Change: Suitability, shared clients and responsibility

Mark De Ste Croix MCSI, head of compliance & legal at Raymond James Investment Services, stresses the importance of good communication, between DFMs, advisers and clients


There is a distinct danger that when a subject has been mentioned and covered numerous times that the intended audience can become anesthetised and ambivalent about yet another exhortation or article on the matter. When it comes to suitability and wealth management it could be the biggest, and last, mistake a firm makes.

The FCA think it's a big issue and has been consistently and relentlessly addressing it for many years. They think it's a bigger issue in wealth management than elsewhere and this is not just an academic exercise. Many firms have been visited and a number have had major remediation exercises costing significant amounts of money. Given this, it would be surprising if it wasn't in the list of top three risks faced by every wealth management firm.

The recent suitability review of advice conducted by the FCA produced some impressive results, with 93% of the files they looked at being found to be suitable. This is good news and firms that were involved probably took some comfort from it. However, it was largely aimed at independent financial advisers (IFAs) and did not look at discretionary management at all. The FCA views IFAs and wealth management differently and flags in its Business Plan for 2017/18 the launch of a new round of thematic reviews on suitability in Q3 2017. It has duly done so, with a number of firms receiving their invitation to take part. It is worth noting that it's not just the big firms that are being targeted.

The subject of suitability also raises its head in the upcoming revised Markets in Financial Instruments Directive (MiFID II), and while there are no large changes affecting wealth managers, it keeps the subject fresh and there are detail changes that should not be ignored. A number of these changes are around record-keeping and communicating with clients. Discretionary management can tend to have its own suitability issues that arise from the nature of the service provided. For example, advice requires client contact and so there is an inherent opportunity for regular flow of information between client and wealth manager. However, a discretionary fund manager (DFM) operates within a mandate and, once agreed with the client, can stand removed from the client for long periods of time. Making sure that the mandate and the client details, including their aims and objectives, get updated in a timely fashion has more of an chance to fall by the wayside. A portfolio cannot be suitable if the mandate on which it is based is out of date. MiFID II puts some firm structure around how often client reviews must take place.

The fundamentals of suitability remain the same as they have always done. While there is certainly a lot of detailed work involved, firms tend to fail because of a breakdown at a higher level which is suggestive of a systems and controls problem as much as simple suitability. Are the right questions being asked, has sufficient information been collected from clients, and is it up to date? Has the firm used a structured method to assess the risk a client is willing to take? What are the client’s objectives for their investment (note 'growth' or similar is not an objective in itself, it's what they want to do with it in the future)? What exactly is the mandate from the client, is it specific and measurable? Does the actual client portfolio match what has been agreed? Does the compliance monitoring programme directly address these points? If this is being done correctly then failures are likely to be limited errors related to individual clients based on details, and while never a good thing, it is unlikely to result in the sort of general failure that gets regulatory attention.

Shared clients and responsibility – mind the gap

According to a Defaqto study earlier this year, 50% of surveyed advisers use a discretionary manager to access model portfolios and 63% use a bespoke DFM service. This is probably no surprise to anyone on either side of the fence; the services are widely known about and utilised. As well as saving time and accessing investment expertise, advisers are also likely to see it as a dilution of their risk in the client suitability process as well. DFMs see an efficient way to gather assets and offset a significant part of the suitability risk. Questions arise on both sides as to exactly how that operates in practice. If the client documentation is not correct, then a gap could exist which may only come to light when a complaint arises.

A key part of the typical adviser/DFM relationship relies on the adviser being appointed as the client's agent, particularly with respect to the use of model portfolio services. If this is not done properly then the adviser cannot be regarded as the professional client of the DFM. It is difficult to know the true extent of this problem but David Gurr from consultancy Deminimis has been quoted as saying: "The issue has slipped through the cracks and it is only the benign market that has kept it from blowing up. Billions of pounds of assets are being managed with widespread confusion in the market as to who is responsible for what in the client relationship."

Discretionary fund managers should not be complacent. There are three aspects that they cannot ignore. First, if there is a widespread breakdown then the FCA is likely to see this as a problem involving the systems and controls of both firms involved. It is difficult to see how a DFM can justify turning a blind eye to one aspect of the overall client arrangement when they are actively seeking business and ultimately managing that client's investments. Second, if and when a complaint occurs then it is almost certainly going to be channelled in the direction of the adviser in the first instance (not surprising as they have the relationship) and so they will have a level of influence over where that complaint ends up. And that leads to the last aspect and that's what happens when a complaint ends up with the Financial Ombudsman Service. If a client has been disadvantaged and there is any grey area around who is responsible, they may just take the view that the DFM pays if it's being looked at as their complaint.

The simple advice to DFMs is to check that the relationship they think they have with both advisers and the underlying clients is in fact correct. There's no reason why a DFM cannot reasonably rely on the necessary assurances in writing from the adviser but equally, regardless of those assurances, it would not be acceptable to ignore signs that it is not correct. It is incumbent on both advisers and DFMs to ensure that the services being jointly provided are done so correctly.

Views expressed in this article are those of the author alone and do not necessarily represent the views of the CISI.
Published: 05 Dec 2017
  • Wealth Management
  • Change
  • Compliance, Regulation & Risk
  • suitability
  • Mifid II

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