In my next few articles, I want to look at some ways in which IFAs can learn from the various regulatory reviews and legal judgments affecting financial services. Although some of the examples I will be discussing have resulted in penalties or reprimands to the advisers involved, an understanding of the issues can greatly assist other IFAs in giving appropriate advice to their clients.
The Financial Ombudsman Service deals with complaints against authorised firms on almost the complete range of financial services and products, including personal pensions but excluding occupational pensions. It is a free service to complainants but the firm which is the object of the complaint will usually be charged a case fee, win or lose, unless the FOS believes the complaint to have been “frivolous and vexatious”.
Last month, the FOS reported on some of the complaints it has dealt with recently concerning singlepremium bonds, including high-income or precipice bonds. These cases relate specifically to bonds sold as a result of mailshots and advertising but it is clear that the same principles will apply to face-to-face advice.
In the first case, an IFA's newsletter described an extra income and growth plan offering tax-free income of a little over 9 per cent a year over three years as being suitable for a cautious investor. The capital return was linked to a leading European equity index. By the date of maturity of the complainant's plan, the index had fallen such that the investor got back much less than she had invested.
While the firm was perhaps a little too glib in describing such a bond as being suitable for a cautious investor, could the investor really believe that her capital was even moderately secure after receiving such a high level of tax-free income, which was probably around treble the rate she could have expected from a building society account?
But the FOS rejected the IFA's defence that the client bought the bond in an execution-only sale as no advice had been sought by the client or given by the firm. In the FOS's judgment, the firm's newsletter was so comprehensive and compelling in its support of this product that the FOS believed an average person would legitimately have taken the article and subsequent personalised newsletter to represent advice. Compensation was awarded against the IFA.
What are the lessons from this case? First, take care in how you word adverts, newsletter articles and bulk mailings to clients and prospective clients. You might consider that giving comprehensive information about a product on which the client can act if he so wishes represents an invitation to execution-only transactions but this potentially important FOS ruling demonstrates otherwise.
Second, you must understand that high-income bonds which do not guarantee a return of capital are not generally considered to be low-risk investments which are suitable for cautious investors, even though the income during the period of the bond is often guaranteed.
An associated case quoted by the FOS related to a high-income bond advertised in a national newspaper by an IFA firm. The complainant had responded to the advert and decided to invest after receiving a product brochure and key features document. The capital value of this bond at the end of three years was linked to the Nasdaq index. As with almost all such bonds over the period of the equity bear market, the client was dismayed to receive a much depleted capital sum at the end of the term.
In this case, the FOS rejected the complaint on the grounds that the IFA firm had not specifically targeted the client, the advert being what is known in legal terms as an invitation to treat, meaning an invitation for interested parties to contact the advertiser. This view contrasts with the previous case where the FOS considered sending the newsletter to an existing client, followed by a personalised letter, as an offer or advice by the IFA firm.
Where the dividing line exists between “invitation to treat” and “offer or advice” is a difficult issue which I fear is likely to occupy the FOS in future. But the IFA in the second case helped his cause by clearly stating a number of risk warnings, including “only suitable if the investor can afford an element of risk to the capital sum invested”, “does not guarantee the return of your original investment” and other comments.
In rejecting the complaint, the FOS said: “We confirm that the firm had given the client full information about how the bond worked and about the possible outcome of an investment in it. We did not consider that any of the material was misleading and we noted that the firm had provided a clear statement that customers should seek investment advice if they were in any doubt about the bond's suitability.”
Many valuable lessons can be learned, including the obvious one that high-income bonds can be a valuable part of the portfolio of a significant number of investors, despite bad press.
In two further cases, the FOS strongly suggested that high-income or growth products which did not guarantee full return of capital at the end of the contract term could not be described as being low risk which, unfortunately, was exactly the term used by the two IFAs in question. I mention these cases by way of mild contrast with the first case where the FOS found against the IFA for describing the investment as being suitable for cautious investors.
So now we know. Whether cautious or low risk, the terminology matters not. Particularly where a feature of a bond is that the capital return could fall by twice the amount of any corresponding reduction in the appropriate index, surely the suitability of these bonds is only towards mediumor high-risk clients and then generally only as a part of a more diversified portfolio?
I will continue this theme in my next article.