In the seventh article in the series on making professional connections, Ian Muirhead, of Solicitors for Independent Financial Advice, explains the FSA, Law Society and VAT rules affecting professional firms which refer or introduce financial services work to IFAs.
The Financial Services and Markets Act 2000 perpetuates the distinction created by the Financial Services Act 1986 between the two alternative types of relationship which might exist between solicitors and IFAs or other authorised third parties to whom they might refer their clients for financial advice:
A referral implies a formal relationship, preferably recorded in writing, whereby the professional firm and the FSA-authorised firm agree to work together, with the professional firm keeping a watching brief on behalf of the client.
The joint involvement of the referring firm and IFA brings the referral activity within the Part XX exemption from the FSMA 2000 and the Solicitors' Financial Services (Scope) Rules 2001. In particular, it gives rise to the requirement for the referring firm to account to its clients for any remuneration received.
The FSA has issued guidance in its g:project booklet for professional firms dated August 2001 as to the meaning of the expression “accounting to clients”. This states that firms receiving remuneration for referrals must “treat any commission or other pecuniary benefit received from third parties …. as held to the order of the client. A professional firm will not be accounting to its client simply by telling the client that the firm will receive commission. Unless the client agrees to the firm keeping the commission, it belongs to the client and must be paid to the client.”
The condition would be satisfied “by the professional firm informing the client of the sum and that he has the right to require the firm to pay the sum concerned to the client, thus allowing the sum to be used to offset fees due from the client in respect of professional services provided”.
The logical procedure for firms which refer clients to authorised third parties under Part XX, and wish to retain commission or other remuneration received from those third parties, would be for the referring firm or the authorised firm on its behalf:
To disclose to clients the remuneration receivable.
To explain the services provided by the referring firm to the client which justify it in asking the client to agree that the remuneration should be retained in lieu of or in satisfaction of fees and To obtain the client's consent in writing to the firm retaining the remuneration.
A mere introduction would fall outside and be excluded from the scope of the FSMA altogether and would have no regulatory consequences.
It might typically be made if, when the subject of financial advice arose, the solicitor informed the client that his firm was not authorised to advise but commented that he was aware of an IFA in town of whom he had heard good reports and suggested that the client might care to get in touch with the IFA.
The solicitor would do no more than give the client the IFA's contact details and would leave it to the client to decide whether to pursue his suggestion. He would then have no further involvement.
In guidance to professional firms dated August 2001, the FSA identifies two criteria for determining what might qualify as a mere introduction:
It does not relate to a specific investment but to investment advice in general and It does not involve the professional firm in an ongoing role, for example, as a form of conduit for communications.
The anomaly created by the distinction between referrals and mere introductions is that a professional firm can in theory retain commission without accounting to the client only when it has provided no significant service to the client.
Practice rule 10 and other factors
However, the FSA has stated publicly that it expects that all instructions by professional firms will take the form of referrals, rather than introductions, because this is the most professional way of doing business.
Another reason for avoiding mere introductions is VAT. The case of Cheshire Trafford (Taxation 1999 142 (3692) 450-451) confirmed that, while firms which can demonstrate having participated in the VAT-exempt transaction of arranging an investment can share the benefit of the VAT exemption enjoyed by the financial adviser, payments to firms which do no more than make an introduction will be subject to VAT – as also will any bill rendered by these firms to their clients for this service. It should be noted, however, that the law on this question is not finally settled. Each case is likely to be judged on its own merits and practice may vary between VAT offices.
A further factor is the Financial Promotions Order. Introducing clients to an authorised firm either personally or in a letter, or promoting the services of a particular authorised firm in the instructing firm's brochure or on its web site, can constitute a financial promotion and require FSA authorisation unless one of the exemptions in the Financial Promotions Order applies.
In practice, what this means is that the unauthorised firm will need to have each promotion formally approved by an authorised person – probably the firm to which the introduction is made.
From many points of view, therefore, it makes sense for unauthorised firms to operate on the basis of referrals rather than mere introductions and be seen to be maintaining an interest in the financial advice provided to their clients.
They will thereby be able to demonstrate their commitment to maintaining their role as the coordinator of their clients' affairs and the legitimacy of their wish to be properly remunerated for doing so.
Next week, we will consider the question of how to establish business relations with law firms.