2nd SFC Report on Investment Advisers

In 2004 SFC conducted the first round of thematic inspection on the selling practices of investment advisers (IAs) and issued a report of findings. Last week SFC issued a further report for its second round of such inspection.

Overall speaking, the deficiencies identified from those IAs in both rounds of inspections are similar, e.g. KYC, product due diligence, suitability, management supervision, documentation and management supervision. Investigation has commenced on some cases with more serious breaches of SFC regulations.

I just want to highlight the following more interesting issues / findings from the report:

• Clients were allowed to select all the available investment objectives, from "capital preservation" to "aggressive growth". They even selected "others" without giving further description. Sales staff failed to follow up on such inconsistency.
• When distributing an unauthorized CIS, the IA failed to spot the inconsistencies between OM and marketing materials. For example, marketing materials specified that the CIS is principal-protected although there was no such statement in OM.
• A retiree indicated in the client profile form that his investment objective as security of capital but subsequently switched his portfolio to higher risk funds (e.g. energy funds) without justification on the file.
• A client disclosed in the profile form a monthly income of $12k and personal net worth of $80m but was advised to invest a lump sum of $120k. No rationale for such advice was given.
• Investors signed off on confirmation forms that their advisers did not offer them advice but only carried out their orders. Of course this was not the fact.
• Most of the IAs do not disclose to clients the remuneration they receive from product providers. SFC is currently reviewing this issue and may consult the market on disclosure.
• A salesperson simply put down the words "good product" as the reason for recommending a fund to a client who did not indicate his risk attitude in the profile form.
• When reviewing the recommendations made by their sales staff, the management might not always detect and follow up on glaring exceptions and mismatches even though the had signed off for approving the recommendations.
• One firm had ignored the licensing condition that restricted it to only advise on funds and advised its clients on investing in equity linked financial instruments.