Funds seek compliance health-check as regulators turn up heat

* After bankers, fund managers to face rulemakers' scrutiny

* British markets watchdog flags competition probe

* Fund firms reviewing compliance

By Simon Jessop and Sinead Cruise

LONDON, March 2 (Reuters) - After watching a crack-down on bankers for bad behaviour, British fund managers are calling in lawyers to help to spring clean their businesses as the regulatory spotlight turns towards their industry.

Before the financial crisis, fund management firms made healthy returns from a bull market in equities, bonds and other financial assets and there were few questions asked about the level of fees charged or the service provided.

But post-crisis, regulators and politicians want greater reassurance investors are getting value for money as investment yields tumble.

Britain's financial watchdog has said it expects to launch a review of Britain's 5.4 trillion pound ($8.32 trillion) fund industry, partly to see if customers are being overcharged. President Obama last week put forward a plan to tighten up rules in the U.S. market.

This tougher regulatory climate is prompting firms to take pre-emptive action to review their operations.

"We're seeing a greater number of instructions from asset managers who want to know how they can ensure they meet ongoing regulatory obligations," David Hughes, partner at law firm Dechert, said.

"The answer is to have robust systems and procedures in place to prevent market abuse. Increasingly, we are helping them to review systems related to insider dealing, conflicts policies, money laundering and ... making sure they are selling products appropriately and treating customers fairly."

Even if many larger firms consider that they have adequate processes in place, there is a much longer tail of smaller fund firms that could feel the regulatory pressure more keenly.

"I think most firms run a very good business, but of course, if you look at the number of asset managers out there, I'm sure there is a small percentage of bad boys who could do with more oversight," Jupiter Fund Management Chief Executive Maarten Slendebroek, said.

Firms already feeling the heat from the tougher regulatory approach include Aviva Investors, which recently said it had paid out 150 million pounds in fines and compensation after failing to control conflicts of interest.

Parts of Aberdeen Asset Management (Other OTC: ABDNF - news) were fined 7.2 million pounds in Sept. 2013 for failing to fully protect client money placed in money market deposits with third party banks.

State Street UK was handed a 23 million pounds penalty in January last year for overcharging and hiding fees from clients, while Invesco Perpetual was fined 18.6 million pounds in April for exposing clients to more risk than they knew about.

In the light of these events, the industry has started to worry about potential litigation and compensation claims.

"A lot of [fund firms] feel they are 'fully alert to risks.' But then there's greater publicity about future regulation, and they start to self-analyse a little more deeply," Hughes said.

While investment firms are unlikely to face bank-style fines running into billions of pounds, companies are much smaller on average and even modest penalties will hurt.

"I do think firms are taking it seriously," Monica Gogna, funds lawyer at Ropes & Gray, said.

"They are realising that they have to review policies and the approach with which they train staff on a continual basis so they are up to date with the spirit and the letter of the law."

The watchdog has said so-called "closet tracking" funds, or funds that say they are actively managed but effectively mimic a benchmark stock index, could indicate a "misalignment" between asset managers and their customers.

Actively managed funds charge higher fees than funds that openly track an index.

Fund managers are also preparing for a revamp of rules governing the personal responsibility of executives and managers for the wrongdoing of subordinates, lawyers and advisers said.

From 2016, bank executives will be subject to the Senior Managers Regime, a raft of tight new rules aimed at making them more accountable for their actions. Fund managers remain subject to the older, and broadly discredited, Approved Persons regime, but some could be hauled into the new system before long.

Julie Patterson, investment management regulation expert at KPMG, said fund firms needed to prepare for such cross-over from the banking sector overhaul, citing a debate on whether funds, like some banks, could be "too big to fail".

"The investment management industry is in the regulatory spotlight on many fronts. It must pay close attention to the types of concerns raised by regulators about other sectors," Patterson said. ($1 = 0.6487 pounds)

(Additional reporting by Huw Jones. Editing by Jane Merriman)