The JFSC investment business supervision have issued their annual findings from their 2013 on-site examinations

The topics covered are:

1. CONDUCT OF BUSINESS FINDINGS
2. CORPORATE GOVERNANCE FINDINGS
3. INTERNAL SYSTEMS AND CONTROLS FINDINGS

These matters are shown below using the same numbering as the JFSC report

1. CONDUCT OF BUSINESS FINDINGS

2.1  Suitability of Investments

The risk of a Registered Person mis-selling an investment remains a key area of focus for the Commission and there were a number of instances identified during 2013 where systems and controls required strengthening, as set out below in 2.1.1 to 2.1.4, in order to better demonstrate suitability of investments.

2.1.1  Knowledge of Client

The Commission identified instances where the fact find document or client questionnaire was incomplete or only partially completed, with no explanation for this. In accordance with paragraphs 2.3 and 2.5 of the IB Codes, Registered Persons are required to demonstrate sufficient knowledge of their clients by obtaining, documenting and maintaining information in relation to their clients’ circumstances (financial or otherwise). This client information allows Registered Persons to better demonstrate suitability of advice, having regard to their clients’ circumstances and investment objectives.

An example of good practice

• was demonstrated where the Registered Person, in instances where a client declined to disclose full information in relation to their circumstances and investment objectives, included within the suitability letter specific risk warnings highlighting to a particular client that the lack of such information may adversely affect the service it can provide.
• The Commission noted examples of good practice where the Registered Person also requested the client to sign and return the suitability letter to acknowledge this additional risk.

2.1.2  Concentration Risk/Counterparty Risk

The Commission identified instances where the Registered Persons’ investment advice had resulted in a large percentage of clients’ assets being invested in one single investment but the Registered Persons were unable to demonstrate that the associated concentration risk/counterparty risk had been clearly communicated to clients, in accordance with paragraphs 2.5 and 2.6 of the IB Codes.

An example of good practice

• was demonstrated where the Registered Person had clearly explained in its client proposal/recommendation that the apparent concentration risk/counterparty risk arising from the advice had been adequately considered and communicated to the client during the advice process in order that the client could make an informed investment decision.
• The Commission would expect all Registered Persons to ensure that relevant policies and procedures require consideration of concentration risk/counterparty risk as part of the suitability assessment and ensure that these risks are clearly communicated to clients.

2.1.3  Establishing the level of investment risk a client is willing and able to take

The Commission identified instances where the level of investment risk embraced in a client portfolio was not in line with the client’s stated risk profile and that the rationale for this difference had not been adequately explained. In order to demonstrate compliance with paragraphs 2.5 and 2.6 of the IB Codes, the Commission would expect the difference in risk levels to be clearly highlighted in the suitability letter.

The Commission noted that a number of Registered Persons use a risk assessment questionnaire in order to assess and document a client’s risk appetite. However, examples were identified where the questions were either vague or not clearly worded, which could result in the client misunderstanding the questions and not giving answers that accurately reflect his or her risk appetite.

The Commission expects Registered Persons to ensure that evidence of client discussions in relation to a client’s risk appetite are clearly documented on the client file.

An example of good practice

• was demonstrated where the Registered Person recognised the limitations of its risk assessment questionnaire and ensured that any conflicting answers provided by the client were highlighted and discussed with the client in order to clarify the level of risk they were willing and able to take.
• These discussions were clearly documented and referred to in a suitability letter that explained the rationale for the client accepting a higher level of risk.
• In light of the above, the Commission would encourage all Registered Persons to consider whether amendments should be made to their own investment risk assessment process.

2.1.4  Switching and Churning

Whilst on-site, the Commission identified instances where a Registered Person had advised its client to switch his/her investments. However, the advantages and disadvantages of making the switch were not adequately explained and the client proposal/recommendation had focused solely on the expected returns of the new investment. In order to demonstrate compliance with Paragraphs 2.10 and 2.11 of the IB Codes, the Registered Person must be able to evidence, in writing, why it is in the client’s interest to switch and it must ensure that it is not advising its client to enter into transactions with unnecessary frequency.

In an example of good practice,

• the Registered Person had clearly listed both the advantages and disadvantages of switching, including a comparison of fees and charges, in a suitability letter in order to allow the client to make an informed decision.
• The Commission would encourage all Registered Persons to consider whether their own investment processes would ensure that the above matter is appropriately addressed, considered, documented and monitored.

2.2  Disclosure/Transparency of Fees and Charges

Paragraph 4.6 of the IB Codes requires a Registered Person to adopt a “no surprises policy” in relation to fees and charges and to ensure that these are clearly communicated to clients, in writing, in either a monetary or a percentage figure. However, the Commission identified instances where clients were not informed of the fees being taken by the Registered Person or where the Registered Person had failed to inform the client of charges being deducted by the product provider and/or failed to highlight surrender penalties in a suitability letter.

In cases of good practice,

• the Registered Person had clearly listed all associated charges in a suitability letter and had considered the impact of these charges on expected future returns.

The Commission would expect

• a Registered Person to ensure that it can demonstrate that all associated fees and charges have been clearly disclosed, in writing, to its clients.
• Additionally, the Commission would encourage all Registered Persons to consider whether amendments to their own policies and procedures are required in this respect.

2.3  Product Approval Process

The Commission observed instances where Registered Persons relied solely on a volatility figure in order to determine an investment’s level of risk. An example was identified where, despite the investment being complex and having numerous higher risk factors detailed in the prospectus, such as the use of leverage, the Registered Person had categorised the investment as being low risk.

In order to demonstrate that an investment product is suitable, in accordance with paragraphs 2.5 and 2.6 of the IB Codes, the Commission would expect a Registered Person to evidence that it has considered, amongst other matters, the use of leverage, liquidity of the underlying assets, including whether these are traded on mainstream markets, product complexity and the extent of regulatory oversight of the product or investment.

An example of good practice

• was noted where the Registered Person considered a wide range of risk factors before approving investment products through its prescribed investment approval process, with a summary of the overall level of risk being provided to clients in a suitability letter, allowing them to make an informed investment decision.
• Whilst this would seem obvious, the Commission was surprised by the number of Registered Persons who had not included such information within their suitability letters.

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