Pared-down to the bone, the regulation of financial advisers in Australia has been based on one simple word: Disclosure.
The principle of disclosure has been the backbone of the industry and consumer protection regulation for decades, having been strongly endorsed by the Wallis Inquiry way back in 1997.
Disclosure relies on financially capable, informed and responsible consumers being able to understand the meaning and consequences of what they are being told by advisers, thereby enabling them to make rational financial decisions in their best interests. This is sometimes called giving ‘informed consent’.
Sadly, ‘disclosure’ has failed badly.
In Australia, its shortcomings were questioned by the Murray Inquiry in 2014 and more recently in the Hayne Royal Commission. The failure of disclosure has resulted in the increasingly complex, costly, compromised and ineffective ‘box ticking’ regulation that financial advisers and their clients love to hate. It has also enabled and even encouraged bad behaviour by the industry, a point not lost by the authors of an excellent paper (“Disclosure: Why it shouldn’t be the Default”) published in October 2019 by the Australian Securities and Investments Commission and the Dutch Authority for Financial Markets.
In summary, the reliance on disclosure as the principal regulatory tool has done no favours at all to anyone. To use the parlance of economists, it has created a ‘failed market’ for financial advice in which only a small number of Australians use the service because it is expensive, unintelligible and untrusted.
Thankfully, all of this is about to change for the better for advisers and clients with the advent of the Financial Adviser Standards and Ethics Authority’s Code of Ethics which commences on 1 January 2020. Yes, I know that the Code (especially Standard 3) has caused anxiety and uncertainty. Change always does, especially this change which (building on the Future of Financial Advice laws) effectively removes all forms of conflicted remuneration, including brokerage, asset fees, life insurance commissions and profit shares on ‘white label’ or ‘in-house’ products and platforms from that date.
The Code achieves this in a subtle way, requiring serious thought by individual financial advisers about their values and ethics. Importantly, Standard 3 doesn’t specifically “ban” anything, except acting or advising with a conflict of interest. In that context, professional advisers must ask themselves whether receiving any of the above forms of remuneration (called in the Code, ’variable income’) is acceptable. Add to that the “disinterested person” test in FASEA’s Guidance document attached to the Code and one must conclude that any adviser seeking to mount an argument that any of these forms of remuneration are not in conflict with standard 3 would be in for an uphill battle, to say the very least. The industry’s leaders know this, which is why there has been so much push-back to the Code and especially to Standard 3.
At this point I can hear some advisers crying foul, claiming “all forms of remuneration are conflicted”. I do understand that this opinion is sincerely held. In fact, I would always concede that charging fees based on an hourly rate may lead to inefficiency and even overcharging. Furthermore, for many advisers, the hourly rate methodology is not always the simplest or most comfortable one to use (I know from personal experience as both an adviser and a client). Where appropriate, these problems can be overcome by the adoption of flat or fixed fees. However, the overarching point is that a genuine ‘fee for service’ is clearly not a form of ‘variable income’ anticipated in the Code and is not conflicted in the sense that it does not lead to the inappropriate selling of products or the unnecessary accumulation of funds under management which is the misbehaviour that decades of disclosure-based regulation has unsuccessfully sought to curtail.
So what happens next? The reality for the industry is that from 1 January 2020, the Code of Ethics is compulsory. Advisers will choose to comply with its clear intention or not. If they choose not to do so, they will be breaking the law and they may have to account to their clients, to their PI insurer, to their AFSL holder, to the regulator or to a court as to why they made that choice.
As for AFSL holders, while they are not quite directly in the firing line, they will nevertheless need to give serious consideration to the practices and methodologies that they are willing to accept from their licensed representatives from 1 January 2020 (assuming they wish to retain their licences). Perhaps, there may be some scope for “light touch” regulation and “understanding” and there may even be some practical refinements to the operational details, but the ethical principles in the Code are clear and the law is the law. Advisers are expected to comply with it from that date.
My hope is that the industry will embrace the clear meaning and spirit of the new Code of Ethics. Any plans to lobby government and FASEA to amend its plain words or to dilute its principles or interpretation should be dropped. It is simply not in the interests of the new profession of financial advice to return to a conflicted past that will become history in literally a few weeks’ time.
