The offside rule when it comes to conflict of interest

Conflict of interest has been the major departure point that the Financial Services Board (FSB) has used when motivating the need for the implementation of the Retail Distribution Review (RDR).

The RDR process has been long and arduous, but the FSB is now responding to the comments that it received earlier in the year. In a release on its website, the FSB gave an indication on its possible thinking on the final RDR makeup.

Conflict of interest controls

The FSB is taking a serious view on the issue of conflict of interest, and is working its hardest to implement controls whereby this will be managed within the industry.

According to the FSB release; where the adviser has an employment, agency or similar mandated relationship with a product supplier, the adviser will typically be a tied adviser of that product supplier (product supplier agent).

Such a relationship would therefore preclude the adviser from providing advice in any other capacity and the question of differing degrees of influence from different product suppliers does not arise.

Where advisers enter into outsourcing arrangements (including binder arrangements) with insurers, such arrangements will be subject to existing regulatory requirements. These additional controls are designed to further mitigate the conflict of interest risks arising from these additional income streams.

The bane of the industry

One of the aspects inherent in the financial services industry the FSB wants to eradicate completely is that of the setting of indirect production or sales targets.

According to the FSB release, the regulator proposes that the setting of any direct or indirect production or sales targets by product suppliers be prohibited for all advisers other than the supplier’s tied advisers.

The FSB shares the concern which was raised by a number of commentators that the practice of some product suppliers of terminating intermediary contracts with advisers who do not meet certain production levels, amounts to an implicit production target and may give rise to conflict of interest.

On the other hand, we recognise that it may not be commercially viable for product suppliers to maintain contracts, with the resulting need for administrative and technical support, with advisers that market very low volumes of their product. The FSB also does not believe it is appropriate to be unduly prescriptive to either product suppliers or advisers as to who they should be contracting with, or the circumstances in which they should maintain contracts. 

The FSB will therefore consult on measures to enable advisers whose contracts with a particular supplier are terminated or inactive for production related reasons, to be able to provide a reasonable degree of ongoing service to existing customers. Further, they will be able to continue earning any ongoing commissions to which they would have been contractually entitled if not for the reduced production.

Any other current or future requirements relating to the basis on which ongoing remuneration may be paid, or in relation to adequate ongoing product knowledge, will also apply.

The ownership issue

What if there is an issue of direct or indirect ownership – or other financial interest - when it comes to the adviser and the product supplier?

According to the FSB release, sharply conflicting views were expressed by commentators on the extent to which any form of ownership interest or similar financial interest between product suppliers on the one hand, and advisers or adviser firms on the other, constitutes a fundamental conflict of interest.

Some argued that it is unavoidable that such an interest will result in influence over the advice concerned, thus creating bias and compromising independence. Others argued that it is possible for ownership interests to exist without any such influence being exerted, by ensuring effective safeguards are in place.

The FSB's current thinking is that the mere existence of an ownership interest does not automatically result in influence, but there is a strong presumption that such influence arises. To rebut this presumption and ensure that potential conflicts arising from ownership interests are adequately mitigated, strict standards - coupled with close supervisory scrutiny- would have to be applied to demonstrate that there is no bias in favour of the product supplier concerned.

Indications of such bias would require appropriate corrective action, including potential re-classification.

Editor’s Thoughts:
Conflict of interest has caused many problems in the past and could possibly have led to the unsavoury business practices that the FSB wants to weed out of the industry. Is the regulator communicating its thoughts with the industry in an effective manner? Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts jonathan@fanews.co.za.

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