Distributor influenced funds: A compliance lowdown

DIFs have been nudged back under the regulatory spotlight following a new conflict-of-interest warning last week, so what should advisers be looking out for?

There seemed little obvious reason for trade body TISA to commission a report into distributor influenced funds, but its findings, far from being ignored, have again raised serious issues around recommending the products.

The independent report called for some firms to modify their processes or adopt stronger controls in order to limit bias and conflict of interest issues arising from sale of the funds.

DIFs are funds typically structured as Open Ended Investment Companies (OEICs) where the distributor exerts a measure of control over the fund design and management.

The conflict of interest arises from the fact distributors – mainly adviser firms – generally have a direct financial interest in the DIF they are recommending.

TISA’s report follows concerns voiced by the regulator earlier this year in its retail conduct risk outlook, where it expressed misgivings not only over conflict of interest issues, but also over the complexity of charges.

The FSA said it can be difficult for consumers to decipher which part of the service they are being charged for – the advice or the product - whilst noting DIFs generally carry high charges.

It added an examination of files containing DIF recommendations revealed mixed results with too much advice showing “signs of unsuitability”.

The watchdog said it will continue to monitor the market and warned it may intervene if standards fail to improve.

But how can advisers who wish to keep DIFs as part of their fund universe ensure they do not fall foul of the rules? Professional Adviser asked compliance experts.

Open and honest

Being honest with clients about the ownership structure of DIFs is paramount.
That is according to Geoff Mills, director of Rayner Spencer Mills. “It is a question of being open and honest,” he said. “It’s a question of explaining to the client that this structure has been put in place and you have a financial interest in it.”

Dale Thornley, compliance officer at PK Financial, agreed that transparency is vital. But he said it would be safer for advisers to steer clear of DIFs altogether.

“In my view the risks outweighs the benefits. [These products] are under the scrutiny of the FSA, which has said some pretty scathing comments about them in the past.”

Incentivisation

Charles Meade-King, director of IFAct Services, said he believed principals and supervisers at advisory businesses needed to be particularly careful not to incentivise advisers to sell DIFs.

“You need to be very careful about the incentives you provide and the management lead you give to your advisers. Otherwise you will end up with inappropriate funds being sold unsuitably to the wrong people.”

Mills said advisers ultimately need to think about why they are recommending DIFs in the first place.

“If they are creating a DIF purely to get in on the manufacturing margin without regard to the consumer, then I think the regulator is right to say that it is not delivering the outcomes they are expecting.”

Regulation

While there is a general feeling that conflict of interest issues can be managed within the current regulatory framework, experts said the FSA could do more by way of clarifying its rules.

“I think where the FSA can add value is with good and poor practice examples, which it has produced in other areas of advice,” Mills said. “From our discussions with advisers, they find real value in those practical examples.”

Thornley added that the regulator needed to pinpoint its concerns to help advisers stay on the right side of the rules.

“The FSA should be more direct with firms and say we have issues with this because of X,Y and Z, rather than people reading about the regulator’s concerns in the press.”