Further enforcement action by UK FCA in relation to suitability issues in wealth management

The UK's Financial Conduct Authority (FCA) has imposed a £1,802,200 fine on AXA Wealth Services Ltd (AXA) for failing to ensure the investment advice given to its customers was suitable, and putting customers at risk of buying unsuitable products.  The case is interesting not just because it provides some elaboration on existing guidance on suitability, but also because the FCA examined the adequacy of controls over sales incentives to ensure that advisers did not make unsuitable recommendations or seek to sell unwanted products. 

Interestingly, the FCA highlights the fact that the investment funds underlying the products recommended to customers were predominantly managed by members of the AXA Group, although the FCA does not directly criticise the bancassurance model, nor is there any overt suggestion that potential conflicts of interest were not adequately managed (other than the inadequacy of controls over sales incentives).  The fine is however based on a percentage of AXA’s total revenue from sales of investment products during the relevant period.    

The context

Between September 2010 and April 2012, AXA sold approximately 37,000 investment products to 26,000 retail customers through AXA’s advisers based in the branches of Clydesdale Bank, Yorkshire Bank and the West Bromwich Building Society, with investments totalling £440 million in value  (no criticism or finding of regulatory failing is made against Yorkshire and Clydesdale Banks, or West Bromwich).  AXA’s customers tended to have low levels of investment experience and a majority were in or near retirement.  

The FSA has highlighted a number of deficiencies in processes for advising customers about investment products which it deemed serious, notably:

1.  Deficiencies in relation to establishing the risk a customer is willing and able to take

• Risk categories describing customers’ attitude to risk: AXA asked customers to indicate their attitude to investment risk by selecting from five categories [‘Very Cautious’, ‘Cautious Managed’, ‘Balanced Managed’, ‘Adventurous’ and ‘Very Adventurous’] which did not describe risk in clear terms.  There was no category for those unwilling to take investment risk, no fund available for investment in the lowest category, and a large potential increase in risk between the second and third categories. 
• Inadequate training and guidance for sales advisers on assessing customers’ attitude to investment risk: The need for sales advisers to confirm the risk category selected by customers, and to check (and record how they had checked) that customers understood the level of risk they would be taking, was not adequately highlighted.  Sales advisers were not trained resolving conflicts in customers’ answers to different questions about the level of risk they were prepared to accept, and were not cautioned against influencing customers’ answers to questions aimed at establishing their attitude to risk.
• Inadequate process for assessing customers’ capacity for loss: AXA did not to ensure that sales advisers adequately considered whether customers were able financially to bear the risks associated with the investment products recommended to them.  The FCA noted that this issue had been raised in its Guidance Consultation on Assessing Suitability of February 2011, but changes were not introduced until October that year.

2. Deficiencies in relation to gathering, and taking into account, information from customers

•  Template forms did not prompt the gathering/documenting of information necessary to establish suitability, including
  • customer’s knowledge and experience of investments, including the types of investments with which the customer was familiar
  • nature, volume and frequency of previous investments made by the customer and the length of time previous investments had been held
  • funds in which the customer was currently invested in or previous investments
  • potential vulnerability of the customer
  • the length of time for which the customer wished to hold the investment
• Guidance and training was inadequate, and failed to ensure that sales advisers gathered and took into account the necessary information
• Although mystery shopping exercises and an external consultant review highlighted issues, AXA was slow to respond with additional guidance to sales staff, who in turn failed to maintain complete sales files, which hampered assessment by the compliance monitoring function. 

3. Deficiencies in relation to customers’ investment objectives

• Processes failed to give a proper explanation of how information about customers’ investment objectives should be used to assess the suitability of particular investments for customers.  It was not clear whether this information had been gathered at all.

4. Deficiencies in process for advising on charges

• Guidance for sales advisers failed to prompt sales advisers to consider whether any charges incurred were sufficiently large to affect the suitability of the advice, or to consider the charges applicable to suitable alternative products and funds in AXA’s range.
• Although actively managed funds attracted higher charges, sales advisers were not required to identify client-specific reasons for recommending such funds, particularly for less experienced investors.

5. Inadequate explanations of investment recommendations in meetings with customers and suitability reports

• AXA did not ensure that customers were provided with adequate explanations as to why investment recommendations were considered to be suitable for them in view of their circumstances. 
• Standard wording in suitability reports with regard to the benefits and risks of the recommended investments needed to be more balanced
• Suitability reports did not contain adequate justifications for recommendations to customers to invest in particular products, particularly in respect of investment bonds recommended in preference to OEICs.
• Template suitability reports contained inadequate descriptions of the risks associated with recommended investment products, and unclear in describing customers' objectives.
• A statement in the template letter describing customers as wishing “…to have both the security of deposit type accounts and the potential for greater returns from collective investments” was potentially misleading, and inconsistent with a final paragraph stating that customers were not investing in a deposit account.

