Moonstone: Can a product house refuse to accept an application?

Our research into an apparent contradiction between two Sections of the FAIS Act has led to some very important issues coming to the fore in so far as the consumer, the product provider and the intermediary is concerned.

Section 7(2) in essence determines that a product supplier may not renege on its obligations to a client once the contract has been concluded and the risk/obligation accepted even though the intermediary involved may not have been duly licensed for that specific product.

Section 7(3) which came into effect form 1 May this year prohibits all FSPs, including product houses, from accepting business from a financial services provider who is not duly licensed to sell that specific product.

There are a number of very real instances where FSPs (product houses) are refusing to accept applications from intermediaries, and a major issue arising from this concerns the client who may suffer serious loss as a result of this.

We put the following question to the Financial Services Board:

May a product provider, in terms of Section 7(2) refuse to accept applications and issue contracts where a client had in good faith applied via an intermediary not duly licensed to market such a product? Such refusal could be based on Section 7(3) which prohibits them from doing business with any intermediary not duly licensed. Do the two stipulations not contradict one another?

The FSB responded as follows:

“Section 7(2) provides that a transaction concluded [my emphasis] on or after 30 September 2004 between a product supplier and any client [my emphasis] by virtue of any financial service rendered to the client by a person not authorised as a FSP is not unenforceable between the product supplier and the client merely by reason of such lack of authorisation.

It is important to note that section 7(2) requires that a transaction must be concluded between the product supplier and the client and not the person rendering the financial service and the client. In other words, the insurer as the product supplier, in the case of short-term insurance, should have accepted, for example, to place a client’s car on cover in terms of a contract between the client and the insurer. The fact that the person who had rendered the financial service to the client is not authorised as required by section 7(1) will not in terms of section 7(2) impact on the contract between the product supplier and the client.

Section 7(3) does not change the aforementioned position.

My understanding of your e-mail is that the transaction between the client and the product supplier has not yet been concluded.

The broker you are referring to is acting on behalf of the client in obtaining, for example, insurance for the client’s car. The broker submits the application to obtain insurance on behalf of the client to the insurer who then, because the broker is not authorised, declines in terms of section 7(3) to do business with the broker.In this scenario, no contract has been concluded between the client and the product supplier and section 7(2) therefore does not apply.

In my view, the two sections discussed above are not in contradiction with each other.”

What are the implications of this?

The Intermediary

The first conclusion regarding the above is that the buck now stops at the intermediary. Should the client suffer damage as a result of his or her contravention of the Act, the financial advisor can be held liable for such damage. While the normal reaction for some would be to avoid the issue, checking your license conditions is critical to ensure you are not exposing yourself to serious financial implications.

What would the situation be where business was submitted before 1 May 2009 when Section 7(3) came into effect and the product house had accepted the business from an unlicensed intermediary and issued a contract? We will comment on this next week, and also provide input on the role of PI cover in this scenario. Professional Indemnity Insurance is only compulsory for most FSPs from next year, but it is not a bad idea to consider adding it to your array of self-protection measures sooner, rather than later.

The Product House

While some providers have gone to great lengths to identify the categories for which licensed intermediaries are accredited, others have done very little in this regard and are jeopardising their licenses to operate. The biggest occurrence of transgressions appear to be where intermediaries are selling products with life cover and/or investments with guaranteed values and are only licensed for category 1C and not 1B also.

The Consumer

While the law protects the public, failure to do the basic homework can lead to a very protracted process to resolve issues which normally require speedy resolution such as a death or disability claim. Should it be determined that the financial advisor was at fault, there is of course no guarantee that he or she will be in a position to make good such loss.