Banking practice – fraudulent diversion of cheques
last updated November 2005
The former managing director of an independent financial adviser (IFA) firm recommended to his firm’s clients investments issued by a bank and two building societies. The clients wrote out cheques in favour of the bank or building society concerned, but the managing director paid them into his own accounts. Some clients made complaints against the IFA firm. Some made complaints against the bank or building societies. The firms concerned asked the FSA to consider the issues under the wider implications process.
Having discussed the matter with the Financial Ombudsman Service, the FSA accepted that the case did raise a new wider implications issue. Although frauds such as this case appear to be rare and the case itself only affected a limited number of customers, the banking practice of allowing cheques made payable to a bank or building society to be paid into a third party's account was said to be widespread, and potentially affects a large number of customers and a large number of firms. Frauds involving this practice could damage the financial integrity of a firm.
It was considered that this was a matter primarily of civil law and industry practice rather than interpretation of FSA rules or guidance, as the FSA does not generally make rules or guidance about matters of banking practice. Firms’ conduct is also governed by the FSA’s high-level systems and controls rules, although the FSA generally looks to the industry to develop and improve banking practice in the light of new issues that arise.
The next step was for the FSA to consider whether a regulatory solution would be more appropriate than the ombudsman service deciding individual cases; and if not, whether it wished to offer material for consideration in individual cases being decided by an ombudsman.
Having considered some of the complaints which had been brought against the firms concerned in this fraud, the FSA did not think that regulatory action was more appropriate than the FOS deciding individual cases.
Firstly, the issue did not relate primarily to the interpretation or application of FSA rules or existing FSA policy. While this case may raise questions about the systems and controls operated by the firms concerned, the potential financial exposure or liability of the banks and building societies turned partly on the implications of civil law and banking practice and partly on the particular circumstances of each transaction. Secondly, it was not clear that there would be any advantage in resolving the issue through the use of the FSA’s restitution powers, having regard to the criteria for such use set out in the FSA Handbook (see section ENF 9.6). There are a limited number of persons affected, the ombudsman service is available to consider their specific complaints, and in cases where redress is payable the firms concerned have the ability to sort out their respective liabilities between them. Equally, there was no material that the FSA would wish to offer to the firms involved or the ombudsman service to help resolve individual complaints.
In summary, the FSA believed it did not need to become involved under the wider implications procedure, because there were other more appropriate means of resolving the cases for the benefit of the customers concerned, and for considering possible improvements to banking practice which, rather than being a matter for FSA rules, is an area where the FSA would look for an industry-led solution.
As the quickest route to resolving both consumers' concerns and those of the banking industry, the FSA saw good grounds for all the firms involved to get together and come to a common agreement on compensation. But, unless or until there was a demonstrably realistic prospect that the parties could come to such an agreement, the FSA thought there was no sensible alternative to the ombudsman service considering the complaints before it on an individual basis.
This case did, however, raise concerns about the current banking practice of allowing cheques made out to a bank or building society to be paid into the account of a third party not mentioned on the cheque. As explained above, the FSA generally looks to the industry to develop and improve banking practice in the light of new issues raised, and is keen to work with the industry to reach a collective solution on this issue.
The FSA therefore raised the issue with the BBA (the British Bankers’ Association) and the BSA (Building Societies Association) to obtain an understanding of the risks involved and how these can best be mitigated for the future.
In November 2005, the FSA reached an agreement with the BBA and BSA to phase out the acceptance of cheques made out simply to a bank or building society and paid into the account a third party in most situations by October 2006, thus reducing the scope for fraud. The FSA will continue to work with the BSA to ensure that consumers have the right information to protect themselves from this type of fraud.