This page intentionally left blank HOW TO PROTECT INVESTORS As governments around the world withdraw from welfare provision and promote long-term savings by households through the financial markets, the protection of retail investors has become critically important Taking as a case study the wide-ranging EC investor-protection regime which now governs EC retail markets after an intense reform period, this critical, contextual and comparative examination of the nature of investor protection explores why the retail investor should be protected, whether retail investor engagement with the markets should be encouraged and how investorprotection laws should be designed, particularly in light of the financial crisis The book considers the implications of the EC’s investor-protection rules ‘on the books’ but also considers investor-protection law and policy ‘in action’, drawing on experience from the UK retail market and in particular the Financial Services Authority’s extensive retail market activities, including the recent Retail Distribution Review and the Treating Customers Fairly strategy niamh moloney is a professor in the Law Department of the London School of Economics and Political Science international corporate law and financial market regulation Recent years have seen an upsurge of change and reform in corporate law and financial market regulation internationally as the corporate and institutional investor sector increasingly turns to the international financial markets This follows large-scale institutional and regulatory reform after a series of international corporate governance and financial disclosure scandals exemplified by the collapse of Enron in the US There is now a great demand for analysis in this area from the academic, practitioner, regulatory and policy sectors The International Corporate Law and Financial Market Regulation series will respond to that demand by creating a critical mass of titles which will address the need for information and high-quality analysis in this fast developing area Series Editors Professor Eilis Ferran, University of Cambridge Professor Niamh Moloney, London School of Economics and Political Science Professor Howell Jackson, Harvard Law School Editorial Board Professor Marco Becht, Professor of Finance and Economics at Universit´ Libre e de Bruxelles and Executive Director of the European Corporate Governance Institute (ECGI) Professor Brian Cheffins, S J Berwin Professor of Corporate Law at the Faculty of Law, University of Cambridge Professor Paul Davies, Cassel Professor of Commercial Law at the London School of Economics and Political Science Professor Luca Enriques, Professor of Business Law in the Faculty of Law at the University of Bologna Professor Guido Ferrarini, Professor of Law at the University of Genoa and Honorary Professor, Faculty of Law, University College London Professor Jennifer Hill, Professor of Corporate Law at Sydney Law School Professor Klaus J Hopt, Director of the Max Planck Institute of Comparative and International Private Law, Hamburg Professor Hideki Kanda, Professor of Law at the University of Tokyo Professor Colin Mayer, Peter Moores Professor of Management Studies at the Saăd Business School and Director of the Oxford Financial Research Centre ı James Palmer, Partner of Herbert Smith, London Professor Michel Tison, Professor at the Financial Law Institute of the University of Ghent Andrew Whittaker, General Counsel to the Board at the UK Financial Services Authority Professor Eddy Wymeersch, Chairman of the Committee of European Securities Regulators (CESR); Co-Chair of the CESR-European Central Bank Working Group on Clearing and Settlement, and part-time Professor of Commercial Law, University of Ghent HOW TO PROTECT INVESTORS Lessons from the EC and the UK NIAMH MOLONEY CAMBRIDGE UNIVERSITY PRESS Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo, Delhi, Dubai, Tokyo Cambridge University Press The Edinburgh Building, Cambridge CB2 8RU, UK Published in the United States of America by Cambridge University Press, New York www.cambridge.org Information on this title: www.cambridge.org/9780521888707 © Niamh Moloney 2010 This publication is in copyright Subject to statutory exception and to the provision of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press First published in print format 2010 ISBN-13 978-0-511-67557-7 eBook (NetLibrary) ISBN-13 978-0-521-88870-7 Hardback Cambridge University Press has no responsibility for the persistence or accuracy of urls for external or third-party internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate To Iain CONTENTS Preface and acknowledgments Table of cases xvii Table of treaties and legislation List of abbreviations xxv I II III IV The retail investor and the EC page xiii xviii The importance of the retail markets The retail markets and the EC The development of a retail market agenda Scope: the reach of EC investor protection law and policy 13 Beyond the cross-border context 18 But room for local ‘law on the books’ and for ‘law in action’: the UK example 22 Examining retail investor protection through the EC lens 29 Who is the EC investor? 30 Characterizing the target of investor protection 30 The average EC investor: an elusive target? 