FINAL NOTICE

To:


Sun Life Assurance Company of Canada (UK) Limited

1.
ACTION

1.1.
For the reasons given in this notice, the Financial Services Authority (the FSA)
imposes on Sun Life Assurance Company of Canada (UK) Limited (SLOC UK or the
Firm) a financial penalty of £600,000. The penalty is for breaches of Principle 3
(management and control) of the FSA’s Principles for Businesses (the Principles) and
rules set out in the FSA Handbook, namely rules in the Prudential Sourcebook for
Insurers (INSPRU) and the Supervision Manual (SUP). The breaches occurred
between 1 November 2008 and 26 August 2009 (the Relevant Period).

1.2.
SLOC UK agreed to settle at an early stage of the FSA’s investigation. SLOC UK
therefore qualified for a 20% (Stage 2) discount under the FSA’s executive settlement
procedures. Were it not for this discount, the FSA would have imposed a financial
penalty of £750,000.

2.
SUMMARY OF REASONS

2.1.
SLOC UK is a life insurer operating a closed book of business including with-profits
business. During the Relevant Period, SLOC UK’s governance arrangements for its
with-profits business were unclear and inadequate both in their design and in their
practical operation. As a result, there was an unacceptably high risk that
policyholders’ interests would not be protected properly.

2.2.
These failings were evidenced when SLOC UK executed two significant and material
derivative transactions over one of its with-profits funds which held approximately
114,000 policies and £1.2 billion in assets. SLOC UK executed these transactions
without adequate review from its with-profits committee. These transactions were also
executed without the approval of SLOC UK’s board of directors albeit the majority of
the directors were aware of the proposed transactions. This approval process was
deficient and led to an unacceptable risk that proper independent judgment would not
be applied to the transactions.

2.3.
Furthermore, at the time that SLOC UK executed the second of the material
transactions, the Inherited Estate of this with-profits fund had a negative value which
is a breach of the FSA’s rules. SLOC UK also breached the FSA’s rules by failing to
report the negative value of the Inherited Estate to the FSA in a timely manner.

2.4.
The FSA regards SLOC UK’s failings as particularly serious because they occurred at
a time when there was a high level of awareness within the with-profits sector of the
regulatory standards concerning the governance arrangements for with-profits funds,
and the need for with-profits committees to provide independent and appropriate
challenge to management on significant decisions concerning policyholders. In
particular, a “Dear CEO” letter dated 19 September 2007 was sent to the CEOs of
insurers which set out the FSA’s expectations in terms of governance standards for
with-profits businesses.

2.5.
SLOC UK’s failures therefore merit the imposition of a significant financial penalty.
In deciding upon the level of disciplinary sanction, the FSA has:

(1)
not criticised the merits of the two transactions executed by SLOC UK over its
with-profits fund during the Relevant Period;

(2)
recognised that some consideration was given by SLOC UK to its
policyholders’ interests albeit there were significant flaws in the governance
arrangements to ensure that independent judgment by SLOC UK’s with-profits
committee was exercised properly; and

(3)
taken account of SLOC UK’s efforts to improve the effectiveness of its
governance
arrangements
and
SLOC
UK’s
implementation
of
recommendations of a review by a skilled person.

3.
DEFINITIONS

3.1.
The definitions below are used in this Final Notice.

“the Act” means the Financial Services and Markets Act 2000

“the Board” means the Board of Directors of SLOC UK

“the CEO” means the Chief Executive Officer of SLOC UK

“COBS” means the Conduct of Business Sourcebook which is part of the FSA
Handbook

“DEPP” means the Decision Procedure and Penalties Manual which is part of the
FSA Handbook

“EBR” means the percentage of the Fund invested in equities and property holdings

“EG” means the Enforcement Guide which is part of the FSA Handbook

“the Firm” means Sun Life Assurance Company of Canada (UK) Limited

“the First PSC” means the put spread collar which was executed by SLOC UK on 3
and 4 December 2008

“the FSA” means the Financial Services Authority

“the FSA Handbook” means the FSA’s handbook of rules and guidance

“the Fund” means the closed with-profits fund within which the PSCs were executed

“the Inherited Estate” means the excess of assets over realistic liabilities in the Fund

“INSPRU” means The Prudential Sourcebook for Insurers which is part of the FSA
Handbook

“the ISC” means SLOC UK’s investment strategy committee

“the PPFM” means the Principles and Practices of Financial Management which is a
document made available to policyholders informing them about how SLOC UK
manages the Fund. The FSA requires all firms running with-profits business to
establish and maintain a PPFM

“The Principles” means the FSA’s Principles for Businesses which are part of the
FSA Handbook

“the PSCs” means the First PSC and the Second PSC

“the Relevant Period” means the period of 1 November 2008 to 26 August 2009

“the Second PSC” means the restructuring of the First PSC which took place on 18
March 2009

