Please click here to see the FSA announcement.
The review followed agreement by FSA and the Financial Ombudsman Service (“FOS”) to refer the issue of the mounting number of complaints relating to Lehman-backed products to the Wider Implications Procedure, which allows FSA to take wider actions to benefit investors as a whole (FOS only being able to deal with complaints on an individual basis), including regulatory action against firms and the publication of guidance for firms and investors alike.
Scope of the review
The review focussed on the design, marketing, distribution and advice provided in relation to these products and considered whether firms had properly understood, monitored and disclosed the risks associated with structured products, including, in particular, the risk to capital and the credit risk, whether adviser firms had properly assessed the suitability of such products for individual investors, and the systems and controls in place within firms to manage and monitor these practices and deal with the potential risks arising out of them.
Actions by the FSA
FSA found deficiencies both in relation to the marketing and selling of the structured products that it reviewed, as well as failings in firms’ systems and controls and understanding of the products themselves. It has said that it is taking action to remedy the detriment already suffered by consumers, to ensure that in future investors are treated fairly, and to address issues in the wider structured products market. In particular FSA has said that:
Enforcement – FSA is referring three advice firms to Enforcement which have provided unsuitable advice and requiring others (both those who sold Lehman-backed and other structured products) to review past practice and pay redress where appropriate;
Complaints – It is providing firms that gave advice in relation to Lehman-backed structured products with templates to use when dealing with customer complaints;
Guidance – FSA is also providing guidance to all firms providing advice on structured products on its expected standards, including examples of good and bad practice;
Firms in administration – The administrators will write to investors holding Lehman-backed structured products in relation to compensation they may be entitled to from the Financial Services Compensation Scheme (“FSCS”) and FSA will write to, and publish guidance for, all remaining investors of these firms in relation to the steps they may be able to take, including making complaints, if they consider they were misled by product literature or received unsuitable advice; and
Wider structured products market – In addition to requiring past sales reviews, FSA will undertake follow up assessments to ensure its advice and marketing literature standards are being met.
Particular areas of FSA focus
FSA’s guidance on expected standards focuses on three key areas of concern:
Designing – including undertaking due diligence in relation to counterparties, stress testing products, and identifying and assessing key product risks both at the product design stage and throughout the term of the investment, taking contingency action when necessary, and ensuring that effective systems and controls are in place in order to monitor and manage the potential risks;
Marketing – including clarity as to where investors’ money is invested, clearly explaining the counterparty risk, and prominently stating the risk to capital (if this applies); and
Advising – including consideration of customers’ emergency funds, existing liabilities, timescale for investment and implications of fixed-term or early maturity products.
This is clearly an important issue for firms involved in the manufacturing and/or distribution of structured products, both in the past and going forward. Such firms should be aware of, and appropriately prepare for, the likelihood of increasing numbers of investor complaints both to firms and to FOS, enquires from FSA both in relation to past practice and the design and launch of new products, and possible action by investors (and possibly the FSCS in the future) via the Courts.
In relation to potential investor complaints and claims at least, there is no need for the majority of firms to be overly alarmed as investors in Lehman-backed products will still need to prove that they have actually been misled or misadvised in order to be eligible for compensation and the reality is that only a minority of firms will have been engaged in such practices (notably those firms which have already been put into administration as a consequence of the high numbers of complaints against them).
However the issue is clearly high on FSA’s agenda and part of its new “get tough” approach in light of the financial crisis and the need to restore retail investor confidence in the financial sector. In this respect the key to responding to FSA enquiries will be an ability to demonstrate robust selling and marketing practices and effective systems and controls for products already launched and ensuring compliance with FSA’s guidance for new products going forward.
We have extensive experience in assisting firms in relation to product design, FSA reviews and investigations, FOS and other proceedings, particularly in relation to structured products, and would be happy to discuss with you, and assist you in relation to, any of these areas.