Investment Services and the Durability or Suitability Test | Kramer Levin Naftalis & Frankel LLP

Should financial institutions continue to profile customers using the average score method or opt for the “decision tree” approach?

While most financial institutions profile customers and perform the suitability or suitability test based on an average risk score, a recent decision by the AMF Sanctions Committee, followed by an administrative concordat weakens this method.

Profiling a client in the context of providing an investment service — to ensure that a product is suitable or appropriate for the client’s needs and personal circumstances — can take as many forms as there are institutions.

A method widely used in the industry consists of assigning a number of points to each answer in a questionnaire: The more the answer reflects a desire to expose oneself to a high level of risk, the higher the score obtained. This system results in an overall score, which “averages” the customer’s responses, but will not necessarily match all of the information provided in the questionnaire. Sometimes the client will provide answers reflecting a willingness to accept high risk and other answers reflecting a lower risk, and the overall score will be an average.

This method can be opposed to another approach, in which a “decision tree” is applied: a product or service will be considered suitable (or appropriate) provided that it corresponds cumulatively to all the needs and objectives communicated by the customer. . It is no longer a question of retaining an average risk rating, but rather the product corresponding to the lowest common denominator of the answers that have been given.

Reading the decision rendered by the AMF’s Sanctions Committee on October 24, 2022, one wonders whether the first approach described above — the average score method — is still supported by the AMF.

It is true that the decision concerned bond products, subscribed significantly by retail customers. It is also true that in this case some of the customer responses appeared to have been misused. Moreover, it is true that some of the answers were substantially contradictory. However, beyond the specifics of this particular case, the approach adopted by the AMF’s Enforcement Committee suggests that certain information (obviously risk tolerance and loss appetite, among others) should be considered as “exclusion” criteria and must justify the prohibition to offer certain products, even if the average score of the customer allowed access to such products.

The regulations (in particular the “Guidelines on certain aspects of the MiFID II suitability requirements”, Section 49 et seq.) of the European Securities and Markets Authority (ESMA) require monitoring of the answers provided by a client in order to detect possible anomalies and inconsistencies. However, it seems that little by little, the AMF Sanctions Committee is moving beyond this requirement towards an approach that considers a product as suitable or appropriate only when it corresponds to the aggregate data provided by the client (as already mentioned in article 80 of the ESMA guidelines mentioned above).

A recent administrative composition of the AMF (March 15, 2022, No. TRA-2022-02, second grievance § (iv)) seems to confirm this reading.

We will have to wait and see.

Regardless, the fact remains that these rulings encourage the use of overweight criteria for certain questions or the addition of exclusion criteria when profiling a client to ensure suitability. or the relevance of a product.

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