During the mid-1800’s taverns in the USA (particularly around New Orleans) would advertise a “free lunch” to lure in customers during the mid-day hours. They would tell prospective customers that if they bought a drink, they’d get a free lunch. So, as much as the lunch sounds free, customers were expected to first buy a drink in order to get the “free lunch”. The idea was that because the lunches had a high salt content, customers would then be likely to purchase more drinks. Tavern owners had very clear expectations that they would generate enough revenue in additional drink sales to offset the cost of the lunch.
In economic/finance terms this concept of a free lunch suggests that items or services that appear to be free always have a cost to someone, even if it not the individual receiving the benefit.
Are brokers being trapped by “Free Lunches”?
When product providers offer brokers training, entertainment, or invitations to events, does this expose brokers to potential breaches of regulation and therefore possible regulatory actions?
Similar to the tavern owner in 18th century America, we think it is critical that FSPs, particularly smaller FSPs be aware of, think about and then manage the potential regulatory, reputational, and financial exposure that may come with inadvertently accepting or receiving a “free lunch”.
How do the Regulators deal with Free Lunches?
Different to the tavern owners of old, FSPs and financial advisors are subject to strict market conduct legislation, primarily in the form of the FAIS Act and regulations (often published in the form of Board Notices), like the FAIS General Code of Conduct and Board Notice 194 of 2017.
Since the key objective of the Act and the regulations is to protect the consumer, the Act and the Board Notices seek to manage the conduct of FSPs by prescribing and/or outlawing certain behaviours.
Before 2010, the LOA (now ASISA) tried to set boundaries for free lunches by getting life offices to agree to a voluntary code. Despite this self-regulation as to what was acceptable to offer brokers, in 2010 the regulators introduced an expanded set of Conflict of Interest regulations into the FAIS General Code and they, with certain exceptions, specifically banned “free lunches”.
In this article we have limited our focus to the regulatory aspects and have not looked at any unspoken or implied commitments or expectations that often come with “free lunches”.
What is a “Conflict of Interest”?
A conflict of interest is defined in the FAIS Act as any situation where FSPs or representatives have an interest that may influence the objectivity of their obligations to clients or that may prevent them from rendering unbiased and fair financial service to clients, and specifically includes a financial interest.
What may one give or receive?
The General Code, in essence, now states that apart from commission and fees, FSPs may only receive a financial interest from a third party (aka product provider) that is immaterial or for which they pay fair value that is reasonably commensurate to the value of the financial interest they have received.
Section 3(A) was inserted into the General Code and states that:
“A provider or its representatives may only receive or offer the following financial interest from or to a third party
(vi) … an immaterial financial interest; and
(vii) a financial interest … for which a consideration, fair value or remuneration that is reasonably commensurate to the value of the financial interest, is paid by that provider or representative at the time of receipt thereof.”
A focus on some specific wording
In order to make sense of these provisions, we want to focus on some important wording:
- Receive or offer:- while there’s often a focus on the givers of free lunches, the regulations apply equally to persons receiving free lunches. So, an FSP (in our case, a broker) may not receive and an FSP may not offer a financial interest. A breach of the provision applies to both parties, not just the giver.
- Financial interest:- this includes cash, voucher, gift, service, advantage, benefit, discount, travel, hospitality, accommodation, sponsorship, or valuable consideration. While this covers virtually everything, there is an exception in relation to training and, as a broker, you may receive the following without falling foul of the regulations:
1. Product training and legal training related to those products.
2. Training that is on general financial and industry information.
3. Training on specialised technological systems that are necessary for the FSP/rep to render a financial service.
The cost of travel and/or accommodation for FSPs and reps does not form part of the training exception. So, while you may receive the type of training above, you cannot have your travel and accommodation costs paid. It’s also important to note that in order to rely on this exception, the training may not be exclusively available to a select group.
- Immaterial financial interest:- this is the R1000 limit that can be received by an FSP or representative or that can be offered by a product supplier to an FSP or representative. The R1000 is measured in total over a calendar year received from the same third party.
- Fair value:- this is defined with reference to the Companies Act. In simple terms, where you are asked to pay for something that you are offered (eg. entertainment, conference) there should be a reasonable relationship between the value of what is being offered and what you are being asked to pay – eg. you can’t pay R500 for a ticket or event that costs R2500.
