Accepting, for the moment, the premise of the FoFA reforms – that conflicts of duty and interest exist, must be recognised and should be ‘managed’ – the question that presents itself is: is there more that could be done to ‘manage’ those conflicts better?
3.2.1Improved education and standards for financial advisers
I referred earlier to changes to the education requirements for financial advisers, announced in February 2017. As I have mentioned, the changes include compulsory education requirements, supervision for new advisers, a code of ethics for the industry, an industry exam and ongoing annual professional development obligations. Details regarding these changes (as at April 2018) were set out in Part B of the Commission’s sixth published Background Paper.
I said in the Interim Report, and remain of the view, that prevention of poor advice begins with education and training. Those who know why steps are prescribed are more likely to follow them than those who know only that the relevant manual says, ‘do it’.
I believe that, as they come into effect, the new education requirements will improve the quality of advice that is given, and improve the way that financial advisers manage the conflicts of interest with which they are faced.
However, while I am confident that improved education and standards are part of the solution, I do not believe that they will be sufficient, without more being done to ensure that conflicts in the financial advice industry are managed adequately.
3.2.2Design and distribution obligations and product intervention powers
In its submissions in response to the Commission’s second round of hearings, Treasury suggested that a number of reforms already underway may assist in addressing conflicts of interest in the financial advice industry. These included the Government’s proposed design and distribution obligations and product intervention power.
As I noted in the Interim Report, the Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill 2018 (Cth), if enacted, would introduce design and distribution obligations intended to promote the provision of suitable financial products to consumers of those products. The reforms recognise that current disclosure requirements are not, on their own, sufficient to inform consumers fully. The obligations revolve around making an appropriate target–market determination for products and dealing with the product accordingly.
Further, ASIC would be granted a new product intervention power. Under the proposed power, ASIC could make an order that a person must not engage in specified conduct in relation to a product where ASIC perceives a risk of significant consumer detriment. ASIC would also be able to ban aspects of remuneration practices where there is a direct link between remuneration and distribution of the product.
I do not doubt that these changes may assist in addressing conflicts of interest in the financial advice industry. Again, however, I do not consider that these changes will be sufficient, without more being done to ensure that conflicts in the financial advice industry are managed adequately.
One of the principles that informed many of the recommendations of the Wallis Inquiry was that consumers would make better choices if they were given relevant information. This idea of ‘disclosure’ underpins the now teetering edifice of product disclosure statements (PDSs) and Financial Services Guides (FSGs).
The primary means by which a financial adviser’s conflicts of interest are currently disclosed is through an FSG. The provisions explaining when an FSG must be provided are lengthy but, for present purposes, it is enough to say that an FSG must usually be provided when a financial adviser is to give personal advice to a retail client.
The FSG will be prepared and provided by the ‘providing entity’, which will either be:
- the authorised representative – in cases where the financial service is provided by an authorised representative of an AFSL holder; or
- the AFSL holder – in cases where the AFSL holder is providing the service directly or through a representative who is not an authorised representative.
If an FSG is required, it must be provided to the client as soon as is practicable after it becomes apparent that the financial service will be provided to the client, and in any event before that service is provided.
Among other things, an FSG must include information about:
- who the providing entity acts for when providing the financial service;
- the remuneration (including commission) or other benefits that the providing entity (and certain related parties) are to receive in respect of the provision of the financial service; and
- any associations or relationships between the providing entity, or any related body corporate, and the issuers of any financial products, being associations or relationships that might reasonably be expected to be capable of influencing the providing entity in providing the financial services.
At present, there is no requirement to disclose any information about any approved products list used by the providing entity.
The United Kingdom has gone some way towards requiring disclosure of that kind of information. In the UK, financial advisers who provide personal recommendations to retail clients are divided into two types: those who provide ‘independent advice’ and those who provide ‘restricted advice’.
A financial adviser who provides ‘independent advice’ must assess a sufficient range of relevant products available on the market that must:
- be sufficiently diverse with regard to their type, and the product issuers, to ensure that the client’s investment objectives can be suitably met; and
- not be limited to relevant products issued by:
- the financial adviser’s firm, or entities having close links with the firm; or
- other entities with which the financial adviser’s firm has such close legal or economic relationships, including contractual relationships, as to present a risk of impairing the independent basis of the advice provided.
