Personal Pensions Misselling: The Causes and Lessons of Regulatory Failure

AuthorRichard Nobles,Julia Black
Date01 November 1998
DOIhttp://doi.org/10.1111/1468-2230.00179
Published date01 November 1998
Personal Pensions Misselling: The Causes and Lessons
of Regulatory Failure
Julia Black and Richard Nobles*
The retail financial services industry is currently undertaking the largest review of
past business that has ever been experienced. The reason: the possibility that a
large number of people during the period 1988–94 gave up their rights in (or right
to belong to) occupational pension schemes (OPSs) in exchange for inferior
entitlements in personal pension schemes. Life companies, independent financial
advisers, banks, building societies, in short anyone who has sold a personal pension
(PP) policy during that time, are being required by the regulators to examine over
two million sales to see whether policy holders should be compensated. This is not
an example of regulation seeking to punish a few rogue members of an industry; it
is the industry itself which has been found wanting by its regulators.
This article explores how both industry and regulators arrived at this position:
what the pensions misselling episode consists of, what factors caused or
contributed to it, and what lessons may be learnt.1Pensions misselling was more
than just outrageous selling practices, aberrant salesmen, dubious transfer values or
insistent customers, and is due to more fundamental factors than over-expansion by
firms or ignorance by or of regulators. It is all of that, but it is also more. The
pensions misselling episode manifests a critical failing in the regulatory structure,
which cannot simply be blamed on the novelty of the regulation or the climate of
the time.
There is no single causal factor which gave rise to pensions misselling. Rather,
misselling arose, and continued undetected, because of the complex interaction of a
range of factors. Political ideology, product complexity, regulatory novelty,
industry dynamics: it is not so much the presence of each individual factor which
gave rise to misselling, as their interaction. These factors were to an extent context
specific, but pensions misselling cannot be regarded simply as an aberration, a one-
off, an unrepeatable episode. For one of the principal features of the misselling
episode was regulatory blindness, on the part of firms and regulators: no-one took a
strategic look at what regulation required in any one instance. No-one looked at
pensions as posing particular problems because no-one knew or thought to look.
Four broad lessons can be drawn from pensions misselling. These lessons relate
to firms, regulators, and to the regulatory system as a whole, that is, the interaction
The Modern Law Review Limited 1998 (MLR 61:6, November). Published by Blackwell Publishers,
108 Cowley Road, Oxford OX4 1JF and 350 Main Street, Malden, MA 02148, USA. 789
* Law Department, London School of Economics.
We thank all those who agreed to be interviewed by us for their time and co-operation. Our thanks also to
Mandy Tinnams for transcribing the interview tapes. Responsibility for views, errors and omissions
remains our own.
1 As well as drawing upon written sources, the research on which this article is based includes interviews
with some of the key actors involved in the regulatory system and the pensions industry during the
relevant period: regulatory staff (past and present) of the three key regulators of the time, SIB, Lautro
and Fimbra; pension salesmen; sales and marketing managers and directors and compliance officers
from twelve major product providers; actuaries and trade union officials. Interviews were conducted
principally on a non-attributable basis during the period July – November 1997.
of regulators, regulated, and the supposed beneficiaries of regulation – investors.
First, for firms, the pensions misselling episode (or more accurately, its
consequences in the form of the current review of past business and disciplining
by regulators) demonstrates all too clearly that regulation has to be treated as an
issue which is central to management strategy. Compliance cannot be an ‘extra’.
Every part of the organisation has to be examined for its contribution to
compliance. Is the training sufficient? Do the incentive regimes in place to ensure
sales undermine compliance? Are internal monitoring systems likely to pick up
poor advice? Is the senior management sufficiently committed to the selling of
only ‘good’ business? Moreover, misselling shows the need for a dynamic
approach to compliance: the need to continue ‘thinking through’ the implications
for compliance when further changes in either regulation or business strategy are
considered.
Second, on the part of regulators, pensions misselling indicates that there has to
be an awareness that a particular area of business poses particular risks from the
point of view of investor protection, and what those risks are. The idea of ‘risk
based’ supervision is currently all the vogue in financial regulatory circles,2but the
pensions episode shows that for this to work, the regulator needs to have specialist
knowledge of individual product and business areas. Once regulators became
aware of how personal pensions differed from occupational pensions then they
could start to devise rules and adopt monitoring strategies accordingly. Without
that knowledge, pensions misselling could, and did, occur.
Third, pensions misselling shows that regulation itself has to be seen as a factor
which contributes to regulatory risk. Pensions misselling illustrates the unintended
consequences and unforeseen effects that regulation can have, and the need to try
to anticipate these as far as possible. Regulation created new risks. Awareness of
regulatory risk thus has to extend to the potential impacts of current and proposed
regulatory policies and requirements and to the preferred regulatory response
should they arise.
