As the UK regulator puts wealth management - such as client suitability - under its gaze, lawyers warn about the dangers of creeping paternalism and conflicts with principles of freedom of contract.

This publication is re-issuing some of the best features/interviews of 2013. 

Britain has a new regulator and judging by recent statements, the Financial Conduct Authority – which oversees wealth management – is taking a tough line on issues such as ensuring clients are sold products that the watchdog deems “suitable”. However, there is a risk of its vigilance turning into paternalism and putting it at odds with principles about sanctity of contract, a law firm argues.

The FCA – which took over from the old Financial Services Authority in April when the FSA’s regulatory functions were split (bank supervision is now under the Bank of England) – has been busy in ensuring that regulations such as the Retail Distribution are enforced. And with memories still fresh of the financial crisis, the watchdog is also clamping down on products and services it thinks just don’t make sense for the broad mass of the UK public to buy. The FCA is also looking at the wealth management industry as a whole to find potential dragons to slay.

Which is all well and good, but this raises other, not always intended issues, lawyers Laurence Lieberman and Jonathan Rogers at Taylor Wessing told WealthBriefing in a recent interview.

For example, the FCA is very focused on “best interests”, stating that a firm must always invest/advise in the best interests of a client, Lieberman explained when discussing the philosophy of the regulator. A problem with the FCA requiring firms to think always about the best interests of clients could, in some circumstances, lead to a sort of financial “nanny state”, he said.

“Also, whatever happened to the sanctity of contract?” he said. Lieberman said his banking clients are not always certain that their clearly written terms of business will be enforceable if the regulator decides they are not in the best interests of customers.

This position of the regulator, he said, can be contrasted with the courts' approach of interpreting clear contractual clauses with customers, which is different from just taking the customer's side regardless. For example, courts have said that certain clauses in their terms of business are not in fact exclusion of liability clauses (and so potentially subject to reasonableness) but are in fact non-reliance clauses - in other words, that the customer cannot rely on the advice being given, and so cannot later complain, Lieberman continued.

Lieberman specialises in investigating and resolving financial services disputes and regulatory investigations – of which there have been many, although the shape and nature of his work has changed since 2008. “Up until a couple of years ago, the sort of work I was doing was more on the civil litigation side dealing with breach of contract and negligence cases,” he said.

Now there is more of a focus on regulatory intervention, he said. Client lawsuits have declined in frequency as the regulators have taken a more aggressive stance, filling some of the space once occupied by lawsuits by providing a remedy to customers that may have been mis-sold.  The proactive approach of regulators such as the FCA has given customers more information and tools to seek redress from their bank, he said.

Lieberman’s client base is wide. He acts for domestic and international retail banks, private banks and investment banks and a wide range of other financial services organisations. His practice includes disputes relating to structured products, spread betting and contracts for difference, debt securities and bondholder disputes, derivatives, trade finance, investment funds, claims by banks against their professional advisers and complex financial frauds.

And he brings varied experience to the role. As described in his biography on the firm’s website, Lieberman spent nine months on secondment to a “global wealth manager” managing its European litigation portfolio, since when he has specialised in "mis-selling" issues, particularly negligence claims brought by wealthy private customers against their private bank or wealth manager, or advising institutional clients on supervision and enforcement by the FSA (now FCA) in this area.

Meanwhile, Rogers is a partner in the Financial Institutions and Markets group in the London office and he specialises in financial services regulation advising insurance companies, investment banks, wealth managers, funds and other FS sector institutions on the full range of FSA regulation. A typical issue will be authorisation and perimeter issues, advising firms over the regulator’s exercise of its supervisory powers, prudential matters, implementing conduct of business rules, market conduct issues and matters coming out of the European Union. On the latter point, for example, he’s involved in helping clients understand the Alternative Investment Fund Managers Directive (AIFMD), which took effect on 22 July.

“We certainly now see firms trying to rationalise the RDR,” Rogers said, explaining how businesses that had been preparing for the changes have subsequently been trying to justify and deal with the aftermath.  “A number of firms indicated that their business models were aligned with the objectives of the RDR anyway.”

In the run-up to the RDR, there was a lot of commentary from industry figures, in some cases based on  media and other reports, about how the division between “independent” advice and “restricted” advice would lead to very different business models and outcomes. In practice, the significance of this difference had been exaggerated, he said.

Europe's AIFMD.

"There is a real concern about the weight of the rules and the likelihood that they will prove disproportionate to the operations of a large number of the funds in the market. Outside of the larger fund houses, most market participants have not yet got into the detail of what the rules will mean for them and are not prepared for the weight of the rules; most alternative investment funds operate off a comparatively small platform," Rogers continued. 

He is concerned that the AIFMD will for many classes of funds prove too great an administrative burden when compared to the degree of benefit actually secured for the (non-retail) investors. In some cases such as the venture capital sector the new rules could act as a barrier to new entrants and so stifle competition. “A point that has been made since AIFMD was first envisaged is that it is difficult to see how some classes of funds that fall within its scope, such as VC or private equity funds, contribute to the sort of systemic issues that many of the AIFMD requirements are seeking to mitigate," he said.

Rogers weighed in on the approach of the FCA: “The FCA has made it clear that it does not think that unregulated schemes should be sold to normal retail consumers at all. The number of exemptions to this rule of thumb is to be reduced and even where an exemption does still exist, firms will be expected to be able to show that they acted in the customer's best interest when applying that exemption to them."

Exchange traded products are an interesting area, he said. Typically, the regulatory narrative starts with commentary from the regulator on a market issue, a thematic review, further regulator direction or rule adjustment followed by instances of enforcement action. It could be said that the FSA's Q2 2012 ETF Fact Sheet for advisors started this narrative with respect to ETFs and it remains to be seen how the FCA will finish it. There have been concerns about the robustness of “synthetic” ETPs due to counter-party risks and whether advisers and their clients fully understand these risks, he said.

Rulings

Lieberman said some recent high-profile court rulings have highlighted that dissatisfied clients of a bank or other organisation don’t necessarily get the upper hand, especially in the tricky issue of the difference between advising a client, and informing a client.

A recent case surrounds interest rate swaps alleged mis-selling illustrates the issue – that of Rowley and Green vs Royal Bank of Scotland. (Last December, a judge ruled in favour of RBS; the case went to appeal but the ruling was not overturned.)

Lieberman also pointed to the case of where an institution was defended against clients in a alleged mis-selling suit - JP Morgan vs Springwell. The court found for the bank. In that case, the client was highly sophisticated and the courts have much less sympathy for those sorts of clients even if they have lost a lot of money. The issue of the term “sophisticated” is important as typically a “sophisticated investor” gets less regulatory protection than non-sophisticated clients.

That word comes up a lot in deciding levels of investor protection. Lieberman defines it thus: “For my purposes, `sophisticated’ is a term for someone who is immersed in the financial markets for a period of time and who understands the particular products and services being offered and who has a track record of investing in those or similar products.”

The recent surge in regulation in the UK, Europe, US and elsewhere is likely to keep these gentlemen and their colleagues very busy for some time to come.