Secondary

Due Diligence Obligations

The “why” of this requirement is clear to all, but the “what”, “how” and “when” remains one of the biggest grey areas for FSPs.

If you place your client’s business with a leading product provider, it seems ludicrous that you, and each of the hundreds of other advisors who also place business there, should be required to study their financial statements, conduct research into the experience and suitability of their top management, their investment teams, and claims departments etcetera.

The Reasonable Man Test

It seems logical to apply this test when considering where to place a client’s business.
While no guarantees are contained in the size or history of a product provider (Saambou and African Bank come to mind here), cognisance of the standing of leading service providers in the community must play at least some part in assuring advisors and their clients of the trustworthiness of the institution they are dealing with.

At the other end of the scale there are lesser known providers, often with schemes offering exceptional returns and above average fees for advisors. Where does one draw the line?

The best source of reference on the practical application of the due diligence requirements can probably be found in various determinations by the FAIS Ombud.

If you require a blueprint (no pun intended), on what should not be done, take time to read the Gerber Determination by the Ombud on an investment in a Bluezone Property Investments (Pty) Ltd venture which went belly up – pages 20 to 27 deals specifically with due diligence, or rather, the lack thereof.

Concerning a determination made against an advisor who placed funds in the Relative Value Arbitrage Fund (RVAF), the following information is contained in a complaint which stipulates what the client expected from his advisor:

‘As a professional adviser he should have properly investigated and assured himself of the credibility of the Relevant Value Arbitrage Fund amongst others, the following:

  1. Registration of the late Mr Pretorius with the FSB
  2. That the fund had 3rd party verification of funds invested
  3. That the fund prepared financial statements
  4. That the financial statements were audited
  5. That there were appropriate checks and balances that applied to credible investments.’

There is also a school of thought who feels that the Regulator is by far the best equipped and empowered to ensure that products will deliver what they promise. In the case of the RVAF mentioned above, a team from the FSB were unable to find anything untoward during their first visit, and it was only during a follow-up investigation that things appeared to come to a head, with two people dying tragically, and many millions of investor funds lost.

Prosecution of rogue product providers appears to be an extremely long process, and in some instances, the fines meted out will certainly not act as a deterrent to others.

Know your Products

The examples quoted above make it very clear that you have an obligation to go beyond what is contained in marketing material to ensure that the product you recommend is in fact that which will address the needs of your client best.

If you do not understand exactly how a product works, how can you recommend it to a client?

The question that also needs to be asked is: what is the product provider’s obligation in this regard?

The requirement to, at all times, “…render financial services honestly, fairly, with due skill, care and diligence, and in the interests of clients and the integrity of the financial services industry” does most certainly not only apply to financial advisors.

Treating Customers Fairly

The implementation of TCF adds an outcomes-based element to the requirement to ensure product suitability.

By way of example: do you advise a client to opt for a specific retirement annuity option, based on the fact that it pays higher commission, or one with lower costs which is likely to provide better returns for the client?

There are various schools of thought on this issue, but the final determinant should be the welfare of the client, and not that of the advisor or the product provider.

What are the obligations of a product provider under TCF? If you have two similar products, and one generates more income for the provider, possibly at the expense of the client, should the product house continue offering that product?

Who is responsible for Due Diligence?

From the above it is abundantly clear that every role player is obliged to ensure fair outcomes for clients. Thus far, it was mostly advisors who were penalised by the FAIS Ombud.

The tragic truth is that only clients who laid complaints received justice, while thousands of others did not.

And worst of all, the producers of dubious schemes use protracted legal means as a “stay-out-of-jail” card.

Prevention is, indeed, better than cure.

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