The biggest mistake financial service providers make

A recent survey of 1 000 respondents showed that as few as 3% of all financial services providers have closely read the FAIS Act and General Code of Conduct. These providers prefer to outsource the ‘burden’ of ensuring compliance with the Act to compliance officers. And the blind trust they place in these compliance officers could come back to haunt them.

Anton Swanepoel, a counsellor on FAIS, believes that an over-reliance on ‘tick-box’ compliance officers could result in vital aspects of the FAIS Act being neglected. Swanepoel recently shared his thoughts in an article (published in the FSB Bulletin and reproduced for FAnews Online with his kind permission) on the relationship between provider, compliance officer and product supplier.

We encourage you to read his article and consider how compliance is addressed in your organisation. Then ask yourself: Who will be liable in the event of a compliance error – the compliance officer or the FSP?

FAIS: PROVIDERS, COMPLIANCE OFFICERS AND PRODUCT SUPPLIERS UNDER THE SPOTLIGHT

By Anton Swanepoel, counsellor on FAIS

Three years after the implementation of the Financial Advisory and Intermediary Services Act, 2002 (FAIS Act), providers and compliance officers are still battling to come to grips with some vital aspects of the legislation. Although there has been a lot of positive growth in the compliance arena since 30 September 2004, there are still some critical problem areas that have to be addressed to turn FAIS into the success that it should be.

Financial services providers did not take full responsibility

Responses from more than 1 000 providers throughout South Africa indicate that not more than 3% of financial services providers (FSPs) have read the FAIS Act and the General Code of Conduct. The majority trust their compliance officers blindly when it comes to compliance issues and it appears that they have passed that responsibility to their compliance officers. This may just turn out to be their biggest mistake as FAIS primarily regulates the services of providers, not compliance officers. Many FSPs are under the impression that their compliance officers will be responsible if a client complains and wins the case. Unfortunately, if a client complains and the Ombud finds in favour of the client, the provider is liable under the FAIS Act. The FSP may perhaps claim against the compliance officer if there was negligence on his/or her side, but then it will be too late! The damage will have been done and it could take years and a lot of money to settle the case.

When one takes a closer look at the main objectives of the FAIS Act and its subordinate measures, it becomes clear that providers are underestimating the importance of the advice risk they have to assume under the FAIS Act. As the core business of any provider is the rendering of advice and/or intermediary services, it means that the advice and intermediary service process and adequate record-keeping are vital under FAIS. If a provider’s advice process and record-keeping are below par, the effects may only be felt if a client complains, and this may happen years after the advice and/or intermediary service has been provided. As it is possible for only one client’s complaint to destroy a provider’s business, providers have to make the content of their advice process and record-keeping their primary concern. This, most providers have not done as they have outsourced that function to people less skilled than themselves in the area of financial planning and the rendering of financial services under the FAIS Act. Providers simply cannot continue to blindly trust their compliance officers with templates and processes.

Compliance officers are falling short

An independent investigation into compliance services has revealed some concerning facts regarding their value proposition to providers.

1. The FAIS Act and the General Code of Conduct sets one framework for FAIS compliance in South Africa. Unfortunately, every compliance officer has his/her own standard and interpretation of the law. Different interpretations of the Act and the General Code of Conduct are confusing providers and as a result they become irate with the compliance officers and even with the regulator.

2. Compliance officers in general appear to have missed the most vital 20% of the FAIS Act that is responsible for 80% of FAIS compliance, namely the fundamentals of the advice and intermediary service process and the associated advice risk the providers face under the FAIS Act.

3. Many compliance officers do not have experience as providers, nor have they studied the vital parts of the FAIS Act in depth. These compliance officers have turned into tick-box operators, regardless of the fact that the FSB and the FAIS Ombud have warned providers against this practice. The FAIS compliance industry is bombarded with tick-box compliance officers who have been sending many “trusting” financial services providers on the wrong track since 30 September 2004. The question must be asked: “What is the point of keeping good records of poor evidence?” There is a major difference between record-keeping and recording good evidence. In practice compliance officers look at a document that is titled “Needs analysis” or “Risk profile”, they tick the box and the provider passes the audit. Unfortunately it is not the title of the page that will pass the ultimate test, but the content of the document. Mervyn King, chairman of the King Commission on Corporate Governance has also warned against the “mindless ticking of boxes” by compliance officers.[1]

4. Most compliance officers have failed to set their compliance standards in accordance with that required by the Ombud for Financial Services Providers. Mr. Charles Pillai is the referee and he sets the highest standard in the industry when it comes to evaluating whether the provider complied with the provisions of the FAIS Act. One can only wonder how long it is going to take before a provider sues his/her compliance officer on the basis of providing the provider with a false sense of security.

