UK: Funds: Timely Reminders On Product Design, Marketing, Assessing Suitability And Selling

Last Updated: 26 January 2011
Article by Margaret Chamberlain, Tim Lewis and Jane Tuckley

Today's £7.7 million fine on Barclays Bank plc ("Barclays"), the highest so far imposed by the FSA for retail failings, sends a clear warning to firms that shortcomings in the process of selling funds to retail investors will not be tolerated and will be subject to severe punishment. The case comes hot on the heels of two FSA guidance consultations that are relevant to the retail sector: one on assessing suitability and the other on financial promotions.

The Barclays case – unsuitable sales

The FSA's action against Barclays is of particular relevance to firms that are subject to the obligation to assess suitability under COBS 9.2 - i.e. advisers who make personal recommendations and discretionary investment managers.

The case related to sales of two UCITS funds offered by Aviva, The Global Balanced Income Fund ("the Balanced Fund") and the Global Cautious Income Fund ("the Cautious Fund") (both, in fact, sub-funds of the Aviva Investors Funds ICVC) between July 2006 and November 2008. The regulator found that, in a breach of FSA Principle 9 (Customers; relationships of trust) and the relevant conduct of business rules (including COBS 9.2.1R), Barclays had failed to take reasonable care to ensure that the advice given to retail customers was suitable. Barclays has already paid approximately £17 million in compensation to customers and the FSA estimates that it will have to pay a further amount of between £20 million and £42 million in compensation.

A number of clear lessons emerge from the Barclays case for those firms involved in designing and selling retail funds to the public:

  • It is important for firms to take care during the process of product design, development and approval and not to allow complacency to creep into that process. In the Barclays case, the two funds were modelled on a previous product that had been jointly developed by Barclays and Morley Fund Services Limited. Because of this the new funds were subject to an abbreviated approval process, despite the fact that there were differences in investment profile and risk classification.
  • Firms must ensure that their training of relevant staff is adequate: o From the training materials staff should be able to understand the types of customers for which a particular product is suitable.
    • The training should explain the risks associated with a particular product and not give a misleading impression to the adviser.
    • Training must be tailored to and updated for the particular products in question – do not assume that because a product is similar to a previous one that the training given in relation to that previous product will be sufficient.
  • Firms must also ensure that regular sales briefs and product updates which are sent to their sales advisers are accurate and balanced – in Barclays' case, these materials were deficient because they only referred to the potential benefits of investing in the Aviva funds and did not refer to any of the risks. Consequently, the sales advisers were not alerted to risk factors which ought to have been passed on as warnings to the customers.
  • Product brochures and other materials given to clients must contain adequate information, including clear information about the nature and levels of risk associated with a particular product. Risk warnings must be sufficiently prominent. In Barclays' case, for instance, the product material did not sufficiently explain the extent to which investment in the Aviva Funds was linked to fluctuations in the stock market; consequently, for those investors who were looking to the products for the purposes of drawing income, there was an insufficient explanation of the risk of capital loss due to stock market fluctuations and therefore the reduction in the production of income. It is significant that the FSA felt that Barclays, as distributor, had a responsibility regarding the content of customer literature. It said that, since Barclays was involved in the process of reviewing the documentation and had detailed knowledge about the funds and the nature of its customer base, it should have done more to ensure that the documents were balanced and explained the risks (despite the fact that the documents were issued and approved by Morley).
  • Firms must ensure that their sales monitoring and due diligence processes are robust: it is essential that firms are able to detect potentially unsuitable sales quickly and, once identified, ensure that appropriate remedial measures are put in place. The compliance function and product risk committee of Barclays had, in fact, identified a number of risks associated with the previous product on which the Aviva funds had been modelled and which were therefore relevant to the suitability assessment: critically, however, these findings were not appropriately escalated and were not explained to sales advisers or customers.

The FSA's Final Notice against Barclays is here.

FSA guidance consultation: assessing suitability

The FSA's guidance consultation "Assessing suitability: Establishing the risk a customer is willing and able to take and making a suitable investment selection" was issued earlier this month. The guidance consultation is aimed at investment advisers and private client discretionary wealth managers – and also at the providers of risk-profiling and asset-allocation tools, including those provided as part of platform.

The guidance consultation focuses, in the context of the wider suitability assessment requirements, on the obligation which requires firms to asses the risk a customer is willing and able to take – i.e. the obligation in COBS 9.2.2R (amongst other things) to take account of a customer's investment objectives (e.g. regarding his preferences regarding risk taking and risk profile) and ensure that he is able financially able to bear any related investment risks consistent with his investment objectives.

In outline, some of the key messages which emerge from the guidance consultation include the following:

  • Firms must have a robust process for assessing the risk which a customer is willing and able to take – this includes assessing his capacity for loss (i.e. the ability to absorb falls in the value of an investment), identifying whether a customer is best suited to placing his money in cash deposits (i.e. because he is not willing or able to accept the risk of loss to capital) and interpreting information from the customer on a "fact find" appropriately (i.e. by having clear, fair and not misleading question and answer options and not attributing inappropriate weighting to certain answers).
  • Firms should exercise caution when using risk-profiling and asset-allocation tools – while the FSA accepts that these can be useful, it warns that they "often have limitations" which mean that there are circumstances in which "they may produce flawed results". Firms therefore need to identify any limitations associated with such tools and ensure that these are addressed and mitigated in the suitability assessment process – the tools must be fit for purpose.
  • Firms must have a robust and flexible process for ensuring that investment selections are suitable in the light of a customer's investment objectives and financial situation – the FSA is concerned that, even where firms correctly assess a customer's risk profile, the product or portfolio recommended or invested in does not always match the profile;
  • Firms should not just focus on the risk which a customer is willing to face – other needs, objectives and circumstances must be taken into account.
  • Firms must ensure that they themselves understand a product and the risks associated with it before recommending or selecting it as suitable for a customer!

The FSA's guidance consultation on assessing suitability is here.

Consultation closes on 28 January 2011.

FSA guidance consultation: financial promotion

The FSA's guidance consultation is aimed at fund managers and other persons approving financial promotions (particularly "image" advertisements, or advertisements which deal with past performance). While not expressly confined to the retail sector as such, this is the principal focus of the guidance.

The guidance consultation addresses a number of points, including the following:

  • There is a reminder about the key issues relating to the presentation of past performance information – including warnings regarding the use of simulated and actual past-performance data within a single communication, making comparisons with other products and references to the winning of awards.
  • The FSA endeavours to draw a distinction between "image advertising" and what it refers to as "brand advertising". In the latter case, while the advertising focuses on the firm's brand, it may also refer to and promote particular products and services. The FSA argues that "image advertisements" are narrower and consist only of information about the firm, rather than promotion of the firm and its products. The message for firms is that they should not assume that because an advertisement is a high-level, "brand advertisement" that it is an "image advertisement" (which would be subject to exemptions from the COBS financial promotion rules).
  • Firms must consider what the FSA refers to as the "customer journey" when designing their promotional material – particularly in the context of a customer's "journey" through a firm's website. The journey itself must be clear – i.e. so that the customer receives fair information along the way.
  • The FSA appears to be averse to what it calls the use of a "risk sandwich" in financial promotions – i.e. a promotion which includes a section on the benefits of a particular product of service, followed by a section on risk warnings and finished off with another section on benefits. Firms are reminded that they must not hide or diminish warnings.

The FSA's financial promotion guidance is here.

Consultation closes on 25 February 2011.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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