The Financial Services Act received Royal Assent in November 1986 and came into force on April 29 1988. It is a long and complex piece of legislation extending to some 212 sections and 17 schedules. Because of its size and complexity, combined with the fact that it is introduced as “An Act to regulate the carrying on of investment business”, it is not entirely surprising that some general practitioners do not fully appreciate its significance. While it is tru to say that the Act is the concern, primarily, of those organisations and professions dealing specifically with “investment”, it does have important implications for anyone involved, even indirectly, in the provision of financial services. This will include the activities of many estate agents, more particularly following the entry of mortgage lenders and insurance companies into the residential side of the business.
The Act seeks to regulate the carrying-on of investment business as defined in section 1. It affects, among other things, the financing of residential property. A mortgage is not in itself an investment as defined in the Act, but a long-term insurance contract is. Thus anyone advising on an endowment or pension-linked mortgage falls within the regulations set out in the Act.
Investment business
No person may carry out investment business in the UK unless he is either an authorised person or is exempt. Investments are defined in the Act to include a wide range of rights, assets and interests, including shares and stock in the share capital of a company, debentures, Government, local authority and other public authority securities, unit trusts, futures and long-term insurance contracts.
It is the latter category which is significant for the estate agent. The definition of investment excludes contracts whose sole purpose is protection against risk, but mortgages linked to endowment policies, pensions, unit trusts or PEPs (Personal Equity Plans) will be included. The importance of complying with the Act is fairly clear. Operating without proper authority is a criminal offence and carries a maximum penalty of two years’ imprisonment.
Investment business is defined broadly in the Act so as to include dealing in investments, buying, selling, underwriting, offering investments, managing investments and advising on investments.
Authorisation
The framework of the Act is one of self-regulation and the body chosen for this purpose is the Securities and Investment Board (SIB), which is a private company whose members are appointed jointly by the Secretary of State for Trade and Industry and the Governor of the Bank of England. The board has extensive powers including the recognition of self-regulatory organisations (SROs), recognition, or withdrawal of recognition from professional bodies, the grant of authorisation to investment businesses, the making of rules regulating the conduct of investment business, investigation of those carrying out investment business and the prosecution of offenders. The SIB is funded by those subject to its regulations and fees to cover running costs are charged directly to authorised persons, SROs, recognised professional bodies and other authorised bodies.
SROs derive their status from the SIB but do not act directly as their agents. The majority of authorised persons obtain their authorisation through affiliation to one or other of these five bodies and these are as follows:
The Securities Association (TSA)
Association of Futures Brokers (AFBD)
Financial Intermediaries, Managers and Brokers Regulatory Association (FIMBRA)
Investment Management Regulatory Organisation (IMRO)
Life and Unit Trust Regulatory Organisation (LAUTRO)
These are intended to cover the whole range of activities for which businesses will require authorisation under the Act. Thus TSA covers firms dealing and broking in securities; AFBD, firms dealing and broking in futures and options; FIMBRA with the business of dealing and broking in securities and collective investment products, investment managers and advisers, insurance and unit trust intermediaries; IMRO with investment managers and advisers including managers of collective investment schemes and in-house pension fund managers, and finally LAUTRO covering those companies managing and selling insurance-linked investments.
The Act recognises that, in addition to the above bodies, certain professionals, accountants, solicitors and indeed surveyors, provide investment advice and services. Such professions are offered a different route to authorisation. Because investment business represents a relatively small proportion of their professional activity, regulation is built into the existing system of monitoring and disciplinary procedures already in existence through the main professional bodies. A professional body recognised by the SIB is able to issue a certificate to its members enabling them to carry out investment business without having to seek authorisation elsewhere.
The SIB identified 12 professional bodies as possible candidates for recognition including the Royal Institution of Chartered Surveyors. The RICS did not apply for recognition, with the result that their members wishing to carry on any type of investment business are obliged to register with the SIB or one of the SROs where appropriate. Authorisation then can be by membership of an SRO, certification by a recognised professional body or direct authorisation through the SIB.
Conduct of business
A firm applying to join an SRO must be able to meet a number of specific requirements and then comply with the rules of the organisation. Only then will they be entitled to undertake any type of investment business, although the rules of the particular SRO will be devised to prescribe the type of business which can be undertaken.
The SRO will need to be satisfied that the applicant is “fit and proper” and will require from the applicant detailed information about the applicant, their record, expertise and experience, including a business profile setting out the types of activity to be undertaken as well as the scale of that activity.
