Compliance News - 2 December 2011
The Financial Services Authority (FSA) has issued its largest ever retail fine of £10.5 million to HSBC because of inappropriate investment advice provided by one of its subsidiaries, NHFA Limited (NHFA) to elderly customers. HSBC estimates that the amount of compensation to be paid to NHFA customers will be approximately £29.3 million in addition to the fine.
Between 2005 and 2010 NHFA advised 2,485 customers to invest in asset-backed investment products, typically investment bonds, to fund long-term care costs for elderly customers. The products were sold to individuals entering, or already in, long-term care and in many cases these elderly customers were reliant on the investments to pay for their care. Typically these investments are recommended for a minimum period of five years.
The advice and sales were unsuitable because in a number of cases the individual's life expectancy was below the recommended five-year investment period. As a result customers with shorter life expectancies had to make withdrawals from these investments sooner than is recommended. The combination of withdrawals and product charges led to faster reduction of capital than should have been the case if customers had received the right advice. A review by a third party of a sample of customer files found unsuitable sales had been made to 87% of customers involving these types of investments.
It was clear that HSBC's subsidiary, NHFA, had not considered the individual needs of its elderly customers and failed in many cases to recommend suitable products for their circumstances, for example higher fixed interest rate savings accounts and ISAs. It was also apparent that NHFA's advisers failed to consider the tax status of customers before making a recommendation.
The FSA views the failings as particularly significant because:
• NHFA's customer base was particularly vulnerable. The average customer age was almost 83 and they therefore had limited means or opportunity to make up any financial loss resulting from an unsuitable sale;
• NHFA was the leading supplier in the UK of independent financial advice on long-term care products to help pay for care costs, with a market share in recent years approaching 60%;
• the mis-conduct occurred over a period of approximately five years; and
• a significant number of customers may have suffered financial detriment. During the Relevant Period 2,485 customers invested in asset-backed products. The total amount invested was close to £285 million, meaning the average amount invested per customer was approximately £115,000.
The failings breached Principle 9 which states that a firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment. HSBC is undertaking a past business review to determine if customers of NHFA or their families are entitled to redress and will contact customers directly. HSBC has indicated that it expects the cost of redress alone to be £29.3 million. HSBC agreed to settle at an early stage entitling it to a 30% discount on its fine. It also demonstrated its commitment to making changes to its operations. HSBC closed NHFA to new business on 1 July 2011.
Tracey McDermott, acting director of enforcement and financial crime, said
"NHFA was trusted by its vulnerable and elderly customers. It breached that trust to sell them unsuitable products. This type of behaviour undermines confidence in the financial services sector. HSBC, who owned NHFA, has now recognised the issues and taken steps to do the right thing. They have been given credit for that - but for some customers it will be too late. This penalty should serve as a warning to firms that they must have the right systems and controls in place to manage and identify risks when they acquire new businesses. A failure to do so can lead not only to detriment to their customers but to significant reputational and regulatory cost."
Source: Financial Services Authority
PROFESSIONAL REPUTATIONS TAKE A LIFETIME TO BUILD
YET CAN BE DESTROYED WITH ONE ERROR.
DO YOU NEED A REVIEW OF YOUR SYSTEMS AND CONTROLS AND RISK PROFILES FOR YOUR FIRM'S PRODUCTS?
COME TO US AT THE CONSULTING CONSORTIUM
WHERE OVER A DECADE OF EXPERTISE
WILL BE AT YOUR SERVICE.
The FSA has issued guidance to warn that traded life policy investments (TLPIs) are high risk, toxic products that are generally unsuitable for the majority of UK retail investors and should therefore not be promoted to them. TLPIs are known as ‘death bonds’ because investors are putting their money into a pooled investment or fund which invests in US life insurance policies. Basically, a TLPI investor is betting on when a particular set of US citizens will die and if these people live longer than expected then the investment may not function as expected. Evidence from the FSA’s work to date has found significant problems with the way in which TLPIs are designed, marketed and sold to UK retail investors. Many of these products have failed, causing loss for UK retail investors.