“SLOC UK” means Sun Life Assurance Company of Canada (UK) Limited

“SUP” means the Supervision Manual which is part of the FSA Handbook

“SYSC” means the Senior Management Arrangements Systems and Controls
Sourcebook which is part of the FSA Handbook

“the WPA” means SLOC UK’s with-profits actuary. Firms running with-profits
business are required by the FSA to employ a with-profits actuary

“the WPC” means SLOC UK’s with-profits committee

“the WPMC” means SLOC UK’s with-profits management committee

4.
FACTS AND MATTERS

SLOC UK

4.1.
SLOC UK is a life insurer administering a closed book of life assurance and pension
products. It is a wholly-owned subsidiary of Sun Life Financial Inc, an international
financial services group based in Toronto, Canada. SLOC UK has been authorised by
the FSA since 1 December 2001 to perform a number of regulated activities, including
carrying out and effecting contracts of insurance.

4.2.
SLOC UK operates a closed with-profits fund (the Fund) which held approximately
114,000 life insurance and pension policies and £1.2 billion in assets as at 31
December 2008.

The with-profits sector

4.3.
The FSA views effective governance arrangements as critically important in firms
which run with-profits business. This is because with-profits business, by virtue of
their nature and the extent of discretion applied by firms in their operation, involve
numerous potential conflicts of interest that might give rise to the unfair treatment of
policyholders. This was stated in the FSA’s guidance on with-profits business
contained in chapter 20 of the Conduct of Business Sourcebook (COBS) which was in
force during the Relevant Period.

4.4.
As part of the FSA’s focus on protecting with-profits policyholders, the FSA
embarked on major regulatory reform of the with-profits sector in 2001.
Consequently, in 2005, the FSA introduced new rules for with-profits funds which
were designed to ensure that policyholders were treated fairly and to provide further
transparency and accountability within the with-profits sector. In 2007, the FSA
conducted reviews of firms’ with-profits businesses in an attempt to ensure that the
FSA’s rules were complied with and understood. These reviews revealed weaknesses
around the protection of with-profits policyholders’ interests, in particular in relation
to the general lack of independent challenge provided by firms’ with-profits
committees. The FSA found as part of its review in 2007 that the with-profits sector
did not work as effectively as it should in terms of the governance of with-profits
funds which resulted in poor outcomes for policyholders.

The “Dear CEO” letter

4.5.
During 2007, the FSA conducted a thematic review in respect of the appropriateness
of governance arrangements for with-profits funds (including with-profits
committees). During this review, the FSA found that some firms were not doing
enough to provide independent input into the management of with-profits funds.

4.6.
The FSA issued a “Dear CEO” letter in September 2007 setting out its key findings
from the thematic review and asking the senior management of insurers running with-
profits funds to review the FSA’s findings and to take prompt action to address any
shortcomings those insurers identified in their own governance arrangements.

4.7.
The main findings set out in the “Dear CEO” letter included:

(1)
senior management needed to ensure that a firm’s with-profits governance
arrangements (such as a with-profits committee) were consulted on all
significant issues affecting with-profits policyholders’ interests;

(2)
in some firms, the range of issues referred to the firm’s with-profits
governance arrangements (such as a with-profits committee) was more limited
than the FSA would expect;

(3)
in some instances, with-profits committees were only being told of significant
decisions after they had been made or were being given insufficient time to
review and challenge significant decisions; and

(4)
CEOs should consider whether their with-profits governance arrangements
achieve the purpose intended, specifically whether they are delivering the
outcome of fair treatment of with-profits policyholders. The FSA expected
firms to take prompt action to remedy any shortcomings.

4.8.
Further details from the relevant sections of the “Dear CEO” letter are set out in the
Annex to this Final Notice.

The design of SLOC UK’s governance arrangements for its with-profits business

4.9.
During the Relevant Period, SLOC UK designed the governance arrangements for its
with-profits business to comprise the following bodies:

(1)
the board of directors (Board);

(2)
the with-profits committee (WPC);

(3)
the investment strategy committee (ISC); and

(4)
the with-profits management committee (WPMC).

4.10. In accordance with the FSA’s requirement for firms running with-profits business to
appoint a with-profits actuary, SLOC UK appointed a with-profits actuary (WPA) to
advise management on the use of discretion as it affects policyholders. The WPA was
a member of the ISC (for matters pertaining to the Fund) and the WPMC, and also
attended some WPC and Board meetings.

The Board

4.11. The Board had overall responsibility for the conduct of the with-profits business and
the fair treatment of with-profits policyholders.

4.12. The Board had no terms of reference which meant that there was no record of the
matters which were reserved for the Board’s review and approval. The Board
delegated some of its duties to its standing committees, including the ISC. The ISC’s
terms of reference revealed that some duties had been delegated to it by the Board but
the scope of these delegated duties was unclear.

