Retail Distribution Review

Written evidence submitted by Glen McKeown, Financial and Tax Adviser

Summary

The FSA’s proposals ignore, and are probably counter to, the sociological and psychological research that exists.

RDR is based on a set of committee based assumptions that are so far removed from the real world as to be potentially very damaging to the provision of financial advice at most levels, except for the rich, who are probably able to take care of themselves anyway.

Opposing Grandfathering can have a materially bad effect on the short term and could lead to a prolonged contraction in the adviser market. Why should clients rely long term on an adviser relationship if it can be terminated without realistic cause by an outside authority.

The debate on grandfathering is non-existent, and is based on am FSA assumption of the outside world that is so badly flawed as to be positively damaging. Like so much else the FSA view has not been substantiated; a substantial part all their output is either misleading or plain wrong.

As with everything else the proposal is backed by virtually no research commissioned or published by the FSA.

Peter Smith, Head of Investment Policy at the Financial Service Authority (FSA), at a recent conference is reported to have repeated the statement made in Hector Sants letter to the Treasury Committee, dated 13 December, that financial advisers would not be permitted to be "grandfathered" under RDR because a similar allowance for mortgage brokers resulted in widespread "misselling" and 100 brokers were disqualified.  Mr Sants’ words were "incompetent and unethical practices"

The remark that the dismissal of 100 advisers arose because of grandfathering appears to have been taken straight out of the air.  It’s a little like saying a Boeing 707 took off from JFK Airport, and at the very same time a Boeing 707 landed at Heathrow - therefore instantaneous travel is possible. The first important question is - are there any direct connections between the two facts, other than co-incidence.

The second important question is whether the grandfathering of advisers is the same process as the grandfathering of mortgage advisers, and on this point there is evidence that it was very difference.

If that is so, it would make the comparison somewhat dubious, and perhaps unethical.

One initial effect of regulation is to remove those who do not meet certain standards, and many would not, grandfathered or otherwise.  It is possible that if grandfathering had not been allowed far more than 100 may have fallen away from the industry, but there would have been no record.  So it is not really possible to ascertain whether grandfathering was a success or failure.  Figures need to be put into a context before they can be evaluated.

It is interesting how the FSA equate exam qualifications with both competency and ethical behaviour based on an exceeding low level of evidence, though this is in line with them building a business model using an old Australian report based on an assessment of 3 companies.

In any other circumstances such information, namely the disqualification of the brokers and the Australian research, would be the starting point for further research to determine if the correlation is real or accidental.  But that may have resulted in a refutation of the initial conclusions, making the FSA look rather silly - so no point in taking the risk.

There is no indication that the FSA have completed any further search or analysis arising from these initial deductions.  After all it is perfectly clear to all right thinking people that the Sun goes round the Earth.

The evidence from Australia on qualifications was so flimsy it would, in any other context, have been dismissed as an argument either for or against any proposition linking qualifications and competency.

It did raise some curious correlations, which should have been made the subject of further research.  

So far as I am aware

· it did not look at correlations between quality of advice and age of adviser or length of service in the industry;

· it did not specify the basis for the judgement of good and bad advice;

· it did not quantify loss to the client or indeed if indeed there was any loss (bad advice does not automatically mean loss since the external factors in the advice will change over a period, and may make that advice beneficial - and the opposite is also quite possible, that is, good advice could prove damaging due to unforeseeable factors);

· it did not specify the level of benefit to the clients overall i.e. did the negative exceed the positive or vice versa.

In itself the research showed no strong correlation either way between exams, competence or ethics or even benefit or detriment to clients.

The FSA is taking information and interpreting in purely to support its own point of view.  This is highly unprofessional at the FSA level.  As the well known Philosopher of Science Karl Popper would have maintained, the duty of the FSA would also be to find evidence to question or refute their assumptions. They have not done so.

In this respect it may be worth reading a short paper published in the British Medical Journal By Gordon C S Smith and Jill P Pell, Entitled "Parachute use to prevent death and major trauma related to gravitational challenge: systematic review of randomised controlled trials". The document is an interesting comment on assumptions and observational studies. The FSA appear to have made neglible observations in relation to their own assumptions.

On the question of qualifications, competency and ethical behaviour, it would be useful to look at the behaviour of the FSA for confirmatory evidence of this assumption.

I assume that there are a large number of graduates in Canary Wharf, so we would assume a high level of competence. Why we would also assume ethical behaviour I have no idea; some of the most ethical people I have ever met have had low levels of education. I doubt that the leaders of Enron, WorldCom, Arthur Anderson, ad nausea, were poorly educated but one would question their ethical behaviour.

The FSA use of the word is really a rather unethical attempt to use an emotive word in a context that is likely to psychologically strengthen their message, but actually has no real relevance. The ethical context is a red herring to qualification and grandfathering.

I note that Peter Smith (no notification of his exam qualifications) uses the £400m to £600m figures that were amazingly extrapolated from an estimate of around £223m and contained in Hector Sants aforementioned letter.  There is a vague comment as to why the base figure was extrapolated, but no direct evidence. So there is a question here as to the correlation between qualification, competency and ethical behaviour within the FSA itself.

There is research that supports the hypothesis that people will believe the statements of confident people, and the FSA always talk with supreme confidence, or at least they always treat everyone else as wrong.  So whatever figure they put out is likely to be believed - even when unsupported by hard evidence. And especially if they repeat the figures often enough.

