Banks take risks at their peril

CHIEF watchdog the Financial Services Authority last week fined Barclays a record 8 million for mis-selling two investment funds, which could cost the bank a further 59 million in compensation.

This is a record fine for the offence of selling inappropriate investments to clients by, for example, putting cautious savers into high-risk funds.

Complaints that advisers took risks with life savings that investors specifically asked them to avoid always come flooding in when markets tank. Consumers, who thought their money was safe, can suffer traumatic shock if it is wiped out by a crash.

Traditionally, it has been hard to prove the adviser ignored instructions, not least because few investors complain when prices are rising. Furthermore, clients can often give mixed messages. They may indicate a desire to be cautious, but also signal they need an income of, say, 10 per cent. You can't get that from a simple deposit account.

Now, rather than accusing investors of attempting to close the stable door after the horse has bolted, the FSA is taking their complaints seriously. This follows research it conducted into the area of investment suitability which revealed that processes firms use to assess an investor's risk tolerance were faulty in eight out of ten cases.

In the light of these findings, it is introducing new rules to ensure advisers really do listen to their customers and are correctly tuned in to the degree of risk they will tolerate.

Barclays landed in hot water precisely because of the way it sold and marketed two funds, Aviva's Global Balanced Income Fund (the Balanced Fund) and Global Cautious Income Fund (the Cautious Fund), into which it invested nearly 700 million on behalf of more than 12,331 people.

Around one in seven, or 1,730 investors, most of whom were retired or nearing retirement, complained. After investigating, the FSA pinpointed a number of serious failings in the way the funds were sold.

It concluded the company failed to ensure the funds were suitable for customers in view of their investment objectives, financial circumstances, investment knowledge and experience. Sales staff were inadequately trained, particularly when it came to explaining the risks. Furthermore, risks were not highlighted in the product brochures and other documents given to customers.

Barclays is now having to contact customers and pay redress where appropriate. Its own review identified 3,099 sales of the Cautious Fund (51 per cent of all sold) and 3,378 of the Balanced Fund (74 per cent of all sold) as requiring further consideration.The bank has already paid approximately 17 million in compensation and the FSA estimates up to 42 million further could be paid to customers who received unsuitable advice.

But this could be just the tip of the iceberg. When markets crashed, many unsophisticated investors lost a fortune. To be fair to advisers, some thought they were acting in a client's best interests. They were trying to get the best return, and provide a decent pension at a time when returns were pitiful because a crab-like stock market moved ever sidewards.

In other cases though, it was the result of commission-driven sharp practice, incompetence or an over-reliance on tools which were often faulty or substandard.

Advisers have come to rely on risk-profiling tools to automatically calculate a client's risk score, in the same way lenders credit score. The investor is asked a series of questions and answers are fed into a computer program.

However, investigations by the watchdog found that many of these tools were vague, badly designed and poorly understood by those using them. Out of eleven such processes it assessed, nine were seriously flawed.

Either they simply didn't get the right answer, or advisers didn't understand how to use them, or misinterpreted the results. In some cases, they were used not to protect an investor, but to justify putting him into a high-risk fund.

Often they were provided by a third party, but the company using them didn't understand how they worked. On some occasions, the questions were doctored by the in-house adviser, out of a desire to improve the assessments. But tampering with them led to completely spurious results.

Finally, even where the tools did assess the client's risk threshold correctly, the watchdog found that many advisers still went on to pick an inappropriate investment, and put them into volatile packages, rather than recommending a basic deposit account, if that was what their attitude to risk suggested.

The FSA has decided this must stop. Advisers will no longer be able to rely on risk-assessment tools alone to justify recommendations but must specifically quiz the client about how much loss they can stomach. They must then interpret the answer sensitively and accurately. In other words, they must "know their customer".

Margaret Cole, the FSA's managing director of enforcement and financial crime, said: "We require firms to have robust procedures in place to ensure any advice given to customers is suitable. Therefore, when recommending investment products, firms should take account of a customer's financial circumstances, their attitude to risk and what they hope to achieve by investing.

"On this occasion, Barclays failed to do this and thousands of investors, many of whom were seeking to invest their retirement savings, have suffered. To compound matters, Barclays failed to take effective action when it detected the failings at an early stage.

"Because of this, and given Barclays' position as one of the UK's major retail banks, we view these breaches as particularly serious and fully deserving of what is a very substantial fine."