A financial adviser who provides ‘restricted advice’ is not required to assess a range of products of that kind. However, they must disclose to the client, in good time before providing the advice:
- the fact that the advice will be ‘restricted advice’;
- the fact that the advice will be based on a more restricted analysis of different types of relevant products; and
- whether the range will be limited to relevant products issued by entities having close links to the financial adviser’s firm or any other legal or economic relationships, such as contractual relationships, so as to present a risk of impairing the independent basis of the advice provided.
A single firm may have advisers who offer independent advice and advisers who offer restricted advice. However, a firm must not allow a single financial adviser to provide both independent advice and restricted advice.
By itself, simple disclosure of conflicts of interest, is insufficient as a means of managing them. The whole regime of disclosure presupposes that what is given to a consumer in writing will be read, and if read, will be understood. Often, that presupposition is wrong. And given the length and complexity of FSGs and PDSs that is unsurprising. Further, as Professor Sah explains in her research paper, disclosure of conflicting interests may fail as ‘a discounting cue for biased advice, it may even make matters worse’.
This is not to say, however, that matters that might affect a person’s decision about whether to obtain financial advice from a particular adviser should not be disclosed. If, whether because he or she is required to have regard to an approved products list or for some other reason, an adviser will only consider relevant products issued by:
- the adviser’s firm, or entities having close links with the firm; or
- other entities with which the adviser’s firm has such close legal or economic relationships, including contractual relationships, as to present a risk of impairing the independent basis of the advice provided,
this should be disclosed to the client. I do not think it is necessary to go as far as requiring the disclosure of the approved products list itself. In most circumstances, that list is unlikely to assist a retail client to understand the conflicts of interest that might attend the advice to be provided.
In Australia, quite different requirements govern the use of the word ‘independent’ (and the words ‘impartial’ and ‘unbiased’) by financial advisers from those that are applied in the UK. Relevantly, a financial adviser will contravene section 923A(1) of the Corporations Act if he or she uses any of those words in relation to the financial services he or she provides unless all of the following are satisfied:
- the financial adviser does not receive:
- commissions (other than commissions rebated in full to the client);
- any form of remuneration calculated on the basis of the volume of business placed by the adviser with a product issuer; or
- any other gift or benefit from a product issuer that may reasonably be expected to influence the adviser;
- neither the financial adviser’s employer, nor any person on behalf of whom the adviser provides financial services, receives any of those benefits;
- the financial adviser operates free from direct or indirect restrictions relating to the financial products in respect of which he or she provides financial services; and
- the financial adviser operates without any conflicts of interest that might:
- arise from his or her associations or relationships with issuers of financial products; and
- be reasonably expected to influence the adviser in carrying on a financial services business or providing financial services.
At present, there is no requirement for a financial adviser who does not satisfy those requirements to explain to a retail client that he or she is not independent. A client may be able to infer that fact from some of the matters disclosed in an FSG. In my view, however, this is not sufficient. A financial adviser who does not meet the requirements set out above and who provides personal advice to a retail client should be required to bring that fact to the client’s attention, and to explain, prominently, clearly and concisely, why that is so. I consider that disclosure of that kind is likely to be more readily understood by, and therefore more useful to, a client than the existing requirement merely to disclose, in general terms, certain information about the providing entity.
Recommendation 2.2 – Disclosure of lack of independence
The law should be amended to require that a financial adviser who would contravene section 923A of the Corporations Act by assuming or using any of the restricted words or expressions identified in section 923A(5) (including ‘independent’, ‘impartial’ and ‘unbiased’) must, before providing personal advice to a retail client, give to the client a written statement (in or to the effect of a form to be prescribed) explaining simply and concisely why the adviser is not independent, impartial and unbiased.
3.2.4Amending the best interests duty?
A further possibility would be to amend section 961B of the Corporations Act, which creates the obligation for financial advisers to act in the best interests of the client in relation to the advice. There are several ways in which this could be done.
One option would be to amend the provision to be more prescriptive about how an adviser must pursue the client’s best interests. This could be achieved, for example, by requiring advisers to make explicit in the statement of advice the comparisons they have made between products, or to make explicit their reasons for any recommendation to switch products. But I do not favour this approach. It would represent a significant expansion of the safe harbour model and, given that the present safe harbour model does not prevent interest from trumping duty, altering the model is unlikely to work.