31 Investors or consumers? 39 The financial crisis and EC retail market policy 41 Designing a retail investor protection regime I Why intervene in the retail markets? Encouraging the empowered investor, shielding the irrational investor or supporting the trusting investor? 45 Characterizing investor protection 45 The retail investor as an agent of public policy and the empowered investor 47 The irrational and uninformed investor 67 The trusting investor 81 The risks of retail market intervention 92 Regulatory and retail market agenda risks 92 II vii 45 viii contents III Regulation and the retail markets: ‘laws on the books’ and ‘laws in action’ 95 Responding to the drivers of retail market engagement 97 Centralization risks 100 How to intervene on the retail markets? 102 The regulatory toolbox and self-regulation 102 Achieving retail market outcomes 106 Principles-based regulation and the retail markets 108 Evidence-based policy formation and rule-making 114 Controlling risk-taking and segmentation techniques 118 Diversification 122 Product regulation I Product regulation and the retail markets 134 The EC and product regulation 134 The benefits of CIS product regulation 137 The risks of CIS product regulation 142 An integrated model 151 The UCITS investor protection regime and product regulation 152 Inbuilt diversification and liquidity 152 Inbuilt governance: the depositary and the management company 153 The UCITS III product and design risks 157 The UCITS III regime 157 UCITS III and the risks of facilitative product design 162 Beyond UCITS III: alternative investments and product design risks 168 Beyond product regulation: the product provider and the provider/distributor relationship 176 Structured and substitute products 179 The substitute product market and structured products 179 A segmented product regime and its risks 184 Developing a response 187 II III IV 134 Investment advice and product distribution I Intermediation, its risks and regulation 192 The benefits of advice 192 The risks 193 Regulating advice 196 Scope of the advice and product distribution regime 200 The advice and distribution regime 200 MiFID’s scope: a wide range of instruments and services II 192 202 460 supervision, enforcement and redress have arisen in how the Directive has been implemented, the injunctive procedure is not designed to deliver individual redress, it can be costly and proceedings are very lengthy in some Member States.188 b) Class actions The most striking developments in retail investor redress concern the recent tentative movements to develop a discrete EC class action mechanism189 for consumers generally.190 Compensatory class actions for damages afford consumers (and retail investors) a number of benefits, including recourse to the courts in situations where individual claims are too small to justify taking an action, the potential for compensation, access to legal advice and strong deterrent effects The low levels of private enforcement against issuers, product providers and investment firms across the EC certainly appear to be related to the absence of class actions.191 Eurobarometer evidence suggests more generally that consumers would take action more readily through a collective action.192 Although the current EC policy debate is framed in terms of consumer rights and consumer protection generally,193 the potential implications for retail investors are considerable, particularly where systemic mis-selling or product design failures occur Class actions based on the much discussed US model,194 and particularly its lawyer-driven, contingency-fee-based nature, its basis in the taking of action by a defined ‘opt-out’ class (the individual claimants in which need not be identified and the members of which are bound by the claim’s resolution unless they opt out), its association with non-compensatory and often inflated punitive damages awards by juries and the speculative 188 189 190 191 192 193 194 Leuven Report, pp 347–8 A massive literature, predominantly US, considers class actions in the investment field This section seeks only to highlight the emerging EC developments R Mulheron, ‘The Case for an Opt-Out Class Action for European Member States: A Legal and Empirical Analysis’ (2009) 15 Columbia Journal of European Law 409 G Ferrarini and P Guidici, Financial Scandals and the Role of Private Enforcement: The Parmalat Case (2005), ssrn abstractid=730403 Leuven Report, pp 263–4 The Commission’s consumer policy strategy for 2007–13 committed to considering action on collective redress for consumers with respect to infringements of consumer protection rules and breaches of EC competition rules: European Commission, Communication on EU Consumer Policy Strategy, p 11 The 2008 Green Paper on Consumer Collective Redress is similarly couched in terms of consumers’ rights generally From an extensive literature addressing issuer liability e.g J Coffee, ‘Reforming the Securities Class Action: An Essay on Deterrence and Implementation’ (2006) 106 Columbia Law Review 1534 investor redress 461 actions which are incentivized as the loser does not typically pay the costs of the successful party, not form part of Member