4.13. SLOC UK’s WPC was established because the FSA requires firms to take reasonable
care to establish and maintain effective systems and controls for compliance with
applicable requirements and standards under the regulatory system, and for countering
the risk that the firm might be used to further financial crime. The FSA’s guidance for
firms carrying on with-profits business states that, in complying with this FSA
requirement, a firm should maintain governance arrangements which are appropriate
to the scale and complexity of its with-profits business and designed to ensure that it
complies with, maintains and records a Principles and Practices of Financial
Management (PPFM). The FSA’s guidance goes on to state that these governance
arrangements should involve some independent judgment in assessing compliance
with the firm’s PPFM and addressing conflicting rights and interests of policyholders
and, if applicable, shareholders, and that such governance arrangements could include
establishing a with-profits committee. A “with-profits committee” is defined in the
FSA Glossary as:

“a committee of the governing body, including non-executive members of the
governing body and possibly some external non-directors with appropriate skills and
experience.”

4.14. SLOC UK chose to establish a with-profits committee as part of its governance
arrangements and as its means of ensuring that independent judgment was applied to
any conflict between the rights and interests of policyholders and the shareholder, and
assessing compliance with its PPFM. During the Relevant Period, according to its
terms of reference, the WPC had responsibility for:

(1)
ensuring that SLOC UK met its regulatory responsibilities to its policyholders;

(2)
ensuring that SLOC UK complied with its PPFM;

(3)
ensuring that SLOC UK’s policyholders were treated fairly;

(4)
ensuring that SLOC UK exercised its discretion in a way that equitably
addressed the competing or conflicting rights of policyholders;

(5)
reviewing any proposals from SLOC UK that impact on the payouts to
policyholders; and

(6)
reviewing financial matters that impact on the financial position of the Fund
including, but not limited to, investment strategy and significant investment
transactions.

4.15. The WPC’s terms of reference did not define “significant investment transactions”
and they did not explain how the WPC would be informed of “investment strategy” or
“significant investment transactions” impacting on the Fund in order to be able to
review such matters. It was also unclear from the WPC’s terms of reference whether
the WPC’s review should take place prior to or after any such “proposals” or
“financial matters” had been implemented by SLOC UK.

7


ISC

4.16. The ISC was responsible for investment strategy, compliance with investment policies
and investment monitoring of all of SLOC UK’s funds, including the Fund. Its
membership comprised of mainly executives and there were no non-executive
directors on the ISC. The ISC also included SLOC UK’s WPA for matters pertaining
to the Fund.

4.17. The ISC’s terms of reference gave a brief description of matters that should be
referred to the Board such as any change in asset managers, any management proposal
to create, dispose or amalgamate any of SLOC UK’s unit linked or general account
funds and recommendations relating to the ISC’s terms of reference. The terms of
reference permitted the ISC to approve portfolio hedging transactions (including
cashless equity collars) but also stated that, “where required”, the ISC should
recommend portfolio hedging transactions to the Board. However, the terms of
reference did not clarify when this would be required. Furthermore, the ISC’s terms
of reference did not provide any guidance on whether material and significant
transactions should be escalated to the Board. The scope of responsibilities delegated
by the Board to the ISC was therefore unclear.

4.18. The ISC’s terms of reference made no provision for the ISC to refer matters to the
WPC for review. This is despite the likelihood that the ISC would originate
“proposals” and “financial matters” impacting on the Fund and its policyholders
which the WPC was tasked through its terms of reference to review.

WPMC

4.19. The WPMC’s terms of reference stated that the WPMC provided operational
management of SLOC UK’s with-profits business and, as a result, its membership did
not include non-executive directors. Unlike the WPC and the ISC, the WPMC was not
a standing committee of the Board and did not report to the Board. It also did not
report to either the ISC or the WPC and its terms of reference did not provide any
guidance on how the WPMC should interact with the ISC or the WPC. The WPMC
had no authority to approve investment decisions.

4.20. According to their respective terms of reference, the WPC and the WPMC both had
responsibility for:

(1)
ensuring that SLOC UK exercised its discretion in a way that ensured that
policyholders had been treated fairly;

(2)
ensuring that SLOC UK was compliant with its PPFM; and

(3)
looking at the way in which SLOC UK had addressed conflicts of interest
between policyholders and the shareholder.

4.21. However, it was not clear from their respective terms of reference how these
responsibilities were divided between the WPC and the WPMC. There was no
guidance on how the WPC and the WPMC should interact to ensure that they were
clear about how and when they would share responsibilities.

The Put Spread Collars (PSCs)

4.22. The way in which SLOC UK’s governance arrangements for its with-profits business
operated in practice was demonstrated when SLOC UK executed put spread collars
over the Fund in December 2008 and March 2009. A put spread collar is a type of
derivative transaction. The PPFM permitted the use of derivatives for risk
management purposes and derivatives had been used by the Fund in the past for this
purpose.

