OpinionFeb 27 2013

Final guidance on incentives and mis-selling

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In January the FSA published final guidance on what firms should do to avoid creating and operating incentive schemes that drive mis-selling, following review findings published in 2012.

Although the review involved the activity of only 22 authorised firms between September 2010 and September 2011, the findings were worrying as the FSA concluded that 20 out of the 22 firms assessed had features in their incentive schemes that increased the risk of mis-selling. In six of those cases the risks were significant and, surprisingly, only one firm was referred to the regulator’s enforcement and financial crime division.

The guidance makes it is clear that incentive schemes can totally undermine what the regulator has been attempting to achieve in terms of treating customers fairly and suitability of recommendations. Enforcement cases have been taken against firms on issues regarding reward arrangements, but how firms can influence the behaviour of their advisers and sales staff is still an area of concern.

The guidance was aimed at all firms in retail financial services with incentive schemes for staff dealing directly with retail customer transactions. This not only includes staff involved with selling but also those providing a service, such as advisers and those in a discretionary and non-discretionary investment management roles. The FSA has made it clear that the guidance is final and that if firms have not already done so, they should act now. The regulator will be monitoring how firms act on the guidance and is prepared to take action against the worst offenders. Judging by the findings of the limited sample reviewed, there may be many candidates for enforcement action by the incoming Financial Conduct Authority unless firms take the initiative and respond to the guidance.

The FSA does not prescribe how firms should or should not incentivise their staff but it does expect firms to comply with principle three of its principles for businesses. The guidance identifies examples of features of incentive schemes that increase the risk of mis-selling, including disproportionate rewards for marginal sales, inappropriate incentive bias between products, variable salaries according to performance, 100 per cent commission only, inappropriate levels of incentives for sales of additional products and incentives linked to level of type of premium, investment amount or length of term.

The FSA has also identified areas of good practice and poor practice and firms should identify where they fit in context with FSA’s expectations. The regulator reported that many small mortgage and investment firms may pay their advisers purely based on the revenue they earn which may amount to 100 per cent variable pay, and that advisers may also receive additional bonuses for exceeding a revenue threshold. Both forms of incentive may increase the risk of mis-selling.

One example of good practice is the use of balanced score cards where a bonus is not just based on sales volumes but will include other measures that determine how much bonus is awarded, including sales quality results, customer satisfaction, upheld complaints and compliance performance.

Remedial steps taken by some firms have included changing incentive schemes so they are not based on sales volumes, removing high-risk incentive features and conflicts of interest for sales managers, introducing more effective links between incentive schemes and the results of business quality monitoring.

What is abundantly clear is that the success of the retail distribution review to remove product provider influence over adviser recommendations to clients will be a hollow victory if some intermediary firms incentivise their advisers in a way that encourages unsuitable recommendations.

The success of the RDR removing product provider influence over adviser recommendations to the client will be a hollow victory if some intermediary firms themselves incentivise their advisers in a way that encourages unsuitable recommendations.

Philip Ryley is a partner and head of financial services and markets for Michelmores