States’ civil liability regimes The inefficiencies and excesses associated with US class actions, particularly in the securities field,195 appear to have curbed policy and industry support for class actions in the EC Representative actions by consumer and other associations for injunctions are, however, available in all the Member States, although not always with respect to securities and investment matters Mechanisms which support the taking of collective damages actions by representative organizations, procedural rules which support the bundling of individual claims to form group actions for damages (but which not result in binding decisions for those who have not opted in to the group action),196 particularly in the securities and investment field (notably in Germany), and test cases are also being adopted.197 The Netherlands and Sweden have also adopted procedures which, by relying on an opt-out mechanism to define the class taking action, are similar to the US class action.198 Consumers and investors are becoming more aware of compensation opportunities as US class action lawyers increasingly search for claimants in Europe199 and claims are made against European companies in US proceedings.200 Where class actions are available in certain Member States, cross-border investors can, however, be excluded from any settlement.201 195 196 197 198 199 200 201 E.g Paulson Report, pp 71–84 Securities class actions pose particular difficulties as they involve a wealth transfer to one group of shareholders (who have traded during the period when the security’s price was affected by the fraud) from another (the company’s shareholders who will carry the cost of the settlement) There is also some evidence that retail investors can be prejudiced by class actions: J O’Hare, Retail Investor Remedies under Rule 10b-5 (2007), ssrn abstractid=1019295 H.-B Schaefer, ‘The Bundling of Similar Interests in Litigation: The Incentives for Class Actions and Legal Actions Taken by Associations’ (2000) European Journal of Law and Economics 183 Clifford Chance, Class Actions Make Their Way into Europe (2008), pp 2–3 and 4; and Leuven Report, p 261 Leuven Report, p 261 In one notable example, an out-of-court settlement for which approximately 200,000 Dutch investors were eligible was approved by the Amsterdam Court of Appeal in 2005 following the mis-selling of share lease products by the main bank active in this market: Joint Forum Report, p 78 H Watt, ‘US Class Action Star Targets UK’, The Times, 11 March 2007, available via http://business.timesonline.co.uk; and J Heaps and S Jackson, ‘US-Style Litigation and the Spread of the Class Action’ (2007) Law and Financial Markets Review 135 Clifford Chance, Class Actions, pp 2–3, noting also the arrival of professional litigation funders in the EC market Commission, Leuven Summary, p 462 supervision, enforcement and redress The difficulties in extrapolating an EC, cross-border class action mechanism from this movement are, however, immense Aside from entrenched and diverging government, consumer and industry positions on the desirability of class actions, the technical difficulties are very considerable The range of complex issues which a harmonizing measure might engage with include: scope and when class actions should be admissible;202 the relationship between class actions and other redress mechanisms; whether the mechanism should operate on a claimant ‘opt in’ or ‘opt out’ model; the standing and powers of representative bodies;203 procedures; funding;204 damages awards205 and their distribution; the availability of injunctive relief; and costs.206 Reflecting the rather carefully worded support of the Council and the Parliament,207 and given the very considerable national sensitivities and industry hostilities, the Commission has adopted an incremental and tentative approach; policy proposals are hardening, however, in the competition sector.208 Following a commitment in its 2007–13 consumer policy strategy to consider collective redress, the Commission has engaged in extensive consultation209 and evidence-gathering initiatives.210 202 203 204 205 206 207 208 209 210 Including determinations as to when it is more suitable to pursue claims individually, the exclusion of frivolous or vexatious claims and the need to prove individual claims Including which bodies (such as authorized consumer associations or qualified entities under the 1998 Injunctions Directive) have standing to bring claims and their powers to decide on which claims should be pursued The different funding models include public funds (granted to, for example, consumer associations), own resources, loans, legal expenses insurance, contingency fees and thirdparty litigation funding Including whether damages should be compensatory only or have a punitive element and whether damages should be related to individual claims or be designed to support consumer interests generally Including the application of the ‘loser-pays’ principle and management of the risks which would arise were forum-shopping to arise with respect to the party which carries the costs The Council has recommended that the Commission carefully consider collective redress mechanisms: Council, Resolution