4.23. During 2008 the equity markets were very turbulent with declines in the value of
equities. In November 2008, SLOC UK identified that the Fund was at risk of
becoming insolvent if the value of equities in the Fund continued to fall. As part of its
investment strategy to address the potential impact of further equity market falls on
the Fund, it decided to enter into a 12-15 month put spread collar.

4.24. This transaction was executed at the beginning of December 2008 (the First PSC). In
March 2009, following further falls in the equities market and continued risks to the
solvency of the Fund; SLOC UK restructured the First PSC (the Second PSC). The
PSCs were designed so that, for the term of the derivatives, the Fund would be
protected against falls in the value of equities down to a set level of the FTSE 100 in
return for giving away the benefit of rises in the value of equities above a set level of
the FTSE 100.

Significant and material transactions

4.25. The PSCs were significant and material transactions in terms of their size, their impact
on the investments of the Fund and hence on returns to policyholders. The PSCs
covered nearly all of the Fund’s equity holdings (approximately £300 million worth of
equities). The significance and materiality of the PSCs can be explained with
reference to their impact on the Fund’s equity backing ratio (EBR) both as individual
transactions and in combination. The EBR is the percentage of the Fund invested in
equities and property holdings. The FSA estimates that the First PSC had an
immediate impact broadly equivalent to halving the equity portion of the EBR (the
proportion of the Fund invested in equities) from approximately 30% to
approximately 15%. The FSA estimates that the Second PSC had an immediate
impact broadly equivalent to halving the remaining equity portion of the EBR from
approximately 15% to approximately 7.5%. This means that the PSCs had an overall
impact broadly equivalent to reducing the amount of equities in the Fund from
approximately 30% to approximately 7.5%. Implementing the PSCs did not alter the
direct holdings of equities in the Fund but it changed the exposure of the Fund to the
performance of the equity markets during the term of the derivatives because each
PSC consisted of derivatives linked to the FTSE 100 Index. The PSCs therefore made
material changes to the effective EBR of the Fund for the duration of the derivatives.

The operation of the governance arrangements as illustrated by the PSCs

4.26. SLOC UK’s execution of the PSCs demonstrated how its with-profits governance
arrangements operated in practice.

4.27. The ISC was the committee that took the decision to enter into the First PSC. This
decision was based on a PowerPoint presentation which was presented to the ISC by
the Actuarial Function Holder, one of the ISC members. This presentation contained a
detailed analysis of possible actions that could be taken by SLOC UK in relation to
the Fund, including the execution of a put spread collar. The presentation had been
circulated to members of the ISC including the WPA for review and comment prior to
the ISC meeting.

4.28. The ISC did not refer its decision to execute the First PSC to the WPC for review but
instructed the CEO of the Firm to telephone the WPC members separately to inform
them of the ISC’s decision to enter into the First PSC. Not every member of the WPC
had received a copy of the PowerPoint presentation. The WPC did not object to the
proposed transaction. The WPC members did not speak or hold a WPC meeting after
receiving these telephone calls from the CEO.

4.29. Prior to these telephone calls, SLOC UK’s WPA had raised a concern about the First
PSC potentially giving rise to a conflict between the interests of policyholders and the
shareholder. Despite this, the WPC was not informed of this concern at any time. The
WPA confirmed later that he was satisfied that his concern had been addressed.

4.30. Despite choosing to adopt governance arrangements for its with-profits business
which included its WPC applying independent judgment to any conflict between the
interests of policyholders and the shareholder, SLOC UK’s WPC did not adequately
review the First PSC. The First PSC was a significant and material transaction
impacting on SLOC UK’s Fund and its policyholders and a proper review of the First
PSC should have fallen within the WPC’s remit. However, the WPC’s remit was not
clear from its terms of reference.

4.31. Furthermore, the ISC’s terms of reference did not contain any provisions to ensure
that decisions taken by the ISC which impacted on the Fund and its policyholders
(such as the First PSC) would be referred to the WPC.

4.32. The ISC also gave no consideration to whether it needed to refer its decision to
execute the First PSC to the Board for review or approval, and did not in fact refer its
decision to the Board, despite the fact that its terms of reference identified (albeit with
a significant lack of clarity) that certain transactions would need to be referred to the
Board for approval. The First PSC was a “portfolio hedging transaction” which,
according to its terms of reference, the ISC should recommend to the Board where
required.

4.33. The ISC referred its decision to the WPMC and the WPMC agreed with it.

4.34. Following the execution of the First PSC, the Fund was still at risk of becoming
insolvent if equity markets continued to decline. A paper setting out further actions
that could be taken to protect the Fund was prepared for the ISC. The ISC discussed
this paper in a meeting and ultimately decided to restructure the First PSC.

