Licensing of discretionary investment management: A positive outcome from a sorry saga

Law books plus gavel croppedThe David Ross Ponzi scheme was a sorry saga for the New Zealand financial services industry and for the newly created Financial Markets Authority which had responsibility for taking action to investigate the scheme and implement processes to hopefully avoid it happening again. For those investors actually caught up in the scheme, it was devastating as many have lost most if not all of what they had invested with Ross. An important thing to note is the way that Ross Asset Management operated was very different to the mainstream financial adviser industry. He ran his own custody service and there were few if any external checks and balances. Therefore, investors should not fear that everyone else in the market is another Ross Asset Management.
However, there have been a number of positive outcomes from the Ross saga. Greater investor awareness is a positive by-product. Hopefully investors are better informed and realise that consistently high investment returns from one adviser (no matter how nice and articulate he/she may seem) when other advisers/solutions are producing only half the returns should signal that something is not quite right. The most obvious by-product is a whole new licensing regime around the provision of a discretionary investment management service – we in the industry refer to it as DIMS.

DIMS is a service where the client and the adviser agree on what will be invested, the purpose of the investment and how it will be invested. This is documented in a ‘Statement of Advice’ and an ‘Investment Authority’ or ‘Investment Mandate’. The client gives the adviser authority to buy and sell investments but only to the extent that it falls within the conditions agreed on in the investment authority. The adviser cannot deviate from what has been agreed unless there is further client approval for this to occur.
The investments will be held in an independent custodial service which simplifies documentation, provides up to the minute pricing and sorts out the tax reporting. Along the way, the adviser and the client regularly meet to discuss progress, review goals, plus agree upon any changes that need to be made to the investment authority and why these need to be made.

DIMS is great as it enables clients to have a reasonably comprehensive investment portfolio, be kept informed on how it is progressing, have total input into what the rules will be around the portfolio, then step back and let the adviser operate it as per the rules. This frees up the investor to pursue more interesting activities and avoid the plethora of paperwork and signatures involved with running a portfolio directly. The new DIMS licensing regime imposes extensive criteria on the financial advice business in the areas of compliance, reporting, governance, systems, capacity and capability. This is all designed to provide added protection and peace of mind for DIMS clients.

Some advisers will choose not to offer a DIMS service and hence will not be required to meet the stringent safeguards that are part of the DIMS license. For clients of non-DIMS advisers, a different solution will be offered. Clients will most likely have one of two choices:
  • very simple portfolios or just single product multi-asset sector funds; or
  • more comprehensive portfolios (like DIMS clients) but the client will be required to sign-off on every little change or modification that the adviser recommends. In this situation, the adviser will need to send the client an advice document which outlines exactly what the change is, why it needs to occur, the key risks and benefits of the change and the implications. This will be accompanied by research and detailed investment statements relating to the products recommended. All the benefits of having the adviser take care of the day to day operation of the portfolio are lost.
There is no right or wrong approach. Some advisers do not see any value in subjecting their business to heightened compliance and regulatory oversight when they genuinely believe their clients want to be involved in reading all the documents, understanding the rationale for any change and approving every portfolio change.

DIMS is effectively becoming a defining issue for the financial advice industry. Advisers who become DIMS licensed can offer DIMS to those clients who want that ease of investing plus offer non-DIMS to those clients who wish to be fully involved in every little change. However, those advisers who choose to not hold a DIMS license will only be able to offer a non-DIMS solution. Inadvertently offering DIMS to a small sector of a client base without holding a DIMS license is a serious offence which incurs significant penalties. For investors, new decisions need to be made. Investors now need to decide if they wish to deal with a non-DIMS licensed adviser or a DIMS licensed adviser, plus whether they want to be fully involved in all investment portfolio transactions or just be involved to the extent of setting the rules and then regularly reviewing those with the adviser. Talk to us about what you think is right for your circumstances.