- The Securities and Futures Commission has introduced a “suitability clause” for client agreements governing the sale of financial products by intermediaries.
- The clause will provide a mechanism for investors to claim contractual damages against an intermediary where the licensed person either recommends a financial product or solicits its sale and the product is not “reasonably suitable” for the client.
- The SFC expects intermediaries to commence reviewing and revising their client agreements immediately. The expectation is that agreements with new clients will comply well before 9 June 2017.
- Intermediaries should review and update their client agreements as soon as practicable, and, where necessary, re-execute existing client agreements.
The Securities and Futures Commission (SFC) announced on 8 December 2015 it is introducing changes to the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Code) including the incorporation of a new clause by all intermediaries into client agreements (New Clause).This follows consideration of submissions and representations made in response to two rounds of public consultation
The SFC has made it clear that it expects intermediaries to commence reviewing and revising their client agreements immediately. The long-stop date is to cater for intermediaries who “despite their best efforts encounter practical difficulties” when arranging the re-execution of agreements with existing clients. The expectation is that agreements with new clients will comply well before 9 June 2017. We recommend that intermediaries consider an appropriate approach to implementation at an early stage, to review and update their client agreements as soon as practicable, and, where necessary, re-execute existing client agreements; the regulator’s expectation is that intermediaries should generally be in compliance before the end of the transitional period.
Details of the changes and the regulatory rationale
New paragraph 6.2(i) of the Code
A new paragraph 6.2(i) of the Code introduces the New Clause which provides:
“If we [the intermediary] solicit the sale of or recommend any financial product to you [the client], the financial product must be reasonably suitable for you having regard to your financial situation, investment experience and investment objectives. No other provision of this agreement or any other document we may ask you to sign and no statement we may ask you to make derogates from this clause.”
Despite industry comments, the text of the New Clause is unchanged from that proposed in the second consultation on client agreement requirements (Second Consultation). It had, for example, been suggested that the SFC’s decision on the wording for the New Clause should be deferred until a review and discussions on the suitability requirement under the Code had been concluded. The existing suitability requirement under paragraph 5.2 of the Code requires intermediaries when making a recommendation or solicitation to ensure that the suitability of the recommendation or solicitation for the client is reasonable in all the circumstances.
These concerns were dismissed on the grounds that the SFC considers that
“the purpose and scope of the two exercises are [thus] very different”; “the study of the Suitability Requirement is a separate exercise on the requirement under paragraph 5.2 of the Code…The main purpose of the New Clause, however, is to enhance investor protection by filling an obvious gap through giving aggrieved investors a contractual right to claim damages if there is a breach of the suitability obligation under the New Clause”,
and therefore it is not necessary to delay the introduction of the New Clause until the review of the suitability requirement is complete.
The rationale behind the change is investor protection and the New Clause will provide a mechanism for investors to claim contractual damages against an intermediary where the licensed person either recommends a financial product or solicits its sale and the product is not “reasonably suitable” for the client.
Concerns were expressed during the consultation process that judicial interpretation and construction of the New Clause might be different from the approach taken by the SFC resulting to inconsistent standards and procedures. In response to these concerns the SFC noted that “the New Clause is a self-contained contractual term and does not cross-refer to the Code’s Suitability Requirement” and considers that
“there should not be any practical conflict arising from making the suitability obligation both a contractual and a regulatory requirement. If a Court gives referable guidance on the interpretation of the suitability obligation in the New Clause, the SFC would take such precedents into account when applying the Code’s analogous suitability requirement.”
Noting the upcoming changes to the professional investor regime which will take effect on 25 March 2016, from that date intermediaries providing services to “institutional professional investors” or “corporate professional investors” (as defined in the Code) will be permitted to rely on certain exemptions from Code requirements, including discretion to waive the need to enter into a client agreement with such investors. The SFC confirms in the consultation conclusions issued on 8 December 2015 that if an intermediary elects to enter into a client agreement with such a client it will not be required to include the New Clause (on the basis that the client agreement requirement itself can be waived). In the meantime, we assume a similar position will be taken in respect of the application to existing professional investors for whom client agreement requirements may be waived.
It should also be noted that there is no express carve-out from the requirement to incorporate the New Clause in a corporate finance context or for fund managers that do not contract directly with fund investors. However, existing paragraph 6.4 of the Code is unchanged. Under paragraph 6.4, if an intermediary acts under a restricted mandate which does not involve recommending or soliciting the sale of financial products it may use its discretion as to whether to include the New Clause. The SFC envisages there are very limited situations where intermediaries can rely on paragraph 6.4, but these could, for example, include ISDAs and other standard form international agreements.
New paragraph 6.5 of the Code
A new paragraph 6.5 of the Code was confirmed in the Second Consultation. This new provision prohibits the inclusion of terms in client agreements which are inconsistent with obligations of the Code or which misdescribe the actual services to a client. The requirement is to come into effect on the same day as the New Clause.
The new paragraph 6.5 and its related note provide:
“A licensed or registered person should not incorporate any clause, provision or term in the Client Agreement or in any other document signed or statement made by the client at the request of the licensed or registered person which is inconsistent with its obligations under the Code.
Note: This paragraph precludes the incorporation in the client agreement (or in any other document signed or statement made by the client) of any clause, provision or term by which a client purports to acknowledge that no reliance is placed on any recommendation made or advice given by the licensed or registered person.
No clause, provision, term or statement should be included in any Client Agreement (or any other document signed or statement made by the client at the request of a licensed or registered person) which misdescribes the actual services to be provided to the client.”
Where can I find out more information?
The SFC’s press release accompanying the consultation conclusions of 8 December 2015 is available here.
If you would like to discuss these changes please contact James Parker or your usual Norton Rose Fulbright contact.
 Consultation Conclusions on the Proposed Amendments to the Professional Investor Regime and Further Consultation on the Client Agreement Requirements (September 2014)