Fourth, the episode raises fundamental issues of the nature of the relationship
between firms and investors, of the role of general rules such as those of suitability
and ‘know your customer’, and the relationship, and respective responsibilities, of
firms and regulators. We will show that it was a failure to think through the
implications of the broad duties in the particular context of pensions business
which was a critical element in the misselling process. The conduct required by
rules such as suitability, know your customer and best advice is not mechanical:
there is no list of specific actions which have to be done which can act as a
checklist both for firm and regulator. To operate effectively, general rules have to
be supported by a shared understanding of what it is they require, such that they
can be applied appropriately to new or changing situations without the need for
further specification or explanation. Until such an ‘interpretive community’ exists,
general rules will be limited in their effectiveness.3That said, and for reasons we
will demonstrate, these general rules may still provide useful benefits when
seeking to regulate under conditions of uncertainty.
The first three parts of the article examine the different aspects of the pensions
misselling episode. The first part sets out briefly the regulation which was intended
to govern the sale of PPs, the nature of the pension product, the legislative changes
2 See the discussion in PIA’s Evolution Project, Strand 3; SFA has developed a mechanism for
allocating risk ratings to its member firms, FIBSPAM, which includes an assessment of the quality
of management (SFA, Annual Report 1996/7).
3 See further, J. Black, Rules and Regulators (Oxford: Clarendon Press, 1997) ch 1.
The Modern Law Review [Vol. 61
790 The Modern Law Review Limited 1998
which made PPs selling possible and the Conservative government’s role in
promoting PPs. The second part examines the market for and marketing of PPs, the
structure of the industry which was producing and selling PPs, the training,
supervision and remuneration of sales forces, including Independent Financial
Advisors (IFAs), and their selling practices. The third part examines the structures
in place to try to ensure implementation of the regulation in this industry: the
compliance structures within firms and the regulatory enforcement processes, and
explores how and to what extent pensions became marked out as a particular
problem area. The final part develops the lessons that the episode has for
regulatory policy and its implementation.
The structure of the regulation, the nature of the product and the
creation of the choice
Regulating the sale of personal pensions
Any study which purports to be one of regulatory failure has at least to set out what
the regulation actually required. Pensions selling is a very particular business
which differs from the sale of most other types of retail savings products in that
there may be another product against which the PP should be directly compared: an
OPS. PPs are investments within the meaning of the Financial Services Act 1986
(FSA).4Those engaging in (inter alia) their sale and marketing are governed by the
rules made by regulators operating under that Act. OPSs are not regulated under
the FSA. The sale and marketing of the latter, to the extent that it exists, is
therefore not subject to the FSA.5
In the period 1988–94, three principal regulators were involved in regulating
firms who engaged in the sale of investment products, including PPs: SIB, which
regulated the banks and building societies; Lautro, which regulated the life offices,
and Fimbra, which regulated the IFAs.6They all shared a (more or less) common
set of rules. In essence7these required any person advising on or recommending an
investment product to obtain sufficient information from the customer as to his/her
financial circumstances (the ‘know your customer’ rule);8to advise only those
products which were suitable for the customer;9to recommend only that product
which would best meet the customer’s needs (‘best advice’);10 to disclose material
interests,11 (on the part of IFAs the fact that they received commission)12 and the
status of the adviser;13 to give ‘sufficient information’ at point of sale to enable a
4 FSA Sched 1, para 10.
5 It is not anticipated that this situation will alter under the proposed Financial Services and Markets Bill.
6 Some IMRO members also sold PPs. Lautro’s and Fimbra’s responsibilities were taken over by PIA
when it formed in 1994, and Lautro and Fimbra were de-authorised in 1997.
7 See further, Black, n 3 above, ch 4. The SROs (self-regulatory organisations) were required to have
rules which were ‘equivalent’ to SIB’s by the 1986 FSA, Sched 2, para 3, changed to a requirement
that their rules provide ‘adequate’ investor protection by s 203 CA 1989.
8 SIB 1987 Rules, r 3.01; SIB Principle 4.
9 SIB 1987 Rules r 5.01; Core Rule 16; Lautro and Fimbra had equivalent rules. The meaning of the
suitability rule was the subject of a number of discussion documents in which its importance was
repeatedly emphasised: see for example, Regulation of the Marketing of Investment Products and
Services: A Policy Statement March 1991 para 18.
10 SIB 1987 Rules rr 5.07, 5.08; Core Rule 17; Lautro and Fimbra had equivalent rules.
11 SIB 1987 Rules r 5.08, 8.08; Principle 6 (1991).
12 SIB 1987 Rules r 5.13.
13 SIB 1987 Rules r 6.03
November 1998] Personal Pensions Misselling
The Modern Law Review Limited 1998 791

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