As more advisers outsource their investment management, questions are being raised over where responsibility for suitability lies in the relationship.
The issue has been complicated by the formation of different variants of relationships between advisers and discretionaries, which range from bespoke portfolio management to model portfolio solutions held on platforms.
It has also been thrown into the spotlight as the FSA’s suitability review in the wealth management sector continues.
As firms review their internal processes, files and systems, some wealth managers and regulatory consultants suspect there could be growing pressure on discretionary managers to take responsibility for suitability if they are running bespoke mandates for advisers.
Jamie Shepperd, CEO of wealth manager Courtiers, recently attended an FSA-run seminar. ‘It was clearly explained that responsibility lies with both parties.
If you are providing a model on a platform, then that is completely different, but if you have got a relationship with an IFA practice and you are their designated discretionary manager, you need to know what the client’s attitude to risk is and what their objectives are,’ he said.
This is important to bear in mind in the case of client complaints. ‘If a complaint comes, the client will turn against the person with the deepest pockets,’ he added, implying the discretionary management firm could be liable.
When Courtiers works with advisers it asks them to use its fact-find and risk analysis tool. Although it does not seek direct contact with the underlying client, the firm will write the suitability letter and report in the same way it would for a direct client.
Mike Browning, a regulatory consultant at Browning Treasury, also believes discretionaries should take responsibility for suitability, unless they are providing model portfolios on platforms. ‘If you are running a discretionary portfolio, I don’t see how you can avoid doing suitability,’ he said. ‘If you are at a company with an advisory arm you can manage this more effectively and efficiently.’
A source close to the FSA described suitability as a ‘grey area’, but was under the impression that responsibility for suitability falling to discretionary managers for bespoke mandates had been the ‘direction of travel’ at the regulator for some time. ‘This direction of travel flies in the face of where discretionary managers thought they were in the past,’ he added, referring to rule 2.4 of the FSA’s Conduct of Business sourcebook.
What the rules say
According to this rule, if a firm is aware the adviser who is outsourcing to them is acting as an agent for another person, then the adviser is the client of the firm rather than the underlying client.
In this situation, the rules say the discretionary manager may rely on any information about the client transmitted by the adviser, who is also responsible for the appropriateness of any advice or recommendations provided to the client. I
f a discretionary manager is required to undertake a suitability assessment under rule 9 in the sourcebook, it can rely on an assessment carried out by an adviser, the rules say.
Ian Cornwall of the Association of Private Client Investment Managers and Stockbrokers (Apcims), believes documentation and clarity is central to the suitability question. ‘The key is to make sure the client, the IFA involved in the relationship and the Apcims member are absolutely clear about who is responsible for what, and there is no ambiguity,’ he said. ‘Be clear that you are all talking the same language and everyone understands what you mean by the various definitions you are using.’
Nonetheless he stresses it depends on the nature of the relationship. His views are echoed by Chris Macdonald, chief executive of Brooks Macdonald:
‘It comes back to the client understanding who is providing what.’ He added Brooks was comfortable if an adviser prefers to carry out suitability, with the firm stress-testing the adviser’s risk profiling against its own, but equally it is happy to accept responsibility for suitability.
The FSA was less explicit in its view, but stressed the differences in outsourcing relationships. A spokesperson said: ‘The answer to the suitability questions will depend on the exact nature of the services offered by the DFM and the adviser (who we assume to be a registered UK IFA). Suitability will need to be ensured between the parties, depending on the nature and extent of the services provided.’