on EU Consumer Policy, para II.10 The European Parliament’s 2008 response was similarly cautious and urged the Commission to consider consumer redress carefully and highlighted the ‘concerns expressed at the excesses and drawbacks of the US model’: European Parliament, Report on EU Consumer Policy, para 40 European Commission, White Paper on Damages Actions for Breach of the EC Antitrust Rules (COM (2008) 165), which raises the possibility of representative actions and opt-in collective actions by complainants Key initiatives include the 2007 Leuven ‘brainstorming’ event, the 2007 conference organized by the Portuguese Presidency in November 2007, the consultation on the Commission’s Collective Redress Benchmarks and the series of workshops held in 2008 It commissioned three major studies including the 2008 Leuven Report, an evaluation of existing collective redress mechanisms across the EC and an analysis of the difficulties faced by consumers in obtaining redress with respect to mass claims investor redress 463 It ventured into more substantive policy development with its 2008 consultation on its Consumer Collective Redress Benchmarks211 and its subsequent 2008 Green Paper on Consumer Collective Redress The Green Paper acknowledged consumer distrust of redress systems (locally and cross-border), the access, effectiveness and affordability difficulties consumers face in seeking redress, including with respect to financial services, and weaknesses in the harmonized regime (including the absence of compensatory mechanisms), all of which meant that a substantial proportion of consumers who sustained damage could not obtain redress In response, the Green Paper canvassed four options: a ‘wait and see’ approach, based on reliance on existing measures; a model based on Member State cooperation and action in that Member States who have adopted collective redress mechanisms would open them to cross-border claimants and those Member States without redress mechanisms would adopt them; using a mix of policy instruments to support better redress, including consumer awareness initiatives and improving ADR; and ensuring that a collective redress mechanism exists in all Member States (whether by means of a binding or non-binding measure) so that all consumers could obtain adequate redress through representative actions, group actions or test cases The Green Paper also canvassed the difficulties raised by opt-out models, which are associated with encouraging excessive litigation, and opt-in models, which are administratively burdensome Although class actions with respect to investments have not received particular policy attention so far, industry suspicion runs deep and is deeply rooted in concerns as to the importation of the US securities class action212 and, in particular, the introduction of punitive and other noncompensatory damages which are not strongly associated with redress in the EC The costs and risks of developing a discrete pan-EC mechanism suggest that policy resources would be better spent on supporting effective supervision, particularly in the post-MiFID principles-based environment, and on facilitating access to high-quality ADR 211 212 European Commission, Feedback Statement on the Consumer Collective Redress Benchmark Consultation (2008) FIN-USE, in particular, has been supportive: FIN-USE, Response to Consultation on the Consumer Collective Redress Benchmarks (2008), p Industry wariness of the US model has, for example, led to French resistance to class actions, notwithstanding support from consumer and investor associations: FIN-USE, Response to Consultation on the Consumer Collective Redress Benchmarks, p INDEX access to advice 204–7, 278–9 EC and 285–7 to justice 442–4 to trading 365–8 adverse selection 46 advertising risks 254 advice see investment advice alternative dispute resolution (ADR) 451–8 alternative investments 168–72 anchoring effect 292 appropriateness of investment advice 237–40 arbitrage, regulatory 93, 145, 185, 189 Argentina 132 asset allocation rules 162 asset protection 208 asymmetric paternalism 80 Australia 49, 100, 148, 197 authorization of investment advice 207–8 autonomy of investors 53 banking sector 91 Basic Advice scheme 144, 150, 237, 279–81 behavioural finance 68, 78, 79, 291 Belgium 34, 37 best execution 348, 355–6 bond markets 362–3 dealer markets and spread-betting example 360–2 disclosure 358–60 price benchmark 356–8 BME Report 20, 21, 51, 71, 99, 116, 390 boiler rooms 232–3 bond markets 38, 66, 128 best execution 362–3 bounded rationality 68 Canada, Deaves study 71, 99, 116 capability 173 National Financial Capability Strategy (UK) 386 capital 47 protection of 182 requirements 195 capture risks 400 caveat emptor 53, 64 centralization risks 100–2 Child Trust Fund (UK) 4, 101, 102 Citizen’s Summaries 418 class actions 460–3 closed-end investment schemes (CISs) 26, 99, 180 cognitive conservatism 69 cold-calling 91, 232–3 collective investment schemes (CISs) 60, 124 disclosure difficulties 304–7 reform efforts 308–12 investor education and 383 product regulation 134–7 benefits 137–42 design risks 142–5 integrated model 151–2 investor choice assumption 146–51 464 index commission 251, 254 commission