Hksi guidelines on selling investment products

A Guide to the SFC Code of Conduct
for Intermediaries and the Sale of
Investment Products
證監會中介人及
投資產品銷售之操守準則的指引

1 © Hong Kong Securities Institute
Published by:
Hong Kong Securities Institute
© Hong Kong Securities Institute 2010
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Disclaimer
This is a publication for providing general information on the topics and for training purpose
only. This publication does not provide any legal advice, financial advice or expert advice in
whatsoever form and is not intended to deal with all situations. For precise guidance or
advice to suit your particular circumstances, you should consult your own professional
advisers or contact the relevant authorities.
Hong Kong Securities Institute and individual contributor(s) or author(s) do not make any
express or implied warranties or representations of any kind (including but not limited to
accuracy, completeness, reliability, timeliness or fitness for a particular purpose) in relation
to content of this publication. No liability, responsibility or obligation for losses, damages,
costs or expenses suffered by or occasioned to any person acting or refraining from acting
as a result of or in reliance on any materials in this publication will be accepted by Hong
Kong Securities Institute and individual contributor(s) or author(s), whether or not due to any
error or omission in compiling information in the publication.
This guide has been translated into Chinese. If there is any inconsistency or ambiguity
between the English version and the Chinese version, the English version shall prevail.

Preface
Since its establishment in 1997, the mission of the Hong Kong Securities Institute (“HKSI”)
has always been to:
set standards of professional excellence and integrity for members and market
participants, and to provide the means of attaining them;
contribute to Hong Kong's role as a leading international finance centre; and
broaden the membership of professionals and enhance the capabilities and reputation
of members.
The HKSI has been offering licensing examinations for various regulated activities (except
for leveraged foreign exchange trading). It has also been providing Continuous Professional
Training (“CPT”) courses, certificate programmes, executive workshops and tailor-made in-
house courses to the financial services industry.
The aftermath of the financial crisis in 2008 and the Lehman Mini-bond debacle, saw a sharp
increase in demand for training courses on compliance of sales process of investment
products. In view of market needs, the HKSI has decided to launch a project (the ‘Project’)
that would include different kinds of training for members of the financial services industry. It
would include a guide, some lectures for our market participants; as well as a video
recording of the lecture to be viewed on our website.
The lectures will be delivered in English and Chinese (both Cantonese and Putonghua),
while the guide will be available in both English and Chinese (hardcopy and electronic
formats).
Although this Project is only a one-off exercise, we hope that through multiple means and
channels, the HKSI could reach out to more audience and extend the residual effect of these
training courses. For those people who cannot attend our lectures/discussion sessions; or
those who wish to review the lecture, they will be able to watch the video on our website, at
their convenience.
In order for market participants to acquire the most up-to-date information about the SFC
rules and regulations, the Project was scheduled to be launched in September 2010, so that
the latest conclusions from the SFC’s “Consultation Paper on Proposals to Enhance
Protection for the Investing Public” would be included in our training.
Being led by the Chief Executive, senior management staff of the HKSI formed a team to
work together on this major project, in which all the department heads of the HKSI were
involved.
After a rigorous selection process, Mr. Adam Samuel, an internationally renowned consultant
and expert in law, arbitration and complaint handling in the area of financial services was
chosen as the external consultant to work with us on the Project. Adam has practical
teaching and consultancy experience in financial services in Hong Kong. He has played an
important role in the Project. His assignments include the delivery of 3 lectures of which one
will be taped and available for viewing via the HKSI website; and acting as the leader of 9
discussion sessions. Adam’s assignment also includes the writing of this particular guide.

The main objective of this guide is to provide our fellow market practitioners, whether novice
or experienced, with a handy reference of the SFC’s Code of Conduct (“Code”) and various
circulars; as well as FAQs related to selling investment products to retail investors. However,
we would like to stress that this guide only serves as a quick reference for pedagogical and
training purposes. Market practitioners should always refer to the current SFC Code and
other relevant SFC publications when dealing with actual cases.
We would like to take this opportunity to thank Mr. Adam Samuel for his tremendous
contribution; and to Members of the Board, the Executive Committee and the Professional
Education Training Committee, for their guidance and support. Finally, we are grateful to
our staff for their dedication and hard work, which is critical for the success of the Project.
Barbara Shiu
Chairman
Hong Kong Securities Institute
September 2010

Table of Content
1 Introduction ................................................................................................................. 5
2 The General Principles................................................................................................ 6
3 Financial promotions or advertising.......................................................................... 6
4 Client agreements ....................................................................................................... 7
5 Know your customer – anti-money laundering checks............................................ 9
6 Know your customer in order to give suitable advice............................................ 10
7 Giving suitable advice............................................................................................... 16
8 Disclosure and the explanation of the advice ......................................................... 27
9 Execution-only, insistent customers, direct offers................................................. 30
10 Discretionary authorities .......................................................................................... 33
11 Professional clients .................................................................................................. 33
12 Executing the transaction......................................................................................... 35
13 Client assets.............................................................................................................. 36
14 Systems and controls ............................................................................................... 36

A Guide to the SFC Code of Conduct for Intermediaries and the
Sale of Investment Products
1 Introduction
1.1 The Securities and Futures Commission (the “SFC”) licenses and registers
individuals and businesses carrying on investment business. They must comply with
the Code of Conduct for Persons Licensed by or Registered with the SFC (the
“Code”) unless they are operating as a company offering discretionary management
to collective investment schemes. The point of this Guide is to deal with the
requirements that the Code imposes on people selling investments to or advising
members of the public to buy them. Unless the context suggests clearly otherwise,
all references here are to the Code. In recent years, compliance problems have
resulted in many millions of dollars of compensation being paid. The hope is that
advisers and managers reading this will learn not to repeat the mistakes concerned.
1.2 The Code does not operate in isolation. The SFC publishes a variety of
material on what it means: notably Circulars and the 2007 Suitability Obligations of
Investment Advisers (the “2007 FAQ”) on giving suitable advice. The Code was
amended slightly in 2010 following a Consultation Paper on Proposals to Enhance
Protection for the Investing Public of September 2009 and its Conclusions of May
2010 (the “May 2010 Conclusions Paper”). This is all supplemented by the 2003
Management, Supervision and Internal Control Guidelines for Persons Licensed by
or Registered with the SFC (the “Internal Control Guidelines”). There are other rules
on holding client assets and money and unsolicited real-time promotions all of which
must be read alongside the Code. Enforcement News provides brief descriptions of
various disciplinary matters. The Barber Asia litigation also gives one the Court of
Appeal’s view on some of the issues involved.
1.3 Breaches of the Code do not automatically entitle anyone to sue the firm for
any resulting losses. Nevertheless, the Code reflects the law reasonably closely and
breaches of the Code are admissible evidence. The SFC can take disciplinary
proceedings and suspend and fine individuals as part of that process where there
have been material breaches of the Code. Since under paragraph 12.3, firms must
handle complaints fairly, a significant breach of the Code can and often should result
in significant compensation payments.
In 2009, a number of firms agreed with the SFC to buy back Lehman Mini-bonds they
had sold to customers which cost the companies many millions of dollars.
1.4 Rather than just describe the Code, this handbook is going to go through the
process by which a financial adviser actually does business with a client. This starts
with advertising, leads to a client agreement and then whatever service is being
promised. Finally, if there is a problem, firms must handle complaints properly. To
introduce all this, we will begin with a look at the General Principles that underpin the
whole Code.

2 The General Principles
2.1 The Code has nine General Principles followed by 16 “paragraphs” or sections.
It is important to focus on the General Principles because occasionally they change
the meaning that one would otherwise give to the rest of the Code. They are easy to
understand and cover much of the ground dealt with in the Code.
2.2 The General Principles 1, 2 and 7 require people to act honestly, fairly, with
due skill, care and diligence, in the best interests of their clients and the integrity of
the market, and comply with all regulatory requirements. General Principle 5 requires
adequate disclosure of relevant material information in the firm’s dealings with the
customers. This creates a formidable set of basic rules for dealing with customers
which puts their interests clearly ahead of the firm.
2.3 To achieve this, General Principles, 3 and 9, require the firm to have and
employ adequate resources, procedures, systems and controls to ensure appropriate
standards of conduct. Individuals within businesses are responsible for the areas that
they actually or appear to accept authority over.
2.4 Finally, General Principle 6 requires firms to avoid conflicts of interest where
possible and ensure fair treatment where this is not an option. General Principle 8
requires client assets to be promptly and correctly accounted for and safeguarded.
2.5 On top of the General Principles, there are two more paragraphs 2 and 3 which
elaborate further. So, under paragraph 2.1, communications must be accurate and
not misleading when a firm advises or acts on behalf of a client. Supporting General
Principle 1, paragraph 2.2 insists that firms must deal, advise, provide margin lending
and charge fairly and reasonably and in good faith. Similarly, paragraph 3.10 requires
that firms act in their clients’ best interests. This elaborates on General Principle 2
also, which covers due skill and diligence. Paragraph 3 is entitled diligence. Under
this, advisers must execute orders promptly in accordance with clients’ instructions
and on the best available terms and promptly and fairly allocate transactions to
clients. Above all else, paragraph 3.4 requires diligent and careful advice when
providing that type of service.
3 Financial promotions or advertising
3.1 One starts with the General Principle 5 requirement of adequate disclosure of
relevant material information. This means a clear and fair presentation of both the
positive and the negative features of any promotion. Paragraph 2.3 of the Code bans
invitations and advertisements from containing false, disparaging, misleading or
deceptive information.
An advertisement for an investment in an equity or corporate bond fund which refers
to the lower returns usually obtainable from a bank must say with equal prominence
the fact that the capital in bank deposits are extremely unlikely to go down in value
unlike the fund advertised.

