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An FSB “Stamp of Approval” could free up advisers to do what they do best – give advice

01 October 2012 Gareth Stokes, FAnews

What happens when an investment goes belly up? Since the introduction of the Financial Advisory & Intermediary Services (FAIS) Act consumers are more likely to “sue” their financial adviser for poor advice than go after the financial institution or regulator that has oversight. The adviser has become the “catch all” for compromised investors...

Advisers are painfully aware that their clients need only hint at improper advice to stand a chance of a windfall at the FAIS Ombud. In the event an adviser falls short of the advice requirements set out in the Act and its accompanying Code of Conduct, the Ombud can award the complainant damages to a maximum R800 000. And successive Ombudsmen have not hesitated to issue judgements of this size.

Due diligence overkill

Advisers are taking on increasing administration and compliance burdens to keep their "noses” clean. They find the requirement to complete a due diligence on each product they "sell” to be particularly onerous. A related issue that is of equal concern is that they cannot rely on the products offered by product providers to be "fit for purpose”.

Many advisers believe that the Financial Service Board (FSB) should implement a system whereby each product developed by a financial product provider is pre-approved for distribution. Each product would be thoroughly audited at its point of entry to the market rather than being subject to dozens of separate due diligence exercises.

A product with an FSB "stamp of approval” could be assumed fair (in terms of associated costs, exclusions and promised performance) and fit for purpose. The onus to investigate financial organisations would shift to the regulator which has both the resources to carry out the investigation and the legal powers to force product providers to play open cards with their complex risk and savings products.

Never on our watch!

Could such a system work, or is it an adviser-inspired pipe dream? The FSB dismisses the idea out of hand. "It is not the role of a regulator such as the FSB to rate or to approve financial products,” says German Anderson, Deputy Registrar: Financial Services Providers. "Not only is this the international position, but for a regulator to rate financial products, will understandably cause major difficulties”.

The only area where the FSB can set parameters with which a "product” must comply is in the area of collective investment schemes, where it lays down what different portfolios should comprise of on a maximum basis.

Thinus Ferreira, Principal Officer of PPS RA says the debate is somewhat moot because the FSB already has industry oversight. "It grants licences to product providers and should such product provider issue a product that is not ‘fit for purpose’ or ‘safe’ for consumers the regulator can take the necessary action by revoking the provider’s licence,” he says.

Duty of care

But Ian Middleton, Managing Director of Masthead, believes some form of regulatory product approval is possible. "We suggested this as part of our submission to the FSB regarding Treating Customers Fairly (TCF) back in 2010,” he said. Masthead’s standpoint is informed by its hands on interactions with thousands of intermediaries and practice owners countrywide.
 
Advisers have a duty of care to their customers and must conduct due diligence to ensure that the company and product are above board. Unfortunately brokers are easily misled. Most high profile investment scandals are underpinned by glossy brochures, high-powered launches and smooth talking marketing executives.

An unfair risk burden

"As things stand, we believe that advisers are exposed to more risk than the product provider throughout the chain,” says Middleton. There are countless examples where advisers are at risk despite conducting due diligence.

A case in point is the widely-marketed "dividend income fund” which many advisers accepted – on assurances from product providers – as a fund that provided tax free income to customers via dividends. If the fund turns out to be something different and the client loses money then the adviser ends up at the front of the liability queue.

Advisers sell advice, not product

"We hope that TCF will protect advisers against this type of risk,” said Middleton. An adviser should be confident that product has been appropriately developed and performs as indicated. This is no different to what a customer would expect from the advice the financial adviser gives. Advice is after all the "product” an adviser sells!

Product providers have a different take on the matter. Diversified financial services giant Sanlam says that the most powerful mechanism to ensure that consumers get the best outcome is to rely on market forces. (Others might argue that TCF is a better "force” to rely upon).

"One of the six TCF outcomes dictates that products and services marketed and sold in the retail market are designed to meet the needs of identified customer groups and are targeted accordingly,” says Ferreira. "It is now up to product providers to design processes (and adopt the culture) to achieve this”.

A lose-lose situation

Sanlam misconstrues the FSB-rating suggestion as one of "product” standardisation. "Trying to standardise or develop a rating system that caters for consumer’s unique needs will have the unintended consequences of stifling innovation, adding cost to the industry and forcing a one-size-fits-all solution in addition to the range of challenges that consumers face,” they say.

Sanlam adds that advisers play a valuable role in matching the vastly different needs of clients to the different solutions available and claims that product regulation would prevent consumers from getting an optimal outcome and thereby reduce the need for advisers.

But the need for and value of advice is not in question. What is in question is how product providers conveniently disappear from view when a product goes belly up or fails to live up to expectations. Advisers want to be able to trust each and every solution offered by a provider without having to place it under a microscope

Transacting with confidence

"If a licence to operate is granted to a product supplier, advisers should reasonably be able to accept that there has been due diligence applied by the regulator and that there is therefore some stamp of approval placed on the supplier,” says Middleton.

And if advisers contract with a provider that is licensed or approved by the regulator, and behave within the reasonable standards and expectations of the advice role, they cannot be held liable if the provider implodes. "An FSB licence should mean something to both the adviser and the customer,” he says.

Illegal schemes inevitable

Middleton does not think that TCF – applied at product provider level – will cure the industry of its ills. "There is always risk in non-mainstream products where there is no regulation as well as in Ponzi schemes that are disguised as legitimate investment schemes,” he says. "These illegal investment schemes are usually developed and sold in secrecy from the regulator”.

Sanlam sticks to its "market forces” guns. "While the outcome of TCF is fairly well understood, the mechanism to achieve it is not,” they say. "We believe that TCF will improve transparency of products, as well as portability of products – market forces will then drive optimal outcomes for consumers over time”.

The group believes that consumers will receive a fair outcome if they are fully informed how products work, what they aim to achieve, and are able to align the products to their circumstances.

No advisers’ Nirvana

So there you have it… In the perfect world the adviser could rely on the FSB to ensure that the product provider was financially viable and dealing in products that perform as promised. And in the adviser’s Nirvana the product provider would be held accountable if its products did not deliver.

But in the trenches of 21st Century financial services it is the adviser who will carry the proverbial can… You will have to accept that market forces will determine what product providers dish up. And you can be sure that if their product is not up to scratch they will simply shrug and say: We developed it because that’s what the consumer wanted.

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