Advice fee models will change as a result of the unprecedented shockwaves that have rocked the financial services industry thanks to the spotlight shone by the Royal Commission into Misconduct in the Banking Superannuation and Financial Services Industry.
[The following is an excerpt from an opinion piece titled “Implications of the royal commission for managed accounts” written for Professional Planner by Claire Wivell Plater.]
We predict that advice fee models will change, particularly in relation to ongoing fee arrangements, asset-based fees and incentive structures.
Ongoing fee arrangements
Ongoing fee arrangements have been under the spotlight since ASIC’s October 2016 Report 499 Financial Advice: Fees for no service, which reported widespread occurrences of clients being charged for ongoing services that were either never delivered or of little value.
Commissioner Kenneth Hayne’s Interim Report condemned this practice, commenting that part of the problem stemmed from the fact that
“…the services to be provided under ongoing service arrangements were, and still are, often neither well-defined nor onerous, very loosely-defined but also defined in a way that has little or no substantive content…” and expressing the view that the “promised services, even if provided, may not give the client a benefit commensurate with their cost.”
Both ASIC and commissioner Hayne concluded that “AFS licensees and advisers prioritised revenue and fee generation over the delivery of advice and services paid for by their customers.”
That ASIC takes this seriously, and is aware that the fee for no service problem goes beyond the large financial institutions, is demonstrated by a new surveillance campaign, which commenced in October 2018. A considerable number of small to medium-sized Australian Financial Services licensees have been asked to demonstrate compliance with the obligation to provide fee disclosure statements, how they determined whether the promised services had been delivered, and what steps they have taken to compensate clients that had not received services for which they had paid.
Advisers must take heed of the change to the prevailing ethic resulting from the fee for no service scandals. The new expectation is that ongoing fee recipients must provide customers with fair value and service in exchange for the fee.
As a result of Report 499 and the royal commission, all advice businesses, no matter their size, are on notice that if they cannot demonstrate that they deliver (or have not in the past delivered) fair value in relation to the services for which they have received ongoing fees, the fees need to be partly or, where no services have been delivered, wholly repaid. Any failure to do so is a breach of the obligation to provide financial services efficiently, honestly and fairly.
This is not a simple exercise. It will require significant changes to client engagement and ongoing engagement management, along with technology systems that track service delivery.
Although the 2013 Future of Financial Advice reforms, which banned conflicted remuneration in the context of financial product advice given to retail clients, included a presumption that volume-based payments were conflicted remuneration, this did not apply to asset-based fees paid by clients.
Even fixed or flat fees can be conflicted remuneration if they could reasonably be expected to influence the advice given or product recommended. For example, a substantial ongoing advice fee could influence an adviser to recommend that the client use their services, and thereby be conflicted remuneration.
Asset-based fees were strongly criticised by Commissioner Hayne in the Interim Report. He wrote:
“…if the future advice fee is fixed as a percentage of the ‘funds under advice’ (rather than a fixed dollar sum), the question of value for money is all the more evident.”
We predict that peer pressure and market forces will result in reduced emphasis on asset-based remuneration structures for initial and ongoing advice. It is possible, but less likely, that this form of remuneration will be banned.
Rather than one size fits all, some advice firms offer different ongoing service packages, which vary the type or frequency of service to suit clients with different needs and budgets. For the reasons discussed earlier, we believe that, going forward, it will be essential to ensure that ongoing service fees reflect the complexity and volume of work involved in providing the services to the client and that advisers are not recommending services that clients do not need, with the attendant risk of receiving fees for no services.
Commissioner Hayne asked the question:
“Should the adviser and client have to renegotiate an ongoing service arrangement annually?”
We anticipate that ongoing service packages may be required to be reviewed and, if necessary, adjusted annually, based on the client’s likely needs for the coming year.
Adviser remuneration practices are a consistently recurring theme in the Interim Report. commissioner Hayne was trenchantly critical of what he described as a “culture of reliance on automatic periodic payments such as sales commissions and adviser service fees” and that “some advice licensees prioritised advice revenue and fee generation over ensuring that they delivered the required services”.
