Out-Law Analysis | 07 Oct 2014 | 11:37 am | 5 min. read
The boundary of regulation is the same regardless of the medium through which personal recommendations are made. However, there are additional risks where personal recommendations are given to customers electronically. In particular, there is a systemic risk for the firm if part of the process produces unintended or unsuitable recommendations for customers.
Firms need to ensure, therefore, that when designing processes for giving personal recommendations they receive regulatory input to ensure that they hold the necessary FCA permissions and that they have adequate processes in place to comply with the applicable FCA rules.
The FCA has published a guidance consultation with examples that will be helpful to many firms, although may not cover all scenarios that firms may have concerns about. Firms may want to consider what input they might have to the process now to make the guidance for future as clear as possible.
The aim of the FCA guidance consultation paper on retail investment advice is to provide clarity on different kinds of advice.
There is a wide spectrum of advice that firms provide to customers:
The FCA guidance consultation paper brings together in one place existing guidance from the FCA, the European Securities Markets Authority (ESMA) and its predecessor CESR (Committee of European Securities Regulators) on these different kinds of advice. However, it does not particularly add anything new to the existing guidance.
Advising a person is a regulated activity under the Financial Services and Markets Act 2000 (FSMA) if the advice:
Generic advice does not constitute investment advice as defined in article 53 of the RAO but product related advice and personal recommendations do. The difference is between a generic statement, such as 'buy technology shares', which is not a regulated activity and advice on a particular investment, such as 'buy ABC PLC shares', which is a regulated activity. This is the case whether the advice is express or in writing or through a software programme into which an investor has input data where the system generates advice.
For the advice to be regulated it must involve an element of opinion or judgement on the part of the adviser. Regulated advice involves recommending a course of action or making a judgement on the merits of exercising a right, such as to buy or sell. Generally speaking, giving someone information and nothing more is not a regulated activity. Giving facts about the performance of investments or the price of investments does not constitute regulated advice if the investor is left to exercise his own opinion on the action to take.
The circumstances in which the advice is provided can make it a regulated activity. Presenting advice in a selective manner so that it influences or persuades an investor may amount to a regulated activity. So a decision tree will not generally be regarded as providing regulated advice but may do so if it has been designed to lead an investor to a particular investment or service.
Any information which seeks to influence or persuade an investor to buy or sell an investment may also amount to a financial promotion.
The advice must also be given to an investor or the agent of an investor, so advice given to an independent financial advisor (IFA) or tax adviser would not be a regulated activity on the basis that the IFA or tax adviser would not be an investor. But advice given to, for example, an asset manager would constitute advice to the extent that the asset manager is an agent of the investor.
In the Markets in Financial Instruments Directive (MiFID) the activity of investment advice is defined as “the provision of a personal recommendation to a client either upon request or at the initiative of the firm in respect of one or more transactions in financial instruments”.
A personal recommendation comprises three main elements:
The MiFID definition is narrower than the definition of advice in article 53 of the RAO as it requires the definition to be of a personal nature. So making a recommendation in the form of an investment bulletin that is not targeted at individual customers is unlikely to constitute a personal recommendation but would be a regulated activity under article 53 of the RAO.
HM Treasury has not amended the definition of advice in article 53 of the RAO on the basis that a personal recommendation is subsumed within article 53 of the RAO.
Where a person provides a personal recommendation, the person making the recommendation must ensure that the personal recommendation is suitable for the customer taking account of the customer’s personal and financial circumstances.
The firm must obtain from the customer information necessary to understand the essential facts about the customer and have a reasonable basis for believing that the recommendation:
The suitability requirement relates to all personal recommendations, no matter how they are delivered. However, the suitability requirement is flexible and allows firms to develop a different process depending on the product and type of customer for which it is intended. The suitability test is qualified by reference to the nature and extent of the service provided. So the information that is necessary for a firm to obtain varies from case to case: the more complex and high risk the product, the higher the threshold of required information.
Under MiFID II there will be more onerous requirements on firms providing personal recommendations to determine suitability. Firms giving personal recommendations will be required to disclose whether they will provide the client with an ongoing suitability of the portfolio. Periodic reports will need to be provided to clients including an assessment of the suitability of the portfolio, unless the firm is not carrying out a periodic assessment of suitability. Firms providing personal recommendations will also need to provide customers with a statement specifying the basis on which the personal recommendation is suitable for the client.
Michael Lewis is a financial regulations specialist at Pinsent Masons, the law firm behind Out-Law.com.
This article first appeared in a white paper by Pinsent Masons addressing different aspects of the FCA's consultation. You can also see our analyses of retail investment advice; 'Project Innovate'; digital technology; social media and financial advice; the barriers to simplified advice; pensions product advice; FOS as a barrier to innovation, and local authority duties to advise on social care funding.