3.1 Conflicts of duty and interest

As I said in the Interim Report,[1] consideration of conflicts of interest, or more accurately, conflicts between duty and interest, begins from two simple points:

  • So long as advisers stand to benefit financially from clients acting on the advice that is given, the adviser’s interests conflict with the client’s interests.
  • So long as licensees stand to benefit financially from clients acting on the advice that is given, the licensee’s interests conflict with the client’s interests.

The client’s interests always require consideration of whether to take any step, and only then, consideration of what steps to take. Doing nothing is an available choice. Sometimes it is the best choice.

If steps are to be taken, it is in the client’s interests to take whatever steps are best for them (best both in the sense of achieving the best outcome for the client, but best also in the sense of achieving that outcome most efficiently at the best available price).

By contrast, the adviser’s and licensee’s interests are to have the client buy a product or make an investment that will give the adviser, the licensee, or both, a financial benefit. Not only is it in their interests to have the client do something rather than do nothing, it is in their interests to have the client take a step from which the adviser, the licensee, or both will benefit financially.

3.1.1The legislative premise

The premise for the FoFA reforms was that conflicts of the kind described do exist, must be recognised and should be regulated. The FoFA reforms did not seek to eliminate the conflicts. Instead, the reforms have sought to ameliorate the consequences of the conflicts. The legislation sought to do this by imposing on advisers the best interests obligation[2] with the associated requirements that the adviser provide appropriate advice[3] and give priority to the client’s interests.[4]

Those provisions were supplemented in two ways. First, by the prohibitions on conflicted remuneration[5]. Second, by adding to the general obligation of all financial licensees (to do all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly[6]) the further requirement to have in place adequate arrangements for the management of conflicts of interest that may arise in relation to activities undertaken by the licensee or a representative.[7]

The legislative provisions emphasise process rather than outcome. Although the fundamental obligation is cast as a ‘best interests duty’ there is no explicit reference in the legislation to making comparisons of a kind that would merit the use of the superlative ‘best’ in the collocation ‘best interests’. Instead, the Corporations Act provides that the best interests obligation will be met if an adviser follows the steps described in section 961B(2).[8]

Section 961B(2) is a ‘safe harbour’ provision. Six steps must be taken, and there is a seventh and general catchall provision requiring the adviser to take any other step that ‘would reasonably be regarded as being in the best interests of the client’. The six required steps are to:

  • identify the subject matter of the advice;
  • identify the client’s relevant circumstances (objectives, financial situation and needs);
  • make reasonable inquiries to remedy the deficiency if the information about the client’s relevant circumstances appears incomplete or inaccurate;
  • assess whether the adviser has the required expertise;
  • conduct a reasonable investigation into the financial products that might achieve the client’s objectives and meet the client’s needs; and
  • base all judgments on the client’s relevant circumstances.

It is convenient to focus on one of those steps: to conduct ‘a reasonable investigation’ into the products that might achieve the relevant objectives of the client and meet the client’s needs.[9] In practice this requires the adviser to make little or no independent inquiry into, or assessment of, products. Instead, in most cases, advisers and licensees act on the basis that the obligation to conduct a reasonable investigation is met by choosing a product from the licensee’s ‘approved products list’.

3.1.2Applying the current law about the client’s interests

ASIC’s January 2018 report – Financial Advice: Vertically Integrated Institutions and Conflicts of Interest – showed that the approved products lists maintained by advice licensees controlled by the five largest banking and financial institutions included products manufactured by third parties and that third party products made up nearly 80% of the lists.[10] But the report also showed that, overall, more than two-thirds (by value) of the investments made by clients were made in in-house products.[11] (At the level of individual licensees the proportion varied from 31% to 88% invested in in-house products.[12] By product type, the proportions invested in
in-house products varied: 91% for platforms; 69% for superannuation and pensions; 65% for insurance; and 53% for investments. But taken as a whole, the report shows that advisers favour in-house products.)

