This talk was given on 28 November 2006
The text here may not be identical to the spoken text

28 November 2006 Docklands Hilton

Financial Capability, FSA powers, and Commission

After that introduction you’re probably thinking, who?

Anyway, I’m Paul Lewis I’m a freelance financial journalist and as some of you may know I present Money Box on Radio 4.

But I do lots of other things including writing most of the financial pages in Saga Magazine and the views I express here are mine not Saga’s, not Money Box’s and certainly not the BBC’s.

Financial capability
Now tomorrow you’re going to be considering helping people make better financial decisions. Let me tell you a story.

I bought a car the other day. Now these are long term products so I did my research.

The first thing was the ongoing cost. Now. I wanted at least 50 mpg. And the sales literature said that in the past vehicles of this type had achieved 50 mpg and that in the mpg stakes this vehicle was in the top quartile year after year after year. So I bought it. I was going to Manchester that was 210 miles so I put five gallons in the tank. It ran out just north of Birmingham. The salesman admitted it was disappointing but he had explained to me that in the short term mileage was not guaranteed. But the aim was that over the long term the car would outperform most others. Though he wouldn’t promise it. Because past performance was no guide to future performance.

When I bought the car the salesman asked ‘Would you say that clear vision was the most important thing – the ability to see clearly what was ahead?’ Well yes I said. And he told me this vehicle had the translight windscreen that transmitted 99% of the light that hit it. It had an ILT – incident light transmissivity – bit of a mouthful but I was getting used to acronyms – of 99. They don’t come much better than that. And this special transmissive glass only cost an extra £35. I gladly paid it to be able to see.

Just after I had run out of petrol on the M6 I was standing behind the safety barrier wondering how to get some more petrol when a lorry passed by kicking up a small stone. It hit the windscreen and came straight through, shattering the glass into a thousand pieces.

So I rang the Forecourt Standards Agency – the FSA. They explained that the question I should have asked was not about light transmission but about stone protection. Some windscreens let through lots of light and also lots of stones. The ones that protected you against stones cut down the light transmission fractionally but – they didn’t let any stones through. They had a high SPI – Stone Protection Index and that is what I should have asked about. In fact at paragraph 5(j)(14) third blobby point the SPI of my windscreen had been explained and I had signed to say that I accepted an SPI of just 12. So I couldn’t complain. And I had had the advantage of the 99% light transmission for the 120 miles my car had taken me.

I said OK. But I had paid for ‘journey protection insurance’ so would they send another car? I was told if I looked in the boot there was a foldaway bike that I could use to pedal some distance on my way and I would almost certainly reach a destination – if not the one I hoped for. Of course she said you’ll have to leave behind the family and the luggage but it’s better than losing everything.

This is what would happen if cars were sold like financial products. The truth is that like most of the rest of the population I haven’t got a clue how a modern car works. So when I bought my car recently I didn’t have to declare my risk profile on having seat belts fitted or not. I didn’t have to declare my speed appetite to see if I should splash out on tyres made from vulcanised rubber so they didn’t fly apart over 75 mph. I don’t need to go to night school to learn about the tensile properties of windscreens to make sure that the one I am sold won’t shower me with lethal shards when a stone is flicked up by a passing lorry. It wouldn’t be allowed. I don’t need transportational capability to buy a car. Because safety has to be built in by law.

So I can decide on the interesting stuff – like whether red really is my colour, or whether there’s a jack for my MP3 player.

The only reason people need financial capability is because the products they are sold are complex, the descriptions of them are misleading, and some of them are dangerous.

And when people say ‘who is going to pay for educating the public?’ my answer is – the polluter pays. If the industry has to pay to clear up the mess it creates then it will take steps to leave less of a mess.

FSA powers
Let me remind you of a bit of history. No lawful industry has been rocked by such a succession of scandals as financial services.

Mortgage endowments sold from up to the late 1990s will leave three million people up to £40 billion short of the money they need to repay their mortgage. Only £1 billion of compensation has been paid.

Personal pensions mis-sold to nearly two million people up to 1994 cost the industry £11.5 billion in compensation and another £2 billion in running the compensation scheme.

Additional Voluntary Contributions – at least 100,000 customers were sold the wrong sort of AVCs to top up their company pension. More than £250 million in compensation has been paid.

Split capital investment trusts sold as safe investments. Up to 50,000 individuals lost at least £600 million. The industry finally coughed up £142 million and about 20,000 people got less than half what they had invested.

Precipice bonds were sold up to 2004 to 450,000 mainly older customers who wanted safety and a good return. They put in £7.4 billion and may have lost more than £2 billion.

Possibly millions or people lost money by transferring out of SERPS – the state earnings related pension – into a personal pension. An FSA report showed that the average customer lost around £4000 by doing so. Which? says 4.5 million could have lost £7 billion – £3 billion was paid to the insurance industry in charges.

