RegulationJul 28 2014

Markers on the distribution map

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The FCA’s Guidance Consultation on retail investment advice, TR14/10, and a research paper that accompanied it on execution-only and simplified advice were a political necessity.

The industry and politicians keep begging the regulator to give simplified advice a chance. However, any hope that the regulator would provide solid encouragement here was delusional. The Markets in Financial Instruments Directive II (MiFID) and ordinary negligence law limit the scope for something with a personal recommendation from being offered without a proper advice process.

The Guidance Consultation explains well the demarcation between full advice, limited advice, simplified advice, advice without a personal recommendation, generic advice and no advice. It should also give anyone offering execution-only services food for thought. Neither the IFA nor the compliance sector escapes criticism.

Investment advice (regulated) or generic advice (not)

Giving advice to potential investors or their agents relating to the merits of buying, selling and much else of a specific investment has to be regulated. By contrast, generic advice is not controlled. “Generic” involves advice to buy in a country, sector or investment type but not a specific investment. A decision-tree process must be clearly limited to helping a customer make his or her choice of a product. Any steering could turn the process into a personal recommendation. Occasionally, financial planners claim to be able to operate without authorisation because they offer generic advice on investments. Few actually limit their investment activity in this way.

Neither the IFA nor the compliance sector escapes criticism

Advice as opposed to a personal recommendation

Information offered on a “selected rather than balanced basis that it influences or persuades” is “investment advice” if it relates to a specific investment. Distributors of investment bulletins, therefore, have to be authorised or appointed representatives of someone who is. However, such publications do not give personal recommendations. They do not say to customers: “You ought to buy this investment.” Instead they express their views in an impersonal way. They must be “clear, fair and not misleading”.

If a firm makes a personal recommendation, the Conduct of Business Sourcebook (Cobs) 9 – the suitability rules – applies. If the recommendation relates to a transaction in a financial instrument that is presented as suitable or based on a consideration of the recipient’s circumstances, it is probably personal. As the Committee of European Securities Regulators says, “if a firm [says] ‘this product would be the best option for you’”, that is MiFID advice. Likewise, comments such as “people like you do this” and “I would do this if I were you”.

Any private process by which a firm steers a customer to a particular conclusion will meet that description. Even a tweet can be a personal recommendation – the Guidance Consultation says that where a message goes to a group of targeted individuals and the message “contains a solicitation, an opinion or a judgment about the advisability of a transaction”.

Limited advice

The crucial part of the Guidance Consultation for most IFAs’ concerns “limited or focused advice”. The FCA defines this as “a deliberate limiting of the range of personal recommendations sought by the client”. The client request is central. The regulator qualifies the suitability standard “by reference to the nature and extent of the service; information which must be obtained is qualified by the condition where relevant but this remains at the instigation of the customer”. Limited advice “does not require the detailed fact-find of a full advice offering”. The adviser must explain that other needs and objectives will not be addressed. This provides a degree of regulatory protection for recommendations where a full fact-find would have revealed a problem in an area that was not requested.

However, where information comes up during the review, dangers arise. If this is the need to reduce debt in relation to an investment advice-only customer, that recommendation must be given personally to the customer. The FCA says this “arose from the information needed to deal with the specific objective or need the intermediary has agreed to advise their customer on”. Similarly, if during discussions, another need arises, the adviser must draw attention to it, notably the need for protection. The Financial Ombudsman Service, though, has always said that it will judge advice against the context in which it was given. This provides some further modest comfort.

Simplified – dead

Simplified advice has always been a dead duck. It has to comply with the suitability requirements and be delivered by a fully qualified retail investment adviser. Such a person needs also to design the system. The thematic review reports some pretty good reasons given to it for not developing simplified advice: the uncertain breadth of the suitability standard and corresponding fears about Fos, systemic mis-selling risk caused by design errors and the risk of customers buying the recommended products elsewhere. Some providers also rightly worry about how to design systems that exclude unsuitable customers. The FCA provides no comfort here.

Execution-only

Advisers should not do execution-only business. The FCA’s research shows that customers become confused and think they have received advice. A disclaimer that no advice is being given is of no effect if a recommendation has just been given. These problems disappear where a distinctive non-adviser channel is used.

On pure execution-only, the regulator noted with concern that compliance uncertainty restricted the support that firms could provide to purchasers. All relevant types of risk must be clearly disclosed. However, this should be in the body of the text, not at the bottom. This should also assist firms in providing material that helps customers to buy better without giving a personal recommendation.

Worryingly many execution-only customers seek advice about investing higher amounts even though they distrust IFAs. Many are not particularly confident but have a low view of advisers. The uncertainties about whether advice has been given seem confined to human interaction situations. As the Guidance Consultation shows, much of the website material used for execution-only sales is advice but not a personal recommendation. Therefore, it only has to be clear, fair and not misleading. However, where a customer is guided through a process that takes into account his or her personal circumstances, this is probably a Cobs 9 personal recommendation.

Advisers probably throw away business by failing to loop together their annual review recommendations and the use of their customers’ Isa allowances. Often IFAs say that such business is not worth the cost without appreciating that they have been through most of the process already. This may explain why some investors think they have received advice when buying through a non-advised channel. Mailings from advisers tend to be personal recommendations.

Non-advised customers make mistakes. They fail to use Isa allowances before buying other investments, buy something different to what they intended or purchase excessively high-risk products without understanding them.

The FCA wants plain English in short, bite-sized chunks with a final reminder of key points before the sale’s conclusion. This would make sense in all transactions. Clearer charging structures are also needed.

The FCA papers create a model for anyone selling without a personal recommendation that stems from the regulator’s product manufacturing work. Firms must know who is and ought to be buying its products without a recommendation and whether the outcomes appear acceptable. For example, firms that see increased volumes of customers seeking advice when markets fall have targeting problems. Firms must identify the target market, stress-test the way execution-only is going to be processed, review the material to ensure that it is clear, fair and not misleading, and then check that the customers are buying the right type of products as a result. Just putting out a proposition and checking the literature is not enough.

The regulator would like to see more generic financial planning tools and core investing rules made available. Non-Isa investors need reminding of the need to use the Isa allowance before purchasing.

Mailings by IFAs to customers, particularly where a firm has concerns about an investment, can prove problematic. General information that does not relate to the customer’s circumstances may be fine. However, it is easy to go further. Offering factual information about a range of alternatives might appear to be a solution. The difficulty here is that where a fund appears to have a problem, a firm needs to break the link between its earlier recommendation and any future damage. It can only do this by issuing a personal recommendation in a situation where time may be short. Extracting a customer from a Ucis or life settlement fund in recent times on the basis of a less than full fact-find was worth the compliance risk for many firms with exposures in this area.

The FCA papers are thoughtful, accurate descriptions of a complicated distribution landscape. The Guidance Consultation helps IFAs doing limited advice, but only where the client has requested this. Firms would probably be better off just connecting their annual reviews with their suitability reports for individual transactions. This would reduce further the risks involved.

Most advisers are unable to resist the temptation to advise. Execution-only providers have to identify their target markets and create signposts to stop customers doing stupid things and then monitor their transactions to see if this has worked. They have a great deal more to do.

Adam Samuel is a freelance journalist and compliance consultant

Key points

The Guidance Consultation on retail investment advice, TR14/10, and a research paper that accompanied it on execution-only and simplified advice were a political necessity

The crucial part of the Guidance Consultation for most IFAs concerns “limited or focused advice”

The regulator would like to see more generic financial planning tools and core investing rules made available