Due diligence has been thrust into the limelight in the wake of the Berkeley Burke case. The implications are rippling out widely beyond the Sipp market.
Given its weight as a phrase, you might assume due diligence is a clearly defined requirement of the Conduct of Business Sourcebook (Cobs) rules. Not so much. A quick search through the Financial Conduct Authority (FCA) handbook throws up 124 references to the need for due diligence. But none of them occurs within Cobs. Most relate to ‘know your customer’ and financial crime.
In the training and competence rulebook there is one passing mention to ‘provider selection and due diligence’ as an element of understanding the principles of investment planning, but that seems tangential.
So where does the term due diligence come from? Principle two in the FCA handbook states a firm must conduct its business with ‘due skill, care and diligence.’ Alongside that, principle six states ‘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, allowed a customer’s Sipp to purchase an investment that turned out to go very wrong indeed. The firm had checked the investment was allowed to be held within a Sipp, but had not undertaken any further investigations into it.
The Financial Ombudsman Service (FOS) originally looked at the case and ruled that principles two and six together meant Berkeley Burke was obliged to carry out due diligence on the investment. It should have carried it out sufficiently to identify whether the investment was high risk or speculative, genuine or a scam, or linked to fraudulent activity. And it should have independently verified whether the assets were real and secure, and operated as claimed.
That 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 that followed the FOS decision, the judge upheld the ombudsman’s decision. So, applying this to an adviser’s everyday work, what level of skill, care and diligence is ‘due’? How widely and deeply should an adviser dig?
The FCA has provided some guidance with TR16/1, its thematic review on the role of research and due diligence in ensuring suitability. 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.
It goes on to say the ‘due’ level of diligence required depends on the product, service and provider involved. So the adviser must undertake sufficient checks to be sure the nature and risks are fully understood by the client.
Take the driver’s seat
In the context of discretionary investment management services, there is 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 (and perhaps more) important. For example, what is the legal relationship, and who carries the regulatory and contractual responsibility? How are client assets and data protected? How can clients know advisers are putting their 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 is now possible to source widely-used due diligence questions and question sets, with responses delivered online in an easy-to-compare format.
‘Due diligence’ may not exist as a term within Cobs, but it is a regulatory requirement under the FCA’s principles. Even if it was not, every professional adviser firm should 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.
Chris Jones is director at DD|hub