According to the principles of Treating Customers Fairly (Outcome 2), products and services in the retail market, which are sold and marketed, must be designed according to the needs of the customers identified and targeted accordingly. When designing or creating a product, the outcome for the end user must always be considered. While this is seen to be largely the responsibility of product providers or suppliers, what impact does this have on the advisor’s practice, if any? Are there any pitfalls which advisors need to consider to ensure that this outcome is achieved for customers? While being diligent can be seen as being careful, we can extend it to the act of carrying out a due diligence, which can be seen as showing that reasonable steps or procedures were taken to establish the full particulars and credibility of a product or service provider. Failure to demonstrate this is one of the reasons the FAIS Ombud has made findings against financial advisors.
Do you have a Due Diligence process which enables you to show the steps which you have taken to ensure that your customers are treated fairly?
Let us look at what the process of conducting a due diligence involves. Due diligence is, in essence, an investigation into an entity and can be defined as the process whereby a person applies his mind when investigating a person or business before entering into a business transaction with that person or entity. In practical terms, it entails asking questions and verifying the accuracy and truthfulness of the information received. It also entails verifying the source of the information and establishing its reliability. When assessing any risk, one needs to determine if the risk is high, medium or low and, if the risk occurred, what the possible impact would be on the FSP.
The aim of a Due Diligence process is to firstly protect clients against possible losses and bad advice but at the same time to protect the FSP and its reputation, and to ensure the FSP retains its licence and can operate a profitable and sustainable business. The process of conducting a due diligence is 100% aligned to Treating Customers Fairly which forms a key thread through all new legislation being implemented.
Whilst the Due Diligence requirement may appear to apply only to investment type business, the requirement extends to all product types and product providers, or other licensed FSPs the business has dealings with.
Any due diligence investigation must be performed with a high standard of care, skill and expertise that may be expected from a reasonable person performing such an investigation. However, you have an obligation to go beyond what is merely contained in marketing material to ensure that the product you recommend will in fact address and meet the needs of your clients.
A thorough due diligence investigation should cover the following key areas:
- Regulatory compliance
- Governance structures
- Financial soundness
- Operational reliability; and
- Investment management
Below are some examples of the type of questions that could be asked when conducting a due diligence investigation before contracting with a specific Product Provider or selecting a specific product to offer to clients. This is not a closed list and each FSP needs to compile its own list of questions which it feels comfortable with in satisfying its investigation:
Possible questions to ask a Product Provider:
- Is the entity in question a listed company?
- Is the entity in question registered with the relevant regulatory authorities, for example, the Prudential Authority, the FSCA, The Council of Medical Schemes, etc?
- What is the company’s service track record? Does management take responsibility for resolving issues? Are they willing to engage? Do they deliver on their promises?
- What is the company’s track record of delivering value for money? Do the company’s products perform as advertised?
- What is the company’s track record on paying claims?
- Can a high level of corporate governance be evidenced? Does the entity have a longstanding reputation? This question is related to experience and expertise within the provider.
Possible questions about the Product:
- Does the financial product or instrument qualify as a “financial product”? Does it fall within one of the financial product subcategories regulated by the FSCA?
- Is the financial product or instrument realistic? In your experience, is the product realistic in terms of its overall structure, coverage, investment returns, premiums and commissions?
- How does the product work? If you do not understand exactly how a product works, you cannot recommend it to a client.
- Does the product offer specific benefits which meets the needs of the specific client or clients the FSP is dealing with?
The basis on which a due diligence was conducted should be documented in a separate process. Reference could be made to this in the advice process, specifically the record of advice and more specifically the product recommendation section. Having a well-established and entrenched Due Diligence process not only protects clients but also enables an FSP to mitigate the risk of possible financial loss and reputational damage. This in turn supports the FSP’s approach to risk management.
All stakeholders in the FSP should be involved in establishing a robust Due Diligence process and this should be effectively communicated throughout the FSP and form part of the advice culture and process. Due diligence is an ongoing task and data needs to be updated consistently and continuously.
Prevention is, indeed, better than cure.