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The FCA’S rules on secret profits

22 May 2015 | 3 minute read

It is not uncommon for accountants and advisers to benefit from commission or introducer payments where they make referrals to other service providers.

Receipt of commission is, of course, prohibited where an adviser makes a personal recommendation in relation to an investment. However, where there is no personal recommendation, receipt of commission or fees to or from a regulated firm for the introduction of a client to an investment or a third party is not prohibited under FCA rules. While this may be permitted in these circumstances the parties involved should be aware of, and would be wise to take precautions against, the possibility of the client making a claim for secret profits.

Under common law principles of agency, an agent (i.e. the accountant/adviser) owes certain duties to his principal (i.e. the client) not to put himself in a position of conflict of interest and, importantly, not to act dishonestly. Any payment an agent receives from a third party (such as a commission or some other financial inducement) without the "informed consent" of his principal will generally be considered as a matter of law to be "dishonest" and treated as a secret profit. Further, in receiving any secret profit, an agent will be in breach of his duties to his principal.

The remedies available for a successful claim for secret profits include:

The client can rescind any contract with the third party
The client can recover damages from both the payee/donor and from the agent (but not double damages; sums recovered from one would be set off against sums recovered from the other)
The client can refuse consent for commission to be paid to the agent

A claim for secret profits can therefore not only cause reputational damage but is also likely to result in the introducer not receiving any commission or having to pay any commission to the client. We have seen evidence of clients making secret profits claims where they subsequently become aware of a fee or commission being paid of which they were not made aware.

To avoid claims for secret profits the key safeguards to consider are:

Disclose to the client any arrangements to pay a referral fee to other professionals
Disclose to the client any arrangements to receive a referral fee for referring the client to another professional
Obtain advance agreement from the client for all relevant commission arrangements

More specifically, in order to be able to retain commissions for referrals, advisers must ensure they obtain the client's informed consent in advance of the transaction that generates the commission. The ICAEW's Code of Ethics offers some useful guidance on how to obtain consent, which is both informed and advance.

This guidance is consistent with the case law in this area and so is useful to all potential payees/donors of such payments:

Obtain the client's specific advance consent for the receipt of commission. This involves obtaining consent before the commission is received and before the client is obliged to go through with the transaction in question. The actual amount of the commission (or its basis of calculation) and the terms and timing of its payment should also be disclosed in advance
Obtain the client's general advance consent for the receipt of commission. This would likely involve including some general wording within the engagement letter disclosing when commissions might be paid and seeking the client's agreement to this. If this option is chosen the ICAEW suggests including examples of likely commissions that may be received and the likely amounts. Where commissions are significantly larger than envisaged by the engagement letter then it would be advisable to obtain specific consent in those circumstances

For a belt and braces approach it is possible to include generic wording in your client engagement letter but also have a precedent "commission disclosure" letter, which can be sent to clients when it becomes clear commission may be triggered and what the amount will be. As indicated above, a failure to make such a disclosure can have serious financial and reputational consequences. It may also be regarded as not treating customers fairly if such disclosure arrangements are not in place.

Finally, if you are not comfortable in making such disclosure to a client then perhaps you should be asking yourself if you should be paying or receiving the commission at all.

This article was written for Money Marketing.