“There must be a recognition that conflicts of interest and conflicts between duty and interest should be eliminated rather than ‘managed’”. Kenneth Hayne wrote this in the Royal Commission into Misconduct into the Banking, Superannuation and Financial Services Industry Final Report, Vol.1, page 45.

This important message about ethics is at the core of Commissioner Hayne’s recommendations. It is restated in various forms throughout the 2,000 pages of his report.

The same message is at the core of the mandatory Code of Ethics issued in February, 2019 by the Financial Adviser Standards and Ethics Authority (FASEA) in the form of a legislative instrument under paragraph 921U(2)(b) of the Corporations Act.

I congratulate both the royal commission and FASEA for taking such a strong leadership position on this fundamental standard of professional ethics. It’s Ethics 101. Acting upon it comprehensively is in the best interests of advisers and clients alike because it will lead to the creation of the trusted financial advice profession which hitherto has been out of the financial planning industry’s grasp.

While there are many forms of adviser remuneration where conflicts may need to be addressed, I want to focus on percentage-based asset fees on investment products, also known as commissions paid by clients, not third parties, the latter having being banned by the Corporations Act as “conflicted remuneration”.

Many in the industry argue that unlike life insurance commissions or other types of commissions, percentage-based asset fees are not commissions at all and therefore are not conflicted remuneration. They say they’re just a fee collection method, but the reality is they are a whole lot more than that.

Of course, it’s true that percentage-based asset fees are not technically conflicted remuneration within the relevant definition in the Corporations Act. It was a political compromise to exclude them. But they transform into conflicted remuneration in that Act when gearing is involved, thereby recognising their inherently conflicted nature. This was another political compromise to cover-off problems with suspect margin lending practices.

In recent years, the industry has become so bold as to argue that a percentage-based asset fee is actually a professional fee for service. Most of the industry’s leaders privately acknowledge this is nonsense. It’s like arguing that black is white. But they cannot accept the argument that a percentage-based asset fee is just another form of commission because they fear the commercial consequences on the flow of funds under management should advisers become truly independent of conflicted remuneration. And they know that such a concession would lead to considerable criticisms, if not resignations, by members of their associations.

Would other professions do it?

I often explain percentage-based asset fees to consumers by asking them to imagine a doctor who stopped his $85 flat fee for service and replaced it with a 15 per cent fee for service based on the value of the drugs he prescribes. A moment’s thought would indicate that such an arrangement would never be accepted by the public and government because it would lead to the over prescription of drugs. Note that it’s not a commission paid by a third party.

Instead, it’s a commission paid by a patient, but it would clearly lead to the same conflicted result. And yet, that’s what the financial advice industry does every day of the week, arguing with a sense of artful unreality that its conflicted remuneration of choice is merely a conflict-free fee for service, except when it comes to gearing, when it isn’t!

This reminds me of the rather embarrassing story of the accounting profession’s financial planning standard, APES230. In short, the Accounting Professional and Ethical Standards Board (APESB) publicly announced its decision on conflicted remuneration in late 2012.

The decision banned commissions in all of its forms, as it should for a true profession, including life insurance commissions, mortgage-broking commissions and percentage-based asset fees. However, only three months later, the APESB was forced by its shareholders (the accounting bodies), to back down due to intense public and private lobbying by the financial services industry.

As a result, APES230 was diluted into its current and uniquely strange “optional ethics” form, allowing either disclosure or elimination of conflicts at the adviser’s choice. This neutralised the Standard’s ethical impact and rendered it ineffective (which was the whole idea of the complainants in the first place).

I should mention that even though the diluted version of APES230 allows percentage-based asset fees through a disclosure-based workaround, the APESB commendably makes the point that such arrangements are inherently conflicted and that a genuine fee for service (hourly rate or flat fee) “is the most effective method to eliminate threats from conflicted remuneration”.

Enshrined by FASEA

I sincerely hope we will not see history repeat itself. That may occur either through a dilution of the words in some of the more commercially inconvenient standards in FASEA’s Code of Ethics – through an industry-friendly or ambiguous interpretation (“clarification”) of the Code’s plain English words – or simply through silence from FASEA, thereby allowing professional bodies, financial advisers and ethics course designers to reach their own conclusions about the true meaning and consequences of the Code.

