Failures in obtaining information and ensuring suitability

The FSA had inspected the investment service providers’ conduct in their marketing of investment products to persons over 70 years of age. The FSA found several instances of non-compliance with the current MiFID 1 rules, mainly concerning failure to verify the suitability of the investment advice to the client and to obtain and document information on the clients’ economic situation, investment experience, knowledge and objectives. The FSA placed particular emphasis on the marketing of structured products and found, for example, that structured products with maturity of six years had been sold without documenting the clients’ investment horizon. Also, structured products without capital protection had been sold to persons with low risk tolerance.

Conflict of Interest

One of the investment service providers had utilized a computer-based model portfolio in giving investment recommendations to clients. Based on information concerning the client, the system provided a recommended diversification of investments and a corresponding product recommendation. The computer system produced virtually always a recommendation to sell all current investments and invest the proceeds to products offered by the investment service provider in question. This computer system was considered to have created a clear conflict of interest that had not been identified and therefore reasonable measures to prevent such conflict of interest had not been undertaken.

Thinking ahead under MiFID 2

Under MiFID 1 as well as MiFID 2, which will become effective as of the beginning of 2018, investment firms are required to ensure that the recommended products are suitable and appropriate to their clients. MiFID 2 will bring about enhanced obligations in this respect. As part of the suitability assessment, investment firms will be required to obtain information on the client’s ability to bear losses and the client’s risk tolerance. There will also be new requirements to provide the clients with a statement on suitability and to maintain records of the appropriateness assessment including any warnings given to the client. Under MiFID 2, disclosure of potential conflicts of interest to clients – as opposed to taking steps to prevent or manage them – will be a measure of last resort.

D&I Key Insight

It is to be expected that investment firms’ compliance with investor protection rules continue to be scrutinized.  As part of their MiFID 2 preparations, we recommend that firms review not only procedures for obtaining client information but also any elements in their operating model which may favour products of the same group. In case any such potential conflicts of interest are identified, firms should ensure that they are properly addressed and included in the firm’s conflict of interest policy.