3.2 Advisers must be aware of the general prohibition of cold-calling in the
Securities and Futures (Unsolicited Calls-Exclusion) Rules. Personal visits and
telephone calls are essentially banned.
In June 2009, the SFC fined a firm and banned its responsible officer for nine months
in part because of a breach of the cold calling rules.
In its May 2010 Conclusions Paper, the SFC commented on the overriding principle
in this area in the context of structured products:
“Advertisements must not be misleading, and must present a balanced picture of the
structured investment product with adequate and prominent risk disclosure.
Therefore, a “balanced” advertisement is expected to contain, at least, a brief
description of the key derivative components in the context of the risk and return of
the structured investment product. …. Highlighting the relevant warning statements is
of paramount importance for investor protection.”
On a more mundane note, a new paragraph 3.11 introduced in 2010 bans firms from
offering gifts other than a discount of fees or charges as part of a promotion of a
specific investment.
4 Client agreements
4.1 Paragraph 6 of the Code deals with this important subject. The client
agreement sets out the firm’s and customer’s expectations. Before any services are
provided, the firm must enter into a written agreement with the client in whichever of
Chinese or English the client feels most comfortable. The firm must directly draw the
relevant risks involved to the client’s attention.
4.2 The minimum content of the client agreement
Paragraph 6.2 sets out the minimum content of the agreement. It must contain the
full name and address of the customer and the licensed or registered person’s
business including its status with the SFC and his or her CE number. For most
standard retail arrangements, (d), (e) and (h) are the critical sub-paragraphs. The
agreement must describe the nature of services available such as
• Investment advice;
• Discretionary account;
• Portfolio management;
• Unit trusts;
• Securities cash/margin account;
• Futures/options account; or
• Leveraged foreign exchange trading account.
This is vital. The firm has an opportunity to explain what will or will not be offered.
Advisers must not promise levels of service such as ongoing monitoring if their firm
cannot deliver this safely.

4.3 The customer will be paying for these services and a description of that
remuneration and the basis for it must also be set out, regardless of whether it takes
the form of commission, brokerage costs or any other fees and charges.
4.4 The parties must promise to notify each other of any material change to the
information concerned. This does not apply where the service consists of a one-off
transaction.
4.5 Paragraph 8.1 insists that firms should provide adequate and appropriate
information about their business, covering contact details, services available, the
identity and status of staff and agents with whom the customer may have contact.
The new paragraph 8.3A added in 2010 requires in any event that firms deliver to the
client in writing prior to or at the point of sale: the capacity (principal or agent) in
which the firm is acting, any affiliation of the firm with the product provider, monetary
and non-monetary benefits, and terms and conditions in generic terms under which
customers may receive fees and charges discounts. If written disclosure is not
possible before or at the point of sale, the material must be provided in that form as
soon as practicable. Much if not all of this material except perhaps the disclosure of
monetary or non-monetary benefits can sensibly be covered in the client agreement.
Likewise, where staff represent more than one company in a group, the identity of the
company or companies concerned must always be made clear.
4.6 Paragraph 6.3 also forbids firms from restricting any client rights and any
obligations owed by the firms. Nevertheless, the client agreement can restrict the
services being offered.
4.7 Overall, the client agreement must be used as an opportunity to set out the
parties’ expectations of what will happen between them. As the SFC pointed out in
the 2007 FAQ 8:
“Investment Advisers should establish and define their relationships with each client
by way of a client agreement before providing services to the client. The client
agreement should define rights, obligations and responsibilities of each party and
properly reflect the nature and scope of the services to be provided.
For those Investment Advisers who provide continuous services to clients, they
should review each of their client agreements on a continuous basis to ensure that
the nature and scope of the services they provide to each client is properly updated
and recorded.”
In February 2010, the SFC suspended an individual for 5 months for falsely
representing that the individual had explained the client agreement and the attached
risk disclosure statement to the client.
4.8 Finally, paragraph 6.3 also requires firms to observe the terms of the
agreement.
4.9 The risk warnings
Paragraph 6.2 (h) states that the risk warnings in Schedule 1 to the Code must also
be included. The Schedule itself says that the stipulated disclosures are the minimum
acceptable ones. First, though, there is a declaration by staff and acknowledgement

by clients that the disclosure was given in the customer’s preferred language
(between Chinese and English), and that the customer was invited to read the risk
disclosure statement, ask questions and seek independent advice. The risk warnings
themselves must only be given if they are relevant to the service being offered. They
cover
• Securities trading;
• Futures and options trading;
• Leveraged foreign exchange contracts;
• Growth enterprise market stocks;
• Margin trading; and
• NASDAQ-AMEX securities trading at the Hong Kong Stock Exchange.
4.10 Further standard warnings must be used
• where client assets are received or held outside Hong Kong;
• the client is providing an authority to the firm to repledge securities as collateral;
or
• where the firm is to hold mail or send it to third parties.
4.11 For margin or short selling facilities, terms relating to margin requirements,
interest charges, margin calls and the circumstances in which positions may be
closed without customer consent have to be set out. For derivative business, such
as futures or options, the agreement must say that the firm will give the client on
request product specifications and any prospectus or other offer documents. It must
also explain margin procedures again including the procedures for closing a position
without customer consent.
5 Know your customer – anti-money laundering checks
5.1 As part of the process of beginning the client relationship, the adviser must
carry out checks to verify the client’s identity and the source of his or her investment
funds. Paragraph 5 covers this topic. If the client agreement is not concluded in the
presence of an employee of the firm, the client must sign in front of and show
relevant identity documents to another licensed or registered person, an affiliate of a
licensed or registered person, a JP (Justice of the Peace) or a professional such as a
bank branch manager, certified public accountant, lawyer or notary public.
Certification services available from Hongkong Post can also be used.
5.2 An alternative approach to this is to require the customer to send to the firm a
signed physical copy of the client agreement with a copy of his or her identity card
and then the firm must cash a cheque for at least HK$ 10,000 with the client’s name
issued by the new customer and drawn on the client’s account with a Hong Kong
licensed bank. The signatures on the agreement and the cheque must be the same
and the customer must be told of the account opening procedures, notably that the
account will not be activated until the cheque is cleared. Records must show that
this process was correctly followed.
5.3 Paragraph 5.4 lays down a broader requirement to be reasonably satisfied
about the identity, address and contact details of the person or entity originating

instructions and the person that stands to gain or lose from it and the precise nature
of that instruction before implementation. Where a collective investment scheme
makes the instruction, the relevant individuals are not unit-holders but the scheme or
account and its manager. This material must be stored in Hong Kong and available
for SFC’s inspection.
6 Know your customer in order to give suitable advice
6.1 The basic rules
6.1.1 Paragraph 5.1 requires firms to take all reasonable steps to establish
each client’s financial situation, investment experience and investment
objectives. It is important to note that there is no exemption here for execution-
only business.
6.1.2 Paragraph 5.2 contains the central requirement that advisers use
reasonable care to give suitable advice that is the vital background to
paragraph 5.1. The fact-finding has to serve the purpose of creating suitable
recommendations. Actually the Code refers to “recommendation or solicitation”.
So, when an adviser contacts a client with a suggestion or some type of
encouragement to enter into an investment, the obligation to use reasonable
care to ensure the product’s suitability applies.
6.1.3 The fact-finding duty under Paragraph 5.1 relates to the information
about the client that the firm ought to be aware of through exercising due
diligence. Paragraph 3.4 expands on this. When providing advice, the firm must
act carefully and ensure that its advice is based on “thorough analysis and
takes into account available alternatives”. Clearly, the obligation is not just to
“know your customer” but to know other relevant facts about investments, the
markets, risk involved and the like. Paragraph 3.10 reinforces this by insisting
that in general, firms should act in their clients’ best interests.
6.2 Putting the rules into practice – general concerns
6.2.1 In the 2007 FAQ 2, the SFC stated that it is the positive obligation of
investment advisers
“to seek information from clients about their financial situation, investment
experience and investment objectives. In order to better understand this client
information, Investment Advisers should collect from each client information
that includes their investment knowledge, investment horizon, risk tolerance
(including risk of loss of capital)”.
6.2.2 As one can see from this, advice that is in the customer’s best interests
must meet two different types of concern. The first is whether viewed
objectively the recommendation is appropriate. The second is that any
recommendation must conform to the customer’s wishes, hopes and
expectations.

