Wed, 15 Mar 2017
FINANCIAL SERVICES UPDATE MARCH 2017
1. AMENDING THE DEFINITION OF FINANCIAL ADVICE
In September 2016 the government published a consultation exercise on amending the definition of financial advice. That consultation was prompted by matters highlighted in the preceding Financial Advice Market Review, in particular that:-
(1) Consumers were increasingly making and executing their own financial decisions;
(2) Where the consumer’s needs were relatively straightforward or the amount invested was relatively small, the cost of regulated advice was likely to outweigh the benefits;
(3) Financial advisers were unclear about the point at which general forms of consumer support and guidance became regulated advice;
(4) As a result financial advisers were limiting the general support and guidance they were giving to consumers for fear of stepping across the regulated advice boundary, and consumers were provided with less support increasing the risk of poor investment decisions;
(5) There was a strong consensus amongst practitioners that bringing the UK definition of financial advice in line with the Markets in Financial Instruments Directive (MiFID) definition of a “personal recommendation” would allow financial advisers better to help consumers. In addition, financial advice as a “personal recommendation” would be much easier to build into the advisers’ compliance processes.
One potential risk identified in the consultation (resulting from narrowing the definition of financial advice and moving the regulatory boundary) was the creation of a potential space for fraudsters in which to operate, using guidance services to distribute products without being subject to regulation. The government has formally acknowledged those concerns and has promised to take mitigating action against the risks posed to consumers.
The government has announced that it is in the process of laying a statutory instrument, and that the new definition applying to regulated advice will come into force on 3 January 2018.
The position post 3 January 2018 can be summarised as follows.
Regulated firms will give “advice” only when they provide a “personal recommendation” to a customer. To recap:-
MiFID investment advice involves a “personal recommendation” made to a person, either upon the customer’s request or on the financial adviser’s initiative, and it comprises three elements:-
· There must be a recommendation which is made to a person in his/her capacity as an investor or potential investor (or as agent for such a person);
· The recommendation must be presented as suitable for the person to whom it is made, based on the investor’s circumstances;
· The recommendation must relate to taking defined steps in respect of a particular investment that is a MiFID financial instrument (buy, sell, subscribe for, exchange, redeem, hold or underwrite or exercise a right to do any of those things).
Unregulated firms, by contrast, will remain subject to the advice boundary set out in Article 53 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (“RAO”). That means after 3 January 2018 the regulated activity of “advising on investments” under Article 53 of the RAO will be wider in scope than “investment advice” under MiFID. To recap:-
In order to qualify as “advising on investments”, the advice must:-
· Relate to a relevant investment, which includes contracts of insurance;
· Be given to a person in their capacity as an investor or potential investor (or as agent for such a person);
· Relate to the merits of the investor buying, selling subscribing for or underwriting the investment (or exercising rights to do so).
The change wrought by the new definition of regulated advice is intended to remove regulatory barriers constraining the content of guidance services to consumers. One effect of the change will be to remove the different regulatory requirements that currently apply depending on whether the adviser provides factual information on particular investments or moves beyond that into more tailored guidance on the merits and risks associated with buying or selling an investment product. Neither of these endeavours will in future satisfy the definition of regulated financial advice, absent a “personal recommendation”.
It remains to be seen whether, in practice, the new balance struck will deliver a true benefit to consumers.
One thing is clear. The government intends that the advice boundary for regulated firms should match the definition of a “personal recommendation” in MiFID. Notwithstanding Brexit, EU guidance on what constitutes a “personal recommendation” will therefore continue to apply to the new UK definition of advice for regulated advisers.
2. SATISFYING ATTITUDE TO RISK NOT ENOUGH
Full Circle Asset Management Ltd v Joanna King  EWHC 323 (Admin), a judicial review decision made by Mr Justice Nicol in February, upheld a Final Decision by the Financial Ombudsman to the effect that a model portfolio recommended to Mrs King by her financial advisers was not suitable for her, and that she was due compensation.
When Mrs King made the investment she was in her sixties and recently retired. The sum she wished to invest was a considerable portion of her investible assets. Mrs King had complained to the adviser at Full Circle that her previous financial adviser had left a large proportion of her capital in cash.
After the first meeting with Mrs King the adviser had recorded her attitude to risk as an “average risk investor”, but had provided no definition of that description or provided any explanation of what it meant. Even Full Circle’s suitability letter, which was accompanied by an “Attitude to Risk” form and described Mrs King as a “medium risk investor”, contained no definition or explanation of what was meant by that description.
Mrs King then invested £450,000 in a model portfolio recommended in Full Circle’s suitability letter. 15 months later she had lost £90,000 in her investment, with only a capital sum of £360,000 remaining.
Full Circle obtained a skilled person’s report (“SPR”) of the model portfolio which risk rated the investment as “medium risk”. That assessment was accepted by the FCA.
The Ombudsman’s Final Decision (there having been be a previous one which had been quashed by consent) was that notwithstanding the matching of the model portfolio’s overall risk rating to Mrs King’s recorded “medium risk investor” profile, the investment was not suitable for Mrs King’s individual circumstances.
Seeking a judicial review of that decision, Full Circle invited the judge to ask himself “So what?” in response to the Ombudsman’s criticisms of the recommendation. Full Circle argued that Mrs King had been a medium risk investor, and the model portfolio was a medium risk investment as had been determined by the SPR. Those two propositions were and should have been sufficient to dispose of her complaint and lead to its dismissal.
The judge rejected that approach and upheld the Ombudsman’s Final Decision. He commented that the Ombudsman had found that Full Circle had personally recommended the model portfolio to Mrs King. Before doing so, the firm should have assessed whether that investment was suitable for her. That required a more sophisticated investigation than crudely determining that she was a “medium risk investor”. Full Circle had not done that. The Ombudsman had looked at what Mr King’s requirements in fact were and had decided that the model portfolio was not suitable for those requirements.
The answer to Full Circle’s “So what?” question was given by the Ombudsman when he said that he was not clear, on balance, that had the inherent risks of the investment been explained to Mrs King that she would have accepted to proceed with it.
The decision is a salutary warning to financial advisers. They must at all times comply with the required suitability assessment prior to making a personal recommendation. Taking a risk profile shortcut when recommending an investment will lay an adviser open to complaints likely to be upheld, if on investigation the Ombudsman determines that the investment fails to meet the suitability criteria in light of the customer’s circumstances. Even where the main thrust of a complaint relates to the investment being too “risky”, notwithstanding that it matches the customer’s recorded risk profile, the Ombudsman may go further in his inquisitorial jurisdiction (R (Keith Williams) v Financial Ombudsman Service  EWHC 2142 (Admin) at ) and, “as a necessary part of his function” (Full Circle at ), determine the nature of the complaint which may, in reality, be that the investment was not suitable.