INVESTORS have been warned to be on their guard against mis-selling as rogue advisers fill their boots with commission payments that are set to be outlawed next year.
The payment of commission on regulated investments will be banned from the beginning of 2013, under the regulator’s Retail Distribution Review (RDR).
The measure is aimed at eradicating “commission bias”, where advisers sell investment products based on the amount of commission they can earn on them rather than on the suitability to their client.
Many independent financial advisers (IFAs) have moved to a fee-based remuneration system to comply with the new rules, as well as adding qualifications in order to meet the greater standards requirements under RDR, which comes into force in January.
But anecdotal evidence suggests some bank advisers and IFA firms are maximising their commission revenues while they still can, putting investors at risk of hefty losses.
Fee-based Scottish financial planners and advisers have told Scotland on Sunday of a marked rise in the number of people turning to them for help after being sold unsuitable investments by advisers raking in tens of thousands of pounds in commission as a result.
“There may be a temptation for some advisers to have one last bite at the commission cherry and to take as big a mouthful as possible by recommending products that typically pay high commission levels,” according to Ken Welsh, managing director at VWM Wealth Management in Glasgow.
“In the run-up to RDR, almost any product might end up being high commission in a last-ditch effort to attract business by this method.”
The culprits – a very small but unscrupulous minority – will be among the 18 per cent of IFAs that the Financial Services Authority (FSA) expects to leave the industry after 2012.
Paul Lothian, director at Verus Chartered Financial Planners in Dundee, said: “Despite FSA warnings that they will be closely monitoring sales activity in the run-up to RDR, there is strong anecdotal evidence of advisory firms ‘making hay while the sun shines’.”
Whether that is through churning policies, such as shifting your pension, or selling investment bonds and structured products, it is often to the individual’s long-term cost.
The products most likely to be sold aggressively by commission-chasers are those designed to last a long time, where fees can be disguised and performance is rarely monitored on a regular basis.
“A good example is structured products, which typically link returns to the performance of an underlying index and lock clients in for periods of around five years, which will ensure the adviser receives a commission over this period if it is not received all upfront,” said Welsh.
Single-premium life insurance bonds are another candidate for the most likely product to be sold on the basis of commission rather than suitability.
Tom Munro, owner of Tom Munro Financial Solutions in Larbert, believes sales of these bonds, which he views as “smoke and mirrors” plans, will plunge next year.
“These are seldom the most tax-efficient option but they pay up to 8 per cent initial commission through product providers who are buying last-minute business prior to RDR, after which the ability to secure business in this way disappears for good,” he said.
People sold into single-premium bonds can see up to half their investment returns wiped out by charges set up as part of the commission arrangement with the adviser.
And if you want to extricate yourself from one of these plans, the exit charges may prompt second thoughts.
“I am often left trying to unravel this mess for individuals, but penalties on moving the funds to a more suitable long-term financial planning strategy are sometimes so severe that they are left with no option but to stick with the recommendation through the penalty period,” said Munro.
He gave the example of a new client whose previous adviser told them to invest £200,000 into a single-premium investment bond paying commission of 6 per cent.
“It was recommended as the most suitable product even though the client hadn’t used their Isa allowance and a unit trust would have been more tax-efficient to provide the income required,” said Munro.
In a similar case, Iain Wishart, of Wishart Wealth Management in Edinburgh, recently encountered an investor who had previously been persuaded by a national advisory firm to invest a large lump sum in an offshore bond. The adviser in question was paid 7 per cent commission on the sale, working out at £42,000 simply to set up a “tax wrapper”, and without any further review or service.
“The investor could have had an identical plan for £40,000 less with a bit of shopping around. Financial advisory firms who are operating like this are only in it for the short term,” said Wishart.
Also look out for markedly enthusiastic promotion of more complex tax-friendly investment products, such as venture capital trusts (VCTs) and enterprise investment schemes (EIS). These do justify higher levels of commission but are only suitable for a limited number of investors.
And Welsh warned investors to be wary of unregulated collective investment schemes (UCIS), which pay commission of up to 7 per cent.
The City watchdog last week slapped a £60,000 fine on South Queensferry IFA Patrick Francis O’Donnell, of P3 Wealth Management, for advising clients to invest in unsuitable “illiquid, complex and high-risk products” including UCIS.
But by far the biggest mis-selling threat is posed by high-street banks.
Wishart cited another example, this time of a dentist client who was recently advised by a major high-street bank to set up a £150,000 capital investment bond with an insurer owned by the same group – a transaction that produced a commission payment for the bank adviser of more than £11,000.
“At no time was this disclosed to the client, as the commission disclosure was removed from the illustration – where it usually lurks on the back page,” said Wishart.
“It was only when the client received his cooling-off notice that he realised what was going on.”
Wishart also urged investors to avoid banks and building societies for their major transactions. “It is better to go to a fee-based independent financial adviser and agree any costs upfront.”
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