FCA imposes requirements on advisory brokerage firm 

FCA imposes requirements on advisory brokerage firm 

On 15th November 2022 the UK Financial Conduct Authority (“FCA”) imposed conditions on the activities of Pello Capital Limited (“Pello”) because it was held to be:

failing, or is likely to fail, to satisfy the Appropriate Resources and Effective Supervision Threshold Conditions and to advance the Authority’s operational objectives of securing an appropriate degree of protection for consumers and protecting and enhancing the integrity of the UK financial system.”

Pello entered liquidation shortly after the imposition of the conditions by the FCA. The firm had been authorised since 2007 as an IFPRU 50k Limited Licence Firm, with permissions including dealing as agent, arranging (bringing about) deals in investments and making arrangements. Pello was not authorised to hold client money or assets but could control them / arrange for their safeguarding and administration. To this end, Pello had Model B arrangements with third party custodians.  

Pello was also a member of the London Stock Exchange. Its membership was suspended on 16th November 2022. 

The purpose of this article is to summarise the key points from the FCA’s notice. To help practitioners evaluate the strength of their own control environment in consideration of the FCA’s findings in this case, some self-assessment questions are included towards the end. 

What conditions did the FCA impose?

At a high level, the conditions imposed on Pello included:

  1. restrictions on carrying out any regulated activities; 
  2. restrictions on dealings in its own assets; 
  3. books and record retention requirements; and
  4. stakeholder notification requirements. 

Why did the FCA impose the conditions? 

(i) Issues arising from a Section 166 review

The FCA considered that progress in undertaking remedial action was insufficient given the number of “severe” issues that were identified during a Section 166 review undertaken in respect of Pello’s systems and controls in place between 1st January 2020 – 17th February 2021. The report from the review was presented on 29th July 2022, and made findings in relation to:

  • governance:
    • absence of formal terms of reference to govern the activities of the firm’s board and committees;
    • there were no independent non-executive directors on the firm’s board. This contributed to a dearth of independent challenge at board level;
    • Statements of Responsibility (“SoR”) prepared in respect of Senior Manager Function (“SMF”) roles were inaccurate or out of date; 
    • weak training on the requirements contained in the Senior Managers and Certification Regime (“SMCR”);
    • fit and proper assessments were not conducted on all in-scope staff;  
    • the risk function was not clearly defined / no person was identified as being ultimately responsible for managing risk; 
    • absence of formal skills matrices for the compliance function, training was not customised to roles performed within the function; 
    • compliance resources were overstretched;
    • lack of assurance because no internal audit function existed, and external consultants were only used on an exceptional basis 
  • management information:
    • was found to be “under-developed”;
    • focus was on financial information, with limited commentary on matters arising; 
    • lack of current management information pertaining to risk management; 
  • risk management and controls:
    • risk management framework found to be “incomplete, inconsistent and contradictory”; 
    • risk or control owners were not documented;
    • relevant documentation was not “live”, with risks only given consideration at a “high-level” and primarily focused on capital adequacy;
    • in some cases, generic policies and procedures were used that did not reflect the firm’s business;
    • otherwise, policies and procedures were “out of date, duplicative and [in places] contradictory”;
  • managing conflicts of interests:
    • firm did not have a consolidated conflict of interest register;
    • the register was not kept up to date with sufficient regularity;
    • lack of detail on controls in place to manage the conflicts that were identified;
    • elements of the firm’s conflicts policy were not being practised;
    • conflicts training did not form part of employee inductions;
    • conflicts training that was provided was generic, failing to reflect the firm’s business;
    • whilst some conflicts monitoring performed, it was not planned in the firm’s Compliance Monitoring Programme;
  • monitoring of clients:
    • gaps in due diligence documentation supplied by clients;
    • limited independent verification of information received;
    • failure to identify, address and report issues;
    • meaning of taking a risk-based approach misunderstood. This led the firm to perceive transaction volume to be the primary driver of risk;
    • overreliance on third party information providers or brokers to “know” clients, lack of own analysis, particularly around the risks posed by complex legal structures;
    • failure to identify and screen all ultimate beneficial owners; and
    • non-existent or inadequate monitoring to detect where clients’ transactions may have deviated from their risk profile and/or expected levels of activity.

The FCA stated that Pello agreed with all but three of the review’s findings. The authors of the review estimated that it would take the firm between 12 to 18 months to remediate the report’s findings. 

The FCA stated that Pello had provided it with several updates that indicated good progress was being made in improving its control environment. However, despite projecting a six month turnaround to full completion, the FCA said that Pello had not provided it with evidence to support the ambitious timetable. Furthermore, the FCA said that it was unclear regarding how many active client relationships had been terminated because of the firm’s post Section 166 review. 

