An independent adviser approached Dover Legal with an interesting question. (This is not unusual, by the way. Many of Dover Legal’s clients are not Dover advisers.)
The adviser’s client, a 40-year-old executive on a salary of about $400,000 a year was paying about $12,000 a year for risk insurance premiums. There was nothing wrong with any of these policies. Her client was in good health, and there were no matters that needed to be disclosed to a new insurer should he change insurers. Similar insurers offered similar policies with similar premiums, and there was no downside to any change, or churn.
Her question was simple, but had complex implications.
Was it in her client’s best interests for her to churn the policies to trigger a commission refund equal to 120 per cent of the first-year premium, that is, a cash payment to her client of $14,400 less her $2,000 fee?
Could her client complain that she had breached her best interests duty if she did not churn the policies and refund the net commission of $12,400?
Obviously, as an independent adviser, any commissions had to be refunded to the client.
Answering her question required a brief and practical examination of her duty to act in the best interests of her client.
The best interests duty
The best interests duty is a statutory duty introduced into the law as part of the 2013 Future of Financial Advice (FoFA) reforms.
The best interests duty is found in section 961B of the Corporations Act 2001 (Cwlth). This says, with deceptive simplicity, that “the provider must act in the best interests of the client in relation to the advice”. “Best interests” is not defined, and we are left to ponder what the phrase will eventually mean when interpreted by the courts.
An adviser in breach of section 961B faces at least three possible adverse outcomes. These are:
- a civil penalty under the Corporations Act civil penalty provisions
- an administrative penalty such as a banning order or
- civil sanctions such as a damages order by a court or an alternative disputes forum such as the Financial Ombudsman Service and the Credit and Investments Ombudsman.
The section 961B best interests duty is technically separate to and in addition to the section 961G appropriate advice rule and the section 961J priority rule. But in practice these three statutory advice obligations merge together, such that the facts comprising a breach of one will probably, but not necessarily, breach all three. They are often spoken of as if they are a composite rule, for example “your advice is not in your client’s best interests and is not appropriate to your client”.
So, what does this really mean? What does the section 961B best interests duty require financial planners to do?
The best interests duty, like the other FoFA reforms, arose from the ashes of Storm, Trio and Westpoint where the clients were left worse off, if not bankrupt, as a result of the “advice”. The second reading speech introduced the reverse concept of the advice leaving the client better off, by emphasising that “… the vast majority of financial planners do see their role as making their dealings with customers such that … the customer is better off than if the customer had never sought financial advice to begin with…” (emphasis added).
The use of the word “customer” is unfortunate. Obviously the minister should have said “client”. But semantics aside, this concept of the best interests duty requiring advice to leave the client better off than otherwise has been picked up and expanded by the Australian Securities and Investments Commission (ASIC). In Part E of RG 175, at paragraphs 224 to 230, ASIC in effect redefines the best interests duty as a duty to provide advice that a “reasonable advice provider” would believe is intended to leave the client in a better position.
ASIC glosses this basic idea by adding that advice does not have to be perfect, subsequent investment performance is not relevant (i.e. the advice must be tested at the time it is provided, not at a later time) and the advice must consider the client’s objectives, financial circumstances and needs.
Much has been made of the so called “safe harbour” in sub-section 961B (2).
This safe harbour is supposed to protect advisers from the imprecise nature of the best interests duty by stipulating certain tasks which, if attended to, tick off the best interests duty. To be protected by “safe harbor” rules, the adviser must identify:
- the client’s needs and objectives, financial situation
- what advice is being sought
- the objectives, financial situation and needs of the client.
Then the adviser must:
- make reasonable enquiries to ensure the client information is complete and accurate
- assess whether the adviser has the expertise to provide the advice (and if not decline to act)
- investigate what financial products might achieve the client’s objective
- base all judgments on the client’s relevant financial circumstances.
The idea is the adviser is protected if they can tick off each specified process. These processes, translated into English, require the adviser to consider what advice is sought by the client and the client’s “relevant financial circumstances”, and to research any financial product recommended to the client to ensure they match the client’s needs.
But the safe harbour is an illusion. It’s actually no protection at all. This is because, ultimately, sub-paragraph 961B (2) (g) kicks in to require the adviser to take “any other step” that would reasonably have been regarded at the time, presumably by someone like ASIC’s “reasonable advice provider”, to have been in the client’s best interests.
This means you can tick all those boxes as hard and as often as you like, but if after all that ASIC still says there was something else you should have done to make your client better off you are in breach of the Corporations Act and are exposed to statutory penalties and civil remedies.
So you end up back where we started. The most that can be said at this time is that, according to ASIC, to satisfy the best interests duty you have to show that a reasonable financial planner would at the time the advice was provided agree that the advice was likely to leave the client in a better position than otherwise would be the case.
It’s all about the client being better off as a result of your advice. Nothing else matters.
Back to the original question
To resume the original question, could the independent financial planner’s client complain that she had breached her best interests duty if she did not churn the risk insurance policies and refund the net commission of $12,400?
The answer is yes.
This is because, on the facts, a reasonable financial planner would have to agree that the advice to churn the client, that is, to cancel the existing insurance policies and to replace them with similar policies for the purpose of triggering a commission payment that would then be rebated to the client without any apparent detriment (e.g. no loss of benefits or continuity of cover) was likely to leave the client in a better position, that is, in receipt of a net amount of about $12,400.
What ASIC, the insurers or anyone else thinks about churning is irrelevant. They are not your client.
I am not sure what the adviser did next.
