The Department of Labor made the right decision in granting Credit Suisse AG and its related entities a temporary exemption to continue to provide asset management services, at least for the short term, after its banking unit pleaded guilty to assisting U.S. citizens avoid taxes.
To deny that exemption would punish Credit Suisse's asset management clients for the company's illegal activity in which they had no involvement.
Such a denial would have forced clients to terminate the firm quickly and switch to other asset management providers.
Changing investment managers isn't easy and cannot be done in haste. Seeking and hiring new managers and transferring the assets is disruptive at any time, and especially when a client is suddenly compelled to do so because of a change in regulatory or other legal circumstances.
The clients, to satisfy their fiduciary duty, would be compelled to undertake searches for a replacement, a process that takes time and staff resources, and possibly incurs fees to investment consultants assisting in the change. In addition, a change in asset managers could lead to paying for transition management services to ensure the least market impact in moving portfolios to new firms.
The illegal activities of Credit Suisse officials in the banking unit put the company's asset management services in jeopardy. The Department of Labor plans to hold a public hearing Jan. 15 on whether to grant a permanent exemption under the Employee Retirement Income Security Act on Credit Suisse's authorization to continue as a qualified professional asset manager and whether to impose conditions for it to do so.
But Credit Suisse isn't the only company that has put its business with U.S. asset owners and other institutional investors in jeopardy.
BNP Paribas Securities Services' plans to expand in the United States face an obstacle over a guilty plea last June by its French banking parent to charges it processed $30 billion in transactions with countries that are under U.S. government sanction.
BNP Paribas “had set its sights on the U.S. pension fund, endowment and foundation market, playing off its longtime experience in 35 countries in Europe, Asia-Pacific and Latin America, and its current $170 billion in U.S. assets under custody for money managers and hedge funds,” as reported in a July 17 Pensions & Investments story.
Companies like Credit Suisse and BNP Paribas will face trouble maintaining and building their business because of fiduciary concerns about reputational risk and compliance risk. While many of the large financial services companies, such as J. P. Morgan Chase, have suffered reputational damage following the financial crisis, their asset management units have long histories of reliability to help them overcome the damage. Newer firms do not have that residual good will.
But by granting exemptions, the Labor Department risks undermining confidence in enforcement and accountability of money managers and other service providers as fiduciaries expected to commit to high standards of integrity.
Asset owners and other institutional investors will correctly be concerned that similar disruptions might occur in the future, and it will take time for these firms to re-establish credibility.
The asset owners seeking money management and other fiduciary services often have to deal with multiline financial services firms, at which another arm might run afoul of federal laws. The asset management unit might not be involved in wrongdoing or other non-compliance issues, but it could suffer as a result.
When using such firms, clients shouldn't just wait for regulatory enforcement, such as the Labor Department action.
Clients and prospective clients have to broaden their due diligence. They must take it beyond just asset management. They have to look for warning signs anywhere at the company. Actions at unrelated units could affect asset management, as the Labor Department case shows.
Clients should make contingency plans by inserting into their asset management contracts, actions to be taken when illegal or other non-compliance activities are alleged at money managers and other service providers. Clients should specify in the contracts that whenever a company is in violation of the law that would result in costs to clients, the financial services company should pay the costs of transition to a new asset manager, if such a move is considered necessary by the client.
The risks of having to pay such costs might serve as deterrence and provide the money manager with incentives to improve its internal compliance to avoid triggering such clauses. At least, asset owners and their beneficiaries would not suffer the financial consequences of forced transitions in the event that the asset managers are prohibited from providing such services in the future.
Clients should begin to prepare for a transition when allegations first arise against such multiline financial services companies. They must quickly begin planning the steps of a transition, e.g., by gathering a list of likely replacement firms and beginning due diligence, in case a change becomes necessary.