“What is to be made of the fact that, when persons are paid to give advice and rewarded for selling their employer or sponsoring entity’s products, all too often the client’s interests are treated as coinciding with the adviser’s commercial advantage, no matter how obviously that course harms the client? Perhaps the adviser believes that selling the employer’s or sponsor’s product is in the client’s interests, perhaps the adviser does not think about the conflict. But in too many cases, what is sold is not in the interests of the client.”
In this context, Hayne posed the following questions:
“Should any part of the remuneration of financial advisers be dependent on value or volume of sales?”
“How is a value-based commission consistent with acting in the interests, or best interests, of the client? Should intermediaries be subject to rules generally similar to the conflicted remuneration prohibitions applying to the provision of financial advice?”
In effect, he answered the question, when he wrote:
“Put shortly, if crudely, sales staff can be rewarded by commission; advisers should not be.”
“Why do staff (whether customer-facing or not) need incentives to do their job unless the incentive is directed towards maximising revenue and profit? How can staff (especially customer-facing staff) be encouraged to do the right thing (to ask ‘Should I’) except by the line manager observing, encouraging counselling and supporting the staff in that task? What is the point of allowing an incentive payment for doing the assigned task in a way that meets but does not exceed what is expected of that staff member?”
“If customer-facing staff should not be paid incentives, why should their managers, or those who manage the managers? Why will altering the remuneration of front line staff effect a change in culture if more senior employees are rewarded for sales or revenue and profit?”
“If, as seems inevitable, appeals are made to both history and the need to maintain the availability of advice by preserving existing advice business models, what evidence is there that shows that the costs of doing away with payment by commission will outweigh the benefits of improving the overall quality of advice that is given – when in three out of every four cases examined, the advisers appeared to have preferred their own interests to those of the clients?”
“Eliminating incentive-based payments for front line staff will not necessarily affect the ways in which they are managed if their managers are rewarded by reference to sales or revenue and profit. The behaviour that the manager will applaud and encourage is behaviour that yields sales or revenue and profit. The lesson from APRA’s Prudential Inquiry into CBA is that the entity’s culture is compromised.”
“The simplest and most comprehensive severance may be the adoption of a flat share of a variable pay pool that varies with overall entity performance.”
As a result, we predict an increased focus on ensuring that adviser bonus schemes do not contain financially based incentives. We doubt this will require changes to the Corporations Act; we expect that stronger ASIC guidance will be the weapon of choice. The Interim Report’s analysis of ANZ’s revised adviser bonus scheme, which purported to remove financial incentives, but succeeded only in renaming them, is worth reading for businesses that are seeking to change their incentive schemes.
When will all this happen? We are often asked how soon these changes will occur. There is no simple answer to this, for a number of reasons. Firstly, many of the changes that are likely to occur will not require legislative change. Indeed, commissioner Hayne recognised that the existing law is too complex and suggested that “rather than adding another layer of legislation, the industry and community may be better served if the law was simplified to require entities apply basic standards of fairness and honesty by obeying the law, not misleading or deceiving, acting fairly, providing services that are fit for purpose, delivering services with reasonable care and skill and, when acting for another, acting in the best interests of that other.”
The existing law already contains most of the required provisions, it is simply not being complied with and ASIC and licensees’ attempts to require compliance have been inadequate. So, for the most part, the need for legal reform will not be a delaying factor.
The public denunciations of bank staff and management have already led to an increased sense of urgency in both large institutions and smaller advice businesses. In our practice, we are receiving almost daily calls for assistance from advice businesses. They increasingly see reducing vulnerability to regulatory scrutiny through proactive compliance risk management that addresses the “should we” not the “could we” as essential to preserving the value of the business.
One thing is for certain, we live in interesting times!
Claire Wivell Plater is chair of The Fold Legal, honorary counsel to the Institute of Managed Account Professionals, a longstanding member of the Business Advisory Committee to ASIC’s Licensing Division, and a member of the Australian Government’s fintech advisory group.