Richard Leeson: Getting it right on compliant EIS advice

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I have spoken to a number of advisers in recent weeks about enterprise investment schemes and have been surprised at the variety of views that exist on their obligations to consider them.

Clearly, an independent adviser must include EIS advice in their range of services in order to remain as such. However, it seems in practice not all are willing to do so.

EISs are designed to help smaller trading companies raise finance by allowing a number of generous tax reliefs. However, smaller companies are higher risk and coupled with the fact there is no secondary market (making the shares illiquid) means identifying the correct attitude to risk for clients is vital. The tax reliefs can go a long way to mitigating investment risk but they should not be looked at in isolation.

Some advisers have suggested they do not have any clients within the risk profile of EIS investment, while others have cited lack of professional indemnity cover as a reason not to become involved. But it is an area where some providers are now suggesting there is a requirement to include EIS for high net worth investors. With so many conflicting views it is well worth looking at the issues.

In its basic form an EIS can be a single equity. As such, it is for regulatory purposes not an investment that an IFA needs to consider.

However, there are fund managers in the market that offer EIS portfolios which invest in more than one company (typical portfolios might number eight to 10 individual holdings), reducing the impact risk of a failure of one of the underlying holdings. Such portfolios begin to look more like a retail investment product. If the regulator took the view that they were retail investment products, it could be argued that HNWIs (£100,000 of income and/or £250,000 of net liquid assets, as defined by COBS 4.12.6R) should be made aware of them by advisers. I should say, however, that a compliance specialist friend of mine does not share this view, pointing to the fact there is no reference in the handbook or any other FCA material that suggests such a compulsion.

Meanwhile, for an adviser to suggest they have no clients that suit the risk profile of an EIS would seem to be rather sweeping. Many firms have clients who meet the HNWI definition; indeed some make a point of only targeting those that do. Investment risk can be reduced by diversification, so choosing a wide range of underlying securities would be beneficial. This will also reduce the impact of any potential loss of tax reliefs.

From a PI insurance point of view, some advisers may not be aware there is no exemption from the requirement for IFAs to consider all products simply because they cannot obtain cover. It might be a little alarming but the firm would be required to self-insure the risk for negligence on EIS investments if they are unable to find or afford appropriate PI insurance.

This presents a choice between increasing capital adequacy and perhaps choosing to become a restricted adviser. If self-insurance is the only option, the adviser will want to be doubly sure, not only of the suitability of the recommendation but the evidence of that suitability on the client’s file: critically, the attitude to risk, evidence of how that was established and clear warnings about the disadvantages and risks of EISs, including the potential for total loss and loss of tax reliefs. It might be wise to ask the client to initial each warning and sign an appropriate declaration confirming their understanding.

At first glance, EIS seems a nightmare for a small IFA. How do you satisfy regulatory obligations without running the risk of recommending a product that might be too high risk? But if the RDR is about anything, it is about putting the client’s interest first. If an EIS investment meets a part of a client’s financial plan based on an assessment of their risk appetite and tax situation, having due regard for their understanding of the investment, then it should be put forward. Many EIS providers have developed training programmes and the EIS Diploma course from the EIS Association will be a real help for those advisers looking for support.

Richard Leeson is CEO of Adviser Advocate 

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Comments

There are 11 comments at the moment, we would love to hear your opinion too.

  1. Silly me I thought EIS stood for Every Investment Sinks.

  2. Lots of statements and assumptions that are simply not the case:

    “Clearly, an independent adviser must include EIS advice in their range of services in order to remain as such.” False, being an IFA only depends on advice on packaged investment products.

    “Such portfolios begin to look more like a retail investment product.” They may look like it but theyr’re not.

    “If the regulator took the view that they were retail investment products…” But they don’t so everything that follows in that paragraph is speculation not reality.

    “I should say, however, that a compliance specialist friend of mine does not share this view, pointing to the fact there is no reference in the handbook or any other FCA material that suggests such a compulsion.” He/she is right.

    “…there is no exemption from the requirement for IFAs to consider all products simply because they cannot obtain cover. It might be a little alarming but the firm would be required to self-insure the risk for negligence on EIS investments if they are unable to find or afford appropriate PI insurance.” EIS are not classed as products so this is not an issue.