4.35. Again, the ISC did not refer its decision to either the WPC or the Board for review or
approval.

4.36. One of the WPC members had received the paper prepared for the ISC and had
discussed this paper informally and in high level terms with the CEO. He had also
been copied in on emails between the ISC members which discussed whether the
Second PSC should be executed. However, another member of the WPC did not
receive the ISC paper or emails and did not know that a second put spread collar
would be executed until after the Second PSC had been implemented. The WPC did
not hold a meeting or discuss the Second PSC.

4.37. The ISC referred its decision to the WPMC and the WPMC agreed with it.

4.38. In summary, the PSCs, which were significant and material transactions impacting the
Fund and its policyholders, were executed by SLOC UK even though:

(1)
the ISC did not refer its decisions to execute the PSCs to the WPC; and

(2)
the ISC did not recommend the PSCs to the Board for approval.

The negative position of the Inherited Estate

4.39. The Fund’s Inherited Estate had a negative value when the Second PSC was executed
but SLOC UK was not aware of this at the time. The Inherited Estate consists of
assets in excess of realistic liabilities within the Fund. SLOC UK seeks to maintain
the Inherited Estate at an appropriate percentage of the Fund and it is used, among
other purposes, to help provide capital support to the Fund. The FSA’s rules state that
the Inherited Estate must have a positive value. If the Inherited Estate does go
negative, the firm concerned is required under the FSA’s rules to inform the FSA.

4.40. In early July 2009, following an update of an estimate with more accurate
calculations, SLOC UK’s actuarial department became aware that the Inherited Estate
had a negative value as at 31 March 2009 (with this continuing to be the case until late
April 2009). The CEO became aware of the negative Inherited Estate when she
received papers for a WPMC meeting scheduled for 14 August 2009, and the Board
was informed on 19 August 2009 when papers for a forthcoming Board meeting were
circulated. The FSA was informed of the Inherited Estate having a negative value on
26 August 2009 by which time it had been more than five months since the Inherited
Estate had first become negative.

5.
FAILINGS

5.1.
SLOC UK had an obligation to comply with Principle 3 of the FSA’s Principles by
taking reasonable care to organise and control its affairs responsibly and effectively,
with adequate risk management systems. SLOC UK was also required to comply with
SUP 15.3.11 R and INSPRU 1.1.28 R. These rules and the regulatory provisions
relevant to this Final Notice are referred to in Annex A.

5.2.
SLOC UK breached Principle 3 because the governance arrangements for SLOC
UK’s Fund were unclear and inadequate both in their design and in their practical
operation.

5.3.
The governance arrangements for SLOC UK’s with-profits business were poorly
designed because:

(1)
SLOC UK’s governance arrangements included its WPC but the remit of the
WPC’s responsibilities was unclear from its terms of reference;

(2)
it was not clear which matters had been reserved for the Board’s review and
approval because:

(a)
the Board had no terms of reference explaining which matters had been
reserved for its review and approval and which matters had been
delegated to its standing committees; and

(b)
although the ISC’s terms of reference showed that some matters had
been delegated to the ISC by the Board, the scope of the delegated
duties was unclear;

(3)
the terms of reference for the ISC and the WPC did not ensure that the ISC
referred significant and material transactions affecting the Fund and its
policyholders to the WPC for the WPC’s review;

(4)
the WPC and the WPMC shared responsibility for the same matters despite the
difference in their composition and purpose. In particular:

(a)
it was unclear from their respective terms of reference how their
responsibility was shared; and

(b)
there was no guidance on how the WPC and the WPMC should interact
to ensure that they were clear about how and when they would share
their responsibility.

5.4.
As a consequence of the WPC failing to adequately review the PSCs, the committee
which had the specific purpose and the independent membership required by the FSA
to apply its independent judgment to addressing conflicts between the interests of
policyholders and the shareholder did not adequately review the PSCs.

5.5.
As a consequence of SLOC UK’s Board failing to approve the PSCs, the governing
body of SLOC UK which had ultimate responsibility for the Fund failed to review and
approve significant and material transactions impacting on the Fund and its
policyholders.

5.6.
The fact that the PSCs were not referred to the Board is a failing on its own and a
more serious failing when viewed alongside SLOC UK’s failings in relation to the
WPC. Where decisions to execute significant and material transactions such as the
PSCs bypass both the WPC and the Board, non-executive directors may have
insufficient opportunity to properly review these transactions with the result that these
transactions might not receive adequate independent challenge.

5.7.
SLOC UK also breached:

(1)
INSPRU 1.1.28 R by failing to maintain a positive value for its Inherited
Estate; and

(2)
SUP 15.3.11 R by failing to report the negative value of the Inherited Estate to
the FSA in a timely manner.

6.
SANCTION

6.1.
The FSA has considered the disciplinary and other options available to it and has
concluded that a financial penalty is the appropriate sanction in the circumstances of
this particular case. The principal purpose of a financial penalty is to promote high
standards of regulatory conduct. It seeks to do this by deterring firms who have
breached regulatory requirements from committing further contraventions and
demonstrating generally to firms the benefit of compliant behaviour.

