It is an “opt-in” scheme, making use of powers under Section 404 of FSMA, requiring firms to review past business and potentially pay redress to clients. The FSA believes the Arch Cru funds were high risk investments sold to retail investors as lower risk investments.
As much as £470m was invested into the Arch Cru funds by the time of its suspension in March 2009 and the FSA believes that 90 per cent of investors were mis-sold their investments with a potential redress bill of up to £40m.
This article is not a technical analysis of the Consumer Redress Scheme rules. The aim is to consider salient aspects of the scheme, the challenges around implementation and how to avoid potential pitfalls.
The scheme concerns personal recommendations made to retail investors after 13 December 2006 in England, Wales and Northern Ireland or 13 December 2007 in Scotland.
The scheme excludes:
•Execution-only sales;
•Investment through a discretionary management arrangement;
•Failure to provide advice to disinvest from Arch Cru funds; or
•Investors who have received a full and final settlement in respect of a complaint about advice to invest in Arch Cru or have an outstanding complaint at the Fos.
The first step is to identify in-scope cases and contact relevant clients. Firms must send out a prescribed letter offering an invitation to opt-in to the scheme by 29 April 2013. A series of reminders must be sent if no response is received. If an opt-in is received after 22 July 2013, firms are not required to perform a review unless exceptional circumstances prevented a client’s response.
Once an opt-in is received, the case is assessed and the FCA requires firms to use a very detailed suitability template to assess suitability. The key factors upon which suitability hinges are:
•The extent to which the client was willing to take a high degree of risk;
•The risk profile of the client’s overall savings and investments after the recommendation;
•The extent to which the client’s portfolio was sufficiently diversified;
•The extent to which the client was reliant on income from the investments;
•The capacity of the client to accept the level of investment risk;
•The level of the client’s knowledge and experience of investments; or
•Any other reason that makes the recommendation unsuitable.
When assessing suitability, the FCA expects firms to fairly review the contemporaneous advice documents and give fair weight to any information provided by the client during the review process. The FCA will take a dim view if firms rely on the following to demonstrate suitability:
•Signed documentations or disclosures of risk;
•Reliance on general advice processes or procedures at the time of advice;
•An investor’s previous experience of investment in Arch Cru investments; or
•Giving more weight to the recollections or testimony of the adviser than the client.
Where there are indications of non-compliance with relevant Cob/Cobs requirements, a firm must perform the “causation test”. This test asks, “in the absence of non-compliance, would the client have proceeded with the investment anyway?” For instance, if the investment was advised as low risk, but the client would still have proceeded if advised on the basis of a high risk investment, the non-compliance did not lead to the investor’s loss. The balance of evidence, however, must be very strong for firms to rely on an argument such as this.
Additionally, advice involving multiple sub-funds where one fund is suitable and another is not will render the overall advice unsuitable.
Firms are required to send a redress calculation request to the FCA and clients have six months from the date of determination to accept any compensation.
Any complaints received about advice to invest in Arch Cru funds received between 1 April and 23 July 2013 must be treated as an “opt-in” to the scheme. If a complaint is received thereafter, it should be treated as a complaint in the normal way. Firms must take into account their general obligations to assess the complaint fairly when issuing their final response.
With respect to the operation of the scheme, clients have the right of referral to the Fos in relation to the scheme and firms should bear in mind that there are time-limits in chapter two of the FCA’s Dispute Resolution rules which may prevent a complaint from being referred to the Fos.
The scheme became operational when the FSA became the FCA on 1 April. The FCA promises to be a much more rigorous regulator and is likely to undertake supervisory reviews of firms’ activities. There is the potential risk of disciplinary action if standards are not met. This creates the first challenge to design, test and implement well functioning and properly controlled operational processes to perform the review. The key is to equip relevant staff with the right competencies, ensure the right decisions on each case, hit key milestones and maintain adequate records.
The second challenge is the potential conflict of interests between the fair treatment of clients and the commercial interests of the firm. Past business reviews can be very emotive for advisory firms and this can undermine objective judgement. Potential issues to overcome include the FCA’s view that, even where there is extensive due-diligence by the firm, the investments are high risk. The absence of any guidance as to what constitutes a diversified portfolio is problematic and the causation test has real potential for abuse. Strong governance and evidence-based leadership will counterbalance these tensions.
The FCA will judge firms on two key variables. The first is the integrity of its operational processes and governance arrangements. The second is the effectiveness of case decisions. The regulator wants the cases to be assessed effectively, fairly and timely; this means that it does not want consumers to be disadvantaged by not being awarded redress when they should have, but also that firms do not pay redress when the advice was demonstrably suitable.
Where the standards fall short, this could indicate concerns about, not only consumer detriment, but also senior management competence, and the firm’s systems, controls and governance arrangements. With a more forceful regulator, the consequences could be:
•Repeating the review, perhaps using a Skilled Person, incurring additional monetary and time costs.
•Taking statutory action against the firm or individual staff, resulting in disciplinary action and fines.
Esrar Moitra is consulting director of Optimars
What should firms do now?
Firms should:
1.Identify the clients falling within the scope of the scheme and its potential financial exposure.
2.Perform an initial review to determine whether there is sufficient information to assess suitability.
3.Design and test review processes to ensure successful implementation at the “go-live” date.
4.Develop a quality assurance process so that relevant staff are properly trained and cases are decisioned properly.
5.Set up a governance framework to monitor progress of the review with MI that allows senior management to gain assurance that the review is being performed correctly.
6.Make financial provision to cover the costs of the review and potential redress.
Key points
In December 2012, the FSA published its policy statement PS 12/24 “Consumer redress scheme in respect of unsuitable advice to invest in Arch cru funds”.
The first step is to identify in-scope cases and contact relevant clients
One challenge is the potential conflict of interests between the fair treatment of clients and the commercial interests of the firm