An example of these two types of concerns occurred when a customer
contacted an adviser looking for a property fund recommendation to invest
some money in the two years prior to a substantial property purchase. A fund
was duly recommended. The sale, however, was not suitable for the client
because the short period for investment was inconsistent with the charges
involved and the nature of the fund. In this sense, advisers do not take orders
from clients. They give impartial advice on what is suitable bearing in mind
the customer’s feelings, wishes and the like.
6.2.3 The fact-find must be a neutral objective account of the customer’s
position and wishes. Otherwise, it can appear that the fact-finding information is
being compiled to suit the investment being sold. A sudden increase in
customers with particular features would cause alarms and suggest that the
fact-finding is not accurate. Equally, an investigation into the customer’s actual
circumstances may reveal that he or she had been “shoe-horned” into the
requisite profile. It is vital that advisers always have the option of
recommending no change if they are to give compliant professional advice.
In one case, the suitability report indicated that the customer particularly
wanted the asset mix: “Equities 41.8%; Property 34.6%; Bonds 21.8%; Cash
1.9%.” It was hard to believe that the previously cautious investor had come
up with such numbers.
6.2.4 A difficult area concerns the amount of detail that needs to be obtained
about other family members, in particular spouses and other life partners.
Customers are entitled to handle their finances independently. Yet, the
availability of assets or the existence of liabilities in a spouse or other
household member can change the situation completely. Similarly, it may be
fiscally intelligent to put assets into a spouse’s name to take advantage of
different tax statuses. Advisers should always ask about life partners or
spouses and other family members who are dependent on the customer or on
whom the client in some way depends. This is part of the process of forming
the picture of the individual’s financial position. Equally, though, if a customer
declines to give the information concerned or indicates that he or she keeps his
or her finance separately from a partner, this should be respected although
carefully noted.
6.2.5 The dangers of family financial planning are considerable. The adviser
cannot give advice about passing assets amongst family members without a
great deal of up-to-date information about the personal relationships involved.
In its most extreme form, family financial planning can produce impossible
conflicts of interest.

An adviser was arranging investments and general financial planning for a
couple to provide for their children. On the way out of the meeting and before
the advice had been prepared, the husband told the adviser as he walked to
his car that he also had an illegitimate child for which he wanted the same
arrangements without the wife knowing about them. The adviser immediately
withdrew from giving advice. He could not disclose why without breaching his
client’s confidence. He could not advise on family finances as a whole since
he was also being asked to provide for some extra investment for the child on
whose education financing he had not originally been asked to advise.
6.3 Discovering details about the investor’s financial position
6.3.1 The traditional approach reflected in the Code is for the adviser to take
reasonable steps to gather all relevant information about his or her client and
then make suitable recommendations. However, the Code only refers
specifically to the customer’s financial situation, objectives and experience. The
adviser must take reasonable steps to learn about the customer’s assets and
liabilities, income and outgoings, both fixed and discretionary. Employer
benefits and pensions and those held separately must all be noted.
6.3.2 Anticipated income from whatever sources must be noted although it
may not be appropriate to base a recommendation on it since its arrival and
timing may not be certain. The adviser must assess whether the customer can
fund any regular commitments to savings products or margin calls before
recommending products which could involve these.
6.3.3 Before making recommendations, competent advisers take copies of
the information on which their advices are based and do not rely on their
clients’ recollection of their assets and liabilities. For example, it is easy to
obtain from an investment provider or employer (with the client’s permission)
details of much of what is being discussed here. When making
recommendations about loans, notably savings designed to repay them, not
seeing the loan could result in bad advice being given.
The adviser recommended an investment product to repay an interest only
loan. The customer later denied that such a loan existed. Nobody could find
any trace of it. The adviser being the only person with an obvious motive to
“invent” the loan found himself or herself in trouble with the authorities.
Actually, if the loan had been a deferred interest one where some of the
interest is added to the original amount borrowed, the investment product
would have been designed to generate an insufficient sum of money to repay
the loan.
6.3.4 Advisers must research investments held through other companies as
well as their own even if they are restricted to advising only on their own
companies’ products. Recommending a new investment with its attendant
charges would not be acceptable if the old product offered a cheaper or more
appropriate option for the client. The adviser must find out the nature of the
funds already held because it will affect the balance of the customer’s portfolio.
For example, if the customer holds funds with high equity content, adding
further similar funds will increase the customer’s reliance on that asset class.

6.4 The customer’s objectives
As part of the task of ascertaining the customer’s objectives, the adviser must
ascertain the purposes for which the investment is being made and the
timescale involved. This is often connected to other personal data, such as age,
retirement plans and personal life changes. A customer may wish to fund
further education for one or more children, creating the need for liquid funds of
particular amounts at certain dates. Again, one should note the need to keep
these figures realistic both in terms of what the customer can afford and the
actual expenses involved. Those giving advice in this area need access to the
relevant information about expected increases in education costs.
6.5 The experience and knowledge of the customer
6.5.1 Levels of previous experience may also be vital. Recommending a
derivative based product to someone who has no investment experience is not
very sensible. The customer will not understand the product particularly if it is
complicated and will not appreciate when to dispose of it and the
consequences if it does not perform as expected. Experience may be acquired
by professional training or experience of trading or operating in a particular
area. One should, though, be careful not to assume too much knowledge from
a professional qualification. An accountant, for example, may be very
knowledgeable about personal taxation. This does not make the individual an
expert in derivatives.
6.5.2 Paragraph 5.3 requires firms providing any service in relation to
derivative products, including futures contracts or options, or any leveraged
transaction to assure themselves that their clients understand the nature and
risks of the products as well as having the resources to assume the risks and
bear the potential losses involved. A new paragraph 5.1A specifically requires
firms to assess and characterize their clients’ knowledge of derivatives. This
also applies to execution-only and other non-advised transactions.
6.6 Attitude to risk
6.6.1 The idea of attitude to risk
The most important and difficult aspect of fact-finding is ascertaining the
customer’s attitude to risk. Without the customer’s feelings about risk, no
investment advice can sensibly be given. Attitude to risk is an elusive concept.
It probably means the customer’s feelings about a range of adverse outcomes,
ranging from acceptance to anger. The adviser should only recommend
products where negative or disappointing results can be tolerated or accepted.
Again, one is concerned both with the risk that the customer is comfortable with
and that which the customer sensibly should tolerate. A recommendation must
meet both tests. For example, a customer with limited resources and
outstanding debts should not be regarded as a high risk investor just because
he or she has indicated that on a fact-finding form. It is part of the adviser’s job
at the very least to warn customers not to accept risk when a reasonably
plausible negative outcome could be disastrous to a vulnerable customer.

6.6.2 The traditional point-scoring approach
6.6.2.1 A traditional approach now largely discredited was to give a
point score to customers’ attitude to risk and then recommend
investment in those products which received a similar risk score. There
are a number of problems with this approach. Any points scoring system
depends on the reliability of both the assessment of the customers’
attitude and the product and has to be done using the same approach to
both. So, if the adviser concludes that the customer is a cautious
investor, meaning to him or her that the customer does not want to take
any risk with his or her capital, and recommends what another
organization calls cautious even though there is some or significant risk
to the investor’s capital, this is not a suitable recommendation. The
bigger problem is that one customer’s attitude to money and risk varies
considerably depending on the area of investment, the goal sought to
be achieved, the origin of the money and other factors and may differ
further as to his or her response to different negative outcomes, ranging
from losing all his or her investment and a small dip in his or her capital.
6.6.2.2 Human beings do not fit into “little boxes”. They are too
varied. With that in mind, psychometric risk tests which are becoming
more popular need to be handled with care. They are known to being
susceptible to changes in the market. They also do not pick up the
nuances in the way people regard different types of risk. At best, such
tests if proved to be reliable may be regarded as useful guides.
6.6.3 The risk of capital loss
6.6.3.1 The most classic risk attitude relates to capital loss. The
adviser must note the customer’s feelings about the possibility of some
or total capital loss. If the customer is unhappy tolerating that outcome,
it should not be an option.
6.6.3.2 Attitude to capital loss must be assessed not just generally
but with respect to the area of investment under discussion and the
actual money whose potential investment is being discussed. The
answers to all three may be different.
Some customers would regard an inheritance as requiring caution out of
respect for the wishes of deceased elders. Others might take the view
that it is supplementary cash that is not necessary for the household
and can be gambled. Again, the financial position of the investor may
have significant impact here with indebted or illiquid clients unable to
take the same adventurous attitude as those without such difficulties.
6.6.4 The risk of not meeting an objective and the effects of timescales
6.6.4.1 Attitude has to be assessed against the customer’s objective.
A wealthy customer may seek to put money aside in a tax efficient way
to save for a grandchild’s education. It is important to find out whether
and the extent to which the customer could tolerate the investment not