5. Most compliance practices have put their emphasis on the Client Advice Record or Record of Advice in their audit process. Most compliance practitioners have also designed these documents on behalf of providers. A formal study of these records indicates that these documents are currently some of the most overrated compliance documents in the files of providers based on its poor content.

The fundamentals of the essence of FAIS compliance are not in place

It appears that leading advisory and intermediary services businesses and even prominent compliance practitioners have underestimated the significance of the underlying legal relationship that exists between every provider and the client. This is the case, despite the fact that the importance of the contractual relationship between provider and client is highlighted in the FAIS Act,[2] the General Code of Conduct[3] and has been reported on, on numerous occasions.[4] The FAIS Manual contains the following valuable information regarding the legal relationship between provider and client.

“Financial services in terms of the Act…necessarily imply the existence of an agreement or contract between the person who furnishes the advice or renders the intermediary services and a client as defined in section 1(1) of the FAIS Act. This underlying agreement or contract comes into existence through offer and acceptance, (irrespective of whether the offer emanates from the client, the adviser or intermediary services provider).[5]

If the law of contract fundamentally underlies all rendering of financial services under the FAIS Act as correctly pointed out by Van Zyl in the FAIS Manual, the question is: Why don’t financial services providers have contracts with their clients on file? There are different contracts concluded between providers and their clients under the FAIS Act on a daily basis and yet providers and their compliance officers continue to ignore the importance of written agreements as part of their record-keeping obligations. This may prove to be the single most important oversight by these players.

Records of advice offer little or no evidence of FAIS compliance

Providers appear to be using the records of advice designed by their compliance officers without considering the following:

1. Most of these documents do not contain the relevant material information required in terms of section 16(2) of the Act and the General Code of Conduct;

2. Some of the documents contain waiver of rights clauses, which the FAIS Ombud has already ruled on as an act of non-compliance;

3. Most of these documents have a list of statements or questions and it then leaves a gap for the provider to complete (without knowing what the Act requires because most providers have not even read the Act);

4. These documents are not signed by the client on every page, nor where additional information is added to the document;

5. These documents have not been founded on the law of contract and therefore offers second-rate evidence – the type of evidence you can ill afford as an FSP under the FAIS Act;

6. I had the pleasure of interviewing a top financial adviser with one of the life offices and asked him whether he believes his company’s Client Advice Record (CAR) is sufficient. He answered: “No, that is why I submit my CAR document to the company in order to get paid, but I keep an additional record that my client signs if I had to defend myself before the FAIS Ombud. Even some of our major life offices seem to be missing the essence of the Act.

Product suppliers have not come to the party

From a FAIS point of view, product suppliers have missed a great opportunity to simplify the process of compliance for providers. Although product suppliers are obliged to supply providers with the necessary product disclosures in terms of the Policyholder Protection Rules,[6] in practice this is not the case. Many product suppliers do not provide the necessary disclosures, terms, conditions and exclusions as required in terms of the FAIS Act and General Code of Conduct. Although most of the terms, conditions and exclusions are disclosed in the contract issued by the product supplier, these terms are only disclosed to the client after the contract is issued. In view of the disclosures being made to the client after conclusion of the transaction, the provider is not in a position to comply with the provisions of the General Code of Conduct.[7]

Providers eagerly include the fund fact sheets of investment companies in their written proposals to clients while being under the impression that these fund fact sheets comply with the product disclosures of the FAIS Act. Unfortunately there is no alignment between the disclosure requirements under the Collective Investment Schemes Control Act, 2002, or the disclosure guidelines currently offered by the Association of Collective Investments. Fortunately Di Turpin, Chief Executive of the Association of Collective Investments (ACI) has indicated that the Association is willing to look into the matter. On another positive note, the Deputy Executive Officer of the FSB, Dube Tshidi has indicated that if there is a gap between the various regulations, the stakeholders should collectively look for appropriate solutions that will enhance the integrity of the financial services industry.[8] Hopefully this collective effort will take place sooner rather than later because in the meantime providers continue to be non-compliant in their attempts to disclose relevant material product information due to no fault of their own.

In closing

It appears that providers, compliance officers, product suppliers and the regulator still have some work left before the wheels of FAIS can turn smoothly. Unfortunately the provider is the one that is left out in the cold if a client complains. It must be remembered that many clients have entered into financial transactions with providers between September 2004 and now and some of the gaps have been left by other industry players. I am not convinced that the Ombud is going to look favourably on a provider who did not comply due to the actions of his/her compliance officer or the product supplier concerned. Providers beware!

Editor’s thoughts:

As the FAIS Act becomes more established companies regulated by it will become more complacent. There is a danger that providers follow processes without considering whether these processes adequately address requirement in the Act. Do you rely on compliance officers to ensure FAIS compliance, and if so, are you confident in the ability of your compliance officer? Add your comments below, or send them to gareth@fanews.co.za

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