6.2.
The FSA’s policy on the imposition of financial penalties and public censures is set
out in the Enforcement Guide (EG) and the Decision Procedure and Penalties Manual
(DEPP). The FSA introduced a new policy for imposing a financial penalty on 6
March 2010. In this case, as the Relevant Period is 1 November 2008 to 26 August
2009, the breach falls under the old FSA penalty policy. Accordingly, the FSA has
applied the old policy to calculate the appropriate penalty for SLOC UK’s breach. All
references to DEPP below are therefore to the version in place prior to 6 March 2010.

Determining the level of financial penalty

6.3.
In determining the appropriate level of financial penalty, the FSA has had regard to all
the relevant circumstances of the case and the factors set out in DEPP 6.5.2G. Of
these factors in DEPP 6.5.2G, the FSA considers the following to be of particular
relevance to this case.

Deterrence (DEPP 6.5.2(1))

6.4.
Firms that have poor systems and controls in relation to their with-profits business are
a risk to with-profits policyholders and undermine the FSA’s regulatory objective to
protect consumers.

6.5.
The FSA considers that the financial penalty imposed will promote high standards of
regulatory conduct within SLOC UK and deter it from committing further breaches.
The FSA also considers that the financial penalty will help to deter other firms from
committing similar breaches and will reinforce the FSA’s message that firms need to
have in place clear and adequate governance arrangements in relation to their with-
profits business to ensure that with-profits policyholders are fairly treated.

The nature, seriousness and impact of the breaches (DEPP 6.5.2(2))

6.6.
The FSA has had regard to the seriousness of the breaches including the duration of
the breaches, whether the breaches revealed serious or systemic weakness of the
management systems or internal controls and the potential impact on with-profits
policyholders.

6.7.
SLOC UK’s breaches are viewed as particularly serious because:

(1)
the PSCs were material and significant transactions. The FSA estimates that
the execution of the PSCs was broadly equivalent to reducing the equity

portion of the EBR (the proportion of the Fund invested in equities) from
approximately 30% to 15% in December 2008, and then from approximately
15% to approximately 7.5% in March 2009;

(2)
the unclear and inadequate governance arrangements led to an unacceptably
high risk that the interests of SLOC UK’s with-profits policyholders were not
properly protected and taken into account in the actions taken by SLOC UK.
This is of particular importance given the inherent potential for conflicts of
interest arising from with-profits business; and

(3)
the breaches occurred at a time when there was a high level of awareness
within the with-profits sector of the regulatory standards concerning the
governance arrangements for with-profits funds, and the need for with-profits
committees to provide independent and appropriate challenge to management
on significant decisions concerning policyholders. In particular, a “Dear
CEO” letter dated 19 September 2007 was sent to the CEOs of insurers
concerning governance arrangements for with-profits funds.

The extent to which the breach was deliberate or reckless (DEPP 6.5.2(3))

6.8.
The FSA does not consider that the misconduct on the part of SLOC UK was
deliberate or reckless.

The size, financial resources and other circumstances of the firm (DEPP 6.5.2(5))

6.9.
The FSA has taken into account SLOC UK’s size and financial resources. The FSA
has seen no evidence to suggest that SLOC UK is unable to afford the financial
penalty.

The amount of benefit gained or loss avoided (DEPP 6.5.2(6))

6.10. The FSA accepts that SLOC UK did not financially benefit from its misconduct and
that the PSCs were implemented with the objective of preserving the solvency of the
Fund.

Disciplinary record and compliance history (DEPP 6.5.2(9))

6.11. The FSA has not previously taken any disciplinary action against SLOC UK.

Conduct following the breach (DEPP 6.5.2(8))

6.12. In deciding upon the level of disciplinary sanction, the FSA has taken account of
SLOC UK’s efforts to improve the effectiveness of its governance arrangements and
SLOC UK’s implementation of recommendations of a review by a skilled person.

6.13. SLOC UK has co-operated fully with the FSA in the course of its investigation.

Previous action taken by the FSA (DEPP 6.5.2(10))

6.14. The FSA seeks to apply a consistent approach to determining the appropriate level of
penalty and has taken into account previous decisions made in relation to misconduct
by firms which bore similarities to SLOC UK’s misconduct.

6.15. Having regard to the seriousness of the breaches and the risk they posed to the FSA’s
statutory objective of the protection of consumers, the FSA imposes a financial
penalty of £600,000 on SLOC UK.

7.
PROCEDURAL MATTERS

Decision maker

7.1.
The decision which gave rise to the obligation to give this Final Notice was made by
the Settlement Decision Makers.

7.2.
This Final Notice is given under, and in accordance with, section 390 of the Act.

Manner of and time for payment

7.3.
The financial penalty must be paid in full by SLOC UK to the FSA by no later than 1
November 2012, 14 days from the date of the Final Notice.