Margaret Cole, FSA managing director, said: “TLPIs are toxic products which pose significant risks for retail investors. The failure of these products in the past has led to significant consumer detriment and we fear new investors will suffer unless we take the necessary steps now to prevent their sale and distribution. We are issuing a strong warning to the industry not to market these products to UK retail investors. Ultimately we aim to ban TLPIs from being marketed to UK retail investors, and we intend to consult on this next year to help erase the risks they pose.
“Firms should not be selling these high risk products to retail investors, and so our guidance reminds firms of the importance of assessing whether a product is suitable for a customer and whether promotional material makes risk warnings clear enough. Products such as TLPIs are not a simple problem for the FSA to address as many of them are based outside of the UK, and so are outside the FSA’s jurisdiction. There are also considerations under EU law that will affect what we can do. However, the FSA is engaging in discussions in Europe around the MiFID review, AIFM Directive and with other European supervisors to find a solution to give greater consumer protection against these products.
“For now, we want to make our message about these products clear – they are completely unsuitable for most UK retail investors.”
The FSA is asking firms to:
• Consider the significant risks of TLPIs and be aware that they should not be promoted to UK retail investors;
• Conduct extensive research and be able to provide robust justification in the unlikely event they think TLPIs might be suitable for a particular retail investor;
• Be aware of underlying assets within the investments they recommend. For example, know whether a TLPI is an underlying asset within another investment e.g. a fund of funds; and
• They should not recommend products they do not fully understand.
The key risks of TLPIs are outlined in the guidance paper and can be found on the FSA consumer section of the website.
Key risks include:
• The product structure is complex and opaque, involving several firms working together, often in different jurisdictions. The different roles and legal responsibilities are not always clear and so there is a risk that firms may not be meeting their obligations. For instance, offshore entities may require the approval of local regulators and it may be difficult to ascertain if the correct approvals have been given;
• The underlying assets expose investors to high levels of risk:
• If the people whose lives are assured live longer than expected, perhaps because of incorrect actuarial assumptions or new medical advances, the investments may not be able to function as expected;
• We have found that some TLPIs lack sufficient liquidity to meet ongoing costs if the people whose life policies they’ve bought live longer than expected;
• If the TLPI provider needs to sell assets to raise funds, they may find it difficult to sell the underlying policies at a reasonable price, due to the small market and its specialised nature, and this may lead to losses for investors;
• If the firm needs to sell the assets and cannot find a buyer quickly, this could also mean that investors find their money locked into a TLPI for longer than expected; and
• If the underlying assets of the TLPI are based offshore there is also an exchange rate risk, both in terms of the costs of meeting ongoing premiums and the final payout for the underlying insurance contracts.
• Investors may have limited or no recourse to the Financial Services Compensation Scheme (FSCS) and Financial Ombudsman Service as many TLPIs are located offshore.
The guidance consultation is open for feedback until 23 January 2012.
Source: Financial Services Authority
Both firms provided cover for Sky satellite TV equipment in return for an insurance premium. All parts and labour costs were covered for between £6.49 and £11.49 per month. The cover offered by the firms was described as an ‘extended warranty’; however, the High Court ruled on 31 January 2011 that the cover amounted to a contract of insurance. Arranging or providing insurance is a regulated activity, so both firms needed to be authorised by the FSA. Concerned that these firms might be carrying out unauthorised business the FSA asked the High Court to wind up both firms – to which it agreed. A third unauthorised firm was also wound up in January 2011 but did not appeal the High Court’s decision.
Tracey McDermott, the FSA’s acting director of enforcement and financial crime, said:“We’re pleased that the Court of Appeal has upheld the High Court’s decision to wind up these firms. This decision will help protect satellite TV customers from inadvertently dealing with an unauthorised business, but also serves as a useful reminder to other firms that offer similar cover that they may need to seek authorisation.
