Managing my financial journey
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4.2.2 Selling to customers – suitability reports

The FCA lays down a series of requirements for the selling of products to customers in cases where the firm making the sale is recommending the product or where the firm is managing the investment themselves. The key aim is that due regard is taken to ensure that the product – and specifically the risk features associated with it – are suitable, given the needs and circumstances of the customer. Compliance with this requirement is through the completion of a ‘suitability report’ that is required for designated investment products.

In completing the suitability report, the firm needs to assess:

  • the customer’s knowledge of, and experience in, the investment product
  • the capacity the customer has to absorb the financial risks – i.e. the risk of losing money – that could arise through investing in the product
  • the nature of the customer’s investment objectives.

Firms are entitled to base their assessment of the suitability of the product on the basis of the information supplied by the customer, unless there is clear evidence that the information is incorrect, out of date or incomplete.

Once the information has been assessed, the firm can advise its customer on whether or not the product is suitable.

Where the product is deemed suitable, the firm should, in its suitability report, explain to the customer exactly why the product is appropriate – but should still set out the potential disadvantages of, and risks inherent in, the product. This suitability report must be sent to the customer ahead of the completion of the sale of the product.

Where the product is deemed not to be suitable for the customer, the firm must report this to the customer, thus warning them that investing in the product is inappropriate. The customer must also be advised when insufficient information is supplied by them for the completion of the suitability assessment. If, despite these warnings, the customer decides to go ahead with the investment, then it is at the discretion of the firm as to whether they go ahead and conduct the business.

There are some circumstances in which the assessment of the suitability of a product is not required. These circumstances relate to transactions in which the firm is merely executing the customers’ orders (i.e. the firm is neither advising on nor marketing the relevant product). Suitability analysis is also not required for transactions undertaken at the request of the customer in equities and a number of ‘vanilla’ (i.e. non-complex) securities. This is provided that there is information generally available about these investments to form a view of the risks involved. Investments in investment funds – including unit trusts – similarly do not require a suitability test to be completed.

The assessment of suitability provides a safeguard against retail customers ending up incurring financial losses on products that they do not really understand. Additionally, it provides an audit trail to protect firms from accusations of selling products to unwitting customers who were never warned of their inappropriateness to them as investments.

Firms also need to advise customers on their rights to cancel (and hence withdraw from) contracts. The objective here is to give customers a ‘cooling-off’ period, enabling them to reconsider the investments they have made following their initial commitment to them. These cooling-off periods are short – typically 14 days and no more than 30 days because, if they were any longer, the customer would in effect be given the flexibility to walk away from an investment that had moved adversely in value.

Firms must disclose the scope of the advice provided – meaning the range of the institutions whose products are compared by the firm, and from which the recommended products are selected. Additionally, the type of product must fall within the range that the firm sells in the course of its business. In respect of the disclosure of scope, the firm should be explicit about whether its product recommendations are based on the entire market for the product (independent and unrestricted) or a limited number of products or product providers (restricted) or whether only ‘simplified’ advice is given (see Week 2).

From 2013 the FSA prohibited financial advisers and sales staff from receiving commissions from firms whose products they are selling. The move is to help prevent customers being sold products by advisers and sales staff who may be motivated by commissions paid by the product providers. This move may, of course, mean that customers have to pay higher fees for the products sold by advisers and firms, who can no longer recoup earnings from the product providers.

The procedures for selling products are extensive and bureaucratic, but their intention is to provide a framework that minimises the risk of the mis-selling of financial products.

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