Client money in the wrong account and a one-day shortfall
Meridian Investment Management is a boutique FCA-authorised discretionary manager that holds client money. On Monday 3 March a new client transfers £250,000 by CHAPS to open a model portfolio. The money lands in Meridian's own operating account because treasury had not completed the paperwork for the designated client bank account. On Tuesday the firm uses £150,000 of that balance to settle a purchase for an existing client, Marcus Webb, because the proceeds of Webb's sale had not arrived; the transfer out of the client money account was, according to treasury, 'stuck in bank admin'. The shortfall is corrected on Wednesday when Webb's sale proceeds arrive. Meridian's last internal client money reconciliation was performed three weeks earlier. When the firm changed banks in January, the new client bank account was opened but the standard acknowledgement letter was never signed or returned. No client has complained, and the CASS oversight section of the firm's risk register still reads 'satisfactory'.
1. Identify the breaches of the client money rules and explain the principle behind segregation.
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There are at least four distinct failings.
1. Segregation and prompt deposit. CASS 7 requires client money to be held in a client bank account, separate from the firm's own money, and paid in as soon as practicable after receipt. Putting £250,000 into the operating account means it sits alongside the firm's own funds, where it may be treated as the firm's asset if the firm fails. The new client receives no protection beyond an unsecured claim.
2. The acknowledgement letter. CASS 7.13 requires the firm to obtain a written acknowledgement from the bank, in the prescribed form, confirming that the account holds client money and that the bank has no right of set-off. It should have been obtained within the prescribed period of the account being opened. January to March with no acknowledgement is a clear breach and undermines the trust status of the account.
3. Reconciliation. Internal client money reconciliations must be performed at least daily, and external ones at least monthly (more often if the business demands). Three weeks without an internal reconciliation is itself a breach and would have detected the shortfall late.
4. Governance. Recording CASS oversight as 'satisfactory' while three breaches are live is a systems and controls failure and a Consumer Duty issue: the firm has not acted to avoid foreseeable harm to clients' assets.
The principle is beneficial ownership. Client money is held on trust and must never be used to finance the firm's business, including bridging another client's settlement.
2. Why is using one client's money to settle another client's trade a problem, given that the shortfall was corrected within a day?
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The correction repairs the arithmetic, not the breach.
Client A's money was used for the firm's convenience. The £250,000 belonged beneficially to the new client from the moment it was received. Using £150,000 of it to settle Marcus Webb's purchase means Webb's trade was funded by someone else's assets, and the firm took a commercial decision with property it did not own. That is a misappropriation of client money even if every pound is returned.
The insolvency exposure was real, not theoretical. Between Tuesday and Wednesday there was a £150,000 hole. If the firm had failed on Tuesday afternoon, the new client would have been an unsecured creditor for £150,000 and Webb's purchase would have been settled with money the estate could not identify as his. CASS reconciliations exist precisely to detect that gap before it can crystallise.
It signals a business model problem. Firms that routinely rely on one client's money to bridge another's settlement are usually under-capitalised or have broken settlement processes. The explanation given - a bank transfer 'stuck in admin' - suggests failures in settlement instruction timing and cash forecasting that should themselves be investigated.
Regulatory consequences. The firm should record the breach, assess whether it is significant enough to notify the FCA under SUP 15.3, consider whether the CASS resolution pack and the CF10a/CF10b responsibilities were discharged, and expect the auditor's CASS report to qualify the opinion. The Consumer Duty outcome - clients' financial assets protected - was not met on Tuesday.
3. What immediate and remedial actions should Meridian take?
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Immediately (same day).
- Transfer the remaining new client money to a properly designated client bank account and confirm the deposit instruction with the bank in writing.
- Obtain and file the CASS 7.13 acknowledgement from the new bank; if the bank will not sign the prescribed form, consider whether the account can lawfully continue to hold client money.
- Complete a full internal client money reconciliation, then an external one, and document the shortfall and its correction.
- Suspend the ad hoc transfers between accounts until the settlement process is understood.
Within days.
- Open a formal breach record with root cause, remediation owner and dates; assess SUP 15.3 notifiability to the FCA, and discuss with the auditor.
- Review how the new client's money was allowed into the operating account at all: mandate opening should not lag the receipt of funds.
- Check whether any other client money has been held in the operating account.
Structurally.
- Restore daily reconciliation with independent sign-off, and move to a daily external reconciliation if volumes justify it.
- Reassign CASS oversight to a named senior manager and correct the risk register.
- Retrain treasury and client onboarding, and test the process with a dry-run new client.
The judgement the exam is testing: a firm cannot rely on 'no one lost money' as a defence where the client money rules are designed to eliminate the risk before any loss occurs.