Another option would be to remove the safe harbour provision entirely. In my view, such a change would not be without merit. As I have said, the safe harbour provision currently has the effect that, in practice, an adviser is required to make little or no independent inquiry into, or assessment of, products. By prescribing particular steps that must be taken, and allowing advisers to adopt a ‘tick a box’ approach to compliance, the safe harbour provision has the potential to undermine the broader obligation for advisers to act in the best interests of their clients.
Having said that, I am not convinced that it is necessary or appropriate to remove the safe harbour provision at this stage. There are already many changes affecting financial advisers that will come into effect over the next few years; there will be more if the recommendations in this report are adopted. Whether it is necessary to remove, or otherwise amend, the safe harbour provision will depend in part on how effective those other changes have been in improving the quality of advice given by financial advisers.
In my view, once those changes have come into effect, there will be significant value in conducting a review to determine whether those changes have been effective in improving the quality of advice. The review should consider not only changes in the law, but also changes in the practices of regulators and financial services entities (whether made in response to changes in the law, or otherwise). If those changes have not – or have not sufficiently – improved the quality of advice given by financial advisers, consideration must be given to what further changes will be necessary.
Among other things, that review should consider whether it is necessary to retain the safe harbour provision. Unless there is a clear justification for retaining that provision at that time, it should be repealed.
Recommendation 2.3 – Review of measures to improve the quality of advice
In three years’ time, there should be a review by Government in consultation with ASIC of the effectiveness of measures that have been implemented by the Government, regulators and financial services entities to improve the quality of financial advice. The review should preferably be completed by 30 June 2022, but no later than 31 December 2022.
Among other things, that review should consider whether it is necessary to retain the ‘safe harbour’ provision in section 961B(2) of the Corporations Act. Unless there is a clear justification for retaining that provision, it should be repealed.
Each measure I have described should improve the way that financial advisers manage the conflicts of interest that pervade their industry.
But, in my view, none of those measures, either alone or in combination, will be sufficient to ensure that conflicts of interest in the financial advice industry are managed adequately.
As I noted in the Interim Report, the results recorded in ASIC’s report on vertical integration were obtained by examining the files of 10 advice licensees associated with the five largest entities: AMP, ANZ, CBA, NAB, and Westpac. As such, they are results based on the work of advisers associated with the largest entities that may, because of their size, be assumed to be the best‑resourced, and the most capable of managing conflicts of interest. They are results that, on their face, deny the fundamental premise for the legislative scheme of the FoFA reforms: that conflicts of interest can be ‘managed’ by saying to advisers, ‘prefer the client’s interests to your own’. Experience (too often, hard and bitter experience) shows that conflicts cannot be ‘managed’ by saying, ‘Be good. Do the right thing’. People rapidly persuade themselves that what suits them is what is right. And people can and will do that even when doing so harms the person for whom they are acting.
Nor, as I have explained above, can conflicts be ‘managed’ by requiring disclosure of their existence. Since FoFA, disclosure has been treated as a central (even complete and sufficient) remedy for conflicts of interest. The evidence shows that the current arrangements have not worked. Too often, interest trumps duty.
It is necessary, therefore, to see what else can and should be done. And to do that, it is necessary to challenge the fundamental premise of the FoFA reforms that conflicts can be ‘managed’. Not all conflicts can be ‘managed’. As far as reasonably possible, conflicts should be eliminated.
The Hon Kelly O’Dwyer MP, Minister for Revenue and Financial Services, ‘Higher Standards for Financial Advisers to Commence’ (Media Release, 9 February 2017).
Background Paper No 6 (Part B), 8–12.
FSRC, Interim Report, vol 1, 143.
FSRC, Interim Report, vol 1, 105.
Treasury, Module 2 Policy Submission, 4–5.
Treasury, Module 2 Policy Submission, 4–5. See Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill 2017 (Cth) Sched 2 ss 301C, 1023C.
Background Paper No 7, 55.
Corporations Act s 941B.
Corporations Act s 941A.
Corporations Act s 941D(1).
Corporations Act s 942B.
Financial Conduct Authority, Conduct of Business Sourcebook, 6.2B.11.
Financial Conduct Authority, Conduct of Business Sourcebook, 6.2B.33.
Financial Conduct Authority, Conduct of Business Sourcebook, 6.2B.29.
Financial Conduct Authority, Conduct of Business Sourcebook, 6.2B.29.
Sunita Sah, FSRC Research Paper: Conflicts of Interest and Disclosure, 7 November 2018, 15 [3(b)].
FSRC, Interim Report, vol 1, 91.