Will asset-based fees go up in smoke?

Financial advisers may need to rethink how they charge for advice as asset-based fees have the potential to create just as much conflict of interest as commissions.

This is the legal view of Claire Wivell Plater, managing director of law firm The Fold, who believes the problem with asset-based fees is that they incentivise advisers to recommend strategies and products that maximise the assets they manage for the client.

Released in mid-December, Regulatory Guide 175 Licensing: Financial product advisers – conduct and disclosure (RG 175) contains detailed guidance on exactly how clients’ interests should be given priority.

While the Conflicts Priority Rule does not prohibit an advice provider from accepting remuneration from a source other than the client, it does prevent advisers from accepting certain types of remuneration, which could reasonably influence the financial product advice they give.

Under the Best Interests Duty, clients must be given non-product-related solutions where appropriate, even if that means the client is less likely to need future advice.

“The new Conflicts Priority Rule means that advisers cannot recommend strategies or products that create extra revenue for themselves or their licensees unless they can demonstrate additional benefit for the client,” said Wivell Plater.

“If they are not actually managing the clients’ assets or where an asset-based fee would not adequately remunerate them, they need a fee structure that remunerates them for the work they do. Advisers also cannot over-service a client to create more remuneration for themselves.”

Rule by example

The regulator gives the example of a client approaching retirement meeting with an advice provider to seek advice on what to do with her superannuation on retirement.

She has been told that SMSFs are an easy way to maximise the value of superannuation but has no experience with investing.

The client has a healthy superannuation balance because she has been contributing to it for the past 35 years. However, her existing employer-sponsored superannuation fund has no pension option.

The client understands that she needs to start making some decisions about superannuation but, because she has no previous investment experience, she is nervous about this process.

She wants a simple, cost-effective solution that she can easily understand and does not require too much of her time. She is looking forward to retirement and does not want the burden of watching the market every day, as she has seen colleagues do.

The advice provider recommends a SMSF and reassures the client that she does not need to be too involved because he will look after it for her.

“The recommendation to set up an SMSF for a client with no interest or expertise in investment means that the client will always need the assistance of the advice provider,” states the ASIC example. “This creates ongoing remuneration for the advice provider and some of the advice provider’s related parties at a level of service that exceeds the simple solution the client was seeking. The client’s interests have not been prioritised when giving the advice.”

If an advice provider with a conflict is unable to prioritise the client’s interests, he must not provide the advice.

Asset-based fees fall foul

Wivell Plater expects a trend away from 100-per-cent asset-based fee structures to fees that are based on the work done for the client, or a combination.

“While the government is not banning asset-based fees outright, they are making it increasingly inappropriate to charge them,” she said.

She likened the rule to the government’s current anti-smoking legislation.

“Smoking is not actually banned, but federal and new state legislation make it difficult to smoke anywhere. New anti-smoking legislation introduced this month in New South Wales, for example, bans smoking in places like transport stops and entrances to NSW public buildings,” argues Wivell Plater.

“It’s similar to the legislation surrounding asset-based fees. Advisers aren’t specifically banned from charging them – but if they do, they risk either falling foul of the Conflicts Priority Rule or not being adequately remunerated for their work.”

Wivell Plater says advisers will need to rethink how they charge for their services and this is likely to present a big challenge.

“Setting up an engagement process is key to complying with the new law,” she said. “Advisers need to understand how to define the terms of engagement from the moment they first meet with a client. If the service proposition and the client’s fee commitment are clear from the minute the client walks in the door, the financial aspects of client relationships become easier to manage.”

For its part, ASIC advises that, if there is a conflict, it expects advisers to keep records of the reasoning behind any recommendation that the client acquire new financial products or increase their interest in an existing product, where this advice would benefit the related party.