Working in a regulated industry, the importance of “due diligence” is drummed into us. The FCA regard research and due diligence as core requirements to ensuring suitability, and that poor research and due diligence can lead to poor customer outcomes (TR16/1).
So you might assume that “due diligence” is a clearly defined requirement of the COBS rules. Not so. A quick search of the FCA Handbook throws up 124 references to the need for “due diligence”, but none of them occur within COBS – most relate to KYC and financial crime. (There’s one passing mention to “provider selection and due diligence” as an element of understanding the principles of investment planning within the Training and Competence rulebook, but that seems tangential.)
So where does the term “due diligence” come from?
Principle 2 says that:
“A firm must conduct its business with due skill, care and diligence”,
Alongside that, Principle 6 says that:
“A firm must pay due regard to the interests of its customers and treat them fairly”
The application of these to “due diligence” was considered in some detail in the recent Berkeley Burke judicial review. Berkeley Burke (a SIPP provider) had allowed a customer’s SIPP to purchase an investment which turned out to be “a scam.” The firm had checked that the investment was allowable to be held within a SIPP, but had not undertaken any further investigations into the bona fides of it.
The Financial Ombudsman had looked at the case and held that that Principles 2 and 6 together mean that Berkeley Burke was obliged to carry out due diligence on the investment. It should have carried out sufficient due diligence to identify whether the investment may be high-risk or speculative; genuine or a scam, linked to fraudulent activity; and should have independently verified whether the assets were real and secure, and operated as claimed.
That obligation to conduct “due diligence” arose from its obligations under the Principles to conduct its business with due skill, care and diligence, and to pay due regard to the interests of its customers and treat them fairly.
In the judicial review which followed the FOS decision, the judge upheld the Ombudsman’s decision.
So, applying this in the real world, what is the level of “skill, care and diligence” which is “due”? How widely and deeply should an adviser dig?
TR16/1 does provide some help. It starts by pointing to the need for an adviser to understand the nature, risks and benefits of an investment product or service, and to consider the credentials of the provider before a recommendation can be made (see Assessing suitability: Research and due diligence of products and services). It goes on to say:
“What constitutes a reasonable level of research and due diligence will differ depending on the adviser’s recommendation and the needs of the client. Although the objective of research and due diligence is the same across different investments, services and providers, there will be differences in the time and effort taken to achieve it. For example, it will usually take less time to assess a product from a familiar provider investing in familiar assets. Correspondingly it will usually take longer to assess a product from a provider with which the firm is not familiar or which invests in assets the firm has not researched before.”
In short: the “due” level of diligence required depends on the product/service/provider involved – the adviser must undertake sufficient to be sure the nature, risks, etc are fully understood.
In the context of discretionary investment management services, there’s a wide range of factors to be considered so it will take time to review, analyse and consider options carefully. Pricing and performance are typically top of an adviser’s concerns, but other areas are equally (perhaps more) important – for example, what’s the legal relationship and who carries the regulatory/contractual responsibility? How are client assets and data protected? How can my client know you’re putting his/her interests first? Where does the adviser fit into the process?
Establishing the right questions to ask is a core part of the process. Technology can help: it’s now possible to source widely-used due diligence questions and question sets, with responses delivered online in an easy-compare-format.
“Due diligence” may not exist as a term within COBS, but it is a regulatory requirement under the Principles. Even if it wasn’t, I suspect every professional adviser firm would want to conduct their business with due skill, care and diligence, and to pay due regard to the interest of their customers and treat them fairly.