On top of these major scandals, the Financial Services Authority has fined 100 companies and individuals a total of £72 million and forced them to pay over £300 million in compensation for a variety of activities ranging from the misleading to the illegal.

And these are not small, unknown companies. Among those fined more than half a million pound fines we have Abbey (3 times), Royal & Sun Alliance (twice), Bank of Scotland (twice), Lloyds TSB, Northern Bank, Guardian Assurance, Royal Bank of Scotland, Allied Dunbar, Friends Provident, Bradford & Bingley, Royal Liver, Axa Sun Life, not to mention Citigroup, Deutsche Bank, Credit Suisse First Boston, and Shell.

And this is all on the investment or insurance side. There are no fines for lending money to people who can’t afford to repay it. There are no fines for promising customers top rates of interest and then cutting them – as ING has done this week. There are no fines for giving sales staff incentives for selling some products and not others.

And even where the FSA has powers are they enough? The FSA recently did some research into the way that Payment Protection Insurance was sold. It had originally done some research on this subject in 2005. Following that research CX John Tiner wrote to the bosses of all the major companies selling PPI warning them about the problems and what they must do. Earlier this year the FSA repeated the mystery shopping. According to Vernon Everett in charge of retail markets at the FSA still found "widespread problems" among the 40 firms they looked at. Later he said it was most of those firms. Let’s be kind and say it is 21. So far just two of these have had disciplinary action taken. And the other 19? Their names remain secret, and they are still selling to unwarned customers.

Let me give you another example. Precipice bonds. Now these were clever products which promised a high guaranteed return from a capital investment. Say you invested £5000 they would promise £500 a year for five years, 10% return. And they paid it. But at the end of the period you discovered that the investment hadn’t grown, instead the 10% return – hear the inverted commas – the income was paid by giving you back your capital. SO you got perhaps £2500 back – but you had had the promised income..

Now it is my view that if the terms had been clearly explained almost no-one would have bought this product. entered into it. And those that did would have had their eyes open and no reason to complain. But they weren’t. In 2002 the FSA warned that precipice bond investors may not get their money back. In 2003 it called for clearer information to investors. In September 2004 it banned David Aaron for widespread misselling of them. He went bust. In October 2004 it fined Capita trust £300,000 for misselling them and in December fined Bradford & Bingley £650,000 for the same.

Precipice Bonds effectively stopped in 2004. But after £2bn had been lost.

But now they’re back – maybe. Here is one which is offering 7.5% secure fixed annual income. "This product should offer an exceptional investment opportunity…a lower risk profile and a higher level of income allows you to receive the income you need without the worry of stock market falls and changes in interest rates" And then in the tiniest print "The plan is so structured with the aim of repaying your capital in full at maturity though please bear in mind that this is not guaranteed."

And here’s another making a similar offer.

This time rolling up the income so that you get it all back at the end as a 43.56% uplift which equals 7.5% over five years. Or if you leave it in seven years you get 11.25% or 110.91% of your original investment – minimum £2000.

Now of course these may work. We won’t know for five years. Or if we really want to get a good return, seven years.

And these adverts? I am told by the FSA – off the record – that it is concerned about them. And that’s it. Over the fading clatter of hooves running into the distance you can hear the sound of the stable door creaking shut.

Now I don’t mean to criticise the FSA. It acts as best it can within the powers it has. What I am here to ask is – does it need more and different powers?

Let me remind you that there is another FSA. With considerable powers. Let me read you from these recent press releases…

"Batchelors has recalled certain batches of Chicken Flavour Super Noodles 100g due to the possible presence of small pieces of hard white plastic in the flavouring sachet." (21 November 2006)

"H J Heinz Co Ltd has withdrawn Heinz Toddler’s Own Sweet Potato and Beef Casserole 250g because some packs have been labelled incorrectly." (21 November 2006)

"Dunbia Northern Ireland is recalling a number of meat products after finding that an Over Thirty Month old cow has entered the food chain without being tested for BSE." (10 November 2006)

"The Food Standards Agency is urging customers to be vigilant about the risk of foreign objects that have been found in the packaging of Kingsmill sliced bread produced by Allied Bakeries at its Orpington bakery." (12 October 2006.)

A product is mislabelled, it is withdrawn, a notice is issued and anyone who wants their money back can have it. Bang.

So this FSA – the Food Standards Agency – working with local authorities can name names, take action and ban things. And it hasn’t ended the retail food market. Heinz, Batchelor, Kingsmill are still in the shops.

But our FSA sets up a TV and advertising monitoring unit – but keeps secret the adverts it is concerned about. It carries out mystery shopping exercises but refuses to name the companies which fail the test. And it has internal meetings about new products that slip between its regulatory powers – and says nothing. And it keeps all this under its cloak of secrecy because of the laws under which it was founded.

