customers’ money and assets. These should be performed regularly, and the reconciliation of the bank accounts and asset records should be carried out by those who were not involved in their original completion. This segregation of responsibility between the record maker and the record checker is an important financial control.
The reconciliation process will involve both internal and external checks. The internal ones are where the financial services firm checks its own records on customer money, albeit with the segregation arrangements outlined above. The external ones are where the firm’s own records are cross-referenced to those prepared by an external party – typically the bank that holds the customer’s money.
Any discrepancies in the records have to be investigated, and if a shortfall (or excess) in customer money or assets is proven, then the firm must rectify the position.
Failure to execute effective reconciliation procedures is viewed seriously and firms failing to comply with these procedures are required to inform their regulator. Proof of this came in June 2010 when the investment bank, J.P. Morgan, received a record fine from the FSA of £33.3 million for failing to segregate its clients’ money properly. The original fine was £47.6 million but was reduced by 30 per cent because J.P. Morgan worked constructively with the FSA once its regulatory failure – which went back over a period of 7 years – had been detected.
In 2010 the FSA reinforced the requirements of CASS through its Policy Statement – the Client Assets Sourcebook (Enhancements) Instrument (FSA, 2010). The measures were in response to issues relating to client assets that surfaced during the financial crisis – particularly those identified following the insolvency of Lehman Brothers. Amongst the measures are greater restrictions on the investment of client money, with institutions within the same banking group as that holding the client’s account. This is designed to diversify the investment of clients’ money thereby avoiding excessive credit exposure to one or a few financial firms. There is also a requirement for financial firms to establish a CASS controlling function.