producing sufficient returns to meet the goal in question. If the
customer has access to other funds or knows that the child’s parents do,
the customer may easily tolerate that result. Otherwise, a more cautious
approach is needed. Issues have arisen where the customer has taken
out savings plans in order to repay the capital of interest-only home
loans. In that situation, it is vital that the adviser notes clearly the
customer’s feelings about the possibility not just that the plan may go
down in value but that it may not go up sufficiently to meet the
indebtedness. This attitude to mortgage risk must be carefully noted
separately.
6.6.4.2 The time for investment can affect a general risk profile.
Where an objective must be achieved in a short time or the customer is
due to retire and wants to accumulate the money only up to that point,
this can reduce the customer’s appetite for risk. In effect, the brevity of
the investment period increases the riskiness of otherwise more
cautious investments.
6.6.5 Attitude to different asset types
6.6.5.1 Having ascertained the customer’s attitude to risk in these
ways, the adviser also needs to find out the customer’s feelings about
investments falling outside his or her normal attitude to risk. Some
clients object to certain types of investments with particular possible
negative outcomes. So, the adviser must stay strictly within the
parameters of the risk assessment. Other customers are content in the
interests of balance to have a more adventurous product to balance out
greater caution than is required in other parts of the portfolio.
6.6.5.2 Another area of investment enquiry linked but not the same
as risk is the customer’s feelings about different types of investments
that may be contemplated. For ethical or religious reason, some
investors may object to certain types of funds. The more common way
in which such enquiries are conducted relates to the ascertainment of a
precise level of risk with which the customer is comfortable. Before
making a recommendation, an adviser would be well advised to check
with the customer that he or she is content to be investing in a particular
asset type with the negative features associated with it.
6.6.6 Changing attitudes to risk
A tell-tale sign of compliance problems with risk profiles is where the declared
attitude differs significantly from that reflected in existing investments, typically
in the more adventurous direction. There is no inherent reason why a
customer’s risk profile should not change particularly as regards the different
areas of risk discussed. Nevertheless, such shifts should be explained properly
on the fact-finding form or other documentation in some detail particularly if the
change is significant.

6.7 Declining to give answers
Where a client declines to give answers to questions, the adviser must still
make an assessment of the customer’s attitude to risk, expectations and the
like, and should explain the inherent limitations of the advice given and the
assumptions made. This was made clear in the 2007 FAQ 2.
The Court of Appeal in the Barber Asia disciplinary case rejected the argument
that the customer might have other undisclosed assets. Stock JA commented:
“that fact does not absolve an adviser from advising on the basis of what he
knows and assessing on the basis of what he knows whether a product is
suitable….”
7 Giving suitable advice
7.1 At its simplest level, the requirement to give suitable advice is about finding
products that suit the customer’s factual situation, including his or her wishes and
aspirations. Actually, that often may not represent good advice. The correct answer
may be to do nothing or to make a change in the customer’s finances which does not
have anything to do with buying a product or investing in a fund. Perhaps, the
customer had debts which should be repaid first or insurance needs which ought to
receive a higher priority.
7.2 Who is the customer?
7.2.1 The advice given must be suitable for the customer. However, some
doubts may arise as to the identity of that person, particularly where the elderly
and infirm are concerned. The adviser must establish clearly whose money is
involved. Otherwise, he or she risks becoming involved in efforts to defraud his
or her client.
7.2.2 The Internal Control Guidelines makes the need for this clear in control
guideline VII.1 “Management establishes and maintains processes to obtain
and confirm information regarding every client in relation to establishing the
true identity of the client, the beneficial owner(s) and person(s) authorised to
give instructions.”
In one case, the client’s daughter who held a power of attorney for her mother
approached the adviser for advice on investing the mother’s money. The
adviser went along with the idea of putting the product into the daughter’s
name “for convenience”. This had the effect of allowing the daughter to steal
her mother’s money and not necessarily apply it wholly for her mother’s
benefit. Matters could have become worse if the daughter had died leaving
her estate to her husband who might have fallen out with his mother-in-law in
the past!

7.3 A limited range of products or providers
7.3.1 A common problem in this area is that advisers may have a limited
range of providers and products that they are allowed to recommend. The
requirement to give suitable advice still applies. If nothing in the range is
appropriate, the adviser must not suggest the least unsuitable product that he
or she can sell. Equally, an adviser must take reasonable steps to recommend
the most suitable product from the range that he or she can sell. One
sometimes observes firms who recommend higher commission paying
investments which, by definition, tend to be more expensive for the customer.
There may be other features such as tax treatment which favours one type of
product wrapper over another.
7.3.2 Any recommendation must then be both suitable and the best available
from the range of options for the customer bearing in mind his or her objectives,
timescale for investment, attitude to risk, knowledge and experience of
investments, wishes, fears, aspirations and ethical beliefs. Sometimes, advice
simply cannot meet all these demanding requirements. While the adviser can
assist the customer to prioritise his or her needs and moderate expectations, it
is not possible to give suitable advice to the customer with conflicting objectives.
An example would be a customer who wants a high level of income without any
risk to his or her capital. Sometimes, the best way to comply with the Code is
not to give any advice and lose the customer, or to have further discussions to
agree on some sensible objectives.
7.4 Dealing with the customer’s circumstances
Sometimes, information gathered from the investor indicates a particular timescale
for investment. This must be strictly honoured. For example, a customer approaching
retirement has a lower appetite for risk than the same person 10 or 20 years younger.
When no longer working, customers cannot make up investment losses through
earnings or just patience. They tend to need to take increased levels of income all of
which makes their existing investments riskier. Similarly, the customer wishes to
purchase property in the short term should not be recommended a higher risk
product because the short investment period accentuates any risk element in the
investment. It greatly increases the probability of overall capital loss on the
transaction. With a short-term investment, products designed for longer periods tend
to have larger initial charges rendering them unsuitable anyway.
7.5 The customer’s experience
General Principle 4 and paragraph 5.1 specifically requires investment advisers to
have regard to the client’s “experience”. To give suitable advice, the adviser has to
go further. He or she must only recommend products that the customer can
understand. Where a customer has limited comprehension of financial matters, the
adviser must be exceptionally cautious. An investor holding an over-complicated
investment does not know when to hold or encash it, or even seek advice about it.

7.6 Know your product
7.6.1 Generally
7.6.1.1 While investment advisers focus rightly on knowing their
clients well before giving advice, there is another “know your” with which
advisers need to familiarise themselves: know your product. A common
danger arises when investment advisers make recommendations of
investments they do not properly comprehend. Unsurprisingly in this
situation, the investment adviser tends to recommend complex products
to the wrong investors.
7.6.1.2 The SFC emphasised this “know your product” obligation in
the 2007 FAQ 3:
“Investment Advisers should not recommend investment products which
they do not understand. They should conduct due diligence work in
selecting appropriate investment products for each client.”
The same FAQ explains further what this due diligence involves:
“Due diligence involves Investment Advisers developing a thorough
understanding of the structure of investment products, how they work,
the nature of underlying investments, the level of risks they bear, the
experience and reputation of product issuers and service providers, fees
and charges, the relative performance and liquidity of investment
products, lock-in periods, termination conditions, valuation and unit
pricing, and safe custody arrangements.
Depending on the nature of the investment products and services
provided to clients, other factors which Investment Advisers need to
consider include market and industry risks, economic and political
environments, regulatory restrictions and any other factors which may
directly or indirectly impact on risk return profiles and growth prospects
of investments.
Investment Advisers should make their own enquiries and obtain full
explanations from product issuers about the risks inherent in the
investment products. It is not advisable for Investment Advisers to rely
on prospectuses, offering circulars or marketing materials as
necessarily being self-sufficient and self-explanatory.”
7.6.1.3 The 2007 FAQ 3 emphasises that this product verification
must be fully documented, particularly the criteria for selecting the
products, the features that lead them to be considered to be suitable for
different types of investors, and the approvals that need to be received
from senior management before these products are promoted. This
whole process must be done on a continuous basis to ensure that it
remains up to date.

