By Jonathan Howland, Compliance Officer/MLRO at Church House Investments
The FCA has just issued their findings of their 2015 thematic review about benefits provided and received by regulated firms. This focused upon the inducement rules and how firms are addressing the requirement that any payment or benefit is designed to enhance the quality of service to the client.
Twenty years ago, before RDR and MiFID, inducements were quite commonplace in the financial services industry. Arrangements with third-parties were often on a “quid pro quo” basis; investment houses would trade with certain brokers on the basis of reduced trading commissions and research; IFA referrals would be based on rebates to product charges; the use of some trading houses was rewarded with entertainment, such as sporting events, drink receptions, etc. Rebates and cuts in brokerage were rarely passed on to the client.
Following the last recession, the collapse of sizeable investment banks and high-street institutions saw a plethora of regulation, domestic and European, which looked to address issues within the industry that had led to so much failure. Greater disclosure and transparency led to improved clarification over what and who clients were paying for.
With an increased level of awareness by both the regulator and clients themselves, greater attention has been placed upon the treatment of “non-monetary” benefits, especially following the introduction of the Bribery Act 2010.
So when does entertainment become an inducement? What is acceptable as a non-monetary benefit under the FCA’s COBS 2.3? The rules seem to suggest that the assessment is upon whether the firm can demonstrate that any benefit provided or received does not prevent it from acting honestly, fairly and professionally, and that it can continue to act in the clients’ best interests. As they stated in their review, the FCA warns:
“When providing or receiving a non-monetary benefit we expect firms to consider and assess whether all aspects of the benefit are designed to enhance the quality of the service to the client including the location and nature of the venue, and those activities which are not conducive or required for business discussions, e.g. sporting and social events and activities.”
A “networking lunch”, for example, in which members of a variety of firms attend to discuss industry-wide topics, such as impending EU regulations or the impact of changes to the pension rules on clients, can be considered as a benefit that can enhance the quality of the service provided to clients. The shared knowledge and insight can provide a new approach to business or a greater understanding of the environment in which the client service is provided.
A “day at the races” is less clear. Meeting up with industry colleagues and clients at a race meeting, engaging in entertainment is less easy to demonstrate that the cost incurred equated to a business benefit. Was the race meet in any way related to the products or services offered by the firm? Did the racing enhance the quality of the services provided to the clients? The relationship with the clients who attended may well have improved, giving them an opportunity to meet with some fund managers and to meet socially with their portfolio manager. But would such an event be offered to all clients or just those that are considered worth the investment? This could fall into the “inducement” trap.
What about taking a client out for lunch? Does the lunch “enhance the quality of the service to the client”? This may depend on circumstances and the reason for the lunch. Generally, given that an investment manager is obliged to undertake regular reviews of their client portfolios to demonstrate ongoing suitability, amongst other things, such reviews are best conducted on a face-to-face basis and, on occasion, the investment manager may well elect to treat the client to a complimentary lunch.
Is this an inducement or bribery? Since the client is already established, has already invested and the lunch is not necessarily provided with a view to obtaining any additional business, it can be seen as merely an extension of the client relationship, helping to strengthen the bond between the client and the firm. . It forms part of the social element of a client relationship, which can often be as important as the investment itself.
Using a lunch with a client to promote a new product line is difficult to justify under the Bribery Act or COBS 2.3, and would likely fall into the inducement trap.
Client entertainment can be a tricky area and some opt to avoid the risk of falling foul of inducement rules by not providing any. Is this in the best interests of the client? There is no right or wrong answer, it is a business judgement but should always be about intention. What is the entertaining aiming to achieve? To strengthen a client relationship or promote a new product/service? The former is acceptable; the latter is generally not.
Please note that the comments and opinions in this article are of the author alone and do not reflect those of Church House Investments or Industry Events Online.