If the financial penalty is not paid

7.4.
If all or any of the financial penalty is outstanding on 2 November 2012, the FSA may
recover the outstanding amount as a debt owed by SLOC UK and due to the FSA.

7.5.
Sections 391(4), 391(6) and 391(7) of the Act apply to the publication of information
about the matter to which this notice relates. Under those provisions, the FSA must
publish such information about the matter to which this notice relates as the FSA
considers appropriate. The information may be published in such manner as the FSA
considers appropriate. However, the FSA may not publish information if such
publication would, in the opinion of the FSA, be unfair to SLOC UK or prejudicial to
the interests of consumers.

7.6.
The FSA intends to publish such information about the matter to which this Final
Notice relates as it considers appropriate.

FSA contacts

7.7.
For more information concerning this matter generally, contact Andrew Wigston of
the Enforcement and Financial Crime Division of the FSA (direct line: 020 7066
6286/fax: 020 7066 6287).

………………………………………
Tom Spender
FSA Enforcement and Financial Crime Division


ANNEX A

RELEVANT STATUTORY PROVISIONS, REGULATORY PROVISIONS AND FSA
GUIDANCE

1.
STATUTORY PROVISIONS

1.1.
Under Section 2(2) of the Act, the protection of consumers is one of the FSA’s
statutory objectives.

1.2.
Section 206 of the Act provides:

“If the Authority considers that an authorised person has contravened a requirement
imposed on him by or under this Act, it may impose on him a penalty, in respect of the
contravention, of such amount as it considers appropriate.”

1.3.
SLOC UK is an authorised person for the purposes of section 206 of the Act. The
requirements imposed on an authorised person include those set out in the FSA
Principles and rules made under section 138 of the Act.

1.4.
The FSA’s rule-making powers are set out in Chapter I of Part X of the Act (Rules
and Guidance). The FSA has made rules, in particular those contained in SYSC,
COBS, INSPRU and SUP in accordance with its powers and provisions under this
part of the Act.

2.
REGULATORY PROVISIONS

FSA’s Principles and Rules

2.1.
The FSA’s Principles are a general statement of the fundamental obligations of firms
under the regulatory system. They derive their authority from the FSA’s rule-making
powers as set out in the Act and reflect the FSA’s regulatory objectives.

2.2.
Principle 3 states:

“A firm must take reasonable care to organise and control its affairs responsibly and
effectively, with adequate risk management systems.”

FSA’s Conduct of Business Sourcebook (COBS)

2.3.
COBS 20.3.2 G states:

“In complying with the rule on systems and controls in relation to compliance,
financial crime and money laundering (SYSC 3.2.6 R), a firm should maintain
governance arrangements designed to ensure that it complies with, maintains and
records any applicable PPFM. These arrangements should:

(1)
be appropriate to the scale and complexity of the firm’s with-profits business;

(2)
include the approval of the firm’s PPFM by its governing body; and

(3)
involve some independent judgment in assessing compliance with its PPFM
and addressing conflicting rights and interests of policyholders and, if
applicable, shareholders, which may include but is not confined to:

(a)
establishing a with-profits committee;

(b)
asking an independent person with appropriate skills and experience
to report on these matters to the governing body or to any with-profits
committee; or

(c)
for small firms, asking one or more non-executive members of the
governing body to report to the governing body on these matters.

The FSA’s view on With-Profits Funds

2.4.
Through Chapter 20 of COBS which was in force during the Relevant Period, the
FSA sought to protect policyholders of with-profits funds to ensure that they were not
treated unfairly.

2.5.
COBS 20.2.1G states:

“With-profits business, by virtue of its nature and the extent of discretion applied by
firms in its operation, involves numerous potential conflicts of interest, that might give
rise to the unfair treatment of policyholders. The rules in this section [meaning the
rules contained in COBS 20] address specific situations where the risk may be
particularly acute. However, a firm should give careful consideration to any aspect of
its operating practice that has a bearing on the interests of its with-profits
policyholders to ensure that it does not lead to an undisclosed, or unfair, benefit to
shareholders.”

FSA’s Senior Management Arrangements, Systems and Controls (SYSC)

2.6.
SYSC 3.2.6R states:

“A firm must take reasonable care to establish and maintain effective systems and
controls for compliance with applicable requirements and standards under the
regulatory system and for countering the risk that the firm might be used to further
financial crime.”