risk 257–63 demand side 263 disclosure 263, 338–44 supply side 263–6 Committee of European Securities Regulators (CESR) 18, 117, 132, 179, 247, 317–20, 407–9 investor education and 396–8 retail markets and 419–24 supervision and enforcement 434, 436–40 comparability 294–6, 297 compensation schemes 434, 436, 440–2 competence risks 183 complaints 447–50 complexity 150 conduct of business regulation 208–9 conduct of business sourcebook (COBS) 25 conduct rules 156 confirmation bias 292 conflict of interest 156, 194 disclosure and commissions risk and services and costs disclosure 338–44 general disclosure requirements 337–8 investment advice 208–9, 214, 244–7 commission risk and 263–6 trading sector 348 confusion 150 consumers 55, 57 investment advice and consumer protection 227–31 investors as 39–41 contracts between investment firm and investor 247–9 costs see fees and costs Council of the EU Financial Services Committee cross-border context 18–22 cross-border redress see redress cross-border risks 433–6 465 day trading 351 de Larosi` re Report (2009) 43, 396, e 418, 437 dealer markets, best execution and 360–2 Deaves study 71, 99 debt markets, diversification and 128–33 decision-making 115, 147 failures 70 Delmas Report 49, 56, 74, 76, 106, 151, 177, 185, 198, 261, 343 Denmark 34, 38, 39, 182 depolarization 268 depositary 154–5 de-regulation derivatives 35, 127 design risks 142–5, 172–4 designing retail investor protection regime 59 characterizing investor protection 45–7 direct investments 33 disclosure 103, 126, 196, 337–8 in action 300–4 best execution 358–60 commission risk and 263, 338–44 developing response 330–3 difficulties 304–7 eclipsing of 213–15 for financial instruments and structured securities 323–30 MiFID regime 324–30 prospectuses 323–4 fragmented regime 322–3 general investment firm and services disclosure 334–7 investor understanding 72, 73, 166, 290–2 comparability 294–6 evidence for problem 292–4 issuer disclosure 363–5 marketing communications 333–4 redress disclosure 447–50 reform efforts 308–12, 316–22 retail market regime 288–90 risks 296–300 services and costs disclosure 338–44 466 index disclosure (cont.) UCITS regime 312 poor disclosure design 313–16 reforms 316–22 distance marketing 8, 14, 21, 57, 289 investment advice 226–7 distribution 166–8 open distribution 149, 261 provider/distributor relationship 176–9 Retail Distribution Review (2007) 151, 269–72, 281–5, 389 segmentation risks and 251 diversification 66 debt markets example 128–33 patchy commitment to 125–8 product regulation 152–3, 158, 162–5, 172 retail markets 122–4 dotcom bubble 32, 61, 176 drivers of retail market engagement 97–100 education of investors 103, 285 benefits 374–7 Committee of European Securities Regulators (CESR) and 396–8 design 380–4 strategy 389 UK example 384–9 empowered investors 53–8, 84, 97 attractions of empowerment model 58–60 blending empowerment and trust based strategies 89–92 risks of empowerment model 60–7 endowment effect 69 enforcement see supervision and enforcement Equitable Life 433 equity investments 38, 164 Eurobarometer surveys 20, 116, 293 European Commission 410 Eurobarometer surveys 20, 116 Financial Integration Monitor 19 investor education and 393, 395 European Community (EC) access to advice and 285–7 fee-based investment advice 273–8 internal market investor education and 389–96 investors’ involvement in policy and law-making 398–9, 402, 405–9 product regulation and 134–7 retail governance and 411–13 Committee of European Securities Regulators (CESR) and 419–24 improving investor governance 413–19 institutional proxies 410–11 law-making environment 405–9 need for retail voice 399–402 organizing retail investors 402–4 self regulation risks 409–10 supervision and enforcement regime 426–9 European Court of Justice 90 European Fund and Asset Management Association (EFAMA) 179 European Parliament 4, 51, 392, 410 ECON Committee 52 evidence-based policy formation and rule-making 114–18 evolutionary model 78 exclusionary policies 77 execution-only services 126, 127, 167, 239, 350–4 expert groups 406 fair analysis advice 253 fair deal agenda 54 fair treatment principle 215–17, 234 risks of ‘fairness’ 217–19 Treating Customers Fairly initiative 177, 178, 219–24, 241, 387, 430 Federation of European Securities Exchanges 34 fees and costs 147 disclosure 306, 338–44 fee-based investment advice 266–73 EC model 273–8 financial crisis 41–4, 64, 66, 94, 115, 195, 436 index Financial Ombudsman Scheme (FOS; UK) 453, 457 financial planning Financial Services Action Plan (FSAP) 8–11, 32, 34 Financial Services Authority (FSA; UK) 1, 3, 5, 15, 16, 22, 24, 28, 50, 51, 62, 76, 89, 92, 95, 107, 258 alternative investments and 169 Basic Advice scheme 144, 150, 237, 279–81 best execution and 356, 362 centralization risks 100 complaints and 448 disclosure and 292, 294, 298, 299, 300, 308, 328, 329, 341, 343 diversification and 123 empowered investors and 54–6 fee-based investment advice and 267–72 Financial Services Consumer Panel (FSCP) 55 Handbook 25 hedge funds and 163 investment advice and 198 investor choice and 150 investor education and 376, 379, 384–9 objective remuneration and 264 organizing retail investors 402 packaged