I used to think that writing about the meaning and consequences of professional and ethical standards, especially the mandated Code of Ethics, would be an uncontroversial and useful activity, especially given the industry’s much promoted desire to evolve into a profession.
After all, it’s widely accepted in the Australian community that avoidance (not just disclosure) of conflicts of interest is the unique and special quality that distinguishes a true and trusted profession from a conventional occupation. Therefore, it would be reasonable to conclude that assisting financial advice industry participants to understand their professional obligations would be welcomed.
I quickly learned that of all the standards in the Code, Standard 3 is easily the most controversial. That’s because it brings into question (and even contradicts) certain forms of remuneration, structures and behaviours that many in the industry do not wish to stop. These include life insurance commissions, percentage-based asset fees and profit shares/incentives on “in-house”, preferred and “white label” products and platforms.
As a result of this realisation, opponents of Standard 3 have adopted a number of (sometimes disingenuous) strategies designed to dilute, reinterpret and ultimately ensure that the standard is ineffective in its intention to remove conflicts of interest from the industry, while concurrently arguing that the industry has become a profession.
One strategy is to create doubt about the meaning of the words in the standard when, in fact, the opponents know exactly what the words mean. Ironically, the clarity and inconvenient consequences of the words is the problem, not their lack of it.
Another strategy is to argue that the industry’s behaviour has improved in recent years. Therefore (so the argument goes), conflicts of interest should be allowed to continue, so long as they are managed or disclosed. This should be reflected in a rewritten and diluted Standard 3. Sadly, however, the industry’s long history of poor behaviour and the well demonstrated impact of conflicts of interest on human decision making in general (not just the financial advice industry), show that mere management or disclosure of conflicts doesn’t work. This is especially so when an industry is seeking to create the level of trust required of a true profession.
And then there’s a strategy that has become all too common in recent times. This one is promoted by some commentators who should and (I suspect) do know better. It’s based on the mischievous proposition that financial advising and business life in general are unavoidably full of conflicts. Therefore, all forms of remuneration, including hourly rates and flat fees, are conflicted. Accept this proposition and all forms of remuneration becomes acceptable. And conveniently, Standard 3 becomes meaningless.
Whether deliberately or otherwise, what many of these commentators fail to take into account in considering the meaning of Standard 3 is the concept known as the “standard of judgement” when dealing with conflicts of interest or duty. This is described by Code of Ethics co-author Simon Longstaff in code guidebook ‘Everyday Ethics for Financial Advisers’ as “commonly used in the law. It is neither novel nor unfamiliar. Indeed, it is very much a matter of common sense. The components are simple. All that an adviser needs to do is ask if an unbiased (disinterested) and reasonable person, in possession of all the facts, could reasonably conclude that an arrangement or benefit could induce and adviser to act other than in their client’s best interests. An arrangement that fails this test is in breach of Standard 3. Otherwise, arrangements are permitted, whatever their specific form. The adviser merely needs to be confident of their arguments (and the evidence) if challenged. If in doubt, then the adviser should not enter into the questionable arrangement.”
This “unbiased (disinterested) and reasonable person” test is common in other professions. For example, the CEO of the Accounting Professional and Ethical Standards Board, Channa Wijesinghe, explains that the accounting profession’s Code of Ethics “requires the member to view the situation (of conflicts) through the lens of a reasonable and informed third party and exercise professional judgement to determine whether their actions would comply with the fundamental (ethical) principles”.
Expanding on this concept in the context of financial advice, Simon Longstaff writes “it has been claimed that advisers who own a share in their advice firm may be conflicted. However, no unbiased, reasonable person objects to a doctor charging a fee in a practice that they own. There is no objection to a partner of a law firm charging their client a fee… it is difficult to see why an adviser would wish to argue against such a standard, other than for reasons of self-interest. Yet one of the principal objectives of the Code is unambiguously to curb the self-interest of the professional adviser in favour of the interests of their clients. Given that one of the defining characteristics of a profession is that its members subordinate their interests to duties owed to others, it is difficult to justify a regime in which conflicts are allowed as long as they are ‘managed’.”
One could go on at length with examples, but that’s not the point. Suffice to say that the Code is deliberately not prescriptive about these issues. It is principles-based. It was “drafted in broad terms so as to limit to the greatest extent possible, any opportunity to avoid its clear intent through the exploitation of loopholes. This is an essential point… the first point of judgement does not lie with the regulator but with each adviser… Standard 3 is at the core of the professionalisation of the financial advice sector. It marks a turning point, where what was previously common practice for some, is now prohibited. Prior to the standards, it was an accepted practice for financial advisers to provide advice where a conflict of interest existed and to explicitly disclose the conflict of interest.”
Importantly, the drafters of the Code were clear that they were neither prohibiting nor approving any particular arrangement or form of remuneration. However, it was made clear that financial advisers using arrangements such as percentage-based asset fees, life insurance commissions, profit shares/incentives on “in-house”, preferred or “white label” products or platforms will need to be confident (with evidence) that they have met the “disinterested person” test which is central to an understanding of Standard 3.
Nothing could be clearer or fairer than that. In summary, the differences are:
- Conflicts of interest are now prohibited. They are not to be just ‘managed’ or ‘disclosed’; and
- Financial advisers are now required to make personal and professional judgements about their compliance with the standards in the Code. They can no longer rely on the opinions of compliance managers or on the contents of prescriptive lists of what’s in/what’s out.
Most advisers know what this means. Whether they like the consequences is another matter. However, these are the fundamental underpinning principles required of any true profession. Therefore, if we want to be recognised as such and widely trusted by the community we serve, then the consequences must be accepted. The obfuscation and avoidance must cease.