Instead, the profession’s leaders should support a vision in which the box-ticking complexities and conflicts of the old disclosure based regime will surely recede into a distant memory and advisers in the industry will be accepted by the public (and themselves) as the true professionals that the Code of Ethics will allow them to become. Of course, there are already many financial advisers who have successfully adopted these principles years ago. They will be exemplary role models for the rest. A new profession is about to emerge. We should embrace that development with enthusiasm and a sense of opportunity, not with negativity and doubt.
At last! After reading the author’s views on this subject for years, he finally confronts the elephant in the room – charging hourly rates is both variable remuneration, and conflicted. By his own arguments, it should therefore be banned.
The author’s attempt to deal with this fails. Conflicts of interest extend way beyond selling products or accumulating funds under management. If charging hourly rates was so evil, it would be a banned form of remuneration for all professions, yet it isn’t. It is almost the default method of charging.
FASEA’s misguided over-reach in trying to remove all conflicts is a serious error. Other professions are treated as adults and permitted to manage conflicts – as our emerging profession should be permitted to do.
Financial planners are being compelled to accept the responsibilities of a profession – which we should embrace, yet denied the accompanying privileges – which we should reject. We should reject Standard 3 of FASEA’s Code of Ethics and it is shameful that FASEA has put us in this position.
It would make a pleasant change for those regulating us to make informed decisions based on principles – not ill-informed decisions based on prejudices or ideology.
Let’s be clear, ‘fee for service’ is not a nirvana to avoid conflicts of interest and any attempt to place it on a higher moral level than FUA based fees is fraught.
One view could be that if an Adviser charges for their advice based on the value of funds under management, they are incentivised to maximise the FUM, which is also what the client wants – performance. Objectives are aligned.
There is not necessarily a ‘one way’ here. Both models can work effectively from both a client and a business perspective.
Advisers who adopt the spirit of the Code of Ethics will be able to work this out.
Having often disagreed with previous posts by the author, but I think he is right in this case. Where the code helps to establish professionalism, dare I say, we may eventually see regulatory relief, allowing us to spend more time on client focussed activities and less on compliance functions.
Ending in 2007, a German truck driver raped and killed thirteen women. The police knew he was a long-distance truck driver and eventually found him. They could have found him within a day or two as all heavy trucks in Germany leave complete records of their movements but the German laws forbid such an intrusion of privacy. In other words, the principle of privacy was more important than the lives of any further women the truck driver would have killed.
This raising of principles to such a level of supremacy over people is fraught with danger as we know from many other spheres of life as well.
Here the principle is that only the client must pay the adviser, regardless of the consequences. This principle is breached in many ways in practice, for example by subsidised financial counselling, or insurance companies paying for advice for a recipient of a lump sum claim, or lawyers working on a no-win-no-fee basis or using litigation funders, or doctors getting paid by Medicare or, dare I say it, ASIC paying for customers to shadow shop financial advisers :). Each of these instances breach the principle of client-only remuneration but each instance has strong arguments in its favour.
A similar case exists for life insurance – a relatively small change in commissions (the change looks much bigger than it is, over the longer term the new way pays as much as the old way. Only misusing the old ways by churning or getting extra commission for moving the bulk of your applications to an insurer was more profitable), a small change in commissions has led to a major drop in profitability and therefore sustainability for the life insurance business with APRA proposing a change in income protection policies that will be severely damaging for some claimants in future as they will get less or nothing under the new policies.
Getting paid in any other way than through life insurance commissions only works for a small proportion of customers. It is clear that stopping life insurance commissions will eliminate advisers from most insurance applications which will have severe consequences. The article is silent on this.
FASEA’s code of conduct is a great change for the better but with up-front commissions being identical from all providers I consider the code being perfectly compatible with life insurance commissions as there is no financial incentive to choose one insurer over another. In other words, the remuneration arrangements do not induce a change in behaviour and a change in behaviour is the essence of a conflict of interest – a person with a conflict of interest has an incentive to change their behaviour and here there isn’t one.
If the argument is “yes there is a change in behaviour – an adviser will recommend insurance that is not needed in order to get paid” – then this is true for all forms of remuneration.