Having said that, it’s hard to imagine how the Code could be ‘read-down’ or diluted and retain any credibility. This is especially so given the conclusions of the royal commission about the imperative for conflict elimination and the key statements by FASEA that “this Code imposes ethical duties that go above the requirements in the law” and “the primary ethical duty of this Standard is that if you have a conflict of interest or duty, you must disclose the conflict to the client and you must not act”.

Here are some common examples, sourced from my extensive work in consumer financial education, that demonstrate how percentage-based asset fees lead to poor outcomes for consumers:

  1. A client inherits $100,000 and consults an adviser who uses percentage-based asset fees. The client seeks advice on whether to pay down a mortgage or invest in a managed product. The obvious problem here is that the adviser may be conflicted into recommending investment of the inheritance in a product from which a percentage-based asset fee can be earned, rather reducing debt on which nothing can be earned;
  2. A client is thinking of using an industry superannuation fund and asks an adviser for recommendation. The adviser who uses percentage-based asset fees cannot easily charge them on an industry fund, but can easily do so if the client uses a fund from the adviser’s approved product list;
  3. A client is a public servant or military retiree thinking about how much of his defined benefit superannuation entitlement to commute to a lump sum. He seeks advice from a financial adviser who uses percentage -based asset fees. The adviser cannot charge percentage-based asset fees on a government defined benefit pension, but he can charge them on a superannuation platform he promotes, so he advises the client to commute his government-guaranteed pension entitlement to the maximum;
  4. A client has $250,000 in term deposits with a bank maturing next month. He asks the adviser for a recommendation about where to invest. The adviser can’t charge percentage-based asset fees on term deposits, so he recommends the use of a platform or a product on which he can so charge;
  5. A client has $250,000 in a managed equities fund/platform through an adviser who uses percentage-based asset fees. The adviser believes it would be in the client’s best interests to move some of the money into cash at a bank (noting the $250,000 government guarantee), but is not inclined to offer that advice because he continues to earn a percentage-based asset fee through keeping the money where it is, but would earn nothing if the money was moved into cash; and
  6. A client has $500,000 in savings and seeks advice about moving the money into direct real estate or a combination of direct real estate and cash for renovations. The percentage-based asset fee adviser is inclined to persuade the client to leave all or some of the money where it is.

The list goes on, including where self-described ‘independent’ advisers promote their own ‘white label’ products and in-house platforms. Given these circumstances, it beggars belief that the industry persists with the claims that there are no inherent conflicts in percentage-based asset fees, that they are not a form of commission and that they are merely a fee collection method which should be characterised as a professional ‘fee for service’.

If the sad (and I sincerely trust, unlikely) day comes when FASEA accedes to these representations, the mandated Code of Ethics will become little more than a box-ticking exercise, joining many of the other politically compromised laws and regulations that have been introduced with good intentions in recent decades, including the Future of Financial Advice legislation and the flawed ethical standard, APES230. As a result, the Code will not be the much anticipated catalyst for comprehensive cultural and behavioural reform that the Australian community expects and that FASEA was established to achieve.

In those circumstances, we can look forward to more mistrust, more scandals, more ineffective and costly compliance rules, more legislation and eventually, another royal commission. The far better alternative is for the industry to show some much-needed leadership. It should unambiguously support the professional and ethical intent of the Code and accept the obvious conclusions about the detrimental impact of all forms of conflicted remuneration.

Then the industry should get on with building the true profession to which it aspires, rather than trying to hold back a tide that will eventually engulf it should it fail to act in the public interest as the royal commission, FASEA and the community demand that it should.

Robert MC Brown AM is a chartered accountant with more than 30 years’ experience in taxation, superannuation and financial planning. He is independent chairman of the ADF Financial Services Council, and a member of the government’s Financial Literacy Board.
8 comments on “FASEA’s Code of Ethics should kill percentage-based fees ”
  1. Avatar Christoph Schnelle

    This is an excellent comment. Thank you.

