Your IndustryMar 31 2016

What is a ‘reasonable amount’ of due diligence?

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What is a ‘reasonable amount’ of due diligence?

The Financial Conduct Authority has never been prescriptive about the exact amount of due diligence needed for an adviser to make a recommendation.

As the regulator has never laid out exactly what firms have to do when carrying out research, Aileen Lynch, head of technical for SimplyBiz, says it is difficult to define what is a “reasonable amount of due diligence”.

Keith Richards, chief executive of the Personal Finance Society (PFS), says the crucial factor for an adviser to make a recommendation is that it must meet the needs of the respective client.

Mr Richards says they must use their professional judgment to ensure they know sufficient information about the product or service to justify that requirement.

To clearly define the relevant parameters, Mr Richards says the PFS’s good practice guide on research and due diligence on discretionary investment managers states: “The care a reasonable and prudent person (adviser firm) should take before entering into an agreement or a transaction with another party (the DIM).

“Gathering detailed, quality information over and above general marketing documentation is a fundamental part of the research process, in order to identify anything deemed material in the service or relationship.

One would not buy a car after simply having a quick glance through the sales brochure Keith Richards

“By using the same due diligence process systematically, advisers will be equipped to make an informed decision ensuring all the costs, benefits, known and potential risks are analysed and assessed against the adviser firm’s pre-defined criteria.

“This will lead to greater confidence in client outcomes meeting the identified client needs.”

Mr Richards says it is unlikely that advisers can rely on provider’s marketing material when carrying out due diligence.

He says: “Getting a marketing spin instead of the requisite detail is not going to be sufficient to identify whether or not something is suitable for a client.

“It is likely the provider wants to focus on the benefits and unique selling points they have to offer, rather than any potential downsides.

“One would not, for example, buy a car after simply having a quick glance through the sales brochure.”

Sheriar Bradbury, managing director of Bradbury Hamilton, says he always takes marketing material with a pinch of salt based on the purpose of the material.

He says: “Our industry has learnt the hard way that if something is too good to be true, it probably is and we continue to pay for this in our Financial Services Compensation Scheme payments.”

David Heffron, head of financial services regulation at Pinsent Masons, says while firms can rely on factual information provided by EEA-regulated firms as part of their research and due diligence process (for example, the asset allocation), they should not rely on the provider’s opinion.

Mr Heffron says firms should therefore not rely on a provider’s assessment of risk.

He says: “Firms should ensure they have a sufficient understanding of a product to be able to come to their own independent assessment of risk, and should ask the provider to supply additional information or training where that seems necessary to understand the product or service adequately.

“Firms need to come to their own assessment of a product’s suitability, having regard to the particular needs of their individual clients.”

If providers present material as a fact, Richard Nuttall, head of compliance policy at Simplybiz, says an adviser would not be expected to verify it further.

But where the provider includes subjective opinions regarding certain aspects of their products or funds then Mr Nuttall agrees with Mr Heffron that firms should challenge and not rely solely on the information given.

Mr Nuttall says: “This is about ensuring they deliver what they say they will.

“An independent assessment or factual evidence is best obtained. We are not saying providers deliberately set out to mislead but there have been numerous instances in the past where what they identify as the risk is not always played out in practice.

“The FCA has specifically commented firms should not rely on a provider’s assessment of the investment risk level of a product, and highlighted this by referring to the consumer redress scheme which has been set up regarding the Arch Cru funds.”

In March 2009, Arch Cru was suspended by the Financial Services Authority over liquidity concerns following increased redemptions.

On 21 December 2010, the fund’s consolidated net asset value was calculated at £234m, which represented “a significant loss to investors”.

Ben Wright, head of technical services and research for Tenet, agrees you can rely on factual information published by a regulated provider but not solely on opinions and marketing statements.

Mr Wright says: “Be prepared to ask your own further questions of the provider if it is a product you have not recommended before.

“Advisers should use reasonable care and skill to undertake their own assessment of the risks. Arch Cru is a good example of why you should not take a provider’s assessment of risk at face value.”