Abstract
The Australian Financial Planning industry has its roots to the tied insurance agent industry established many decades ago. Although selling life insurance required excellent interpersonal skills, it did not require a wide range of technical and other competencies that the Birkett report found in 1996 and from that date begin to formulate the knowledge and skills competencies required for financial planning.
Many of these insurance-based corporations are still in existence today but are now operating as diversified wealth businesses offering a financial planning service through a tied network of salaried advisers owned by banks and large corporations. The attractiveness of these business models allows the organisations products to be widely distributed through the tied financial adviser network.
In April 2006 ASIC released the results of its shadow shopping survey on superannuation advice, which surveyed 259 individual advisers and assessed the standard of their advice.
ASIC reported that advisers are between three and six times more likely to provide unreasonable advice where a conflict of interest is present. It identified as major problems the following practices:
not examining existing funds before recommending new ones.
not disclosing the reasons for recommended action; and
not disclosing the consequences of switching funds.
Perhaps most worryingly, ASIC concluded that most clients who had received poor advice did not realise it was so.
What are the sources of Best Interest Obligations?
Fundamentally sources of best interest obligations compel advisers to act in the best interests of clients which translates to providing appropriate advice, warning clients if the advice is based on incomplete or inaccurate information and fundamentally to prioritise client’s interests before their own.
The best interest’s duty and related obligations in Div. 2 of Pt 7.7A of the corporation’s act 2001 require advice providers, when providing personal advice to retail clients, to:
- Act in the best interests of their clients s961B (1) (RG 175.242 – RG 175.361)
- Provide appropriate advice s961G (RG175.362 – RG175.385)
- Prioritise the client’s interest s961J (RG 175.390 – RG175.411)
Interaction between the best interest’s duty in s961B (1) and the safe harbour s961B (2)
Called the safe harbour process was produced to assist advisers to comply with their best interest obligations and is included with the Corps Act s961B (2).
Showing that all the elements in s961B (2) have been met is one way for an advice provider to satisfy the duty in s961B (1)
The safe harbour for meeting best interest duty obligations under S961B(2)(b)(i) requires an advice provider to identify the subject matter of the advice sought both implicitly and explicitly. A customer’s relevant circumstances would normally include any matter that the customer considers important both implied and explicit.
FASEA was formed in 2017 and is primarily responsible for developing and mandating the education standards to ultimately improve the professionalism of the financial advice industry. FASEA has developed a very comprehensive code of ethics and national exam that advisors must complete to continue to practice.
FASEA FG002 code of ethics guidance prescribes five values.
- Trustworthiness, Competence, Honesty, Fairness, Diligence
Combined with 12 standards that cover standards of.
- Ethical Behaviour, Client care, Quality process, Professional commitment
Of note is standard 2 of the FASEA guide which compels advisers to act with integrity and in the best interests of clients and are expressed in S961B, C, D & E of corps act 2001 which also links closely with FASEA standard 3 that states you must not advise refer or act in any other manner where you have a conflict of interest or duty.
The FASEA obligations extends existing legal obligations contained in the corporation’s act for example the corporations act permits referral fees, but the FASEA guidelines do not.
In addition, the corporations act defines a wholesale client based on their assets, however, the code encourages the adviser to exercise professional judgement in considering the clients level of financial literacy and weather they would be more appropriately treated as a retail client.
The corps act also permits the management of conflicts of interest between adviser and clients (including by disclosure), however, the code requires that you must not act if there is an actual, potential or perceived conflict.
Why Does Best Interest obligation exist?
The best interest’s duty and related obligations are designed to ensure that retail clients receive advice that meets their objectives, financial situation and needs, and that you act in the best interests of your clients when providing advice.
Remuneration and incentives have been the biggest influence on how financial advisers operate in Australia (Richards & Morton) argue that the business models within which financial advisors operate in can enable or inhibit the ability of an adviser to act in a client’s best interest.
