COB 2.2 Inducements and soft commission

Principles 1 and 6 require a firm to conduct its business with integrity, to pay due regard to the interests of its customers and to treat them fairly. The purpose of this section is to ensure that a firm does not conduct business under arrangements that might give rise to a conflict with its duty to customers.

The purpose of COB 2.2.3 R (2) is to prevent the requirement in COB 2.2.3 R (1) being circumvented by an inducement being given or received by an unregulated associate. A firm may be able to demonstrate that it could not reasonably have knowledge of an associate giving or receiving an inducement. It should not, however, direct business to another person on the instruction of an associate if this is likely to conflict with the interests of its customers.

3An offer or agreement to publish investment research which is, or to change a published recommendation so that it becomes, favourable to its subject (even if the subject is a customer of the firm), is an example of offering or accepting an inducement which is likely to conflict to a material extent with the firm's duties to its other customers. (See also COB 5.10 in relation to inducements related to corporate finance and COB 7.16 in relation to investment research.)4

1. (-2)

   To comply with COB 2.2.3 R, neither a product provider nor any of its associates should give, and a firm should not receive from such persons , any indirect benefit, if the benefit is likely to conflict to a material extent with any duty owed by the receiving firm when giving advice on investments to private customers on packaged products. Such conflicts may arise, for example, where the gift might induce material bias as regards:5

   1. (a)

      the choice of product provider whose products are recommended; or5

   2. (b)

      the type of product which is recommended.5

2. (-1)

   The guidance in COB 2.2.7 G is not relevant to indirect benefits which may be given by a product provider or its associate to its own representatives.5

3. (1)

   The FSA will not regard a firm as being in contravention of COB 2.2.3 R if it gives or receives gifts, hospitality and promotional competition prizes of a reasonable value, providing they do not conflict with the duties that the recipient owes to its customers.5

4. (2)

   A product provider may assist another firm to promote its packaged products so that the quality of its service to customers is enhanced. Such assistance should not be of a kind or value that is likely to impair the other firm's ability to pay due regard to the interests of its customers, and to give advice on, and recommend, packaged products available from the recipient firm's whole range or ranges of packaged products. The recipient firm should be mindful of the requirements of COB 5.3.5 R (Requirement for suitability generally).5

5. (3)

   In relation to the sale of packaged products, COB 2.2.7 G indicates the kind of benefits which, in the FSA's view, a firm can give and receive without contravening COB 2.2.3 R.

6. (4)

   COB 2.2.6 G does not apply to indirect benefits provided by a firm to another firm that is in the same immediate group. In this situation COB 5.7.5 R will apply.5

When the soft commission broker is part of an 'integrated house', a firm may be able to meet the requirements of COB 2.2.8 R (4) if it is able to monitor the individual transaction prices obtained by the broker, and has taken reasonable steps to ensure that the broker has complied with its best execution obligation. Alternatively, a firm should select a soft commission broker who is able to demonstrate independence of action in the market place. This is unlikely to be fulfilled when that broker deals exclusively with one market maker.

When a broker is only partly remunerated by commission, in complying with COB 2.2.8 R (4) a firm should take reasonable steps to ensure that the commission element that should be disclosed constitutes the greater part of that broker's remuneration. A broker firm should also set its multiple at a level which it can demonstrate would generate sufficient commission income from softing transactions to cover the costs of the goods and services provided, and the costs of dealing and settling the associated transactions, together with the specialised softing administration. When considering whether the commission is sufficient to cover the costs of the services provided, the broker firm may have regard to the aggregate number of bargains transacted rather than each individual transaction.

Although "commission recapture" and "directed commission" arrangements are not covered by COB 2.2.8 R, a firm should have regard to the prohibition on inducements in COB 2.2.3 R.

Examples of particular goods and services that could be provided under a soft commission agreement include, to the extent they would assist in the provision of the services specified in COB 2.2.12 R:

1. (1)

   research, analysis and advisory services, including those on economic factors and trends;

2. (2)

   market price services;

3. (3)

   electronic trade confirmation systems;

4. (4)

   third party electronic dealing or quotation systems;

5. (5)

   computer hardware associated with specialised computer software or research services;

6. (6)

   dedicated telephone lines;

7. (7)

   seminar fees (if the subject matter is relevant to the provision of the services set out in COB 2.2.12 R); and

8. (8)

   publications (if the subject matter is relevant to the provision of the services set out in COB 2.2.12 R).

Examples of goods and services that the FSA does not regard as relevant to the provision of the services specified in COB 2.2.12 R include:

1. (1)

   travel, accommodation or entertainment costs, whether or not related to the conduct of designated investment business;

2. (2)

   any seminar fees not falling within COB 2.2.13 G (7) ;

3. (3)

   any subscription for publications not falling within COB 2.2.13 G (8);

4. (4)

   office administrative computer software, for example, word processing or accounting programmes;

5. (5)

   computer hardware not associated with specialist computer software;

6. (6)

   membership fees to professional associations;

7. (7)

   purchase or rental of standard office equipment or ancillary facilities;

8. (8)

   employees' salaries; and

9. (9)

   direct money payments.

In complying with COB 2.2.8 R when a firm is able to and does reclaim or offset all or part of the VAT payable on benefits received, the firm should ensure that its soft commission account with the broker is charged only with the net amount at the firm's effective rate. Disclosure of the value of benefits received, in accordance with COB 2.2.18 R, should be expressed net of VAT reclaimed, when appropriate.

When making the disclosures required by COB 2.2.16 R, a firm should note that:

1. (1)

   it is acceptable to make a general disclosure that soft commission agreements are, or may be, in place;

2. (2)

   the requirements apply equally when deals are placed directly, and not solely on an agency basis, with a third party (for example, a unit trustmanager in the same group), that itself is a party to the soft commission agreement; and

3. (3)

   the policy statement should explain generally why the firm or a member of its group might find it necessary or desirable to pay soft commission, bearing in mind the practices in the markets in which it does business on behalf of its customers.