In early 2010, they introduced a requirement for investment services enterprises to prepare investment advice minutes. In addition, the legal basis for the Employee and Complaints Register entered into force in November 2012. Both provisions contain tools that have proven important to supervisory practice.

Investment advice minutes

Since 1 January 2010, investment services enterprises are required to keep written minutes of all investment advice given to retail clients (section 34 (2a) of the Securities Trading Act (Wertpapierhandelsgesetz – WpHG)). The WpHG defines investment advice as the provision to clients of personal recommendations relating to transactions in certain financial instruments, whereby the recommendation is based on an evaluation of the investor’s personal circumstances or is presented as being suitable for the investor.

As a general rule, investment advice minutes must contain information on the reason for the investment advice, the duration of the investment advice session, the client’s personal situation, their investment interests, as well as the bank adviser’s recommendations and the reasons for these. After the investment advice session, the adviser must sign the minutes and give them to the client without delay.

Evidence and supervisory tool

The aim of introducing investment advice minutes was to strengthen bank clients’ rights. Previously, it was the client’s word against that of the investment adviser in the case of disputes. The client now has a written record of the investment advice. This can be used as evidence if the client wants to bring a civil claim for damages due to wrongful advice, as the burden of proof usually lies with the bank client.

The minutes also make it easier for BaFin to supervise investment advice. They have become an indispensable source of information, even more so now that complaints made against individual investment advisers are compiled in the Employee and Complaints Register. Investment advice minutes provide BaFin with additional information on the investment advice underlying the complaints.

Erroneous minutes

Some investment services enterprises initially had difficulty implementing the new requirements. For example, BaFin’s investigations revealed insufficient documentation, a lack of IT support and incorrectly filled out documents. Free text fields were also missing in some cases. To date, BaFin has issued four administrative fines of €10,000 each for violations. Thirty cases under the Act on Breaches of Administrative Regulations (Gesetz für Ordnungswidrigkeiten – OwiG) are currently pending.

In response to the results of its investigations, BaFin included a module in its circular of June 2011 entitled Minimum Requirements for the Compliance Function and Additional Requirements Governing Rules of Conduct, Organisation and Transparency pursuant to Sections 31 et seq. of the Securities Trading Act (Wertpapierhandelsgesetz – WpHG) for Investment Services Enterprises (Mindestanforderungen an die Compliance-Funktion und die weiteren Verhaltens-, Organisations- und Transparenzpflichten nach §§ 31 ff. WpHG für Wertpapierdienstleistungsunternehmen – MaComp). The module sets out the requirements for investment advice minutes with the aim of addressing market uncertainties relating to the content of the documentation.

While the quality of investment advice minutes has since improved, problems still exist. Some banks use standardised text blocks, for instance, while some advisers do not yet make enough use of the free text fields. As a result, it is often impossible to adequately reconstruct what actually happened during the investment advice session. BaFin is combating these problems by regularly reviewing the quality of investment advice minutes during on-site visits, for example. Appointed auditors also check during regular audits whether the company has implemented organisational measures to properly take investment advice minutes and to make these available. In the case of material irregularities BaFin takes administrative measures and, if necessary, issues administrative fines.

Clients have a part to play

However, investors also have a part to play in permanently improving the quality of investment advice minutes. Investment advice minutes can only serve their purpose if the client reviews the minutes. Clients can only increase their chances of asserting a claim if the content of the investment advice – for which there are usually no witnesses – is adequately recorded. If they discover that points are missing or incorrectly reported, they should request the adviser to amend or supplement the minutes.

Bank clients can find further information on investment advice in the flyer entitled “Investment advisory services – what consumers need to know” (only available in German) published by BaFin.

Employee and Complaints Register

Investment advice only works if clients have confidence in it. The financial crisis shook this confidence by exposing weaknesses in investment advisory services. Lawmakers identified shortcomings in employee qualifications and the adverse effect of institutions’ interests in making sales as the main reasons for this.

They responded by introducing section 34d of the WpHG, which entered into force as of 1 November 2012. Investment services enterprises may now only engage employees who have uniform minimum qualifications for specific tasks. These employees must also be registered in a database – the Employee and Complaints Register. In addition, retail clients’ complaints about the work of investment advisers must be reported.

Investment advisers, distribution officers and compliance officers

The new supervisory regime also affects other employee groups above and beyond investment advisers – specifically, distribution officers and compliance officers. Lawmakers consider these employees to have significant influence on the quality of investment advice. The selection of these groups underscores lawmakers’ assumptions that shortcomings in investment advice are not exclusively attributable to individual investment advisers. Rather, it signifies that defects in investment advice may also be due to operational weaknesses in the sales organisation. The introduction of the term “distribution officer”, which had not been used in previous versions of the Act, highlights this regulatory approach. As a result, concerns frequently voiced that the responsibility for misconduct by investment services enterprises could be shifted to individual investment advisers should remain unfounded.

BaFin prepared itself thoroughly for its new role. The main focus was on setting up the technical infrastructure, as well as on training the employees concerned, who qualify as financial planners using a recognised training programme for investment advisers. This means that the institutions and investment advisers are supervised by BaFin staff with an in-depth understanding of investment advice.

BaFin follows up clusters of complaints

BaFin examines the complaints it receives for irregularities, with a focus on unusual clusters, and investigates the issue further if necessary. Supervisors may visit branches and speak to advisers, for example. Around 80 branches of private, savings and cooperative banks have already been visited since the register was launched on 1 November 2012.

These visits give BaFin a steady stream of insights into advisory practice. For example, the first round of visits revealed that, in individual cases, investment recommendations still tend to be based on sales targets. In light of this, the benefits of the individual investment recommendations to customers require explanation in individual cases. BaFin is pursuing the issue further, and investment advisers and distribution officers will therefore have to continue to expect that BaFin will challenge the benefit to the customer of their recommendations or sales decisions.

BaFin has not yet used its new supervisory tools for investment advisory services. Under the WpHG, the institution and the employee may be warned, or the employee even banned from providing investment advisory services for up to two years, in addition to fines and other penalties.

Further regulation expected

The effort involved in advising retail investors has definitely increased. However, investment advisers are not the only ones facing stricter requirements – customers do, too. Customers are now required to carefully review the investment advice minutes and inform themselves well enough that they can actually exercise their right to good advice and benefit from the expertise of their adviser.

The introduction of investment advice minutes and the entry into force of the regulations governing employee qualifications and notification requirements are expected to be only the latest round in the regulation of investment advisory services. Further regulatory projects are already clearly on the horizon, such as the introduction of another type of investment advice – fee-based investment advice.