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Simon Collins: Ethical case study on Ucis

UCIS and tell?

Scenario: You are a distributor firm operating mainly in the investments arena. Over the years a number of clients have invested in what are now recognised to be Unregulated Collective Investment Schemes.

As you now know, the FSA has taken an increasingly intrusive interest in these types of investments over the last couple of years and a number of firms have already had substantial fines issued to them. The FSA’s main concerns have been firstly the lack of application of the intended marketing restrictions on such products; and secondly the general suitability of UCIS investments for retail clients.

The latest proposals from the FSA, set out in CP12/19 of August 2012, further restrict the marketing of UCIS investments and even consider extending the ambit of these rules to cover other similar investment schemes (which may not technically be UCIS schemes). The latter category of investments will be named non-mainstream pooled investments.

NMPI are defined as being pooled investments or ‘funds’ characterised by unusual, speculative or complex assets, product structures, investment strategies and/or terms and features. They are UCIS; securities issued by special purpose vehicles; qualified investor schemes; and traded life policy investments. Note that not all pooled investments meet the statutory criteria for a ‘collective investment scheme’; pooled investment special purpose vehicles, notably, do not generally amount to a collective investment scheme.

Your firm understandably now has a number of restless clients invested in existing UCIS and you need answers to a number of questions. Firstly, what should be done with those existing UCIS investors? Should they be left invested or not? Secondly, some investors may want to increase their existing UCIS holdings, can you or do you advise on this and will it be wise?

Answer

For existing customers who invested in a UCIS/NMPI following advice, you should be able to explain why you believed the investment was suitable for their circumstances. The FSA has not indicated that firms must proactively review existing UCIS investors’ investments unless their contractual arrangements with their clients require them to do so. If you do review and decide that the investment no longer meets the client’s objectives and circumstances then you will need to consider how to meet the client’s best interests in terms of disinvesting and potentially reinvesting in a product that is more closely aligned to the client’s current circumstances.

The FSA is conscious that existing customers wishing to disinvest from a NMPI may find that there are delays in accessing their funds or, for certain products, that early surrender is difficult, costly or not possible (or all three). Such delays and difficulties will be due at least in part to the illiquid assets often held in NMPIs. Customers for whom these are suitable investments should understand that such issues may arise and should not be dependent upon the product for income or immediate access to capital.

It is clear that the FSA means to increase standards in this area and you should consider acting now to ensure that your standards are appropriate and your documentation robust. This may involve a review of internal procedures and practices to determine if the advisory and, if necessary, marketing activity will withstand robust regulatory scrutiny. You should consider whether your existing compliance monitoring function is sufficiently detailed to evidence these required and expected standards.

If compliance monitoring activity is not considered to be able to deliver the assurance required, you should consider undertaking a detailed sample of past business to determine if your standards are satisfactory.The FSA will expect firms to have regard to Principle 6 in paying due regard to the interests of its customers and to treat them fairly. If problems are identified then firms are expected to consider the possibility of providing redress to clients impacted by those problems on their own initiative.

Customers who invested without advice may wish to seek independent advice on the investment and on what their options might be. If they no longer think the investment is right for them, they should speak to a financial adviser to discuss their options.

Where firms wish to market UCIS to retail customers in the future they will need to consider whether an exemption in the PCIS Order is available or whether one of the remaining exemptions in COBS 4.12.1R applies. In effect, this should prevent firms from marketing UCIS to ordinary retail customers.

At present, Category 1 in COBS 4.12.1R(4) allows firms to promote UCIS to people who are already participants in a UCIS or who have been in the last 30 months. As the quality of promotion and sales in the past is perceived as being so poor, this category could compound potential consumer detriment by allowing further promotion to investors on the basis of an investment that may have been unlawfully promoted and/or unsuitably recommended. In general, therefore, the FSA proposes to remove the ability of firms to promote UCIS to retail customers under this category.

In the future, the FSA proposes that this category will only be available where the NMPI being promoted is intended to absorb or take over the assets of the investor’s existing holding, or where the investment is offered by the operator of the investor’s existing product as an alternative to cash on its liquidation. While there is still a risk that the original investment may have been mis-sold and the replacement investment may not be any more appropriate than the original one, the FSA considers that it is preferable for customers to hear about the planned replacement product than have to accept a return of funds without any choice in the matter.

Distributor firms might be concerned that the proposed changes to the rules mean they cannot provide ongoing advice to retail customers who already have exposure to one of the NMPI products covered. This is not the case.

The proposed marketing restrictions are drafted specifically so as to permit advice on the ongoing suitability of an investment that a customer already owns. Advice to keep a current investment unchanged or to disinvest in favour of a more suitable, more mainstream investment would not be caught by the marketing restriction. However, a recommendation for further investment into an existing NMPI willbe subject to the marketing restrictions.

The new rules proposed in CP12/19 also do not include execution-only sales if there has been no financial promotion of the NMPI. Where it is genuinely the case that a retail customer seeks out an investment, acting entirely on their own initiative (for instance, following their own research on investments) and not in response to any promotional communications of any kind, then the proposals will not restrict investment.

To improve compliance with the rules and thus secure better consumer outcomes, the FSA proposes to introduce a new, more specific rule requiring firms to document and retain records of the precise basis on which they make each promotion of a NMPI to a retail client. This should set out which COBS 4.12 category, PCIS Order or FPO exemption or, for QIS, eligible investor category has been used and the basis for that decision. Where advice is given, firms should already record their detailed reasoning for recommending the investment to a retail investor. This latter rule change will be a significant compliance burden.

Simon Collins is managing director of Resources Compliance

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