(ii) Termination of Model B arrangement

In late summer 2022, Pello received notice of termination from its Model B custodian. Pello was unable to source an alternative custodian that was acceptable to the FCA. Given that Pello was unable to hold client money or assets, the FCA was “unclear” as to how the firm would be able to continue trading.   

(iii) Financial resource concerns

The FCA had imposed restrictions on Pello’s activities in late Summer 2021 because of its failure to:

demonstrate that it had sufficient financial resources, as well as failing to repeatedly provide adequate responses to enable the Authority to complete its capital adequacy assessment.” 

Following the section 166 review that concluded in 2022, the FCA then expressed concerns that the firm’s Internal Capital Adequacy Assessment Process (“ICAAP”) was based on unsound assumptions.  The FCA had removed the restrictions it had previously placed on Pello because of progress the firm said it had made in addressing the issues.  

Notwithstanding the above, Pello subsequently advised the FCA that it was seeking a capital injection to avert a breach of applicable capital adequacy and liquidity requirements. The costs of undertaking the remedial action in the aftermath of the section 166 review were significant. Consequently, the FCA requested to see Pello’s Internal Capital Adequacy and Risk Assessment (“ICARA”). The FCA said that Pello supplied the ICARA in draft form, but that this was  “not informative” because of a large amount of “placeholder text” and a lack of supporting data. 

The FCA would go on to reject Pello’s proposals for recapitalisation, averring that they had the characteristics of a “speculative high-risk investment”. Accordingly, the FCA challenged Pello as to the extent of the disclosures it had made to the prospective investors behind the proposals, particularly regarding the nature and extent of the regulatory challenges the firm faced. Eventually, the proposals would fall through. 

Self-assessment questions for boards and senior management

  • Have your board / committee structures been sufficiently and consistently documented?
  • Does your paper governance framework reflect what actually happens in your business? 
  • Do you record the key decisions taken by your board and senior management? 
  • Does your board include an appropriate number of independent non-executive directors? Do your independent non-executive directors have the experience and skills to offer challenge with respect to the non-commercial aspects of your firm’s business? 
  • Has your firm conducted fit and proper assessments where these are required by SMCR? Does your firm seek to periodically refresh these?
  • Is your firm’s risk control framework up to date? Is it clear who does what? Has assurance been obtained as to the risk control framework’s consistency with the firm’s processes, including other systems and controls?
  • Is there evidence that your firm’s board and senior management actively use the ICARA process to inform its strategy and decision making?
  • Is your firm’s documentation and training tailored to its business and the specific roles performed by its employees?
  • If your firm has a material outsourcing relationship, such as a Model B arrangement, can it demonstrate that it has assessed the possible impact of termination on its customers and continued ability to provide services to them? Is this fed into the firm’s ICARA process?
  • Does your firm produce comprehensive and consistent management information which is distributed to its directors and senior management with sufficient regularity?
  • When were your SoRs last reviewed? Do the firm’s processes ensure that they are reviewed as a matter of course when the firm is considering appointing a new senior manager, or if an existing senior manager leaves?
  • Is your firm’s Conflicts Register complete and up to date? 
  • Does the monitoring of conflicts form part of your firm’s compliance monitoring programme?
  • Has your firm assessed whether it is collecting all relevant due diligence information from clients? Is this information verified using independent sources? Does your firm seek to form its own views about clients’ risk profiles or does it leave this to other firms in a distribution chain?
  • Is your firm conducting ongoing transaction monitoring to ascertain whether clients’ activities match their risk profile?

Need help?

C&G’s consultants have substantial, C-suite level, experience of trading operations and compliance. Please contact us if you have any questions about the contents of this newsletter.

References

2022. First Supervisory Notice: Pello Capital Limited. Financial Conduct Authority, 15th November 2022. Available at: https://www.fca.org.uk/publication/supervisory-notices/first-supervisory-notice-pello-capital-limited-2022.pdf (last accessed 23rd January 2023).

2022. Information Sheet: Suspension of Membership – Pello Capital Limited. London Stock Exchange, 16th November 2022. Available at: https://www.londonstockexchange.com/information-sheet/pello-capital-limited/2022/89 (last accessed 23rd January 2023).

2022. Appointment of a voluntary liquidator. Companies House, 20th December 2022. Available at: https://find-and-update.company-information.service.gov.uk/company/05267797/filing-history (last accessed 23rd January 2023).

Alexander Culley

Alexander Culley

Alexander Culley

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