Trustees: Know your risks

In the concluding part of a series of articles examining the areas of risk faced by professional trustees, Karl Lavery considers some of the largely unexplored practical implications of the Trustee Act 2000 and the Financial Services and Markets Act upon professional trustees.

Introduction

The first article in this series focused on the costs of running a trust, the trustee’s obligations to ensure those costs are managed, and how this might be achieved.

The second article focused on the need for a clearly defined, robust investment process to be applied to all the trusts in ones care, for which the assessment of the client risk profile and asset allocation are key drivers. Furthermore, the view was expressed that ‘passive’ fund management was more appropriate than an ‘active’ fund management approach.

ECA readers will already have dealt with the impact of the Financial Services and Markets Act (‘the Act’) upon business activities, having encountered the question of whether or not to become directly authorised by the Financial Services Authority (FSA) or to simply cease providing any regulated financial advice. The vast majority of law firms understandably, given the added limitations and complexities, chose the latter route. However, even this can be fraught with problems. This may be exacerbated if a solicitor is acting as a professional trustee.

The Act is still in the rather youthful period of its application. At the time of writing, I am not aware of any professional trustees that have been the subject of court proceedings as a consequence. Things are thus, even more than usual, ‘open to interpretation’. Like every other writer for ECA, I am exposing myself to public ignominy if my observations are groundless. I should, in any event be pleased to be the route by which readers might wish to obtain their impartial financial planning advice.

The following is offered as ‘food for thought’ to assist readers in establishing how they might best position their services to ensure their client obligations are met, how they might comply with relevant legislation, keep their sanity and hopefully make a reasonable profit.

Financial Services and Markets Act 2000 - Chapter 8 Part II - Regulated and Prohibited Activities

Section 19 addresses the issue of the general prohibition, saying that (1) No person may carry on a regulated activity in the United Kingdom, or purport to do so, unless he is

(a) an authorised person; or

(b) an exempt person.

Section 21 subsection (1) of the Act says that a person must not, in the course of business, communicate an invitation or inducement to engage in investment activity. Section 21 (8) “Engaging in investment activity” has two definitions of which - (b) “exercising any rights conferred by a controlled investment, to acquire, dispose of, underwrite or convert a controlled investment.” (Controlled investments are specified in any order issued by the Treasury, currently Schedule I Part II, Paragraphs 12-27 of the Act).

This combination throws up an anomaly insofar as a professional trustee is both the legal adviser and the client (as trustees). In that position, you cannot really avoid making the decision to engage in an investment activity.

Section 22 addresses the classes of activity and categories of investment. Section 22 (1) states that an activity is a regulated activity for the purposes of this Act if it is an activity of a specified kind which is carried on by way of a business and

(a) relates to an investment of a specified kind; or

(b) in the case of an activity of a kind which is also specified for the purpose of this paragraph, is carried on in relation to property of any kind.

Section 22 (4) also confirms “investment” includes any asset, right or interest.

A difficulty may arise in determining what constitutes ‘work’ and what constitutes advice that is incidental to the professional service supplied, that arises out of, and is complimentary to, that professional service. Unfortunately, this seems to be a grey area.

In the event of a complaint, at what point would it be deemed by the courts or the FSA that a professional trustee has over-stepped the mark and moved into the realms of regulated activity? Other than suggesting that one err on the side of caution, there does not appear to be a clear-cut answer. Going forward, where any advice is to be given in relation to the disposal or acquisition of assets, one should have in place a team of appropriately qualified tax and financial planners which can be approached to provide the relevant opinion and advice, be that within the firm, or contracted to the firm, and that a copy of the advice is kept on file.

There are several other sections and subsections that might be of even greater concern to professional trustees. Section 27 of the Act covers agreements made through unauthorised persons; this could for example be law firms and accountancy firms that have not gone down the route of direct authorisation. Section 27 (1) states that an agreement made by an authorised person (“the provider”) –

a) in the course of carrying on a regulated activity (not in contraventionm of the general prohibition),

but

b) in consequence of something said or done by another person (“the third party”) in the course of a regulated activity carried on by the third party in contravention of the general prohibition, is unenforceable against the other party.

How might this affect a professional trustee? If you are that ‘third party’ and have decided the most appropriate investment route for a trust’s monies is via a stockbroker, then the stockbroker is only responsible for their actions within the scope of their terms of engagement. The fact you may have omitted to consider the negative tax implications to the trust of resorting to this form of investment management, is not likely to be considered the responsibility of the stockbroker (see the first article in this series, ECA Volume 10, Issue 1, November/December 2004). If the beneficiaries were to complain they had been disadvantaged as a consequence of poor tax planning on the part of the trustees, it would be the professional trustees who would be held to account and not the stockbroker.

Part XX of the Act covers the Provision of Financial Services by Members of the Professions. Section 327, exemption from the general prohibition, point (5) states that a person must not carry on, or hold himself out as carrying on, a regulated activity other than –

(a) one which rules made as a result of section 323 (3) allow him to carry on;

(b) one in relation to which he is an exempt person.

If one considers this in conjunction with Section 21, one has a dilemma. Readers will, no doubt, already have decided whether to appoint a traditional independent financial adviser (IFA) firm or a stockbroker. The IFA will invariably use collectives such as unit trusts and open ended investment companies, or insurance-based products such as bonds, as the investment vehicles. In contrast, the stockbroker is likely to use collective or direct equity investments. Whether choosing the stockbroker or the IFA, the professional trustee is appointing a firm to deal with the financial advice, despite the fact they have already made the decision as to the tax regimes to which the trust is likely to be subjected.

A professional trustee wears two hats. Unless the right process is in place, it might perhaps be argued they are carrying out a regulated activity by effectively dictating the investment route.

As a professional trustee acting in the best interests of the beneficiaries of the trust (who have no control), the trustee takes responsibility for all the decisions. However, Section 328, which covers directions in relation to the general prohibition, point (9) states that if a member of a profession is carrying on an exempt regulated activity in his capacity as a trustee, the persons who are, have been or may be beneficiaries of the trust are to be treated as persons who use, have used or are or may be contemplating using services provided by that person in his carrying on of that activity. It seems, therefore, that Section 328 (9) appears to be advising ‘professional trustees’ to view themselves as the ‘professional’ through the eyes of the beneficiaries when appointing advisers in relation to regulated activities under the Act.

A professional trustee has little option but to make these decisions, but unless there is a clearly documented process that is robust, totally impartial and objective, and applied even-handedly to all relevant trusts, the professional trustee may be left open to being challenged at a later date. In this case, were such a challenge to be successful, it would not just be a civil action but an offence under Section 23 and/or Section 25 of the Act.

Author's final note…

Having been the harbinger of woe, it also falls upon me to try to shed a little light and hope. If you consider the three articles as a whole, it may be appropriate to review your firm’s panel of advisers.

If they are unwilling, unable or not sufficiently qualified to help you establish a robust process that covers all of the issues raised across the three articles and provide their services to you objectively and impartially going forward, it may be necessary to question the appropriateness of those relationships, for they could cost you dearly in the courts at some point in the future.

Karl Lavery is a holistic fee-based financial planner with Baxter Fensham Limited and would appreciate your feedback. He can be reached via 0113 2741100, mobile: 07958 736397 or e-mail: klavery@baxterfensham.com

Source of information: Extracts of the Financial Services and Markets Act 2000