John Tiner, Managing Director at the FSA, has today written to the Association of Independent Financial Advisers (AIFA), other principal trade associations and consumer bodies attaching a note which re-states the key principles surrounding the FSA's approach to so called "mis-selling" of investment products.
It has been issued now in the light of continuing uncertainties in the market and at a time when some independent financial advisers are finding it difficult to obtain professional indemnity insurance because insurers are concerned about potential liabilities for the future.
The note sets out the statutory context within which the FSA has developed its risk-based approach to regulation and emphasises the responsibility this places on firms and their senior management for compliance with regulatory standards. It then explains the FSA's approach where there are claims of "mis-selling". The note acknowledges that firms are rightly concerned that they should not be subject to retrospective regulation coloured by hindsight.
John Tiner invited the principal trade associations and representative consumer bodies to attend a discussion after Easter of any issues arising from the note.
The full note is reproduced below.
Clarifying "mis-selling": a note by the FSA
This note has been prepared in the light of industry concerns about the need for clarity about what kind of exposures can give rise to claims about "mis-selling" of investment products to consumers. It does not constitute guidance given under the Financial Services and Markets Act 2000 ("FSMA").
This statement confirms relevant regulatory and statutory provisions to clear up misunderstandings in the market. It is particularly important for the FSA to do that at a time when a number of independent financial advisers (IFAs) are finding it difficult to obtain professional indemnity insurance, partly - though by no means entirely - because insurers are concerned about potential liabilities for mis-selling claims in the future. Arguably, mis-selling is not a regulatory concept at all. It does not feature in our Handbook. But the term is commonly used to refer to an advised sale which does not meet the Handbook requirements for suitability, or the "know your customer" obligations and it is in this context that we use the term in this note. Historically, poor selling which has not met these requirements has been a major source of consumer detriment.
Regulation and the industry
Trust and confidence between the regulator and the regulated are essential if the financial services industry is to be successful in meeting consumer needs and expectations. We recognise that perceptions about "mis-selling" risks - specifically the potential for future retrospective reviews of advice given - can undermine industry confidence. By explaining why and how products have been and could be "mis-sold", and the approach we will take to any reviews of past business, we aim to remove misperceptions and provide some reassurance.
It is important to acknowledge, at the outset, the extent to which the industry has taken the initiative to raise its marketing and sales standards since the scandal of pensions mis-selling. There are welcome signs too of a greater readiness by firms to put things right when problems do emerge, although there remains some resistance to this in some areas.
Statutory context and FSA requirements
The FSA works within the duties, objectives and powers set out in the FSMA which include securing the appropriate degree of protection for consumers and promoting public understanding of the financial system. In considering what degree of protection is appropriate, we are obliged to have regard to the principle that consumers should take responsibility for their own decisions. The principles of good regulation, also included in the FSMA, are also important: particularly the need for the FSA to use its resources in the most efficient and economic way and to have regard to the responsibilities of those who manage the affairs of authorised firms.
We have built on these statutory foundations through our Principles for Business. In the context of "mis-selling", five are particularly relevant -
- No 1: "A firm must conduct its business with integrity."
- No 2: "A firm must conduct its business with due skill, care and diligence."
- No 6: "A firm must pay due regard to the interests of its customers and treat them fairly."
- No 7: "A firm must pay due regard to the information needs of its customers, and communicate information to them in a way which is clear, fair and not misleading."
- No 9: "A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgement."
For the avoidance of doubt, it is the suitability of the recommendation for the consumer, not the investment performance of the product that matters. As long as suitability was established at the time of sale, and the required explanation of risk made, then consumer dissatisfaction about investment returns achieved gives no basis for an allegation of mis-selling. Investment performance may be relevant in assessing redress due where mis-selling is shown to have occurred.
Consumers rightly expect those who advise and sell financial services products to behave with honesty and integrity and to apply their skills, experience and judgement to give them appropriate advice and sell them a suitable product. In short, they expect financial firms to give them a fair deal. Our rules and guidance, including the Principles, make it clear to firms that this is what we expect of them.
There are those who feel strongly that the regulator should define or catalogue "mis-selling" in such a way as to give certainty about what is expected of firms and advisers in terms of the detailed business process to be followed in every circumstance. However, it would not be practicable or ultimately desirable for the FSA to provide an exhaustive set of specifications by way of safe harbour. If those specifications were to be exhaustive, they would be bound to be very lengthy, detailed and prescriptive. A central aspect of the FSA's regulatory regime is the responsibility of firms' senior management to run their business in a way that meets our requirements and hence to decide what systems and controls to adopt to ensure they write good quality business which meets customers' needs.
The regulatory approach and responsibilities of firms' managements
By leaving boards and senior management to do their job, we realise that they will need to put necessary business systems and controls in place to avoid the risk of regulatory action after the event. In this way, there can be assurance that business is done to the required standard, with customers treated fairly, first time round.
