The Financial Markets Authority (FMA) has laid out more stringent client-reporting obligations for financial advisers, custodians and platforms in an updated money-handling guide.
Custodial reporting issues hit the regulatory radar during the Barry Kloogh ponzi scandal in 2019 after the Dunedin-based adviser diverted platform-to-client communications to his own address.
Kloogh drained more than $15 million from clients to fund an extravagant lifestyle while hiding their true account information via the simple addressing ruse.
“We are aware of at least one instance where a financial adviser directed that a significant number of client reports be sent to his address or associated entity addresses,” the FMA guidance says.
“While the clients may have agreed to this, our view is that it may facilitate the potential for fraud (as it did in this case), as clients do not have an independent record of transactions relating to their money and property and must rely on information from the adviser.”
Under the new regulatory guidance custodians have greater responsibility to ensure reports flow to verified client physical or electronic addresses.
Custodial reports “should be provided directly to a client via an address of their choosing, rather than to a financial adviser or other person involved in the transactional chain”, the FMA says.
“… we acknowledge this may be highly restrictive where many of the parties in the transactional chain provide a suite of services to clients, which include financial advice, brokerage and custody services and offer clients a single online portal,” the guidance says.
“In our view, the overriding consideration is that the client receives accurate reporting, and that the information cannot be altered by any party involved in the transactions.”
The FMA ‘Guide for providers of client money or property services’ reinforces the need for platforms and other relevant providers to clearly disclose and justify revenue derived from “margin” such as interest on customer cash or “funds subject to foreign currency conversions”.
“Those margins can be taken as fees for services provided,” the guide says. “Before a margin can be deducted, it must be expressly, clearly and unambiguously disclosed in the relevant agreement between provider and client, and providers should obtain an express direction from a client to make this type of deduction, before making such deductions.”
Revenue earned by platforms etc on client cash has soared during the current high interest rate era.
“We also expect the provider should ensure the client understands that a specified rate of interest will be paid, and (if applicable) disclose that this is less than the actual rate of interest paid on the client money bank account (with the difference being the provider’s margin),” the FMA says. “Disclosure of the deduction of a margin should not use language that is likely to be confusing or mislead clients as to the true nature of the deduction.”
Among other details, the guide also reminds discretionary investment management services (DIMS) licensees – or DIMS custodian – that they are subject to the client money- and property-handling rules.
“Client money and client property under a retail DIMS must be held by a custodian who is independent of the DIMS provider, except where the client money and client property are held directly by the client,” the FMA says. “We may, under limited circumstances, allow the use of an associated party custodian as a condition for a DIMS licence. The DIMS licensee and the custodian are jointly and severally liable.”
Following the Kloogh fraud, the regulator also raised the prospect of a full licensing regime for NZ custody providers – a move called for by the International Monetary Fund a decade ago. The FMA recommendation to consider licensing custodians was passed on the Ministry of Business, Innovation and Employment last year.