Penny shares: higher risk securities
Penny shares are shares where the bid/offer spread is ten per cent or more. Penny shares are considered high risk due to this large bid/offer spread, and the smaller and more volatile nature of the companies involved. In this case, the shares were traded on the Alternative Investment Market.
Failure to provide required risk warning and pay due regard to customers’ information needs
The FSA found that Wills & Co failed to provide a risk warning in accordance with the conduct of business rules in force at the time (COB 5.4.3R). The required risk warning was intended to make customers aware of the extra risk of losing money when purchasing penny shares. The FSA’s focus on this particular requirement is interesting, in particular, given the move towards more principles-based regulation (“MPBR”) and the less prescriptive conduct of business rules relating to this issue now in force; it presents a more hybrid approach to MPBR and firms may wonder whether previous standards will continue to be relevant even where they have been replaced by high-level rules.
The FSA was also concerned that Wills & Co did not provide risk warnings and information to customers immediately before and at the time of each transaction; instead, Wills & Co advised that the warning set out in its terms of business, given to customers at the beginning of the business relationship, applied. While the FSA’s interpretation of Principle 7 makes sense in relation to new customers, it seems unduly onerous in respect of established customers familiar with Wills & Co and penny shares. No doubt the FSA was influenced in this case by the combination of higher risk shares and private customers; nonetheless, the FSA’s stated intention of giving firms more flexibility inmeeting standards going forward does not sit comfortably with the detailed guidance in this final notice.
Failure to provide information in a way that was clear, fair and notmisleading
The FSA found that Wills & Co communicated information about the Shares in a rushed and unclear manner, and in an ambiguous and/or confusing way; this constituted a breach of Principle 7. In particular, Wills & Co failed to communicate the mark-up on the Shares, the principal position that it held in the Shares and the total level of customer risk exposure. In many cases, this information was only provided after customers agreed to purchase the Shares. While customers should be provided with this information before they decide to purchase higher risk securities, the same observations made above regarding the provision of risk warnings to established customers apply here (at least, in relation to the first two categories of information).
The FSA was concerned that customers were not given balanced information about the Shares, for example, in relation to past performance (past performance information for unrelated shares was provided) and unsupported information (in one transaction, the customer was advised that the price of the Shares would increase by 40%, but this could not be substantiated). Past performance and the provision of balanced information have been on the FSA’s agenda for some time, for example, in the context of its financial promotion work.
Wills & Co’s failure to provide clear, fair and notmisleading information about its charges was also highlighted. For example, in 10 of the transactions reviewed, customers were advised that the transaction was “commission free”; in fact, there was a £15 compliance charge, waived for only the first three trades, as well as a mark-up (see above). Remuneration and the disclosure of charges to customers are currently subject to ongoing debate in the context of the FSA’s Retail Distribution Review.
Failure to implement adequate compliancemonitoring arrangements and controls
The FSA found that Wills & Co did not have adequate compliance monitoring arrangements, for example, the number of transactions reviewed was not proportionate to the overall volume of sales and compliance monitoring was not risk-based. Wills & Co’s systems and controls were also found to be lacking: it did not have documented procedures for compliance monitoring, its records were not detailed enough and it did not conduct comprehensive assessments or analysis of compliance monitoring findings. Accordingly, Wills & Co was not able to identify and manage regulatory risks or ensure that issues of regulatory concern were dealt with appropriately. Wills & Co’s compliance monitoring and systems and controls failings constituted a breach of Principle 3.
Compliance monitoring is an industry hot topic, and the FSA issued a “Dear CEO” letter on managing compliance risk which discussed monitoring in July 2007.While the letter was directed at investment banks, the good practices outlined in it were couched in high-level terms and it is arguable that they can be applied to firms in other sectors (indeed, it is evident from recent enforcement actions that the FSA expects firms to read across guidance in this way). In the letter, the FSA stated that compliance monitoring was becoming increasingly important in firms and had a key role to play in compliance risk management. Good practices identified in this area included developing a risk-based compliance monitoring programme and ensuring that reviews concentrated on business practice improvements.
Treating Customers Fairly
While the final notice does not allege breaches of Principle 6, the importance of treating customers fairly (“TCF”) is implicit in the discussion of Wills & Co’s failure to provide risk warnings and information. Indeed, the press release announcing the Wills & Co fine states that telling customers about the risks of investment is an essential element of TCF. The TCF initiative continues to be a priority for the FSA, and the final deadline for firms is December 2008.
Sample size: 17 transactions reviewed
The FSA makes clear in the final notice that its findings were based only on the 17 transactions reviewed, and does not attempt to extrapolate the poor practices identified to all the transactions carried out during the relevant period (8,375 sales). Presumably, the FSA is keen to avoid allegations similar to those raised in Legal & General. Nonetheless, the FSA’s findings are presented in general terms, and it is implicit in the final notice (although perhaps not the fine), that the problems identified were more widespread.