Provided firms meet our requirements as set out in the Handbook (including our high level Principles), as it stands when they give advice, then the regulator will not be pursuing them after the event for mis-selling. Where Handbook requirements have not been met and consumer detriment has resulted, it is right that firms can be called to account for their actions. And it is important to note that the key requirements with which we are concerned are not absolute. They require a firm to take "reasonable steps" to obtain information about a customer's circumstances.
Having met our requirements we do, however, expect firms to keep a reasonable record of the advice given and the reasons for it. Keeping adequate records will both help firms to demonstrate compliance and lessen the need for regulatory attention and intervention.
We recognise that there may be circumstances in which firms may be genuinely uncertain about the application of our rules and guidance such as, for example, with novel or complex products or changing market circumstances. We are ready to give individual guidance to firms in such situations. Our FSMA powers equip us better than our predecessor organisations to respond quickly and positively to any intelligence and to guidance requests from firms. The pro-active and risk-based approach to regulation we have now put in place will help further. We also acknowledge that there may be instances where changes to existing guidance, or new guidance might be helpful to firms. We are prepared to consider such instances as are brought to our attention. Equally, in assessing any individual case, the FSA will seek to proceed on the facts, rather than on the unsupported assertions of the consumer or the firm.
Enforcement
The charge of mis-selling is a serious one. Where a firm has not complied with its regulatory obligations and consumers have been mis-sold, the FSA will rightly be concerned. In appropriate circumstances, the imposition of disciplinary measures helps to maintain market confidence that regulatory standards are being upheld.
However, disciplinary measures are only one of the tools available to the FSA to ensure that consumers are compensated. Compensation may also be made available to consumers where firms themselves agree to compensate consumers directly, where firms uphold complaints or where firms are ordered to pay compensation by the Financial Ombudsman.
Overall, the regulatory response will be tailored to the scale and incidence of the problems. Our first step is usually to approach the firm and, where appropriate, to seek to minimise detriment to consumers. As we have clearly explained in the cases where we have required firms to review their past sales of mortgage endowment policies, failures have arisen because advisers had not met the established requirement to identify whether a customer was prepared to take the risk that their mortgage might not be repaid at maturity. Regulatory intervention was therefore clearly justified to deal with the detriment to such consumers and disciplinary action has been taken against the firms responsible in appropriate cases.
Where we contemplate disciplinary action, the FSMA contains important process protections for firms such as warning notices and we have added further protections, in particular through the issue of preliminary findings letters and through setting up the Regulatory Decisions Committee (RDC). The RDC procedures give firms the opportunity to make representations to the Committee before any regulatory decision is made and firms can refer disputed decisions to the Financial Services and Markets Tribunal. That was not a feature of the former PIA régime.
Retrospection and reviews of past business
Firms are rightly concerned that they should not be subject to retrospective redefinition of regulatory requirements, which could be coloured by hindsight. Retrospective redefinition is out of the question, given the need for the FSA ultimately to justify any proposed disciplinary action before the Financial Services and Markets Tribunal. The rules and standards to be enforced will continue to be those in place at the time of the sale and not some retrospective reconstruction.
It was within just such a framework that the regulators instituted industry-wide reviews of past business in the case of personal pensions transfers and opt-outs and of FSAVCs. We concluded that the problems arising for consumers had been foreseeable at the time of the original transactions but had not been properly taken into account and/or that the potential risks had not been adequately explained. In calculating redress where it was due, current market conditions were of course relevant but the standards against which sales compliance was assessed were those applying when the sale was made.
It is important, for the future, to recognise the differences between an industry-wide review - on a basis similar to the Pensions Review - and a more targeted firm-by-firm review of past sales, such as has been undertaken in the context of mortgage endowments. Since 2001, section 404 of FSMA has reserved to the Treasury the ability to authorise the FSA to establish any industry-wide review of past business. The Act provides that HM Treasury would need to be satisfied that there had been "widespread and regular failure" and that "private persons have suffered (or will suffer) loss." This takes the burden of proof way beyond incidental shortcomings within particular firms. Moreover, the Act requires the Treasury to proceed by way of specific Order, which must be approved by both Houses of Parliament. The FSA is therefore not able, as previous regulators were, to order industry-wide reviews of past business on its own account.
Other rights of consumers
Quite apart from the regulatory framework and our supervisory approach described above, consumers may have other rights, where they believe they have bought a product that is not appropriate for them. For example, consumers may be able to bring actions against firms in the courts in contract or tort such as for negligent advice, misstatement or breach of statutory duty, including as provided in section 150 of FSMA. Consumers can also approach the Financial Ombudsman Service (FOS). The FOS will exercise its own judgement as to whether the firm has acted fairly and reasonably, although it will take into account our rules and guidance which are relevant. The requirements of the FSA's regulatory framework are only one aspect of the firm's responsibilities to its customers.
Conclusion
In drawing together key aspects of the FSMA requirements and the FSA's approach, this note will be useful to firms in planning confidently for compliant development of their businesses. In relation to "mis-selling" we will not act with hindsight or inverting the burden of proof which would otherwise apply. And any industry-wide reviews of past business will require Parliament to have approved a specific Order made by the Treasury.
