Laurence Lieberman, a partner in the financial disputes team at international law firm Taylor Wessing, discusses what firms need to be doing to comply with their suitability obligations post-RDR.

Many private wealth advisors will currently be finalising (hopefully not commencing) their arrangements to ensure compliance with the Retail Distribution Review when many parts of it come into force on New Year’s Eve.  Much has been written on training and competency, adjusting business models to deal with the independent/restricted categorisation, and dealing with fee transparency.  But will the RDR impact on suitability obligations?

The backdrop

Clearly, suitability failings in the retail sector (which for these purposes includes private banking/wealth management) are uppermost in the FSA’s mind.  Its 29 August 2012 statement that “wealth management businesses can expect to see continuing and increasing supervisory focus” followed on from the “Dear CEO” letters in June 2011 sent to 16 wealth management firms. These letters referred to “significant, widespread failings” in demonstrating suitability, including an absence of, or outdated, know-your-customer information, inadequate risk-profiling and client classification, lack of a record of clients' financial situation and failure to obtain information on client knowledge, experience and objectives.

When it came to risk-profiling, whilst firms tended to ask a client about their attitude to risk they often failed to assess whether they were able to bear the risk or understood the risk of the investment proposed - both equally key parts of a robust risk profiling process and required under COBS 9.2.2.

The 29 August statement also heralded a “new phase” of thematic work, even broader than that undertaken in 2011. The FSA will, again, be making judgments on the suitability of client outcomes but also bolstering this with a “direct assessment of firms’ systems and controls”.  Firms need to be introspective and honest in their ability to fend off the regulator if it comes looking for client files, or to understand the process for preventing customer detriment and should obtain professional advice now to avoid heartache later.

Impact on suitability

The RDR is wide ranging, aimed at improving standards and improving the customer experience in the retail investment market.  How will this impact suitability?

By way of reminder, the RDR will bring about three key changes:

1.    Advisors will no longer be remunerated by way of commission but must charge clients upfront for providing advice and explicitly disclose those charges (in the form of a price list or tariff).  This will then inform clients’ expectations of their financial advisors, with a greater emphasis on demonstrable value for money.

2.    Advice will now also have to be either "independent", meaning an unbiased opinion across a broad range of retail investment products from a wide range of providers, or "restricted", either by product type, provider or some other restriction (such as only considering ethical products). The type of advice must be disclosed to the client before it is given.

3.    In order to make personal recommendations advisors will now need to hold an appropriate qualification, subscribe to the FSA code of ethics, be issued with a Statement of Professional Standing (SPS) and undertake 35 hours of continuing professional development (CPD) annually.

Inevitably, not all of this may result in a better deal for consumers. A combination of the cost and difficulties in implementing the new professionalism standards, and changes to what can be called independent advice, has resulted in some of the larger institutions and some boutiques saying that they will no longer provide independent advice.  This may mean some consumers cannot afford or have access to the advice they need, and will turn to execution-only services.  Clearly, without the necessary advice, those consumers may be purchasing unsuitable products.

As to the impact on suitability, it should be noted that the RDR does not actually make any changes to COBS 9.2, the section of the FSA Handbook which sets out suitability requirements.  However, as a result of the new changes, there should be a significant indirect impact on standards of assessing suitability.  Previous incentives based on trail commission to recommend products which may not have necessarily been the most suitable for the client should be eliminated.  The new professionalism and disclosure standards will result in better trained advisors – or rather in far less poorly trained advisors – resulting in better informed clients and better interrogation of the investments best suited to their needs.  All of this will, for many firms, lead to an improved service, greater capture and retention of clients and fewer scenarios where portfolios underperform and clients complain.  Even if disputes arise, firms should be able to point to a better methodology and recording of suitability assessments to defend their actions.

With the Financial Conduct Authority coming into effect next year and the spotlight focusing again  on the robustness of the industry’s systems and controls, 2013 signals a new era of even greater vigilance for private banks and wealth managers.