Poles apart

Previously, the financial services market was said to be polarised between those “independent” financial advisers (“IFAs”) who have a duty to consider every available product when making recommendations to their clients, and those who were confined to recommending the products of a single company, to which they were tied.

The Government and the FSA took the view that this dichotomy was failing to serve the interests of consumers. Enterprising tied sales organisations such as J Rothschild (now St James’ Place) had demonstrated that the tied sales proposition could be made more attractive by incorporating a small selection of investment fund options within a given product, and that clients would benefit from reduced dependence on the fortunes or skills of a single fund manager. Equally, the authorities were aware that most IFAs tended to favour a relatively small group of product providers and might be influenced in their decisions by the amount of commission each provider might be offering.

Who is the master?

Consequently, a different dichotomy was emerging – one which distinguishes between those financial advisers whose primary obligation is towards the companies whose products they sell, and those whose primary obligation is to the clients they advise, the well-established principle being that no man can serve two masters.

A key criterion in determining which side of the fence an adviser falls on is commission. Consequently, under the new regime, those who wish to retain the right to call themselves independent will be required, after a transitional period which expires in June 2006, to give their clients at the outset of a relationship a “menu” which spells out how they will be paid for their services.

There are two alternative types of menu: one which gives the client the option of paying a fee or permitting their adviser to retain commission in lieu, and the other which confines the adviser to a fee basis. The former proposition is a complicated one, in that it requires the adviser to compare his commission retention policy in each of nine different product categories with a “market average” retention figure provided by the FSA, based on its own research. This is likely to be over-complicated for many clients and irksome for the adviser, who will be deprived of the flexibility to take account of factors such as the size of a transaction before deciding how much commission might reasonably be retained.

The result is likely to be to encourage IFAs to opt for the fee-only menu, a decision which in fact is less dramatic than one might imagine because it can encompass commission-offset, a method which has long been favoured by many IFAs working within the professions.

A three tier profession

Add into the equation the fact that commissions on life and pensions products are declining rapidly, as a result of the commercial pressures on the providers, and it seems clear that the financial services market of the future will operate at three levels. At the ground floor, there will be plain vanilla products, offering insufficient margin for advice and sold off-the-page or through banks and building societies. At the next level there will be slightly more sophisticated products sold by multi-tied salespeople, often organised under the umbrella of financial adviser networks and remunerated by commission, the quantum of which will be the major influence in determining the selection of the companies with which the ties are effected.

At the top level there will be a diminished but reinvigorated group of independent financial advisers, operating on a predominantly fee basis and addressing what might be termed the professional client. This group is set to grow and it will concentrate on clients the value and complexity of whose affairs necessitate financial planning advice; clients who are accustomed to paying fees to professionals; and clients who in many cases will be in the burgeoning age group of 50 to 75, where myriad options are about to become available as a result of the 2006 pensions simplification proposals.

This re-categorisation is the way the FSA would have it, and clearly it has merit. The Authority is on record as seeking a retail financial services sector which consists of organisations which are large enough to pay its mis-selling fines. But what is striking is that the fines have related almost exclusively to mass-market products sold to clients with little understanding of what they have been buying, and with an instinctive inclination to complain when events do not turn out as expected. These are the clients who will continue to be served by the multi-ties, not by the professional IFA. The more sophisticated client will receive a more sophisticated service.

The ascent of the new breed of professional IFA will hasten the decline of the traditional stockbroker, whose propensity to recommend individual shares is inappropriate for most clients and whose portfolio skills do not bear comparison with those of the better fund managers. Their objective is to maximise funds under management, and for the most part they are uninterested in providing financial planning advice. Little wonder, then, that a recent report from Boston Consulting concluded that individual equity holdings represented only 9% of the typical investment portfolio for a higher-net worth client and that the weight of money was now going into collective investments.

Where solicitors come in

So where does this leave the legal practitioner? Brenda Gibson, Manager (Polarisation and Advice) at the FSA, commented in a recent video for Legal Network TV: “I think it makes a great deal of sense for solicitors to have a close working relationship with IFAs. They should, of course, make their own enquiries and make sure that they are happy with the calibre of people with whom they are dealing. But solicitors themselves probably will not want to become directly involved in regulated financial services business and will not want to risk overstepping the mark and finding that they have strayed into territory for which they are not authorised.”

The implicit message is that the FSA does not expect solicitors whom it does not currently authorise to become authorised. And it has to be acknowledged that for all the synergy between legal and financial services, the business models are different. Hence the growing tendency of professional firms to hive off their financial services departments into separate units managed by their financial advisers, thereby also removing uninvolved partners from the stony gaze of the FSA.

Hived-off units have the particular advantage that, while retaining their professional credentials, they are sufficiently detached from the influence of their parent firms to be able to offer a resource to which other firms can refer their clients without the risk of conflict of interests. Details of such units and of other solicitor financial advisers in Scotland are available via the contact page of the website of SIFA, the support group for solicitor financial advisers (www.sifa.co.uk); while details of firms with advanced specialist qualifications are available from the online directory of professional financial advisers at www.sifa-directory.info. The directory enables solicitors to identify appropriate advisers by reference to a number of criteria including business specialisation, qualifications, location and basis of charging.

Professional IFAs will be able to assist solicitors in marketing financial services to their clients. They will also be able to provide complimentary handbooks on subjects such as pensions and divorce, IHT planning, trust investment, and the action they need to take in relation to their own pensions before the new pensions regime comes into operation in April 2006.

One aspect of the solicitor/IFA relationship of which some firms are insufficiently aware is the FSA requirement to account to clients, in fee terms, for any remuneration they receive for making a referral. This means that firms must be seen to be sufficiently involved in the financial adviser’s advice process to justify rendering a fee bill. Typically this would be done by hosting an initial meeting between client and IFA; providing factfind and perhaps money laundering information; receiving and acknowledging a copy of the financial adviser’s report to the client; providing client money and custody services; and generally keeping a watching brief. Again, professional financial advisers are able to supply the complete paper trail.

The reasons for referring clients to IFAs are as compelling as they have ever been. Clients value the provision of an all-embracing service; while solicitors benefit from referral revenue and avoid the potentially costly accusation that they have failed to take account of all the extraneous financial and other factors which could impact on their legal advice.

Ian Muirhead is Director of Solicitors for Independent Financial Advice Ltd