    “At first glance, EIS seems a nightmare for a small IFA.” But at least they have a choice as to whether to enter the nightmare.

    That’s not to say that IFAs wishing to provide a more complete service by including EISs in their advice shouldn’t do so. However, scaremongering is not a good way of promoting them.

    @Harry – lol

  3. If advisers are working with other professionals on IHT and tax planning, EIS schemes are a vital tool in the box, and whilst not suitable for everyone, knowledge of the schemes can only add to credibility.

    Nothing worse than a client finding out from someone else and potentialy losing that client. At least let them know that these schemes exist.

  4. @Geoff Sharpe

    So what’s wrong with AIM shares? No middlemen (the sponsors) and no flaky firms just there to qualify for the tax breaks.

  5. The reason there is so much confusion is that it is a complex area and people use the incorrect language. Lets all agree on this: RDR covers advice on ‘Retail Investment Products’ (RIPs). Grey Area, you are incorrect when you say:

    “Clearly, an independent adviser must include EIS advice in their range of services in order to remain as such. False, being an IFA only depends on advice on packaged investment products.”

    Before I explain, so I cannot be accused of being a wolf in sheep’s clothing, I am (“boo hiss”) a product promoter/provider…. If you had said “Being an IFA only depends on advice on Retail Investment Products (RIPs)”, I would have agreed with you.

    RIPs have a much wider definition than ‘Packaged Products”. The challenge for us all, is that some EISs are RIPs, many/most are not (eg an investment in a single EIS company). Even with a single EIS Company they may still be deemed suitable for Retail Clients – but that doesn’t mean all IFAs are qualified to advise on them. But lets ignore single companies for now….

    I have an email sent last week from one of the top UK law firms talking about an EIS Fund and I’m happy to show anyone in private the email: “It is definitely a RIP”. He may be wrong, but I should be able to dig out some communication with the regulatory that supports this view if you want at the same time. In short, some (but by no means all) EIS funds are RIPs.

    I sympathise with those that can’t get PI cover – there are underwriters that do cover EIS and have previously helped an underwriter that had said ‘no EIS’ to allow certain types of EIS product. Anyway, it’s a complex area, but it’s all I’ve been doing for the last 10 years just about and I am a qualified IFA with a current SPS. I’m happy to sit down with anyone that wants to understand more about EIS and the regulatory aspects. I am not a regulatory adviser….I certainly don’t have all the answers, but at least we can share views and hopefully both learn something.

    I have deliberately registered a new account here, so I can’t be accused of ‘promoting’ anything…other than understanding.

    PS I have never marketed EISs by scaremonging IFAs (though appreciated some promoters try to).

  6. Absolutely Harry, BPR in it’s many forms should be considered where appropriate and the solution does not have to be packaged. EIS schemes are just one of the tools available, not exclusive.

    If I have been able to discuss all the possibilities with a client I think I have done a good job, I was restricted as a bancassurer many years ago and felt as if my hands were tied behind my back. From a regulatory perspective I was advising within my limitations, but being already AFPC qualified in 1995 I knew I was selling clients short, hence becoming an IFA.

  7. @Harry: Being able to roll over capital gains is the obvious one. Someone may want to reinvest a portfolio into AIM shares so they can pass it to heirs tax free, but that may result in a large capital gains tax bill. Re-investing into EIS won’t as the gains are rolled over and eventually extinguished on death.

    Obviously this is irrelevant if all the EISsesses sink and nothing is left for the heirs. I lol’ed at your acronym. Each to his own.

  8. @J Smith
    OK, I admit to using a generic term when I referred to “packaged investment products.”

    However, your assertion that “RIPs have a much wider definition than ‘Packaged Products'” is a little suspect. If you read the definition of ‘retail investment product’ the meaning is quite clear and all RIPS are packaged investment products. Indeed, ‘packaged investment products’ is wider because it includes pension transfer and long term care products which are not RIPs (and IFAs don’t have to advise on to retain their independent status).

