HSBC acquisition inherits suitability of advice failings

In its largest ever retail fine of £10.5million imposed on HSBC Bank Plc (HSBC), the FSA has once again sought to remind financial organisations that it is not enough to have the proper systems and controls in place to ensure the suitability of advice given to customers, but also of the need to ensure that such systems are fully implemented and properly reviewed, particularly on the acquisition of a new business.

HSBC was fined for mis-selling asset-backed investment products by one of its subsidiaries, NHFA Limited (NHFA), acquired by HSBC in 2005. NHFA had sold the products, primarily investment bonds, to elderly customers, entering or already in long term care, to fund their care. The FSA identified a number of systems and controls failings that were considered to be particularly serious as NHFA was the leading supplier of independent financial advice on long-term care products, their customer base was vulnerable given their age and reliance on their investments, a significant number of customers were affected and the mis-conduct occurred for over five years.

Although many of these failings were fact specific, they pointed to more systemic and generic problems that apply to a range of financial organisations. Such failings have, for example, featured in recent FSA enforcement action against Coutts & Co and Credit Suisse Private Bank and should prompt organisations to take note in considering their own systems and controls. These failings included:

Attitude to risk

There was no consistent approach to assessing customers’ attitude to risk (ATR) or use of a suitable risk profiling questionnaire, leading to advising inappropriate investment strategies. The ATR was often recorded as ‘low to medium’, although this was not consistent with the strategy of withdrawing capital from these asset-backed investments. Investment bonds were recommended based on unsuitable projection rates of 6%, which overstated the potential returns. For investment periods of less than five years or when using lower risk assets unlikely to generate strong returns, 4% or lower was more appropriate.

Lack of tailored investment advice

Investment bonds were sold, for example, despite the customer’s life expectancy being less than the minimum typically recommended term of investment for such products, namely five years. As such, the charges on the bond and the need for customers to make early withdrawals meant that capital was eroded more quickly than would be the case on a more suitable product. Customers were also advised to invest a large proportion of their funds into asset backed investments, resulting in over-concentration, despite the fact that it was foreseeable that they would need access to cash funds on deposit. This resulted in high levels of withdrawals from the investments at early stages, also reducing the possibility of the value of the investment growing sufficiently to cover the charges incurred.

There was also a failure to consider the tax status of the customer, with potentially more tax efficient investments not being offered.

Investment diversification

Diversification of investments and savings plans was inadequate. The majority of recommendations were for investment bonds, when higher rate savings accounts and ISAs, for example, would have been more appropriate.

Documentary failings

Suitability letters were issued that:

• used standard paragraphs, rather than being tailored to the circumstances of the individual customer, and which failed to explain why the adviser concluded that the investments were suitable for them;
• failed to give balanced information by focussing unduly on the benefits of an investment while failing to provide sufficient warnings about possible disadvantages; and
• included standard appendices with out-of-date or irrelevant information.

In addition, there were inconsistencies in the way that investment ATR was discussed and recorded, leading to potential confusion for the customer, including using ‘cautious’ and low to medium’ interchangeably.

Review failings

Although sales quality checking of customers’ files was undertaken, this was by sales managers who did not identify the potential issues. NHFA was an independent financial adviser operating in a highly specialised area and the complexity of the business and its associated risks were not adequately assessed and managed.

Following acquisition of NHFA by the HSBC Group, there was little progress in integrating NHFA’s operations to those of HSBC before management control was passed to HSBC four years later in 2009. After acquisition. reliance was placed on the fact that sales were reviewed by the compliance team within NHFA before they were processed, so that the compliance process was not scrutinised by HSBC compliance until 2009.

The FSA stated that the fine would have been significantly greater, had HSBC not demonstrated significant and pro-active co-operation by making improvements to NHFA’s sales process and management/ adviser training, and implementing a customer redress programme that it anticipated would result in a further £29.3 million being paid to affected customers.

Tracey McDermott, acting director of enforcement and financial crime warned:

"This penalty should serve as a warning to firms that they must have the right systems and controls in place to manage and identify risks when they acquire new businesses."

Clearly, the vulnerability of the target customer played a major role in the size of the fine. It is extremely rare in the wealth management and private banking industry, the more typical focus of the FSA’s enforcement efforts relating to suitability, for an institution to be servicing a customer base comprising elderly people in care. To some extent, HSBC was a victim of inheriting a specialist advisory business that did not have in place a well run sales process. That said, it is a warning to any institution acquiring an investment advisory business to get to grips immediately with the record keeping and composition of the products historically sold by the target.

Lawyers Laurence Lieberman, Julie Simpson Day