Does liability for advice stop when clients are sold?

Jon-Paul Hale questions whether an adviser, under the new regime, will still be responsible for the advice given after selling a book of clients to another adviser/FAP.

Friday, November 13th 2020, 3:21PM

by Jon-Paul Hale

Jon-Paul Hale

I’ve talked in the past about choices with your transitional licence setup. The follow on from this is change down the track.

At the time, my comments were all about the FAP setup. More specifically the point of putting your TL under your own name and still having liability for your advice while creeping around with your Zimmer frame.

The majority of my commentary was based on the discussions to date with the FMA, and other parties, throughout the consultation period.

In hindsight, there wasn’t any discussion about restructures, buy/sell, and other reasons for the change in a business. It was all focused on setup and operation.

To be clear; the inclusion of an individual holding a licence in the FSLAB review was to ensure consistency with NZ law.

It was not in the first draft, as this was not an intended licence structure to be used. It was only included for consistency, and the FMA comments at the time were, "We don’t expect it to be used".

Which raises an interesting point after a chat with Mark Banicevich at Partners Life, previously with the FMA – where I first met him.

We’ve known/assumed that buying and selling of clients would take place, pretty straightforward. And buying and selling of businesses and their licences would happen too. You buy/sell the shares.

One of the things that is becoming clearer as we get closer to D-Day, is the need to have some clarity around how these things can be restructured and changed.

Now for many, it might sound like it’s simple – you change it. At the same time with full licence provisions about to be released, these things are not that clear.

Talking with Mark, there is an expectation that licence holders will be able to restructure things, which is good.

In basic terms from the discussion, it is applying to the FMA for these structural changes and transfer of licence.

One of the points in my prior article was about the issue of the personally licensed adviser being able to sell their clients, but not their licence. They are the licensee and sale of you is called slavery. (Mark’s slavery comment, which I thought made the point well.)

Which also reinforces my prior comments about being responsible for your advice to the grave. Now certainly there is some push back on this with the “Sell your clients, transfer the risk” approach to things, which is how it works presently.

But no. The FAP that gave the advice is responsible for the advice. The movement of the client to another adviser through S&P doesn’t absolve the original adviser FAP from their advice.

There are a couple of things going on here. The original advice and the appropriateness and execution of that advice stay with the original FAP. If the client transfers (sale or regular servicing changes) then the new FAP becomes responsible for their advice, and the endorsement of the prior advice, once they have engaged the client and advised the client from that point forward.

I’ve not seen anything that specifically absolves the originating FAP from liability in anything I have read to date. (Happy to have it pointed out if the rules say different (rules not your opinion), as we all need clarity on this.)

The quite subtle point that has been missed in the discussions is that the client has a FAP advice relationship with the originating FAP. The commercial transaction of selling that client to a second FAP doesn’t get in between the client/FAP relationship.

Which makes the prospect of you being the FAP somewhat of a challenge. Aside from the bit, you can’t call yourself a financial adviser.

It’s not until the client is directly engaged with the new FAP that the future advice risk is transferred. The original FAP is still responsible for the original advice up to that point.

Confused? Yeah, most are by now.

Which brings me to the restructure piece. Part of the discussion with Mark was talking about the transfer of the FAP licence from the individual to a new company so that the personal risk is moved off the individual.

Mark referred to this as a variation to the licence. And I suspect this is a similar approach to significant changes in any FAP licence ie change of shareholders, directors and company officers.

Which is going to be a new concept for many. And the process for this is going to be relatively fresh too. I haven’t gone looking for it, but I did see a condition that material changes to the FAP need to be notified to the FMA.

So there appears to be a way to move your personal FAP off to a company, to transfer it, then have you unencumbered while you scoot around with your Zimmer frame.

However, that raises some other considerations. Let’s say you do 20 years with your FAP as you, personally, and then you look to transfer to a company when you retire.

First off, in transferring the FAP to a company, you will likely have additional requirements to meet. So there is an increased overhead with the change. That may not have been required if you started as a company.

Second, you lose the trading history associated with your individual FAP, as the company is a new entity. Financials and other information relevant to a buyer are not relevant to the company’s trading history.

Lastly, while there is file history for the clients, there isn’t the operational advice history for the company. So from the perspective of a buyer of your FAP, which you will ultimately want, the value isn’t going to be as high as if you had this trading over 20 years.

Food for thought on that one.

There is also another run on interesting impact at the other end.

I’ve seen from time to time advice businesses somewhat phoenix, not in the real sense of the word, failure and re-emerge. More that they set up a new company every five years or so and they transfer the business to this and then shut down the old one.

It is limiting the historical advice risk in the process, which is perfectly allowable in the present rules. It will, however, become an issue in the future.

The new rules are designed to capture this and put a lid on it.

In trying to limit advice risk in this way, there becomes significant challenges.

The first is in transferring the FAP licence from one company to another, if it was to be approved, this wouldn’t mitigate the advice risk – it would move with it.

The second is in letting one licence go to take up a new one on the new company; you have high cost and hassle in acquiring that new licence. Not to mention the questions the FMA will be asking when the business is the same except for the trading company name.

It’s likely to raise a significant spotlight on the operation and raise many questions on competency and compliance.

Licensing is going to be an interesting thing for a time as many advisers transition from sales contractors to business owners. And yes, that is the majority only just waking up to the reality.

And when I still hear questions like "What is a FAP?" even in the last month, I have real concerns that a significant portion of advisers haven’t been listening.

Tags: FAP Jon-Paul Hale licensing