The Financial Conduct Authority (FCA) has imposed a fine of £126m on The Bank of New York Mellon (London Branch)(LB) and The Bank of New York Mellon International Limited (IL).  

The FCA found that LB and IL breached Principle 10 of the FCA’s Principles for Businesses (Clients’ assets) throughout the period 1 November 2007 to 12 August 2013. The FCA also found that LB and IL breached the rules in Chapter 6 (Custody rules) and Chapter 10 (CASS Resolution pack) of the FCA’s Client Asset Sourcebook (CASS).

LB and IL specialise in providing custody services for fund managers, pension funds, and professional and retail clients. They operate directly, and by utilising a network of sub-custodians, as well as central securities depositaries. During the period in which breaches were made (November 2007 to August 2013), the custody asset balances held by LB and IL peaked at £1.3trn and £236bn respectively.

The fine imposed on LB and IL is truly monumental: £126m is the largest of 2015; the 8th largest fine ever, and the largest fine of its kind (6 of the 7 largest fines were FX / LIBOR / EURIBOR related, whilst the 7th was in connection with the so-called “London Whale”).

LB and IL neglected to maintain accounts in a way that ensured they were both accurate and corresponded to the safe custody assets they held for their clients. In addition, they failed to carry out regular reconciliations between their internal accounts and those of their group sub-custodians. This was due to the fact that the internal accounts were simply not detailed enough to enable them to do so.

Furthermore, asset reconciliations were not carried out on a “regular basis” which, the FCA stated in its Final Notice, “in the context of [LB’s] operations[,] should have been at least every six months”. It is, nonetheless, unclear from the FCA’s Final Notice how “on a regular basis” came to mean “at least every six months”.

LB and IL were also unable to demonstrate that, prior to July 2012, they had funded any un-reconciled shortfalls for which they were responsible, because (as aforementioned), they were unable to perform adequate reconciliations to see if any shortfalls existed.

The FCA’s Final Notice also highlighted LB and IL’s failure to properly segregate their clients’ custody assets from their own. Underpinning this was a fundamental failure to maintain “adequate organisational arrangements to minimise the risk of loss or diminution of clients’ safe custody assets … as a result of … misuse … fraud, poor administration, inadequate record-keeping or negligence”.

As a consequence of these shortcomings in reconciliation, accounting records and other areas, LB and IL failed to maintain adequate “CASS Resolution Packs” for a 10 month period, and submitted incomplete and inaccurate Client Money and Asset Returns to the FCA.

It is difficult to make a straightforward judgement on this fine, and the reasons for which it was imposed. On one hand, the FCA has undoubtedly uncovered some serious failures on the part of these two firms. Critically, if the firms had entered into some kind of insolvency procedure during the relevant period, these failures could have put clients’ assets at significant risk. 

On the other hand, it seems that the FCA’s Final Notice finds specific rules breaches that might not have even occurred, before making considerable leaps of both faith and logic in order to justify such a substantial fine as £126m. For instance, the assumption is made that “on a regular basis” meant “at least every six months”, these facts. Moreover, who would have known that a firm could be punished for failing to fund an unreconciled shortfall on an account without any evidence (albeit as a result of the firms’ own failures) that a shortfall actually existed and that it went unfunded? 

In addition, there remains an underlying sense that the FCA – which has been extremely sensitive about CASS rule breaches – might be looking to punish these firms for its own historic failures.

Finally, the FCA’s CASS rules are still too complex, despite recent changes (and perhaps because of them). Regardless of efforts to comply, the CASS rules are difficult to both interpret and apply, as well as expensive to honour. As such, the risk of breach is higher than it might otherwise have been and, due to the FCA’s sensitivity about these matters, the risk of being caught, and consequently receiving a large fine, is a substantial one. 

Many who will read the FCA’s Final notice may develop a sense of “there for the grace of God go I”. Those that do should check their socks have been pulled up.

Chris Finney is a partner at Cooley LLP. He leads the Financial Services practice (UK and Europe).