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Public Companies Update October 2004
5 RESPONSIBILITY FOR MANAGEMENT OF CONFLICTS OF INTEREST
IN MAJOR INVESTMENT BANKING OPERATIONS
5.1 Introduction
In its recent of letter sent to Client Executives and those
involved in the apportionment and oversight controlled function
of investment banks, the Financial Services Authority ("FSA")
warned that it will be subjecting investment banks to increased
scrutiny and challenge about current and developing practices.
The FSA has conducted a series of consultations on managing
conflicts of interest at institutions that offer both investment
research and allocations of securities. These consultations
follow the implementation of the FSA's new regulations on
this area in July 2004 and subsequently the FSA has issued
a statement on the application of the regulations.
The latest letter from the FSA does not set new standards
for management of conflicts of interest but rather it outlines
approaches to the practical application of the new regulations,
highlighting what the FSA expects to see in a "well managed
firm".
5.2 FSA Requirements
In July 2004 the FSA's new requirements on investment research
that is held out as impartial (i.e. if it is labelled "independent",
"objective" or similar) came into force.
The effect of these additions to the Conduct of Business (COB)
Rules is that senior management are now responsible for identifying
and managing conflicts of interest which might affect the
impartiality of the investment research that is published
or distributed.
Where such research is being held out as impartial the senior
management must create, enforce and make publicly available
a policy that is appropriate to the firm for effectively managing
the conflicts of interest. The senior management must also
then identify the types of investment research to which the
policy applies and make provision for systems and procedures
to identify and manage effectively those conflicts of interest.
If the firm's identification procedures do not identify any
conflicts then the requirement to create a policy to manage
them will not apply. Firms will have to monitor their identification
procedures to ensure that this is the situation at all times.
5.3 Practical Application
The FSA has conducted reviews at major investment banks to
observe the various ways in which organisations have constructed
their conflict management procedures. As a result they have
produced a set of features that characterise a "well
managed firm":
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Senior management must be fully engaged
with conflict management at their organisation and should
ensure that effective systems and controls are put in
place for both existing and new business and that decisions
taken throughout the firm have a consistent approach. |
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Senior management should continuously assess
the levels of conflict risk in the firm. It is suggested
that this be achieved through regular testing of the management
procedures, supplemented by top-down reviews of conflict
identification and management. |
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There should be a consistent treatment of
conflicts of interest throughout the organisation. This
would involve clear and consistent guidelines on which
risks cannot be appropriately managed and which need to
be referred up the management hierarchy for a decision. |
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Senior management should make clear the
type of mitigation that is required for each of the risks
that they have agreed to manage. |
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Senior management should be receiving management
information on the extent of and mitigation of conflicts
of interest at their firm. |
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The culture of the firm, both in terms of
formal procedures and structures and in terms of the values
of the staff, should be conducive to the effective management
of conflicts of interest. |
5.4 Financing Transactions
In their communication the FSA reiterated the professional
standards which senior management should bear in mind when
undertaking financing transactions.
Senior management are responsible for managing the full range
of risks that can arise from such transactions. These include
not only the market and credit risks but also the potential
legal and reputational risks which famously arose in the Enron
and WorldCom cases.
The professional standards to be adhered to when conducting
financial transactions include the following key issues:
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Senior management must take full responsibility
for transactions within the businesses for which they
are responsible. |
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Mechanisms should be present in order to
produce the necessary information and analysis to allow
decision-making on risks. |
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A clear audit trail of the business intent
of the transactions should be present to guard against
improper behaviour within the organisation. |
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Adequate disclosure and documentation
should be present. |
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There should be risk disclosures to cover
the eventuality of the product being sold on to a retail
customer. |
The FSA emphasised the importance of outlining in such procedures
what is unacceptable, as well as what is acceptable, practice.
5.5 Conclusion
The FSA's latest communication outlines approaches to implementing
the new regulations on management of conflicts of interest
relating to investment research. After conducting reviews,
the FSA has produced what it considers to be the best practical
approach to the new regulations and highlights what the FSA
views as the minimum standards for a "well managed firm",
departure from which could leave firms open to criticism.
If you require further information on any matter covered in
this note, please contact your principal contact at Charles
Russell or Simon
Gilbert, Katy
Knight, Clive
Hopewell or Alexander
Keepin (London), Francis
Rundall or Richard
Norton (Cheltenham) or Catherine
Drew or Geoff
Sparks (Guildford) on 0207 203 5000.
To download these articles in pdf format, please click
here
Please note that the summaries above are
a general indicative guide only. They are not exhaustive.
This information has been prepared by the firm as a service
to our clients. As it is a general guide, we recommend that
you seek professional advice before taking action. No liability
can be accepted by the firm for any action taken or not taken
as a result of this information. The firm is not authorised
under the Financial Services and Markets Act 2000 but we are
able in certain circumstances to offer a limited range of
investment services to clients because we are members of the
Law Society. We can provide these investment services if they
are an incidental part of the professional services we have
been engaged to provide.
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