6. Ineffective controls over the incentives paid to sales advisers

• Controls over the incentives paid to sales advisers were not effective, and there was an unacceptable risk of sales advisers making inappropriate recommendations to customers in order to qualify for bonuses:
  • Sales advisers were entitled to earn fixed and variable bonuses based on their sales performance, and once targets were reached, the rate of bonus paid increased significantly. Without proper controls, these incentives gave rise to an unacceptable risk that sales advisers (particularly those who were close to a bonus threshold) would make unsuitable investment recommendations to customers or seek to sell products to customers who did not want them in order to receive a bonus.
  • Although low customer cancellation and upheld complaints rates, and minimum requirements in relation to the quality of sales files were required to qualify for a full bonus, the file quality standards set by AXA did not ensure that advisers did not make unsuitable recommendations or seek to sell unwanted products - advisers could still receive a full bonus even when a significant proportion (40%) of their reviewed files were considered to be unsuitable.
• Additional bonus incentives were introduced without an appropriate assessment of the risks resulting from these changes or consideration of whether additional controls should be introduced in view of the increased risks arising from the changes.

7. Inadequate compliance monitoring of sales

• Procedures for monitoring sales of investment products were inadequate, and compliance monitoring staff failed to identify promptly and investigate effectively potentially unsuitable sales.
• Compliance monitoring staff were required to review sales files against a guidance document given to sales advisers using a template check-list, which did not comprehensively cover all aspects of making suitable recommendations to customers, in particular information that should be gathered from customers and captured in sales files and suitability reports.
• Training and guidance for compliance monitoring staff failed to remedy these issues.
• Despite identifying issues in relation to a limited number of sales files and expressing a view that improvements were required, AXA’s compliance audit function failed to identify that compliance monitoring staff were failing, in a significant proportion of cases, to carry out appropriate reviews of sales files.
• Reviews conducted by an external consultant after January 2012 first identified the extent of the deficiencies in compliance monitoring of sales files: the external consultant disagreed with compliance monitoring staff assessments that the files were demonstrably suitable in 79% of the cases reviewed, on the basis that they did not identify:
  • failures by sales advisers to capture sufficient information in sales files (including suitability reports for customers) to justify their recommendations to customers
  • recommendations which appeared to be unsuitable based on the information recorded in the sales files
• AXA did not introduced a new compliance vetting template which facilitated holistic reviews of the suitability of recommendations to customers until May 2012

Regulatory contraventions: The FCA considered that these failings amounted to a breach of Principle 9 (Customers: relationships of trust) of the Principles for Businesses, and also breached:

• COBS 9.2.1R(2), COBS 9.2.2R and COBS 9.2.3R - failure to ensure sales advisers gathered all necessary information from customers
• COBS 9.2.1R(1) and COBS 9.2.2R - failure to take reasonable steps to ensure its investment recommendations were suitable for customers
• COBS 4.2.1R - failure to ensure that communications with customers were clear and fair (vague and unclear risk categories)
• COBS 9.4.7R - failure to ensure suitability reports were provided to customers which adequately specified their demands and needs, explained the conclusion that its recommendations were suitable and sufficiently explained possible disadvantages of the recommended investments.

Penalty: The FCA concluded that it was not practicable to quantify any financial benefit that AXA may have derived directly from the breaches, and considered that the total revenue generated by AXA during the relevant period in respect of its sales of investment products was indicative of the harm or potential harm caused by the breaches in this case.  Although the FCA noted that many of AXA’s shortcomings only came to light during a review by the FCA, the Final Notice also recognises that AXA took a number of steps to identify the failings in its sales process and compliance monitoring of sales and to address those failings both during and after the relevant period.  The FCA also noted that customer detriment resulting from these issues is difficult to assess, but may currently be low given movements in the stock market since the advice was given.  AXA qualified for a 30% discount, having agreed to settle at an early stage of the investigation. 

Remediation: AXA agreed to contact all customers who may have been affected by these suitability issues: customers who have suffered loss as a result will be fully compensated; those sold inappropriate products will have the opportunity to switch or withdraw their investment, in order to avoid potential losses during future stock market downturns.  A third party will oversee a review of any issues identified as a result of the customer contact exercise.