FSA bans referral payments from discretionary fund managers to advisers

The City regulator has proposed (174-page / 1.30MB PDF) new rules that would ban such a payment arrangement for referrals from advisers to the fund managers from 31 December 2012. The FSA previously set out rules banning advisers from receiving commission from fund managers for recommending their services as part of its Retail Distribution Review (RDR).

"Adviser firms should not be remunerated by, or receive commissions, remuneration or benefit of any kind from discretionary investment managers (DIMs) for referrals to the DIM, or for any other activity the adviser firm may perform for a client in relation to their investments being managed on a discretionary basis," the FSA said in its consultation paper. "The prohibition would apply only where the adviser firm has also provided that retail client with a personal recommendation in relation to a retail investment product."

"The recommendation to the DIM does not of itself need to be a personal recommendation in relation to a retail investment product to be caught by this new rule," it added.

Under the FSA's proposed new rules, advisers would generally be banned from being paid for "managing a relationship" with DIMs by acting as an "agent" for clients dealing with DIMs or by passing "material to the DIM on the client's financial situation and/or investment preferences". In addition advisers would be banned from being paid for passing on material from DIMs to their clients, monitoring their client's investment performance with DIMs or re-evaluating whether the use of a DIM is in a client's best interests, the regulator said.

"We propose to make it clear in the new rule ... that any service provided to a retail client by an adviser firm in relation to the investment managed by a DIM will be a ‘related service’ and therefore, in scope of the adviser charging rules," it said.

The FSA said that adviser firms could "receive additional remuneration" for forging links between investors and DIMs providing that the payment arrangements have been "set out upfront" and agreed on, and paid for initially, by investors.

Under the proposed new rules advisers can recommend a particular DIM to their clients "based on a thorough consideration of their investment needs and objectives" and receive payment for doing so, provided they "never provide a personal recommendation to that retail client in relation to a retail investment product". However, the FSA said that advisers still have to comply with separate rules that require firms to act in clients' best interests and those governing 'inducements'.

"In order to comply with the inducement rules, both the DIM and the adviser firm would need to ensure that they meet certain tests before paying or accepting such payments," the FSA said. "This includes being able to demonstrate that the payment does not impair compliance with the firm’s duty to act in the best interests of the client and, where relevant, is designed to enhance the quality of the service to the client and is clearly disclosed."

The FSA said that advisers and DIMs that arrange referral payments prior to 31 December can continue those arrangements after that date.

"As with trail commission, our preference is that adviser firms receive no additional remuneration post-RDR for recommending that a client invests more money through their DIM-managed portfolio," it said. "The adviser firm could continue to be paid by the DIM for the investment amount resulting from a pre-RDR referral."

Under the FSA's RDR financial advisers can only be remunerated through charges they levy to their client investors for the advice and related service they provide on investments. The charges must be agreed on by the clients prior to the provision of that advice or service. The rules were created among a package of measures outlined by the FSA in a bid to increase transparency around the charging regime in the retail investment market and also to eliminate 'bias', where advisers select products or particular providers based on the payments they receive for doing so.

For similar reasons the FSA has banned other payment arrangements too, such as those that involve platforms receiving payments from product providers for promoting certain products to investors or their advisers. In addition, product providers and fund managers are banned from paying cash rebates to investors' platform accounts after the FSA identified problems with the dynamic of such arrangements in how those sums are often used to pay adviser charges.

The Association of Independent Financial Advisers (AIFA) recently warned that banning cash rebates would serve to increase "cost burdens" for investors. The UK's Investment Management Association (IMA) has also criticised the FSA's plans to ban commission payments, claiming that it would affect the UK's "competitiveness" and be "open to legal challenge" for non-compliance with EU rules.