7.6.2 Aspects of “know your product”
7.6.2.1 Fund content
7.6.2.1.1 Advisers have to be familiar with products they
advise on from a number of different angles. First, they need
to know what is in the investment being recommended.
What is the asset mix within the fund concerned? This is
important in determining the level of risk involved and in
ensuring that the customer has a sensible blend of asset
types. Research has shown that one can reduce risk by
holding asset types whose movements in value do not
correlate with each other. Regardless of the theory, it is
important that investors do not have too high a proportion of
their investments in the same asset types in order to reduce
the risks involved. One can find high equity holdings in
apparently medium risk or managed funds which if
increased without regard to this can generate surprisingly
concentrated amounts of risk. A stock market fall can have a
massive impact on a family’s finances in this way.
Vulnerable customers such as the elderly may not be able to
make up losses through employment.
7.6.2.1.2 It was mentioned earlier that there is a real
danger of just assessing a customer as cautious and
selecting cautious fund if the customer’s attitude to risk and
the fund labels are determined using different criteria. Labels
for funds can be very misleading. One finds “cash” funds
with considerable exposures to asset backed securities,
notoriously sub-prime mortgage debt. When confidence in
such asset types disintegrates or there are fears of
substantial defaults, such products do not behave like cash.
For the purposes of short-term access, they demonstrate
high degrees of volatility. A common problem with bond
funds is that they vary from those holding principally very
highly rated debt and Government stock to those investing in
junk bonds with most things in between. There is nothing
inherently wrong with this. However, the adviser must
understand the nature of the assets being recommended so
as to be able to decide whether they meet the customer’s
needs.
7.6.2.1.3 Hedge funds or, more commonly in the
consumer arena, funds of hedge funds create complicated
assessment problems. Since there is no formal definition of
a hedge fund, the assets held within them conform to no
particular type. It is often argued that they can reduce risk in
market downturns through the use of counter-cyclical
strategies. Nobody is arguing that one cannot make money
through hedge funds. The problem is identifying what assets
they correlate with and what the risks involved represent.

For this reason, the SFC issued on 1st
April 2003 its Circular
to Intermediaries on the Marketing of Hedge Funds. It
contained a reminder for intermediaries to take all
reasonable steps to establish the “financial situation,
investment experience, investment objectives, time horizon
and risk tolerance of the client. This will help intermediaries
to properly assess their client’s ability to bear the financial
risks and potential losses that may arise from investing in
hedge funds.”
7.6.2.2 Rights or powers given to customers by a product
7.6.2.2.1 Some investments give the investor different
types of rights. With a guaranteed investment, the customer
is receiving a promise from a third party that certain things
will happen. The adviser must assess the strength of that
guarantee. This may change with time.
The effective collapse of Bear Stearns in March 2008
triggered of press stories that week that Lehman Brothers
could be the next investment bank to fail. This completely
changed the nature of any guarantees offered by that
investment bank. So did the downgrading of the bank’s
credit rating in June that year.
7.6.2.2.2 Sometimes, the problem is not so much with the
strength of the guarantor as the nature and scope of the
promise involved.
Precipice bond is a good example of this. Under these
structured products, investors received three promises: a
percentage of the growth of a particular index over a fixed
time period, a guarantee if the index concerned fell up to a
certain level and then beyond that level, the loss of twice the
index fall. It is extraordinarily difficult to find an investor who
wants the benefits of the guarantee for which he or she is
prepared to give up some of the investment growth
otherwise available through a tracker product but who does
not mind the “two for one” losses in the product’s value in
the event of the index falling below a certain level.
Understanding this should have persuaded advisers to avoid
this product which has generated large losses.
7.6.2.2.3 One of the problems with Lehman Mini-bonds is
that capital and income losses could occur in uncertain
amounts and proportions in the event of a number of
companies in a variety of different commercial areas and
countries failing. An inherent problem with anyone
recommending Lehman Mini-bonds was that it was unclear
what events would trigger which precise consequences.

The Press Releases in 2009/2010 announcing that two firms
had agreed to buy back the Mini-bonds they sold,
emphasises the regulator’s concerns as to “the adequacy of
measures implemented ….to review and evaluate the nature
of and risks associated with… Mini-bonds; and … of training
and guidance given to sales staff on Mini-bonds to enable
them to understand the product and all its material risks”.
7.6.2.2.4 One can see similar problems identifying the
nature of the investor’s rights in almost every sphere of
financial advice.
For example, a film partnership sounds straightforward until
one realises that the film company is going to allocate a
proportion of its general running costs to the films involved in
the deal. It can be important to know whether the fairness of
this allocation is being independently monitored or audited.
7.6.2.3 Gearing and other features
7.6.2.3.1 Products with extra features may generate
significant higher levels of risk for investors which the
advisers must be able to take into account when making
recommendations.
An example of this is geared traded endowment policies
(GTEPs) which have given rise to problems in a number of
different countries. These are essentially second-hand
savings plans. They were being sold to customers who were
being advised to borrow the purchase price. In all probability
the underlying savings plans will return more than the
premiums paid into them. Unfortunately, this is not the only
risk to which the investor is exposed. He or she may have
overpaid for the policies and their premiums previously paid
into them. They are exposed to the risk that the plans will do
well but not well enough to return the price they paid. Even if
the product achieves that, it must also do better in order to
finance the interest payments on the loans taken out. This is
a problem with all geared investments. In the GTEP context,
one has a combination of modest investment risk,
substantial pricing risk and the need to outperform the loan
costs in order just to break even. The outcome has all too
often been unacceptable.

7.6.2.3.2 The managing of gearing may require further
measures to protect investors.
In January 2010, the SFC issued a circular reminding
advisers who provided margin financing to their clients to
buy Offer Shares of the United Company Rusal Limited to
“set a prudent credit limit” for each client taking into account
the customer’s financial situation. Intermediaries doing this
were also required to “monitor the overall financial risks
arising from the provision of margin financing on the Offer
Shares and manage the aggregate exposure to the Offer
Shares.”
Another example is the Barber Asia case
A consumer successfully sued her advisers who were in turn
suspended by the SFC, both decisions essentially upheld by
the Court of Appeal. The customer had a life assurance
investment plan with most of her savings in it. The adviser
recommended pledging it to a bank in order to borrow a
Japanese Yen loan worth two and a half times as much,
through which the customer would acquire another life
assurance investment product. This all depended on the
Yen going down against GB pounds. It did not and the effect
was that the lender made two margin calls, the first of which
resulted in the customer borrowing further amounts and the
second led to the liquidation of two policies and the
repayment of the loan. The Securities and Futures Appeal
Tribunal concluded that the adviser “had failed properly to
assess the suitability of this investment to this particular
client notwithstanding her announced, and admitted,
increase in risk profile.”
7.6.2.3.3 Accumulators
7.6.2.3.3.1 The product
A problem emerged in 2008 with accumulators. These
involved the customer being committed to buy a
particular share at a “discount” on the basis that they
would invest regular sums to buy the share at the same
price on a daily or weekly basis throughout the term of
the contract. If the share price reached a certain point,
typically, a 4% rise, the accumulator was then knocked
out or terminated and the customers received their
money back with interest at above the market rate.
Where the share fell below the discount level, the
commitment to purchase was now at above the prevailing
market price of the share.

7.6.2.3.3.2 The problem
Essentially, customers were set to make money if the
stock price remained broadly still but large movements
upwards would just result in the termination of the
arrangement. Movements down could cost investors a
considerable amount. This was then aggravated by the
sale on margin of these accumulators which led to margin
calls aggravating a losing position.
7.6.2.3.3.3 What was significant here was the huge
downside risk to investors as opposed to the limited
upside. The other problem was the difficulty in
understanding the effects of significant market
movements on this investment, and the way in which it
closed down in the event of a fairly limited rise in the
stock. Such a complex product was not considered
appropriate for an unsophisticated investor. Those
recommending this idea even to sophisticated investors
still had to explain to them how it all worked and the
nature of the upside and downside involved. As the SFC
pointed out in a 2008 Press Release on the subject:
“Regardless of who the client is, the sale process for all
securities and futures products - by both banks and SFC
licensees - is governed by the Code of Conduct for
Licensed and Registered Persons. This requires
intermediaries to explain to the clients the products and
the risks involved.“
Anyone giving advice on these products has to
understand customer’s attitude to risk, objectives, fears
and aspirations.
7.6.2.4 Custodians and managers
7.6.2.4.1 Having identified what is in the investment or
what rights it confers, one has to go onto look at who is
holding the assets and who is managing them. The
custodian or holder of the assets is vital to avoid money or
investments going missing. It is also important that they
operate under a solid regulatory system. A number of the
more fiscally attractive locations lack adequate supervision
of custodians with the result that investments go astray. It is
not just a question of location or nationality.