    It is debateable whether an EIS fund can be a RIP – they are not funds in the conventional sense. An EIS fund is structured as a nominee vehicle which invests funds in EIS-qualifying companies on behalf of the investors. The nominee vehicle holds the legal title to the investee company shares, while the investors hold the beneficial title. The latter beneficial title is required under sections 131 and 157, Income Tax Act 2007 (ITA 2007); section 150A and Schedule 5B, TCGA 1992s in order to get tax relief. Holding units or shares in an overarching fund or company without having direct beneficial ownership of the underlying EIS qualifying company doesn’t work. That said, EIS funds are similar to unit trusts and French and Luxembourgeois ‘fonds commun de placement’ investment funds so there is an argument that they could be RIPs but it’s far from clear. Lawyers can give an opinion, only a judge in court can decide. There are probably added risks in dealing with EIS fund structures that look like, or even may be, RIPs but why bother with the added complication in an already highly complex area?

    Perhaps you could name the EIS fund that purports to be a RIP so that we can decide for ourselves?

  9. @Sascha

    Oh and BTW – VCT = Void Capital Totally.

    An investment where the promoters make more than the investors and where opacity is a byword. A prime example of the tax break wagging the investment tail.

  10. Your comment on my comment (!): “However, your assertion that “RIPs have a much wider definition than ‘Packaged Products'” is a little suspect.”

    I quote from the ‘bible’ (the FCA handbook – because that’s what the regulator will beat you with):

    Packaged Product definition…

    https://fshandbook.info/FS/glossary-html/handbook/Glossary/P?definition=G831

    (a) a life policy;
    (b) a unit in a regulated collective investment scheme;
    (c) an interest in an investment trust savings scheme;
    (d) a stakeholder pension scheme;
    (e) a personal pension scheme;31
    whether or not (in the case of (a), (b) or (c)) held within 8an ISA or a CTF7, 32 and whether or not the 8packaged product8 is also a stakeholder product.33

    Retail Investment Product…

    https://fshandbook.info/FS/glossary-html/handbook/Glossary/R?definition=G2763

    133(a) a life policy; or
    (b) a unit; or
    (c) a stakeholder pension scheme (including a group stakeholder pension scheme)140; or
    (d) a personal pension scheme (including a group personal pension scheme)140; or
    (e) an interest in an investment trust savings scheme; or
    (f) a security in an investment trust; or
    (g) any other designated investment which offers exposure to underlying financial assets, in a packaged form which modifies that exposure when compared with a direct holding in the financial asset; or
    (h) a structured capital-at-risk product;
    whether or not any of (a) to (h) are held within an ISA or a CTF.
    [Note: Section 238 of the Act and COBS 4.12.3 R set out restrictions on the promotion of non-mainstream pooled investments to retail clients. See also COBS 9.3.5 G (Non-mainstream pooled investments).]141

    Given the ‘bible’ states the RIP definition is broader, are you still going to tell me with authority “…your assertion that “RIPs have a much wider definition than ‘Packaged Products'” is a little suspect.???????

    You go on to say; “It is debateable whether an EIS fund can be a RIP”….there is an email that has been distributed widely to IFAs sent by the regulator (with their consent) saying even EIS single companies can potentially be classed as a RIP. I know, you’re going to say that’s completely and utter bonkers….and I agree with you, but I don’t make the rules. Worse still I appreciate that when ‘something goes wrong’ the rules will may be enforced in arbitary way as far as IFAs are concerned.

    You also say “An EIS fund is structured as a nominee vehicle which invests funds in EIS-qualifying companies on behalf of the investors.” – I agree that some EIS funds do, but not all.

    I haven’t joined this debate to start naming any products – simply to point out that people need to precise & accurate with the language they use as it only adds to confusion in, as you say…what is a highly complex area.

  11. @J Smith
    I’m well aware of the FCA Glossary definition. If you take a close look you will see that everything listed is a packaged product.

    Since I used the term “packaged investment product” which is generic and not defined it follows that it covers everythng in the glosary definition but would also cover anything packaged that isn’t within the definition, e.g. instiutional type arrangements. Ergo, your assertion that RIPs has a wider definition than ‘packaged investment products’ is, putting it kindly, suspect.

    I’ve already acknowledged I used a generic term when I could have been more precise and used RIPs instead, though I think the intent was pretty clear. Anyway, always happy to join in and split hairs for the sake of precision and accurracy.

    I haven’t seen the email from the FCA that you mention. However, however, an email doesn’t ‘make rules’ and unless it constitutes official guidance it can’t be relied on either.

    Now, shall we talk about PRIPs and PRIIPS for a bit of added fun…

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