The following comment article, by Peter Moore of IMS Group, talks about the importance of segregating assets across financial service firms and about what the UK regulatory fine of Alberto Micalizzi does, and does not, mean for the industry.

Editor’s note: The following comment article, by Peter Moore, head of regulation and compliance at IMS Group, talks about the importance of segregating assets across financial service firms and about what the fine of Alberto Micalizzi does, and does not, mean for the industry.

Background:

The Financial Services Authority this week fined Alberto Micalizzi £3 million (about $5 million) and banned him from performing any role in regulated financial services for not being a "fit and proper" person. Micalizzi and his London-based hedge fund management company Dynamic Decisions Capital Management have referred the decision to the Upper Tribunal. Micalizzi was the chief executive officer and a director of DDCM.

In the FSA’s opinion, in late 2008, to conceal “catastrophic” losses of $390 million, approximately 85 per cent of its value, Micalizzi lied to investors about the true position of the fund and entered into a number of contracts, on behalf of the fund, for the purchase and resale of a bond to create artificial gains. The FSA believes that the bond was not a genuine financial instrument and that Micalizzi was aware of this when he entered into the bond contracts. In May 2009 the fund was placed into liquidation

Moore’s comments:

The news that the UK securities regulator has fined a hedge fund “boss” or “chief” such an enormous sum and banned him from the profession is certainly the biggest story of its type since the similar instance from August last year involving Michiel Visser, chief executive of Mercurius Capital Management, who was fined £2 million and also struck off by the FSA.

So what are some of the true lessons of such decisions - is the FSA getting tougher on the founders, owners and registered representatives of authorised investment firms?

Not necessarily. This is clearly a huge fine for an individual, one which the FSA has curiously chosen to market as its largest ever in a non-market abuse case. However, it will pale into insignificance as compared with the losses suffered by the fund’s investors. Furthermore, in reading the FSA’s findings and its related comments, one is not struck by a (post financial crisis) sense of neo-puritanism on the part of the FSA as the  FSA’s assessment was that “Micalizzi’s conduct fell woefully short of the standards that investors should expect and behaviour like his has no place in the financial services industry”.

It is also worth noting that the Micalizzi case was one of misfeasance or willful wrongdoing which is to be compared with the FSA’s recent unsuccessful attempt to hold a senior UBS executive culpable for nonfeasance, a failure to adequately manage and control his team.  The FSA certainly has the desire to hold senior staff vicariously liable in such failure to control situations. However, this may require a rule change to enable it to do so.

Material significance

Other than both being hedge funds, of much more material significance was the fact that both Dynamic Decisions and Mercurius Capital were firms in which the crucial segregation of investment activities broke down catastrophically, abetted by an abuse of the firms’ size and ownership arrangements. Accordingly, these cases demonstrate the critical importance of the segregation of activities across a financial services firm, whatever its size.

The requisite quality in systems and controls will be achievable at firms of all sizes if there is a desire to achieve this standard by senior management. Furthermore, potential fund investors will insist on this by assessing in their due diligence the quality of all the components of the asset management firm and not simply the experience and track record of the investment staff.

So, will the FSA get tougher on hedge fund managers as a result of these cases? Not necessarily. The FSA supervises all of its (currently around 29,000) firms on a risk-based approach. 

The FSA supervises by themes rather than by sectors, which means that it will be on the look-out for firms with similar characteristics to those at which client detriment has actually occurred. However, we can trust the FSA to look past the grouping hedge fund and generally direct its resources accordingly.