On 18 May 2005, the Financial Services Authority (FSA) published a warning to firms that are involved in the trading of equity based Contracts for Differences (CFDs). A CFD is a contract whereby a customer will either pay or receive money when the contract is closed out, with reference to the movement of the price in the underlying equity, which is identified as the basis of the CFD contract, from the date the CFD is opened to the date of close out. A CFD effectively allows the customer to be exposed to price fluctuations in the underlying equity without actually holding the underlying equity.
The FSA's warning to such firms was published in the form of a letter from its head of Retail Intelligence and Regulatory Department to compliance officers. The letter was the result of visits made by the FSA to several firms involved in the trading of CFDs and serves as a warning to other firms also involved in this market.
The letter highlighted that, on an number of instances, the firms involved had reclassified customers as "intermediate customers" under the FSA's Conduct of Business Rules (COB) despite there being insufficient evidence to support the reclassification.
According to COB, a reclassification from a "private customer" to an "intermediate customer" can only be effected if:
- the firm has taken reasonable care to determine that the client has sufficient experience and understanding to be classified as an intermediate customer;
- the firm has given a written warning to the client of the protections it will lose as a result of reclassification;
- the firm has given the client sufficient time to consider these implications; and
- the firm has obtained the client’s written consent or is able to demonstrate informed consent was given.
The FSA places particular importance on reclassification as those customers that are re-classified lose the protection of the Financial Ombudsman Service and Financial Services Compensation Scheme.
It is clear from the FSA's strongly worded letter that firms should not reclassify customers unless the strict requirements in COB have been adhered to and that compliance procedures must be followed. The FSA has indicated that enforcement action will be taken against firms that ignore this warning.
This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq
Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.
The original publication date for this article was 20/06/2005.