Agent as client – a risky operating model?

Over the past few years, we have seen a continuing increase in advisers’ use of Discretionary Investment Managers (DIMs) for client portfolios. A significant number of the relationships between DIMs and adviser firms are based on the ‘Agent as Client’ (AAC) operating model whereby the DIM considers the adviser to be the client.

The FCA’s Conduct of Business rules (COBS 2.4.3) allow for this model, if the Adviser is acting in a genuine agency capacity and has been appointed by the client accordingly.

However, this operating model carries a number of risks:

Unsuitable investments
There are investment vehicles that can be promoted to professional clients, but which are not permitted to be used for retail clients. Under the AAC model, the Adviser may be considered to be a per se ‘professional client’. This may result in the DIM including high risk and/or illiquid investments within the discretionary service that are incompatible with retail clients. Accordingly, the adviser firm has a duty of care to the end client to have appropriate controls and oversight in place, along with the capacity and expertise, to ensure that the discretionary service is, and continues to be, compatible with the actual investor/end client.

Authority to act as agent
It is the Adviser, as agent for the underlying client, that is giving the DIM authority to act. This is fine where the adviser’s agreements with the end investor/end client have the necessary agency authority. Many adviser firms do not have wording in their client agreements/terms of business that authorises them to act as agent for the client.

Lack of clarity on where responsibilities lie
The investor, i.e. the adviser firm’s client, does not have a contractual relationship with the DIM.


Potential liabilities of the AAC operating model

  • The AAC model can expose firms to complaints and claims if the portfolio does not perform as expected – especially if there are investments that are unsuitable for retail clients;
  • An additional difficulty arises from the end investor not being the client of the DIM in that the investor might not be considered an eligible complainant;
  • It is also possible that the adviser firm may struggle to discharge its responsibilities under this model – overseeing the changes that occur in the portfolios to ensure that the holdings are suitable for retail clients could be a significant piece of work.

The possibility of liabilities that could arise out of the AAC model might come as unwelcome news to adviser firms. But it is possible that these could also be a surprise to PI Providers in the event of claims arising.

As a minimum, firms should identify the nature of any agreements they have with DIMs and, if AAC applies, should work closely with their PI Provider to make sure that cover is in place for such circumstances. (See here for a PI Broker’s perspective.)

 

An alternative model – ‘reliance on others’
The ‘reliance on others’ rule (COBS 2.4.4) is an alternative operating model where the advisory firm arranges for the client to have a direct (contractual) relationship with the DIM.

Under this model, the DIM relies on the client information provided, and the suitability assessment being done, by the adviser, with the adviser being responsible for any liabilities arising from those aspects.

Responsibility and liability for the suitability of the portfolio construction, both initial and ongoing, lies with the DIM for a bespoke discretionary service.

Where there are pre-defined model portfolios, it is up to the adviser to select the suitable portfolio from the range of pre-defined strategies. The suitability of the transactions in that portfolio remains the responsibility of the DIM.

Potential liabilities – reliance on others
This model helps adviser firms to de-risk their businesses. However, it is possible that the DIM could struggle to discharge its duties to the individual investor in terms of ensuring a suitable portfolio and transactions – especially bearing in mind that it is likely that the adviser will hold all suitability information. Regardless of whether the roles and responsibilities are clearly articulated to the client, it’s a difficult conversation to have with an end investor / end client in the event of a complaint (i.e. it’s not my fault – its theirs!).

Equally, under this model the DIM could face the risk of ‘bulk complaint’ from all the adviser’s clients if issues arise.


Ongoing review
There is an obligation, both initially and ongoing, to assess the suitability of a discretionary service for the end investor / end client. This suitability assessment should happen at least annually.

This means that clients cannot enter a discretionary service without a suitability assessment being undertaken. Equally, either the DIM, or the adviser, must assess ongoing suitability. It should be made clear in the terms of business with the client, and in the adviser / DIM agreement, where the responsibilities and liabilities lie between the adviser and the DIM for assessments of suitability and for other aspects.

Where the DIM undertakes the ongoing suitability assessment, advisers should consider the value that their own ongoing service is adding to the client, where one is offered.

Where the DIM doesn’t provide the ongoing assessment, then the adviser must. Clients should be made aware of the need / importance of engaging with the ongoing suitability assessment. Continued lack of engagement could result in one of several outcomes, including the discretionary element of the service being stopped by the DIM for the client, and the need for the adviser to consider whether continuing to take an ongoing adviser charge is justified.


DIM and independence
COBS 6.2B, which requires firms to disclose their regulatory status as independent or otherwise, only applies to investment advice on Retail Investment Products & Financial Instruments. DIM is a service and so, strictly, a referral to a DIM is not subject to COBS 6.2B. That said, the now retired FSA guidance paper (Final Guidance – June 2012 ‘Independent and restricted advice’) made clear that, if a discretionary service is ‘predictable’, including model portfolios, then it would be considered investment advice, as the adviser is effectively recommending particular funds offered by the DIM.

The Independence paper also indicated that although a referral to a DIM does not need to be based on “… comprehensive or fair analysis of the market …” (MiFID II updated this definition to “… a sufficient range that is sufficiently diverse …”), firms still have an obligation to undertake adequate due diligence.

“However, the firm should undertake sufficient due diligence on a DIM before recommending it to a client, so that it can make a judgment about whether it is the right solution for the client.”

As mentioned above, the independence guide has been retired, following a number of updates to the definition of advice and the definition of independence. However, none of these updates appear to include anything which brings a recommendation of using a DIM into the Investment Advice definition (unless ‘predictable’). Therefore, in the absence of updated guidance from FCA, ATEB believes that the guidance provided in the Independence paper holds good.

Important Note: ATEB news is intended to provide general information ONLY. The content, including any views expressed or guidance provided, does not replace the need to comply fully with FCA Rules and Guidance. Unless you have discussed news article content with ATEB, and specifically how it relates to your circumstances, then ATEB disclaims all liability and responsibility and actions arising from any reliance placed upon it. For the avoidance of doubt therefore, any reliance you place on such information without our consultation is at your own risk.

ATEB Compliance offers compliance and regulatory advice.

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Our View

DIM solutions are widely used by adviser firms. Yet we believe that the risks highlighted here are not widely understood.

Attention to these aspects when next reviewing the firm’s investment process would be prudent.

Action Required By You

  • Check all DIM / intermediary agreements that are in place to identify any that are on the ‘Agent as Client’ basis;
  • If AAC applies and the firm is not comfortable with the risks and issues we have highlighted here, the DIM should be asked to amend the agreement and to treat the underlying investor as their client;
  • Check client agreements – many do not go as far as giving firms the ability to commit and bind the client to a discretionary management agreement on an AAC basis.

If you retain the agent as client operating model – ensure that:

  • Appropriate systems and controls are in place, along with capacity and expertise, to be able to monitor any risks for the investor;
  • Your PI Insurance covers this arrangement
  • Ask the DFM to reclassify you as a ‘retail client’, so placing an appropriate restriction on the DIM’s use of investments that are not compatible with retail clients.

The PFS guide on this subject is worth reading. An updated version with some additional information was published in July 2019 and can be accessed here.

Otherwise, contact your usual ATEB Consultant or contact ATEB directly.

About the Author

Technical Manager - Often referred to as the Oracle or the Sage, Alistair has a wealth of financial services experience. He is our go-to Technical Manager and enjoys nothing more than a complicated conundrum. Feel free to test his renowned knowledge by getting in touch.

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