  2. Avatar Graham Taylor

    Best Interest Duty would put advisers under each of your examples in a position that they would need to justify. I am happy to listen to arguments like this but our industry has got into trouble when the view becomes the reason behind another shift in policy,. Too many decisions are being made taking a one dimensional view and the consequences not appreciated until after the fact (e.g. this auto-cancelation of ‘inactive’ insurance policies – just informed by a super fund that they could not confirm if or how a member had been notified about this matter). The layers of rules we are governed by have become too much and the layering continues.Best Interest Duty was supposed to be like Part IVA in the accounting world.

  3. Avatar Martin Watson

    Mr Brown’s comments show a distinct lack of regard for facts!

    Percentage based remuneration on any investment made with borrowed funds was banned following the Storm Financial enquiry in 2008/9? That is why it is not dealt with by the Hayne Royal Commission or FASEA!

    As for accountants and their ‘holier than thou’ position?? I have seen countless clients put into investment properties or schemes where the accountant was involved either directly or indirectly. I doubt there was disclosure of the conflict of interest or how much the accountant received as a referral fee for each off the plan property they recommended a SMSF client invest in. Or even the legal arrangements where there was a kick back for legal work referred.

    I don’t paint all accountants as crooks, but i certainly don’t feel that advisers should also be tarnished with one brush. I have personally seen more money lost by accountants advice than financial planning advice. Let’s also not forget that most accountants disclaim their responsibility when a client signs off on their tax return to say that accept all responsibility for the accuracy of their returns and as a previous comment noted, accounting advice is rarely put in writing.

    I have been in this industry since 1996 – just after Financial Services Reform (FSR) was introduced – full disclosure of fees and remuneration were the key take out from FSR and for me it has just been the way we do business. Advice documents to back up what we say and a PI scheme whereby we are personally responsible for the $20k/$25k/$50k excess has ensured I try to adhere to the intent if not the letter of the law. Best Interest Duty was taught in the old Diploma of Financial Planning and was rammed home when i obtained by first Proper Authority in 1996 – 23 years ago! It’s never changed – but we seem to claim that now it is a fiduciary duty it will all be better. Crooked advisers, accountants, lawyers and real estate agents will still be there no matter what legislation is introduced BUT the numbers are certainly a lot less than they were when i first started and the financial planning INDUSTRY is becoming a PROFESSION at last – it should be respected for the changes it has had to endure and the fact it still exists today is testament to the quality advisers that remain committed to doing the right thing by their clients.

    As for Asset Based Fees I have a simple explanation I use with my clients. Our business charges a 0.55% Portfolio Management Fee, for that we monitor the investments, recommend any changes and implement them when agreed with the client at no additional charge to the client – our advice is there because it is the right thing to do – not because we get paid (having worked in a stockbroking firm, where remuneration was directly related to turnover – not client wealth creation, I can attest to who’s interests were sometimes put first and it was NOT the client. I should also add there are some GREAT stockbrokers out there!). The crux of an Asset Based Fee is that our interests and the clients interest are aligned perfectly – the more wealth we create for our clients, the more we get paid – if we lose clients funds we lose revenue – is there a better alignment of fees/outcome?? To state that this is a conflicted arrangement is ignorant at best! It is a fee agreed upon between the client and the adviser – if the client does not like it, they do not have to be a client or can invest directly if they wish to save money and take on the risk.

    Ah! And that’s the point – clients are happy to pay a professional to take on that risk of research, recommendation and advice backed up by written documentation as to why it is good for them and backed up by a professional indemnity policy and AFSL subject to regulatory review.

    The real sad thing here that seems to be forgotten by everyone? Commissions allowed those that could not afford the true cost of advice to have access to an adviser because there was payments being made that the client did not have to bear directly. Bill Shorten (please don’t hit me for using that name!) stated a few years back “We want to make financial advice, more affordable and more accessible to more Australians” a statement I agreed with and yet what we have seem is legislation and rhetoric that has achieved the opposite. Fees have had to increase just to survive, as commissions are removed, some businesses will close, staff will lose their jobs and most importantly, clients will no longer have an adviser. Who will look after them then???

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