Unwittingly accepting a Free Lunch
The regulations do not require intent on the part of the giver or the receiver to be a conflict. Therefore, the reason for accepting a free lunch is irrelevant. The motive, no matter how pure, does not provide a defence, although if found guilty, lack of intent may be a mitigating factor.
Given this, FSPs/brokers may find themselves accepting a free lunch without realising it and therefore they may inadvertently breach Conflict of Interest regulations. If so, they are also exposing themselves to regulatory, reputation, and financial risks.
Can training be regarded as a free lunch?
Board Notice 194 came into effect in 2018 and sets out a number of competency requirements for FSPs, KIs and Reps. Amongst other things, this board notice requires them to meet the following training requirements:
– Class of Business training (CoB),
– Product Specific Training (PST), and
– Continuous Professional Development (CPD).
Since this board notice, we have seen an uptick in training provided by product providers, and we believe that there is potential danger for FSPs, KIs and Reps who blindly accept such training. As mentioned, the COI regulations prevent FSPs/brokers from receiving a financial interest (which is defined very widely) from product providers. But, since training is excluded from this definition, one would think that it is okay to accept training from a product provider. However, that’s not necessarily the case – anyone being offered training by a product provider should consider the following:
- Test whether the training falls under one of the three types mentioned earlier. If you are receiving Product Specific Training, that’s okay- in fact, we believe that product providers should provide this training.
- Make sure the training is genuine training and not a disguise for something else. We’ve seen examples where conferences or events are labelled as training, or the training component is only a small part. We’ve also seen situations where it is more about the location and less about the training.
- Make sure the type of training is what it professes to be – we’ve seen product specific training marketed as CPD. In terms of the law, PST cannot be CPD. We have also seen training marketed as Class of Business when it’s CPD. In both instances, the brokers would have missed meeting their regulatory requirements.
- Make sure that the training is not exclusively available to a select group. You cannot be the only advisor or part of a select group of advisors receiving the training. If you are, then it does not fall under the training exception, and the normal COI rules apply.
- The onus is on you as broker – it is your licence and your reputation at risk. So, if a product provider is offering something, ask them to verify that the training falls within the COI regulations – in other words, ask them to confirm that “it is not a free lunch”. If they’re not prepared to give you the assurance, don’t take it.
- Consider the reciprocal nature of what you are getting – what is expected from you in return?
What about product providers offering CPD?
Over the last year we have seen a number of product providers providing CPD in an effort to help FSPs, KIs and Reps meet their obligations in terms of BN194. Can they legitimately (within the requirements of COI regulations) provide CPD to brokers? There are, in our view, several questions to be asked.
For the “CPD” to fall under the training exception so that it does not create a COI, it must:
- Not be available to a select group – if it is, it is disqualified from the exception and the normal COI rules apply.
- It needs to be in relation to general financial and industry information – it does not give product providers carte blanche to provide any and all “CPD”. A lot of the CPD offerings we have seen are specific and cannot, in our view, be categorised as “general financial and industry information”.
- If it does not fall under the “training exception”, it must also pass the normal COI rules, including the fair value test linked to financial interest. If the CPD “training” has value, then the exception only applies if the receiving party (the FSP) pays fair value that is reasonably commensurate to the value of what was received.
There are enough commercial offerings to be able to easily determine commensurate value – it’s simply the cost you would normally pay to attend or complete a course. So, if you are receiving CPD that has value and you are receiving it for free, there is risk that you (and the product provider) are in breach of the COI regulations.
We believe that when the regulators introduced these provisions (ie. the exception irt training) back in 2010 it was a concession to the industry, and the intention was not to exempt CPD and Class of Business Training that would normally be paid for by FSPs/reps. Therefore, if product providers are relying on this training exception, it seems they are stretching interpretation of the provision. While we have had informal discussions with the FSCA on this point, we have sought formal clarity from them.
If the CPD does not fall under the exception iro training, and it is not paid for (iow. there is no fair value in return), it can be tested against the “immaterial financial interest” – ie. the value of the CPD plus anything else you receive from that product provider cannot be more than R1’000 for the year.
We believe that there are many CPD offerings that will fall foul of the COI regulations. Our concern is for brokers who gratefully accept “free lunches” and inadvertently breach the COI regulations. They, and the product providers offering the training are putting their licences at risk. As we said at the beginning, “there ain’t no such thing as a free lunch”. Is this a cost you’re prepared to take?