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| Financial Law Update | Back to article summary. |
| The hard sell - regulation of the sales process for financial products |
| Joe Beashel |
| Both the sub-prime crisis in the USA and some recent publicity in Ireland have highlighted the need for all firms selling financial products to ensure that such products are properly sold. A recent case in the UK resulted in JP Morgan succeeding against allegations of mis-selling of complex products by a sophisticated investor. On the other hand, in Ireland the Financial Services Ombudsman has reported a 29 per cent increase in complaints compared to last year with some complaints relating to the sale of long term products to the elderly. |
| Joint Forum Survey Clearly potential mis-selling of financial products is not a purely Irish phenomena rather it is an international issue. As the recent publication entitled ‘Customer Suitability in the Retail Sales of Financial Products and Services’ by the Joint Forum of International Regulators, including the Basel Committee, IOSCO and the International Association of Insurance Supervisors (the Joint Forum Report) shows, there are common concerns across diverse markets especially when dealing with retail customers. The Joint Forum Report indicates that mis-selling has become a prominent issue for both regulators and firms across the 11 countries (both EU and non-EU) involved in the survey, and there remains wide disparities between what different regulators require of firms and the steps that firms must take to address those requirements. The Joint Forum Report identified a number of areas of particular concern which are: The sale of investment products with similar characteristics using different suitability requirements that depend on the financial sector in which they are sold. The availability of unregulated investment products in the jurisdictions involved in the survey, many of which are unsuitable for retail investors. The remuneration of salespeople and in particular the desire to adopt a co-ordinated approach across the banking, insurance and securities sectors so that rewards should be provided for those who comply with the highest standards of suitability and disclosure. Practical Steps to Avoid Mis-selling No doubt the implementation of the Markets in Financial Instruments Directive (MiFID) last year will have helped to standardise processes across Europe, but it will be some time before one can judge whether this effort to create a consistent European standard of sales process has been successful. In Ireland we can recognise some of the issues identified by the Joint Forum Report, in particular, the fact some firms must juggle MiFID with the Consumer Protection Code (CPC) with, in some cases, applicable insurance regulations. While some work could be done, at a domestic level, to better align MiFID and the CPC, more fundamental structural changes are needed at an EU level to bring greater co-ordination between securities, insurance and deposit based products and the sales process for those products. In our view the whole framework in this area is product focussed rather than customer focussed. This lack of customer focus results in overlap and duplication resulting in cost and complication for firms who are typically dedicated to delivering an efficient, smooth and rewarding experience for their customers. What steps should firms take then to protect themselves against the regulatory risk of mis-selling? It’s a statement of the obvious, but both MiFID and CPC are the cornerstones of the regulation of the sales process in Ireland. Adherence to these standards needs to be constantly assessed through reviews. There should be a process, supervised by senior management, to ensure that any weaknesses are addressed. Perhaps not so obvious would be our recommendation that conduct of business rules, including the relevant suitability tests, be incorporated into the product development process. Compliance teams can assist the business in explaining whether particular products or product features are suitable for particular market segments. The firm may also want to consider how the product will be marketed, by whom and to whom and what controls will be put in place to prevent mis-selling. Considering the risks for the investor will also be very important and we would suggest that firms should have a clear understanding of the complexity and transparency of the product and how it will function before introducing it to the sales team. This can be a particular challenge where a firm distributes a product manufactured by another firm. Firms may also want to subject complex products to stress testing in order to gain an understanding of how the product will operate under different market conditions. The findings of this assessment will most likely drive training for the firm’s salespeople and financial advisors. It may be worthwhile clearly indicating in product literature and training manuals who the product is suitable for and who it is not suitable for. We would suggest that all agreements and client documentation should contain full disclosure which should be suitable for the class of client at which the product is targeted. Face-to-face meetings should be documented where possible and full suitability assessments performed where required. Firms may want to consider reviewing their remuneration structure to avoid a culture of ‘a sale at any price’. Recent Case law Naturally one would expect both legislation and the focus of regulators to be on retail investors due to their relatively weak bargaining power and in some cases, relative lack of sophistication. There is a lighter regulatory burden when dealing with more sophisticated customers, though such customers typically have the resources to resort to litigation if they have a grievance. The recent UK case of JP Morgan Chase Bank v Springwell Navigation Corporation (April 2008) illustrates that lengthy and expensive litigation is possible when dealing with this category of investor though one could offer a sweeping generalisation that such litigants have a more difficult job to prove their case than might be the case for retail customers. This case concerned the sale of Russian bonds and instruments referenced to Russian bonds called GKO-Linked notes, to an investment company run by a Greek ship-owning family who then incurred substantial losses during the Russian financial crisis of August 1998 (note the 10 year gap between the losses and the court decision). The investment company contended that the salesperson had a duty to advise on the appropriateness of the investments at point of sale and to give ongoing advice to the portfolio thereafter. The UK Commercial Court disagreed however and held that while a salesperson may build a relationship with their clients and offer their views and recommendations, this does not necessarily mean that the salesperson takes on advisory duties. The court looked at the sophistication of the investment company, the contracts that had been entered and the relationship between the salesperson and the company. The court found that the investment company was a sophisticated investor, well versed in transactions of this type and that they had made all investment decisions themselves. Interestingly, the court further held that even if that was not the case, the lack of an advisory agreement between the investment company and the salesperson and the fact that existing documentation excluded the duty to advise meant that any representations made by the salesperson could not be relied on as advice. Although a UK decision, the case clearly indicates the very different approaches taken to sophisticated clients where allegations of mis-selling are made and provides some reassurance when selling complicated products to such clients, while emphasising the importance of robust contractual agreements. Conclusion Ensuring that customers get the right products for them is a constant concern for financial services firms. Sometimes mistakes are made but generally there are robust processes to avoid such mistakes. The implementation of MiFID and the CPC in Ireland have significantly changed the regulatory landscape in Ireland over the last year or more. Following initial roll out of compliance with these new requirements, firms have the ongoing challenge to ensure compliance with them on a daily basis. Adherence to processes and procedures, the use of robust documentation, and ongoing review and improvement are, in our view, the essential steps to ensuring that what can be a difficult sales process does not become an impermissible and maybe unlawful hard sell. |
Joe Beashel is a Partner in the Banking and Financial Services Department and is Head of the Regulatory Risk Management and Compliance Group. He can be contacted by phone: +353 1 232 2000 or by email: joe.beashel@mop.ie. Further information on the firm is available at www.mop.ie |