In the UK, Rule 4.2.1 of the FSA’s Conduct of Business Sourcebook (“COBS”) provides that a firm must ensure that a communication or a financial promotion within the scope of that Rule is fair, clear and not misleading. This will generally apply to financial promotions communicated to retail clients and is to be read in conjunction with Rule 4.5.2 of COBS, which provides that information for retail clients must be “sufficient for, and presented in a way that is likely to be understood by, the average member of the group to whom it is directed, or by whom it is likely to be received.”

In October 2009, the Financial Services Authority (“FSA”) published a report (the “Report”) summarizing its findings following a review into the financial promotions of structured investment products. Among other things, the Report highlighted a concern that financial promotions often made prominent claims that investments were “secure,” “safe,” “protected,” or “guaranteed,” without clearly and unambiguously explaining what such terms mean. As a consequence, the FSA felt that use of these terms has not always been “fair, clear and not misleading.” Some examples of misleading descriptions were given by the FSA.

In relation to products where some or all of the investor’s capital is at risk, describing the risk in terms of “contingent protection” or similar was considered misleading, particularly where there is a prominent claim of “capital security” and a less prominent and insufficient explanation of when capital can be lost. The FSA considered that describing such a product as “safe” or “secure” undermined the message that capital could be lost, and therefore breached the FSA’s Rules. The FSA also considered that the same view could be taken of the use of the word “protected” for such products, unless the limits of the protection were very carefully explained.

Even in relation to products where the issuer is obliged to return capital in full on maturity, the FSA still considered that the use of terms such as “safe” or “protected” require an explanation that the investor is protected from market risk at maturity, but not counterparty risk, i.e., the risk that the issuer is unable to pay what it is obliged to pay at maturity, and what this risk means for the investor.

For any product described as “guaranteed,” the FSA was concerned that this terminology gives the impression of a guarantee or assurance by a third party, and if there were in fact no third party obligor, the FSA considered this terminology misleading. Where there is a third party guarantor, there should be a clear explanation of who provides the guarantee and what its limitations might be, for instance when it is provided by a member of the same group of companies as the issuer.

Where a third party provides capital protection on maturity, for instance via a guarantee or by issuing a bond or other instrument to the issuer, the FSA also found that a large proportion of the financial promotions it reviewed were ineffective at describing the counterparty risk, in relation to that third party, to which investors were exposed.

Following on from the Report, the FSA has, in Appendix 5 to its most recent quarterly consultation paper,3 proposed making amendments to COBS4 and Banking: Conduct of Business Sourcebook (BCOBS),5 (which contains similar provisions to COBS in respect of fair, clear, and not misleading communications) to provide explicit guidance in this context.

The proposed guidance states that the words “guaranteed,” “secure,” “protected,” or similar language should not be used in promotions of financial products unless (i) the term used is capable of being a fair, clear, and not misleading description of the product’s features and (ii) the firm communicates all information necessary, and in a sufficiently clear and prominent manner, to make the use of the term fair, clear, and not misleading.

Comments are invited on the proposed guidance up until August 6, 2011.