investment products and 210 Primary Advice 281, 283 principles-based regulation 108–14 product regulation and 142 Retail Distribution Review (2007) 151, 269–72, 281–5, 389 segmentation risks and 252 self-regulation and 105, 409 suitability rules 236 supervision and enforcement 432 Treating Customers Fairly initiative 177, 178, 219–24, 241, 387, 430 Financial Services Consumer Group (FSCG) 12, 40, 416 Financial Trust Index 85, 87 FIN-NET 456 fixed-income investments 38 467 framing effect 69, 292 France 116, 181 banking sector 91 commission risk 259 Delmas Report 49, 56, 74, 76, 106, 151, 177, 185, 198, 261, 343 empowered investors and 56 home bias 71 investment advice 198 investment patterns 33, 37 investor education 379, 389–96 irrational and uninformed investor 74 savings 35 TNS-Sofres Report 73, 292 generic investment advice 279 Germany 181 commission risk 259 fee-based investment advice 277 insurance market 91 investment advice 199 investment patterns 33, 35, 37, 38 investor choice in 149 mis-selling 258 savings 35 trading sector 348 governance product regulation 153–7 retail governance 411–13 Committee of European Securities Regulators (CESR) and 419–24 improving investor governance 413–19 institutional proxies 410–11 law-making environment 405–9 need for retail voice 399–402 organizing retail investors 402–4 self regulation risks 409–10 Greece 39 harmonization investment advice 209–12 hedge funds 163, 169, 170–1 herding behaviour 70, 73 hindsight bias 69 home bias 71, 82, 123 home ownership 100 468 index incentive risk 93, 156, 257–63 independent financial advisers 268, 270, 271 index schemes 147 index-linked bonds 182 inducements 264–6, 344 information asymmetries 46 injunctions 458–60 innovation 159 obstruction of 144 institutional investors 76 institutional proxies 410–11 insurance market 37, 91, 115 solvency regime 195 unit-linked life insurance products 32, 36, 180 interest groups 401 intermediaries 104 see also investment advice International Capital Market Association (ICMA) 131 International Organization of Securities Commissions (IOSCO) 2, 375 intuition 73 investment advice 23, 79, 86, 103 access to advice 204–7, 278–9 EC and 285–7 authorization and prudential requirements 207–8 Basic Advice scheme 144, 150, 237, 279–81 benefits 192 commission risk 257–63 demand side 263 supply side 263–6 conduct of business regulation and conflict of interest management 208–9 conflict of interest 208–9, 214, 244–7 commission risk and 263–6 definition 203–4 delivering high quality advice 256–7 fee-based 266–73 EC model 273–8 generic 279 incentive risk 257–63 regulation 166–8, 196–200, 208–9 cold calls and boiler rooms 232–3 conflict of interest risks 244–7 consumer protection and 227–31 contracts between investment firm and investor 247–9 effectiveness 234–5 fair treatment principle 215–17, 234 marketing communications 231–2 marketing risks 224–6 maximum harmonization 209–12 online and distance contacts 226–7 principles-based regulation 212–13 risks of ‘fairness’ 217–19 shaping firm conduct and eclipsing of disclosure 213–15 suitability and appropriateness 237–40 suitability and objectivity 235–7 suitability in action 240–3 Treating Customers Fairly initiative 177, 178, 219–24, 241, 387, 430 risks 193–6 scope of advice and distribution regime 200–2 segmentation risks structured and substitute products 252–6 UCITS regime 250–2 suitability in action 240–3 appropriateness and 237–40 commission risk and 263–6 objectivity and 235–7 wide range of instruments and services 202–3 investment trusts 28 split capital 94, 175 investors 30–1 advice see investment advice average EC investor diverging investment patterns 36–9 investment pattern 31–6 index compensation schemes 434, 436, 440–2 contracts between investment firm and investor 247–9 education 103, 285 benefits 374–7 Committee of European Securities Regulators (CESR) and 396–8 design 380–4 developing strategy 389 UK example 384–9 empowered investors 53–8, 84, 97 attractions of empowerment model 58–60 blending empowerment and trust based strategies 89–92 risks of empowerment model 60–7 investor choice assumption 146–51 investor protection 29, 45–7 harmonization of target of 30–1; 30–1 see also individual topics investor understanding 72, 73, 166, 290–2 comparability 294–6 evidence for problem 292–4 as investors or consumers 39–41 involvement in policy and law-making 398–9, 402, 405–9 irrational and uninformed investor evidence for 67–74 implications 74–81 prejudices 146 redress access to justice 442–4 class actions 460–3 complaints and redress disclosure 447–50 out-of-court settlement and alternative dispute resolution 451–8 private rights of action 444–7 representative actions for injunctions 458–60 retail markets see retail markets trusting investor 81–8, 97 469 blending empowerment and trust based strategies 89–92 irrational and uninformed investor evidence for 67–74 implications 74–81 issuer disclosure 363–5 Italy 33, 34, 181 centralization risks 100 commission risk 259 home bias 71 investment advice 199 investment patterns 38 investor choice in 149 irrational and uninformed investor 74 savings 35 transparency in markets 132 Joint Associations Committee (JAC) 179 Joint Forum Report 2008 197, 432 