It is natural for a financial adviser to turn to the FCA’s Handbook for guidance on what to do in specific situations. But the general law underlies the FCA’s rules and guidance, and, of course, applies to everyone all the time. That means that the adviser needs to be aware of, and comply with, the general law as well as what the FCA has laid down in its rules.
Thus the general law has rules about the way in which agents and some advisers must deal with conflicts of interests between themselves and their principals and clients; and the FCA has built upon the general law to make its rules relating to inducements from third parties, such as product providers, and other conflicts of interest.
An appreciation of the general law helps to understand where the FCA is coming from in its finalised guidance on inducements and conflicts of interest which was published in January. For example, the law imposes on all advisers a duty of care which is owed to clients. That duty is usually expressed as a duty to act with due skill, care and diligence. It is not surprising, therefore, that the second of the FCA’s 11 principles for businesses is that “A firm must conduct its business with due skill, care and diligence”.
It is also generally the position that when a financial adviser is acting as agent for his client, for example, when arranging an insurance contract or an investment, the adviser is in a fiduciary relationship with the client and so owes the client a number of fiduciary obligations. Those include a rule that a person who is in such a fiduciary relationship with another must not allow his interests to conflict with the duties he owes to the other person.
The FCA has expressed that in its eighth principle in these words: “A firm must manage conflicts of interest fairly, both between itself and its customers and between a customer and another client”. Those words do not forbid getting into a conflict of interest with a client. The emphasis is on managing the conflict fairly.
The law goes much further. Its starting position is that the fiduciary must not put himself in a position where his interests conflict with those of his principal; ie, the client.
In 1895, Lord Herschell said in the House of Lords: “It is an inflexible rule of a Court of Equity that a person in a fiduciary position… is not, unless otherwise expressly provided, entitled to make a profit; he is not allowed to put himself in a position where his interest and duty conflict. It does not appear to me that this rule is, as has been said, founded upon principles of morality. I regard it rather as based on the consideration that, human nature being what it is, there is danger, in such circumstances, of the person holding a fiduciary position being swayed by interest rather than by duty, and thus prejudicing those whom he is bound to protect. It has, therefore, been deemed expedient to lay down this positive rule.”
More recently, in 1997 in the Court of Appeal, Lord Justice Millett described a fiduciary as “someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence. The distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his fiduciary. This core liability has several facets. A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal. This is not intended to be an exhaustive list, but it is sufficient to indicate the nature of fiduciary obligations. They are the defining characteristics of a fiduciary. …[He] is not subject to fiduciary obligations because he is a fiduciary; it is because he is subject to them that he is a fiduciary.”
On the other hand, as Lord Justice Millett said in that passage, if the fiduciary does have the informed consent of his principal, he may act for his own benefit. This means that if the agent explains exactly what he proposes to do, and how that will conflict with the interests of his principal or client, and the client consents to that course of action, then there will be no breach of the fundamental obligation of loyalty and good faith.
One of the serious conflicts of interest which exists in the financial services industry has to do with commission and other inducements. Since time began and until recently, insurance companies and other product providers paid commission to the financial adviser who placed his or her client’s business with them.
Of course, any client who thought about it for a moment would have realised that the adviser was being remunerated by commission. Usually the client did not object because he would have known that but for the commission, the adviser would be charging a fee. But very few clients would have known quite how much the commission would have been.
Strictly, without full disclosure of the terms of the commission and the consent of the client, the adviser would have been in breach of his fiduciary duties by accepting commission. One consequence of that breach would have been a right on the part of the client to require the adviser to pay over the commission. Hence the origin of the rules on commission disclosure which have now been in place for many years.
Hence, too, the origin of the recent rules which say that a firm “must not pay or accept any fee or commission, or provide or receive any non-monetary benefit” in relation to most of the kinds of business the average IFA will conduct. That is designed to prevent an adviser from being induced to recommend one product rather than another in order to gain the benefit of the inducement – at the expense of the client. That is obviously a rule which has its origins in the law of fiduciary obligations.
In its recent finalised guidance, the FCA says: “We are concerned with both potential and actual conflicts. …Any payments or non-monetary benefits made by providers to advisory firms connected with distribution give rise to the risk of conflicts of interest as they may incentivise a firm to act in a way that is not in the best interests of its customers. …Advisory firms and providers should ensure that the risks of conflicts through offering or accepting any benefits… is effectively managed so that accepting these payments does not impair their duty to act in the best interests of their customers. …There are some situations, however, where the only effective way to protect clients’ interests is for the relevant agreements [between provider and adviser] to be terminated or simply not entered into.”
If a financial adviser is in any doubt about whether to accept a benefit from a provider because it would or could create a conflict of interest between that adviser and his or her clients, the golden rule in these circumstances is, if in doubt, don’t.
Peter Hamilton is a barrister specialising in financial services at 4 Pump Court and co-founder of moneymatterslegal.co.uk