“Indeed, we are aware of other firms who offer similar insurance products, but not just satellite equipment. We are also seeing cover for white goods, home entertainment equipment, electricity, plumbing and boiler problems. Some of these firms have quite rightly taken steps to become authorised, but consumers should take a moment to consider who they are dealing with and whether or not that firm needs to be FSA authorised.”
The appellants now have 28 days to seek permission from the Supreme Court of the United Kingdom to appeal the decision.
Source: Financial Services Authority
Lord Turner, the FSA’s chairman, said: "We are pleased that Paul has been appointed to the FSCS Board as non-executive director. He brings with him valuable experience which will greatly benefit the FSCS."
David Hall, FSCS Chairman, said: “It is with great pleasure that I welcome Paul to the Board of the FSCS. His wealth of experience in finance, financial services and consumer issues will be invaluable at a crucial time in the Scheme’s development. He is an excellent addition to a strong team.”
Source: Financial Services Authority
management is outsourced to other firms but the distributor may have a degree of influence over the fund (short of day-to-day asset selection).
These products present different risks to those to which distributors and their customers are ordinarily exposed. Given this, FSA expects firms to put in place robust systems and controls to ensure that the use of these products is in the best interests of each client and does not simply increase complexity and costs without providing new services and good value for money.
FSA published factsheets in 2008 to help firms active in this market or thinking of entering it. They are now consulting on an update to the factsheets to take account of coming changes to the rules as a result of the Retail Distribution Review (RDR).
FSA expects the RDR to have a significant impact on the use of distributor-influenced funds. In particular:
• firms advising on distributor-influenced funds should no longer receive a share of the annual management charge for their role on a distributor-influenced fund governance committee;
• adviser charges for recommending a distributor-influenced fund should not vary inappropriately compared with substitutable or competing retail investment products; and
• FSA believes it will be extremely difficult for firms to recommend distributor-influenced funds and meet the RDR standard for independent advice.
Comments are required by 30 January 2012.
Source: Financial Services Authority
The IMA and ABI have announced that they are harmonising their Managed/Mixed Investment sectors to provide greater clarity to consumers, creating consistency and comparability across insurance and investment funds. Both the IMA and ABI conducted qualitative and quantitative consumer research with further consultation with IFAs, funds of funds managers, platforms and other market participants. The IMA’s consumer research found that when presented with sector definitions, investors focused on the percentage exposure to asset classes. The majority of UK active investors said the sector name was not the most important factor in deciding what to invest in, but a quarter (28%) have used the sectors to help them reach their final investment decision, so the sector names need to act as a useful signpost.
The ABI’s consumer research showed that customers want jargon-free names for fund sectors to give them simple information about the minimum and maximum exposure to shares. The research found the Mixed Investment format was significantly less likely to lead to consumers misinterpreting the type of funds they choose to invest in.
The sector names indicate the mixed asset make-up of the funds and the maximum and minimum amount of shares permitted. The definitions set out the permitted investments in each sector, including the percentage exposure to equities, fixed income and cash investments and currency requirements. Although the definitions have changed, many of the limits on asset class exposure remain broadly consistent with both the ABI and IMA’s previous limits.
The Flexible Investment sector (formerly the IMA Active Managed Sector and the ABI Mixed Investment 60%-100% Shares Sector) permits the fund manager to exercise significant flexibility over asset allocation and does not have a minimum or maximum for equities.
The changes will come into effect from 1 January 2012. Firms will have until the end of April 2012 to make the necessary changes to their funds. Both the IMA and ABI will issue guidance to their members on the new sector names and definitions.
Source: Association of British Insurers
Responding to the Chancellor's Autumn Statement that the temporary first-time buyer stamp duty concession will end on 24 March 2012 as planned, CML director general Paul Smee said:
"It is disappointing to see the government withdrawing the stamp duty concession that currently benefits first-time buyers. While the concession may not have stimulated additional demand, it was a significant help to home-owners entering the market and its removal runs counter to the themes of the new housing strategy. It is likely that we will see a bunching of eligible first-time buyer transactions early next March to beat the expiry date on the concession."
Source: Council of Mortgage Lenders