In one scheme, the identity of the custodian of the
investment was not revealed in the product literature. In fact,
it was a regulated business in a well-known country.
Unfortunately, it failed to stop the investment managers
pledging the funds as security for the company’s margin
trading in the USA! Only the custodian’s professional
indemnity insurance staved off a major disaster.
7.6.2.4.2 In a managed fund, the identity of the fund
managers is central. Good past performance is not a reliable
indicator of good future performance particular with
managers moving around from company to company. Bad
past performance can be a sign of problems ahead. Where
a fund has just started and its managers are not well known,
a certain amount of scepticism is appropriate. To give the
fund the same rating as a well-established fund requires a
very good reason.
7.6.2.5 The wrapper or legal structure
7.6.2.5.1 The wrapper or legal structure in which a fund is
held may be important in a number of respects. Certain
products typically attract charges and different tax treatment.
While one should rarely make an investment
recommendation purely because of its tax benefits, it is an
important factor when selecting products. Withdrawals from
the investment or income may be taxed in different ways
depending on the wrapper used. It is important that the
adviser takes this into account.
7.6.2.5.2 Equally, the way in which the wrapper attracts
charges may affect those for whom it is suitable. A
substantial initial charge would make most products
inappropriate for short-term investment since a little like
gearing, the underlying funds need to out-perform the
charges to break even as far as the customer is concerned.
Commission and charges are inherently linked to a degree
with high levels of initial commission generating significant
initial charges. This makes it even more important that the
adviser is not persuaded by the higher remuneration
available from one product or typically wrapper to
recommend it over another one which may be more suitable
for the client.
7.6.2.5.3 The wrapper and again the charges it attracts
may affect the flexibility of the product in a major way. In
some cases, Governments lay down restrictions on the
timing and form in which a customer may take benefits. On
the first point, a structured product will often preclude
encashment during the lifetime of the policy except for with
major penalties. In general, advisers should have regard to

the liquidity or marketability of investments, lack of which
can significantly increase the risks involved, notably where a
customer is locked into an investment that is falling in value
or where difficulty finding a market may reduce the resale
value. Again, the customer’s attitude to the time-scale and
objective of the investment will be critical here alongside
more general concerns about risk.
7.6.3 The need to verify information given by providers
7.6.3.1 Intermediaries must be careful to verify material on risks
provided by product providers. In December 2008, the SFC Circular to
issuers of advertisements relating to SFC-authorised Collective
Investment Schemes finished by noting that it was
“also important that intermediaries undertake proper product due
diligence on the Collective Investment Schemes to be marketed and
that their sales staff and distributors thoroughly understand the risks of
the product. Intermediaries should not simply rely on the marketing
materials in marketing or selling products to the investing public.”
7.6.3.2 This was not new. The 2007 FAQ 3 had pointed out:
”Investment Advisers should make their own enquiries and obtain full
explanations from product issuers about the risks inherent in the
investment products. It is not advisable for Investment Advisers to rely
on prospectuses, offering circulars or marketing materials as
necessarily being self-sufficient and self-explanatory. Investment
Advisers should document verification work and enquiries which they
have made about the investment products, the criteria for selecting the
products and in what aspects they are considered suitable for different
risk categories of investors, and the approvals they obtain from senior
management for promoting the products.”
7.6.3.3 Ultimately, as the 2007 FAQs point out, the adviser must
assess whether the features and risks involved in each product
including costs, gearing and any currency risk are in the client’s best
interests in view of the his or her objectives, time horizon, risk tolerance,
financial circumstances and everything else that the adviser should
have discovered about him or her.
7.7 Wraps and platforms
7.7.1 It is important not to confuse “wrappers” with “wraps” or “platforms”
(although technically different, we will use these last two terms inter-
changeably here). Advisers often use wraps or platforms in order to hold their
client’s investments. The advantage is that the customer can easily see the
value and extent of his or her various holdings through internet access to his or
her platform or wrap holdings.

7.7.2 There are, though, advice problems with these facilities. First, wraps
imposed further customer charges for the facilities involved. Where a flat rate or
minimum charge is involved, this may render a wrap inappropriate for
customers with low levels of investment. Equally, the wrap may only offer a
limited range of funds and providers. The adviser cannot restrict the range of
his or her advice by reference to the limits on his or her favoured wrap’s
investment options or facilities. His or her duty to give suitable advice cannot
be compromised in this way. The use of some wraps may generate re-
registration problems when the customer wishes to move away from the
platform meaning that the customer has to encash the investment and re-invest
or pay a substantial fee for this. This can have unfortunate investment and tax
consequences. Finally, a wrap must be chosen in the same way as a fund or
product wrapper, namely by reference to price, facilities, restrictions and the
like.
7.8 Other concerns about advice quality
7.8.1 An important general lesson for advisers is that they should not
recommend investments and approaches on which they are not technically
equipped to give advice. One of the many causes of the Lehman Mini-bond
problem was that many advisers did not know the product well enough to
assess it, appreciate the risks involved and explain to the customer the features
of the product and its potential disadvantages. Advisers should not recommend
what they do not fully understand.
7.8.2 Something not often discussed is the adviser’s duty when reviewing the
customer’s affairs to advise on existing holdings. This is particularly important
where an investment appears to be out of kilter with the customer’s attitude to
risk or other goals. In that situation, the adviser must at the very least point out
the apparent dissonance between the fact-finding information and the
investment concerned. He or she must probably research the cost of replacing
it and balance this against the risk of a negative outcome occurring for which
the customer would not be suited. It is vital for the adviser to disclose to the
customer clearly the nature of the problem, the risks of the product involved
and the cost of replacing the asset.
7.8.3 In its 2007 FAQ 4, SFC states that commission rebates or other benefits
must not influence the advice process. It also warns advisers to take extra care
when dealing with the elderly or unsophisticated customers, particularly when
products recommended involve long maturity periods and significant early
surrender penalties. The 2007 FAQ 7 points out that advisers who use
computer models retain overall responsibility for the outcome and must check
that they use objective criteria to generate recommendations matching the
client’s personal circumstances against suitable investment products.
7.8.4 Churning and other switch selling
7.8.4.1 A common problem with investment advisers is churning or
switch selling as it is sometimes called. There is nothing wrong with
advising a customer to dispense with one investment and put the
proceeds into another. However, this decision must be justified in terms

of the customer’s best interest and not just by the adviser’s desire to
earn commission or other remuneration from the activity. The
replacement of one product with another will almost inevitably cost the
investor something in terms of set-up charges for the new product and
sometimes exit penalties for the old one. Churned life assurance based
products could also add a further element of increased insurance costs
and the risk of loss of insurability. Consequently, the adviser must be
able to show that the new product is likely to be sufficiently better than
the old one that the greater cost to the investor is justified. This may be
because of the existing investment’s poor historic performance or lower
charges.
In November 2008, the SFC banned and fined an individual for churning
clients’ accounts to generate commissions and holding equal long and
short positions for clients for no obvious reason.
7.8.4.2 A technique commonly used is to ascertain the critical yield
or the amount of extra growth required in the new product to out-
perform the old one and then decide whether it is realistic to expect that.
This approach is often used in other similar activities, such as deciding
whether a customer should remain invested in their pensions or buy an
immediate annuity. The critical yield required to beat an annuity
purchased immediately will help to determine whether the advice is
sensible.
7.9 Disclosure and suitability
Disclosing all the details relating to the product and the risks involved does not
reduce the obligation to give suitable advice. Nor do any cooling off rights.
Customers cannot consent to be given inappropriate advice.
7.10 Record-keeping
Finally, as the SFC pointed out in the 2007 FAQ 6:
“To demonstrate compliance with regulatory requirements, Investment Advisers
should document and record contemporaneously the information given to each client
and the rationale for recommendations given to the client, including any material
queries raised by the client and the responses given by the Investment Adviser. In
addition, Investment Advisers should keep sufficient documentation on all client
transactions including orders placed to product providers.”
8 Disclosure and the explanation of the advice
8.1 The Code provisions
8.1.1 We return again to General Principle 5 and its obligation to give
adequate disclosure of relevant material information in its dealings with clients.
Paragraph 2.1 of the Code requires any representations made and information
provided to be accurate and not misleading. The key provision here, though, is
paragraph 8.2(a). Once a transaction has been executed for a client, except in

the context of a discretionary account, the firm must endeavour to confirm
promptly with him or her the essential features of the transaction. This involves
disclosure being made at two different stages. First, before the client commits
himself or herself to the transaction, adequate disclosure must be done under
General Principle 5 to ensure that the customer understands the risks and
nature of the transaction and commitment involved. As will be seen, this is
typically done when setting out the reasons for the recommendation in line with
FAQ 6. Then, under paragraph 8.2(a), after the transaction has been executed,
the investment adviser must confirm the essential features of the transaction.
8.1.2 Intermediaries should note that the existence of Product Key Facts
Statements and cooling off periods both introduced in 2010 does not take away
from their obligations to give adequate disclosure. Handing a document over,
particularly without giving the customer time to read it before committing
himself or herself does not constitute compliance with General Principle 5. At
the very least, the intermediary would be expected to go through the contents
of the Product Key Facts Statement for each product recommended and
correct any errors in it. The adviser should also add further information insofar it
is necessary to give the customer adequate disclosure of relevant information.
Since cancellation notices and other post sale material are typically not studied
by customers who are happy with their investment advice, advisers cannot
regard these items as making up for deficient pre-sale disclosure.
8.1.3 One aspect of cancellation which must be disclosed at or prior to the
point of sale is the way in which the effect of exercising these rights will not
result in a full refund. A market value adjustment and an administrative charge
may be deducted and this must be disclosed.
8.1.4 A firm providing services in relation to derivatives or any geared
transaction, must, under paragraph 5.3, ensure that the customer understands
the nature and risks of the products. This applies regardless of whether any
advice was given.
8.2 Providing the reasons for the advice
8.2.1 The adviser himself or herself may need to write a written report
explaining the advice given and pointing out the risks and disadvantages of the
transaction not only to comply with General Principle 5, but also to protect
himself or herself from an allegation of unsuitable advice. By setting out the
facts which form the basis of the recommendation, the adviser can make it
clear to any regulator why the course of action selected was taken. Without
such a record, the regulator may assume that the fact-finding and suitable
advice requirements have not been met.
8.2.2 As the 2007 FAQ 6 says:
“Investment Advisers should document and provide a copy to each client of the
rationale underlying investment recommendations made to the client.
To demonstrate compliance with regulatory requirements, Investment Advisers
should document and record contemporaneously the information given to each

