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The route to compliance

Compliance expert Adam Samuel says the FSA wants the key elements of minimum acceptable compliance to be found in every business

In May, a frantic IFA rang me up to ask for help. He told me that he and his business partner were “completely non-compliant”. On the way to see him, I had to think what if anything of value I could provide him with. As a two-person business, he was miles below the FSA radar screen.

The task, it seemed, was not to make him compliant. No small IFA practice could manage to comply with every detail of some of the rulebooks. What was necessary was to make the business safe both for those running it and their customers. In this way was born the logically indefensible notion of “minimum acceptable compliance”.

It was acceptable in the sense that neither regulator nor client could take exception to it. It was risk-based because it reduced the extent to which both client and regulator were exposed to risk. Some elements were built into the threshold conditions – capital adequacy and compliant PI cover. In spite of the problems of recent years, most small businesses have this under control.

Being mid-May, the obvious starting point was the initial disclosure document, terms of business or client agreement (depending on whether the client signs it) and schedule of fees and commission or just fees. Every business must have a set of investment, insurance, mortgage and combined IDDs to the extent that it is in all three markets.

The forms must be checked to ensure they are a precise match with the forms on the FSA website. In a recent paper, the FSA commented that although variations were not serious, few advisers were producing totally compliant documents.

Some fee-only firms do not realise they have to produce a statement of fees in accordance with the relevant form on the FSA website. It is easy to do but easy to forget.

Now that every IFA must offer a fee-paying option, it makes no sense to hand over a terms of business without getting the client’s signature. There is much to be said for the customer actively accepting the terms on which the adviser will offer his services.

At the last three Institute of Financial Planning annual conferences, I have been discussing the elusive notion of the compliant effective agreement. The document has to cover the elements in COB 4 annex 2 while describing both parties’ expectations in a meaningful and, therefore, readable way.

The document should introduce the firm, indicate when the agreement starts, set out the reference to the fact that the FSA regulates the business and mention any areas that the regulator does not cover. It then covers what the IFA offers or commits to such as confidentiality, whether ongoing service of any description is offered, including conservative limits on office hours. This last point may be vital. Many businesses offer reviews and monitoring that cannot be delivered. By doing so, they are creating possible legal liabilities.

The adviser has to indicate that he or she cannot assess the client’s investment objectives or risk profile until he has discussed this with the customer. This “profile” can easily change from moment to moment, depending on the aspect of the consumer’s finances being discussed.

The suggestion in COB 4 annex 2 that it should be in the client agreement is dangerous to both parties. The agreement must deal with whether and if so how any real-time promotions (cold-calls) will happen.

One of the biggest and most surprising challenges generated by the June deadline was for IFAs to describe what they charge. They have to say clearly when invoices will be generated and why. Commission-charging firms must provide for a fee to be charged to cover out of the ordinary admin problems with product providers, otherwise they risk having to carry that cost themselves. To maintain independent status, the IFA must provide for all commission credited against future business to be paid to the client on termination except for trivial amounts of trail commission.

The client agreement must describe how to complain. This must not indicate that the customer must put his gripes in writing. Other than that, the agreement needs to use the IDD description of the FSCS, state a choice of law (England, Scotland and Northern Ireland each have different legal systems) and comment that the Contract Rights of Third Parties Act does not apply. The firm does not handle client money (unless as a small business it needs its head examined).

Customers can become highly irritated by money-laundering checks so it helps to mention them. The agreement must cover the management of conflicts of interest. This can lead to a contract being terminated and the firm has to retain that right. Indeed, the document should conclude with the end of the agreement and its consequences in terms of commission.

Training and competence worries bedevil small IFAs but they should not. When I made it to the office, the partners were struggling to download an FSA paper. It came as a pleasant shock to them to know that they were doing T&C, whether they knew it or not. In fact, you are probably doing it by reading this newspaper.

Once exams have been passed and supervision completed, most IFAs are only missing two fairly minor elements. First, they are supposed to meet and note for each adviser his training needs. Second, how this is met should be noted, with an evaluation of them. A meeting every six months or so to list training needs in each person’s individual T&C file along with a review of the office diary and transcription of some of its details into the file with comments about how effective they were will produce compliance.

Financial promotions for most firms consist, if anything, of a website and a newsletter. IFAs must not distribute other people’s material without checking it themselves for compliance. They must not assume that product provider documents have been approved for distribution at all, let alone by themselves. If an adviser adds a covering letter, it takes on compliance ownership of the material, even if it makes it “better” than the original version.

Anything that actively encourages customers to use the firm or products that it markets is a promotion, including websites and newsletters. A competent person has to approve non-real-time promotions as compliant and this must be recorded.

The key is to ensure the risks involved are given equal prominence to the positive descriptions of the product or offering involved. The moment that a website describes a financial planning service, it must say prominently something along the lines of: “Saving in the types of products recommended can lose you a significant amount/all of your money.”

More complaints are upheld because of fact-finding and suitability problems than any other reason. Firms need to review their fact-find forms and techniques regularly. People do not fit into little boxes or neat numerical classifications.

Fact-finding is a prose activity and forms must leave extensive room for comment. A customer’s appetite for risk relates to at least four angles – loss of capital or income, failure to meet a particular objective, the area such as pensions, mortgages, savings and investments and the overall picture. Each of these, along with the extent of the relevant tolerance, has to be considered. The splits fiasco has taught us to ask whether the client can handle the total loss, however unlikely the investment.

The danger for small IFAs is that they do not write down what they know about the client, either in the fact-find or suitability letter. They then fail to demonstrate how they went from the facts discovered about the customer to the solution or plan recommended. A simple route map describing the pertinent facts, any changes suggested, an explanation of the recommendations and disclosure must be issued every time a particular step(s) is put forward. For financial planners, this keeps the plan constantly up to date.

Now, all the firm needs is a decent complaint procedure. This must be in writing although it must again stress that complaints may be made by whatever means the customer chooses. The procedure now has to cover the referral of complaints onto product providers or other firms. The investigation must, where possible, be done independently. In a small business, that will probably mean the “other adviser”. Four-week and eight-week letters have to be referred to in the procedures.

The firm should issue final responses in a similar way to good suitability letters – introduction, facts, analysis, conclusion, FOS referral, six months warning, leaflet.

The business must co-operate with the ombudsman, implement accepted compensation offers and ombudsman decisions. Do not even think of trying to charge clients for handling their complaints.

Any small IFA complying with the above suggestions will not be 100 per cent compliant. The FSA knows that nobody but an anorak compliance consultant would have any chance of knowing all the rules that apply to financial advisers. Such a person would last about five minutes running an IFA business.

Although it can never say so officially, the FSA wants to ensure that the main factors of “minimum acceptable compliance” are present in every business. Einstein may not hang out in Canary Wharf but somebody there has worked out the formula.


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