Vertical integration is on the nose. In 2018, the business model management consultants and industry visionaries have supported enthusiastically since the 1990s is near death. The banks and other institutions are moving quickly to offload many of their wealth, superannuation and insurance businesses in light of embarrassing disclosures arising from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
The reality is that these moves have been coming for some time as a result of accumulated reputational damage caused by the unethical attitudes and activities of many people in the financial services industry, not just financial planners. In that sense, the royal commission was the “straw that broke the camel’s back”.
In an ideal financial services world, I would prefer that vertical integration didn’t exist. In fact, I’m sure it wouldn’t exist if we were establishing the financial planning industry today as a green field project. In support of this sentiment, a number of industry commentators, including former Australian Competition and Consumer Commission chairman, professor Allan Fels, have publicly supported so called “structural separation” as a key issue that the royal commission should address to stamp out poor and conflicted behaviour. Their analysis appears to be that deconstruction of vertical integration would act to “professionalise” the industry as a result of hundreds of institutionally owned or licensed planners gaining their freedom from the shackles of product targets, budgets and sales incentives (conflicted remuneration).
If only it were that easy. Such a conclusion does not take into account the likelihood that most of those formerly vertically integrated planners would seek to replicate the conflicted remuneration arrangements that were in place under their institutional ownership and licensing arrangements. Nothing would change for the benefit of consumers when new ‘independent’, non-aligned and independently owned firms of financial planners continued to receive commissions and asset fees and even promoted their own in-house products through whitelabelling arrangements with institutions. My conclusions are supported by what happens now in the non-institutional sector of the industry, where most participants have conflicted remuneration at the centre of their so-called ‘independent’ (or similarly described) business structures. In fact, deconstruction might even make the situation worse because consumers might be misled into believing that so-called ‘independent’ advisers could be guaranteed to act without remuneration conflicts.
In saying this, I’m certainly not supporting the continuity of vertical integration. Its existence is fundamentally inconsistent with the development of a true profession in which clients’ best interests are paramount. However, developers of public policy must not be drawn into a simplistic conclusion that the “answer to all our prayers” is the removal of vertical integration, thereby creating an independent profession free from conflicts of interest.
As always, the answer to genuine and permanent reform in the financial planning industry lies in removing all forms of conflicted remuneration, product incentives and targets (not just some of them), irrespective of ownership. The industry’s leaders know this action will work and often acknowledge it, at least privately. That explains why such a solution has been so strongly opposed by the industry over many decades (and continues to be opposed).
The closest anyone ever came to where the industry needs to be on conflicted remuneration was the accounting profession’s draft ethical standard, APES 230. This was publicly announced by the Accounting Professional and Ethical Standards Board in 2012. Its centrepiece was a mandated five-year transition to genuine fees for service and the removal of all forms of conflicted remuneration. This version of the standard never saw the light of day due to a ferocious lobbying campaign mounted by an unlikely coalition of institutionally and independently owned dealer groups who were determined to destroy it (and did so). Their unprincipled action, combined with the weakness of the accounting profession’s leadership, set back the ethical development of the financial planning industry (and of the accounting profession itself) by many years.
This failure was an important factor in allowing the industry to continue the behaviour that eventually led to the establishment of the royal commission in 2017. There’s much irony in the fact that the original proposal of the APESB was to transition to genuine fees for service over five years to 2017, the year in which the royal commission commenced its inquiry.
Recently, we’ve seen a draft Code of Ethics issued by the government’s Financial Adviser Standards and Ethics Authority (FASEA). Basically, it’s a statement of high level principles to which no one could possibly object. The challenge for the industry posed by the code is to take it seriously and recognise publicly that its participants’ widespread poor behaviour is the result of a deeply embedded and corrupted culture of product selling. This culture exists at all levels in the so-called value chain and not just in the banks. Therefore, recent disclosures should not be characterised by ill-informed commentators and industry lobbyists as the historical actions of a few bad apples who have since left an industry that has now cleaned up its act. That would be a serious mistake and a missed opportunity to achieve meaningful reform.
Furthermore, the well-educated and generously remunerated professional directors and managers of companies within the industry, most of whom should and do know better, must accept direct responsibility for what has happened. That responsibility must not be limited to financial planners at the bottom of the food chain whose conflicted remuneration and incentive structures are quite deliberately designed or supported by those very same directors and managers to achieve the perverse and lucrative outcomes that are now being examined by the royal commission.
This brings us to the royal commission’s findings and recommendations. While I expect its recommendations will quite properly include tougher action against offenders and increased regulatory controls, I truly hope the commission does not overlook the one thing that will permanently improve the lot of consumers and undoubtedly lead to the creation of a financial planning profession worthy of that descriptor. That is, the removal of all forms of conflicted remuneration and sales incentives, without regard to ownership. Of course, I would prefer the industry take these actions voluntarily and, to some extent, on its own terms. However, if it doesn’t, it will only have itself to blame when the clock stops ticking.
Robert MC Brown AM is a Chartered Accountant, independent chairman of the Australian Defence Force Financial Services Consumer Centre, and member of the Australian Government Financial Literacy Board. He writes this column exclusively for Professional Planner.