client and the rationale for recommendations given to the client, including any
material queries raised by the client and the responses given…”
8.2.3 The relevant material information concerning investment advice must
include the underlying facts or information on which the recommendation was
based, the advice itself and the features, the risks and disadvantages involved
in any changes. This must be promptly delivered after execution of the
transaction to comply with paragraph 8.2(a) and before the customer commits
himself or herself in order to comply with General Principle 5.
8.2.4 The term “essential features of the transaction” will always give rise to
arguments. They should at a minimum include a description of any fund
selected, the risks and disadvantages of it and any wrapper selected. The price
paid typically in charges should also be given. It should contain the factual
information collected from the customer which led the adviser into thinking that
the proposed course of action was suitable. The May 2010 Conclusion Paper
also reminds one that advisers must disclose the risk of a market value
adjustment or reduction when recommending with-profits investments. It is
important to avoid the impression that such funds cannot go down in value.
They can and the investor loses out through such downward adjustments.
8.3 Disclosure of commission and other benefits
In 2010, the SFC introduced provisions for the disclosure of monetary and non-
monetary benefits before or at the point of sale into paragraph 8.3. Where a firm or
its associates receives monetary benefits from a provider for distributing an
investment, it must disclose them on a transaction basis as a percentage ceiling of
the investment amount or a dollar equivalent. Where benefits cannot be quantified
before or at the point of sale or they are non-monetary, the existence and nature of
the benefits received must still be disclosed.
Firms must also disclose any trading profits from a “back-to-back” transaction where
the adviser buys an investment on the customer’s order and then sells it to him or her.
Where a firm does not receive monetary benefits for selling a product issued by it or
its associates, it must disclose that it or its associates will benefit from the origination
and distribution of the product.
8.4 Other disclosures
The 2003 SFC Circular to Intermediaries on the Marketing of Hedge Funds insisted
that intermediaries provide customers with the scheme prospectus and other relevant
scheme information. It also urged intermediaries to provide SFC educational leaflets.
This was reiterated in the 2007 FAQ 5 which says:
“Investment Advisers should provide each client with recommended investment
products’ prospectuses or offering circulars and other documents relevant to the
investments. … Investment Advisers should help each client make informed
decisions by giving the client proper explanations of why recommended investment
products are suitable for the client and the nature and extent of risks the investment
products bear. … Investment Advisers should always present balanced views,
drawing the client’s attention to the disadvantages and downside risks as well.”

In the Barber Asia case, the Securities and Futures Appeal Tribunal concluded that
handing over the product literature was insufficient disclosure. Mr Barber had to
amplify “the downside risks within this investment which clearly involved a leveraged
forex position”. The Court of Appeal agreed and went further. Stock JA said: “given
this client’s profile, the extent of her assets known to the adviser, and the very
particular risks attending this specific product, more was required than a mere
reading through of the literature and advice that she should read it carefully through
herself. … The point of showing losses or potential losses, to a non-expert client of
limited assets, with a high risk product of this kind, is to bring home to such a client
the full picture; to show what funds she may have to produce at short notice in the
event of an adverse currency movement, so that with this information, as well as with
the positive picture put to her, she can make an informed decision whether she can
afford the risks involved and whether she is in the light of her investment objectives,
nonetheless prepared to take that risk.”
9 Execution-only, insistent customers, direct offers
9.1 Defining advice as contrasted with execution-only
9.1.1 The central duty for all financial advisers is to make reasonable efforts
to give suitable advice. However, this assumes that advice, recommendations
or solicitations are taking place. The SFC sometimes faces the argument that
no advice was being offered or the transaction was execution-only. If a firm
suggests to a client that he or she ought to do something or in any way
encourages the customer to do the act concerned, this amounts to advice, a
recommendation and a solicitation. Since investments are typically complex
products, the vast majority of consumer sales are advised or solicited. It is the
only way in which they can be completed.
9.1.2 A disclaimer does not make advice execution-only and will often breach
the rules on misleading information. Whether advice was given is a matter of
fact. Regulators and courts will assume that, in certain types of situation where
a recommendation is typically given before taking out certain types of
investment, advice was given in the particular situation.
The Court of Appeal in Field v. Barber Asia was faced with the claim that Ms
Field had selected the execution-only service. It replied:
“The different services offered by Barber Asia were irrelevant. What mattered
was whether irrespective of the level chosen, it preferred investment advice
which gave rise to a duty of care. Indisputably the advice rendered did not
conform to the client’s request.”
The Securities and Futures Appeal Tribunal dealt with the same argument. It
responded with similar robustness:
“There is no doubt that in his relationship with Ms Field that Mr Barber was
acting qua adviser”.

The Court of Appeal upheld this decision. Stock JA said:
“It was not a case in which the investment adviser was expected by the client to
do no more than to act as an agent or product marketer. He remained an
investment adviser; and he remained her adviser.”
9.1.3 It is sometimes suggested that salesmen are just that and not advisers.
The flaw in that approach is that advice and solicitation are the techniques
through which investment sales are actually made. The adviser may wish just
to sell the product. However, he or she has to persuade the consumer that his
or her firm has the expertise required to help him or her buy the right or a
suitable product. As soon as such a holding out occurs, as a matter of Hong
Kong law and the Code, the adviser is required to comply with the rules on
giving advice, discussed below.
9.1.4 When considering transactions with consumers, regulators are very
sceptical about claims that a transaction is execution-only and with good
reason. Most investments are actually sold not bought. Firms recommend
products and customers buy them. Moreover, some products are too complex
for a customer realistically to approach a firm and seek to purchase them.
Finally, in some cases, the lack of sophistication on the part of the customer
makes it inherently unlikely that a customer would have selected the product
type and provider and size of investment without prompting from the firm.
A good example of this concerns the recent problems involving Lehman Mini-
bonds. These were extremely complex debt instruments in which the
customer’s capital and income were put in jeopardy in the event of a number of
different companies defaulting on the underlying loans. It is highly improbable
that any investor would have approached a firm expressly seeking out such an
investment and even less likely that they would have identified the particular
investment as being for them.
9.1.5 Firms wishing to do execution-only business must also be aware of the
risk that staff may give advice even though they have been instructed not to do
so. Tapes of telephone conversations should be rigorously checked for this
purpose. The only safe way for organizations which are set up to give financial
advice to be a little more confident that they are not soliciting business in some
way, is to divert all execution-only business through a specific channel
designed for this purpose.
9.1.6 It is sometimes said that an insistent customer, one who has rejected
the firm’s advice, is an execution-only client. This is incorrect. The firm has
given advice. It has just not been followed or caused any loss. This type of
business is extremely dangerous. First, the firm is helping a client to do
something which it does not think is in the client’s best interests, creating an
immediate conflict with General Principle 1 and paragraph 3.10. Secondly, it is
almost impossible to see how the firm can provide adequate disclosure of all
the relevant material information to a client who is not interested in hearing or
receiving it.

