10.5 Regulated Advice Standards and Due Diligence on Products

What Is Regulated Advice?

Under UK law, regulated advice is a personal recommendation given in the course of business by an authorised person. The legal basis sits in two linked provisions:

• Section 22 of the Financial Services and Markets Act 2000 (FSMA) — defines a regulated activity as one specified in the Regulated Activities Order.
• Article 53 of the Regulated Activities Order (RAO) — specifies 'advising on investments' as a regulated activity where the advice is given to a person in his capacity as an investor or potential investor, or in his capacity as agent for an investor.

A personal recommendation is a recommendation to enter into a specific transaction or to take a specific course of action. Generic information, guidance and explanation of product features are not, by themselves, regulated advice.

Giving regulated advice without the appropriate FCA permission is a criminal offence under section 19 FSMA, punishable by up to two years' imprisonment on indictment. It is also unenforceable — the client can recover any loss from the unauthorised adviser.

Advised vs Non-Advised

The distinction between advised and non-advised sales is critical:

A firm cannot avoid suitability duties simply by labelling a service execution-only where, in practice, the client has been guided or steered towards a product. The FCA looks at the substance of the interaction, not the label.

COBS 9 — Suitability

COBS 9 sets the suitability requirement for personal recommendations to retail clients. The core obligation is in COBS 9.2.1R — a firm must take reasonable steps to ensure that the recommendation is suitable for the client. To do this, the firm must:

1. Obtain necessary information about the client's knowledge and experience, financial situation, and investment objectives (COBS 9.3).
2. Assess suitability — the recommendation must be appropriate to the client's circumstances.
3. Provide a suitability report — a written statement of the recommendation, the basis on which it was made, and the disadvantages of the recommendation (COBS 9.4).

The suitability report must be tailored to the client — a generic boilerplate report is not sufficient. The adviser must explain, in language the client can understand, why the recommendation is suitable and what the disadvantages are.

Reasonable Basis Suitability

Reasonable basis suitability means the adviser has a reasonable basis for the recommendation based on the information gathered from the client. The test has three limbs:

• Suitability of the product type — is this kind of product appropriate for the client's needs and objectives?
• Suitability of the specific product — is this specific product, with these features and charges, appropriate?
• Suitability of the amount and risk — is the amount invested and the level of risk appropriate to the client's capacity for loss?

If any limb fails, the recommendation is not suitable.

COBS 9A — Pension Transfers and Conversions

COBS 9A imposes additional suitability rules for personal recommendations on pension transfers, conversions and opt-outs where the client has safeguarded benefits (for example, a final salary pension). Key features include:

• The firm must start from the assumption that a transfer or conversion will not be suitable.
• The firm must carry out an appropriate pension transfer analysis.
• The adviser must consider whether the client has sufficient knowledge and experience to understand the risks of giving up safeguarded benefits.
• A suitability report is mandatory and must include a one-page summary for transfers and conversions (other than where the only safeguarded benefit is a guaranteed annuity rate).

Abridged Advice

COBS 19.1A introduced abridged advice — a shorter, less costly initial suitability assessment that allows the adviser to determine whether a full transfer recommendation is likely to be suitable. If the abridged advice concludes that a transfer is unlikely to be suitable, no further work is needed. If it appears it may be suitable, the full process under COBS 9A must follow.

COBS 9B — Pension Conversion

COBS 9B applies to pension conversion — where a client converts pension benefits within the same scheme (for example, from a final salary promise to a money purchase arrangement). The rules mirror those for transfers and require a similar suitability assessment and report. The starting assumption is again that conversion is not suitable unless the adviser can demonstrate otherwise.

PROD 4 — Product Governance and Due Diligence

The Product Intervention and Governance Sourcebook (PROD) Chapter 4 imposes product governance duties on both manufacturers and distributors of insurance and investment products.

Manufacturer Responsibilities (PROD 4.2)

A manufacturer of a product must:

• Identify a target market of end clients whose needs the product is designed to meet.
• Ensure the product is distributed only to the target market.
• Review the product regularly and where it no longer meets the target market's needs, withdraw or modify it.
• Provide distributors with the information needed to assess compatibility.

Distributor Responsibilities (PROD 4.3)

A distributor must:

• Understand the financial instruments it distributes.
• Assess the compatibility of the product with the needs of the client, taking into account the manufacturer's identified target market.
• Distribute products only when in the best interests of the client.
• Have adequate product governance arrangements.

A distributor that recommends a product outside the manufacturer's target market must be able to justify that decision on the specific facts of the client's case.

Reasonable Basis, Target Market and Suitability

The interaction between PROD 4 and COBS 9 is important. PROD 4 ensures that products are designed and distributed to suitable client types; COBS 9 ensures that the specific recommendation to a specific client is suitable. The adviser is the bridge — they must select products within the manufacturer's target market and then apply the suitability test to the individual client.

Practical Example

A firm advises a 55-year-old retail client who is a member of a defined benefit pension scheme. The client asks whether to transfer to a personal pension. Under COBS 9A, the adviser must: (i) start from the assumption that a transfer is not suitable; (ii) carry out an appropriate pension transfer analysis; (iii) assess the client's knowledge and experience; (iv) issue a suitability report with a one-page summary; and (v) be able to demonstrate a reasonable basis for the recommendation. The firm must also consider PROD 4 — is the receiving product within the manufacturer's target market for a client of this profile? Failure on either limb can give rise to a suitability complaint and FOS referral.