Let us look further at the figures involved.  The total detriment to the consumer, depending on which set of FSA figures are more believable (or provable) appears to be about the same cost as running the FSA (and probably its successor).  Not a great sense of value for money.

But to that has to be added the £1.5bn for implementing RDR.  And do not exclude the ancillary regulation industry including the compliance departments for every company.  I do not know the figures, but an estimate of between £2bn and £3bn a year does not appear to be unreasonable.

All to save something between £250 and £600m, allegedly.

Let's put some of the figures into a general context.  In Hector Sants letter of 13 December 2010 he includes a level of detriment to clients in respect of Investment bonds and Equity ISAs of £92m.

This figure of £92m appears to represent the detriment of unsuitable sales.  But there is a 66% variance between their low and high estimates.  This is extremely high.

Why are they using estimates - do they not have genuine figures.  Regulation had been in force for 20 years, and the FSA were in position for 5 years.

It also raises questions about the amount in question when it is realised that £92m is somewhere between 0.24% and 0.39% of the Investment Bond Market.  The figures are based on the value of the 2007 and 2008  (£38.6bn and £23.6bn respectively) markets because I do not have the figures for 2005.  I have no reason to believe they would be materially different.  And the percentage does not take into account the size of the ISA market because I cannot access a figure.  Overall then the level of detriment appears to be between 0.1% and 0.15% of the total target.

It would certainly be swamped by just one good or bad day on the Stock Market. In percentage terms it is in the "negligible" bracket.

The statement by Mr Sants that the FSA do not believe that RDR will threaten the availability of good advice is, again, just belief and not substantiated by any research.

The fact is that since the introduction of regulation in 1986 the trend of independent advisers has been to advise richer individuals. This trend accelerated after 2000 with the introduction of a more onerous regulatory regime, that created excessive administration and therefore significant additional cost.

Quite simply if it not practical now to provide advice to clients below a specific wealth or income level. Recently I spoke to an employer about the way he would provide investment advice for a person paying £100 a month to a pension scheme. The reply was unambiguous; he wouldn’t be dealing with anyone making such a low contribution. Whenever I have spoken to colleagues and stated that IFAs really only looked after the rich I have never had anyone deny the comment – there is actually a positive response.

I have personally turned away clients who I believe would not be comfortable with the fees I would charge them.

It has always bemused me why the FSA is so keen on protecting the rich, because that is what these changes, in the main, will accomplish.

Quite simply the assertion that advice will be widely available is not sustainable.

Take out 3,000 to 5,000 advisers just leaves more rich clients available. Do not expect competition for "lesser" clients.

Providing any level of advice will now require a number of hours of work to ensure that all the regulatory requirements are met. It would be difficult to charge the client less than £250. Is that likely to be acceptable to a client planning to invest £40 to £50 a month?

The FSA are living in cloud cuckoo land if they do not see that the cost levels they have laid out as being created by RDR (and when did anyone ever over estimate?) can be recouped by dealing, on an advisory basis, with lower income people.

IFA advice will not be available to them and the FSA is being disingenuous to suggest it will be.

Are you aware of many legal and accountancy practices that target the lower paid? That is the level of competence the FSA are targeting. Is the targeting actually justified? What does the research say?

These figures, and others cast serious questions about the competence and ethics of the FSA in the presentation of evidence supporting RDR.  However, based on their analysis there should be no such problem, because they are all highly qualified and therefore highly competent and ethical. Does this alone not cast doubt about their base assumptions?

There is a large question about whether the consumer is getting value for money, for, ultimately, it is the consumer that pays.

Once RDR is in place the FSA must assume that the level of detriment will be reduced. It can never be eliminated, so to what level do they assume it can be reduced? I note the FSA does not provide targets for anything, presumably to avoid having to answer for failure. But let us put a base level, below which detriment is unlikely to fall at say £200m. In a billion pound industry this is actually a very, very small percentage. So the consumer saves £300m a year spread over how many million people, lets use a low figure of 10m finance clients (remember the RDR is not merely about IFAs) which equates to £30 per person. Life changing?

Lets put the figure to compensate clients for detriment at £500m pa.  A workforce of about 100 could pay out the compensation; cost in the order of £10m pa.

Disband everything else.  Saving to the consumer - in excess of £1bn a year.

So once again I ask the question - is the consumer getting value for money, or merely fleeced in order to keep a few hundred highly educated people off the unemployment register - or even doing a genuinely useful job.

One of the problems of casting doubt on evidence is the implication that the main topic, in this case RDR, is totally opposed.  I doubt that you will find any in the Adviser section who would oppose better overall standards.  What we oppose is the bureaucratic mentality in implementing them.  Whilst the proposed outcome is to be welcomed, we believe that the treatment is likely to kill the patient long before we get to that outcome.

There are better methods to implement the changes. The FSA has not listened to or spoken with the IFA sector. For evidence on this find any material changes between the initial report and the current implementation.

And find any targets specified by the FSA that can be used to measure success or failure.

I have been a financial adviser for 40 years, and before that was 7 years with the Inland Revenue.

I have worked for accountants, stockbrokers and some of the top Adviser Firms.

Over the last few years I have completed a significant level of study on the psychology and sociology of investment and human interaction with investment and finance subjects.

January 2011