9.2 Two types of non-advised transaction
9.2.1 Non-advised transactions are confined typically to two situations. First,
the client requests the transaction without expecting or receiving any advice on
what to do, the company to do business with, the type of product, term of
investment – anything. This is a traditional execution-only transaction. The
second case where no advice is involved is a direct offer transaction where the
firm publishes an advertisement generally which the customer who sees it can
respond to directly by purchasing the product.
9.2.2 Direct offer promotions may well generate transactions where no advice
has been sought or given. However, most of these provide a help line for
customers. It not infrequently happens that a customer sees the advertisement,
rings the helpline and study of the tape reveals that advice was given. In the
circumstances, the transaction has to be treated as an advised one.
A customer saw an advertisement for a product. She contacted the firm asking
whether the product would be suitable for her. It reacted by sending her a
proposal form. She reasonably inferred that the firm was recommending or
soliciting the transaction. So, advice was deemed to have been given.
9.3 The consequences of a transaction being execution-only or non-advised
9.3.1 A firm doing execution-only or non-advised business still has an
obligation under paragraph 3.10 and General Principle 1 to act in the client’s
best interests. In some cases, where a product is not safe to be sold without
advice, doing an execution-only transaction could amount to a breach of
paragraph 3.10 and General Principle 1.
9.3.2 The firm must also ensure that any representations made and
information provided are accurate and not misleading for the purposes of
paragraph 2.1 and that adequate disclosure of relevant material information in
its dealings with its clients has been given as required by General Principle 5.
9.3.3 One should also note that a direct offer as an advertisement must also
comply with General Principle 5 and paragraph 2.3. Bearing in mind the fact
that the customer is expected to make his or her purchasing decision without
advice, “adequate disclosure of relevant material information” will involve
presenting a considerable amount of information in a digestible form during the
promotion.
9.3.4 When dealing with derivatives, such as futures or options or any
leveraged transaction, on an execution-only or non-advised basis, the firm still
has to satisfy itself under paragraph 5.3 that the customer understands the
nature and risks of the products and has sufficient net worth to absorb the risks
and potential losses involved. This is particularly important in the area of
spread-betting.
9.3.5 The new paragraph 5.1A, added in 2010, requires firms to assess the
client’s knowledge of derivatives and characterize the client. If a customer who
does not have derivatives knowledge wants to buy such a product traded on an
exchange, the firm must explain the risks involved. If the product is not traded

on an exchange, the firm must warn the client about the transaction and advise
the client on whether it is suitable, based on the information which the firm
should or does have. If the transaction is unsuitable, the firm can only carry out
the transaction if this would be in the best interests of the client which would be
most unusual.
10 Discretionary authorities
10.1 In essence, the position of an intermediary operating under a discretionary
management agreement is the same as that of an ordinary adviser except for the fact
that there is no need for the intermediary to give product disclosure and
communicate features of each transaction in quite the same way.
10.2 Paragraph 7.1(a)(ii) deals with the creation of discretionary accounts. The client
must have authorised the firm or its employee to effect transactions. In that situation,
the firm has to explain the terms of the authority to the customer. VII.2 of the Internal
Control Guidelines requires firms to have procedures to ensure that the precise terms
and conditions under which such authority may be exercised are effectively
communicated to the client, and that only transactions which are consistent with the
investment strategies and objectives of the relevant client, are effected on the client’s
behalf.
10.3 Under paragraph 7.1(b), the firm needs to confirm at least annually whether the
customer wishes to revoke the authority. It can just tell the customer that the
authority is renewed unless specifically revoked before the expiry date.
10.4 The firm’s records must designate discretionary accounts as such and they
must only be opened with senior management’s approval.
11 Professional clients
11.1 Firms are exempt from some of the Code’s rules with respect to professional
customers but only as regards the products and markets for which they have this
status. It is important for firms not to mis-classify customers. Part 1 of Schedule 1 of
the Securities and Futures Ordinance lays down two groups of professional
customers in its definition of “professional investor”.
11.2 The two categories of professional clients
11.2.1 The first deals with market professionals such as registered or licensed
firms, financial institutions, exchanges and the like. The list of the first group is
set out in Schedule 1 of the Securities and Futures Ordinance. It is broadly
speaking:
• any recognized exchange company, recognized clearing house,
recognized exchange controller or recognized investor compensation
company, or any person authorized to provide automated trading
services under the Ordinance;

• any intermediary, or any other person carrying on the business of the
provision of investment services and regulated under the law of any
place outside Hong Kong;
• any authorized financial institution, or any bank which is not an
authorized financial institution but regulated under the law of any place
outside Hong Kong;
• any insurer authorized under the Insurance Companies Ordinance, or
any other person carrying on insurance business and regulated under
the law of any place outside Hong Kong;
• any authorized collective investment scheme or one similarly constituted
under another legal system or the operator of such a scheme;
• any registered scheme or its constituent fund under the Mandatory
Provident Fund Schemes Ordinance, or its approved trustee, service
provider or investment manager;
• any registered occupational scheme or an equivalent offshore scheme
or its administrator;
• any government (but not a municipal government authority), any
institution which performs the functions of a central bank, or any
multilateral agency; and
• a wholly owned subsidiary or owner of an intermediary or other
investment firm.
11.2.2 The second group are basically high net worth customers with a
minimum portfolio of HK$ 8 million, who are knowledgeable and are judged in a
written assessment to have sufficient expertise and experience in the relevant
products and markets and who elect to be treated as professionals. The next
section considers the assessment of investors falling within the second group
or “elective professional investors” to see whether they fall within the relevant
criteria.
11.3 The rules surrounding and consequences of classification as a professional
client of the second type
11.3.1 A separate written assessment must be made for each different product
type and market. If a client stops trading in a product or market for two years,
the assessment has to be re-done. Product types for this purpose are the same
if they have “a similar nature, features and inherent risks”.
11.3.2 Experience, knowledge and expertise are judged by reference to the
• types of products traded;
• frequency and size of trades with an expectation of at least 40
transactions a year;
• dealing experience with at least two years activity expected and
awareness of the risks involved in the products and markets concerned;
and
• the customer’s knowledge and expertise in the relevant products.
Records must be kept of all relevant information relating to any assessment.

11.3.3 Any adviser wishing to treat a client as an elective professional client, or
second type of professional investor, must provide a written explanation of the
risks and consequences of such status, in particular the disclosures the client
will not receive. It must also tell the client that he or she can withdraw from
being a professional as regards all or some of any products or markets. In
exchange, the adviser must obtain a signed declaration that the consequences
and right to withdraw have been explained to the client and that the client
wishes to be treated as a professional investor. The confirmation exercise must
be done annually so as to ensure that this second group of professional
investors still meet the criteria.
11.4 The effect of classifying an investor as a professional
Firms do not need to comply with some of the rules discussed here for their
professional investors, notably the need to:
• establish the client’s financial situation, investment and derivatives
experience and objectives - unless advising on corporate finance;
• ensure suitability of recommendations or solicitation;
• provide a written client agreement and the relevant risk disclosures;
• obtain a written authority from the client to carry out transactions without the
client’s express authorization, explain the authority and confirm it annually;
• tell the client about the firm and the identity and status of its employees and
representatives; and
• confirm promptly with the client of the essential features of a transaction after
effecting it.
12 Executing the transaction
12.1 The first point to note is that under paragraph 7.1(a), unless the adviser has
prior authorisation, no transaction should go ahead.
In July 2009, the SFC banned an individual for entering into an accumulator
transaction for a high net worth client with the individual’s authorisation. The adviser
claimed that it was a good investment and that the client normally accepted the
individual’s recommendations.
Equally, where a client does instruct the adviser to do something, it must be done
promptly.
The SFC banned an intermediary for life in May 2009 for failing to act on instructions
to buy shares as well as unauthorised and negligent trading.
12.2 Paragraph 3.2 requires client orders to be executed on the best available terms
or receive “best execution”. Executed transactions must be promptly and fairly
allocated to the relevant clients (paragraph 3.3). Client orders must be handled fairly
in the order in which they are received and in priority to those of licensed or
registered persons or accounts in which they have an interest. Again, where an
order has been aggregated with one for its own account, the firm must give priority to
the client instruction.

12.3 Paragraph 13.5, inserted in 2010, requires an intermediary to have procedures
in place and to ensure that customers can exercise their cancellation rights smoothly
and receive the refund less reasonable administrative charge due to the customer
under the cancellation rules without delay. Advisers must not deduct any sales
commission from this.
13 Client assets
Paragraph 3.7 insisted that firms keep separate accounts for each client for dealings
in securities and for transactions concluded on a cash or margin basis. Paragraph
11.1 and General Principle 8 insist that firms account promptly and properly for client
assets and ensure that they are adequately safeguarded even if they are in a third
party’s possession. Firms have to be careful to comply with the Securities and
Futures (Client Securities) Rules and the Securities and Futures (Client Money)
Rules and ensure that where assets are held abroad, customers are told that they
may not enjoy the same protection as they do under the Hong Kong regime. The
Code lays down the basic principle. The Securities and Futures (Client Securities)
Rules and the Securities and Futures (Client Money) Rules contain the detail that
firms must observe.
In April 2009, the SFC fined a firm for depositing client money into a third party bank
account instead of a segregated account to net off transactions.
14 Systems and controls
Paragraph 12.4 lays down the general rule that a licensed or registered person is
responsible for the acts or omissions of both employees and representatives. Firms
have a duty under paragraph 4.1 to ensure that staff employed or any person
appointed are fit and proper and appropriately qualified. As required by paragraph
4.2, firms must also have supervised diligently those individuals. They must report to
the SFC immediately under paragraph 12.5 any material breach of the law, rules,
regulations and codes, giving relevant details and documents.
Firms have to handle complaints from clients relating to its business, under
paragraph 12.3, in a timely appropriate manner, investigate and respond and tell
customers of any further steps open to the customer under the regulatory system.

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