The result is not surprising. Advisers may be expected to know more about the products manufactured by the licensee with which the advisers are associated than they know about a rival licensee’s products. Advisers will often be readily persuaded that the products ‘their’ licensee offers are as good as, if not better than, those of a rival. And when those views align with the adviser’s personal financial interests, advising the client to use an
in-house product will much more often than not follow as night follows day.[13]

It is the very fact that the result is not surprising that shows that the premise of the current law is flawed. It is not surprising that, despite the breadth of approved product lists, more than two-thirds (by value) of the investments made by clients of vertically integrated institutions were made in in-house products.[14] And that is not surprising because experience shows, and has shown for decades, that, more often than not, interest trumps duty. But, as noted above, the premise for the FoFA reforms was that, although conflicts between the duties owed by an adviser or a licensee and the interests of that adviser or that licensee exist and must be recognised, those conflicts can be ‘managed’ and regulated. As I have said, the FoFA reforms were not designed to eliminate the conflicts, but to try to ameliorate their consequences.

As the January 2018 ASIC report shows, however, the law, as it stands, has not resulted in conflicts being managed successfully. It has not seen the client’s interests being preferred over the interests of the adviser and the entity with which the adviser is aligned. The law, as it now stands, has not prevented the outcomes described in that report.

The report concluded that, in 75% of the advice files reviewed by ASIC, ‘the adviser had not demonstrated compliance with the best interests duty in section 961B of the Corporations Act’[15] and ‘the adviser appeared to have prioritised their own interests – or those of a related party of the adviser – over the customer’s interests, in breach of section 961J’ of the Corporations Act.[16]

Not only that, the report said that a ‘common theme we saw across the noncompliant advice was the unnecessary replacement of financial products, where advisers recommended that a client switch to a new product where their existing product appeared to be suitable to meet the customers’ needs and objectives’.[17]

In none of the 75% of files judged by ASIC to be ‘noncompliant’ did the adviser demonstrate that following the advice given to the client would leave the client in a better position.[18]

In 10% of all the files ASIC reviewed, ASIC ‘had significant concerns about the potential impact of the advice on the customer’s financial situation’.[19] The impacts included changed insurance arrangements resulting in exclusions or loadings being applied to the new policy, new insurance arrangements requiring payment of significantly higher premiums ‘on a likeforlike basis’, and the move to a new superannuation platform increasing the continuing superannuation product fees without any additional benefit.[20]

The Commission’s case studies pointed in the same direction. First, there were cases, such as those involving Mr and Mrs McDowall[21] and Ms Donna McKenna[22], where the adviser proposed that the client invest in inhouse products that would give an immediate and direct financial benefit to the adviser but which, if followed, would not be in the clients’ best interests. Second, and just as importantly, many of the cases in which entities accepted that clients should be compensated for poor advice were cases where the advice had been to invest in products (inhouse or other) that gave the adviser a financial benefit.[23]

[1]FSRC, Interim Report, vol 1, 139.

[2]Corporations Act s 961B(1).

[3]Corporations Act s 961G.

[4]Corporations Act s 961J.

[5]Corporations Act ss 963E963L.

[6]Corporations Act s 912A(1)(a).

[7]Corporations Act s 912A(1)(aa).

[8]Section 961B(3) of the Corporations Act deals separately with satisfaction of the best interests duty when advice is given by Australian ADIs.

[9]Corporations Act s 961B(2)(e).

[10]ASIC, Report 562, 1 January 2018, 28.

[11] ASIC, Report 562, 1 January 2018, 28 [113].

[12] ASIC, Report 562, 1 January 2018, 29.

[13] Sunita Sah, FSRC Research Paper: Conflicts of Interest and Disclosure, 7 November 2018, 3–11.

[14] ASIC, Report 562, 1 January 2018, 28 [113].

[15] ASIC, Report 562, 1 January 2018, 36 [137].

[16] ASIC, Report 562, 1 January 2018, 42 [174].

[17] ASIC, Report 562, 1 January 2018, 36 [139].

[18] ASIC, Report 562, 1 January 2018, 37 [147].

[19] ASIC, Report 562, 1 January 2018, 37 [145].

[20] ASIC, Report 562, 1 January 2018, 37 [145].

[21] FSRC, Interim Report, vol 2, 169–74, 179–80.

[22] FSRC, Interim Report, vol 2, 242–9.

[23] See, eg, FSRC, Interim Report, vol 2, 218–20.