UPDATE 3-UK watchdog probes Queen's bank over fund sales

* FSA notified RBS of probe in July

* Investigation into sales by Coutts of ALICO bond fund (Adds more background)

By Chris Vellacott

LONDON, Aug 6 (Reuters) - The UK financial services industry watchdog has launched a probe into sales of a fund product by Royal Bank of Scotland's (RBS.L) private banking arm Coutts, which counts Queen Elizabeth II among its clients.

The investigation is into the sale by Coutts of a savings product offered by U.S. insurer AIG (AIG.N), which was forced to suspend withdrawals on the fund in 2008 when it landed in financial trouble during the credit crisis.

RBS added that it was "cooperating fully" with the probe by the Financial Services Authority (FSA).

"In July 2010, the FSA notified RBS Group that it was commencing an investigation into the sale by Coutts & Co of ALICO (American Life Insurance Company) Premier Access Bond Enhanced Variable Rate Fund to customers between 2001 and 2008," RBS said in a statement on Friday.

A spokeswoman at the FSA said the statement was accurate.

AIG has agreed to sell its ALICO foreign life insurance business unit to Metlife (MET.N) as it seeks to repay taxpayer money after a government bail-out. [ID:nWBT013955]

The private banking industry has struggled to rebuild its once-solid reputation after falling out of favour with well-heeled clients who lost money on investments that went bad in the financial crisis.

Coutts found itself under fire from entrepreneur and loyalty card schemes inventor Sir Keith Mills, who says he made a 65 million-pound ($103.4 million) investment in the ALICO products.

He has mounted a high profile publicity campaign, including placing billboard advertisements criticising the private bank close to its headquarters on London's Strand.

He also says on his website that he wrote to the FSA to ask about investigating Coutts's sales of the product, and that he met the regulator's chief executive Hector Sants.

Mills was not immediately available for comment.

A source close to Coutts said about 250 of its 72,000 UK-based customers have investments in the product.

While Mills' campaign has focused on Coutts, other high profile Britons have launched outspoken attacks on their bankers for selling them products related to AIG, including Jeremy Clarkson, presenter of the BBC's Top Gear TV motoring show.

The news of the probe came alongside RBS's second-quarter results which showed lower impairment losses had helped operating profit rise from the first quarter. [ID:nLDE6741UI] ($1=.6288 pounds) (Reporting by Chris Vellacott; Editing by Mike Nesbit) (For the Funds Hub blog: blogs.reuters.com/hedgehub) (For Global Investing: here)