Part 2 Interests
This is the second instalment of Jenny’s article on Conflict of Interest (COI). In the first part, she provided a summary of the COI Amendments, and looked at the definition and the Duty to Avoid. She also gave an overview of a Conflict of Interest Management Policy. In this instalment, she explores the different kinds of interest and the implication resulting therefrom.
A. Financial Interests
What types of financial interest can a provider receive and a product supplier offer?
1. Allowable financial interest
A provider or its representatives may only receive or offer:
(i) Commission authorized by the Short term or Long Term Insurance Acts;
(ii) Commission authorized by the Medical Schemes Act;
(iii) Fees under the above Acts if those fees are reasonably commensurate with the service being rendered;
(iv) Fees for rendering a financial service (where the above commission/fees are not paid) if the fees are specifically agreed to by the client in writing; and which may be stopped at the discretion of the client;
(v) Fees or remuneration to a third party reasonably commensurate with the service being rendered;
(vi) An immaterial financial interest (explained below).
What types of financial interest can a provider not receive and a product supplier not offer?
2. The definition of Financial Interest
Financial Interest means any cash, cash equivalent, voucher, gift, service, advantage, benefit, discount, domestic or foreign travel, hospitality, accommodation, sponsorship, other incentives or valuable consideration, other than:
(a) an ownership interest;
(b) training, that is not exclusively available to a selected group of providers or representatives on-
(i) products and legal matters related to those products;
(ii) general financial and industry information;
(iii) specialized technological systems of a third party necessary for the rendering of a financial service;
but excluding travel and accommodation associated with the training.
Comment
The definition of financial interest is very wide. Different opinions exist in the industry as to whether it is necessary to be so wide in order to eradicate some of the inappropriate practices which have existed in the past to cause business to flow in a particular direction. Nevertheless, the legislation is in place and the industry is compelled to factor this new thinking into our practices.
Training
In the draft stages of the notice, there was a concern that the words “service, advantage, benefit” would extend into the realm of training, legal and technical education sessions, industry information seminars, technical information seminars and product or technology workshops, which, it is believed, would not have served the industry well nor clients who are dependent on their advisors receiving knowledge from forums of this type.
We are pleased to note that the final version has greatly relaxed those earlier provisions. It seems that training sessions of the type listed above will be acceptable subject to their not exclusively being offered to a selected group.
It is interesting to note that the principle of allowing “training” does not extend to providing travel and accommodation for training sessions. This shows that the regulator does not see the provision of travel and accommodation as being a natural concomitant of training. This will have the additional effect of suppliers being unable to couch entertainment sessions as training sessions.
Cash, cash equivalent, voucher, gift, service, advantage, benefit, discount, domestic or foreign travel, hospitality, accommodation, sponsorship, other incentive or valuable consideration
From this very large list it is clear that providers and product suppliers will have to carefully scrutinize the many and varied forms of marketing and entertainment initiatives, free services and software tools and programs, white labelling of products and other free non-cash incentives which have been provided until now. It will require a great deal of time and effort and, in some cases, large teams of people will need to become involved. In some cases, providers may have to pay suppliers for benefits and services which they used to receive free of charge. In some cases, practices of the past will have to be exorcised. The industry has only six months to identify, analyze and find solutions to practices which may be in the interests of clients as long as they are offered in a way which does not constitute a COI.
B. The definition of Ownership Interest
An ownership interest does not constitute a financial interest but it is an interest which could cause a COI and which must be disclosed.
Ownership interest means:
(a) an equity or proprietary interest for which fair value was paid by the owner at the time of acquisition, other than an equity or a proprietary interest held as an approved nominee on behalf of another person; and
(b) includes any dividend, profit share or similar benefit derived from that equity or ownership interest.
Comment
The definition of ownership interest is narrow. It seems that one should disclose a shareholding in a company and dividends received where fair value has been paid at the time of acquisition. However, if fair value has not been paid, such as, if a product supplier has given share options to a provider at less than fair value, this would not be an ownership interest as defined, and would be a prohibited financial interest which is not permitted.
C. Any relationship or arrangement with a third party
The definition of COI includes this as an interest which could constitute a COI situation.
The definition of “third party” includes
(a) a product supplier;
(b) another provider;
(c) an associate of a product supplier or a provider;
(d) a distribution channel; (a separate definition of “distribution channel” 4 exists)
4 “distribution channel” means
(a) any arrangement between a product supplier or any of its associates and one or more providers or any of its associates in terms of which arrangement any support or service is provided to the provider or providers in rendering a financial service to a client;
(b) any arrangement between two or more providers or any of their associates, which arrangement facilitates, supports or enhances a relationship between the provider or providers and a product supplier;
(c) any arrangement between two or more product suppliers or any of their associates which arrangement facilitates, supports, or enhances a relationship between a provider or providers and a product supplier.
(e) any person who in terms of an agreement or arrangement with a person referred to in paragraphs (a) to (d) above provides a financial interest to a provider or its representatives.
Comment
The definition of “third party” is very wide. It stretches to associates of the supplier, distributions channels, and any contractual arrangements with other providers which might result in a potential COI. Service providers like Masthead and other broker networks, broker consultant franchise arrangements and the like would fall within this definition. Providers will need to apply their minds to the different types of relationships and arrangements which they have with third parties and assess whether these must be disclosed to clients as relationships which may be seen as having potential for causing bias.
(First published as Old Mutual Did You Know 6 of 2010)
D. Immaterial Financial Interest
A provider is permitted to accept and permitted to offer an “immaterial financial interest. An “immaterial financial interest” means any financial interest with a determinable monetary value, the aggregate of which does not exceed R1000 in any calendar year received by-
(a) a provider who is a sole proprietor;
(b) a representative for that representative’s direct benefit
(c) a provider, who for its benefit or that of some or all of its representatives, aggregates the immaterial financial interest paid to its representatives.
Comment
Suppliers will be able to provide a financial interest to a provider if it does not exceed R1000 per natural person per year. It is made clear that this may not be aggregated at provider level i.e.: a provider with 100 representatives cannot be allowed R100 000 to be used by 10 of its people. It has to be allocated on an individual basis. This low value will obviously mean that lavish and regular entertaining of representatives of providers will fall away and only the occasional modest meal or refreshments will be able to be provided in future. This will obviously be extremely difficult to monitor because the R1000 applies across all associated companies in a group. For example in a group like Old Mutual, it would extend to Mutual and Federal and Nedbank. In time, the FSB has indicated that it may be prepared to entertain submissions for this amount to be raised if it is shown to be extremely unworkable.
PROVIDERS AND THEIR OWN REPRESENTATIVES 5
5 This will also apply 12 months from 19 April 2010 i.e. 19 April 2011.
Although most of the rules apply inter provider, specific rules apply to providers in relation to “in house” practices which could compromise the objective performance of the representatives’ obligations to a client and which could lead to biased financial advice.
In this connection a provider may not offer any financial interest to its representatives for giving preference to:
- the quantity of business to the exclusion of the quality of service rendered to clients;
- a specific product supplier, where a representative may recommend more than one product supplier;
- a specific product of product supplier where the representative can recommend more than one product of that supplier
Comment
Product suppliers will need to conduct an audit of their in house competitions, recognition programs and service standards to ensure that they do not contravene the limited provisions which apply in house. This will also apply to broking houses who provide incentives to their representatives to prefer one product or supplier above another based on this prohibited basis. Certain organizations such as banking institutions which have product quotas with certain product suppliers may also need to review these arrangements in the light of the above.
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