justice, access to 442–4 Key Investor Information (KII) 16, 295, 302, 316–22, 331 Lamfalussy Report 8, 397, 405, 413, 438, 439 language difficulties 20 law 95–7 law and economics 67 law-making 398–9, 402, 405–9 learning 79, 83, 379 legal action access to justice 442–4 alternative dispute resolution (ADR) 451–8 class actions 460–3 private rights of action 444–7 representative actions for injunctions 458–60 Lehman Bros 94, 183, 252 libertarian paternalism 80 liquidity liquidity risks 183, 190 product regulation 152–3 470 index London Stock Exchange 387 loss aversion 69 Luxembourg 38 Madoff scandal 154 management company 155 marketing cold calls and boiler rooms 232–3 disclosure of marketing communications 333–4 distance marketing 8, 14, 21, 57, 289 investment advice 226–7 investor choice and 147 marketing risks 224–6, 254 public policy and 47–53 regulation of marketing communications 231–2 markets disruption 76 market failures 46 volatility 60, 75 merit strategies 77 mis-selling 189, 194, 197, 220, 258 moral hazard 143 mortgages 100 mutual recognition National Financial Capability Strategy (UK) 386 neo-classical economics 46 Netherlands 181 centralization risks 101 closed-end investment schemes (CISs) 99 cold-calling 91 commission risk 259, 261 disclosure 310, 344 empowered investors and 56 investment advice 199 investment patterns 34, 37, 39 investor choice in 149 investor education 390 irrational and uninformed investor 74 self-regulation 106 noise traders 60 objectivity investment advice 235–7 objective remuneration 264 obsolescence 144 Ombudsman Scheme (FOS; UK) 453, 457 online brokerage 345, 352 online investment advice 226–7 open distribution 149, 261 Optem Report 39, 87, 103, 117, 293, 294, 303 Organization for Economic Cooperation and Development (OECD) 374 out-of-court settlement 451–8 outsourcing 208 over-investment 75 packaged investment products 36, 190, 210, 329, 332 Parmalat 132 paternalism 47, 218, 236 asymmetric 80 libertarian 80 pension products 32, 35, 36 Poland 34 polarization system 86 policy making 398–9 political over-reaction 94 portfolio management 157 Portugal 39 prejudices 146 price benchmark in best execution 356–8 Primary Advice 281, 283 principles-based regulation 108–14, 212–13 processability of trading 368–73 product regulation 103, 134–7, 175–6, 187–91, 196 advice and distribution 166–8 benefits 137–42 design risks 142–5, 172–4 diversification 152–3, 158, 162–5, 172 integrated model 151–2 investor choice assumption 146–51, 172 index investor understanding 166 product provider and provider/distributor relationship 176–9 retailization of alternative investment and its benefits 168–72 risk management 165–6 segmented product regime product regulation and substitute products 186–7 sectoral regulation 184–6 structured products 180–4 substitute products 179–80, 186–7, 190 UCITS regime 157–62 inbuilt diversification and liquidity 152–3 inbuilt governance 153–7 prospectus disclosure 323–4, 370–2 prudential rules investment advice 207–8 public policy marketing and 47–53 Rand Report 99, 116, 267 rationality 67, 78 bounded 68 real estate investment schemes 169, 170, 175 reasonableness fairness and 218 redress access to justice 442–4 class actions 460–3 complaints and redress disclosure 447–50 out-of-court settlement and alternative dispute resolution 451–8 private rights of action 444–7 representative actions for injunctions 458–60 regulation 6, 381, 411–13 Financial Services Action Plan (FSAP) 8–11 investment advice 166–8, 196–200, 208–9 471 cold calls and boiler rooms 232–3 conflict of interest risks 244–7 consumer protection and 227–31 contracts between investment firm and investor 247–9 effectiveness 234–5 fair treatment principle 215–17, 234 marketing communications 231–2 marketing risks 224–6 maximum harmonization 209–12 online and distance contacts 226–7 principles-based regulation 212–13 risks of ‘fairness’ 217–19 shaping firm conduct and eclipsing of disclosure 213–15 suitability and appropriateness 237–40 suitability and objectivity 235–7 suitability in action 240–3 Treating Customers Fairly initiative 177, 178, 219–24, 241, 387, 430 principles-based regulation 108–14 product regulation see product regulation regulatory arbitrage 93, 145, 185, 189 regulatory failure 64, 65 regulatory risk 92–5 regulatory tool box 102–6 self-regulation 102–6, 409–10 see also governance; supervision and enforcement representative actions for injunctions 458–60 responsibilization literature 58 Retail Distribution Review (2007) 151, 269–72, 281–5, 389 retail markets 29 achieving retail market outcomes 106–8 Committee of European Securities Regulators (CESR) and 419–24 472 index retail markets (cont.) controlling risk-taking and segmentation techniques 118–22 cross-border context 18–22 development of retail market agenda early developments 5–8 FSAP and retail interest 8–11 post FSAP 11–12 disclosure regime 288–90 diversification 122–4 evidence-based policy formation and rule-making 114–18 financial crisis and 41–4 importance of 1–5 principles-based regulation 108–14 regulatory tool box and self-regulation 102–6 retail governance 411–13 Committee of European Securities Regulators (CESR) and 419–24 improving investor governance 413–19 institutional