Australia has largely adopted an authorised representative governance model where an Australian financial services licensee (AFSL) can authorise a financial advisor to give advice on their behalf and takes responsibility to ensure that financial advisors comply with relevant legislation s912
The financial planning industry in Australia has experienced significant reform in the last decade most notably the royal commission. This reform has not only made a considerable impact on financial planners but also on other groups such as the accounting profession, regulators, the financial services industry, educators and consumers. Although consumer protection was at the heart of this reform, it has also prompted the industry and other groups to consider financial planning as a profession. (Cull, 2009)
Financial planners can exert significant influence on the distribution of funds into various investment products. It could very well be argued that financial advisors became more product focussed than more client focused. From a client’s perspective the relationship between licensee, product provider and advisor are not obvious, and conflict of interest disclosures didn’t prevent clients’ best interests being protected.
In July 2006 ASIC accepted an enforceable undertaking from AMP Financial Planning Pty Ltd to modify the way in which it provides financial advice to customers. ASIC reported that a significant proportion of AMP planners had been advising clients to shift from rival funds into AMP products without disclosing a reasonable basis for the advice. Therefore, AMP undertook to change several its internal procedures and offered to review its clients' advice.
At the time of the paper produced by (Richards & Morton) approximately 85% of financial advisors were associated with a product manufacturer, so that many advisers act as a product pipeline.
A lack of independence can break this trust and in Australia we have seen a constant increase in regulation and scrutiny to increase the professionalism of the industry. Clients rank ethical values as more important than technical competence in a financial advisor (Cull & Boyer 2017). Institutional advisers have a high conflict of interest as they must serve the product providers interests and attend to a client’s needs.
A client’s best interest obligations have been legislated in Part 7.7A Corporations Act which was preceded by the Future of Financial advice reforms in 2012.
Best interest duty is contained within the corps act 2001 and was designed to make personal financial advice more likely to leave the customer in a better position if they follow the advice recommended.
In The royal commission final report p.164 the commission found that the current law has not resulted in conflicts being managed successfully. The vertical integration of financial planning corporations has not been banned despite ASIC’s report 562 into vertically integrated institutions and conflicts of interest Jan 2018 which found that in 75% of files gathered from Australia’s largest advice providing institutions advisers had not complied with best interest duty and prioritised their own interests or those of the product provider over their own.
In Australian Securities and Investment Commission v Westpac Securities Administration Limited [2019] FCAFC 187 a test case brought by the regulator concerning the provision of advice from two Westpac subsidiaries – Westpac Securities Administration Limited (WSAL) and BT Funds Management Limited (BT Funds) where the regulator claimed they provided personal advice when recommending customers roll out of other superannuation funds into Westpac-related superannuation accounts.
The regulator also alleged WSAL, and BT Funds failed to ensure the financial services covered by their licences were provided efficiently, honestly and fairly; failed to comply with the conditions of their licences, which only permit those licensees to provide general advice; and failed to comply with the financial services laws in the Corporations Act.
Who are the parties affected by best interest obligations?
In 2017 the commonwealth parliament amended the corporations act 2001 to raise the education, training and ethical standards of financial advisers and financial planners, promote enhanced consumer trust and confidence in financial planners and financial advisers and refocus them from providing commercial services to acting as professionals
The Government has two organisations it uses to enact legislation namely ASIC and FASEA. ASIC controls the financial services licensees and is responsible for enacting legislation and regulatory guides which oversee and govern financial advice.
One of the proposals offered to the royal commission is for each advisor to be individually licensed through ASIC but these suggestions have not been endorsed by parliamentary enquiries into financial advice. Instead, it seems that Government, education providers, professional bodies and not to forget clients will seek to influence financial advice.
An essential element of the advice relationship is the one that the advisor has with their clients and is sometimes referred to as the agent – principal relationship. In his submission to the Parliamentary Inquiry (Moran) referred to the financial crisis that commenced in 2007 and led to several high-profile corporate collapses (in particular, Storm Financial) that led to a review of the actions of financial advisers. Financial advisers are generally perceived to operate under agency theory where a natural conflict occurs between the best interests of the agent versus the principal.
