The internal authorised corporate director of two Henderson Global Investors funds has been fined £1.9m for charging retail investors up to 1.5% to invest in two index funds that the Financial Conduct Authority has dubbed closet trackers.
Between November 2011 and August 2016, before Henderson Global Investors merged with Janus Capital, the Henderson Japan Enhanced Equity and the Henderson North American Enhanced Equity funds reduced their level of active management.
Despite the fact the ACD, Henderson Investment Funds Limited (HIFL), was aware of the changes and had informed institutional investors their charges would be dropped it continued to charge retail investors active fees for a period of five years. More than 4,500 direct retail investors as well as 75 intermediary companies.
HIFL collectively charged investors £1.8m more than if they had invested in a passive product. It remains an internal ACD for Janus Henderson, according to Companies House.
The FCA fine follows its announcement in March 2018 that it had ordered asset managers to pay investors £34m in compensation for closet trackers. It refused to name any of the firms involved at the time.
‘Beta enhancements’ used to justify lack of action
HIFL had delegated the management and administration of the funds to Henderson Global Investors.
Initially, the funds had tracked the FTSE World Japan and World North America indices respectively with an alpha overlay but firm-wide redundancies that affected several fund managers prompted the active enhancements to be dropped.
Instead Henderson introduced “beta enhancements”, such as stock lending for fee revenue, which it used to justify its decision to not issue a client note about the changes on the basis the prospectus had not outlined the level of enhancement investors could expect from the funds.
Retail investors paid up to 1.5% for passive management
Nearly all institutional investors were informed and Henderson Global Investors offered to manage the funds without charge. But retail investors were in the dark with no communication about the changes nor disclosure in the funds prospectuses.
They were charged between 0.75% to 1.5% depending on their share class. Institutional investors had been charged between 0.05% and 0.20% for the same funds.
In total, 4,713 direct retail investors were affected, representing £37.8m assets under management between the two funds. The two funds were part of a six-strong range, the Global Enhanced Equity Funds and most institutional investors held the entire suite. Henderson also failed to inform two institutional investors about the changes.
Communications with institutional investors
Henderson was explicit in its communications with institutional investors about the change in strategy.
In a note sent in November 2011, it said: “Within global Enhanced Index mandates, where most clients have a UK biased benchmark, the North American and Asian regions will move to being managed on a passive basis, subject to regulatory and client approvals being obtained, with the UK and Europe-ex UK regions continuing to be run on an Enhanced Index basis.”
A Q&A that accompanied the letter said: “We propose to manage the passive portion of the portfolio for free – not at passive fees, for free.”
But retail investors were left in the dark even though internally there was concern about the discrepancy between the service offered and the fees charged. “I can’t see how we could continue to charge this if we are telling everyone this is a tracker product,” one member of staff said, according to the FCA final notice.
It was only in September 2016 that retail investors were told they had been overcharged and were entitled to compensation. Two months later fund literature was updated to reflect the changes to the funds that had happened five years earlier.
Taking too long to fix issue
The FCA said the situation revealed “serious weaknesses” in HIFL’s systems and controls, which resulted in the problem not being “identified and resolved for a considerable amount of time”.
There had been no ongoing monitoring of the Japan or American funds to determine whether they were continuing to meet their investment objectives or investor expectations, the final notice said.
In September 2014, the matter was referred to the investment performance and risk committee, which considered it for nine months and then failed to take decisive action.
A second subcommittee, the global strategic product committee, then considered reintroducing an enhanced index approach to the products before this was rejected by an institutional investor in the funds in December 2015.
It took until March 2016 for the committee to decide fees were too high and should be moved in line with Henderson’s passive products at 0.50%.
The FCA noted the matter was then immediately referred to the regulator and an internal investigation launched.
FCA executive director of enforcement and market oversight Mark Steward said: “The FCA requires firms to treat all its customers fairly, not just some customers. In this case, retail investors paid fees for active investment management they did not receive.
“For retail clients, the Japan and North American Funds were in effect operating as ‘closet trackers’ as the fees charged to them were inappropriate given the diminished level of active management. The matter is aggravated by the length of time HIFL took to identify the harm being caused to the retail investors and to fix it.”
Principles breached
The FCA said HFIL had breached principles three, management and control, and six, customers’ interests.
On principle three, it said the ACD had failed to exercise adequate oversight over the decisions made by the investment manager, Henderson Global Investors, and subsequently failed to properly monitor the management of the funds.
The regulator said HFIL had breached principle six because it failed to treat all customers fairly based on the fact it communicated with institutional investors and dropped fees, while leaving retail investors none the wiser as it continued to charge them active fees.
The initial fine of £2.7m was reduced by 30% due to the cooperation of HIFL. This was calculated from the £5.8m revenue the ACD made from the two funds during the relevant period.
In determining the fine, the FCA decided the incident represented a level three breach on a sliding basis from one to five. This would have resulted in a fine of £580,119, but this was increased due to the length of time it took Henderson to tackle the issue and because the FCA felt a stronger deterrent was needed.
Response
A Janus Henderson spokesperson said: “The FCA’s notice relates to events in the period 2011 to 2016 prior to the merger between Henderson Global Investors and Janus Capital Group in 2017.
“Janus Henderson Investors accepts the FCA’s findings and the financial penalty and has co-operated fully throughout the process. Affected clients had already been separately contacted and fully compensated. Since the incident Janus Henderson Group has improved its systems and controls.”
For more insight on UK wealth management, please click on www.portfolio-adviser.com