FSA’s Supervision Manual (SUP)

2.7.
SUP 15.3.11 R states:

“(1)
A firm must notify the FSA of:

(a)
a significant breach of a rule (which includes a Principle) or Statement
of Principle; or

(b)
a breach of any requirement imposed by the Act or by regulations or
an order made under the Act by the Treasury (except if the breach is
an offence, in which case (c) applies);

(c)
the bringing of a prosecution for, or a conviction of, any offence under
the Act;

(d)
a breach of a directly applicable provision in the MiFID Regulation;
or

(e)
a breach of any requirement in regulation 4C(3) (or any successor
provision) of the Financial Services and Markets Act 2000 (Markets in
Financial Instruments) Regulations 2007;

by (or as regards (c) against) the firm or any of its directors, officers,
employees, approved persons, or appointed representatives or, where
applicable, tied agents.

(2)
A firm must make the notification in (1) immediately it becomes aware, or has
information which reasonably suggests, that any of the matters in (1) has
occurred, may have occurred or may occur in the foreseeable future.”

Prudential Sourcebook for Insurers (INSPRU)

2.8.
INSPRU 1.1.28 R states:

“In addition to complying with INSPRU 1.1.27 R, a realistic basis life firm must also
ensure that the realistic value of assets for each of its with-profits funds is at least
equal to the realistic value of liabilities of that fund.”

2.9.
Enforcement Guide 2.25 (3) states:

“Guidance and supporting materials are, however, potentially relevant to an
enforcement case and a decision maker may take them into account in considering the
matter. Examples of the ways in which the FSA may seek to use guidance and
supporting materials in an enforcement context include: (3) to inform a view of the
overall seriousness of the breaches e.g. the decision maker could decide that the
breach warranted a higher penalty in circumstances where the FSA had written to
chief executives in the sector in question to reiterate the importance of ensuring a
particular aspect of its business complied with relevant regulatory standards.”

The FSA Glossary

The FSA Glossary states that a “with-profits committee” is:

“a committee of the governing body, including non-executive members of the
governing body and possibly some external non-directors with appropriate skills and
experience.”

3.
EXTRACTS FROM “DEAR CEO” LETTER

3.1.
The “Dear CEO” Letter states:

“Governance arrangements for with-profits funds (open and closed)

The purpose of our guidance is to secure an appropriate degree of protection for
with-profits policyholders and to promote confidence among such policyholders.
Consistent with the Senior Management Arrangements, Systems and Controls (SYSC)
part of our Handbook (specifically SYSC 3.2.6R), our approach is that governance
arrangements should, “be appropriate to the scale and complexity of a firm’s with-
profits business” and should “involve some independent judgement in the assessment
of compliance with PPFM [the Principles and Practices of Financial Management]
and how any competing or conflicting rights and interests of policyholders and, if
applicable, shareholders have been addressed” (COB 6.11.5G)1. We accept that
independent judgement can be provided in different ways (and that the effectiveness of
the arrangements depends on both the quality of challenge and the skills/ experience
of the independent input). These may include, but are not confined to, establishing a
With-Profits Committee (WPC) or asking an independent person or non-executive
member of the Board to perform this function (COB 6.11.6G). We also acknowledge
that the Board could take a different view to any independent input it receives – the
Board has ultimate responsibility for the proper conduct of the firm’s with-profits
business.

Scope of WPC/independent reviewer. We found that some firms’ arrangements aim
to comply with our guidance (i.e. monitoring compliance with the PPFM) rather than
thinking about the broader outcome that the governance arrangements are intended
to achieve in terms of Principle 6 (treating customers fairly) and Principle 8
(managing conflicts of interest). As a result, in some firms the range of issues referred
is more limited than we would expect it to be. Senior management need to ensure that
firms’ with-profits governance arrangements are consulted on all significant issues
affecting with-profits policyholders’ interests (e.g. changes to investment strategy,
charges and bonuses). They should also be able to provide an independent challenge
in the assessment of how any conflicts of interest between policyholders and, if
applicable, shareholders have been addressed.

Timeliness of information and access to the Board. We found several examples
where the WPC/independent reviewer was told of significant decisions after they had
already been made by the Board. In other instances there was not sufficient time
given for the WPC/independent reviewer to review, challenge and report back to the
Board and, in some instances there was no audit trail of the challenge process.

1 COB 6.11.5G and COB 6.11.6G ceased to apply from 31 October 2007. The provisions contained in COB
6.11.5G and COB 6.11.6G were included within chapter 20 of COBS which came into force on 1 November
2007.

We expect senior management of firms that operate with-profits finds (whether large
or small) to review how they have implemented the Principles for Businesses (and our
SYSC requirements) in their governance arrangement and oversight of closed funds in
run-off. This will include reference to the provisions set out in COB 6.11 and COB
6.12, where relevant. You should consider whether your arrangements achieve the
purpose intended, specifically if you are delivering the outcome of fair treatment of
with-profits policyholders. Where this review reveals shortcomings, we expect firms to
take prompt action to remedy them.

We will continue, as part of supervisory work, to assess firms’ compliance with our
relevant Principles, rules and guidance in relation to with-profits governance and
run-off plans. And we will take supervisory or enforcement action, where appropriate,
in cases where we find that customers are not being treated fairly.”