Complicating the agency approach is the fact that there is frequently a secondary agent principal (A-P) relationship between the financial adviser/planner and their employer or legal controller. Because of the nature of the Corporations law in Australia, the vast majority (more
than 80% according to the ASIC submission to the PJC (Ripoll, 2009b)) of advisers licensed by the regulator ASIC are subject to an employment or corporate authorised representative status whereby the holder of an Australian Financial Services Licence (AFSL) authorises
advisers to act on its behalf and under its rules.
Professional bodies are another external influence on the best interest obligation, however, the direct power that a licensee has over a financial adviser makes any attempts for an industry body to influence a secondary element.
We can’t forget Education providers who work with regulators like ASIC and FASEA since the education level has been raised with new entrants to the financial advice requiring a degree from 2019 and existing advisers have until 2024 to meet the new requirements. Personally, I have found the Ethics courses at university level and the FASEA exam excellent sources of knowledge around what constitutes best interest for clients. Going forward universities and education providers will play a prominent and important role in influencing financial advisors by educating advisors on best interest practice with clients.
Reflection and conclusion?
Despite this legislative and regulatory oversight, the Australian financial services industry has been plagued by scandals and serious misconduct overseen by some of Australia’s largest banks and corporations.
ASIC with its oversight of licensees and financial advisors means it has a high degree of control through its authority to apply penalties and disciplinary control and ultimately revoke an advisor’s licence to practice.
Sanctions include warnings, reprimand, training, counselling, audit and removal from approved compliance scheme
The most serious sanction that can be imposed by a disciplinary body is exclusion from coverage of the disciplinary body’s compliance scheme. Under s921H of the act, each relevant provider must be covered by an approved compliance scheme.
AFS licensee has obligations under s912A & 912B and more specifically s912A(1)(c) and remedies include an enforceable undertaking, criminal action, civil action and administrative action.
AFS licensee must tell ASIC in 10 days from becoming aware of the breach about any significant breach or likely significant breach
Penalties include for an individual a max of $1.05m or 2 years jail and for companies $10.5m or to a maximum of $525m. Not surprisingly ASIC is questioning the ability of penalties it can apply here in Australia to deter breaches of best interest duty and more broadly breaches of the corporation’s act in relation to financial advice and has illustrated its concerns about the size of penalties available in Australia, ASIC pointed to the fines totalling over $6 billion that JP Morgan received as part of the 'London Whale' trading scandal. These fines consisted of £138 million by the UK FCA; US$200 million by the US SEC; US$200 million by the US Federal Reserve; US$309 million by the US CFPB; and US$300 million by the US Office of the Comptroller of the Currency.
I think regulation of financial advice industry is here to stay and compliance and monitoring is necessary which comes at a cost which ultimately is born the client.
As a professional who has worked in the industry for more than 20 years much of which has been with banks and product providers, I worry that not much will change as the temptation for highly organised and influential firms to put their own interests before clients and advisors.
This is still a necessary tactic to contest the billions of dollars that flow into the superannuation system every year. Sadly, self-interest alignment between AFSL’s and product providers will always become the primary motive as the temptation to achieve higher and higher market share and satisfy short term profit incentives will prevail.
References
Anti-Money Laundering Act 2006
ASIC’s report 562 into vertically integrated institutions and conflicts of interest Jan 2018
ASIC v AMP Financial Planning Pty Ltd (No 2), Federal Court of Australia, 05 February 2020
Consultation paper 329, implementing the royal commission recommendations: Advice fee consents and independence disclosure March 2020
Corporations Act 2001 Ch 7 Vol 4 & Vol 5
Cull, M., The rise of the financial planning industry, Business and Finance Journal, 2009
FASEA Ethics & Application RG 36, RG 78, RG 245, RG 246
Richards & Morton, Conceptualising financial advice in Australia: the impact of Business models and external stakeholders on client’s best interest Practice
Submission to the Parliamentary Joint Committee on Corporations and Financial Services
Inquiry into proposals to lift the professional, ethical and education standards in the financial services industry Paul Moran
Sunita Sah, Conflicts of interest and disclosure, Nov 2018
Tax Agent Services Act 2009
Westpac Securities Administration Limited v ASIC (High Court of Australia, S29/2020, commenced 7 May 2020).
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