proxies 410–11 law-making environment 405–9 need for retail voice 399–402 organizing retail investors 402–4 self-regulation risks 409–10 risks of retail market intervention centralization risks 100–2 laws on the books and laws in action 95–7 regulatory and retail market agenda risks 92–5 responding to drivers of retail market engagement 97–100 scope of EC investor protection main elements 13–14 movement of retail market issues from member states to EC 16–18 prescriptive regime 14–16 supervision and enforcement 426 EC regime 426–9 risks 429–36 UK example 22–9 review of investment performance 72 risk assessment 53 controlling risk-taking and segmentation techniques 118–22 disclosure 296–300 investment advice 193–6 marketing risks 224–6 product regulation 165–6 design risks 142–5, 172–4 investor choice assumption 146–51, 172 risks of empowerment model 60–7 risks of retail market intervention centralization risks 100–2 laws on the books and laws in action 95–7 regulatory and retail market agenda risks 92–5 responding to drivers of retail market engagement 97–100 segmentation risks structured and substitute products 252–6 UCITS regime 250–2 trading sector 350–4 transfer of understanding of 73 rules of thumb 69 SANCO 117 Sandler Review 50, 73, 140 savings 35 scope of EC investor protection main elements 13–14 movement of retail market issues from member states to EC 16–18 prescriptive regime 14–16 sectoral regulation 184–6 Securities and Exchange Commission (SEC; US) 5, 49, 65, 93, 95 diversification and 123 empowered investors and 53 Rand Report 99, 116, 267 segmentation 118–22, 196 segmentation risks index structured and substitute products 252–6 UCITS regime 250–2 segmented product regime product regulation and substitute products 186–7 sectoral regulation 184–6 Segr´ Report (1966) e self-regulation 102–6, 409–10 share clubs 345 smart money effect 82, 147 social capital 84 Spain 181 commission risk 259 fee-based investment advice 277 investment advice 199 speculation 351 split capital investment trusts 94, 175 spread-betting 360–2 stakeholder products 144, 163 standardization 329 status-quo bias 69 structured products 180–4 disclosure and 323–30 segmentation risks 252–6 substitute products 179–80, 186–7, 190, 255 disclosure and financial instruments and structured securities 323–30 fragmented regime 322–3 segmentation risks 252–6 suitability rules 211 in action 240–3 appropriateness and 237–40 commission risk and 263–6 investment advice 235–7 supervision and enforcement 426 Committee of European Securities Regulators (CESR) and 436–40 compensation schemes 434, 436, 440–2 EC regime 426–9 redress see redress risks to retail markets 429–36 473 cross-border risks 433–6 stable model 429–33 supervisory convergence 436–40 Sweden 37, 199 systemic bias 68 taxation 21 technology 195 Thoresen Review 198, 389 tied financial advisers 268, 270 TNS-Sofres Report 73, 292 trading accessibility 365–8 best execution 348, 355–6 bond markets 362–3 dealer markets and spread-betting example 360–2 disclosure 358–60 price benchmark 356–8 execution-only services 126, 127, 167, 239, 350–4 issuer disclosure 363–5 matrix of rules 354–5 processability 368–73 promoting access to trading benefits, diversification and trading costs 345–50 risks 350–4 transaction costs 99 transparency 369, 376 debt markets 132 Treating Customers Fairly initiative 177, 178, 219–24, 241, 387, 430 trend-chasing 70 trusting investor 81–8, 97 blending empowerment and trust based strategies 89–92 understanding of investment 72, 73, 166, 290–2 comparability 294–6 evidence for problem 292–4 unfair commercial practices 14, 40, 216, 228 unfair contract terms 248 uninformed investor see irrational and uninformed investor 474 index United Kingdom 49, 86, 181 Basic Advice scheme 144, 150, 237, 279–81 closed-end investment schemes (CISs) 99 fee-based investment advice 267–72 Financial Ombudsman Scheme (FOS) 453, 457 home ownership 100 investment advice 210, 261 investment patterns 22–9, 36, 37, 39 investor education 384–9, 390, 391 mis-selling 258 National Financial Capability Strategy 386 open distribution 149 Retail Distribution Review (2007) 151, 269–72, 281–5, 389 retail markets 1, savings 35 segmentation 120 supervision and enforcement 430 trading sector 347 see also Financial Services Authority United States of America 47 fee-based investment advice 266–7 Financial Trust Index 87 interest groups 401 investor education 379 mutual funds 147 trading sector 350 see also Securities and Exchange Commission unit-linked life insurance products 32, 36, 180 volatility of markets 60, 75 Wallis Report 197 warrants 182 ... retail investor protection through the EC lens 29 Who is the EC investor? 30 Characterizing the target of investor protection 30 The average EC investor: an elusive target? 31 Investors or consumers?... Practices Directive The retail investor and the EC I The importance of the retail markets This book examines the nature of retail investor protection It considers the protections which do, and those... 224 Delivery-specific protection: online and distance contacts 226 Horizontal protection: consumer protection directives 227 Investment-specific protections: MiFID 231 VI Regulatory technique (3):