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