Why you should put your interests ahead of your clients’ interests when doing due diligence.

by Damian Davies on 09·02·2022

They say history is written by the victors, and in poor old Richard III’s case, that is certainly true.

You see, Richard III was the last of the Plantagenet kings, and the last King of England to be killed in battle, when he was slain at the Battle of Bosworth.

His victor was the first Tudor King, Henry VII and the Tudors had a great propaganda machine in the form of William Shakespeare, who took patronage from Henry’s granddaughter, Queen Elizabeth I.

The thing is, if Richard had picked his partners a bit better, he may not have lost the Battle of Bosworth and he might have had more of a chance to influence history to favour him a bit more.

I’ll show you what I mean.

At the Battle of Bosworth, Richard’s army outnumbered Henry’s and he decided to group his army into three. One part under his command, one part under the Duke of Norfolk and the third under the Earl of Northumberland.

Norfolk led the attack but struggled. Units started to flee the battleground, so Richard told Northumberland to go and get stuck in. The thing is, Northumberland did nothing, he ignored Richard’s order.

Risking everything, Richard decided to go piling in on his own, which cost him the battle, the throne, and his life.

Richard trusted Northumberland to be there when he needed him, and he clearly shouldn’t have.

This is a very similar situation to every adviser business today (seamless segue).

Clients need two things to do business with you.

They need to like you and they need to trust you.

Likeability is not something you control; it’s just about being yourself. You are likeable to people who like the sort of person you are.

Trust, however, is earned. It is earned by delivering what you promise.

Each time you make a personal recommendation to a client that relies on a product, you are risking that hard earned trust on the provider.

That company can’t let you or your client down. If they do, they immediately evaporate a part of the trust you have spent years developing.

This is why I believe that Due Diligence is the one part of a financial advice business that should be conducted entirely selfishly.

Yep, I think the adviser should put their interests first when doing due diligence.

I can hear the uproar amongst compliance now, saying that the client should be the heart of every decision.

I don’t disagree, but when due diligence is done properly it is right to be selfish, to put yourself first, as it will create the best outcome for your clients too.

This will only work, however, if you realise that due diligence is one stage of a wider process that needs to be approached in the right sequence.

Stage 1 – Client Segmentation

Segmentation is an article in itself! The essence of segmentation is that you can identify clients that are grouped together with shared investment requirements and characteristics.

The biggest mistake we see here is advisers blurring their use (or understanding) of the word segmentation with their service propositions.

You might hear people say, ‘I have three client segments: Gold, Silver and Bronze’. You might also hear people link those to value of assets.

Service propositions and segmentation are very different things, even if some bits, like value of assets, overlap.

Our guidance is that segmentation is actually a matrix of different investment requirements, so firms can have lots and lots of segments.

Once you have clear segments, you can understand what those segments need from a product, and you can then compare the meerkat of similar products.

Stage 2 – Comparative Research

When you enter the research stage, you have the whole available market of products to look at.

Research is assessing how the investment features of a product can be used to help a firm deliver its service proposition to a stated client segment.

You will essentially filter down from the whole market to those products that provide features that match the needs of your clients.

The biggest mistakes firms make here is not having enough research to support expressions like ‘my preferred platform’ or ‘my favourite DFM’.

These sort of expressions suggests that every client you deal with that goes onto the platform or under the DFM is completely homogeneous – they are all identical. This is impossible and will get the regulator chewing their eyebrows off.

Importantly, research doesn’t have to result in just one product or provider. Instead, good research for each segment will help identify the most appropriate products.

Once you have a shortlist, this is where PROD comes in.

Stage 3 – PROD

PROD is a bit like research but focusses on characteristics rather than features.

If you do this after the comparative research, it is much less onerous, as you are not using it to comparatively compare every product. Instead, you are using it as a sense check on the results of your research.

It becomes a bit like a toddler’s shape sorting toy. You use the PROD rules to make sure everything fits together.  You might come away with the same number of products in the shortlist as you did at the end of the comparative research, or PROD may help filter the shortlist down further.

Stage 4 – Due Diligence

Having done the comparative research and the PROD sense check, you now have a shortlist of products that might all be perfectly good for the clients in the different segments.

Research done so far has been comparative.

Due Diligence is the analysis undertaken on the organisation delivering a product to consider its legitimacy as a commercial entity.

Due diligence is therefore absolute

In other words, the due diligence is nothing to do with functionality or tax wrappers (that satisfy the client needs) but rather how is the business built.

• What does their business continuity plan look like?
• How are senior executives remunerated?
• What is staff turnover like?
• What are their accounts like?

We managed to help a firm identify a provider that had CCJs listed against them.  Everything was perfectly innocent, but imagine if it wasn’t and the firms carried on recommending a product from a provider that was going to fold? 

The work done in the due diligence stage will help you understand how well you can maintain your reputation.

If your reputation remains intact it means your clients are getting a good outcome – win/win!

The biggest mistake we see here is trying to do due diligence BEFORE the research has been done.

Summary

Approaching the production of a CIP process in this way means you are putting clients at the heart of the decision.

This is why I say that an adviser can, and indeed should, be selfish.

If every product in your shortlist can do the same thing, you need to decide which company providing those products most deserves YOUR trust.

To be fair, up until 2018, it was hard to know this was required as there was no legislation to follow, just ideas of ‘good practices’ shared by the regulator.

Since 2018, however, and the introduction of the MiFID (COBS9A) and PROD rules, it is a clear as a whistle, and the regulator is unlikely to be forgiving if you get it wrong.

We have been helping firms build their CIP processes, undertake research and due diligence for 20 years, and I wrote my first article on due diligence back in 2013.

Since then, I am glad to say the direction that the regulations have gone since then has actually really helped advisers reduce their systematic risks, particularly as MIFID and PROD have both created rules that state the regulator expects to see procedures for t