The Act gave the SIB the power to formulate practice rules for investment businesses and these have the force of law. While these apply specifically to directly authorised organisations, those authorised by way of SROs or professional bodies will, at the very least, be required to provide an equivalent level of protection. The purpose of these rules is to ensure that investment business is carried out honestly and fairly, that operators carry out their responsibilities capably, carefully and to the best of their abilities and that they should be fair to their customers.
Among other things, the rules establish a general “know your customer” principle. This requires the adviser to recommend transactions which are of a type and size appropriate to the customer and is especially important in the case of advice given to the “ordinary” investor, that is someone with little or no experience of such transactions. This will require a detailed investigation to establish, in the first instance, whether or not the customer is experienced and, in the case of the ordinary investor, an examination of relevant financial circumstances. This would almost certainly include tax status, assurance that the customer has the financial means to meet any liabilities which may arise from the proposed transaction and that the customer understands the risks involved.
Before advising on a particular investment, a firm or individual, acting as an agent, must be satisfied that the transaction in question is suitable for the customer, having regard to other investments available in the market and all other personal and financial circumstances. This is known as “best advice” and is intended to prevent recommendations which are made on the basis of the interests of the agent, the “pushing” of products, for example, on the basis that they produce higher commission payments. The conduct of business rules also provide for the disclosure of the basis of remuneration, and any material interests. Further rules deal with a variety of issues including independence, product bias, charging, personal visits, customer agreements and advertisements (hence the need for the now ubiquitous conspicuous warning of the risks and volatility of certain types of investment). There are also detailed ruled governing the financial resources required before entering particular areas of investment business.
All authorised firms must have a proper complaints procedure. A client who thinks he has not been given a fair deal has the opportunity to take the case to the organising body which has given the adviser an operating licence.
The Securities and Investments Board operates a compensation fund which will cover losses where a firm goes into liquidation, but only where the adviser is fully authorised. Compensation would not be available where losses arise as a result of normal market forces.
Polarisation
Organisations offering financial services are obliged to decide on what basis they intend to operate. These fall into two categories; appointed representatives and independent intermediaries. Appointed representatives are those offering the products of a single company or group of associated companies. Authorisation will be obtained through the company being represented and it will not therefore be necessary to seek authorisation independently, provided that no other financial services are being offered. Thus the company takes responsibility for the advice given.
Independent intermediaries are those whose advice is not limited to the products of a single company. These will be responsible for advising the client on the most appropriate products available in the market bearing in mind the client’s specific circumstances. Independents will have to be authorised on their own account by a self-regulating organisation.
Agents who refer clients to a separate authorised intermediary, who provides the advice and takes responsibility for it, become introducers and are not as such required to seek authorisation.
Polarisation means that anyone giving financial advice must make it clear on which basis they are operating, whether as independents offering a full range of products or representatives limited to the products of one company. Clearly an independent adviser will be better placed to shop around to find the best product in the market place to suit a particular client’s needs.
Estate agents
The Act gave a number of professions typically involved in financial services the option to obtain authorisation through their own professional body as a recognised professional body rather than an SRO. The RICS have not done so, and any members engaged in such business will therefore need to be authorised through an SRO, usually either FIMBRA or TSA. Estate agents owned by one of the insurance companies will generally only be able to act as an appointed representative and not as an independent. But, all financial advisers, whether tied or independent must conform to the basic rules of business conduct. The same will also apply to the majority of agencies owned by building societies since the majority of the big societies have opted to “tie” with insurance companies, limiting themselves to the sale of the products of that company.
Anyone involved in advising or arranging investment-linked mortgages will need to be authorised. This will require the surveyor or estate agent giving advice to a client to observe the rules of business conduct. They must make it clear whether they act as an appointed representative or an independent intermediary. They must be judged to be “fit and proper”, that they have sound financial resources and are of good character.
Clearly, the Act does nothing to prevent the operations of the unscrupulous but, if the customer is encouraged to establish that the adviser is authorised or licensed and to know whether they are talking to a tied or independent adviser, it should make it more difficult for the unprincipled operator to take advantage of the financially inexperienced investor. It would seem that there is evidence of certain areas of malpractice, agents for example “blackmailing” potential housebuyers into particular mortgage and insurance products before offers can be accepted. In general terms there is concern that the increasing involvement of the insurance companies in agency is not the best way to guarantee “best advice”. Some institutions are effectively circumventing aspects of the legislation by setting up their own “independent” financial advisers, putting them in a position to offer their agents as independents rather than appointed representatives. The debate will no doubt continue. What is clear, however, is that no practitioner involved in the mortgage business can afford to ignore the provisions of the Act.
