Many mis-selling claims turn on whether or not the investment recommended was suitable. There have also been an increasing number of FSA enforcement actions arising out of unsuitable recommendations. The FSA’s new guidance on assessing suitability will therefore be of crucial importance.
Today’s guidance is not a complete code on everything to be taken into account in determining the suitability of an investment recommendation or decision to trade. That requires consideration of (a) whether the investment meets the client’s investment objectives, (b) is such that he is able financially to bear any related investment risk consistent with his investment objectives and (c) is such that he has the necessary experience and knowledge to understand the risks involved (COBS 9.2.2).
The new guidance focuses entirely on the second of those tests, whether the customer is able financially to bear any related investment risks. In publishing 28 pages of guidance on only one of three limbs of the suitability test, there is a danger the FSA may be over emphasising that aspect of the test, at the expense of the others.
The key element of the new guidance is that when determining the suitability of investments, advisors must assess not only the customer’s attitude to risk (ATR – i.e. the risk they say they want to bear), but also their capacity for risk (i.e. objectively the risk the customer ought to be advised to bear). This may encourage a paternalistic approach to investment advice: it appears customers should not be allowed to take greater risks than they have the capacity for, even if they want to take high risk. There is a possible contradiction between a low ability to bear risk and the need to take higher risks to achieve investment objectives which has not been discussed.
Whilst the guidance is new, it is a statement of what the FSA considers to be required under the COBS rules and, implicitly, what has always been required. It is based on files the FSA reviewed between March 2008 and September 2010, almost certainly relating to investments dating back to the implementation of MiFiD and new COBS on 1 November 2007. Yet again, it appears investment advisors are going to be judged retrospectively against a new interpretation of the rules.
As has become common in recent FSA publications, this guidance sets out examples of poor and good practice. While the status of the FSA’s examples of poor practice is obvious – don’t! – the status of the examples of good practice is less clear: will firms who do not adopt these suggestions of good practice be viewed by the FSA and the FOS as failing to adhere to the required standards?
The FSA’s guidance also notes that many firms use in-house or purchased tools to assess ATR, and that poor outcomes can occur if firms use tools which are not fit for purpose. In that case, firms are likely to be dealing not with a small number of isolated incidents of mis-selling, but a flood of similar cases. Firms will in that event have to consider their obligations actively to compensate similarly affected clients. There will no doubt be substantial debates between firms and their PI insurers as to the extent of their obligations to pay compensation and as to the number of excesses and limits of indemnity which might be applicable.
This blog is a summary of recent developments. It should not be regarded as a substitute for advice in any particular case. RPC is not responsible for the content of external websites.