So my question this evening is do we need a FSA which can ban products? Zeros, precipice bonds, land banking, pension unlocking, contracting out of SERPS – things that the FSA says are just about always a bad idea – but which it won’t ban – because it can’t.

Do we need an FSA that can act like its namesake and swoop down and close a factory making unsafe financial products? Shut down a production line that is turning out mislabelled financial goods? And stop anyone selling stuff that is only designed to do customers financial harm and enrich the folk who are selling them?

IFAs and commission
Finally how does an industry which employs millions of people, collects tens of billions of pounds from us each year, lends us more than a trillion pounds depend on misselling on such a scale?

First the term financial adviser. In my view that is misleading. If I asked you to name twelve things people, your clients, want financial advice on they might come up with

Credit cards
Social security benefits
Income Tax
Bank accounts
Tax credits
Savings accounts

Out of those twelve, how many can High Street IFAs give detailed advice on?

Pensions – yes
Investment – yes
Savings accounts – Maybe.
Mortgages – other retail intermediaries
Insurance – other retail intermediaries
Debt? – no. Some IFAs will not even say pay off debt before you save or invest.
Credit cards? – no.
Social security benefits? – pass. That’s the DSS or something isn’t it?
Income tax? – You may know that ISAs are tax-free but you can’t really check PAYE.
Bank accounts? – Nope.
Budgeting – I find it hard to make ends meet. Not me.

So if financial advisers can’t give advice on at least half and probably three quarters of the financial problems people have in what sense is calling them financial advisers ‘fair and not misleading’? It is not. Calling themselves financial advisers is not fair and is misleading. It misleads customers to expect them to be more than sales people.

And how well do they do what they can do? Not very. In 2001 when it first allowed out the term ‘treating customers fairly’ the FSA said that the industry

failed to provide relevant information

poor standards of complaint handling

marketing practices that led to unrealistic expectations

the sale of complex, opaque products where risks are not identified

jargon in literature

barriers to switching

Now, five years on, the FSA is reviewing the retail process. And it has found

over half the firms did not obtain know your customer information before making a recommendation;

letters lacked clear and concise information about the key risks and reasons for the recommendation;

only a third undertook a full review of customers' needs and objectives;

around a third of firms had inadequate training and competence procedures in place,

That sounds much the same to me. And then it said

less than a fifth of advisers gave consideration to recommended products that did not attract commission

And that brings me finally to commission. Now I used to do what I thought was a strong sequence on commission. I called it the cancer at the heart of the financial services industry – rather mixed medical metaphor but you know what I mean.

But now I just quote the FSA. Chairman Sir Callum McCarthy had a first go at this in September. Under the title ‘Is the present business model bust?’ he said

"we have a system which serves neither the producer of the services nor the consumer of the services. It is doubtful whether it serves the intermediary either."

He said that it was "incompatible with developing either a reputation for the industry as a whole, or … for individual companies."

He said that customers suffer detriment from paying unnecessary commissions, charges or fees when induced to switch from one product to another

And he said intermediaries – financial advisers – have a "built encouragement to churn" he also added that at May 2006, the top 21 IFAs had turnover of £640 million, but operating losses of £22 million – twice those of a year earlier.

And look at the major financial scandals of the last twenty years – from pensions mis-selling to precipice bonds to splits. And the disciplinary action taken against those 100 firms. Would those industry wide or company specific mis-sales would have happened without commission. Of course they wouldn’t.

I know the argument for commission – how do you motivate people without commission? Well most people who work don’t get paid commission. What motivates consumer advocates, charity workers, teachers, plumbers, the people who run this hotel, even journalists.

If they do the job it well, they are valued, promoted, and yes maybe given a bonus at the end of the year. A fair wage for a worthwhile job. And if people don’t do their job well, then they are offered advice, perhaps some training, and if that doesn’t work they are disciplined, warned. And ultimately sacked. That’s what controls most of us at work.

It’s called management.

Are people who work in financial services so different from the rest of us that they can only be motivated to get out of bed by the thought of earning £2000 for selling a product that isn’t wanted, isn’t needed and may not even achieve the limited objectives it actually has? I don’t think so. Treat them like people, not like greedy bastards, they might behave that way.

Commission is literally and precisely a conflict of interest between the financial adviser and the customer.

I know at least two IFAs who don’t pay commission. They manage their staff as any other business does.

And outside financial services, PC World scrapped commission across its 150 stores in March this year because the company realised that

"The previous commission-based selling scheme encouraged behaviour that was not necessarily in the customer’s interests"

So they piloted no commission. And stores where it was tried out – called One Team – showed a 5% better performance in converting visits to sales than the stores which still paid commission.

So it can be done. And the sooner financial services does it the better.

28 November 2006

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